Lincoln National Corporation (LNC) Earnings Call Transcript & Summary

Hello, I'm Tracy Benguigui. I'm the Insurance Analyst at Barclays, and I'm pleased today to conduct a fireside session with Dennis Glass, President and CEO of Lincoln. Before we get into the Q&A portion, just a housekeeping item. A quick reminder on the left side of your screen, you could either submit questions or be a part of our audience response system, which is our polling questions.

And with that, Dennis, to start off, can you describe some big-picture thoughts on the current macro environment for Lincoln?

I'll be delighted to do that, and thank you for having us. It's always a high-class conference, and we're glad to be a part of it. So big-picture issues around right now are that we are -- let's start with COVID and its effect on operations. Because of COVID we all know how terrible it's from a health perspective, but just setting -- moving on to the consequences to Lincoln. First thing is the operating model. And we moved 11,000 people from working at home -- excuse me, from working in the office to working at home. And I'm very pleased to say that, that's been a very good experience for us. In terms of productivity, it has -- actually, in some instances, been better during this period of time than working in the office. We don't know if that will continue. So that's been good. From a distribution standpoint, moving from in-person to virtual has been very powerful as well. And we've seen quite a bit of actual improvement in reaching our customers. So on an operating perspective, it's been quite good for us. Now when you move to COVID specifically, of course, you have the excess claims, both in our group business and our life business. And we've spoken to that and given some guidance, what the effect on our earnings is, approximately $12 million for every 10,000 deaths in the United States. So we're working with that. The consequences of COVID economically have us focusing on a couple of things. The first one is credit. Obviously, credit would be a big issue in a continued recessionary environment. I would say that our actual experience so far with credit, credit defined as investment losses and downgrades, has been much better than our expectations. Part of that is related to the support that's coming out of both the treasury and fiscal support. And so as long as that continues and gives the economy time to recover, I think we'll see that same improvement in expectations with respect to losses and downgrades. Equity markets, we were -- they hurt a little bit in the first quarter and the consequences to particularly alternative investments in the second quarter. We expect that to come back. Equity markets have come back, and we expect that to have a positive impact on our alternative investment earnings in the third quarter, as we talked about. The other thing that's happening big picture is interest rates have been declining for some time. I think the economic consequences of COVID has accelerated and earnings have dropped quite a bit, 10-year now in a plus or minus 70 basis point rate. That affects us in 3 ways. Importantly, it affects the pricing of our products. And so we have been in a continuous state of repricing our products and maintaining the return on capital. That's been helpful. Spread compression is an issue in lower interest rates. I think we get about 1/3 of our earnings from spread in our overall earnings mix. And so that's moved up a little bit. We're able to offset some of that by some of the very strong cost programs that we have underway, and we can get into that. We've talked about, from a statutory perspective, lower interest rates possibly presenting a challenge on our statutory asset adequacy, but our guidance on that right now is, even at these rates and a little bit lower, we're in that $100 million to $200 million range of having to strengthen our reserves, which is not a very significant issue. So that's the big picture from my perspective.

Excellent. Let's just talk a little bit about the economic shutdown. The shelter in place has made it tougher to sell life insurance, couple that with the ultra-low interest rate environment. What are the new normal growth prospects for Lincoln? In a way that today's environment provide an accelerant of initiatives that you have already done but are doing more so now with greater urgency?

Well, I already touched on them. We have a couple of programs. Let's talk about the interest rate effect on our products. We, a long time ago, 4, 5 years -- 4 or 5 months ago -- 4 or 5 months before COVID started, we had a program of reprice because interest rates were always -- already falling. Reprice and expand our product portfolio. So the repricing has been underway for some time to -- again, to assure that we have the appropriate returns on the capital we put behind our products. The shift to products that support our capital management goals. For example, the index variable annuity, which is then meeting its pricing targets, has grown to a very significant part of our overall annuity sales. So that's offset some of the problem that's related to having to significantly reduce the -- increase the prices on our variable annuities with living benefits. So that's an example of the shift that can work very well. And then we're going to add new products, well-priced products that prove -- that achieve appropriate returns. I think one opportunity in that area is to add inside of our retirement plan because of SECURE Act, the ability to sell guaranteed lifetime income products. So reprice, shift and add. In terms of the long-term effect on growth rate, I think we can go back in our history and see that because of the strength of our product development and the strength of our distribution, we've already been able to make significant changes in the portfolio. One that stands out is guaranteed universal life, used to be 64% of our sales about 5 years ago, maybe 6 or 7 years ago, and today it's only 4%. So it's a combination of providing good products in the marketplace and a very strong distribution model that we have, tremendous shelf space and a very large productive wholesale distribution organization. So the combination of those 2 things, product development and the ability to put products into the market through our distribution will help us over time, keep the top line growing.

Great. And I do want to talk a little bit more about product development and distribution, but maybe I could just play up your comments on the index variable annuities. And that has a lot of names in the industry, structured annuities, buffer annuities, [indiscernible] call it. It seems to be a bright spot, because Lincoln actually climbs the #1 rankings in the second quarter. Basically, we [indiscernible] you to established players. So do you expect to see your index variable annuity market share up in a segment that's gaining in popularity?

So let me come back to sort of the foundation, which is very good product development. And what's happening in the indexed annuity space is, as you pointed out, there's a buffer on the other type of value propositions, customer value propositions. The product also is structured such that it provides the opportunity for other consumer value propositions and, to some extent, provides the same type of value proposition for customers that index -- fixed index annuities do. And so we're going to continue to improve that product, provide additional consumer value propositions, and that will help Lincoln continue to grow in the space. Now you're absolutely correct, because the product meets so many different consumer needs, others are coming into the marketplace. But it will take some time for those new entrants to get shelf space. We already have it. We've been adding it significantly over the last 6 months. Sometimes when people come into a new market, they might, on a temporary basis, underprice the market to get market share. So we could see some of that. But I'll come back to the basic foundation. We have the best distribution platform in our industry to get newly developed products into the hands of our customers, and we'll continue to rely on those trends.

Okay. Great. And just staying on the macro themes, how significant of an impact are you anticipating higher unemployment will be on the group protection business, both employee paid and employer paid plans?

So COVID is having an impact right now, direct COVID claims. And again, we've talked about that, and I've shared the guidance we've been providing. If you go back in time, and you'll see that there is some connection between recession and increasing LTD claims. And so depending on where we go economically, you could see some effect on our risk ratios, LTD short-term disability from a recession, if it has the same relationship that we've seen in past years. So the effect is at the margin, it's happened before. We expect to some extent it will happen again. It's very hard to quantify what that means, but there will be some impact. And of course, the fundamental question is, when does the economy get back to where it was? That is in part predicated on the path of COVID. Hopefully, mostly from a health perspective, we can get that under control. And then the consequence of that would be a stronger economy. So yes, there's a connection. Most important, what is the direction of the economy?

Great. And maybe on -- maybe just walking around the product world, right? We talked about a few of your products, but maybe one that sticks out is your fixed annuity sales, which decreased by 77%. It did seem purposeful for this product. New sales get priced -- repriced seems like every other week, and I'm hearing that credit rates are approaching 0%. And so what are your long-term prospects for FAs? And if I could also sneak in FIAs, which also have guaranteed credit rates?

Yes. Fixed annuities have -- we look at it from 2 perspectives. One is return on capital deployed. And the second issue would be fixed annuities have a higher first year strain, requires more capital than some of our other products. And then the third thing I would add is that we have a business model that doesn't rely on excess credit spread to be successful, but it's the interaction of product development, our strong distribution model, taking -- obviously, we take some credit risk. And so when we add all those things together, we do not see fixed annuities as coming back to the level that we have been selling them at before. And again, protecting the capital on our balance sheet, getting the appropriate returns being the 2 key issues. And again, some business models, I'm not trying to make pluses or minuses about other business models, but our business model doesn't rely on taking a lot of credit risk. And so we're competing against models where they take more credit risk than we'd be prepared to do. So bottom line, I don't think fixed annuities are going to come back in our mix in the short term to medium term to the extent that they were a year ago. Now I mentioned a moment ago that the index variable annuity can capture on a much more capital-efficient basis some of the consumer value propositions inside of more traditional fixed index annuity. And so we'll get some of that business, but that business will come through our index variable annuity rather than the fix annuity chassis.

Got it. And maybe just shifting gears to life insurance. It does have a little different pricing dynamic, but UL and MoneyGuard sales were also meaningfully down. How are you going to build a new mousetrap both for product design and pricing in order to solve customer needs on balance with near 0 interest rates?

Yes. That's really a very good question, and that gets back to just what you're saying is a 2% investment rate credit spread plus 10-year treasury. It's very hard for products like guaranteed universal life and MoneyGuard to provide the same level of guaranteed outcomes as you could when you were investing at 3% and 4%. So using MoneyGuard as the example, we've got a lot of interesting work underway where we'll be shifting the investment engine more to the equity markets and then providing much more upside on the benefit payments for the consumer than what you could get out of a product where the investment engine is the general account and bonds. So we'll be moving to a product design that gives bigger opportunity. The guaranteed returns might be a little bit lower, will be a little bit lower, but we think the combination of upside potential and -- will offset the lower guaranteed part of the program. So we're redesigning the product. And this idea of where products have been the investment engine of the product has been the general account, bonds and mortgages and stuff, investments like that, it's just very much more difficult and so you have to be more creative. I want to come back once again to the strong foundations that we have, best distribution, great shelf space, great product development. And we've done this before, as I mentioned already. Guaranteed universal life has used to be in the life business, 64% of sales, it went to 4%, while we were increasing our overall sales volumes. So that's what we're thinking about. And you have to react to the interest rate markets, there's no question about that. We've done it before. And if I can repeat myself one more time, we've been able to do it because of the strength of our distribution and product development capabilities.