Allianz Q3 Earnings Call Transcript

123jump.com Staff
02 Dec, 2008
New York City

Allianz Group net revenue decrease 3.8% to 21.1 billion euros. Dresdner bank was treated as discontinued business. The insurer took impairment charges of $370 million in its fixed income portfolio. The insurer lost 2.2 billion euros from continued operations.

Allianz SE ((AZ))
Q3 2008 Earnings Call Transcript
November 10, 2008 5:00 p.m. ET

Executives
Oliver Schmidt – Head, Investor Relations
Helmut Perlet – Chief Finance Officer and Member of the Board of Management.

Analysts

Andrew Broadfield – Morgan Stanley
Bill Morgan – Goldman Sachs
James Quin – Citigroup
Michael Huttner – JP Morgan
Marc Thiele – UBS
Brian Shea – Merrill Lynch
William Hawkins – Keefe Bruyette Woods
Nick Holmes – [Numerack]
Stefan Kalb – Sal Oppenheim
Michael Haid – Cheuvreux

Presentation

Oliver Schmidt – Head, Investor Relations

Yeah thanks Neville. Good afternoon ladies and gentlemen. Welcome to the Allianz conference call. I think due to the magnitude of information that we would like to speak about today, including a special section on our investment I shouldn’t waste any time. So, let me hand over to Helmut right away.

Helmut Perlet – Chief Finance Officer and Member of the Board of Management

That was quick Oliver.

Oliver Schmidt – Head, Investor Relations

Yeah.

Helmut Perlet – Chief Finance Officer and Member of the Board of Management

Good afternoon, ladies and gentlemen. It is in fact a pretty large presentation and I’ll try to focus on the most important things. If we start out with the overall summary, then I think it is fair to say that Q3 was a continuous tough environment but our fundamentals by and large remained strong. We had 1.6 billion of operating profit, 6.5 billion year-to-date with all core segments contributing and what is really important from my point of view, P/C is likely unaffected by the financial market crisis. Our solvency ratio is at target level, divestment of Dresdner is on track. We had no accounting changes. There was some reclassification on the Dresdner side but it has absolutely no impact on the group’s operating profit nor net income. So, no accounting changes and the bad news is as the 6.5 billion are already somewhat short of what we have expected, we will see that by year and we fall short of our operating profit target of 9 billion and also for 2009, if we do not see a recovery in the equity markets, we cannot confirm the 9 billion plus.

Now I think on the next slide the only number I’d like to point your attention to is net income and respectively the net loss from discontinued operations, -2.5 billion and we come to that in a second which gives us together with net income from on going operations a net loss for the third quarter of 2 billion, year-to-date net income including discontinued is at 667 million of profit. Now, important I think on page #4, let us talk a little bit about the solvency ratios. Our solvency ratio was 157%. It is within our target defined target range. We have as you are certainly aware of, the BaFin has reconsidered and changed its regulations how to calculate the solvency ratio based on the financial conglomerate and that would mean that we do eliminate going forward unrealized gains and unrealized bonds from the calculation of this ratio which would put us at a level playing field with our main competitors in Europe. That was compared to the old asset improves the solvency ratio by 13 percentage points and we had also some positive impact from the Dresdner Bank divestment, where we anticipated divestment of 9 percentage points. That 9 percentage point is only a snapshot of course based on the available market conditions end of September. All things being equal as we go through closing 1 and 2, I would expect another 10 percentage points plus out of this transaction. Now two final remarks on that slide if at the end of October where we had in the months of October pretty defective equity market, our solvency ratio would stay at 152 and in both numbers 157 and 152 we had these numbers a net of accrued dividend of 1.6 billion. Now you might ask, “Why exactly 1.6 billion?” and the answer is yes we try to be somewhat consistent in line with our previous communication regarding dividend policy. What we have accrued for is 40% of the net income of continued operations. And ultimately with our level of capitalization, we are still comfortably above the necessary thresholds for a AA rating. So, that all in all we feel very well positioned based on our own requirements but also in relative terms compared to the competition.

With that let’s quickly go on to the drivers from a group perspective. Revenues was 21.1, are holding up. They are down -0.8 on a like-to-like basis, internal growth and that is basically noting new. You see the impacts in the yellow bubble. Main impact is on the life side, further shortfall in unit-linked production and in particular in countries where unit-link is distributed via bank assurance because the banks increasingly try to substitute life products by term deposits and other things in order to boost up their own liquidity positions. P/C is up 7.8% but a good part of that is specifically related to the core business at the fireman’s fund which I will come to when we talk about P/C. Adjusted for that our growth would have been 5.2% and you can rest assured that we are still putting profit first and volume second i e, trying to maintain strict underwriting discipline. I think in the sake of time I can jump over page 7, make just one remark on page 8, where you see that non-operating items end result is hit by impairments of round about 920 million with 750 million of equity impairments, that is slightly above the number of 600 I gave you when we were discussing our Q2 results but that is by and large a factor that financially Institutions have structurally and systematically underperformed and therefore we do see a higher number here.

There is another 134 million of debt impairments which I’ll come to in our special section when we talk about our bond portfolio. Now I think you can also jump over page 9, and maybe spend more time on page 10, where we talk about the Dresdner Bank transaction and how this is accounted for in our financials. If we see on the left hand side and you will surely recall the presentation when we informed about the deal in early September and has basically five components we’ve received in exchange for 100% Dresdner Bank and that is cash that is the asset manage of Commerzbank, Cominvest that’s approximately 360 million Commerzbank shares, that’s the distribution agreement and the trust fund, the trust fund which as you might remember provides a certain protection to specified assets of Dresdner.

Now, in the middle column we have the approach how this consideration or these components have to be evaluated for our financials, end of September, and obviously to describe the issue on cash for cash. Cominvest is an evaluation for IFRS opinion which translates into 700 million. There was no change. Now, the most important point is probably Commerzbank shares. Owning 28.6% ultimately in Commerzbank would mean that we have to report Commerzbank at equity now and this is reflected in this approach because this will be our accounting entry when we receive those Commerzbank shares physically and reporting at equity will mean simply we take 26.8% of the projected net asset value of Commerzbank. Now the net projected net asset value of Commerzbank is a) what they have at the end of September, that’s a known number and b) capital increases for the completion of step1 & 2 of this transaction and as the value for the large issue we have bought Commerzbank share at the end of September, ie, the Commerzbank share price ie 10.40 euro per share. Now, then we have to evaluate the distribution agreement and the trust fund. The distribution agreement is based on the agreed upon projects with Commerzbank with a certain cushion or buffer plus the margin we are making traditionally on our life products with the banking channel and the trust fund is based on a mark-to-market approach which was a very cautious valuation. You see that we have only assigned 100 million to this trust fund. So, if worst come to worst and all the assets which are in the trust that are covered by the trust would ultimately default, then there is a 100 million trust fund to this consideration but there is also some upside if those assets still perform better.

Now what that means on our books is illustrated on the right hand side in this slide. We had to start out with a carrying value of Dresdner end of September and that is 9.2 billion and if you compare this to the 7.8 I’ve just explained then the expected loss out of this Dresdner divestment is 1.4 billion. We have to add to this, we had net loss of Dresdner from Q3 which is another 1.2 billion and that gets us to that 2.6 billion net loss from this continued operations Q3. Now let me make a few more remarks on that one. A) You might ask the question, “You told us in August or in September that the carrying value of Dresdner is 10.5 or 10.6 billion.” Yes that was true, that was the carrying value end of June. Now we have to adjust this carrying value for the net loss of Q3 of 1.2 billion and there is some highly technical minor adjustments, driven by acounting regulations that gets us to the 9.2 billion carrying value end of September. Second remark is and the question obviously on this side is how likely is this number attained and what are maybe contributions further positive or negative from Dresdner? Point #1, in internal talks whatever the result of Dresdner’s is going to be in Q4 and going forward in 2009, there is no impact ultimately on our result because that is now fixed with this anticipated loss from that transaction.

Nevertheless that 1.4 billion still can change because ultimately it depends on the net asset value of Commerzbank at the time of closing and that net asset value obviously can change for two reasons. One is the results of Dresdner from October 1st onwards and secondly if the capital increase is done at a different price as I have just explained namely the 10.4%, but that is most likely only supposed to be a minor change.

Now with that being said let me move on. I think we can also jump over page 11. That just gives you the movement analysis of our reported IFRS net equity and let’s go into the group’s P/C, z I think as I have mentioned P/C is likely unaffected by the market crisis. It contributes or continues to be a reliable generator of profits and free cash flow. Now the operating profit is down from 200 million on a quarterly basis. That 200 million is caused mainly by two specific events which are somewhat related to the financial markets, one is credit insurance. As we currently observe overdue payments and those are a lead indicator for higher future losses which we already closed into or baked into our results end of September and secondly fireman’s fund had to absorb losses from the crop business following a slump in commodity prices at the end of September. Those two numbers add up to euros 160 million or euros170 million and basically explain the shortfall in the underwriting result which you can see on the right hand side. Also on a year-to-date basis, year-to-date we are at 4, 411 million. That compares with 4.65 billion for 2007, so a shortfall of roughly 230 million and that to some extent is explained by the combined ratio as we will see in a second, roughly 100 million and 150 million of investment income.

Now if we move on, the premium development again, you see 7.8% of internal growth. You see the growth drivers on the left hand side and as I’ve said, there was special impact based on the crop business in the Unites States. Have to put this in a different context on an net basis. Fireman’s fund has grown 2.5% instead of 34.4 on the growth side and that’s almost entirely driven by this crop stuff. I could come to that later on maybe there are some questions how does that work? Basically it works that fireman’s fund is fronting a good part of this crop business for a Wells Fargo subsidiary which has no license for many of the US states. So fireman’s fund is fronting that business, it is ceding it to the Wells Fargo subsidiary and then the Wells Fargo subsidiary is ceding again that business according to the ultimate positions to farmer’s fund and to the insurance company in this setup and that again does artificially inflate the gross premiums written of fireman’s fund. Most importantly I think if we look at the price development, it is basically unchanged from what I’ve told you in August. We see across the portfolio a decline of roughly 0.5 percentage point. If you divide this or make a differentiation between the businesses, then we see a decline of 1.5% roughly in Model which is to some extent driven by the Bonus Model system whereas on average the other businesses are increasing by 1%. From a regional point of view the US was -3.9. Most affected price decreases whereas the UK and Australia enjoy already stronger rates.

Now, on page 15, our combined ratio for the quarter was 96.2% and that was up about 2.1 percentage points over Q3, 2007 and again specifically driven by the two events I’ve mentioned, the AGCS and Firemen’s fund and on top in Q3 and that explains the 116 combined with the ratio of fireman’s fund. Fireman’s fund was pretty hardly hit by the hurricane Ike which caused more than Euros 130 million net. Apart from that I think what you see is a pretty healthy combined ratio in all the other corporations and even more on the credit side we are still below 100%.

On the right hand side, you see the development of the expense ratio which is clearly going in the right direction and you’ll remember that our mid term target here is around 25% and we still stick to that of course. Now let’s just quickly talk about the outlook for 2009. 2008 on the combined ratio was year-to-date 94.9. That would mean we need to have a Q4 at around 91% in order to achieve ultimately the 94% target and I think let me put it the other way, very frankly I don’t see that this happening in the current circumstances and talking with our overall experience in 2008. However I am rather confident that we will still come in at around or slightly below 95% for the full year.

If you look in more detail, the loss ratio at the next slide, then you see that the loss ratio has gone up by say a few compensating issues. On the positive side we had lower impact from NatCat. That was about 0.8%. We had lower impact from life gains, 0.4% and we had lower frequency of round about 1.1%. Though that’s a positive impact of 2.3%, on the negative side we had this already mentioned, crop and credit impact was round about 1.6% and severity including stronger IVRIs coming through was about 3.2% which net-net gets us to the 71.5. Now on the expense side, page # 17, I think we are pretty much on track. The run rate is now falling by 191 million that is more or less evenly spread over the last three quarters and I do expect further improvement for the remainder of this year. So, our measures are striding threshold impact here. Final remark with respect to P/C and I’ve done this slide slightly different as compared to previous years, investment income and what I’m simply trying to illustrate with the bars here that you can expect basically over the course of the year round about a billion of net investment income which is very stable, also based on the quality of our assets under management and which is providing a predictable say 4 billion of operating profit for the P/C business. Now, you might make your own forecast or adjustment but if you assume or appraise me that a combined ratio of say 95% is achievable that would put you somehow in the range close to 6 billion and I think it is important to understand that this investment income I’ve just mentioned is now subject to a lot of volatile issues like impairment etc which are all reported below the line. So, that’s a pretty stable and predictable number and basically this 4 billion of investment income translates into something like 10% based on net premiums.

Now with that lets us move on to life and you have seen that number as market conditions take their toll on the life business and that is by and large owned of course by a lower investment result as we come to the next generation in a little detail. If we simply look at the profit development then operating profit is down 75% which of course looks ugly. At a first glance it looks ugly. At a second glance as well but most likely better because you might remember that 2007 there was a 170 million reserve true up in Korea. So, that on a like-to-like basis this trading point is rather 700 or to put in the other way around, on the right hand side adjusted for this one off in 2007 the technical result would be basically flat. So, the main impact is investment result where we talk in a second about is 385 million lower. There is only 35 million left and we have a reduction in the expense ratio which is basically a mixture of two or three components. Point #1 is that obviously based on market development we have a lower base of assets under management and that of course translates into lower asset management fees. On the other side, with the reduction of the overall premium there is less expense loading to cover the fixed cost of the total life segment. Ultimately there is also some reallocation on the fringe side of expenses which used to be formerly in the holding, asset holding in the P/C segment and now in the life health segment. So, that all in all gets us to the 218 million.

I think I can quickly jump over page 21, because I think you are by and large familiar with the development. The only remark I’d like to make is that our professional business is still nicely growing at 5% internal growth. That is to the right of the column the IFRS premium and mainly driven by Germany and Switzerland and some other countries and what you see is those countries are hit hardest where we sell unit-linked products via bank assurance channels. That’s equally in Asia Pacific and also the United States where our variable annuity production is down in line with the US market. Against this background, we see basically the same effect when we look at new business. One is of course the present value of new business premiums is stronger affected than just the gross premiums written on a statutory basis because the statutory numbers still benefit from an on going basis of recurring premiums from the in first business which is not true on the new business premium consideration. Therefore the value is down roughly 15.6% and the value of new business on an internal basis is down by 17% although the margin is pretty stable. It is down 10 basis points to 2.6% and you see the distribution across the most important countries and operations on the right hand side. Maybe if we have a look or quick look at the margins based more on a product or a locked approach, then the margins in our traditional business continue to be very strong. We have 3.7% as opposed to 3.6% last year but we see a reduction in unit-linked and equity-linked business. Unit-linked is down to 1.2 versus 1.9 last year and equity-linked, equity indexed is down to 1.4 from 2.3 last year.

The growth I think still looks okay. We had 4.1 billion for a quarter and we’ve 11.4 billion year-to-date. Now let’s finally look at the investment income. Now what you see here like in P/C on average we are generating some 3.2, 3.3 billion of current investment income, interest income and dividends per quarter. Now, what you also see in the line “other” is while we had a positive contribution of 325 million from harvesting in Q3 in 2007. That very number is now down to -1.2 billion. So, that is a difference of 1.5 billion and that of course comprises the reduction of the investment income we have seen on the first slide in the life health business. If you simply take this 1.5 billion of minor other investment income and you apply some 30% rate on that one, then you basically have the explanation for the shortfall in our investment income. You can take this the other way around and say we’ve 3.3 billion of current investment income in the third quarter. You basically need around, for our non-unit linked business we need around 2 billion per quarter to meet all guarantees and constructive obligations or guarantees. So, that would leave us with 1.3 billion of excess interest income over guarantees which basically then are set between the policy holder and the shareholders say anywhere in the range of 30% plus minus. Now against this 1.3 billion we have to deduct the 1.2 billion minus others which leaves us with 100 and 30% or 35% of that 100 is the 35 million investment return you see on the first page in the life segment. But having said this, you can take this on an annual basis where we make 13 billion plus current investment income minus say 8% we need to achieve for guaranteed interest rate and what I’d call constructive obligation ie no formal guarantees but whether it is for market expectations and the competitors are paying certain amounts. That leaves us with an excess investment income of 5 billion plus minus harvesting, which is then subject to profit sharing with your policy holders that gives you also an idea of how much of cushion is there going forward for the impairments and does not take into consideration that we’ve about 16 billion of unallocated policy holder funds which by and large are available to buffer losses in case those losses would occur. So what I’m trying to say is that there is a certain flow in the business going forward in terms of operation profit.

Now, on the banking side I think I’d like to jump over page 26 and page 27, just one remark probably that is separate. We are talking about operations of round about 600 million right now of revenue per annum. That is very small compared to the other three segments and as soon as Dresdner will be finally deconsolidated I guess we do not show any more a separate banking statement, just as a result of macro reality. Let’s talk about asset management, page 29, profit is down 43% but that is pretty much impacted by negative FX development and some one offs. But one-offs basically are reflected, if you look at the operating profit drivers, by the reduction in other income which is likely mark-to-market at 3.8. That used to be a positive number last year and negative number this year and also by the negative contribution of FX hedges, mainly US dollar hedges. But there is also an increase in expenses which we are not happy about but there is some explanation which I come to in a second on page 30. If you look at the three divisions then and I apologize for talking to you last few years from that slide, but if you look at fixed income, then you see that fixed income is growing by 16%, revenues are growing stronger in line with the expenses, so that net-net fixed income is reportedly an increase in operating profit. Now you have the contrary picture in equity where revenues are severely impacted by all the other competition and by the markets and the outflow, basically the outflow from equity fund, but we have not reduced the expense base by the same level because we think going forward there will be again once the market comes back to normal we want to be positioned to take advantage of that and to some extent that goes also for our distribution division.

Now, if you look at performance issues then you’ll see that on a three year rolling basis there is a short gap in performance end of September to 51% out performance of the asset under management. That is almost entirely driven by our fixed income portfolio which was to some extent severely hit by the unprecedented US market disruptions in the second half of September 2008. But despite this performance volatility we do believe that our fixed income is well positioned for the future and that is illustrated by the net service on the right hand side where we have positive net flows of 8.5% and if you look at the next page the total net inflows for the year has been 39 billion and that is entirely fixed income. In fact it was over 40 billion because for the year we had also net outflows from our equity business.

Now very quickly on the special topics, first of all Dresdner and this is the former GIX2 which we had reported in the previous quarters. We have a net operating growth of 835 million. Profit drivers are illustrated on the right hand side. I think in revenue terms, apart from mark downs, interest income ex IX at 39 was pretty stable and especially in PCC well under way. PE income reduced in particular regarding development of our giant activities and also advisory fees from the investment banking and the main drivers for the reduction obviously was trading income. Now from a divisional perspective, P/C has been almost stable year-on-year, just 20 million down. So, the main shortfall is coming from DKAB. Now you see also a pretty huge increase in expenses. That is entirely driven by higher bonus accruals which were largely triggered by change of control clauses following the transaction with Commerzbank and we have kind of anticipated the consequences here but in order to make that point as well type expense management and control continues at Dresdner on a year-to-date basis including the effects I have just mentioned, our personnel expenses are down by 40 million and non-personnel expenses by some 130 million and we also see an increase here in the loan loss provision, 240 million, that is mainly driven by some several large tickets and in particular its Lehman brothers and two of the Iceland Banks which defaulted in end of September.

Now, page 34, you see the usual slide of vertical exposure. Three or four remarks on that, firstly to better reflect reality, we have reclassified certain assets, with a market value or notional value of 1.7 billion impact on our P& L. That means 450 million negative impact on OCI, 155. So, the net impact on equity was 250 million plus. Having talked about reclassification, remark #2, equally important, we have not changed our valuation approach. Even also the most recent clarification of the SEC, we had no change. We still use observable marks to the extent available to review our valuation. Third remark, net exposure is up. You should be aware of that because I think we’ve talked already during at the presentation of Q2 about this. That was about 2.5 billion or 2.6 billion formerly protected by mono-liners, Excel and CIFG, who went through some restructuring in the meantime and where we had to put those two positions from flat risks to outright positions. That explains the increase in the exposure and then you see on the very right hand column the impact of on the P&L in the third quarter and the only remark really I want to make or maybe two is if you look at the LBO commitments there is 105 million 90 of which also is included in this 240 million increase of those provisions I’ve just mentioned and the other one is K2, where based on further increase of credit spreads we have a mark-to-market assessment of 148 million. To close the Dresdner Bank section, on page 36, our tier-I ratio is 8.1%, still a very competitive level of capitalization and also our liquidity profile, where we point to the two ratio of 1.1 is well above the required needs.

Now then let’s go quickly through the investment portfolio. We included that section because there is increase in the customer out there in the market. On many occasions what is the quality of investment portfolios and what more is to come. I think I can put the key message very simple there is nothing to worry about from my perspective. I guess we can jump over page 38 because we have talked about this at the very beginning. Also page 39 is just for information and I think self explaining. It gives you the breakdown of our gross exposure, the shareholder exposure net of policy takes and our loyalties and the underlying risk capital taken from our models and at the end if you go back to the previous page you’ll see that our excess capital both in terms of conglomerate solvency as well as in terms of risk capital is higher than what we have allocated in 09, 99 97 confidence level as necessary risk capital. Maybe it should become more pragmatic on talking the real stuff on page 40, we have given you again the equity structure based on the end of September numbers and what you see here is that say with further deterioration of 10% or 20% or 30% on our equity portfolio, that is the additional impairments we are likely to expect to suffer. As of today, we are probably half way in between or two thirds in between the 10% and 20% scenario. That would mean that at year end if we close at the end of October stock market levels, I would expect round about a billion of impairments in the fourth quarter. On the right hand side, you see what would that vary development due to our remaining unrealized gains and losses in our equity portfolio and what is the impact on the solvency ratio.

Now, on the next page, we have given you some sensitivities and stresses on our interest rate risk. What you see on the right hand side of the slide is the duration and you’ll see no major change from when we talked last time. On the left hand side you see the economic impact of the parallel shift of the yield curve. That would be 100 basis points up, the economic effect on Allianz would, the economic effect meaning the net present value of the expected profits out of that would be 1.5 billion plus. On the down shift that is -3.3. You see that this is mainly driven by life health and that kind of illustrates the asymmetric risk distribution we have in life health and with a further down shift of interest rates, obviously the options and guarantees come closer or get into the money. Now before I get misunderstood, or there is some confusion for there is some rate cuts being announced by the Federal Banks in England and the US etc. Those are all rate cuts at the short-term, which will not impact that calculation because we have only impact if the rates come down all along and I think currently there are two schools of thought out there and some of them are projecting an increase of rates and others just the opposite. So, we need to sit down to wait and see. Whatever you see from the bullet points and the takeaways at the very bottom, there is still huge buffer available to cope with those developments.

I think our fixed income portfolio page 42 is of high quality and well diversified. You see that more than 60% are government and covered bonds. You see on page 43, the impairment and let me just say in Q3 and that is for policy holders and tickets etc. We have 370 million impairment worth of fixed income portfolio. That was almost entirely driven to a large extent by three positions. Lehman unsecured exposure, we have written off 80%, AIG subordinated debt we have written off 100% and Washington Mutual unsecured exposure we have written off also 80%. Over a five year period, five basis points impairment overall I think that’s an okay number and should imply some improvement and implies a rating of AA. Now there is also just basically some concerns about the credit quality of some countries. You see on page 44 the bulk of our government exposures is in G-10 countries. Of course we have also exposures in some countries which are currently under discussion. Please keep in mind or let me make two remarks on that. We have only exposures in those countries if we are writing business in those countries and obviously we have to cover our liabilities in local currency. That’s why we are there. We do not take that in countries which might provide nice interest rates but where we don’t do business and just look at the very less number. So, we are not taking. That is already covered points. I think you are familiar with this stuff. I do not need to talk.

About this bank debt portfolio on page 46, two thirds of that is in the life health business. We have a strong average rating and above all it is just 8% of our total fixed income portfolios and if you look at the left hand side, Eurozone, NAFTA, Germany, UK, those are all banks and countries which currently have provided rescue packages for their markets and which should be in reasonable good shape. Our other corporate debt portfolio again I think is pretty well diversified. There is high share of NAFTA is simply explained by the fact that our investments, the assets under management and assets are largely invested in a corporate form as is with other life insurance companies stocks. That we have made this comment already upfront, they have only very little exposure and this is different to other US life insurers. They have only very little exposure in spot check credits.

You see on the very next page our investments in asset backed securities and that there is only 0.4 billion in structured credits and you have only 25 million, I repeat 25 million, in sub prime. Let me also mention on the very right hand side, because that’s the next category where we see some concerns out in the market and I’ve mentioned this already earlier is credit card, 5% of this 20 billion ie a billion is in credit card and it is on a very strong and daily monetary. The last slide 49, to me was almost unnecessary because it talks about liquidity. Of course in the longer course of the business there is no real liquidity issue in this business. We have high predictable cash flows. We are the only ones to collect the price in advance and as you know and I’ve mentioned the numbers we have ongoing free cash flow generation in our life and non-life business but for those of you who have still some concerns on the right hand side are illustrated. I was just talking about Eurolend about 140 million of this total portfolio would be eligible as collateral for the ECB and I mean I think with this I can stop on that post that there is certainly no liquidity issue for Allianz going forward. In the sake of time I’m too long already. I’ll spare you the brief summary because it is the same as we talked before and I’d just like to go to reemphasizing or reiterating that I do believe that our underlying fundamentals are strong and we’ve a very strong capital position and no need for capital increase and with that let me just open the floor for your questions.

Question-and-answer session

Operator

We’ll take out first question from Andrew Broadfield from Morgan Stanley.

Andrew Broadfield – Morgan Stanley

Hi good afternoon. Just two quick questions I hope and on the dividend if you could and I understand the mechanics for the way you accrue your dividend and I was just wondering that when it comes to decision time in February or whenever it is made, how much would be the sort of minimum value if you had to cut on the prior year? I am assuming that the solvency benefit you would get at 4.8 on the year end dividend down from 5.5, this would be the smallest albeit that helped you through really. So, I am assuming that you do 5.5 or you do something significantly less. I’m just wondering what your thoughts are on that and the second question is on the P/C business, I am sure the reserve positions were down a little bit in the quarter and I appreciate it has gone down quarter-on-quarter but I guess just sort of looking ahead, is there any sense in your mind that we are seeing this sort of gradual turn around in the reserving cycle? If you have the greatest releases that you are going to have cyclically and that you have got a period where your reserve is likely to be cyclically low?

Helmut Perlet

Good with respect to your first question Andrew I am always in the same awkward position in that our dividend is subject to the supervisory board not only approval but decision. I think what we have done is let me make two comments. What we have done is simply to accrue dividend in line with what we have stated as policy and if you were to compare the 1.6 with what we had to accrue based on previous years dividend that would translate into 1.8. So, there is not a real meaningful or decisive difference. I can remark I think we do know and we are very conscious about the fact that dividend is a very important factor for our investors and this will be appropriately considered in our final decision. Let me put it this way, our recommendation to the supervisory board to be politically correct. Now, in terms of run off I think I mentioned, we took the opportunity to strengthen a little bit IBNRs with the 1.5% run off in Q3, we are still at 3.3% year-to-date which is slightly in excess of what we had in 2007 where we were at 3.1 at the same time. So I think what I am trying to say here is you should not take the 1.5 % in whatever shape or form as an indication for weaker reserve positions.

Andrew Broadfield – Morgan Stanley

Okay thanks. I was just kind of coming back to my dividend question. It is a reasonable assumption that you wouldn’t recommend 5.5 but 4.8% dividend can’t be given, since the sensitivity number is 5.5 or significantly smaller or 5.5.

Helmut Perlet

Well, I just wanted to make you aware that at that point in time you cannot seriously expect that we will give you any complex statement about what is the ultimate number or the ultimate level of dividend. All I am saying is I think we have a good sizeable amount. We will continue to accrue Q3 to Q4 and then we have to make our decision. Again I mean if you look at our solvency ratios and those are as I have said net of dividend accrued. I think that would put us in a reasonably good position.

Andrew Broadfield – Morgan Stanley

Okay great, thanks so much.

Operator

Our next question comes from Willie Morgan from Goldman Sachs.

Willy Morgan – Goldman Sachs

Hi good afternoon. I’ve got a couple of questions today. The first one is just on the P/C business. It appears that you are now posting albeit a very slight premium grade. I just wanted to know your kind of outlook on the great franchise of the core business and whether or not some of the talk we are seeing about pricing up in the reinsurance echelons are actually may begin to fall down as your core business is going forward and just related to that I just wanted you state whether or not your policy of increasing your attentions going forward in the P/C business is still intact and whether or not you might actually look to try I guess preserve capital as much as possible in the current set of environment by perhaps even buying more reinsurance and the second question I have just relates to any comments you might have on M&A in general. Obviously I guess given some of the changes you have made to the accounting side, I guess the solvency position is looking a little bit more relaxed and what are you thinking about in terms of the opportunities out there in the market for deals and also specifically relating to the Hartford. It is not something that was a one off investment or is that something that you could potentially expand your interest in down the line. Thank you.

Helmut Perlet

Okay we will switch back to P/C. I think when you talk about pricing when I talk to my CFOs and we have tried it at the budget discussions, they are slightly optimistic about pricing for 2009. Frankly I’m less optimistic. I think what we should expect going forward is flat prices and no increase in pricing unless there is a triggering event. But I think the financial markets crisis has not yet turned into a triggering event for P/C. So, I would think we will see flat markets which would mean our focus is still put profit first and volume second. We would like to maintain our underwriting discipline. But by the same token do we want to buy more reinsurance? I don’t think so because we are making very nice returns on our P/C business which are still in the range of 20% return of risk adjusted capital and I would try to keep this the way to the reinsurers. Now, M&A, I think in general yes there are opportunities out there. Obviously I think you would also expect us to look and analyze what comes along but point #1 I think there is no need to hurry. Point #2, it needs to work out in terms of financial terms and point #3, I think in this kind of environment and I made this point in a different context, it is our first obligation to preserve a strong level of capitalization. So, having said this there is not a lot of room.

Now with respect to Hartfords, well let me put this very simple. Currently we have a mutual agreement that we are not going to increase our shareholding over and above 25%. It is a financial investment and nothing has changed so far.

Willy Morgan – Goldman Sachs

Great, thank you very much.

Operator

Next question comes from James Quin from Citigroup.

James Quin – Citigroup

Yes good afternoon. I have three questions please. The first one is simply I was wondering if you could let us know what’s the off balance sheet unrealized losses on the Commerzbank stake and so when you began as you got in as message and what’s the market value was at the end of September and the second question is just coming back to the life operating earnings and I have known you have tried to give us some guidance there and I was wondering if you could possibly try and give us a range from what you would see as the life operating earnings run rate if it assumes no realized gains and no realized losses either and then the point if it is really this that’s causing the I guess your decreased level of confidence in 2009 operating target where there is something slightly different. And then the third question is just on the 150% target for solvency, I mean obviously the back end has given you bit of a free policy and I guess it is just coming to knowing what the other regulators are doing but it would seem so strange that there is something so obviously not risk based in this approach. Won’t it will have a great deal of impact on what you will see for example your ability to pay dividend or how you see this solvency position more broadly and so I want you to give some comments on that and maybe just how you would characterize the services alone? Would you also say that needing 12 months of the balance sheet rebuilding to get you back to levels you feel truly comfortable with? Thank you.

Helmut Perlet

Well off balance sheet unrealized loss of Commerzbank I mean at that point in time we were just talking about an anticipated loss out of the Dresdner transaction. We don’t have yet Commerzbank shares on our balance sheet just to be clear. Now what you can say is if you take the calculation we have applied for this anticipated loss then on average the Commerzbank shares in our calculation or the book value of the Commerzbank share is close to 16 euros. Now I think today’s share price of Commerzbank is some 8 something. So, then that is an easy calculation to make that up but ultimately again that will be decided once we have Commerzbank on our books and obviously going forward then the question is as always with equity accounting those book value has to run through a credit impairment test and we are here and if for whatever reason at the fundamental value at some point in time would be below the net asset value, obviously that would trigger some impairment but for that situation I think that would mean that Commerzbank going forward is more or less a loss making operation.

Now on the life side operating or range of operating profit shares, coming back to that calculation, and that’s really a rule of thumb or the back of the envelope calculation. Again if you think that we are going to make 13 billion of investment income then we need 8 billion for again the guarantees and constructive obligations with no harvesting and no impairments. That would leave about 5 billion to be shared between policy holders and shareholders, and now again if you apply a range of 30% plus minus which of course depends on the markets, then you’ll have about say 1.5 billion of investment income plus what you would normally expect as technical result that’s on average probably for 2006 to 2008, 700 million to 800 million plus average level of expense gains which tend to be a little bit lower for the reasons I’ve mentioned and are probably rather than being 200 million historically maybe even only 150 or even slightly lower. Now that could be an indication of where we are. Now, that goes for the bulk pipe of our business. If you divide our business based on how it is reflected in the balance in the financials, then we have say 350 billion of reserves on our life business, 290 or more yeah 290 are non unit-linked and 60 billion as separate account assets. Now on the separate account assets and unit-linked business the bulk pipe of that is really plain vanilla unit-linked where any change in equity markets will change our management fee but not a lot but on top of that because they will bear quietly any guarantees. That’s different for the US VA business as you know and short-term of course if we have a significant reduction of the equity markets along side with the current level of volatilities that could give us, in whatever quarter, that could give us some difficult numbers maybe in Q4 this year or in one of the quarters next year. And that’s also, if we assume that volume has less confidence in our outlook for 2009. Obviously if we have on going impairments in 2009, maybe not over the average of the year, you could even have the same level of the stock markets beginning of January and end of December but with a lot of volatility on the way, you might well run into impairments and you might well run into some of your VA obligations or guarantees being in the money with impact on your results. Not huge but in the range that we might not achieve in the 9 billion.

Finally your question with respect to solvency, yes you are right, it is not risk-based. But if on the other side you take into consideration that from an asset liability management point of view our interest rate risk is very much limited and very much manageable what we have got now with the Buffin with these new regulations would even over estimate our interest rate risk i e the other way around on a pure risk point of view we would need lower capital to cover the interest rate than what is now reflected in our calculations.

James Quin – Citigroup

Okay I thank you for that and I mean I guess just broadly on solvency then would you effectively characterize the balance sheet as, I mean obviously strong enough, but would you look to really maybe put another year of earnings in the high yield before you say it was back in value where you want it to be?

Helmut Perlet

Well again I think we are okay with that number. We said always we want to manage our business between 150 and 170. 150 to us is kind of the lower the floor where we can survive major equity crisis without going out in the market and asking for fresh money but that between 150 and 170 would give us some financial flexibility to take advantage of opportunities on the street and above 170 we think that there is excess capital available for contribution to the shareholders.

James Quin – Citigroup

Okay, thank you.

Operator

Next question comes from Mr. Michael Huttner from JP Morgan.

Michael Huttner – JP Morgan

Hi there, I have two questions. One is crop insurance. I don’t understand, I spoke to someone earlier in exchange world that normally corporate insurance guarantees the income for farmers. Two you seem to be guaranteeing the price of the crops which is against the contract and the second you just gave a very nice explanation of the earnings power of the life business. Do you have a figure for the guarantees, what is the kind of cost in terms of the volatility of the guarantees in the VAs or the US or maybe in the moneyness of these contracts and final one I looked at on the corporate bonus where you seem to say you feel quite comfortable, the 50 billion figure and the other corporate bonus is 30% which is BBB. The 15 billion in total and I just wondered it seems very high percentage and I just wondered what’s fixed in there. Thank you.

Helmut Perlet

Okay, price for crops, the term crop products, we offer two kinds of protection. A, if there is something happening to the harvest i e there is hail, flood what have you, but also that the price for crop is locked in and that’s why it depends on the commodity. Now, before you finger point at the fireman’s fund the product as well as the pricing of the product is entirely set by the government and if you look in today’s market that’s probably the crop protection is 50:50 split between harvest and price and fireman’s fund is no exception here. We simply have to accept if the customer farmer is asking for protection we have to accept this. Now what the government is offering in return is that you can rather cede the business to the government. Normally you have also yeah a kind of a natural hedge in this business because the commodity prices basically do change if the harvest is changing. Now in this time at the end of September it was just a yeah, component of say an entire cyclical development where it was just a component of the more global development of raw material commodities and other things. That’s why we have been hit here but still year-to-date our crop business is a good number but is one thing if I am not mistaken out of the top of my head at 103 combined where traditionally it was in the order of magnitude of say 92 plus minus 2%.

So earnings power of life I am not sure about that about your question.

Michael Huttner – JP Morgan

Yeah I guess probably an explanation giving the traditional business 2.3 but on the unit-linked it is kind of well I didn’t get a number.

Helmut Perlet

Well that’s true. I am interested to keep some sensitivity. If in the US market if the SMP is going down to say 800, at the level of volatility we have observed in October where we had daily volatilities of 80% plus. That would cause a hit of 300 million to 400 million to our variable annuity business in Q4, plus the sensitivity. Let me just take this opportunity to make some clarifications because there is too much excitement out there. If you look at our DAC, we are carrying 900 million of DACs in our variable annuity business and that hit I’ve just described to you, the potential impact or the power is carrying lower as our separate account assets or general fund assets are growing. But in more general terms talking about the Allianz life portfolio as a whole, if you look at our DACs our K factor is still 0.6 meaning we need only 60% of the expected operating profit to cover the DACs going forward. So, if you take this around and take into consideration that we have about 12 billion of DAC on our life business so the expected profit margin which is still included in the reserves out of that business is 20 billion. So, there should be again some comfort that then needs to have a lot of I’m told to get insurance covers on our life business.

Now on the corporate fund portfolio, we have, yes there is…it could be 30% somewhere around that. I’d come back to that one in a second. It is roughly out of here.

Michael Huttner – JP Morgan

Right, thank you.

Helmut Perlet

We have always a question I cannot answer out of the top of my head.

Michael Huttner – JP Morgan

Thank you, thanks.

Operator

Next question comes from Mark Thiele from UBS. Please go ahead.

Mark Thiele – UBS

Hi there. Just coming back to slide 40, and the Stratford that you present, I’m also following up on Michael’s question regarding the tax, could you also provide us with sensitivities on how that would be impacted on these various scenarios and then you just said 14 percentage points for 0.6% decline compared with the end of September but the number presented on slide 4 is 5%. Am I missing something? Can you reconcile these numbers?

Helmut Perlet

Yeah you are missing something because that is a very precise calculation at the end of October and at the end of October we had also a positive impact from FX, so equity is increasing and that explains the difference. On your question regarding the debt I do not have percentage activity with me. I can only broadly answer that but having said this that the K factor is 0.6, so I think at the end of the day what I can say is in spite of those scenarios we see a ride of FX. The only thing, that’s why I mentioned this, was there could be some write off the tax, the US variable annuity business and again there we are carrying 900 million euros I think and 1.2 billion in US dollars. There could be, if we are in this kind of scenario, SMP down to 800 and the same level of volatility, there could be some write off if that is being required.

Mark Thiele – UBS

Fine thanks a lot and do you allow one question on the P/C side? Can you give us a bit of a feeling for how you sort of want to benefit from AIG’s weakness to a degree both in the US as well as globally?

Helmut Perlet

Well I think that there is no comprehensive strategy to attack AIG and their businesses but obviously what we see is that in particular on the industrial side business is being offered in some other countries as well. In broad terms I think we are likely to benefit a here because we are perceived in the market and rightfully so as a pretty strong player and if market is treating us as new carriers then I think this is a competitive advantage but again no comprehensive strategy to attack this business in whatever shape or form.

Mark Thiele – UBS

Thank you very much.

Operator

Next question comes from Brian Shea from Merrill Lynch.

Brian Shea – Merrill Lynch

Good afternoon. I have two questions for you and first of all on the pricing of assets non-life I think you said the average price change here today was a negative 0.8% and I remember you might be faulted there. You said back in February you were expecting an increase by 0.5% to 1%. I would like to know what’s changed here. I appreciate you have given and outlook for present and next year but why don’t you give us what your outlook was and then secondly the rate of that calculation in discontinued operations is still going on at 350 million shares to be issued. Does that mean that you shouldn’t end that? Do you still think the exchange ratio is 1.41 given how much things have been changing and how Commerzbank has got to the government. Should we expect the exchange rate to be different now? Thank you.

Helmut Perlet

So, on the pricing side I think Brian already in Q2 and also in Q1 I indicated that the assumptions we had in our plan are not likely to come through. We have observed slightly lower prices already starting in Q1 albeit the level is coming down somewhat. I think 3 or 6 months ago I had estimated a higher price change that we are actually in. What has changed here is really across the board but pricing assumptions of our operations turned out to be a little bit too positive. In particular I think we are more impacted in the United States where I said as price decrease in our book of 3.9. We had lower assumptions of around 1% to 2% but 3.9 in our book compared to the market, I think the market and the commercial lines business is around -7% to -8%. On the discontinued operations I think we need to make first of all a distinction between step1 and step 2. For step 1, 160 million of shares are predetermined. They will come in any case. Now then obviously the exchange ratio you mentioned is important for step 2 when we go into the merger and the exchange ratio will only have impact on the remaining or the value of the remaining 40% of Dresdner and so far the exchange ratio is important. Do I expect a major change? Well as of today I have no evidence that there will be a change but ultimately this depends on the multi year plans going forward of those in prospects meaning the plan of 2009 to 2011 plus and you know that we have neutral auditors here to make the valuation what they think about the planning. Now the rescue package that’s a good question and I don’t have a firm answer now and this is getting into a real valuation. I think what one should assume or should know is the additional capital Commerzbank is raising is via a silent participation and is not equity capital in so far the assumption would be that it would not basically not have a major impact on this exchange ratio.

Brian Shea – Merrill Lynch

Okay very good, thank you very much.

Helmut Perlet

Thanks Brian.

Operator

Next question comes from William Hawkins from KBW.

William Hawkins – Keefe Bruyette Woods

Hi thank you very much. I am just interested to know, the 157% solvency ratio that you published how is that solvency ratio been affected by the change in the way you’ve accounted for the discontinued operations? And you know as you said back in September that it was going to be on the basis of unoccupied Commerzbank and now you have done your share of the book value. I am assuming the numerator is 2.5 billion higher that it would otherwise have been but I’m more curious what happens to the denominator side. So, if you could help on that and then secondly are you positive this is a bit of strategic question but Allianz has been the leading proponents of market consistent accounting both in solvency and drive for us to possible to argue that the Bonn decision and the Commerzbank decision is today from the numbers will go against that principle. So, I’m just wondering I notice the way the special instances are always applied but how were your experiences affected your think and potentially the firms thinking about market consistency?

Helmut Perlet

Okay. Well, your first question William is not an easy one but you might remember we had said in September, 1st of September the potential impact is probably up to 14% whereas today as we see end of September 9% plus when the transaction comes through in line with those values we have at the end of September that will translate into another benefit of say 10%. So, if you just take these numbers 9 plus 10 minus the 14 my intuitive reaction would be the difference is 5% but to be honest I haven’t made this reconciliation. But it sounds like a reasonable number. Now with respect to your second question, I don’t think that is close intuitively again to value accounting. We have within all this we have value accounting stuff and our investment as you know have to be accounted for as fair value and equity accounting has been, still is, and is expected going forward to be at a point to consider. Now you might say “Oh Jesus why don’t we use a fair value for this Commerz share price instead 1, when you physically put these shares firstly on your books. Yes you could do that if you were to have a fair value for the market price but then if you compare this to the net asset value in terms of an equity accounting you immediately come up with the bad news. If your cost is lower then the pro rata net asset value, then you have the bad news and also under fair value accounting this will add to net income. Now, we could have probably with this approach window dressed our earnings going forward, but we have not done this equity approach from the very beginning. With respect to the unrealized bonds, I’m fully with you. I mean there is nothing to do with a risk consideration or if you view our solvency as going to apply going forward but coming back to what I’ve said earlier on, we do think that based on our ALM approach we run only a very limited interest rate risk and this year the limited increased risk has not been reflected in the previous approach where whole interest rate increases goes on against our solvency ratio so i e it has deteriorated but decreased our solvency ratio where in real terms our net asset value should have gone up, just the opposite. So, at least with this approach we are half way between.

William Hawkins – Keefe Bruyette Woods

Does this new approach make any distinction for credit spreads and risk free movements or you have just made a….

Helmut Perlet

It doesn’t, it doesn’t. That’s a weakness clearly.

William Hawkins – Keefe Bruyette Woods

Okay that’s great, thank you.

Operator

As a reminder to ask a question, please press “*1”. We’ll take our next question from Nick Holmes from Nemorack. Please go ahead.

Nick Holmes – Nemorack

Yes I had a couple of questions. The first one is why is that you haven’t hedged more of your equity exposure and you said that you have hedged a lot of them but stopped short of eliminating the risk and my second question is how much of your investment out of that is held by policy holders and do you expect it to remain as a policy holder investment? Thanks.

Helmut Perlet

Okay on your first question basically we have hedged about 30% to 40% of our equity exposure. Now we might have a long discussion, was that prudent enough or not and should we not have done more? I think it was a real charge. If you hedge every thing you shouldn’t buy in the first place. So, that’s how it is. With respect to the other bonds the shares and the volumes are held by the holding company Allianz SE and the bonds are spread over the universe and that is probably…do we have a breakdown of the bonds? How much is held by life and how much by non-life? The major part I think of the bond is held by life companies, what the guys are just calculating there. I’ll come back with that.

Nick Holmes – Nemorack

Okay, can I just follow up on the equity hedges and equity exposure? I mean would it provide, Helmut some of your caution about the operating earnings next year is really driven by the equity impairment or at least a large part of that is driven by the equity impairments. Could I have some on the life side?

Helmut Perlet

Yeah.

Nick Holmes – Nemorack

And, because you are increasing your operating earnings to some extent, it puzzles me that you haven’t either hedged those arrays out of someplace as you may well access or as you have done or you haven’t actually decided to change your definition and exclude equity against losses and impairments in the life operating earnings. I just wanted if you had any comments on that? Thanks.

Helmut Perlet

Yes, first of all it is true that the caution we have going forward is in fact in comments and on a small part of the business relativity might have on our results on the life side. Of course the equity market also plays down don’t forget have some impact on our earnings in the asset management operations, point #1. Point #2, are we going to change in any shape or form our definition of operating profit going forward or exclude impairments. Was that the question, did I get this right?

Nick Holmes – Nemorack

Yes.

Helmut Perlet

The answer to that is no we will continue with that same approach and I think it is appropriate because we have, we can and we have, we can share impairments partly with the policy holders and we have to share gains on equities also with the policy holders and therefore I think it makes a lot of sense to have it in operating even so that might go against us in the remainder of Q4 and maybe in Q1 2009.

Nick Holmes – Nemorack

Okay thank you very much.

Helmut Perlet

Thank you. Before we move on we have about, that was I think William, the answer I still owe you, about 70% of the bond exposures in the life health operations and 30% in the non-life operations. Okay next question please.

Operator

Our next question comes from Matt Clark from KBW.

Matthew Clark -- Keefe Bruyette Woods

Hi good afternoon. A question on slide 75, on the ABS portfolio disclosure, the mark down ratio is on the high grade on the mezzanine CDS. I don’t think it was aggressive as they were in last quarter. I was just wondering what is it about the assets that were previously insured by Excel and CIFG that seems to have transferred across that makes them better quality than the assets that were in the ABS CDO bucket as of the second quarter, if that’s clear and thanks.

Helmut Perlet

Yeah I think you mentioned the main reason we had the reclassification of the formerly monoline protected assets impacts a lot these mezzanine position. Now again the valuation of this mezzanine positions follows the same rule as are made at the beginning, the same rule we’ve applied consistently over the last four quarters so the result is what it is and we all feel very comfortable about this. I should mention that we have also now changed our approach a little bit in terms of classi