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Executives

Dennis R. Glass - Chief Executive Officer, President, Director, Chairman of Committee On Corporate Action and Member of Executive Committee

Analysts

Jay Gelb - Barclays Capital, Research Division

Lincoln National Corporation (LNC) Barclays Select Series 2013: Insurance Forum March 18, 2013 3:05 PM ET

Jay Gelb - Barclays Capital, Research Division

All right, good afternoon, everyone. I'm Jay Gelb. It's a real pleasure here, to have Dennis Glass, who is the Chief Financial -- I'm sorry, Chief Executive Officer of Lincoln Financial Group. Lincoln has a particularly strong presence in 4 key areas: life insurance, annuities, retirement savings and group insurance. So we're going to continue the fireside chat format we've been using today. And Dennis, why don't we start off with what's at the top of your mind?

Dennis R. Glass

Well, Jay, first, thank you for having us here. We greatly appreciate it and I appreciate the attendance and the people who are listening in. I'm pretty optimistic about the opportunities for the insurance industry over the next decade, and I'll sort of narrow it down to Lincoln specifically. But we serve employer markets and particular segments of the employer markets in our Retirement businesses and in our Group Ancillary businesses. And that segment of the market, this is important, is the smaller employee base companies, so 1,000 and under. And McKinsey work shows that, that segment, the smaller employer, the growth opportunities are double what they are in the overall market for employer products in the retirement system and in the Group Protection business. So where you participate, what segment of the market you participate in is a very important piece. If I go over to our individual markets, there we have power of very significant demographic movements. We sell income guarantee products, there's a lot more people because of the baby boomers that are retiring. That group is particularly wealthy, and so the dynamics in that marketplace are pretty strong as well. So when I look at, specifically, from Lincoln's perspective, when I look at the markets that we serve, the buying preferences inside of those markets, I'm pretty optimistic. When I drill down to Lincoln in particular, I just want to draw everybody's attention to the fact that over the last 5 years, we've completely recovered in terms of earnings power, earnings per share power, absolute operating earnings and ROE. As I compare that to the banking industry, the banking industry over that same period is up 2%, the life insurance industry is down 9%, so we've outperformed our peers over that period. More importantly, it's not the outperformance, it was just the strength of the company has returned to pre-'07 levels or the earnings of the company and ROEs and so forth. Same point on the balance sheet. Today, the balance sheet is stronger than it's ever been. One key metric there is we carry about 2 years of debt service at the holding company, whereas in pre-2007, Lincoln and a lot of other companies ran a negative cash balance because the capital markets were always open and of course, that changed during 2009. So you have $700 million at the holding company level. Our RBC ratio is near 500%, at 490%, in that area. And so it's very solid, very strong, gives us the opportunity to have flexibility, whether through share buybacks or whatever one might want to do, invest in the businesses, another example. When I look into 2013, so we have this great market opportunity, the company is as sound as it's ever been. And when I look at the emphasis for 2013, we're in 4 businesses, as you mentioned, and we'll continue to invest in all those businesses. I think they're good businesses. We're going to overinvest in the Group Protection and retirement businesses. We think there's better opportunity there for ROE and growth. Again, on the segments that we participate in. Pressure on all the business units to increase pricing across the board, continue our emphasis on strong risk management and effective risk management and continued pretty active capital management with more share buybacks. So we've had 9 quarters of meeting or beating Street estimates. I've been saying for the last 6 months, I don't ordinarily talk about price [indiscernible] progression analysis because our price was about $9 below where it should be on that line, I've argued that it will move up more quickly and we've outperformed the industry for the last 15 or 18 months or at least all but 1 or 2 companies. And I think there's still $4, $5 of just sort of getting back to where the industry is in terms of valuation, and then hopefully, the whole industry will rise. So I'm optimistic. Strong company, strong markets that we serve and a low valuation.

Jay Gelb - Barclays Capital, Research Division

Let's start with a broad question about the life industry, Dennis. As you think about the operating environment for the life insurers, what do you see as the major opportunities and challenges this year and then the next 3 years beyond?

Dennis R. Glass

Pretty much what I've been talking about. I mean, the demographics are pretty strong. The products that we provide Americans are products that are always in demand. Each company has to compete effectively in getting -- compete in getting those products effectively and priced right to American consumers. But I think as compared to the last decade where maybe the banks had an advantage and the mutual fund companies had an advantage. Post crises, guarantees, focus on safety, the insurance industry is in the best position to meet those concerns and the needs of the American consumer. So I think that's all very positive, and the industry is -- not only is Lincoln well-capitalized, but the industry is well capitalized, by and large. So those are positives. Obviously, if you're in capital-intensive businesses, life insurance or annuities, low interest rates mean that you're getting a low return on the capital that you have to put behind your products and so that's a bit of a headwind. But the industry is not simply a victim to that. You can lower your crediting rates, you can cut your cost, you can improve product pricing, and so you just don't just wait around to be affected by it, you try to take positive actions to deal with the environment. And at Lincoln, we've done that pretty effectively. And although it gets harder every year, some of the tools get used and aren't available anymore such as reducing crediting rates, but there's other things that we can do to blunt the impact of low interest rates.

Jay Gelb - Barclays Capital, Research Division

Turning to the Variable Annuities business. This is a business has a garnered a lot of attention due to industry product changes, as well as for some companies in the industry, sizable charges to earnings and even some recent merger and acquisition activity. Lincoln has maintained a steady presence although sales in the fourth quarter were higher in variable annuities on a relative basis. How do you view the current state of the VA business specific to Lincoln, and how do you think about it going forward?

Dennis R. Glass

Yes. I think it's -- a well-managed Variable Annuity business is a very good business. It has risks associated with it, but it's priced at middle teens, we've been showing 18%, 19% ROEs, and we need 18% or 19% ROEs because there's certain risks in the business. When I step back and I look at the last 5 or 6 years, definitely what's happened is the pricing has hardened up, and so the products that are in the market today are still good consumer products but the dynamics of return on equity, taking less risk, having less risk features, is a clear pattern over the last couple of years. So the competitive marketplace, at least from a pricing standpoint, the features [ph] is as good as it's ever been. There's a couple of people, as you've said, who have left the business. I think most of the time, you'll find that they stumbled pretty badly at 1 point, and probably underpriced the product and have ended up with a big book of business and sort of hard to get out from under that business. But when you look at players that remain in the market, smart, cautious people, the Metropolitans, Prudentials, Lincoln and others, so we've got good competition. And the fact that the seats have changed a little bit is, from my perspective, actually a positive because the players that remain I think make better decisions -- have made better decisions over the years that they've been in the business, and so it's a better environment for the product.

Jay Gelb - Barclays Capital, Research Division

From a long-term perspective, do you see VAs maintaining that level of importance within the advice channel.

Dennis R. Glass

Absolutely, yes. Coming out of the -- going into the crisis, everybody thought they could invest in mutual funds and grow their nest egg without risk. And then 2008, 2009, came along and there's very definitely a shift in consumer attitudes towards, for some portion of their portfolio, wanting more certainty. And income guarantee benefits provides that for the consumer, and so that would just be one example of changing consumer attitudes and how it fits well with the annuity business in particular. But I think more generally, this whole concept of peace of mind and financial security is provided by the life insurance industry, and that's sort of the mindset of more people today than pre-crisis.

Jay Gelb - Barclays Capital, Research Division

From Lincoln's individual perspective, how have you been able to keep the returns on equity at such an attractive level, and can that be sustained going forward?

Dennis R. Glass

On the VA business?

Jay Gelb - Barclays Capital, Research Division

Right.

Dennis R. Glass

So we've, I guess, 18% is what we've averaged over the last 5 years, 17% or 18%. And of course, that's because we priced the product to get those kinds of returns. But with Lincoln, you have to start with our value proposition which is that we sell account value growth first and guarantees second. And so we've never competed on the basis of the most rich guarantee, the highest roll up rate, the highest payout rate when it gets to the distribution period. An example of that would be we're very careful about the funds inside of our mix of mutual fund advisers. We have more 4- and 5-rated, Morningstar-rated investment managers than any of our competitors, is just one example of account value growth first. Then we're constantly in the market, we're consistently in the market. The average American consumer makes 2% less than the S&P 500 over time because they buy high and they sell low. I think a lot of our competitors found themselves in the same position. The markets began to get wobbly and they withdrew from the marketplace. 2008 and 2009, again, being an example of that, whereas we've been in the market when the market's been low. We've been in the market when the market's been high, and so that consistency in the marketplace is good for your returns. As I've said already, we don't put a product or a feature into the marketplace that's not hedged, and so that protects us quite a bit. And so, consistency in the marketplace, products that aren't as rich as some of the products are in the industry, comprehensive hedge program, all contribute to -- and then again, I'm going to come back to distribution. We've been fifth for the last 5 years in terms of market share, whereas, the top 4 are all different names and the next 5 are all different names. And in part, it's because we have such good shelf space. Every major commercial bank, every major wirehouse, every major regional wire, every independent distribution company, we have shelf space and we have an army of some 600 wholesalers that deliver our product message and value proposition so they can sell product even when you don't have the cheapest product.

Jay Gelb - Barclays Capital, Research Division

Okay. Why don't we switch gears to the Retirement Plans business?

Dennis R. Glass

Yes.

Jay Gelb - Barclays Capital, Research Division

You've made a lot of progress in retirement plans since taking a more focused direction a few years ago. Where do you see this business over the intermediate term and how would you measure success in this unit going forward?

Dennis R. Glass

You're absolutely right to say we did take a more focused approach. The first thing that we had to do was get a new administrative system, which may sound like a detail at a meeting like this, but fundamentally, whereas, the variable annuity product or life insurance product or even a group product can be -- I mean, the value proposition can be defined more in the context of the product. In the Retirement business, the value proposition is defined more in the context of customer experience, the plan participant experience. Can they get on the Internet at 1:00 in the morning and get their balances? Can they get fast movements of their money from one account to another account? So the system that you have in place and the interfaces that you have in place are important. So we started that program about 24 months ago, and we've converted most of -- all of our new plans are going onto the new platform and all of our in force plans, I think the majority of the large cases moved onto that and now the small case is moving onto that. So that's very positive. We have also invested in expanding distribution and particularly like the small-market cases I said earlier in my comments, best growth opportunity, pricing in there is a little bit easier to get to because the person that's being sold a product, the CEO or the CFO of a smaller company, they're more concerned about the full value proposition and their customers having a good experience with their savings vehicle than they are on getting less $0.25 on a per participant cost of recordkeeping. And then you have to have a very large and comprehensive footprint in terms of shelf space and wholesalers in order to sell the products in the small case market. And again, we have that so the expansion of distribution. So we're getting good returns there. We also are in the mid-to-large case market, which is a little more price competitive, a few more players in that space, distribution is through consultants, and so you sharpen [ph] pencils on other side of the table. But if we pick our businesses and pick the size of plans that we want to be in, which again is slightly smaller, we'll do okay. But there's more pricing pressure there. And then the nature of the business is such that you have short duration assets that we've seen a little spread compression. But I think long-term, with the investment that we're making, we continue to see positive net flows and a couple of headwinds on earnings, particular interest rate compression, but a good business for us long term.

Jay Gelb - Barclays Capital, Research Division

To what extent would the benefit of record level equity markets offset that interest rate impact within the retirement business?

Dennis R. Glass

I'll probably be wrong about this but I think our source of earnings on the retirement business is -- and the interest margin and the equity fees are probably pretty close. So, yes, if equity markets are going up, that's helpful to offset a little bit of the interest rate compression. But in-force business by itself won't do that, so we have to have large dollar amounts of new business.

Jay Gelb - Barclays Capital, Research Division

Okay. And what are the trends looking like in that area?

Dennis R. Glass

Good. We've had -- I forget exactly last year, but I think 20% or 30% increase in deposits overall. Positive net flows around $1 billion. And that's a business where a year ago we were having net outflows in a couple of quarters, so it's very positive. Back to the strength of Lincoln. I think it's another important note to say that from a net flow perspective, we've never had a year where we haven't had positive net flows right through the middle of the crisis, which is another example of the power of distribution and the power of having a of good solution set that you can pivot to either because the company wants to pivot to it or because consumers have changed their buying behavior and want to pivot to a different solution. I don't think there's many companies that can talk about positive net flows from all their businesses collectively through the crisis.

Jay Gelb - Barclays Capital, Research Division

Fair point. So keeping with the theme of making progress, you've also been investing in the group protection operation.

Dennis R. Glass

Yes, yes.

Jay Gelb - Barclays Capital, Research Division

And the results there have been hurt by elevated loss ratios, correct?

Dennis R. Glass

Right, right.

Jay Gelb - Barclays Capital, Research Division

What's happening in the Group business and what should we expect as we look out over the few years?

Dennis R. Glass

Probably, at Lincoln, there's more change going on in the Group business than in any of our businesses individually, except maybe the Retirement business. But we're investing heavily. I think we've talked about numbers in the neighborhood of $150 million over the next 3 years. And we're shifting the target market from what's called True Group, which is employer-paid ancillary benefits, long- and short-term disability, dental and life insurance, our 4 biggest products, to voluntary, which means the employee pays for those products and other products. Critical illness products, accident and health products. So we're making a very significant change in the mix of business, and I expect, maybe not next year, but sort of at the end of 2014 and into of 2015, that investment will create a fairly significant rise in earnings if we execute well. In the meantime, we have to be a little cautious about loss ratios. Last year, we saw our mortality loss ratios climb a little bit. We think that was just normal fluctuations -- it will happen from time to time. But we've also seen something that I haven't seen as much in the decade that I've been -- decade or more that I've been watching this business, and that's an increase in severity, which means larger dollar amount of claims per claim, and it's coming from higher wage bands. And I just haven't seen -- you always see in an economic downturn, you see lower wage earners go on disability, short-term disability, more so than when their job prospects are better. And I'm not suggesting that they're doing something that's not right, it's just -- that happens to be the fact. I've not seen in a decade or more where you have an unusual spike in higher wage bands, $56,000 and higher. So I don't know if that's a change coming out of the crises and the economic -- prolonged economic and unemployment downturn or if that's just, again, a fluctuation that'll correct itself. So we're watching loss ratios on LTD, STD, more closely and may take some pricing changes if in fact there's a systemic issue there as opposed to just a normal fluctuation.

Jay Gelb - Barclays Capital, Research Division

As the economy hits a steady pace of recovery, would you expect that to be a benefit to loss ratios going forward?

Dennis R. Glass

Well, certainly a benefit to the top line, and we've seen this already in 2012. We had 9% premium growth last year, 1/2 of that premium growth came from our in-force business, and of the 0.5% -- 5% increase in premium, 4.5% increase in net premiums, a part of that came from more employees at our customers' employment -- or more employees employed by our customers. It came from wage increases and then it came from product pricing -- excuse me, renewal pricing. So at least 1/2 comes from those -- for those reasons. And so as the economy continues to improve, people get paid more, that we have a slight recovery on the back of an improving economy.

Jay Gelb - Barclays Capital, Research Division

Right, okay, right. Let's talk about probably the major macro issue, which is the sustained low interest rate environment. If rates were to remain at low levels for the foreseeable future, what's the impact on Lincoln and the industry more broadly?

Dennis R. Glass

Yes. Of course, the biggest issue is a drag on earnings growth. And the reason that happens is because interest rates have been falling for the last 20 years. And so universal life players in particular, which was the dominant product during those 2 decades, had minimum guarantees, crediting rate guarantees. And so as interest rates kept coming down, you kept lowering the guarantees and now, the industry is probably at the floor there. And so, you'll see some spread compression as portfolios turn over and you can't lower your crediting rates, so that's an issue. Another issue is, this is sort of a round figure, but when you're looking at the profitability of an insurance product, maybe 20% of the profits come from a return on your capital. And so when your capital is earning 6% or 7%, that's a bigger number than when it's earning 3% or 4%. So those are the 2 issues but the insurance industry, and certainly Lincoln, is not a victim to this. I mean, you have to take action and just as an example, when rates drop down to 2%, there was -- there were 2 concerns that people had about Lincoln: One, what was the earnings impact -- I'll talk about that in a second, and the second, what was the balance sheet impact? And the simple thought process -- I don't mean it was simple -- people -- but the simple thought process was, well, you receive a claim -- excuse me, you receive a premium and you pay a claim 20 years down the road. So instead of getting 6% return on that premium, you're only getting a 3% return on that premium, doesn't that mean that you have to put more reserves up to be able to meet your obligations, and it's a very simple thought. What was missed in that analysis is that every time you put a liability on the books, you invest assets for the term of that liability. So looking at Lincoln as an example, our unrealized loss -- excuse me, our unrealized gain on our investment portfolio is $9 billion, and that's the $9 billion that even though interest rates are low, that's going to pay those claims off over time. So we were properly asset-liability matched. So there is no, what we've been saying, there is no cliff event on the balance sheet, either statutory or GAAP, of Lincoln in the near term. And we've put some numbers out, about $500 million some time in the second half of the next decade from a statutory requirement, but that $500 million compares to $700 million or $800 million a year that we make in statutory earnings, so it's a manageable number. So there's no balance sheet impact, and we've been saying that, and I think the market is beginning to believe it. Then, there is the issue of earnings drag and yes, I think we have numbers in the market right now that it's about $35 million a year in earnings drag, $100 million next year. That's certainly a drag on earnings, but we're not sitting still. We still have levers, improving the pricing on our products. And I've said in my outset, we're going to do that across the board. We still can take more cost out of the company and we are expecting to grow earnings. And by the way, just about all this spread compression is easily offset just by our share buyback pro -- share repurchase program at the $400 million level that we've been talking about. So it's an issue on slowing the growth of earnings but I expect that our earnings will grow over the next several years subject to a lot of inputs of reasonable stock market, rates not dropping much lower than they are now, things like that. But a lot of our competitors are talking about flat earnings and I'm expecting growth.

Jay Gelb - Barclays Capital, Research Division

Okay. Staying on the issue of life insurance, it's an important product line for Lincoln but it appears you're willing to shift your focus as conditions warrant. Are we seeing a permanent shift in Lincoln's business with the decline in sales of universal life with secondary guarantees?

Dennis R. Glass

No. Although we did see a decline last year and that was an easy decision to make because particularly, with respect to single -- to guaranteed universal life and short-pay guarantee universal life. And by that -- short pay, I mean there's premium patterns, right? You sell a policy for $1 million, you can take one premium and you don't -- the customer doesn't have to make any more payments or you can have periodic payments and they'll make payments over 30 years. Well, the short-pay stuff, no one was repricing and you couldn't achieve an internal rate of return of more than 5% or 6% on that. And we're pretty disciplined about putting capital out at or above our cost of -- our average cost of capital. And so we've priced ourselves out of the short pay guaranteed universal life market intentionally because there was no returns and then we shifted our emphasis to products that still met consumer needs, but had a higher return profile. And real easily, we all could follow this math, every dollar of life insurance sales uses $1.00 worth of capital. If I reduce sales, if our sales because of pricing changes were reduced by 20%, about $200 million, why would you spend $200 million selling new product that's only earning 5% or 6% when you can take that $200 million and buy your stock back and get a 15% or 16% return on that? So that's what happened last year. But actually, by the end of the year, our guaranteed universal life sales were a very small proportion of our total sales, but total sales had gotten back to the same level in the fourth quarter that they were in 2011. Again, coming back to having powerful distribution that can tell the story, alternative solutions in your product set that sort of meet the same needs as what you had been selling but on a basis that's profitable to the company.

Jay Gelb - Barclays Capital, Research Division

Okay. So once rates revert back to some more normal level, let's say, above 10% on the 2 year, which we've been dealing with for so long, what would you anticipate the outlook for life products would be?

Dennis R. Glass

Well, I think life products, the way we're -- the products we're selling right now, which are higher faced [ph] term, Indexed Universal Life, Variable Universal Life -- and we put our MoneyGuard product in that same category of life insurance sales -- are getting acceptable returns. We've repriced all those products several times and they're getting good returns. So on a new business basis, as interest rates rise, the history has repeated, you're not going to get an enormous increase on the return on your capital because people will reprice, but we'd be back in the 12% to 13% range on life insurance products, and that would be a good thing.

Jay Gelb - Barclays Capital, Research Division

Okay. So let's turn now to capital management. Lincoln has been an active repurchaser of its own shares. I believe over the past 9 quarters, that you purchased roughly $1 billion. And over the next year or so, do you think any differently about the allocation of deployable capital, whether that's share buybacks, dividend increases, de-levering or perhaps even acquisitions?

Dennis R. Glass

Well, first of all, I think everybody in the room can figure out if you're seeing a 50% or 60% book, which we were at different times in the past 12 months, buying your shares back is an incredibly good idea. And so we were very aggressive and bought, as a percentage of our market capitalization, more shares back than any of our competition did. We were in a position to do that because of the strength of the balance sheet. So I was happy to do that. We have about $400 million of free cash flow at the holding company each year, $800 million coming out of the subsidiaries in one form or the other, $400 million of debt service and dividends at the holding companies, so netting out to $400 million. With the stock trading where it's at, my expectation is that we'd continue to use most of that $400 million for share repurchases. We have a strong RBC, we could probably do a little bit more of that, but we'll start the year thinking about free cash flow as the limit on share buybacks. I spoke earlier about the overall strength of the firm, and some of the capital that we have is not fungible with excess capital, it's not fungible with share repurchases. The rating agencies have limits even though our RBC is very high. I couldn't take $1 billion and buy our shares back. So there's money that is available for M&A that wouldn't be available for share repurchases. And because the company is so strong, we have an excellent track record. My management team has done I think, $15 billion or $17 billion worth of acquisitions. They've all been accretive, we've gotten all the cost saves out of them that we ever intended. So given the strength of the balance sheet, the quality of the underlying businesses and the management team that knows how to price and integrate deals, all of those things would make me more ambitious around M&A than I've been for a little bit -- for a little while here, especially during the crisis, obviously, during the crisis. But let me caveat that again by saying that if we're talking about dollars for M&A that might otherwise be used for share repurchases, that's always the litmus test for the minimum hurdle rate that I would expect out of an acquisition -- it being what I expect to get out of a share repurchase. And so that would blunt the otherwise enthusiastic level that I have for M&A.

Jay Gelb - Barclays Capital, Research Division

Fully understanding that, what areas might you look to expand in from an acquisition standpoint?

Dennis R. Glass

Yes. We've said the Group Protection business and the Retirement business, we'd like to see those grow as a percentage of our overall capital allocation and earnings. Now having said that, that doesn't mean I'm going to slow the growth in the Life Insurance business, and slow the growth in the Annuity business. I want to keep those on the same patterns they've been on, but we're over-investing capital into the Group Protection business into the Retirement business to accelerate the rate of earnings growth there and from an M&A or nonorganic basis, those would be the first priorities. And let me hasten to say, we build our financial plan on our growth in earnings around organic growth. And if we can accelerate our strategic objectives on an organic growth basis through an acquisition, we'll do that. We don't look to acquisitions as a source of earnings growth.

Jay Gelb - Barclays Capital, Research Division

Makes sense.

Dennis R. Glass

In of itself.

Jay Gelb - Barclays Capital, Research Division

Let's open it up to the audience. Any questions?

Question-and-Answer Session

Unknown Analyst

Could you comment on the difference between operating income and GAAP income and where you think that you might see differences in the future? You've been closer than your competition in the past couple quarters, but there had been quarters earlier in the crisis where you had a significant gap, the cumulative gap is still large. And I'm just trying to reconcile your comments on earnings power recovering, where we'd like to see GAAP income so that book value grows.

Dennis R. Glass

Yes. I think our book value growth is, again, been at the top of the industry, pretty close -- certainly upper quartile, which means that our -- over the last 24 months, our net income has tracked pretty well with operating income. So the things that can separate the 2 would be asset losses, a write-down of your goodwill, and -- or a write-down. There's been a lot of write-downs of intangibles because of -- in the VA blocks this last couple of quarters because of policyholder behavior drifting from pricing. And we haven't had any of that in the last 2 years. I'm pretty -- other than asset losses or your hedge program not working the way it should, those types of things, I don't see any big diversions between operating income and net income.

Unknown Analyst

If you were to have hedge losses because we understand we've had other presentations today that have told us when the GAAP income differs from your reserve release on a hedge loss. How would you think about that recovery process going forward and how the 2 would close the gap?

Dennis R. Glass

Well, let's -- there's 2 buckets, and let's talk about them separately. There's the policyholder behavior bucket where, if you have a drift between -- a negative drift between your pricing assumption and actual experience, and that's what a couple of our competitors had this -- in the third quarter, I guess. You can have some pretty big numbers. And we haven't had any of that in the last 24 months, net-net. We haven't had any of that because some of our experience has been more positive in pricing, some of our experience has been as positive as pricing. But net-net, it's not been a big number. When you start talking about the second bucket which is the -- what's called hedge breakage, which -- does the hedged target that you have change proportionately with your hedge asset? That goes to the quality of your hedge program. We've done a pretty good job on that as well. And how does that drift apart? Most of the time, it drifts apart because most of us use the S&P 500. We buy the S&P 500 as a hedge against equity movements in the underlying policyholder accounts. And the underlying policyholder accounts have a different mix of investments than what's in the S&P 500. So sometimes the S&P 500 does better than the subaccounts, sometimes it does worse. Over time, it seems to be pretty close together. So I just looked at some numbers on that, I don't have on the tip of my tongue but the breakage has not been cumulatively severe. And in each of the last 5 years, while we were producing 18% ROEs, our hedged target has always been lower than the assets that we have to meet those claim payments which is what a hedged target is.

Unknown Analyst

And then have you -- you mentioned on the policyholder behavior, one of the things we've seen most occur is a difference in the lapses assumption when the client is in the money from what the company had originally expected. Are there any trends you're seeing in either of the 2 major parts, policyholder behavior, under-utilization or lapse?

Dennis R. Glass

For the industry, lapse assumptions have been higher than lapsation. And over the last 3 years, we've had some of that at Lincoln as well. It's not a easy calculation. Let me give an example of what I mean by that. For older-aged policyholders that are deeply in the money, the surrender rate assumption might be as low as 1% versus a younger-age policyholder who is not in the money on their account, and that might be 5% or 6%. So I mean, there's a whole series of different assumptions as to what the lapse rates should be. But having said that, we've drifted modestly apart. I think we've got it all corrected now, based on the assumptions and experience. On utilization, which means how much of the income guarantee do people use? And when did they start using it? Our experience has been the opposite, which is people aren't using it as much as we expected and they're taking it later than we expected it. And so when you add those 2 policy behavior actions together, we haven't had a significant net increases on the liability because of policyholder behavior. Although again, we have had, like everybody else in the industry, a little bit of hurt related to surrenders being higher than what -- even with our dynamic models, higher than what we've made [ph]. It's very interesting, I'll just tell you a little story. We run about 100 million scenarios a night to reposition the hedged portfolio the next day for what's gone on in the capital markets, or what's going on with the hedged, with the underlying assets. Used to take up 7 hours because we'd do it through a series of PCs. And then we switch the operating system to the operating system that all our kids use to run their video games. And it went from 7 hours to 7 minutes. And so that's been an improvement in our ability to manage the hedge position, and that gets to scale. And throughout Lincoln, we're pretty much at scale in all our businesses, which means we have low manufacturing costs, we can attract the right talent to run the businesses. We have a distribution presence that's significant in every product line. And so if somebody wants to sell the product, they come and talk to us for sure, so we're in pretty good shape in from the scale business. The one part of the business that's not as big as I'd like it is the Retirement business. It should be -- we're $40 billion in assets, it should be somewhat bigger than that to be at scale.

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Source: Lincoln National's CEO Presents at Barclays Select Series 2013: Insurance Forum (Transcript)
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