Security Life of Denver Insurance Company (LNC) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Lincoln National Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Al Copersino, Head of Investor Relations. Please go ahead.

Thank you, Shannon. Good morning, and thank you for joining us on short notice. This morning, we issued a release announcing our reinsurance transaction with Resolution Life. Before we begin, I have an important reminder. Any comments made during the call regarding future actions, performance or financial results, including the expected impacts of the reinsurance transaction and intended use of the capital generated, are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from current expectations. These risks and uncertainties include those described in the cautionary statement disclosures in our press release issued this morning as well as those detailed in our 2020 annual report on Form 10-K, most recent quarterly reports on Form 10-Q and from time to time in our other filings with the SEC. These forward-looking statements are made only as of today, and we undertake no obligation to update or revise any of them to reflect events or circumstances that occur after this date. Today's call may include a discussion of certain historical non-GAAP financial measures. Full reconciliations of such non-GAAP measures, including adjusted return on equity, and adjusted income from operations or adjusted operating income to their most comparable GAAP measures can be found in the statistical supplement posted on the Investor Relations site of Lincoln's web -- the Investor Relations section of Lincoln's website, www.lincolnfinancial.com. Presenting on today's call are Dennis Glass, President and Chief Executive Officer; and Randy Freitag, Chief Financial Officer and Head of Individual Life. After their prepared remarks, we will move to the question-and-answer portion of the call. I would now like to turn the call over to Dennis.

Thank you, Al, and good morning, everyone, and thank you for joining us on short notice. This morning, we are pleased to announce we've entered into an agreement to reinsure a block of our in-force life insurance business to Resolution Life. This transaction will generate approximately $1.2 billion of capital. In a moment, Randy will discuss the details, including the blocks to be reinsured, planned use of proceeds, timing and the expected impact on our financials. As we've long discussed, it is our core strategy that continues to drive our 8% to 10% growth expectations. We view block deals as an opportunistic way to generate additional shareholder value by freeing up capital to buy back shares at attractive prices. This is precisely what we plan to do via this transaction, which is expected to be highly accretive to our adjusted operating earnings per share and expand ROE. We have been creative in our use of these reinsurance tools over the years, and we remain open to additional block deals as well as flow reinsurance agreements as we continue to focus on maximizing shareholder value. It is important to note that this transaction will not have any impact on our relationships with our policyholders as we'll continue to administer the policies covered under this transaction, nor does it have any impact on our distribution partners, who will continue selling Lincoln's high-quality life insurance products. Going forward, we remain committed to growing our life insurance business and each of our businesses, and we'll continue to focus on executing our core strategy, bolstered by our distribution strength and product breadth, which again drives our 8% to 10% growth expectations. Once again, I want to say how pleased we are about completing this sizable transaction, and I will turn the call over to Randy.

Thank you, Dennis. This morning, we are excited to announce that we have entered into an agreement with Resolution Life to reinsure approximately $9.4 billion of life insurance reserves, which will generate significant capital. The deal will have an effective date of October 1, 2021. Closing of the deal is subject to usual and customary closing conditions, but there are no regulatory approvals required to close. The $9.4 billion of reserves we are [ seeing ] includes $5 billion of general account and $4.4 billion of separate account reserves. $8.1 billion of ceded reserves come from our Executive Benefits business, with the balance coming from our Universal Life business. This represents approximately 1/8 of total life insurance reserves. Resolution Life will reinsure 90% of the ceded blocks, and Lincoln will retain the remaining 10%. Additionally, Lincoln will provide administration for the ceded business and will remain an active issuer of both Executive Benefits and Universal Life business. The transaction will generate approximately $1.2 billion of capital or about 16x expected earnings in the block, which will fund about $900 million of incremental share buybacks. We'd expect that the buybacks will be complete by the end of the first quarter of 2022 with $500 million accomplished through an accelerated share repurchase program that will begin shortly after closing. The remaining proceeds will be used for general corporate purposes, primarily paying down debt, which will keep our debt-to-capital ratio consistent with recent periods. Looking forward, Life Insurance segment operating earnings will be negatively impacted by about $40 million per year after tax, net of a benefit from amortization of a deferred gain related to the transaction. Additionally, any debt reduction would lower interest expense in the other operations segment. When factoring the subsequent share repurchases, we expect the deal to be approximately 5% accretive to Lincoln's 2022 adjusted operating EPS. We expect the impact on book value per share, including AOCI, to be de minimis. As Dennis said, we remain committed to our core strategy that continues to drive our 8% to 10% growth expectations. This includes continuing to grow our Life insurance business and the Executive Benefits and Universal Life product lines. Lastly, this transaction is only possible because of the high quality of our book of business that we created through the strength of our distribution, product strategy and industry leadership. With that, let me turn the call back over to Al to begin Q&A.

Thank you, Dennis and Randy. We will now begin the question-and-answer portion of the call. [Operator Instructions]. Within the short duration of this call, we ask that questions be focused on today's release, and that you save questions and other topics for our upcoming third quarter earnings conference call. With that, let me turn the call over to Shannon to begin Q&A.

[Operator Instructions]. Our first question comes from Erik Bass with Autonomous Research.

I was hoping you could provide more detail on the breakdown of the $1.2 billion capital benefit? What was the ceding commission received and what came from releasing excess capital?

Erik, as you can tell, it was a very attractive amount of capital generation. There are 3 components to the capital generation. There's a ceded commission and then taxes, which we will pay and then the capital release. What I would tell you is that the capital we were released and the taxes about offset each other. So the ceding commission was pretty much in line with the capital generation we talked about.

Great. And then maybe if you could talk about a little bit how this transaction, maybe changes some of the risk metrics for your block going forward? And I guess, specifically, how has the transaction change your sensitivity to interest rates, both in terms of spread compression risk, but also exposure to potential changes in long-term assumptions?

We really don't see this changing our risk profile at all. We expect to continue to have, for instance, mortality/morbidity represent about 30% of our overall earnings. I'd point out with this business, Erik, I had noted that these reserves represented roughly an eighth of our Life Insurance business reserves. And I'd point out that the earnings represent a very similar percentage. So we don't see this as having any material impact on our overall risk profile, Erik.

Our next question comes from Thomas Gallagher from Evercore.

So first question, you got a 16x PE multiple on this, obviously, very attractive relative to where your stock trades. Would you consider doing more of these in the future on the Life Insurance side or other businesses, if you have that sort of extremely high spread over your current PE? Like is this something that we could expect you to continue to evaluate and potentially execute? Or should we view this more as a one-off and now less likely to do something like it going forward?

Tom, as [indiscernible] and I both say that we're going to continue to evaluate opportunities. As we move forward, to add to our core strategy, which is going again to drive, and we're very confident of this that we've been saying on calls an 8% to 10% EPS growth over time. As you know, I think this may be the third or fourth transaction, including block sales, flow reinsurance transactions. And so we have a history of executing when appropriate on the right terms to improve shareholder value. So we've done it. We're open to doing more. But again, I want to come back to our core strategy remains our primary focus, but we are very, very open to opportunities to add value on top of that core strategy.

Okay. And then just a follow-up. Randy, does this change the gap to free cash flow conversion ratio at all? Or is that still expected to run around the 50% to 55% level?

Yes. I don't -- the way I think about it, Tom, is I don't expect that this is going to change at all or $850 million to $950 million capital return to shareholders over the course of the year. Of course, we're giving up some small amount of earnings, which I referenced in my script. But when you think about the fact that we continue to issue profitable new business and when you factor in growth and you factor in the strength of our balance sheet, I don't expect any change to our previous expectations for capital return to shareholders over the course of the year.

Our next question comes from Humphrey Lee, Dowling & Partners.

Just related to, I guess, using some of the proceeds for debt reduction. But in your prepared remarks, Randy, you talked about the impact to book value is de minimis. So I guess, what is the thinking between using some of the proceeds for debt reduction as opposed to using more on share repurchases?

Yes. I think, Humphrey, as we said, we're selling away some small amount of overall Lincoln earnings. And so I think when you're doing that, it's prudent to think about what you might do with those proceeds. And I think some level of debt reduction, as I mentioned, we expect our ratios to largely remain consistent with recent periods with this mix. I think the percentage we're allocating to buyback is 75%. I think that's a strong indication of being very proactive in how we're using the capital, but some level of debt reduction, I think, is just prudent.

Got it. And then in terms of kind of being open to additional transactions, so are you still going to be proactively looking? Or are you just going to be more kind of -- you kind of dialed back a little bit from that -- the asset that you've been putting on kind of since the beginning of the year? So how should we think about how proactive Lincoln will be following this transaction?

Humphrey, again, at this moment in time, it's kind of interesting because a lot of the business that we're putting on the books is at much higher returns on capital that we're deploying than what buyers are requiring. So we're putting new business on the books at high IRRs. And going forward, if the market stays the way it is, we could sell some of that new business into the private market and create value for the shareholders. So when we do another deal, it is just up to market conditions, and we'll continue to follow it. And again, we're looking both at block opportunities as well as flow transactions. And we're going to keep our -- we're going to keep attentive to the opportunities to create additional shareholder value that go beyond our core strategy.

I'd just add -- Humphrey, I'd just add. We're never not looking at these things. And we have people whose job is to keep in touch with the marketplace. So yes, this is something that's going on continuously in the company focused around the exact strategy that Dennis noted.

Our next question comes from Joshua with Bank of America.

Well [indiscernible] you might answer my question at the end. I was just wondering about the process a little bit. In terms of this deal, this is [indiscernible] it's not something that there's a lot of strain and stress from investors looking at it as a high-risk segment of your portfolio. When you're out there, looking at block to sell, are you being approached? Are you approaching parties? Is anything on the table? Obviously, people are looking for VAs as the thing to be converted into earnings, I guess. Like can you talk about the rest of the book and how the process goes with you looking to sell blocks and whatnot?

Josh, as you might have -- might imagine, it goes both ways. I mean, we're talking to people and people are coming into our offices and are in this world virtually and talking with us. So it isn't any one or the other. Specifically, when you decide you want to move forward, typically, you will create a process that you'll run, that will include multiple bidders, which this process did include multiple bidders, who are all very interested in this business, and it's reflected in the price, which is very attractive.

Our next question comes from Tracy Dolin-Benguigui with Barclays.

This is Alex Rakow, on for Tracy. I just had one question. What type of general account assets will be part of the coinsurance treaty? And what I'm getting at here is just the pro forma asset allocation of your general account look different?

So Alex, the way these things work, we will transfer assets to Resolution that are equal to the reserves minus the ceding commission. And then as part of the deal, there will be an investment strategy, which I'm not going to give any details of, which we've reviewed and approved with Resolution. So they have an allowed investment strategy and the day-to-day decisions they make will be up to them, but they will be done inside the context of the investment strategy that was agreed to as part of the transaction.

Our next question comes from Ryan Krueger with KBW.

A couple of quick ones. One, just -- am I doing the math correct, it's a blocker and $75 million a year, but then net of the benefit of the deferred gain of the ceding commissions that's what gets you to the $40 million?

Yes, Ryan. I think you've got the math. It's between $70 million and $75 million of earnings that -- I mean you can do 1.2 divided by 16, and you'll get a number that's pretty close to the earnings. And then there is the benefit I noted, which means that the Life earnings will be reduced by roughly $40 million when you factor in that we'll be amortizing in this gain. And then additionally, the third I am going to point it out was that to the extent we do some debt pay down, that will benefit other operations earnings with lower interest expense. I'd size that probably $8 million to $10 million.

Got it. And then on buyback is -- I'm assuming you'll continue your normal buybacks each quarter and then we should just layer in the $900 million on top of those through 1Q '22?

Yes. Ryan, as I mentioned, we don't expect any change to that $850 million to $950 million guidance. So there should be no change in our ongoing buyback program from what we've noted before. And back on our last call, we talked about how we were going to be back at pre-pandemic levels of roughly $150 million a quarter. Now we'll have to factor in, Ryan, how many buybacks can be done of Lincoln stocks in a quarter. So that may influence the timing of those. But over the course of the next 15 to 18 months, we'll be on track, and these will be incremental to the normal program.

Last quick one was just can you give any more detail on the UL reserves that were ceded in terms of were they ULSG or current assumptions? And anything on like the vintage of when that business was written?

On when this business is written, we've been in these businesses for decades, and this business has been written over the entirety of those decades. On the UL reserves, they are a current assumption you will, that's been written over the decades.

[Operator Instructions] Our next question comes from Mike Ward with UBS.

I was just wondering, does this deal change at all the potential impact from LDTI? Or could you quantify that at all? And then maybe was that part of the motivation for this particular deal?

No, we don't expect any change to our expected LDTI impact. Any material change...

Okay. And then so I understand this deal doesn't require regulatory approval. But I guess I just wanted to confirm that you don't anticipate any holdups in Denver or anything similar to what happened with the delays in an earlier deal with Resolution Life with one of your peers?

We do not, and that's covered by the phrase that you repeated, which there are no additional regulatory approvals needed.

And I'm showing no questions at this time. I'd like to turn the call back over to Al Copersino for closing remarks.

Thank you all for joining us this morning. As always, we are happy to take any follow-up questions that you have. you can e-mail us at [email protected]. Thank you all, and have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.