2010: GIC Issuers: Building Strength in More Stable Times

Throughout our twenty-four year history, FCM's stable value management approach has 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.

As we move beyond the financial crisis that lasted from late 2007 to mid 2009, GIC issuers' credit profiles continue to stabilize along with strengthening economic and financial market conditions. During 2010, the healthy performance of the equity and fixed income markets eased many of the pressures that faced issuers during the crisis and has resulted in more stable earnings results and robust capital positions. Moreover, financial flexibility remained

healthy as issuers continued to access the capital markets at favorable terms through debt and equity offerings. The proceeds of these offerings have been used to augment holding company liquidity positions and address upcoming debt obligations, along with funding strategic acquisitions. In addition, management teams continued efforts to reduce balance sheet leverage and risk exposures, which have included increased hedging activities, de-risking certain equity-linked product offerings, repositioning investment portfolios, exiting more capital-intensive product lines, and divesting non-core businesses. Overall, credit ratings continued to stabilize in 2010 with the majority of issuers having their ratings affirmed with stable outlooks. Moreover, all of the major credit rating agencies (Fitch, Standard and Poor's, Moody's, and AM Best) have revised their rating outlooks for the life insurance industry to stable from negative.

As of year-end 2010, GIC issuer capitalization remained sound with FCM's GIC issuer universe reporting total statutory surplus of $121.7 billion, up 6% from 2009. During 2010, issuer capital positions benefited from solid operating earnings and lower investment losses. As a result, the median ratio of surplus to general account assets for FCM's GIC issuer universe increased from 8.8% to 9.1%, which is above average for the last ten years. On a risk-adjusted basis, capital ratios remain very solid with our issuer universe reporting an average NAIC Risk-Based Capital ratio of 452%, which is significantly above regulatory minimums and even a little above the pre-crisis high of 450% in 2007. Earnings results were solid in 2010 with our issuer universe reporting an aggregate statutory net operating gain and net income of $11.6 billion and $7.0 billion, respectively. Overall, earnings benefited from the improved performance of the equity and credit markets resulting in higher asset-based fee revenue, lower reserves for variable annuity guarantees, and higher investment income. Although aggregate net operating gain was down somewhat from the historic high reported in 2009, statutory net income more than doubled in 2010 due to significantly lower investment losses.

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. In 2010, below investment grade (BIG) bond holdings declined to 8.0% of total bonds on average from 9.3% at year-end 2009. As detailed in the chart below, BIG holdings jumped by 2% in 2009 largely due to rating agency downgrades of non-agency mortgage related securities. However, as a result of principal pay-downs and write-downs on impaired securities, exposure to these higher risk securities declined in 2010. After bond holdings, commercial mortgages comprise the second largest investment allocation representing 11% 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 continues to perform very well with the average level of non-performing mortgages to total mortgages reported at only 0.2% as of year-end 2010. Although the level of problem assets is currently very manageable, commercial real estate (CRE) market fundamentals remain challenged and losses are expected to creep higher in 2011. Overall, FCM considers issuer CRE exposure to be very manageable given current expected loss projections. That said, the size and nature of exposure varies amongst issuers and certain issuers will be impacted more than others, especially during a double-dip recession.

GIC issuers experienced historically elevated investment losses in 2008 and 2009 driven largely by write-downs on housing related structured securities (Subprime and Alt-A MBS), corporate bonds, and equity securities. During 2010, investment losses dropped sharply to more manageable levels as financial markets continued their strong recovery from the March 2009 lows. Going forward, investment losses are expected to continue to moderate at these more normalized levels as the economic recovery moves forward. Moreover, FCM believes that further investment losses, particularly from real estate related assets, should be manageable given available resources including solid operating earnings and excess capital positions. That said, we continue to face very uncertain times including the possibility, albeit low, of a double-dip recession, which we believe could challenge even the most creditworthy of financial institutions.

In summary, we expect GIC issuers to continue to be one of the most creditworthy segments of the high-grade fixed income market and FCM views recent operating trends as further supporting credit fundamentals.

David J. Molin, CFA

Historical GIC Issuer Universe Trends (Graphs)