Lincoln National Corporation (LNC) Earnings Call Transcript & Summary

[Audio Gap] life insurance session of the day, where it's going to be my pleasure and privilege as we introduce Randy Freitag, CFO of Lincoln Financial Group. Before we get started, I would remind everyone that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com\researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So with that out of the way. Randy, thank you again for joining us. Really appreciate your participation.

One of the questions that I get most with Lincoln is risk transfer. And I'm sure it's a question you get a lot as well. But you kind of discussed your appetite to potentially look at transactions. So that would be a good place to start -- overall progress that you've been making, what you're seeing and where we stand with regards to that overall market.

Well, Nigel, first off, thank you for hosting us today. Always, I would appreciate an opportunity to spend time with you and with the investors that are attracted to your conference. Well, you might be surprised, this is the first time I've ever gotten this question, right? So -- but I think the nature of anything like this is that until you announce something, it looks like from the outside, like you're doing nothing, that's the sort of the nature of this. But let me assure you that consistent with what Dennis and I said, and repeated in earnings calls, but also in other investor meetings we've done. We are allocating significant resources to researching, whether at whole concept of block sales might be something that makes sense for Lincoln. And so I think the question is, why are we allocating more resources than we have historically. On a high level, Nigel, we have eyes, something we can observe that there have been actual transactions being done at a pretty fast or rapid clip. We have ears so we hear all the rumors about all the people interested in books of business. We have experience. This is the stuff we've done in the past. It was 2018, where we sold a book of fixed indexed annuities to Athene. So we have a lot of indications that there is an appetite for -- from investors or from buyers, for various reasons to look at books of business. And so we think that creates an opportunity to do something that will add to EPS and ultimately add to shareholder value as we believe there's an opportunity to find buyers who are willing to pay more than we're currently receiving via our share price. So Nigel, I guess that's at a high level, what I'd say about that topic.

I guess when you talk about potentially being accretive to as for EPS, it's 2 parts of the equation there. There's, one, the amount of capital we you could free up from a transaction; and two, where you're in stock price is trading. Your stock prices obviously improved materially from where it was this time last year. So does that meaningfully change the equation? Does that make it somewhat more challenging to make -- to find a transaction that kind of ticks all the boxes?

No. I mean, yes, our share price is up. So let's be clear, from my standpoint, we've moved from a ridiculously low valuation to a ridiculously low valuation, a ludicrously low valuations to ridiculously low valuation. I mean the reality is where were we at $66, $67 per share yesterday. I don't know what your estimate is for next year, but that's probably what, 6x or so most analysts to view of next year. That's just crazy in our opinion for a company with our return profile, our history and record of returning capital to shareholders, our history and record of allocating capital appropriately to new business at appropriate returns. So I don't see the current share price as an impediment at all. And I think the share price could go up pretty significantly before you would get close to that. At a high level, when we think about entering into these transactions because there's a gap between when you and on something and when you actually transact. You sort of factor that in. So we shoot for EPS accretion of 3% to 4% at announcement date to allow for share price to move to still have something that's accretive at a high level. Those just numbers, obviously, that can change with the size or so. So you've got that side of it. I don't see the share price as an impediment. And then you have the other side, which is the buyers, right? And I think the prices you've seen for books has been pretty attractive. I think if you broke it up, we did a fixed annuity deal a couple of years ago. There seems to be on the life book side, a tremendous amount of demand. And I am a believer. I took a lot of economics course of the college to boost my GPA. And so I am a believer in supply and demand. And so there's a ton of demand out there, and I believe that will drive really strong prices. I think there's a smaller group of buyers on the variable annuity side. So we'll have to see how that whole equation. But we're looking across our portfolio in all of these areas. But I don't see share price as an impediment to anything.

Is it -- and would you potentially do more on the fixed annuity side as well? It seems like that's been the -- could be the hottest part of the market where there's been a large number of different players looking to buy blocks.

Of course, we would, if something made sense, but I would point out that we did an $8 billion transaction just a couple of years ago. So that was a pretty good chunk of our fixed annuity book at that time. So our fixed annuity book is not as large as -- on a relative basis, as say, our Life Insurance book of business, where we haven't done anything over the years.

Great. And I guess even without a transfer transaction, the whole issue of capital management remains important. I think you would -- like everyone else kind of put on pause when the pandemic hit your plans to buy back stock as things began to normalize and you kind of come back to the market. You're now in a position where you're kind of buying back at pre pandemic levels. Is that any alteration to our expectations? Should that continue to be the case there going forward? Or what are some of the factors that we should be watching out for? Is it credit or pandemic or what -- as you're thinking about your capital management practices, what are the key variables?

Look, when we in the industry paused in the first or second quarter of last year, as most of the industry paused through the first or second quarter of last year, there was a very strong belief, that belief was expressed through credit spreads that had blown out that we were about to -- we're staring down the barrel of a credit cycle, which is historically the item that is the main capital use during at time of stress at Lincoln and really across the industry. So we all went into and enacted our action plans for that exact scenario, which means that we largely cut back on share buybacks. Now we never experienced the credit cycle. And so at Lincoln, we've seen our balance sheet grow tremendously. I think in the first quarter, capital was up $1 billion over the prior year. In the first quarter, it grew $400 million alone. Our RBC ratio was up 13 points in the first quarter. We were at 464% from an RBC standpoint. So we prepared or we enacted our plans for a credit cycle. We never experienced that credit cycle. And so the balance sheets, like our balance sheet, the Lincoln is in tremendously strong shape. And so that allowed us in the first quarter to announce that we were going to get to pre-pandemic buyback levels. So I think much earlier than we would have originally thought or how the investors would have thought. I only talked about on the call about the next quarter, so I can't go beyond that. But I think the fact that we returned to pre-pandemic levels. I think the fact that the RBC and the capital position are so strong. I don't know, on an actual and on a relative basis, I think it's just a good indication of our ability to continue to deploy capital in that fashion. So we're feeling very good about the strength of Lincoln's balance sheet and what that means for our ability to return capital to the shareholders through buybacks.

I guess one of the other uses of capital would be M&A, but given your prior comments on the ridiculous low valuation. It seems the bars pretty high to be considering anything, but you view this to whether that's an opportunity for you.

Yes. I think M&A, first off, when we build our financial plans. And when we build our financial plans, we target building plans that allow us to grow EPS 8% to 10%, and we plan for 3 periods. So we got plan for that, and we've actually overachieved on that over the last decade. So we don't use block sales or M&A as sort of a plug into this financial plan to meet our aspirations. So they're not part of our core strategy as embedded in our 3-year financial plans. There are things that are opportunistic when they make sense, right? So right now, we've talked about why they may make sense. Our share price is depressed below where we believe it should be. And we believe there's a strong demand from buyers, which could create attractive prices above what's embedded in our share price. So as we see these things as opportunistic. Then when you look at our businesses, we have 4 businesses. Every one of those businesses has everything that needs to be successful. All right. So the last time we did big M&A was when we doubled the size of our group business. That was something we had talked about with investors for a number of years. We knew we had capital on our balance sheet. If we were to use it, it would likely be a for group acquisition. We did that. That really put our group business to really a full-scale provider across the spectrum all case sizes. And so that business is where it is, obviously, our life and annuity business are -- they are top 5 players in the U.S. and then our retirement business is exactly what we want it to be, right? We leverage our strengths to -- in the retirement business to compete where we want to compete. We're not a record keeper. We're not a jumbo case provider, right? We leverage our ability to distribute through LFD in our big broker-dealer payor partners. We leverage our capabilities from a service standpoint. So all of our businesses have everything they need to be successful. So there aren't any holes that I think that we would look to fill with M&A. So I would say that's highly unlikely.

Switching to another topic, the pandemic. I think we have seen quite a significant improvement in the COVID case rates and the resolving the associated results. Any reason to believe they shouldn't just work directly through your mortality experience that you would expect to have been? Any lag in recording or...

I can't think of any reason why it shouldn't -- and you've seen a tremendous decline in the number of people passing. Look we had 205,000 deaths in the first quarter, that was the peak. It looks like at current trends, that will end up a little over 50,000 for the second quarter. So it will be 1/4 of what we were in the first quarter. And the trends, at least as we exit June, will be very positive for the summer months. So I can't think of any reason why those shouldn't pass-through to Lincoln. There are no -- I think there are actually reporting lags in terms of -- at the state level when they actually report COVID claims. I think what -- some of the things you see at the CDC are claims that happened a while ago because they -- some states, some municipalities wait for the death certificate. In Lincoln's case, we get -- we record a claim when we get a call that tells us that an individual has passed away. And that happens in most cases, relatively, quickly. So we record a claim when we get that call, and then we wait for the death certificate. Before we actually paid out. But it's already in our financial statement. So I don't see any lag. You already started to see the benefit of the vaccinations in our life business in the first quarter. You saw the impact come down in the first quarter. I believe the group business is probably on a 3-4 month lag from the life business, just given its age demographics, it's more working-age population as opposed to our life businesses, which is more of an over 60 age -- over age 65 population. So yes, I think the trend is our friend here.

Right. How about the non-COVID related mortality, that seemed to be an area that -- yes, it had deteriorated that somewhat as well. A lot of people say the referral of care and various other things, other people point towards opioids and other kind of things like that. Is that a trend which should also kind of track COVID given that it's kind of indirectly related to COVID or just views on non-COVID mortality trends as well?

Look, our assessment of excess mortality in 2020. And in the first quarter of 2021 was that it was all related to the pandemic. We looked at causes the deaths. We're not seeing any increased deaths from opioids or suicides or those such things. Every -- all the excess mortality was around -- if it wasn't directly reported as COVID, it was all around causes a death that you would say were probably related to the pandemic, whether they're respiratory or cardiac. So our assess as we look through the data, and this is also supported. I read a number of CDC studies, I think last -- in 2020, the reported COVID deaths were 360,000, but the overall excess deaths in America were more than the 5 -- I've seen different studies on the low end in the 500,000 on the high end at the 700,000 or 800,000. So. I think our experience is very consistent with America's overall experience in last year's in the first quarter's excess mortality was all influenced by the pandemic. I don't -- we didn't see anything else, and I don't expect there's any other trends in mortality that we would expect to persist.

I guess one of the other aspects of the pandemic is that it has illustrated the value of Life Insurance. Is that translating to a better sales prospects from -- as people recognize just how important having Life Insurance protection in place can be.

Yes, we've definitely see that in our policy types that are geared more towards a younger age population. So we have a very digitally focused product called TermAccel, for instance. And you've seen the numbers, the case counts of those -- of that business go up tremendously. Now the reality is term insurance -- that TermAccel product. A lot of cases. But in terms of paid annualized premium, which is how we measure sales, it's a relatively small portion of our overall business. Our sales numbers are going to be driven by the more complex, more whole life type business we sell, the VUL, the IUL, the MoneyGuard, for instance. So yes, we've definitely seen an uptick in interest in the types of policies you would expect, but it hasn't had a huge impact on our sales. I think in the life business, as we talked about, our sales, we did we did a boatload of pricing in the products that were impacted either by low interest rates or by the new reserve reregulation PBR that went into effect. And I think we moved first, and that had a negative impact on sales. We believe we bottomed in the fourth quarter -- first quarter of 2021. And so we'd expect to start growing again. But I think we're still working through the other companies that are just sort of cleaning up and finishing up the repricing cycle, which has been behind us for some time now.

How about the rising interest rates, does that allow you to perhaps reverse some of those price increases and be a little more competitive in terms of pricing [indiscernible]. Doesn't matter.

Yes. Look, I think rates are definitely up, and that helps. So there's no doubt that the rates today relative to the middle of last year, for instance, they're in a better place, and that is supportive of pricing. I think on the other side of that, credit spreads, I mean the risk-free rate is up 100 basis points year-over-year, but credit spreads are down somewhat. So you do have a little bit of an offset to that. Net-net, I don't see the earned rate environment. I think it's supportive, it's important of the assumptions on our balance sheet. I think gets supportive of pricing, but I don't see it as a huge driver of price decreases from where we are today.

I guess when interest rates dropped a lot last year, one of the actions that you took was largely backing out of the fixed annuity market years ago like the available returns there weren't at a point, which justified writing that business generating your target returns. Are we at a point now where you potentially could reenter that market? Or would we still need higher spreads, higher treasury rates in order for that to be a product which would reemerge as being more attractive?

Nigel, I think there are 3 things that impacted fixed annuity sales at Lincoln. And the first one is what you mentioned is the absolute level of interest rates. But that's not a Lincoln specific item. I think that the reduction in interest rates impacted the whole industry and brought fixed annuity sales as a percentage of overall annuity sales down. And that was especially in conjunction with the growth in the other hot product IVA. So you saw from a macro standpoint, you saw industry fixed annuity sales down. The other 2 items, I would say, are more Lincoln-specific, and had a bigger impact on our sales individually. The first, I think, is just a different view on how we view and price credit/liquidity risk, I think a slightly different approach than some companies take there. I think you could call our approach more conservative than some of the big providers today. And I think that had a negative impact. Probably the biggest impact, Nigel, was what we did last year when we are really -- we've always been disciplined on capital allocation. But when we really sat down with share price at very low levels when we upped our targeted returns for fixed annuities. You may have heard me say that for -- since Diner serves [indiscernible] Europe, the fixed annuity business has been a 10% business. Well, we have our targeted return to 12% last year, and I think that had a fairly negative impact. One point on those -- when I quote those numbers because universally every other company talks about higher returns on fixed annuities. When I do that, I think the main difference is that when I do that, we include and we talk about returns on fixed annuities. We include an expected cost of credit, right? So 15 to 20 basis points. I do think when most companies talk about the returns they're getting on fixed annuities, they ignore credit losses or the economics or credit losses. So typically, you'll see or hear me talk about fixed annuity returns at lower levels than almost every other company, I ever hear talk about them. And I think that's the main difference.

Right. That makes sense. I guess 1 of the things that you did in response was pivot. You -- your portfolio or your product portfolio strategy. And clearly, buffered annuities was one of the key areas that you kind of move towards. And we have to put out some very good numbers there, industry-leading sales numbers. But it also seems like every other company has adopted that strategy as well. Now it does seem to be getting a little more crowded. Is that still a good market? Or do we want the risk of -- I think we've all seen the movie in the past where get influx of competitors leads to erosion in pricing and eventually in rational market. Is that a risk at the moment? Or is that -- or are you still satisfied with the returns that you're generating in that part of the market?

Yes, absolutely. We're still satisfied. I think IVAs are buffered annuities whatever we're going to call them, are still a very attractive marketplace. I think when we entered that business, we were able to leverage the things we do really well, right? So our ability -- my assessment, our ability to get on the distribution platforms that sell a product like IVA, I believe is unparalleled. I don't think anybody in America is better -- has a better ability to get on distribution platforms like Morgan Stanley than Lincoln. LFD is, I think, the unparalleled leader in that capability. So we were able to leverage that along with the ability to manufacture these products creative, innovative products. And I think that's what ultimately caused our sales to shoot up. Now I'd point out on IVAs in general. They -- IVAs were a product that took the fixed indexed annuities and said, "Hey, You know what, the capital markets are paying a lot if you'll accept little risk, right? And if you will accept that risk, you can get a much more attractive upside value proposition. That proposition last year allowed companies that have 200% caps or so in IVAs. As volatility has come down and when volatility comes down, the capital markets are paying a little less for a consumer to take on that risk. The value prop you can offer to the consumers has come down. So I think from a value product standpoint, they're a little less attractive than they were a year ago, but they're still a very attractive option. In terms of other companies coming in, I mean, this happens all the time. You may see some companies as they come in, we'll have teaser rates for a period of time. But we still see rational behavior. These are smart companies. They have to set -- they face the same [indiscernible] that Lincoln does capital allocation, we always have buybacks and other things we can do. So we have to be disciplined with the returns we seek. So yes, I think you could see momentary noise, but I would expect that Lincoln will, as we've always been when we've entered and made a commitment to an industry. We'll be a top 5 player. We'll bounce around in there. I don't expect to be #1 all the time like we were in the fourth quarter of last year, but we'll be a top 5 player.

Let's see kind of target returns there for fixed annuity is always been around 10 to 12 if you stretches. Are these IVAs a little higher than that? Other companies have talked around mid-teens? Is that a real number? Or is that a little aggressive?

I don't see that business is a mid-teen business. So I would position it just a little above fixed annuities. These are products without guarantees. But they are a little more complex than the fixed index annuity. So I talked about our target right now at 12 at fixed index annuities. I position IVAs 12, 13, 14, somewhere in there. I wouldn't think of them as a is a mid-teen business. I wouldn't be surprised at all if the difference between what I say and others once again, is credit and expectation for the cost of credit.

And I guess another -- a just switching topic. One of the things that you've been talking about over the last several years has been the opportunity for technology-driven expense reduction. The pandemic obviously led to a bit of a change in -- a bit of acceleration in the pace of some of those changes. But just an update there would be helpful as well.

Yes. Look, I think expense Management is a strong capability at Lincoln. I think it is something that differentiates us. It's the capability to both announce and talk about programs and then to actually be able, from an investor standpoint to see those pronouncements come through in our results, right? So when we talk about a savings program, you can actually and you have historically been able to see it, come through. I hear a lot of companies talk about programs, but you have to be inspector Clouseau to actually find their expense ratios come down. So that's not the case at Lincoln, right? So you go back to the original technology-driven program, which we enacted a few years ago. We talked about ultimately getting $90 million to $150 million of savings from that program. We're well on the way to that. We were at roughly $50 million last year, that over $30 million to $40 million a year for a couple of years. And that program will be behind us. But you've seen those numbers come through in our results. Last year in response to the pandemic, we took $100 million of expenses out. And then we committed to keeping them out forever, right? So -- and how do we do that? We did that with technology. We did that with changes now we work. So there's another $100 million that's all forever. And then you've heard Dennis and I talk about, we believe there's further opportunity. I mean the pace of technology, the pace of how work is done are changing and they're ramping up the pace. We think there's another opportunity. So we're currently doing a lot of research analysis around a next big program. We expect to the extent our analysis finds anything, and I expect it will, that's something we could talk with investors sort of in the back half of this year.

How about the that as pandemic winds down Clouseau some of the travel and associated expenses coming back. Is that going to be a headwind that we need to be factored in some elements of your expense structure artificially low because of pandemic and seems it could reverse.

No. I mean, yes. People are going to travel again, but it's at the end of the day that's a small component of our overall expenses. But I think are more fundamentally the change in how we work, the number of employes will be working virtually to a far greater extent than that. Well, world has fought back -- reiterate the $100 million we took out last year is out forever. So -- yes, as I see things today I don't think about expenses bouncing back as a headwind to our EPS growth.

Not the most exciting topic, but 1 that everyone still wants to touch on accounting changes. LDTI, you've view as to where things are headed, the progress that you've made when we potentially could see some quantification of the impact. Just an update there would be great.

Unfortunately, still targeting the middle of next year. It's a big project. I think the FASB was prudent and appropriate when they extended the date by 1 year. We've been very successful operating during that pandemic. So I think another year would have been appropriate even in the absence of a pandemic, but that sort of sealed the deal from the FASB standpoint. There's just a lot of analysis we have to do. I mean I'll pick -- I'll point out one thing. And you and I have actually briefly talked about this, right? So we have a hedge program that has been structured and has performed over the years to deliver the assets needed to pay off any claims, right? It's done that. It's done a tremendous job of that. I think of it as 1 of the best programs in the industry. We've also had the benefit of that program matching our liabilities reported on our balance sheet, right? So you haven't had that gap of volatility than some of our peer companies, especially those in the GMIB space have had to face. And that's been, I think, a benefit for us. Well, now we're going to be looking at a different approach to accounting. So we're going to have to analyze -- does our hedge program makes sense. The FASB insanely came out with a pronouncement that, for instance, return of premium death benefits need to be fair valued. Well, I think it's highly unlikely that Lincoln is going to look at a return of premium death benefit, the risk profile of that particular benefit and say that, that's something we should try to hedge on the current valuation. So we're going to have to sort of analyze, right, with potentially with hedge program that now differs from how things are accounted for. What are the implications of that? Are there things we should think about in terms of how we hedge. I can show you that any changes we do make, but we'll communicate. And they will still be all geared around the exact same goal we've always had, which is making sure we have a hedge program that generates the assets required to pay off. Any claims for these guarantees, which is fundamentally what you want to do. At the end of the day, the view with guaranty business is the following things: It's the world's greatest asset management business; it's a high fee, high persistent asset management business with a guarantee. And so you need to make sure you manage that guarantee in a way, so it doesn't negatively impact the company over time by running a hedge program that generates the assets, or it could pay off the claims. But outside of that, the VA business, the VA living benefit business is -- and I don't think investors appreciate this enough. It is the world's greatest asset management business. Higher fee, higher persistency than any other asset management business in the world.

Maybe we're running short on time, but I do have one other one, which just came across the web. Just regarding the reversion to the main corridor in DAC and waiver. You can just -- probably just as an update as to the size of that cushion, how that's been moving recently.

Well, it's -- I believe I'm going from memory here. I believe at the end of the first quarter, it was roughly $300 million in total positive. So it's significant. It's actually an item that potentially could be an offset to any negative impacts from LDTI, for instance. So yes, it's grown as the equity markets have continued to grow. grow as our underlying assets have continued to grow. So we've benefited in many ways from what the capital markets have done over the last year, whether that's interest rates increasing or whether that's the equity markets and the tremendous returns we've seen there. And you see that in our results, including in a significant buffer in our reversion to the mean.

Right. Okay. I have a bunch of other questions, but unfortunately, we are at time. So we better leave it there. But Randy, thank you so much for taking the time to share with us -- sharing your insights with us today. And for everyone who joined, thank you for joining as well. We'll land it here. Thanks