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2008: GIC ISSUERS WEATHER UNPRECEDENTED MARKETING CONDITIONS - MANAGING THROUGH THE CRISIS

Throughout our twenty-two year history, FCM's stable value management approach has primarily utilized diversified portfolios of traditional guaranteed investment contracts (GICs) issued by major life insurance companies. We have found several relative value advantages in using GICs over other stable value products including policyholder status and superior yield premiums relative to comparable high-grade obligations. In general, GIC issuers represent the most creditworthy segment of a mature, highly regulated industry that exhibits strong credit fundamentals including: solid capital levels, diversified revenue and earnings sources, consistent operating cash flows, and conservative balance sheets.

At the start of 2008, GIC issuers were well positioned to weather the credit crisis with historically strong credit fundamentals including robust capital levels. As the credit crisis evolved, issuers generally fared better than other financial institutions due to more stable liquidity/funding needs and generally stronger balance sheets with lower exposures to "toxic" assets.

However, the credit fundamentals of several issuers began to weaken in late 2008 as the credit market turmoil and unprecedented equity market declines significantly depressed earnings and pressured capital levels. In response, management teams have taken actions to shore up balance sheets including capital raising initiatives, augmenting liquidity positions, and reducing risk exposures. Overall, FCM considers these actions to be credit positive and we expect management to implement more strategic initiatives including divestitures of non-core businesses. In October, the rating agencies changed their outlooks for the life insurance industry from stable to negative, and several issuers have experienced downgrades. Overall, these actions were not unexpected and most GIC issuers still retain strong financial strength ratings.

As of year-end 2008, GIC issuer capitalization remained sound with statutory surplus totaling $99.9 billion, down 10% from the historic high of $110.6 billion in 2007. During 2008, issuer capital positions were negatively impacted by depressed earnings and higher investment losses. As a result, the median ratio of surplus to general account assets for FCM's GIC issuer universe decreased from 9.7% to 7.7%, the lowest level since 2002. On a risk-adjusted basis, capital ratios remained solid with our issuer universe reporting an average NAIC Risk-Based Capital ratio of 414%, significantly above regulatory minimums and down only modestly from the historic high of 443% in 2007. Earnings results were dismal in 2008 with our issuer universe reporting an aggregate statutory net operating loss and net loss of $1.8 billion and $15.7 billion, respectively. Overall, earnings performance was negatively impacted by credit and equity markets conditions resulting in significantly higher investment losses, lower asset-based fee revenue, lower investment income, and higher reserves for variable annuity (VA) guarantees. Of note, statutory accounting understates the true earnings picture due to the fact that hedging gains related to the VA business flow directly to capital and are not reflected as income.

GIC issuers have traditionally maintained high quality investment portfolios. Investing activities are primarily focused in diversified bond portfolios representing approximately 70% of invested assets. Bond portfolios are typically comprised of 60% to 70% corporate bonds, with the remaining 20% to 30% invested in structured securities including mortgage-backed and asset-backed securities. In general, GIC issuer bond portfolios are conservatively managed with over 90% invested in investment grade securities and significant diversification by individual issuer and sector. As of year-end 2008, below investment grade (BIG) bond holdings represented 7.2% of total bonds on average, compared to just over 9% during the weak credit environment in 2002. By the end of this credit cycle, FCM expects BIG holdings to potentially surpass 2002 levels given recent rating agency downgrades of certain mortgage related securities and the potential for substantially higher levels of "fallen angels". After bond holdings, commercial mortgages comprise the second largest investment allocation representing 12% of the average issuer's invested assets. In general, GIC issuers have demonstrated expertise in managing this asset class and typically invest in conservatively underwritten and well diversified mortgage portfolios. This asset class has performed very well in recent years with the average level of non-performing mortgages to total mortgages at only 0.1% as of year-end 2008. Although the level of problem assets is currently very manageable, the commercial real estate market is expected to weaken significantly in 2009.

During 2008, GIC issuers experienced sizable investment losses largely driven by the historic defaults within the financial sector and impairments on structured securities. Going forward, FCM expects issuers to continue to experience above average losses in the near term. However, the overall impact on financial strength should be manageable given that most issuers produce solid operating cash flows and maintain excess capital positions to absorb losses. That said, we continue to face very uncertain times with unprecedented volatility in the credit and equity markets along with the possibility of an extended economic downturn, which we believe will continue to challenge even the most creditworthy of financial institutions.

In summary, we expect GIC issuers to continue to face short-term financial pressures given the unprecedented market conditions; however, FCM believes that long-term credit fundamentals remain favorable relative to high-grade fixed income alternatives.

David J. Molin, CFA