Lincoln National Corporation (LNC) Earnings Call Transcript & Summary

All right. So we'll go ahead and get the session started. Thank you, everybody, for joining us, both in person here in the room and also virtually. So the -- towards the end of the session, I will stop a little short of the time just to allow if there are any questions from the audience whether in person here or virtually, I do have a feed. So if there's any questions, keep that in mind. Dennis, thank you for being here. I have Dennis Glass, President and CEO of Lincoln. So it's always a pleasure to have you, but thanks again for being here.

And thank you for inviting us. It's a great conference, and we are glad to participate.

So I thought we'd start with a higher level question about some of the growth initiatives. And maybe you discuss some of the key areas for Lincoln over the next few years. What are some of the products you're having success with? Where is that strategic focus right now?

Yes. Alex, if we could just -- we talk about a target of 8% to 10% and the components of that target 8% -- 8% to 10% EPS growth. And the components fall into 3 categories: management actions. So the 8% to 10%, that's typically 6% capital market impacts, which is the offset of spread compression by assets under management, that's about 1%. And then typically, we get about 2% from our share buybacks and that adds up to 10%. So the first 2 are about the same. But because of the accelerated share buybacks related to the block sale instead of that number being 2, we expect to be 4%. And so Randy and I talk about, and Ellen talked about being slightly ahead of our 8% to 10% growth over the next couple of years. Part of it is driven by that share buyback. So now I'll go back to management actions inside the 6%. Typically, you have 4% coming from top line revenue growth in aggregate for the businesses. It's a little bit south of that because we're rebuilding our sales volumes with new products, new consumer value propositions. And as we all know, that's related to drop in interest rates over the last 36 months. And then margin improvements, mostly in the group area and then expense improvement across all of the businesses on top of that. When we look at the growth of the individual business lines, because of margin improvement, we expect to see the Group Protection business grow pretty dramatically over the next 3 years. Our retirement RPS retirement income business has got good growth rates. The VA business, good growth rates. Life Insurance is a little more challenged because a lot of the spread compression is occurring in that line of business. So we're comfortable with communicating that we expect to be over the 8% to 10% growth that we typically talk about are at the higher end of that at least driven by all those factors. But again, when you buy such a significant shares, part of your shares back, I think we're estimating as a 4% to 5% EPS.

That's helpful. And so recently, there was a new initiative, the Spark initiative that was rolled out. So maybe you could help us think through that initiative. What are some of the things being done there to generate efficiencies.

Yes. We've had a series of efficiency programs that have a cost saving component to them but are much bigger than that. Let me start with the digital program. We set out to improve the customer service levels and aimed at not just being -- having better customer service experiences for our clients and partners than our Life Insurance competitors but trying to match what people are seeing from the Board, digital companies. And so it will be stand on the corner and get an Uber and take it anywhere in the United States. You don't want to wait 45 minutes to change your address on the phone. So that project also though had a big cost component in it, cost savings component. I think we estimate that of $120 million, maybe $200 million, $300 million of investment. And that's coming to an end. And so now we have what we're referring to as Spark which is a much more comprehensive program in the sense that it covers digitization. That's a big part of the savings. And it covers -- so for example, with virtual distribution, our cost of distribution is going to go down. We don't have people traveling as much and are, in fact, more effective in certain segments of the sales process virtually than they were in person. So that would be a piece of it. It's -- and there's a lot of small things that are going on, just cutting meeting times and providing people with better leadership development. But the dollars of savings, which will weigh more than offset spread compression over the next 3 years, I think we're talking about $260 million to $300 million pretax growth exiting '23 and '24. That's way more than the spread compression that we'll see in those same years. And the majority of it is coming from a big picture -- a lot of it is coming out of the IT department going from sort of going from where we are to the cloud that has big savings associated with it and how we run the IT department. Another big part of the $260 million to $300 million is coming out of group. And that's digitization, the first time around with project ambition. We're in the midst of an integration, and so we delayed the converting paper processes to digital processes. So that's a big part of what's going to happen, getting to that bigger number. But we're more excited because it's going to improve customer service. It's going to improve the way we execute at Lincoln, that really is a very comprehensive improving the way we do business, saving money while we do it. Let me hasten to say that when we put a number like that out, these numbers have been thoroughly vetted. We didn't get to that number until we spent 9 months of betting the opportunities, putting the investment associated with the opportunities on a piece of paper and having some person responsible for executing and getting the savings. I think we can say at Lincoln would never missed a cost savings target that we felt comfortable sharing with our investors and at meetings like this. So it's an exciting program.

That's helpful. Maybe we move over to Group Benefits, and there's been a lot of focus on mortality and under age 65 individuals recently in particular. And I'd just be interested in your thoughts on what you're seeing there and any need to reprice the product over time?

So let's speak with the near term -- speak to the near-term. In the fourth quarter, we're seeing some of the same trends, which is -- that's in the working age cohorts, which is where our group business is focused with its Life Insurance products and risk. Yet to see how much of the national trend, which was consistent in the fourth quarter, the third quarter in terms of cases that manifest themselves in our numbers. But I think the industry, in general, is looking for some similar trend in terms of group. So with respect to pricing, we've said that we have increased pricing new business by 5% last year, we did another 5% next year. That should cover some lingering COVID experience. And I think the industry and Lincoln will just have to see what's the expression in long haul impacts on people and LTD and STD and mortality but develop out of the 24 months longer COVID -- we'll see how that works.

Maybe sticking on Group Benefits, the growth outlook is something I wanted to touch on, and there's some tailwinds maybe back in terms of employment, wage growth, et cetera. Would be interested in nearing how this year is shaping up in terms of the growth and the open enrollment process.

This is really a very good question because it points out that about 50% of our premiums I guess, this year, 59% of premiums come from employee-paid products inside of the Group business. So when you asked the question, how is enrollment going? That's very important to us because it's such a big percentage of our premiums. So on that dimension of sales and premium growth, it's pretty good. To your point, there's more people employed. So that helps more people after the experience of COVID power sort of market research as people are more interested in the life insurance business products, broadly speaking, financial protection. So that's a positive. The segment that still is trailing a little bit in terms of new sales, and we've talked about this is new business to new customers. And we're seeing more quotes for new business, new customers, but it's still pretty sticky. The company's corporations of America still a little reluctant to move the Group business to a new carrier even though there might be a cost advantage. And -- but even though that slows new sales, it protects the existing premium because we're the beneficiary of not having business taking away from us by a competitor.

The next topic I wanted to touch on some of the cash flow dynamics, the statutory earnings power, I think investors are increasingly looking at these things. And I guess when I think about the statutory earnings power of Lincoln, could you help us think about how much capital the company generates? How much of that is being driven back into growth versus kind of converted into what people sort of categorize this free cash flow?

So such earnings can move around a little bit, but let's just focus on Lincoln generates of $2.6 billion of statutory earnings this year plus/minus last year. And that's the number that should grow over time in the same way GAAP earnings grow over time because of our cost savings program, because of profitable new business margin improvement and things like that. So that doesn't have a component in 8% to 10% associated with capital allocated share buybacks but all the other components. So the $2.6 billion should grow. Today, again, this is round figure, is about $1.5 billion to $1.6 billion of the $2.6 billion backs new product sales. And that's why very careful about making sure we get double-digit returns on capital back in our new sales. If you get your returns at those levels, the $2.6 billion will grow over time for the reasons I've talked about. The other part of the $2.6 billion, we talk about about $900 million of that $2.6 billion being dividend up to the holding company, and we have $300 million worth of dividends plus/minus about $600 million worth of share buybacks. So when people start talking about free cash flow as being equal to dividends plus share buybacks sort of missing the component that by putting that $1.5 billion into profitable new business and growing the business, growing the $2.6 billion over time, that's really critical. And so we could take the $900 million to $1.1 billion by so doing $1.5 billion in capital behind new sales to $1.3 billion. But we don't think over the long term, that's a good decision. The other thing I'll say about the $2.6 billion and the $1.5 billion that's being put behind new business is the products that we're selling today have less capital associated with them and the products that we were selling 2 or 3 years ago. So the $1.5 billion for the same dollar amount of sales, it's going to be roughly 5% to 6% less going forward because the products that we're selling are -- don't use as much capital.

Maybe along those lines, I think you recently announced the flow reinsurance agreement. And maybe you could talk about how that sort of all plays into the capital efficiency of the new business as well.

Yes. The flow deal was for I think sales that aggregate $1.6 billion over the next 2 years. And the reinsurer reinsured the living benefit risk and using the same math that we use. So they took the responsibility for that and the capital associated with the reinsurance -- excuse me, with living benefits, We kept the base contract fee income which is the majority of the earnings that would come off of the business because our rider fees are just a little bit stronger than our expenses associated with hedging and so on and so forth. So I think we improved our ROE on the capital behind that $1.6 billion because we don't have the rider risk and the associated -- excuse me, the living benefit risk and the associated capital by about 400 basis points. So it's a good deal. We're happy to keep some living benefit risk. So -- but as we sort of manage where we want to put our capital, ROEs and things, these reinsurance deals can be a very good tool over time, and we'll continue to do.

I thought we could also touch on the Retirement Plan Services business. And I think I found that increasingly, companies been talking about scale, companies are talking about reducing unit costs and so forth. I just thought I would ask, do you feel like you have scale in this business? Is this a business you need to be a consolidator in to win?

Yes. Scale is an important issue across businesses. But it has a couple of different definitions. So when I think about scale, less use a very specific metric, cost per participant. Our cost per participant because we concentrate just in 3 principal market segments, government, health and education where we have good market position. Our cost per participant is pretty close to average. And based on the Spark, it will get better than average. So from a scale perspective, we're fine. You also see that manifested in the ROAs that we get on the business, which run in the low 20s, which is competitive with any one-off, if not in excess of the large-scale consolidators. So we're very comfortable with the business. It's one of our best return business, best growth business. We've had 7 years of positive net cash flow. So a lot of the consolidators can't say that. So it's a good business. We get -- I think we've got 2 or 3 awards again for superior technology back to project condition and investment in digital. So it's really a good business. We run it really well. We get the appropriate returns. And scale is not an issue. I'll make one more comment about scale. The other thing you have to have is in distribution. So the way we price distribution in the insurance industry is. You don't want your cost of distribution being bigger than the allowable that you have in your pricing. And we achieved that very easily. But because a large part of our business on top of those 3 segments that I talked about are in small case 401(k). I think financial distributors, which sell annuities and life insurance and retirement products across all channels. We have scale on the distribution side for the businesses that we do, for the segments that we go after, particularly the small case. I mean, for example, Merrill Lynch was looking for a new small case carrier, not because it was about 6 or 7 years ago, we chose Lincoln. Not because they needed another 401(k) supplier, but they needed a study like Lincoln that could help them with their cross-selling initiative. We have VA people working with small businesspeople or reselling VA products or life insurance products to small businesses, and that's where the cross-sell comes a financial adviser is working with the CEO of a small business. He wants to also to sell them insurance product. And so the scale of Lincoln helped Merrill grow their total sales, and that's why they brought us in the platform.

That's interesting. So the next topic I have for you is a fun one. The accounting changes that are coming in 2023. I think a lot of people are grappling was what the earnings impacts are, and I'm sure you're not ready to provide quantitative disclosures, but I thought maybe you could comment on it. And maybe specifically on the variable annuity aspect of it with these market risk benefits and the impact.

So Alex, let's go to the highest level and just talk about LDTI in total. LDTI is a GAAP accounting change. And it has no consequence to make it whatsoever on 2 important pieces of the business, that is how we generate cash flow, financial leverage. So it's not a problem from the perspective of some fundamental economic impact on the company. For Lincoln, all this is about is lowering the discount rate at Lincoln, lowering the discount rate on future benefits from what we're using now. And so when you present value future benefits back at a lower discount rate, the liability goes up, and that's all that's happening with LDTI again, at Lincoln. And so if you think about the other places on the balance sheet where you have interest rate adjustments that people sort of cost to the side, AOCI. So we have $14 billion worth of book value that nobody pays any attention to in the difference between what the books -- the assets are carried at what the market values at them today. I can say we haven't quantified the number, but I can tell you the LDTI impact coming from the reduction in interest rates is significantly lower than the amount of AOCI benefit we had, if you were to add that back. And we're not going to get into any more detail at significantly lower because it's still is complex again to figure out which liabilities are actually covered by the GAAP guidance. But my bottom line is it's noneconomic and if you compare it to AOCI is considerably smaller impact based on today's interest rate levels and equity market levels.

That's really helpful. Thank you. Another topic that's a little more nuanced, I wanted to talk to you about is you have this reinsurance arrangement, and you have Barbados legal entities. It's actually provided a healthy amount of dividend in the company over the last few years. So I'd just be interested in anything you can comment on there in terms of capitalization and dividend capacity.

Yes. So let's stay with LDTI. LDTI is an issue for the subsidiary. And I'll tell you why in a second. But back to your point, we've had LNBar in place forever. Really, it's a real subsidiary with real capital and it pays real dividends up to the holding company or into Lincoln National Life and then up to the holding company, I forget the route. And the reason it's a part of LDTI is because Barbados defines regulatory capital equal to GAAP equity. And so we need to work through and we have several options to deal with that change, and we're not concerned about it. Just sort of back to a very high level, if we collapsed LNBar into Lincoln today, we have no material effect plus or minus on RBC that could be a little bit different capital market conditions. But we've said over the years that we could collapse any impact. So that's an option that we could use I suspect that we will keep Barbados, we'll work through this statutory equaling -- excuse me, regulatory capital equaling equity. We'll work our way through that. In terms of our as a significant source of distributable earnings, we manage our as part of the overall capital of the company. And so I won't get to -- I don't get too hung up on whether the capital is coming from Lincoln National Life or it's coming from Barbados because we just manage that to our overall capital needs, our targets and RBC, things like that.

Understood. Next I wanted to ask you about just sort of the market views and your -- you have on misconceptions in the market around the way that some of these companies are valued and I think you guys are taking some action, right? You took some -- you've taken some action on some over time to help the earnings of the company in response to some of that. But what are your views on that? What are the biggest misconceptions out there?

We debate this as a management team. We debate with the Board. And we debate it with you and we debate it with our investors. So my view right now is that there's sort of this focus on the VA business, which is 50% of our GAAP earnings. And it has a lower multiple and that lower multiple comes from 2 -- for 2 reasons, I think. Reason number 1 is despite the fact that we've never had a blow-up in that business, despite the fact that we have a 20% return on capital north of 20%, 21% return on capital, other companies have had low-ups. And so I think there's a little guilt by association, even though we have had them. I mean, it's got a 20% business for decades of that at least as far as my memory goes back. So I don't think we get enough credit for the quality of that book of business, the consistency of earnings coming out of that business. No hiccups, policyholder assumptions and things like that where the other companies have had those problems, some of them, not all of them. So you have that guilt by association. The other issue is that with the VA business. It's a little hard to get into tail risk and understand the tail risk for an investor. So Lincoln needs to do a better job. We have the tail risk covered. There's some risk. I mean if you run your general account and only invest in AAA government securities are not going to be able to do anything. And so if you run your hedge program as if the were only investing in AAA securities and didn't take some risk, there wouldn't be much -- it wouldn't be as profitable as it is. So I think the VA issue, we get a little discouraged think again, after decades of no problems and excellent returns, good growth that you get more credit even though some have not everybody, but some people. The second thing that I think is missed is the overall diversification of our business. So we have 3 sources of income, spread compression, fees on assets under management and mortality and morbidity. Our mortality and morbidity business is Life Insurance business and the Group Protection business are very good businesses overall. The VA business that we talked about in an RPS, which we've talked about. So I think if people would step back and say, well, the VA maybe is a little hard to figure out tail risk. But when you look at the diversification of the company, the 8% to 10% growth that we've achieved over time, some of the best ROEs in the industry. I think if you add it all up, and not just focus on 1 little piece, there should be more benefit from looking at the whole and diversification.

One of the other trends that we've seen in the industry is greater partnership between life insurance companies and asset managers. You saw with the Brookfield. You saw most recently with AIG's Life for business and Blackstone. Just given the asset management isn't a part of the business that you guys have chosen to focus on, would a partnership make sense at some point for you all?

Yes. Alex, we decided we have a retail business model. And that means that we deliver products in the hands of everyday Americans to create financial peace of mind. In order to do that, you need great distribution. You need good investment results. You need great product; you need great overall risk management. We decided years ago that we didn't need to be in the business that's selecting individual securities. So Ellen runs the investment department. She has a great team underneath her. We focus on asset liability management. We focus on portfolio construction. In general, we focus on aggregate credit risk, but we source out the general account investment grade assets to asset managers to pick the individual assets. Our alternatives, we source out to the best alternative investment managers, private equity firms because they have sourcing. And so we have access to all in the asset segments and access because we hire managers to pick the individual securities to a much greater extent than most insurance companies have. A lot of -- most insurance companies rely on their own employees to pick these assets. Well, you can't have as broad of a range as we do because you just can't -- even in a private equity company, they specialize in different segments. And then private equities as an example. So we start off in a much better position because of the way we run our investment portfolio. And so we have access to these asset managers that our competitors don't necessarily have. Now having said that, because of the AIG situation, Blackstone is going to get a higher percentage of management of the general account, as I understand it, at the spin off the company. We could do something like that. And if it was good for Lincoln, it was good for our shareholders, and it was good for the asset management company, and we're taking a look at things like that, that could work out very well. But again, I start from the position because we have a manager selecting the individual assets. We have access to the best in every asset segment already. So there's no asset class that we don't have access to through our model. But is there some way to take a particular asset manager who brings unique capabilities to the table. We could allocate more to them. So work out for them, work out for us if it works out for our shareholders.

Got it. So at this point, I'll take a question from the audience, if anyone has one. Maybe I'll ask 1 more. I think you guys frequently get questions on interest rate risk and universal life insurance, I think is frequently, guys with concerns around interest rate risk and just if you could talk about that product, and I think you guys have talked a lot about the statutory impacts and so forth, but what gives you comfort in your individual life book and on the of low rates?

So the UL business was put on by a lot of -- it's better, I think, back in the late 1990s, 2000s, guaranteed universal life probably represented 80% to 90%, may be a little bit high, but directionally, it's correct of aggregate life and -- life insurance sales in the United States. And so we were a big life insurance company. We participate in that business. Turns out collectively for the industry and for Lincoln that the interest rate assumptions used in pricing were higher than what we're experiencing today. So on GUL, that manifest itself in part by spread compression. And as I've just discussed, we've got 8% to 10% earnings growth and have been effective at overcoming spread compression on the whole company, including the Life Insurance business and the GUL found in there. That's part of that. So that's an issue, and there's no easy answer to that. But again, there are some questions in the industry about policyholder lapse assumptions. People are concerned that people will pay more premium for longer than what the pricing assumed. We don't think so, but we'll have to see how that plays out over time. So it's a big part of our life business. Again, in the aggregate spread compression is the near-term issue we're going to overcome that. And over time, we'll have to see how GAAP earnings are affected by this spread compression. The other thing I want to mention very quickly, though, is from a statutory perspective, we've said, and it continues to be the case that there's modest statutory capital of incremental reserve requirements even with the 10-year at 50 basis points. So it's not a grab on capital based on our assumptions right now, even down to 10 -- excuse me. 50 basis point tenure.

All right. Well, we're out of time. So thank you very much for being here. Really appreciate it. That's a great conversation.

Great. Thanks, everyone. Thank you all for being here.