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Randal J. Freitag - Chief Financial Officer and Executive Vice President


Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Lincoln National Corporation (LNC) JPMorgan 2013 Insurance Conference March 21, 2013 10:45 AM ET

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

So our next speaker is Randy Freitag. Randy is the Chief Financial Officer of Lincoln National. Prior to being named CFO, he's -- he held a variety of roles at Lincoln, including Chief Risk Officer. And we would like next time for him to bring some ducks or something else also.

Randal J. Freitag

That's right. Something we can hand out.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Go ahead.

Randal J. Freitag

Thank you, Jimmy, and thanks, everybody, for showing up this morning. It looks like a third grade class, everybody sitting in the back, so congratulations on that. As always, thank Jimmy for putting on this conference. It's a great conference, and we're always glad to do it, and it's not many conferences I get to come to and get a duck for my children. So those of you who are parents will understand, I have to be able to go home tonight and tell my now 8-year-old Alex happy birthday, and tell him I told everybody in the room happy birthday. So happy birthday to my now 8-year-old.

Everybody can spend 15 minutes reading the safe harbor, all of you with 20/20 vision, and then we will move to Q&A. No. That's what you want to do, but you're going to have to listen to me today. You're going to have to listen to me talk about Lincoln, a very strong and powerful insurance franchise that is leveraging industry-leading manufacturing capabilities, distribution strength, risk management and a very strong balance sheet to demonstrate very strong financial performance over the last 5, 6 years, and especially recently.

So let's talk about that a little bit. It has been a very interesting 5 or 6 years. Not many environments that haven't existed over the last 5 or 6 years. We've got to experience everything one could want to experience in a 200-year life, and it's been educational. And so what's happened at Lincoln over those years? As one would expect, it was a financial crisis, so Lincoln's a financial company and a company with a very strong balance sheet, and that balance sheet absorbed some of the stresses to the point where, at the end of 2008, if you look at our Life Insurance company and our Holding company, we had roughly $4.4 billion of capital. A very strong company, but you're at the point there right after you experienced a number of losses where you're going to rebuild your balance sheet for a few years. So we set into a period of rebuilding the balance sheet.

Pre-crisis, where were we from an earnings standpoint? A little below $450 million [ph]. Where were we from an ROE standpoint? A little below 12%. Where were we from a dollars of earnings standpoint? Roughly $1.2 billion. But we enter this period of rebuilding, about a 3-year period of rebuilding. What do we do? We focus on the balance sheet first. We rebuild that balance sheet to the point today where, if you look at those same 2 metrics, they add up to about $8.3 billion. So about $4 billion of growth in the capitalization of the organization.

What happened on the earnings in the metrics fronts? Earnings are back to where they were pre-crisis, above where they were pre-crisis. ROE is above where it was pre-crisis. EPS is above where it was pre-crisis. So there we go. All of the earnings metrics have recovered, all of the value drivers have recovered, the balance sheet is immensely stronger. The only thing that hasn't recovered is the share price.

We've had a pretty good run recently. We just ended 2011 at roughly $20, and we sit here today at a little short of $33. So it's been a good run, but we have some more room to go, and we'll talk about that in a little bit.

So that's the longer-term performance. Near-term, just looking at 2012 once again, an excellent year. So if you look at the key metrics we look at, deposits were up nicely, net flows are up nicely, account values are growing at a double-digit rate, revenues are growing at a nice pace. So all of those business metrics are growing nicely. And then the key value drivers, ROE at 12%. It's above the industry average. EPS growth of 13%. I think, well above what people expected coming into the year.

So everything in 2012 was a green light. It was a great year. We were able to leverage our balance sheet to buy back over 20 million shares, nearly $500 million. That puts us up to $1.1 billion of share repurchases over the last 2 years.

So I classify 2012 as a year of very strong performance. Now we still sit here today with what I think of as a bit of a valuation gap to our peer group. We've closed quite a bit of it. If I showed you this graph a year ago, it probably said it was about a $12 gap, so we've probably cut it in half with our outperformance in 2012. But there is still more room to go.

2 primary areas that people tend to focus on when I sit down with them, and so I must assume they're the drivers of the valuation gap, include: "What is the impact of low interest rates?" and "How about that variable annuity business?" So let's talk about those 2 areas.

Low interest rates. It's #1 or #2 or #1a or whatever in the issues that we get asked about. And we've been showing this slide for, oh gosh, a couple of years now. And I think that investors are starting to understand the story around low interest rates. There's more room to go, and we'll continue with our disclosures in helping you understand what low interest rates are and aren't to Lincoln.

But I think we have come a fair way on this particular issue. So what are low interest rates? They're a headwind. They're a headwind to earnings growth. What I know about a headwind to earnings growth is that I can do everything possible to overcome it. I can continue to issue profitable new business. I can manage my expenses nicely. We had a $30 million expense saving initiative in the third and fourth quarter of last year. I can buy back stock. I talked about all the stock we bought back. I can come up with ways to offset an earnings headwind. That's what we have done. That's obviously what we will continue to try to do.

Now the focus at the beginning of this whole thing, and I would note that rates have been low for quite a while, was really on the balance sheet with investors. Everybody assumed that there were large balance sheet issues coming, not just at Lincoln but across the industry, from low interest rates. And what we've been showing for some time now, both on sheets like this and then with our actual results, is that this isn't really a balance sheet issue for the foreseeable future.

So that's both types of balance sheets. We have GAAP, we have statutory. From a GAAP standpoint, the big driver or the big impact is on our long-term interest rate assumption. So what is that new money assumption we're assuming as we go forward? What we show, if we have to bring that down 50 basis points, that's roughly a $125-million impact or roughly 1% of equities, so relatively modest.

And if you look at our assumption today, it's roughly, I don't know, about 50 to 75 basis points above the forward curve out there in the future. We follow the forward curve for about 5 years and then we go a little above it, but it's $125 million if you were bring it down another 50.

And then on the statutory side -- and statutory is really what drives the capital management of an insurance company. This drives the cash flows, this drives what you can do from a share repurchase standpoint. What our analysis has shown steadily for this entire period is that there really is no impact on the statutory balance sheet for a period of at least 5 years, possible up towards the end of a decade. We'd have up to $500 million on the subset of the business, but that's a relatively modest number and easily managed inside of a company of our size, a company with, as I mentioned, $8.3 billion of Life company capital and Holding company cash and a company that earns $750 million to $800 million of statutory earnings in any given year. So a very manageable number. We'll continue to try to help investors understand this story, but this is the story of low interest rates.

The second area we get questions on is the VA business, and I will grant you that there are ample examples out there of how not to operate in the variable annuity business. We can all go through the roster of companies who've had major issues operating this business. One company that will not be on that list: Lincoln. I don't know what other companies do in the variable annuity business, but I do know how we operate in the variable annuity business, so let me talk a little about that.

This is a business that you do not want to dabble in. You need to know what you're doing. It is a business that takes beginning-to-end execution. By the way, that is something we are very, very good at, beginning-to-end execution. 3 main things, 3 main points along that execution line that I think about: there's manufacturing, what do you do from a product standpoint; there's distribution in the middle; and at the end, there's risk management. And wrapped all around that entire line is your philosophy. How do you approach this business?

So how does Lincoln lay out in those regards? First, from a product standpoint. We have never approached this business as a guarantee-first business. It's always been an account-value-first business. What does that mean? That means that you've never seen us with the hottest product on the street. We have a good product, a product that will earn Lincoln an attractive return, a product that will derive real value for consumers.

Around that product, we wrap the best distribution force in the industry, and we wrap this philosophy of consistency in the marketplace. It's a little thing, but it is very important, this consistency theme. Think about if you're a wholesaler. You're going through the year, you've got a great year going, and the company you're selling for tells you that they're pulling your product in November. You've got bills to pay. You've got children to send to college. You're not a happy camper. What do you do? You call Lincoln. That's why we have, I've said it, you take my opinion on this, but the best distribution force. We attract the best wholesalers in the industry to come to Lincoln to sell our story. They aren't necessarily always looking for the hottest product. They're looking for a product that they know they can go out there and do their job on a regular basis.

The results are that, on the bottom of the page, I think they tell the story. A consistent market share, a consistent place in the marketplace and a strong return year after year after year.

Now we don't focus on market share. This just happens to be where we end up by constantly tweaking our product along the way. This is just where we end up. And I can tell you that all the companies around us, they move all around.

So what does this consistency theme lead you to? It leads you to a book of business that has a number of different pieces, all with different characteristics, right? But you wrap them all together and you get a good story. Now if I had sold all of my business in 2006 and 2007, I would not be a happy camper. I would have a book of business that was very volatile, that was very difficult to hedge, that caused a lot of volatility. Now if I had sold business all throughout the cycle, which we've done, you end up with this. You end up with a book of business that has a total net amount of risk of roughly 1% right now. You end up with a book of business that is hedgeable, does not provide all the volatility that other companies tend to see. You end up with a very positive story.

At the end of that chain, risk management, variable annuity hedging. Lincoln has, as recognized by outside forces, one of the best hedge programs in the industry. What is our hedge program? It is a program that's focused on the economics of issue and variable annuity guarantees. We hedge all the major Greeks. If you think about what we issue consumers, we issue them a put option, we issue them a long-dated put option, so what do we buy? We buy a lot of long-dated put options. That is the backbone of our hedgeable. Of course, you have interest rate swaps, you have a lot of other things in there, but the backbone is a lot of long-dated equity put options.

It's a hedge program that always has hedged every benefit, focused on the economics, every product from issue. This has made a huge difference. A lot of companies -- I think a lot of the companies who got in trouble when we hit the crisis didn't have any hedge program or had sort of incomplete hedge programs, and that created all sorts of volatility. If I had, had to create the book of derivative assets that I hold today during the last 3 or 4 years, it would've been very, very, very expensive. I didn't have to create it. We already owned them. We already owned them.

That means that, that book of derivative assets has went up in value when the markets have gone down, it's gone down in value as the markets have recovered, but it has done exactly what I've asked it to. It's covered the risk that I have. What is the risk that I have to consumers? What am I going to have to pay them out in the future? And I want to develop the assets to make sure I can do that. As we sit here today, we have a little short of $800 million of assets in excess of that responsibility we have to consumers. So the hedge program has done what we've asked.

There's been a lot of noise around policyholder assumptions lately. I think there've been some large charges across the industry. And I can't tell you why other companies have charges. It probably has something to do with where they start, from an assumption standpoint. Lincoln changed its assumptions last year during the third quarter. It all added up to a big 0.

So, once again, I don't know where other companies start from, but I know where Lincoln started from, and I know when we did our unlocking of assumptions, it had no impact. Over the last 5, 6 years, we've constantly tweaked our products, tweaked the benefits, we've raised prices; we've done all the things you would expect a company operating that business in an environment we've operated in to do. And it's led to a very strong return profile, averaging 17% over the last 5 years, averaging 20-plus percent over the last 3 years.

Let's move on to the franchise. What is distribution at Lincoln? This is distribution at Lincoln. I told you I think we have the best distribution capabilities in the industry, and this is what it is. It's over 600 wholesalers at LFD representing us across all of our product lines. It is an industry-leading retail distribution network of over 8,000 representatives selling Lincoln products on a daily basis. It is over 160 group reps out there selling our group products. It is over 300 retirement consultants out with employers helping employees understand what they need to do to meet their retirement needs.

It is a distribution system that gives us a great mix of business in the 4 businesses we choose to operate in: Annuities, Life Insurance, Group and Retirement. This is a distribution system that we're very proud of, and this is a distribution system that we see the benefits of every single day, and we'll talk about that little bit as we move forward.

So the businesses we're in. Life Insurance. We are a leading player in the Life Insurance business. Over the last 5 years -- 5, 6 years, we've been #1, #2 or #3 in the Life Insurance business. The Life business, the big thing we did, I guess, not really recently anymore, but roughly 18 months ago, is we made the decision, long before the rest of the industry did, that rates were going to stay low for a while, and that caused us to make pricing adjustments on our products that were most impacted by low interest rates, secondary guarantee and Universal Life being the most obvious one.

So we raised our prices at the end of 2011. That caused our secondary guarantee Life sales to go down significantly. Go back to 2007, they were roughly 60% of our sales. Look at last year, they were roughly 23% of our sales, so an over 50% reduction in the sales of those products. At the same time we were doing that, we focused on products without as much intersensitivity: Variable Universal Life, Indexed Universal Life, Term Insurance. And this is where the power of our distribution force comes in.

We can incent that team to go out, and they can tell the story, and what you see on the page is you get dramatic growth in the products you focus on. So last year, those products made up nearly 50% of our sales, and I would expect them to keep growing. So the story -- once again, it's a beginning-to-end story, but it's what you do with your products. Are you disciplined with what you do with your products? Do you have the distribution strength to make that happen? And the answer is yes at Lincoln.

If you think about the spreads, that's the one area in Life Insurance that gets a fair amount of focus. Despite the low rate environment over the last 5 years, we've actually seen our spreads increase a little bit. This is the one area, as you look forward, that I would expect roughly 10 to 12 basis points of spread compression in the Life Insurance business, as most of our rates are guarantees.

But this is why we focus on things like expense management and share buybacks and the other areas we can use to offset the impact of low interest rates. So that's Life Insurance.

How about the Retirement business? 2 areas that we're focusing on investing at Lincoln: Group Insurance and the Retirement business. Both these businesses are of shorter duration as opposed to the Life and the Annuity business, which are longer-duration businesses. So we've been investing significantly in these businesses. We've been investing in new platform, new technology in the Retirement business. That system is pretty much in place. We have over 1/2 of our in-force assets and all new business goes on that system these days. So we've come along way in going from 5 platforms 3, 4 years ago to where we are today. It's a pretty good story.

The Retirement business is about a segment focus. So we don't play in the jumbo space. So we're not out there going after the IBMs of the world. We play in the small market, we play in the mid-to-large market. In the health care space, we're a leading player, and recently, we've started to focus on the government space.

I think that segment focus makes a difference. If you're in the jumbo market, you're pretty much in a recordkeeping business. You're in a very low ROA sort of world, a business where the buyers are definitely in control. It's when you come into that small market that your retirement consultant platform can really make a difference. You're dealing with employers who are really looking for people to come in and help their employees understand what they need to do to fund their retirements.

When you move in to that mid-to-large, I would say this is the area where you've started to see a little more competition, especially over the last 12 months. The bigger the asset amount of any particular plan, the more competition you're going to see. So you're actually seeing us, inside of this space, actually, the average-size case we look at come down a little bit as competition has really heated up for those cases that fall at the upper end of the large market. It's a great business. It's a business we're in very good returns, roughly a 13%, 14% ROE in, and that's what we look for in a new business. So it's a business that we think has a very strong future.

If you're looking at the demographics, if you think about what employers are doing, if you think about what governments are doing, there's obviously a huge need for employees to figure out a way to fund their retirements, to look for the knowledge, the education they need to really help understand how to do that. So it's a business we've invested in, and you've seen it in the results.

The Group business, the other business we're investing in. Once again, a segment focus here. We're not going after the jumbo cases. We're in the below 1,000 life marketplace and I would say our sweet spot is actually below 500, but we classify this as below 1,000.

We've also focused recently in the voluntary space. That's where you've seen the most growth at Lincoln. We've had real strong earned premium growth over the last few years, averaging 8%, 9% a year, and it's really come from 2 areas: It's come from an expansion in our distribution force, so we've extend -- expanded our sales reps 10% and the number of brokers out selling our products over 20% here recently.

And it's also come with this focus in the voluntary space, which is where we really see a strong growth potential moving forward. So that core market, the employer-provided term, is really a lower-growth aspect of this business, but there are areas that are growing significantly, and that's where we're focused. That's where we're focused in the group space as we try to grow this business disproportionately relative to the rest of our -- rest of the company.

So that's our businesses. We talked about the Annuity business, the Life business, the Group business and the Retirement business. So how about a little more on the balance sheet? If you think about the investment portfolio, this is where we had most of our losses during the crisis, we had roughly $2.5 billion of realized losses over a few year period.

So we, for a period of 3, 4 years, really, really significantly took the risk profile of the general account down. Like you saw, this is a very high-quality investment strategy for a number of years. A low allocation to below investment-grade securities, high allocation to higher-grade securities.

Looking where we saw value, the BBB space, where we saw a lot of value over the last few years. And that's put us in a position today where the general account is in great, great shape, and it's allowed us to start thinking up more proactively about adding a little risk here and there in the general account.

So where are we looking to do this? Most recently, it's in the private corporate investment-grade loan marketplace. One of the advantages that an insurance company has is a very favorable liquidity profile, so we can take on a little more of the investments that have a little less liquidity than a public corporate, and the private corporate space fits into that.

You can typically pick up 30 to 40 basis points. We like this space. In fact, recently, I guess a year ago, we entered into a relationship with Prudential Asset Management, where they're sourcing roughly $500 million of additional private corporates for us. We obviously have a big platform at Delaware where they source a lot. They're our main asset manager already, but that's one of the areas we've been adding.

We also find value in the middle market loan space. Not all the time, but episodically, you'll see value come into the middle market loan space, and so we've allocated a little bit to that space recently.

We also are looking at our alternative investment portfolio, really private equity hedge funds, where we have a below-average allocation, roughly 1% of our general account. And over time, we might move that up towards the 1.5% range. We'll do it slowly in a disciplined way, but we think we have some capacity to take on a little more of those investments.

We've proactively hedged against low yields. So roughly 3, 4 years ago, we put on significant book of treasury locks focused on our secondary guarantee universal life, and that's going to benefit us over the next 4 years or so. We locked in really $1.3 billion of investments, which pretty much covers the cash flows for the guarantee universal life book that exist today, but we locked in yields of roughly $675 million, which is one of the reasons you don't see as much compression in the business as people might expect.

So it's a very strong story in the investment portfolio. You really see the strength of the portfolio when you look at the unrealized gain position. It was $9.4 billion at the end of the year, so well over 10% and well above the industry average.

Now that unrealized gain is really a reflection of the ALM program at Lincoln, right? I mean, we issued long-duration liabilities. We know that, and so we invested long-duration assets, and long-duration assets have gone up in value significantly over the last year or so. So we sit in a very strong position from the investment portfolio standpoint.

So strong businesses, strong balance sheet has allowed us to be very proactive from a capital management standpoint over the last couple of years. So $1.1 billion -- over $1.1 billion of share repurchases in that period. 140% increase in the dividend. Over $200 million reduction in net debt outstanding. And what does that represent? It means we've returned roughly 45% of income from operations to shareholders. We've repurchased roughly 50% of our market cap over those last 2 years. So we have been able to leverage the strength that we've built up to really, really go out and buy Lincoln stock at what has felt like a very attractive price to me, and I'm very proud and happy to have done that.

The other things we've done, we've been -- I talked about this earlier, we've been very proactive on the product pricing standpoint, raising prices when needed. We understand that we operate in a capital-intensive business, and so there's no reason, especially in an environment we have something like share repurchase you can do, to allocate capital at below returns -- below the returns that you'd like to get on your products. We've been very proactive in raising prices, especially on the Life side.

And we're looking at making strategic investments in a couple of spaces, the Group and Retirement business I mentioned. So our focus is all about being very effective and efficient with our capital management strategy in an environment where capital is precious.

So what are the themes for 2013? As I mentioned, we are going to overinvest in the Group and Retirement business. We're going to focus on making sure we're getting the new business returns we think we need to get out of our products. We are going to maintain that same product and risk management focus in the VA business. You won't see that change at Lincoln. We're going to leverage that distribution strength to support anything we have to do in the product side, and we are going to focus on deploying capital to its highest and best use. I thank you for listening to the Lincoln story today. And Jimmy, I'll gladly take any questions that the crowd may have.

Question-and-Answer Session

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Sure. Maybe first, if we look at your results the last several quarters, they've been generally better than expected. The one area of weakness has been the Group business. So maybe talk about what's going on in that market from a pricing standpoint, what it is that you're doing to improve your margins.

Randal J. Freitag

Sure. I talked about this a little on the last quarterly call. Really 2 spots that we got hit in the group space last year: Life mortality, a little earlier in the year, and then towards the end of the year, severity on the LTD side, and that led to a below-par Group result. So we've really focused on making sure that the pricing we're putting into the marketplace is efficient, reflects everything that we know about today, low interest rates, reflects the competitive environment that we face today. I think that, when you look at the results and we go back and analyze it, the Life results looked like it was more episodic, sort of one of those earlier blips you might get in mortality, which is not uncommon. There's seasonality in mortality that's existed forever. On the LTD side, I do think there's a little bit of work to overcome that hiccup. I think maybe 18 to 24 months before we fully work our way through the LTD experience. One thing I note, though, is that despite a subpar group result, we had a great year overall, reflecting the fact that we have 4 businesses that work together. Sometimes, they'll all hit on all cylinders, but sometimes, they won't. We can still have a very good result, like we did last year.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

And maybe on -- you mentioned growth in Group and in Retirement. How much of that are you planning on just through organic means, and are you looking at potential deals? And what's the deal environment in those markets in terms of availability of properties?

Randal J. Freitag

Sure. Obviously, we don't comment on anything specifically around M&A, but what we have said is if -- the 2 places where we would look at for nonorganic growth would be in the Group and the Retirement space. So if we were to look, it would be there. When we think about M&A, we're obviously very cognizant back to my -- the last point I made at making sure that capital is going to its highest and best use. And over the last couple of years, with our share price where it's been, that's meant that the bar for doing M&A was going to be pretty high with the implied return we thought we could get to ensure buybacks. So maybe that cost of capital embedded in our share price come down a little bit, but we're still being very cognizant about -- we're very aware and in tune with cost of capital when we think about anything we might do from an M&A standpoint.

Unknown Analyst

Hey, Randy. On the alternative stuff, are you guys favoring any particular types of managers, and what's your position on hedge funds versus private equities within the alternatives book?

Randal J. Freitag

We've had better performance for our private equity book than our hedge fund book over the years, and I tend to think that you can get a little better returns in the private equity space. The downside of private equity is the return profile of private equity, which is sort of 0, 0, 0, 0, then a lot. From an insurance company standpoint, you'd rather have sort of that steady return. But when you look at both the investments, I think the total expected return in private equity is a little higher. So I think we've had a bit of bias to the PE space over the hedge funds space. I wouldn't say there are any particular managers. We're just looking for a diversified portfolio of investments that -- we tend -- when we -- anytime we make any investment, we're looking at the overall company, and we're looking for things that aren't necessarily all correlated. So we maybe looking for a space that isn't as correlated to the equity market, things like that. So I think we're focused on areas in the marketplace that don't necessarily add as much to risk as you might expect from an investment like that.

Unknown Analyst

Can you expand on your Variable Annuity hedging program? Specifically, you said you use long-dated puts. Do you do dynamic hedging for a portion of the portfolio?

Randal J. Freitag

I describe our hedging program as dynamic in that, every night, we are running millions of scenarios and valuing that liability and coming back with the profile, right, the Greek profile of that particular liability. And then we're going out multiple times during the day, and we're updating the profile of our assets to match the profile of that liability book. So our program is not static. It is definitely dynamic. It isn't what would be described as macro. You hear people talk about macro hedge programs, which I think are generally just programs people add when they're under-hedged in their normal program. Our program is complete. It's meant to cover everything. It's meant to change with the profile on the book.

Unknown Analyst

And then a couple of follow-up questions. And someone recently mentioned at another conference that there are over $200 billion in these products, a lot of them that are using the same techniques, and that one concern is you have an event where there's a market break, and do you have any type of gap [ph] protection?

Randal J. Freitag

Do we have any type of what protection?

Unknown Analyst

Gap [ph]. In another words, out of the money to protect against a -- if you can't rebalance the portfolio, if there's a sharp correction overnight.

Randal J. Freitag

Yes, I think that, with the book positioned to replicate the liabilities, it should move like the liabilities for some distance. Now if you get sharp movements in the marketplace, you can get some second-order breakage that comes in. But all of those first-order Greeks will pretty much move with the marketplace. And if you think about what we're buying, the interest rate protection is very easy to get, right? The interest rate swap futures market is very liquid. The delta -- the futures market, where you go to get some of your delta, is very liquid. It's really only the volatility space that, if the market moves quickly, can be tough to sort of keep up with the amount of volatility required for your book. And that's been the only space in past years where we have decided to make an explicit under-hedge, so we haven't chased the marketplace. Volatility as we went from 30 to 40 in a very short period of time. So that's really the only Greek that, historically, we haven't chased if needed. We've waited for it to come back down.

Unknown Analyst

And then one final question. In terms of pricing, do you use, I guess, implied volatility for pricing? Has long-term historical volatility -- what are you -- what are you using?

Randal J. Freitag

I mean, we use the real volatility curve as long as it's visible, right? So I think the volatility curve is generally visible for 10 years, maybe 10 to 15 years, and then you have to create the volatility curve beyond that. I mean, I think you can get a good picture of what the marketplace is really pricing out through 10 to 15 years. But after that, there isn't just much activity. So it's theoretical on what the level is. But we price our products economically, right? We capitalize our products looking at the detail of the risk when we price the products. So everything we do in the VA space is focused around thinking about that product as -- in a very economic fashion.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

On variable annuities, there's been a decent amount of disruption in the market. Some of the companies are deemphasizing. Some have exited. And your books are obviously in better shape than many of the other companies that have exited, but what's your view on how large of a business would you want it to be as a percentage of your overall earnings, as a percentage of your overall capital, and how close are you to those limits?

Randal J. Freitag

Yes. We're very happy selling the amount of variable annuity business we're selling today. As I mentioned, we want to grow the Group and the Retirement business disproportionately, so we want the Annuity business to keep growing like it's been growing, but we would like other areas of our company to grow at a little faster pace, and that's why we're investing in those businesses, expanding distribution, investing in the technology underlying those businesses. So we're very happy with where we are today, very happy selling business at the pace we're selling today. You're right. There has been some companies who have announced that they would like to lower their VA sales. What tends to get not as much focus, though, is that there are a number of companies who are actually coming into the space. I mean, you've seen AIG has entered back in, and I think Aegon is coming back in, and you've got some smaller players coming back in. So I'm not sure that the overall capacity in the industry has changed yet. I don't think we'll know that for 6 months to a year, but it isn't just a one-way street, I would note, in the variable annuity space. There are companies coming in.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Maybe just one last one. On -- did you see any potential impact on your business because of changes in either the treatment of captives or just AG38 changes?

Randal J. Freitag

We -- AG38, which impacts guaranteed universal life, we had -- when we repriced that product at the end of 2011, we had made some assumptions about what the impact would be. So some of that's embedded in our pricing. Recently, we've been tracking, gosh, something like 20 pricing changes going on at our competitors in the guaranteed universal life space, so I think you see a lot of pricing changes going on across the space now as companies respond. I think we'll look at where we land from a competitive standpoint and move appropriately in that particular space, but there's no doubt that AG38 -- the new AG38 has had some impact across the industry in what a consumer can get out of that product. On the captive space, it's something we keep our eyes on. We use captives to do reserve financing transactions. Recently, the NAIC has been looking at them. Recently, the Federal Insurance Office file has been looking at them. So we're actively involved, both as an individual company and then also through our primary representation, which is the ACLI, in following that issue. Ultimately, I think what they're looking for is a set of principles and rules around the use of captives. When we do a captive, what you see is that it's a -- our captives are capitalized just like our main companies, pretty much the same RBC ratios. We do transactions that are reviewed by the rating agencies and by both captive states and by a number of actuarial firms. So I think what they're looking for, in the end, is a set of rules probably not too dissimilar from the way we operate in the captive space. But we don't know. We're obviously very focused on that issue, as we do use captives as part of our running our business, and so we want to make sure that the outcome is reflective of what it should be.

Jamminder S. Bhullar - JP Morgan Chase & Co, Research Division

Okay. Thank you.

Randal J. Freitag

Thank you all for coming.

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