Lincoln National Corporation (LNC) Earnings Call Transcript & Summary

Good afternoon. I'm Tracy Benguigui, Insurance Analyst at Barclays, and I'm pleased to host our fireside session with Dennis Glass, President and CEO of Lincoln. [Operator Instructions] I would like to actually begin congratulating Dennis on his upcoming retirement, and after a long, illustrious career, clearly demonstrating prominent industry leadership. And I guess, as you think of advice to tell your successor when you pass the baton, what would you tell your earlier self that you wish you would have known?

Tracy, thank you for having Lincoln and me, and thank you for congratulations and the nice, kind words. Well, I think it's pretty easy. I believe that companies are successful because they create a culture and an environment that attracts people. And once you attract people, if you provide great development opportunities, experiential and otherwise, you're going to have a great team. And if you have a great team, you're going to be able to both grab opportunities as well as overcome hurdles. So I'm most proud when we do biannual -- or excuse me, biannual engagement surveys, we're off the charts. People like working at Lincoln. And again, if you can get the best people, you're going to get the best results for your shareholders. So I would tell my successor, invest more money in our people.

It's great pearls of wisdom. Could you also spend a few minutes talking about the succession planning process, as I think many folks would have guessed the next CEO would have been Randy, given his heightened visibility in front of investors?

Tracy, succession planning, so to say, inside the event and outside the event. So outside the event, over the years, we, the Board and myself, my management team have spent an incredible amount of time making sure, again to my point, that we have the right people on the team, and then those who had the opportunity to follow on my footsteps get a lot of training. So the candidates, the internal candidates, all had that. So that was where it started. Once you get inside the event, which means the Board and I agreed that it was time to get a new CEO, then -- and I've been hedged down on this since March. You want to make sure that the Board has a good understanding of the -- a better understanding of the strategy and the challenges and the opportunities for the company. We want to make sure the Board has a sense of what are the leadership traits, the experiences that the new CEO needs in order to be successful, not only just in this current environment, but in future environments, macroeconomic environments or macroeconomic issues, economy, interest rates, equity markets and all those things. So inside the event, we had a lot of process around identifying what I've just talked about. The candidates had the opportunity to give their point of view on the opportunities for the company in one-on-one meetings with the Board. And out of that process, which is a thorough process, included scans of external candidates. The Board decided on Ellen. And she's a terrific person and a terrific pick by the Board to take Lincoln to the next level.

Got it. Also, just maybe switching gears to some big picture themes. How would you characterize the current macro environment for Lincoln?

Yes. I think the seminal issue for Lincoln over the last 3 years has been an acceleration in the decline of interest rates and particularly -- or most particularly in our individual businesses. And lower interest rates affect Lincoln in 3 primary ways: one is product; two is spread compression; and three is the potential impact of lower interest rates on statutory reserves that you need to add capital to maintain your reserves. Let me take them easily in reverse order. In terms of statutory reserves, we've published a lot of estimates about increases in cash -- excuse me, in reserves necessary if interest rates drop below 50 basis points or not there. And even below 50 basis points, it's a fairly -- it's not a big issue for Lincoln, very manageable, any increases. With respect to spread compression, we have our chart, which -- our waterfall where we identify the categories of earnings that get us to the 8% to 10% range that we're talking about. One of the headwinds in that range is spread compression. So if there was no spread compression, we wouldn't have a headwind. There is spread compression, and we estimate that to be about 2% over the next 3 to 4 years relative to getting to the 8% to 10%. Well, we've set out on a very ambitious cost saving program. You've seen that we've had others over the years. We executed on each of them. My estimate right now is at a minimum, every dollar of earnings that we lose over the next 3 to 4 years to spread compression, that 2%, will at a minimum be replaced by these cost savings. So we've taken the 2% off as a headwind. So no problem on statutory reserves, and we're replacing every dollar of spread compression due to interest rates with the cost saving program. So that leaves the other important issue, which is the effect on product design and product demand from low interest rates. And as you and I both know, I'm going to oversimplify it, our business is a simple one. You collect the premium, you invest the premium and you pay a benefit. Well, if the interest rate is low, that means that the benefit that you have to pay, which hasn't changed, has to be -- you have to increase the premium to make the math work. So as you increase your premiums for a product, demand will go down. The second issue that is related to interest rates is that in a lot of our products over the years have been give us a buck and we'll give you a guaranteed benefit payment, whether it's a $1 of premium for a term insurance policy or $1 of premium for a long-term care product. If you gave us a buck, you could count on a pretty healthy guaranteed outcome. Well, with low interest rates, not so much for term insurance to take our MoneyGuard product, the dollar of premium for a guaranteed long-term benefit, the value proposition just doesn't work for the consumer. And so what we've done is the investment engine under our MoneyGuard product is now a combination of general account investments, and we've introduced equity into the investment -- equity mutual funds and things like that. And so now the consumer both gets a smaller guarantee, but the upside potential is much bigger for the payment of the benefit over the long term. So what that does for us is -- and this is repeating into a couple of the different business lines. But there's two things for us. One, the changes for that product to segment, we have sharing and upside potential based on an equity -- partially equity-driven investment engine. You have a younger demographic that works far better than the older demographic where you had $1 for a guaranteed outcome. So we've added market segments. As a result of that, we've had a lot more distribution. And so it's going to work out quite well over time. And then -- and I expect interest rates by the end of '24 to be higher than they are today. That may draw the guaranteed products back into the market with a decent value proposition. So while waiting for interest rates to go up, we've got new value propositions. When interest rates come up, we'll have the new value proposition plus the old value propositions, and the top line will continue to grow. So interest rates have been tough, but we've responded very well. All of the business that we're selling today are giving sort of a low teen double-digit returns so the capital -- on the capital behind these products. So I'm optimistic to the cost savings programs plus everything else we're doing, it makes me comfortable, I've said this that we're going to be within our 8% to 10% earnings per share target growth. I think with the cost savings program at the high end of 8% to 10%, and with a little help, maybe even north of that.

Got it. And we're going to revisit many of those themes in our discussion. But I guess, what's on a lot of investors' minds, can you just maybe discuss the goals of your block deal strategy? And I think, you're thinking lately is a little bit more on the life side.

Yes. Our block sale transactions are focused on generating proceeds by selling liabilities to buy our shares back. That's the only objective. And in the marketplace today, given the nature of some of the buyers, but in the marketplace today, what makes a good market for selling liabilities is two things: one, and this is sort of basic finance, the buyer wants to be able to predict with some accuracy the outflows to benefit payments. And so Life Insurance has a fairly higher probability of narrow range of outcomes, so they like that. And then the second thing is they like products or liabilities that have the reserves backed by general account assets and because some portion of the buying community have asset management capabilities. And so they might take a little bit more credit risk than Lincoln would take. They might take a little more alternatives behind the liabilities than we might. And so there's a little more juice for them than the way we run our business. So those two characteristics, definable, predictable benefits, guarantee -- excuse me, reserves in the general account makes that liability today the best one to sell. There's a deep market. I know that we've been talking about this for a little while. You all can't see the progress until you see an announcement, I get that. But I'm hopeful that we can see the progress, and we're optimistic that we'll get to a good outcome. And I can't tell you when that's going to happen, though.

Okay. So maybe just a quick follow-up there. I mean, Life Insurance products are also perpetually in accumulation stage. So it is less asset intensive, even though it's in the general account. And you said the market is deep. I guess, when I asked Randy at the AFA Conference, who reinsures these life blocks, he said outside resolution and [ Welton REIT ] and protective, it's more specialist buyers. If the pool of buyers are much more specialists and narrow, what gives you confidence in your ability to transact on the Life side?

Well, I think all of the players are credible buyers. Even the specialty asset managers are credible buyers. And obviously, during the due diligence process, if you felt uncomfortable with a bid because the structure or you didn't know the people, you'd be cautious about something like that. But we know the people that are involved in the auction process. And we're -- it's a high-quality group of people.

So you're saying it actually expanded to the specialty asset managers for Life?

I don't have the list in front of me. And I'm not sure exactly who you mean by specialty Life Insurance people. But it's a broad base of credible buyers with good experience.

Okay. Got it. Okay. And you talked a little bit about this as your outline, product design and how you're navigating lower interest rates for a while. If we could touch upon structured annuities, I know you have a different name for it. It tends to be a growth sterling for the industry, and Lincoln's made notable progress in a very short period of time. While there is more competition, the pie is growing. So I'm wondering how Lincoln could differentiate itself in that area.

Well, in the Life Insurance business, everybody can see the product filing of every one of the competitors. And so you're always constantly filing product competition in the seats which you have, you understand through your own research areas who's doing what, why, what are the features. So there's nothing new in the IVA market. Lincoln's strength has always been a broad product portfolio matched up with strong distribution. We have 1,800 client-facing employees, and we have excellent shelf space. So when you come into a market, it's not easy to get those 2 things. And so that's how we were able to advance so quickly. The market has more players. The aggregate market is growing. We only need to be -- in each of our products, we want to be in the top 5, so we don't have to be #1 in the way we have been. So I'm comfortable. It's a little more crowded. The math on the product is a little less good for the consumer as volatility, which is part of the pricing, has declined a little bit. But it's a great product and good competition, and we have a good product in the competition and a great distribution system.

Okay. Got it. You were talking a little bit earlier about product redesign and recognize all the repricing actions last year heading into this year. And you were even talking about 2024 and where interest rates could be and maybe a higher appetite to take on more guaranteed risk. I'm just wondering, I mean, that's been a playbook for a while. How does the J-curve look with these newer products that are well known on a marketing standpoint like MoneyGuard? When could we see a little bit more of that profitability? And when do you think sales could return to pre-pandemic levels?

Yes. Tracy, let me talk about product pricing for a second and the interest rate assumption. There's 3 methods used in the industry by our competitors. One is some people still price product off of the general account yield, some people price product off of the J-curve, as you've mentioned, and some people price product off of the current yield curve. So when I talk about 12% to 13% returns across our portfolio, our interest rate assumption that goes into that calculation is the forward yield curve. Pure and simple. So whatever the forward yield curve is today, it's how we price our products. So the J-curve, which has typically, even for Lincoln, a more aggressive slope and the rise in interest rates, we don't do that in our product pricing. The other thing that we make sure of is that the capital that we put behind the products probably use 400% RBC. Some people use 350%. So both the interest rate assumption and the capital assumption, I think, are strong in terms of getting good returns for the customers as we go forward.

Got it. And I guess, just the second part of my question. When could we expect sales to return to pre-pandemic levels?

Yes. And that's a line of business issue. We said that we would be building off of the sales levels, roughly speaking, in the fourth quarter of 2020, last year, and then build gradually back up to levels above pre-pandemic over the next 2 to 3 years. And I think we're on track in most of the lines of business to achieve that.

Got it. Good to see many checks there. Now just turning to capital management, your RBC and capital position seems supportive of pre-pandemic capital returns. In fact, you signaled $200 million in the third -- for the third quarter. Should that continue to be the case going forward? Or what are some of the factors we should be watching out for?

So I think Randy, I think, at the last conference mentioned that we've been in the $950 million range in terms of the aggregate over time of share buybacks and our dividend level. And of course, the largest use of capital is for new sales. And so in the next couple of years, as we're building our sales back with less capital-intensive products, the amount of capital absorbed for new business at the level maybe down a little bit from 2019. And then when we get the volumes back up, that will start to get bigger. But we've had a pretty good track record of raising the dividend. So that will go up. And the reason to hold back on a little bit of the free cash flow would be to strengthen the balance sheet, but we're actually ahead of where we expected to be even a couple of years down the road. We are -- we're already where we expect it to be. So we're not going to hold that much capital back to further strengthen the balance sheet because, to repeat myself, we're at where we wanted to be. So I think we'll -- and then even though we're going to get sales volumes back up above 2019 over time, they are going to be products with less capital requirements. And so I think the $950 million can grow over time and it just depends on macroeconomic conditions. So for example, if the pandemic stays at the levels that we're talking about and we have excess -- excuse me, that we're seeing today or we saw last year, that reduces profitability, that reduces cash flow. So -- but when I say $950 million is going to get bigger, I'm assuming that, that excess claim payments go away over the next couple of years.

Okay. Great. Maybe moving on to mortality risk. I think going into the pandemic, I guess, the thesis at the time was that mortality risk is skewed more towards the aging population. But I think the way the losses for the Group Life with the younger cohorts shaped up was a bit of a surprise. Does this experience, especially if COVID or Delta really turn out to be a longer-term issue and a pandemic, does that change your risk appetite or pricing strategy for Group Life risk?

Yes. The Group Life -- again, in 2020, there was a little bit of Group Life increase in mortality. But as we know, the original COVID was striking older ages. And so we had a pretty significant amount of mortality in the Individual business. As we've all watched and read in the newspapers, the mortality is now occurring in age cohorts that fall into the working -- all of us who were over [indiscernible], but most of the age cohorts that are employed and younger. And so we'll have to watch that. But one of the issues in the group marketplace is that a lot of employees buy their term insurance in -- at the work site. And so they may have more term insurance in addition to -- or Life Insurance in addition to the employer purchased for them, that benefit. So we'll have to see how that develops. The good news in the Group business is if we have to change our mortality assumptions, it's a short-term problem because we can -- the business rolls off over 3 years. And then you can reprice the business to accommodate a change in mortality assumptions.

Got it. And maybe just staying on Group. Do you feel like you have enough scale there in your Group Insurance?

Yes.

Yes. And what other capabilities would you want to add for books of business? So I'm just wondering about the overall growth potential there.

Yes. The product that we had to offer was hospital indemnity, which we didn't have, which is an important product in the market for ancillary products in general. And so we just started offering that. And so now we have the right suite of products. And although that's sort of the voluntary space, companies who are in the true group, if you will, wanted to see that package of products. So that will help us attract new customers. We're a very dominant player in the markets that we participate in, in Group. And it's one of the higher-growth businesses that we have, and so we're optimistic.

Yes. And I think others like Group as well, are you seeing pricing as rational there?

Maybe you hear people say that there's -- 1 or 2 of our competitors are trying to take market share. But Tracy, I've been in the business for a long time and I always hear that. Sometimes people make mistakes and they underprice the product, and they figure it out in a short time and they reprice it. Sometimes people intentionally underprice because they want to get shelf space. So that's just a characteristic of the -- actually, any marketplace when people are trying to get a foothold. But on balance, a good set of competitors, no one's doing anything stupid. Everybody is focused on getting the right return on capital.

Got it. And just sticking with products. I mean we saw some sequential pickup in your VA with guaranteed living benefit sales in the second quarter. And I guess, are you finding the pricing dynamics to be more attractive just given less underwriting capacity being dedicated there? And I guess, my follow-up would be high back-up could be with GLB goal if pricing is more attractive for you in terms of how representative it is to sales?

I don't have the numbers right in front of me, but guaranteed living benefits resonate with the segment of the marketplace. The structure that we have in those products right now has less optionality for the policyholder, but still a good value proposition. So I expect VAs with living benefits to continue to play an important part of the overall product sales. What we actually have seen is a pickup in sort of vanilla VA, which just is tax per rep or mutual funds. That's how the whole product got started. And that's because of people who're looking at the potential for the Biden proposal, higher marginal tax rates and so forth. So there's a little bit of a -- and today, they've come out in less than 24, 48 hours House Ways and Means Committee has published some of the tax pay-fors. And so higher marginal tax rates, lower state tax exclusion or said otherwise, more state tax payments, that's helpful to our products in general, has been over time.

Got it. And you talked about the expense savings, and I know that's something that you're going to announce a little bit later. But any kind of other, I guess, preview you could provide us and how we could think about how that engine could keep turning?

So Tracy, this is the most comprehensive program we've had to -- and there's a couple of dimensions to it. There's a cost benefit dimension. There's also skill training for our employees, particularly around execution. So we're very excited about the overall program. Randy will provide some definition of how much and when and what the investment requirements are to get these savings in the third quarter accounts call. So I don't have much to add. What I can tell you is that for the last 8 months, we've been in the discovery phase. And in the last 90 days, we've been taking our sort of first cut expense opportunities and converting them specifically into numbers with an investment associated with it, a timeframe associated with it and somebody's name behind it, so that we can put it into the financials and, as we have with all of our other cost programs, execute on it. And we're about 30 days away from that. It's going to be bigger than anything we've done before. And again, it's just one way to measure that or to quantify it is the 2% spread compression number is going to be offset by this -- by the cost saving program.

Got it. I'm just going to remind folks, you could send questions, about the time I'll take some audience questions. I do have a few more follow-up questions as those flow through. Maybe it's a little bit more philosophical. So I'm wondering how a traditional insurer like Lincoln over time could compete with the PE-backed insurer who may operate under different capital requirement mandates. And you could really excel at privately sourced asset origination capabilities. I guess, as an equation, that's more effective in managing long-dated insurance risk as permanent sources of capital.

Yes. So 10 years ago -- and I'm an investment guy. But 10 years ago, I made the decision that the best use of our investment department would be to focus on portfolio construction, credit loss minimization and higher outside managers to pick individual securities. So we're actually in a better shape than some of the standalone companies because standalone asset management companies that add value because I can go to any one of them. We can go to any one of the 5 or 6 originators of structured investments, and we can pick the kind of structured investment we want. Somebody else is going to source it, they already have the infrastructure and scale in place to do that. If you're a specialty asset manager, you just don't have the capacity to be across all products inside of, say, structured -- or inside of structure. So I think the business model that we initiated, I think, in the United States really is -- positions us as well as anybody to take advantage of strong origination capacity of the asset management industry.

Got it. I guess I want to mention LDTI, it's probably too early to talk about the impact for you. But I'm wondering how you just view accounting rules and if that would have maybe some changes in your strategy as you try to work with it, or are you more of a cash flow business and you're more agnostic on the accounting side on how you manage your business?

So I guess if we just look at where the industry is today, the one interest rate adjustment that's made on the balance sheet is AOCI. And so -- I forget, but I think we have -- our book value might be $95 if we added back in the interest rate gains from the book value of our assets. But we subtract it out. We don't pay any attention to it, and that's true for other competitors. So I'm not sure why -- because you lowered the discount rate on the liability, because of some accounting -- GAAP accounting theory, why you wouldn't just add that one back, too. And so -- but we'll see how that works out, but AOCI is ignored. Why would we spend so much time worrying about what is essentially the same thing. It's simply a different interest rate assumption when creating the present value of the liability. So we'll have to see. I mean investors, and rightfully so, don't like numbers moving around, volatility to the extent that operating earnings begins to be defined differently by different companies. I think it's very difficult. It's not good for the industry. It's not good for the industry's valuation. So I'm hopeful that the industry comes together that we come up with some -- again, I'd just simply like to add back the discount related to the interest rate adjustment on the LDT -- excuse me, on the liability benefit stream, the same way we do on AOCI and just ignore it.

That's one way to go. I guess my take on why folks do that is because there's so much asymmetry between the assets and the liabilities, so you kind of fix that problem with LDTI. So that may reduce the motivation to take it out.

Well, it depends on the mix of assets. But where my analysis falls through a little bit is that the assets on the -- inside the general account that created AOCI don't back the liabilities that LDTI are going to be. So I'm just saying forget them both because the current GAAP accounting is good.

Got it. I'm not getting any audience questions. So I guess my last question for you would be what your 2022 bold prediction may be.

2022 bold prediction. I cannot remember a time in my career, which spans 50 years, when it's been more difficult to make bold predictions. You have so many different macroeconomic issues. We look at the -- as one example, if you look at the monthly unemployment rates where the number of people going back to work, I mean we missed the last estimate of 800,000, it was on 260 or some number like that. But who really can try to understand what family has to stay home and take care of the kids or who's on vacation. I mean, it's just a very unpredictable period of time right now. So let me just make a prediction. No, I'm not going to do that. We'll leave that up to your economists.

Okay. Again...

Here's a prediction, Lincoln Financial is going to get an outstanding new CEO. That's my bold prediction for 2022.

Because I was going to congratulate you again on your retirement, and it's been a pleasure speaking with you, and that concludes today's session.

Thank you, Tracy. Thank you for inviting us.

Take care.

All right. Bye.