Lincoln National Corporation (LNC) Earnings Call Transcript & Summary

Good morning, everyone. I'm Ryan Krueger and the life insurance analyst at KBW. With me is Randy Freitag from Lincoln, who is the CFO and Head of the Individual Life business. Thanks, Randy, for joining us this morning and supporting the conference again this year. Just take kick it off last week, Lincoln announced that Ellen Cooper will succeed Dennis Glass as CEO next year. Can you discuss what that means for Lincoln as well as you personally?

I think it's great for Lincoln, and I'll dig into it a little bit. For me, personally, I've read some of the reports with a little bit of fascination. I mean, Ryan, I have like the greatest job in the world, and I'll dig into a little bit what I made you that. So for me personally, I've had the greatest job in the world, and I'm going to continue to have to greatest job in the world. So I continue to be the same excited CFO and Head of Life that I've been for a long time now. When I think about why, why do I think of this as like the greatest job in the world. I mean there are a number of streams that come into that. First, and Ryan, you and I have probably talked about this, but my passion for this industry and the company the passion that I have in this industry, which is born of some personal experience, having lost both my father and my wife way too early in life. It's sort of as a way of ties me to this industry and really drives me each and every day. And then for Lincoln, I mean I guess a little over 26 years ago, Lincoln hired a kid with a somewhat sketchy academic record as a senior assistant actuary with exactly 0 people reporting to him and now I've -- now I'm the CFO for this amazing company. So that passion, that's one stream what makes us the greatest job, but then leadership, right? I mean if you think about leadership looking backwards, right? I've had the honor of working for Dennis Glass with and for Dennis for all of those 26-plus years and Ryan, you spent time with Dennis. He's an amazing leader, take so much from him. But sort of if I had to bolt on, I mean, the man is just sort of embedded in the culture of Lincoln this concept of doing the right thing. And I'm always always going to remember that about Dennis incredibly proud to have worked with him in forms along. And then when I look forward with Ellen taking over the reins, I mean, I've known Ellen for a long time, but I was part of the interview team that when we hired Ellen. I remember early on in her tenure, I was I got to help her understand what it's like to work with data, sort of introduce her to the wide array of connections and relationships I have across Lincoln. I saw -- I got to see her come in as a new Chief Investment Officer and I've seen her sort of develop to the point where now she is sort of a leader among Chief Investment Officers in the industry. I've seen her continue to take on new responsibilities. She runs our hedge program and overall enterprise risk and I've seen sort of take those things and make them better each and every day and more recently she took over our annuity business, so I feel wonderful about the transition from Dennis, this man I've worked with so long to Ellen, this person I've not only known for long time, but I've seen the amazing things she has done in her -- in a decade and so here at Lincoln. So that's -- I've got this passion. I work for great people. I work with great people and then I'm the CFO for one kid who has like this amazing track record of performance in, if you look at what we've done over a decade. I mean we've grown -- whether you look at it 3 years, 5 years, 10 years, we've EPS at or above our target of 8% to 10%. This amazing record of financial performance and as a CFO when you look at our -- the strength of our balance sheet, I mean we've -- as we said here today I don't think our balance sheet has ever been stronger than it is today and then another aspect, which makes this job really nice. I mean we're literally a capital generation machine. I know this is sometimes a question that comes off, but Lincoln we believe strongly in the fact that organic growth is doing business at appropriate returns is the -- at the end of the day will drive the company. So, we allocate lot of gap to hold up new business. If we look at return -- capital return to shareholders versus capital reallocate to new business, probably about 2/3, 1/3 over time and when you look at one of those the amount of capital return to shareholders over the last 5 years, I'm just looking at this yesterday is $4.7 billion that is $944 million a year that is about 70% to buybacks, it's about 30% to dividends. I think that's a good mix. It's a lot of capital return, but then when you factor in that additionally, we've allocated over $9 billion to support this organic growth engine that we've been and then when you factor in that along the way, we were able to even double the size of our group business with acquisition liberties. So I mean over a 5-year period, Ryan, that's by my math $15 billion of deploy capital, which is amazing. So I mean this is a great job. This is a great company to be part of. I'm very excited about the future of Lincoln.

Thanks, Randy. That was great. Thanks for transition into something new you had just commented on, which is EPS growth. I guess I was hoping we'd be closer to being done with the pandemic at this point, but I guess we're still somewhat in it, but we are hopefully getting closer. So I was hoping you could talk about both how to help us think about the normalized earnings power of Lincoln at this point in time? And then if you do view the 8% to 10% EPS growth target as achievable in the current environment?

Ryan, there are 2 big things that have been impacting earnings in recent quarters, the pandemic negatively impacting us. And then offsetting that, really strong alternative investment income. And so if you go back to the last quarter where we reported operating EPS of $3.17. And if you adjust for those 2 items, you would get back to about $2.80 sort of underlined. If you went to the first quarter into that same math, that number was $2.66, if you move back to the fourth quarter and did that same math, I think it was about $2.58. So that's a powerful record of just underlying growth through this pandemic. And I think it speaks a lot to sort of the diversity of earnings streams and types of earnings that we have at Lincoln. And I think when you look forward, I mentioned our track record looking backwards, but as we sometimes joke, let's not talk about our grandfather's company. Let's think about this looking forward. And I'm very confident when we -- we're in the middle of our annual financial planning process, we typically plan for the next 3 years from a financial standpoint. And very confident that as we sit here today, we'll be able to achieve again what we strive for, which is 8% to 10% EPS growth. I think the nature of that growth is going to be a little different than the past few years. I think they'll be a little less from organic as a lot of the products that we've rolled out sort of build over the 3 years. So there will be a little less of that. We've returned to prepandemic levels of buyback, so that will return to its normal level. But I think we can more than overcome that slightly lower level of organic growth with expense opportunities over the next few years. So yes, very confident that as we put together financial plan this year, we will once again achieve our goals.

Maybe going into more detail on the expense side. You have had a number of expense initiatives. Can you, I guess, both update us on where the current initiatives stand and then also discuss the new initiative you been working on and give any sense of how meaningful in size that could be?

Broadly speaking, Ryan, we think that being an expense leader is sort of a key element of outperforming peers. And that's what we have been looking backwards, and that's what we intend to be looking forward. If you think about how we've done that over the years. We do that with a very disciplined and rigorous annual budgeting process, the benefits of which sort of continue to accrue over time. But in terms of specific programs, it was a few years ago, we launched what we call project ambition, which was really around broadly distributing and using digital technologies across the organization. We expected that, and we're right on track to achieve $90 million to $150 million of net savings. That program is sort of coming towards the end. And then during the pandemic, in response to the pandemic, the amazing -- put a goal out there, and the amazing employees of Lincoln delivered $100 million of expense savings that we just permanently took out of the organization. That was an amazing achievement by the organization. And now we're -- we're in the middle stages of sort of the next program, which I think speaks a lot to the fact that the world is really changing at a very rapid pace in terms of technologies that are available, sort of best business practices all sorts of things. Companies over the years have always went through expense programs. It needs to occur maybe every decade. Now they seem to occur at a faster pace, which once again, I think speaks to the change. I think in terms of the next program, I think on our next call, we'll be positioned to talk about it, but I think it is a real opportunity. Where that opportunity occurs I think it will be across the organization, but specifically I think there is a good opportunity in our group business because the focus of our group business has been more of integration for the last few years. So I think there's a big opportunity to earn. I think across the rest of the organization there is another opportunity and we will talk about that more on our next call.

Got it. Moving to free cash flow, I guess prepandemic you typically talked about an annual range of about $850 million to $900 million. Is that -- as you -- as we emerged from the pandemic, is that still the range or have some of the things you've done on product mix and reducing capital intensity of new business. Well, could that produce some upside?

Yes, I think it's still a reasonable range. I'd point out I mentioned some numbers earlier what we've done over the last 5 years, which on average has put us at the very tippy top of that range $944 million versus the upper end of that range of $950 million. I think just in terms of helping you understand I think that mix of roughly $150 million a quarter of buybacks, which is typically [indiscernible] dividends now or just a little over $300 million. So I think that $850 million, $950 million range is still a reasonable starting point, but as we do we can start for all the time we always strived to overachieve at the least tip of numbers we talked about, right? I think one of the things for very problem is that we walk the walk, we don't just talk the talk. I think the facts and performance speaks for itself, but I think that's a reasonable expectation looking forward.

You touched on this a little bit in your opening comments, but I wanted to just go back to it briefly, which is how to -- just how to think of when free cash flow is an output of in-force earnings and new business strength and just how to think of those 2 pieces together? I know you did mention this already, but I just wanted to go back to this because I think sometimes that's maybe underappreciated by the market, what -- how to think about new business strength?

Yes. It bounces around a little bit. But at a high level, as I mentioned, when we think about the overall capital we generate and what we choose to do it. It's averaged about 2/3 to support new business organic growth and about 1/3 sort of returned to shareholders either through dividends or buybacks. And I think that's a reasonable rule of thumb as you look forward. I think in terms of allocating capital to new business, it's all about are you getting the returns consistent with that capital allocation. And that's why we're so focused each and every day on making sure that we're doing that on a very thing. And so let's look at last year. The Life business is probably one of the businesses that's impacted significantly by lower interest rates. And so we had a lot of repricing we had to do. It led to price increases across a number of products. But we didn't stop there. We sort of -- because we believe in the underlying thesis of the products we sell. We went out and sort of innovating created new products. And that's one of the things I talked about how our sales will build over the financial planning as those products get rolled out. Yes, I think, Ryan, that sort of 2/3, 1/3 is a reasonable proxy. But it's predicated on us getting and achieving the returns that we believe are appropriate.

Got it. That's helpful. So risk transfer has definitely been a big topic for the industry as well as Lincoln over the last year or two. I was hoping to get your -- an update on your latest thoughts on risk transfer. I know you're asked this all the time, but a I'll ask it again. What business lines you're most focused on? And also just how does your own stock's valuation kind of impact the equation when you're thinking about doing something.

The -- I think I've said before, Ryan, it's just the nature of upbeat so these sorts of things that until you announce something that sort of appears from the outside like you're doing nothing, but that is definitively not the case because we do think there's an opportunity, and part of that opportunity is a share price that we believe is undervalued, which means that allocating capital in a differentiated way towards things like buybacks, you make sense from a financial standpoint. So we think there's a big opportunity. I think we've been very clear that we happen to think that opportunity is bigger on the life side, and that has nothing to -- that has -- well, let me say this, but that has everything to do with the fact that -- there are just more buyers for life blocks than annuity blocks and a believer in the whole theory of supply and demand. And when there's more demand, that means that you'll get better products. I think that's just -- it's a pretty efficient marketplace in that way. So I happen to think there's right now at this right moment better opportunity in the life cycle. We've got these things -- look, we did an annuity transaction, a fixed annuity transaction a few years ago. I think at this red hot moment, as I mentioned that there's a bigger opportunity in life, but it really comes down to -- is the -- do we believe there's an opportunity for the private marketplace to pay us a price that is above the price that's embedded in our share price. And we do believe there's a real opportunity. We're allocating a lot of resources to figure out whether that thesis is in fact true.

Got it. Well, sticking with life, more mortality experience at least in the Individual Life business as been more favorable than this year than kind of the typical sensitivity at least relative to population deaths with COVID. Can you give a little more detail on what you're seeing there so far this year?

It's we're a big company, obviously, with nearly $1 trillion of life insurance and forth. So I think really the only surprising quarter is when mortality comes in exactly the number we expect. It's just the nature of this stuff that you're always going to get volatility or typically going to get volatility one way or the other. We have a really good year when 3 of the quarters come in a little better than our expectation and one comes a little worse. We have a bad quarter when it flips the other way and we have a quarter or a year, excuse me, in line with our expectations when sort of two or above and two or below. And if you look at the first half of the year, we've had really good underlying individual life experience. And that's been driven by, I believe, in the first quarter, it was primarily about historically favorable flu season, which we typically see elevated mortality in the first quarter of the year. But I think driven by the fact that there was almost a nonexisting flu season this year that we didn't see that. And then in the second quarter, it's tough to say. It's not like we have deep in-depth conversations with all of our claimants. But I suspect there was a little bit of, what is it called, the bounce-back effect or whatever. The fact that we had elevated claims last year means that those people, unfortunately have left. So you can't [indiscernible] at a high level. So I think there was a little bit of that in terms of looking forward. I expect it to bounce around. I think if you think about COVID itself, we've started to see the benefit in the individual business, we believe, of the vaccinations, which started with sort of older age groups, which is -- we have a lot of younger aged people also, but on average, our Individual Life business is a little average older age than our group business. So we started to see the benefits of that. I'd expect that to continue. I think on the individual side, you're sort of looking back, COVID was driven by sort of frequency, right? There were just a lot of claims. I think you'll probably see more because the frequency is coming down associated with good vaccination in -- where our business is located, you probably see severity sort of be more of a variable in terms of any particular quarter's impact. On the group side, underlying mortality experience's been running roughly in line with our expectations. We haven't seen the same benefit yet on the group business of vaccinations. And in fact, I was reading a report the other day that indicates that last year, if I forget the exact percentages, but if 65% to 75% of the desks where people over 65 is kind of flipped this year, which would indicate more in line that deaths are flipping to the part of the market that's more where the group business travels. So that may have a negative impact. So it is what it is. We're very proud of the business is in, we'll pay the claims. We've paid a lot of claims over the past year, and we still managed to grow our earnings. We still managed to -- I believe our capital has grown $1.5 billion over the last 12 months, which is like amazing in pandemic. So we'll deliver on the promises we've made to consumers, but we'll continue to, I believe, drive the company forward.

You have, I guess, much of a view on the post-pandemic mortality potentially. I mean it does seem like -- it's been a very long time, but usually, following a pandemic, if you go way back in time, it does seem like general population mortality gets better for a little bit of time before reverting back to normal.

I think you have -- I agree in general that there should be some bounce back benefit. But I think you're going to have a couple of things fighting against each other in opposite directions. First, a lot of people have passed over the past 18 months that would have passed over the next few years, and that means that mortality looking forward should be a little better than we would have thought before the pandemic. On the other hand, I do believe there probably could be a negative impact from the fact that a lot of people haven't been getting -- haven't been doing their annual checkups and that sort of stuff. So it's tough to say which one of those will win out. But I think there are pluses and minuses. I'm balanced and probably expect it to be a modest positive, but it's really tough to know for sure, Ryan.

Got it. On new business, in life insurance, you've made a number of product changes over the last several -- I guess, a few quarters. Can you talk about what type of new business returns you're giving in the current environment as well as your outlook for growth in the business going forward?

Yes. We are across all of our businesses, achieving returns at or above our targeted levels. In the Life business, at a high level, it's a little different for different products. Once again, economics rule, the riskier products have higher return targets and the less risky products have a little lower targets. But at a high level, if you average it all up, it's roughly in the 12% range and we are achieving that. Those are products were priced reflecting the reality of today's interest rates. So feel really good about that. Now what that's meant is that the prices for some of those products were not quite a bit, right? The guarantee universe like, for instance, we don't sell any of it. It's actually still on our platform. But the price is such that it just doesn't make sense for people to buy it. Fixed MoneyGuard, so its prices go up quite a bit and you've seen our competitive positioning in that particular space fall and thus our sales fall quite a bit in that space. But we sort of looked at those products, and we've created -- in the case of MoneyGuard, right? We've rolled out a variable-based MoneyGuard, which is a very different value prop, right? It's more about accumulation, you're accepting the risk of the taking an exposure to the equity markets. We can't provide the guarantees we did in the fixed product with that sort of risk. So we sort of transfer risk to the consumer, but give them access turn higher returns. Then we could earn investing in corporate bonds. So we're seeing that product get great uptake. But just as in any new product, it takes a while, it kind of get about all the distribution platforms and got to help advisers understand the nature of the product. So we'd expect that product to continue to grow over the years. So yes, in the Life business, but it really across all of our businesses were achieving our targeted returns, Ryan.

Just one more on life insurance. The legacy reinsurance pricing has caused some earnings headwinds for that business. Can you talk about where you are in that process at this point? And also what have been some of the actions you had taken to offset that, that negative impact?

We've, I guess we've said we've reached agreements with really our biggest reinsurance partners, I think the top 3 for instance and that means from a presentive's standpoint 80% to 90% of our reinsurance arrangements have actually reached agreements and the nature of those agreements has varied across the board, right? And in some instances we've taken business back and actually got paid for that and other instances we've just taken business back and other instances we've accepted some level of price increase. So substantially we've resolved that. We do have some outstanding arbitrations on that remaining part. We've put an assumption inside of our DAC models for help with the resolution of those arbitrations will be. And I'm very confident that we'll manage any level of price increase or capture or whatever that ends up coming out of those. But I think I see this issue is one that we can largely look at in the rearview mirror, but we do have to be aware of what's in front of us as we do a little bit of stuff to deal with.

Do the agreements generally preclude any further actions taken by the reinsurers in the future on those blocks of business?

Yes. Just these are all negotiated agreements with these parties. And so I don't want to sort of speak to them, but let me say we're very happy with the outcome with our 3 biggest partners, which I'm not going to specifically name. They're still very active participants with us. They tend to think about our relationship holistically. And I think both sides feel very good about the nature of those agreements.

Got it. Well, shifting to the annuity business. The ROA has generally been in the 75 to 80 basis point range, I'd say, over time. If you look at the last couple of quarters and you adjust for variable investment income, it's more towards the lower end of that range. Can you give a little color on your expectations there going forward?

I think Ryan, over the near to midterm, I think that still is a reasonable expectation. I think we've seen a little bit of a lag this year because of some of the mechanics of our products. If you think about the VAs with guarantees, we have a feature where the fees we charge are based upon the benefit base as opposed to the account value and those benefit bases reached on an annual basis. So in an out market, you're sort of always lagging that. And so you've seen the fee rate sort of lag the growth in the markets a little bit. So I think that had a modest negative impact. But that will catch up. And by the way, that is great risk management benefits in the out markets, which is the whole thesis of why we did that. I think over time, the ROA will be driven by the nature of the products you're selling. And let's take buffered annuities or index variable annuities, for instance. It's a very different risk profile than a view of guarantees. So those products themselves, which don't have the guarantees and that sort of stuff. Once again, an economics rule. They're going to have modestly lower ROA targets than a product where you're offering guarantees. So over time, that could have an impact. But I think near to midterm, it's a reasonable expectation 75 to 80 as you talked about.

Okay. Great. The -- we have a couple of different things happening in terms of the NAIC is in the process of developing a new interest rate generator, then you have new GAAP accounting for variable annuity liabilities in 2023. To what extent do these changes have any impact on the way you plan to actually manage the variable annuity business? Or do you view them as not affecting how you manage the business and they are just changing the accounting?

I think if you just look at the calendar, the new accounting is near the new generators, so I am going to talk about that one first. Our focus in providing guarantees on variable annuities has always been to run a hedge program whose focus is to generate the assets needed to provide the claims that we may experience in the future. That means we run a very robust hedge program. It's an expensive program charge consumers for the nature of that. I think as we've talked about, we pull around $500 million of fees of operating income from the hedge program that additionally we have a little bit of expected breakage, which appears below line. So it's not cheap to offer guarantees and so that's what we've done historically. Now, in running that program, we've had the benefit of not only to ever program that has this goal and it meets it's goal of generating assets we need, but it also has been in alignment with GAAP accounting, which is probably fairly unique to Lincoln that were in that particular position. So now GAAP accounting is going to change, and we're going to have to look at the facts and circumstances are created by those changes right? Still have that core goal run hedge program that creates the assets needed to provide for any claims that we're going to experience. But we'll have to think about that in the context of the new GAAP. Probably the best example, which I use is guaranteed a minimum death benefits, this especially return of premium death benefits, which is like 90% of our debt benefits. I've looked at this, Ryan, 16 ways to Sunday. I think the FASB is making a big mistake in asking companies to try to fair value those. It's what I call specious precision to think you can value something without optionality and no liquidity. It just sort of divide -- defies the whole theory of how you value derivative. It just can't be done. And so it's highly unlikely that our hedge program is going to be targeted to try to match the movement in something which is a meaningless number, which is the fair value of a return of premium death benefit, as one example. And we'll have to think about the collateral impacts, and does that cause us to have to make small tweaks or real tweaks in the program? And we're in that analysis phase right now. But at the end of the day, what's not going to change is sort of that core goal of running the hedge program. When it comes to ESG, our current expectation is at the earliest that's 2023 may even slip from there kind of similar to the C1 process, right? The NAIC went out and hired a talented party in [ Corning ]. They came back with an approach and sort of when you looked at that generator that came out with, there were just some glaring issues with it, regulators grafted onto the fact that the generator that was originally provided just didn't make sense. So now we're in the phase of the industry, which is the same thing that happened on the C1 factors working with regulators. So I think we have a great history of working with regulators. And I have no doubt that we'll end up with a generator that both makes sense and that we'll be able to work with.

One more on LDTI. Just can you give us any sense of how far you are along in the process at this point? And when you think the right time might be to dispose the impacts of the public?

I think around the middle of next year. So maybe after second quarter earnings next year or something like that, we'll do something with investors. We're in the analysis and there's a lot of systems work and that sort of stuff has been done. So a lot of that's going on right now. We're sort of doing the analysis on do we need to make tweaks to the hedge program. We're trying to sort of button down the final definition items, right? Whenever they come out in new an accounting pronouncement, it isn't like you can go read the words and go, "Ah Oh", that's exactly what they mean. There's always a lot of interpretation that goes on. So I feel good about our progress. We're right on track. When I talk to the outside experts who have engaged to work with us, they tell us that we're at or ahead of sort of peers. So I feel good. But it's a ton of work and it's expensive.

Got it. In just the retirement business, we have seen quite a pickup in consolidation there within the industry. I guess how do you feel about Lincoln's positioning and scale? And do you have enough -- do you feel like you have enough scale in that business to effectively come with these kind of larger mega players that are starting to emerge?

Yes. And once again, to hamper this, I sort of look at the facts. And it makes it really easy for me to support that statement. And the facts are that -- we report an ROA in that business in the 20 to 25 basis point range. It was a little higher last quarter because of the strong outperformance. And that's sort of right in line with peers. It's hard to find perfect peers. It's well above what just the peer record keepers would earn. But it's aligned with companies that have sort of that mix of business we do. So the facts would say that from a return or from an earnings standpoint, yes, absolutely, we're competitive. Now when you pull back and you go, what does it mean to have scale? And why is our retirement business, which doesn't have as many assets as some of our peers, why is it able to do that? I think it's -- there's a number of factors go into that. One, I think our retirement team has amazing leadership and Jamie Ohl and the team she's created, and that's really important. But they also do a great job of leveraging the benefits of being part of the broader Lincoln, right? So for instance, when they are negotiating with underlying fund families that are going to be on the platform, right? But it's more than just our retirement business going in with $100 billion or so of assets. They've got the power of an annuity business with a lot of assets. I think they can leverage those benefits. They get to leverage the benefits of LFD, right? And we've said this all the time, we get on every platform from -- this is a small market of retirement business in America because LFD is the best in the world at getting access to these platforms, and we have all of our other products on those platforms. On a stand-alone basis, I don't think our retirement business would be able to be on all of the platforms where it is today. So once again, it's leveraging the benefit of Lincoln. And then Jamie and her team are just very good at understanding that you absolutely have to remain competitive from an expense standpoint. They were early adopters of digital. It's allowed them to drive. I think it was going back to our last review with them. I think they've driven their cost per participant down about 5% a year for the last 3 years, right? That's each and every year. So in every metric we look at, our overall costs are once again, right in line, and that's reflected in the results. So yes, they've done a great job. It's a powerful story of performance, which is at the end of the day what we're all about.

Great. Well, I think we have reached the end of the time. So we're going to wrap it up here. Thanks a lot, Randy and Lincoln for participating and into the audience for listening. And I will end it there.

Ryan, thank you for having us. It's always nice to see you, if only virtually.

Yes. Someday we'll be back in person. All right. Take care, everyone. Thanks, Randy.

Thank you.