Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Lincoln National (NYSE:LNC)

Q4 2011 Earnings Call

February 08, 2012 11:00 am ET

Executives

Jim Sjoreen - Investor Relations Professional

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

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

Analysts

Edward A. Spehar - BofA Merrill Lynch, Research Division

Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Joanne A. Smith - Scotiabank Global Banking and Market, Research Division

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

Randy Binner - FBR Capital Markets & Co., Research Division

Andrew Kligerman - UBS Investment Bank, Research Division

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Robert Glasspiegel - Langen McAlenney

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Eric N. Berg - RBC Capital Markets, LLC, Research Division

Operator

Good afternoon, and thank you for joining Lincoln Financial Group's Fourth Quarter 2011 Earnings Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to Senior Vice President of Investor Relations, Jim Sjoreen. Please go ahead, sir.

Jim Sjoreen

Thank you, operator, and good morning and welcome to Lincoln Financial's Fourth Quarter Earnings Call. Before we begin, I have an important reminder. Any comments made during the call regarding future expectations, trends and market conditions, including comments about liquidity and capital resources, premiums, deposits, expenses and income from operations, 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 are described in the cautionary statement disclosures in our earnings release issued yesterday and our reports on Forms 8-K, 10-Q and 10-K filed with the SEC.

We appreciate your participation today and invite you to listen to Lincoln's -- listen and visit at Lincoln's website, www.lincolnfinancial.com, where you can find our press release and statistical supplement, which includes a full reconciliation of the non-GAAP measures used in the call, including income from operations and return on equity, to their most comparable GAAP measures.

Presenting on today's call are Dennis Glass, President and Chief Executive Officer; and Randy Freitag, Chief Financial Officer. After their prepared remarks, we will move to the question-and-answer portion of the call.

With that, I would now like to turn the call over to Dennis.

Dennis R. Glass

Thanks, Jim, and good morning, everyone. In the fourth quarter and the year, we drove solid sales and net flows, the result of our consistent approach to product and distribution and a continuation of what we achieved in each of the last several years, including throughout the financial crises.

During 2011, we took steps to strengthen our franchise, including: Reducing asset risk by investing in high-quality corporate securities; escalating share repurchases and debt repayment; repricing life and annuity products to ensure profitable new business; and investing significantly in Retirement Plan Services and Group Protection to increase earning power in future years.

Randy will speak to our goodwill review and end his comments. In short, we incorporated a tough economic and competitive environment for several years in our assumptions, and the remaining goodwill asset is a solid number for the foreseeable future.

We accelerated our share buybacks in the quarter with another 200 million of shares, bringing our total repurchases to 575 million. As the year progressed, we did increase our plan for share repurchases, reflecting the good outcome of our balance sheet stress testing and the very low valuation of our shares.

We ended the year with a very solid balance sheet and deployable capital, permitting share repurchases to remain a strong option for capital usage in 2012.

Turning to highlights from our underlying businesses. Sales in our individual Life business were up 10% in 2011. We saw a shift in the mix of sales over the course of the year, with increases in variable universal life, indexed universal life and MoneyGuard, accompanied by a decline in secondary guarantee universal life.

The lower SGUL sales, more pronounced in the fourth quarter, are related in part to repricing actions that deemphasize single-premium type SGUL policies. Our analysis showed that we would need to accept very low single-digit returns on this business in order to remain in the upper quartiles of competitive pricing. This would not be selling on our terms.

Our sales mix and emphasis in 2012 would be similar to what we saw in the quarter on our core products. Total annuities sales were flat for the year, as we saw a 6% increase in DA sales, offset by a 20% decline in fixed annuity sales. Low interest rates affected fixed annuity sales.

We know annuities are important planning tools for consumers, and we are confident in our ability to grow and manage this business profitably. Steps we took in the fourth quarter to improve the risk profile and hedging cost variable annuities included implementing a managed volatility investment strategy on nearly $3 billion of in-force assets.

Additional changes we are implementing in April will encourage new sales to move into these low volatility options. These changes will allow our clients to choose the benefits and investment flexibility most suited to their needs.

Late last year, we announced a relationship with Primerica, to be the only provider of indexed annuities on their platform, and this quarter marks the launch of this program across the entire Primerica system.

In Retirement Plan Services, sales increased 5% for the year and 16% quarter over quarter, momentum building in the latter half of the year. We also saw our second consecutive quarter of positive net flows, bringing total net flows to more than $500 million for the year.

Our investments in distribution, technology and marketing are beginning to take hold, as evidenced by the sales results, along with improved retention across all markets. In addition, all-new mid-large plans are now being onboarded to our new recordkeeping platform. We expect to see the considerable progress we made in 2011 carry into 2012.

Our Group Protection business also turned in an excellent quarter. Sales increased by 33% for the quarter and 12% for the year, helped by our enhanced distribution structure and our expanded product suite. Voluntary sales, an area of emphasis for us, increased significant in the quarter, and we are well positioned to capitalize on opportunities in this growing segment.

Finally, we are very pleased with how well the actions we took in pricing and claims management at the end of 2010 and early 2011 created a significant turnaround in results.

From a distribution perspective, we expanded the strength and reach of both our wholesale and retail systems this past year. At LFD, our wholesale organization, the number of advisors recommending Lincoln Solutions, increased to more than 57,000, and the number of advisors recommending more than one Lincoln Solution, a key measure of the depth of our relationships, grew by 7%. Lincoln Financial Network continues to execute on its strategy of retaining productive advisors and attracting experienced recruits, which helped LFN to meaningfully contribute to Lincoln sales results in the year.

When you add up our robust product portfolio, our proven distribution muscle, the actions we took in 2011 to strengthen the franchise and our strong balance sheet, we are well positioned to grow our business in the coming years.

With that, I will now turn the call over to Randy for more detail on the quarter.

Randal J. Freitag

Thank you, Dennis. Last night, we reported income from operations of $303 million or $1 per share for the fourth quarter. Overall, the quarter served as a high-quality end point to a very strong 2011.

Inside the operating earnings numbers, there are a couple of items that I'll comment on. First, operating revenue declined 2.4% for the quarter, compared to full-year growth of 4.5%. The full-year results are more indicative of what I'd consider to be normal results, as the fourth quarter had a few unusual items, including alternative investment income and income from prepayments was down approximately $65 million from an unusually high fourth quarter in 2010. And as you remember, we had a fair amount of line item noise in prior period results as we converted valuation systems in our life area. This negatively impacted the quarter-over-quarter comparison by roughly $50 million.

And lastly, sales in the Group business were skewed to the last half of the year. Revenues from those sales won't fully emerge until 2012.

The second item I'd note is that there was very little noise in the quarter. There were a couple of items that offset each other, but at a high-level, normalized earnings came in at $1, right on top of reported results.

Turning to net income. We reported a loss of $514 million that included a goodwill impairment of $747 million, $650 million in our Life business and $97 million in the Media business.

Let me share a few thoughts on this year's goodwill analysis. In Media, we wrote down the remaining balance of the $97 million goodwill asset to reflect the fact that with growth in the current recovery somewhat muted, we have not seen, nor do we expect to see, a turnaround in media valuations that we have experienced in past recoveries.

In Life Insurance, we went through a very thorough process that involved a detailed review of assumptions affecting the valuation of the business, including sales expectations and related profitability. Reflecting the difficult environment that exists today, we made the decision to hit all of the key assumptions that go into the goodwill analysis pretty hard for the next several years, before we returned to more normal expectations. The tough assumptions for the next several years is what drove the goodwill impairment.

So while I believe in the long-term value of the Life franchise, I think that it was a prudent decision to take an impairment at this time, as it best represents the expected economic climate and leaves us with a life goodwill asset that is supportable for the foreseeable future in a range of potential scenarios, both good and bad.

After the goodwill impairment, book value per share, excluding AOCI, stands at $40.19, down 2.6% on a sequential basis, but up 5.3% for the year. Other items affecting net income included net realized losses on investments and the results in our annuity hedge program. Neither delivered any surprises.

Net after-tax realized losses totaled $28 million in line with recent quarters, and the hedge program had excellent performance in the quarter, recording a small gain. The unhedged NPR-related reserve change caused a loss of $47 million, as our credit spreads narrowed during the quarter.

As a reminder, the NPR is pure accounting noise that will fluctuate between positives and negatives with no connection to the real economics of the Annuity business.

Turning to segment results, and starting with annuities. Recorded earnings for the quarter were $134 million. Revenue declined 4% from the fourth quarter of 2010 on lower investment income from prepayments and equity markets that were relatively flat compared to 2010.

Net flows came in at $345 million, down somewhat from last year, as deposits dropped modestly, while last experience remains fairly level. We continue to have ample room to manage annuity interest spreads and expect to have little economic spread compression. Any decline in reported spreads will be largely due to the fact that the products we sell today are priced to earn a lower spread than the in-force book.

In Retirement Plan Services, earnings came in at $35 million on good momentum and deposits in flows, as investments in this business began to pay off. Similar to annuities, revenues were down relative to the prior year quarter on lower prepayment and alternative investment income, and lower expense assessments, as average separate account values declined quarter over quarter.

Unlike the Annuity business, we have relatively little room to lower credit rates in the retirement business, and this led to some spread compression in the quarter. Moving forward, I would expect to see 3 to 4 basis points of spread for compression per quarter in today's earned rate environment. Part of the overall spread compression guidance that we've given previously.

I'd also note that all products that we sell today are sold at very low guaranteed interest rates in the 1.5% range. So that the impact of spread compression is something that should decline over time.

Turning to our Life Insurance segment. Earnings of $154 million or $150 million normalized, remained relatively stable relative to prior quarters, after given effect for notable items. Our earnings drivers performed as expected during the quarter, with Life Insurance in force, up 3%, and average account balances up 5.3% quarter over quarter.

Early in 2012, we made some additional rate cuts that should maintain interest spreads through the first couple of quarters of the year. After that, I'd expect to see 3 to 4 basis points of spread compression per quarter in today's environment. Once again, this impact was included with our previous guidance on the impact of low interest rates.

Group Protection delivered another strong quarter and much improved results for the year. Non-medical net earned premium grew 5%, and the non-medical loss ratio for the quarter came in at 72.2%, driving a more than 3 percentage point improvement in full-year loss ratios.

Earnings of $22 million were up 25% from the fourth quarter of last year, but were down sequentially due to higher expenses, as we got an early start on the strategic investments that we discussed at our November investors conference.

Before moving to Q&A, let me do a quick overview of 2011 and what I see as we move forward. By any number of measures, 2011 was an excellent year that demonstrated the strength of both our balance sheet and business model.

To name just a few, operating earnings per share grew 33%, as earnings grew 27%, and our average share count benefited from active capital management.

As I mentioned earlier, book value per share, excluding AOCI, grew over 5% despite the goodwill impairment we took during the fourth quarter. Return on equity grew to 10.7% for the year, benefiting from both strong earnings and share repurchases.

We were very active on the capital management front with 575 million of share repurchases, $225 million of net deleveraging and strong growth in shareholder dividends. I would note that capital usage benefited in 2011 from strong reserve financing performance and continued improvement in the credit quality of the investment portfolio. And overall capital remains strong, with life company capital ending 2011 at $7.6 billion, up $500 million for the year. A year-end RBC in the 500% range and $600 million of cash at the holding company.

Now, as we move into 2012, let me provide a few comments. We will continue to be prudent with our capital usage. This means that you will see continued pricing adjustments in the Life and Annuity space, to ensure that our returns on new business are competitive with other uses, including share repurchases, which we will continue with in 2012.

Absent other impacts, I would expect capital usage on share repurchase and deleveraging to be governed by free cash flow, which I'd size at about $400 million. And while operating earnings growth will be capstoned by the implementation of 09-G, investments in our group and retirement businesses and the headwind of lower interest rates, I expect that earnings per share growth will benefit from share repurchases.

With that, let me turn the call over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Ed Spehar with Bank of America.

Edward A. Spehar - BofA Merrill Lynch, Research Division

Randy, on your last comments, could you be a little bit more specific when you talk about the $400 million of free cash flow? I think that has been the number that we thought about is for equity holders in terms of buybacks or dividends. Maybe could you talk about -- is that the number? Or are you talking about that number is going to be to pay down debt as well?

Randal J. Freitag

Yes, Ed, thanks for the question. First, let's talk about 2011 because I think it serves as a good platform for 2012. We had a very strong 2011 from a capital usage standpoint. $800 million on combined share repurchase in delevering. Net benefited from a couple of factors that I don't think will necessarily repeat in 2012, although we'll do our level best to make sure they -- to try to make that happen. Those 2 items were multiple reserve financings, which we did over 2011, an improvement in the credit quality of the general account assets. Those are items that you can't necessarily count on repeating. But like I said, we'll our level best to see that we'll do the best we can on those items. As in any year, looking forward, the starting point for capital usage is free cash flow. And that's roughly $400 million a year. That's capital usage for both share repurchases and deleveraging. Now I don't think we're going to be doing huge deleveraging as we go forward. It's going to be modest deleveraging. So I would say that the majority of that $400 million, I would anticipate going into the share repurchase side. So $400 million, that -- it's the combined number, I'd say it's skewed toward share repurchases, and we'll do our level best to try to outperform on that number, just like we did in 2011.

Edward A. Spehar - BofA Merrill Lynch, Research Division

And just one follow-up. Considering the -- what your outlook is for Life sales now over the next few years, could you just give some sense of how much that might affect the free cash flow emergence over that period of time? I mean, if you're right about the environment for Life sales, I would assume there has to be some impact on statutory cash flow that would be favorable over that few year period?

Dennis R. Glass

Yes, it's Dennis. It's about 1:1. So just to pick a number of sales went down $100 million. Free cash flow would increase $100 million. And if that were the case, it would be one of the levers that we'd use to increase our share repurchases.

Edward A. Spehar - BofA Merrill Lynch, Research Division

Can you give us any sense of what the expectations are for sales that are built into the goodwill action?

Randal J. Freitag

Ed, I'm not going to get into the specifics of what's behind the sales levels. Just let me reiterate, we took a good, strong run at all of the assumptions that surround the goodwill analysis, including sales.

Operator

Our next question comes from the line of Suneet Kamath with Sanford Bernstein.

Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division

Just one follow-up to Ed's line of questioning on RBC ratio. I think, Dennis, in the third quarter call and then also at the Investor Day, you'd kind of talked about the 500% RBC ratio and perhaps dipping into that a little bit, I'm forgetting the exact terminology used, but essentially allowing that come down to fund additional capital redeployment. I didn't get the sense that, that's what you were alluding to in terms of your comments and Randy's comment earlier today. Is that still something that's on the table? Or how should we think about that?

Dennis R. Glass

I think what Randy is saying is that we're guided every year at the outset of the year by free cash flow. And that's just a fundamental approach that we take. We certainly are very comfortable with the amount of, or the strength of the balance sheet, and don't have any hard and fast rule about not dipping into that, if we think it's appropriate. That's the excess capital.

Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division

Understood. Then I guess my other question just again goes back to the Investor Day, where you showed those scenarios for a low rate environment and your, I guess, statutory reserve redundancy, which if I recall, was pretty significant, I think, in one scenario, $8 billion in the more adverse scenario, maybe $6 billion. So I guess my question is, is I'm not sure that the market truly is reflecting that level of cushion in your valuation. I'm actual pretty certain it's not. So I'm wondering if there's something that you could do, maybe securitizing some of those excess reserves, just to sort of prove to the market and to investors that these are truly redundant, sort of by way of third-party affirmation. Just wondering if you had any thoughts on that.

Dennis R. Glass

Suneet, of course, we're always looking at all aspects of our balance sheet to optimize capital usage. And I'd point out, in one of the comments I made, when we do these reserves financings, that's essentially a reflection of reserve redundancy. We're essentially front ending what our redundant reserves. And we did multiple reserve financings in 2011, generating roughly $500 million of capital over the course of the year. So we will look at all aspects of our balance sheet, look to what we have done as a reflection of the fact that there is definite redundancy in our balance sheet. I'll go on to say, I haven't seen anything different in the results from this year's cash flow testing process so far. Of course, we're in the middle of it. I haven't seen any change from what we talked about at the investor conference in November.

Suneet Kamath - Sanford C. Bernstein & Co., LLC., Research Division

Are there any constraints in terms of how much of that you could finance?

Randal J. Freitag

See, I can't think of any constraints on what we could do with our balance sheet. There are a number of different options that companies have out there. I don't have any anticipation of using large pieces of our balance sheet. I'm pretty much guided by the fact that we have been looking at the redundant reserves, specifically, on secondary guarantee UL as an option for creating capital.

Operator

Our next question comes from the line of John Nadel with Sterne Agee.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

A question on Universal Life. I'm just wondering if, Dennis, if you have any update on the status of the NAIC's review of the sort of blended UL term product and the reserving requirements around that?

Dennis R. Glass

Yes, there was quite a bit of action toward the end of the year. And consistent with some of my comments in November, it continues to feel pretty good. The NAIC is certainly looking for a solution that is appropriately, gets the level of reserves to the right amount. And at the same time, doesn't so much increase reserves or change reserves that it's not a good consumer product. So that -- everybody's got the right view, which is, let's get the right reserves, but this is a valuable product in the marketplace and let's not do anything that would change that. The other thing I would say is that they've taken a bifurcated approach at least at this moment in time. That's what they've conveyed to us. And that is, that there would be a different outcome for new business versus in-force business, and the industry was behind that bifurcation. So to summarize, I think it's going in the right direction. The NAIC has got a lot of good people thinking about this, the industry is actively participating, impacting a result that is good for the regulators, good for the companies and good for consumers.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Thanks for that update. Just one more question. I'm thinking more -- I was interested in your commentary earlier about the continued push towards these low volatility investment options that you mentioned inside, I believe it's inside the VA accounts. This is something we keep hearing about. We keep hearing a big push into these types of funds across the variable annuity industry. I'm curious if you've done any study or sort of risk assessment as to just how much assets can move into these low volatility type of funds before they run out of the -- before these types of funds begin to sort of break down around that mandate of continuing to hold the volatility levels low. I'm not sure if you understand that, I'm not sure if I worded that quite right.

Dennis R. Glass

Is it still a good consumer value? Is that...

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Well, I guess just more the risk, more the risk of these low volatility type funds, how much in the way of assets can they truly manage and still maintain that type of low volatility performance? Is there a point where -- is there a tipping point?

Dennis R. Glass

I'd have to have our experts give us an answer on that. We think it's a -- let's go into more detail on that question. But it's a pretty deep market for the type of derivatives that we use inside the subaccounts, and there's also choice. But let me tell you what we're doing next year. I alluded it to -- to it on my remarks. But again back to this concept of giving our consumers flexibility and choice, the action that we're going to take in the second quarter is that we would lower the limited benefit income guarantees by roughly 50 basis points, and that would vary by income start age, for those clients who do not allocate 100% of their assets to the protective funds. So our actions go in the direction of quite a bit of money being put into these funds and our ability to manage it.

Randal J. Freitag

John, I would just add, as you're aware, well aware, one of the items that we're very proud of is the hedge team we have here. And the hedge team has done extensive analysis of the protected fund product that we have developed and we'll roll out a little later in 2012. And it definitely does reduce the risk profile of that product from Lincoln's standpoint. And so we're happy with that. In terms of the runway, I think as with anything, there is probably an ultimate amount, that you can't get over but I think the runway ahead of us is pretty long, in terms of the amount of that product that we can manage on our balance sheet.

John M. Nadel - Sterne Agee & Leach Inc., Research Division

Okay. I mean, that's sort of the point I was trying to get to is, is at what point does an industry full, chock-full of low volatility fund -- assets and low volatility funds. Because you hear this from that, you hear this from pretty much every one of your major variable annuity competitors, just trying to understand how much runway is there.

Dennis R. Glass

Yes, and I'll come back to just from -- that question in my -- again, my earlier comments. But we'll have 2 choices. You can have more investment flexibility, if that's what you would like, but the guaranteed income will not be as high as it would be if you go into 100% in these protected funds.

Operator

Our next question comes from the line of Joanne Smith with Scotiabank.

Joanne A. Smith - Scotiabank Global Banking and Market, Research Division

I have a follow-up to John's question there. Just with respect to the rapid increase of these types of low volatility funds and funds where a lot of the hedging is being done now at the contract level or the fund level. I'm wondering what's the real drive to these projects? I mean, I understand risk management by product design. But I'm wondering if this has anything to do with the potential for the Volcker rule to impact the overall derivatives market? Or is it -- does it have something to do more with just the high cost of hedging and your desire to reduce those costs, or maybe diversify the types of hedges you're using? I'm just trying to figure out why this rapid move into product design hedging versus derivatives hedging.

Dennis R. Glass

I can't speak for everyone. But let me come back to our value proposition, which is about choice. And so what we are providing is choice. And to repeat what I just said, if you want to do 100% in protected funds in your subaccounts, you're going to get a higher income guarantee than if you don't. Some people will opt for the -- more flexibility in the subaccounts. And of course, we're well-positioned for that. You may remember that at the investor meeting, we talked about having the highest percentage of higher MorningStar rated funds in our lineup than any of our competitors. Again, an example of what we're trying to do from a flexibly standpoint. So I can't speak to the entire industry. I think, generally, the industry is trying to tighten up on risk, but still provide a very good consumer value over the long term. I think those of us who are, have been responsible about the way we've built these products over time continue to believe in it, and is just the normal evolution of risk and consumer value, and where is the right crossover point.

Joanne A. Smith - Scotiabank Global Banking and Market, Research Division

Okay. And then I guess as a follow-up, just in terms of the life insurance sales. When you're talking about the non-MoneyGuard UL, your run rate, based on the third and the fourth quarter, is now at about $300 million in sales a year. Is that kind of the run rate that we're looking at? Or you think that you're going to pull that back even more?

Randal J. Freitag

Well, we offer a variety of solutions in our portfolio. Again, we talk about this breadth of solutions to meet different customer needs. At this moment in time, we are shifting our emphasis in our sales and customers are buying a little bit more of our other, other parts of our product portfolio. So we're looking, and again we don't give sales projections, but we're looking to continue this concept of, it's not all about SQL, it's not about variable universal life, it's not all about MoneyGuard, but it's a combination of products that meet changing needs of the consumer over time and with our powerful distribution and product innovation, that's what we're going to continue to focus on.

Operator

Our next question comes from Jamminder Bhullar with JPMorgan.

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

Just -- the first, I just wanted to just follow-up on Randy's comments on free cash flow. The $400 million that you mentioned, that's after whatever you're planning on paying out in terms of dividends on the stock, right?

Randal J. Freitag

Yes.

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

Okay. And then, on my question, given the pace of buybacks recently, should we assume that the M&A market's not that attractive because I think, Dennis, you mentioned group benefits and retirement businesses are potential areas that interested in. But -- if you would just comment on what are you are seeing out there in terms of available properties? And should we assume that since you've been buying back at a decent pace, the opportunity's not there right now?

Dennis R. Glass

I think the M&A market in the insurance industry, except for those big deals that were done overseas, has been fairly muted. And that's because, as the volatility that we've all experienced in the industry is -- can come down somewhat, it's still fairly volatile. And I think managements, in general, more comfortable with what they're doing than trying to go out and buy things. So at a high level, that's what I would say. I also would say that when so many of the companies are selling at a discount to book, the hurdle rate for doing M&A gets higher. And so the combination of just the uncertainty, higher hurdle rates has chilled, in large part, M&A transactions. Having said that, we continue to look for properties again, against those constraints of share, hurdle rate on share repurchases. And over time, there would be opportunities for Lincoln and other companies in the industry.

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

And then, just on your goodwill charge. If you can just give us some idea on what were the main drivers behind that charge, whether it's lower sales expectations or low interest rates? And then, you've still got $1.5 billion of goodwill in the Life business. What gives you comfort at that remaining number?

Randal J. Freitag

Yes, Jimmy, this is Randy. Let's go through the whole discussion here, and let's go with -- let's start with what we know. And that's that we're a market leader in the U.S. life industry. And we expect fully that the Life business is going to be steady, is growing profitable and valuable part of what we do over the long term. Think about what a goodwill analysis is. It's a point in time estimate of what is a 30-year projection of future profits from new business, and it's subject to a variety, a large number of assumptions, including the ones we've talked about, future sales levels, profitability on those sales and the best discount rate to apply to those, that income stream. In our analysis, we hit all the key assumptions pretty hard for the next several years, really reflecting a difficult environment that the industry finds itself in. And then we return to more typical expectations in the out years. So we have tough assumptions for the next several years is primarily what caused the write down. I think as everyone is aware, we've talked about it a number of times. We've made several pricing changes. And the market, as we look at it today, has been, has been somewhat slow to follow even though you see it's starting to pick up. This affects our near-term competitiveness, and so we expect this to impact us, in the near term, in the near to medium term, and we think that will even out over time. If you look at overall conditions today, we expect that the profitability on those new sales is going to be towards the lower end of our target range. So you've seen our target range. We just talked about our target range, as Mark talked about it extensively at the IRB, we expect, given what we see in the environment, that will be at a lower end of that range. So you've got a competitive environment, you've got profitability at the lower end of our range and then you have the additional fact that even though market interest rates were down, we did see the discount rate that we would apply to this business, follow. So even though the market rates were down, which would have normally imply that the discount rates would come down, we didn't see that impact occur. So all of those things we took into account. As imagined, we hit pretty hard as we went through the analysis. Again, the goodwill charge that we took does not alter, in any way, our view of the long-term liability of Lincoln's Life franchise.

Dennis R. Glass

And just to put an end point on that. We think this is a good asset for the foreseeable future. We hit the assumptions hard, to repeat what Randy and I have both said. There's no algorithm here that you stick in 1 level of sales at 1 discount rate, you get an answer. You look at everything in the aggregate and decide what's the best goodwill number. That's what we've done. We think it's a good number. We don't expect it to change in the foreseeable future. And that concludes my comments on it.

Operator

Our next question comes from Randy Binner with FBR.

Randy Binner - FBR Capital Markets & Co., Research Division

I guess I'm going to hope to try and follow up for a little bit more quantification. So as far as hitting the market dynamics hard, is it possible for you to give us a little more color on how long you held rates low at what level? And maybe, I guess you don't give sales guidance, but give it a little more parameters around that. And I guess the final piece I'm looking up -- to final up on is just to kind of to explain how these assumptions got worse relative to the previous assumptions, but why there's no necessary impact to the GAAP or statutory outlook for the same book of business?

Randal J. Freitag

Yes, Randy. Once again, I'm not going to get into the specific, actual numbers. But let's go over some of the facts again. You talked -- yes, you think your first part of your question revolved around the discount rate. Now despite its very nature, the discount rate is something that gets applied for the entirety of a 30-year projection. So we didn't assume a higher rate than go down in the outyears. The discount rate, as I mentioned, did not follow market rates down. That impacts the entire 30-year stream of income that we discount. In terms of actual sales numbers, once again we don't -- we don't give sales guidance. We link our goodwill analysis from a sales standpoint very closely to our plan. We have a strong history of hitting our plan. So I'm very comfortable with where we ended up in terms of the sales that are inside of the goodwill analysis. Once again, it was a near to midterm thing. We believe that when you look in the out years, you'll see most competitors start to respond, raise their prices, et cetera. So you'll see that competitive positioning coming back. And you'll see all those sales return. The strength of the Life franchise hasn't changed one bit by what we've done here from a goodwill analysis standpoint.

Randy Binner - FBR Capital Markets & Co., Research Division

And just a follow up. Why specifically did the discount rate not follow prevailing rates down? What was the mechanism for those to separate?

Randal J. Freitag

Yes, I mean it's really judgment at the end of the day, right? I mean, you can simply do a cap and an -- capital analysis, a market-based analysis of the discount rate, and we do that. We actually hire an outside firm to come in and do that analysis. They look at the risk-free rate. They look at our beta and all the items that go into an analysis like that. And their input back to us was that the discount rate had actually fallen. Against that, we need to look at the overall marketplace that we live in today. And when look at that marketplace, and we talk to other market experts, it was our belief that the market discount rate just hadn't come down like the capital markets model would have said. In fact, we felt that it had gone up a little bit and we reflected that in our model.

Operator

Our next question comes from Andrew Kligerman, UBS.

Andrew Kligerman - UBS Investment Bank, Research Division

Just around the sales, the variable annuity products came in down 8.5% in the quarter. And then just noticing that a lot of your competitors are kind of retrenching on the generosity of their product. I would have expected maybe an uptick. So can you comment around why you think the variable annuity sales were off? And where you see them going over the course of the next year or so?

Dennis R. Glass

Andrew, it's Dennis. Again, thinking market share in this business is easy, if you want to provide a very competitive and rich product for the consumer. We haven't done that as, we've talked about, and we continue to make changes, which give good consumer value and options to our consumers, but continue to improve risk-reward trade-off for the company and our shareholders. The comments about competitors, and again, there's always going to be competitor movement in the marketplace. I think the fourth quarter there may -- you may see some bigger numbers from some of the competitors, as you point out, because the products are getting, they are coming back to where we are, if you will, in terms of richness. And while they weren't, you were seeing big numbers. So what I would say is that the demographics are strongly behind this product. Lincoln and, I think, the rest of the industry, is doing a better risk-reward trade-off of -- in their product design. And I think Lincoln and the industry is going to continue to see good profitability and good growth from these products in the coming years. Again, coming back to the importance of them to the consumer for guaranteed income and the demographics.

Andrew Kligerman - UBS Investment Bank, Research Division

Okay. And then maybe on the Retirement Plan Services. A little more color on why the mid-markets product was so strong, up 29%, or the mid-large markets rather? And then why maybe the micro-product and the multi-fund product were weaker? Maybe just a little color around that.

Dennis R. Glass

Yes, Andrew, the momentum that we picked up across the market, really, is a direct result of our new administrative platform, the direct result of the increase in feet on the street, more people talking to more people about Lincoln, and we won some big cases. And so I think it's just fundamentally, the investments we're making and we're beginning to see the payoffs. Just the way I would explain the year and the fourth quarter. I also think it's important that to mention, or repeat what I said in my remarks, not only are sales better, but our retention numbers are quite a bit better. This comes back to how we're managing distribution right now, because retention is part of distribution, salespeople's compensation. So that's helped. If you look at the overall retention rates this year, it was 12.8%, down from 15.3%. I give these examples as just trying to create the whole picture, which is momentum building because of the investments we're making and the payoff from those investments.

Andrew Kligerman - UBS Investment Bank, Research Division

And just a little color on maybe some of the weakness in the other fund sizes, micro and multi-fund though?

Dennis R. Glass

That multi-fund is not an active product. So the only sales that come through from multi-fund are existing client's renewals, individual employee renewals.

Andrew Kligerman - UBS Investment Bank, Research Division

So that would be -- that should taper off and then on the micro?

Dennis R. Glass

Yes. Excuse me?

Andrew Kligerman - UBS Investment Bank, Research Division

And then on the micro-funds?

Dennis R. Glass

Yes. Again, a lot of expansion going on there, and we'll see good results coming out of that eventually. Distribution expansion. Does that help?

Andrew Kligerman - UBS Investment Bank, Research Division

Perfect.

Operator

Our next question is from Steven Schwartz with Raymond James.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

I guess a couple of follow-ups here. First, referring back to the VA and the low volatility funds. It -- I guess my question is, is it cheaper for you, less expensive for you to be hedging on a subaccount basis rather than, I guess, for lack of a better term, more micro-hedging that you've historically done?

Dennis R. Glass

Yes, it's absolutely less expensive to hedge these protected funds than the broader portfolio of equities and bonds.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. And then, just on the, going back to the SGUL discussions, sales discussions and what we have just. I guess my question here is to what extent the pricing has reflected? And maybe to what extent, and obviously, how that fits into the goodwill impairment, the bifurcation approach that the NAIC looks to be taking. It's -- clearly, it's the use on new business, the LATF methodology. You'll at least have to do more. You'll have more fixed-year reserves, you'll have to do more financing that will affect GAAP, I would imagine. And you may be hopeful, but I think there's a better chance of the Great Pumpkin showing up than a principal base reserving. So did that play a role in all of this that's going on?

Dennis R. Glass

Well, let me try to -- there's quite a few questions in there. Let's speak to AG 38 and what might be the outcome of AG 38. And first, I'd put us all on the same page. The AG 38 interim solution that's being developed right now is simply that. It's an interim solution. And it's going to apply, again, retroactively it's one -- there's one approach and new business going forward, there's another approach. But that in itself, a new business going forward, is eventually going to be, the reserves are going to be based on risk based, not risk based capital, excuse me...

Randal J. Freitag

Principals-based.

Dennis R. Glass

Principals-based reserving. And it's been the expectation for the last 5 to 7 years that principal-based reserving will increase the pricing on some products and lower the pricing on other products. And at least, historically, the expectation is that it would likely lower the reserving on guaranteed universal life. So at this point, I would make the comment that we've got to look to principal-based reserving for the long run reserving practice on the business. And this interim solution, if it's a little bit harsh on new business, if it were, I don't know that it would be, it would be corrected by principal-based reserving. So that's what's going on. But let's back up. This is one of the best products in the industry for key planning purposes, particularly estate tax planning. And so there's going to be pricing elasticity, and as I said, the focus throughout this entire process has been the right level of reserves and a good consumer product. So I think at the end of the day, this will work out fine from those perspectives.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay, Dennis, if I can paraphrase, what you just said, and tell me if I got it right, basically, the message here is, we're not doing anything, haven't done anything with regards to this temporary bifurcation approach because we're confident that something will happen on PBR and, and in the end, will be great. Is that fair?

Dennis R. Glass

Say that again, please?

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

What I'm hearing from you is there's a bifurcation approach. It may be harsh on new business, but that's going to be temporary. PBR comes in, things will be fine, the profitability will be there. We don't have to do anything in the meantime with regards to pricing.

Dennis R. Glass

Well...

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

All else equal.

Dennis R. Glass

Yes, all else equal, our repricing does anticipate some increased reserving requirements. But I think I'd like to separate this AG 38 issue out from just the general reserving and the conservatism that we use. There is a indirect link, but you really don't know what's going to happen with the NAIC solution. And so we're continuing to build our products around what we think the right reserve level is. And I'll say again, we've increased that somewhat in our new pricing. And I think that we're pretty good at what we do. And I wouldn't expect what's going on the regulatory side to be too far different from what we're doing over time.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. I'm sorry to keep beating this. But now I get -- Now I'm hearing something else because historically, the argument, from your point of view is, we got plenty of extra reserves. In fact, as Randy mentioned, we can finance these things. So why assume reserving is going to be higher in the future? Why build that in? If you're looking at PBR?

Dennis R. Glass

Yes. Let me -- I'm trying to weave the whole story here and maybe you're picking pieces that belong to one story or the other. But let me ask Randy to answer that question.

Randal J. Freitag

Yes. So let's break this down. We're pricing a new product, and when we price that product, we need to assume a level of reserves that we're going to hold. We've increased the assumed reserves that we're going to hold as part of pricing. Separate from that, if those reserves are above some economic level of reserves, you can finance those reserves. Now financing of reserves isn't free, it also has a cost. So you have the base level of reserves that you've assumed inside pricing and that effectively has an equity type cost, right? Anything above that, if you felt that level was above economic, and you could assume a financing cost, which is lower than an equity cost. But in terms of what we're putting in pricing that base level of reserves, which gets some equity type cost inside of your pricing model, we have increased that. Because we believe that the amount of required reserves, as part of a new approach, will go up. Now we don't know what the final number is, and will adjust to whatever in that final number is, and will adjust quickly. But for right now, we've assumed that it will go up some and we'll reflect that in our pricing.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

Okay. So the costs in the base level of reserves that you would -- you'd have to hold is going to be greater than the...

Randal J. Freitag

Yes.

Steven D. Schwartz - Raymond James & Associates, Inc., Research Division

The financing, basically?

Randal J. Freitag

Effectively, to think about how it works in a pricing model, that base level of reserves, that amount you don't finance has an equity type cost.

Operator

Our next question comes from the line of Bob Glasspiegel with Langen McAlenney.

Robert Glasspiegel - Langen McAlenney

I'd like to follow-up on Randy versus Randy's exchange. Specifically, interest rate sensitivity to your assumptions -- if the 10 year stays at 2 or 10 years, and the credit spreads stay where they more traditionally have been, what sort of return on capital are you getting on new business and the Life business today?

Randal J. Freitag

So Bob, let's talk about this. We've been chasing over 2011 rates down, right? So we've made multiple assumption changes and pricing changes inside of our Life products. When we've made those changes, we've targeted getting a return in the low double-digit area. As rates have continued to fall, we've needed to continue to adjust our pricing. So we've trailed that a little bit through 2011. Now, looking forward, as I mentioned, we've repriced our products in today's interest rate environment to get a return at the lower end of our target range. So based upon the rates that sit here today, we are pricing our products to get a return at the bottom end of our targeted range, low double-digits. That's the entire book of business. Remember...

Robert Glasspiegel - Langen McAlenney

Right, I know the other business' bid price in different interest rate environment so...

Randal J. Freitag

And we don't just sell secondary RTUL or money where we sell up. Broad book of business, some of which gets 13%, some of which may get 10%, it all blends together into a low double-digit type of number.

Robert Glasspiegel - Langen McAlenney

So you're assuming sort of -- there's a discount rate of 2% plus credit spreads over the life of the product that you're pricing today? That's sort of inherent question.

Randal J. Freitag

Yes, Bob, we're looking at pricing in a number of different ways. We're looking at pricing, if rates stay at level, if they followed a forward curve, if they follow at our J curve. We're looking at assumptions that cover the breadth of potential outcomes and we're trying to make sure that we get a reasonable return in those, all of those scenarios. So based upon what we're doing today, we expect that we will get the returns, just as I said, Bob, at the lower end of our target range, in the low double-digits.

Robert Glasspiegel - Langen McAlenney

Okay. So if the 10 years stays at 2% for 10 years, there wouldn't be any charges related to business that you're writing today?

Randal J. Freitag

I'm going to back to our, the investors conference where we were very clear with the impact of a low interest rate environment for an extended period of time, and we don't see any hit to capital with the potential -- with outside of the potential need to lower our long-term earn rate assumptions, aside of our jack [ph] models, we talked about that, the impact of that last time was about $150 million. So there's the potential that we would do that again should rates stay low for a long period of time. But in terms of the reserves, we don't see an impact on the reserves due to the interest rates staying low for an extended period of time.

Robert Glasspiegel - Langen McAlenney

Okay. Last question, corporate, what's the run rate?

Dennis R. Glass

Corporate earnings?

Randal J. Freitag

Yes.

Robert Glasspiegel - Langen McAlenney

Just for the corporate line, yes.

Randal J. Freitag

Yes, I'd put them in the negative 35% range.

Dennis R. Glass

Yes, maybe I'll just, Bob if you don't mind, I understand the question. But it's been a little tough for the Life business. We continue to make pricing changes to improve the new business ROEs, as we've said, for the next couple of years, we might be at the lower end. But I'd also like to remind you and others on the call that we're getting very good ROEs in the balance of our businesses. So the Annuity business, the VA still is in the mid-teens, we're getting low teens overall, and Group Protection business, we're in that 12% range and in our Retirement Plan Services, we're pricing for and getting pretty close to the 12%, 15% ROEs. So yes, we're working hard to get the Life ROEs up, but we've got balancing and better ROEs in the business lines.

Operator

Our next question comes from Mark Finkelstein with Evercore Partners.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

I'll make this quick, I mean everything was hit pretty hard. Just a question on group insurance. I was a little surprised by the strength in sales there. Can you just talk about what rate increases you're pushing on that? And whether those were part of the Q4 sales or really Q1 '12?

Dennis R. Glass

Yes, let me talk about renewing, renewal pricing, and Mark touched on this at the IR meeting. We get a non-dental, we're 4% improvement, a little bit north of 4% improvement during the year. On our dental product, we're targeting 8% and we got up to 9%. So we've seen nice improvements on renewals. It's a little more difficult to translate that into new business, but it's not going to be too far away from our new business results. The strong fourth quarter was really driven by, again, we talked about this change in our rep structure, we've got quite a bit more alignment with our reps, quite a bit more activity. The fourth quarter, we saw a growth across our products and segments. So there was no reliance on any one facet of the business. As I noted, we're seeing continued success in selling employee paid solutions, what we call voluntary, both our traditional group products and our new worksite products. And we also remain focused on our core strength and the other 1,000 lives. So I would say it's a very good, solid, across-the-board result, which did include pricing increases.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Okay. But just outside of dental, no real range around kind of the average rate increases?

Dennis R. Glass

Outside of renewals, you mean?

A. Mark Finkelstein - Evercore Partners Inc., Research Division

No, no, outside of dental, I think you gave 4% on dental?

Dennis R. Glass

Non-dental, 4%. Dental, 9%. It's harder to give you price increases on new business.

A. Mark Finkelstein - Evercore Partners Inc., Research Division

Yes, no, I meant renewal. That's fine.

Dennis R. Glass

Okay.

Operator

Our next question comes from Eric Berg with RBC Capital Markets.

Eric N. Berg - RBC Capital Markets, LLC, Research Division

A couple of questions regarding the Life business that follow-on the earlier questions. First, it's my sense from hearing from and talking to lots of life insurance agents that price increases are taking place broadly throughout the industry. If I'm right about that, and I've heard it from several agents, I tend to think I am, why does Lincoln think it's going to lose share? If everybody is in the same boat, so to speak, why are you predicting lower sales than you have been predicting? And then I have a couple of real quick follow-ups.

Dennis R. Glass

Yes, Eric, what we said is that the industry hasn't been as quick to follow our pricing changes, but that we would expect over time for them to do that. It's -- there's a lot of different cells, if you wish. But on single pay deal at -- in the fourth quarter, we're off as much as say a male of 55. We were off as much as 17% from the price leaders. We expect those to change in 2012. But that was the reality and that affected our competitive support, because we don't know how fast the industry's going to move and catch up with us. We have more pricing stages coming out in the first quarter. We think eventually, and that may be by midyear or just later in the year, that this will all even out. But right now, we're, not usually, we're leading the market on pricing change.

Eric N. Berg - RBC Capital Markets, LLC, Research Division

I have a couple of real quick follow-ups. In the narrative of your news release describing in detail the goodwill write down and in your comments today, you discussed not only the effect of lower interest rates and your need to raise prices, as a result. But just, these are my words, not yours, but I think I have the right idea. The generally tougher environment for life insurance products, I'd like to know, one, what did you mean by that? The generally difficult environment for Life insurance products, apart from the interest rate issue? And relatedly, why can't you price? Why are you contemplating or why you pricing your new products at the lower end of your targeted range? What prevents you from pricing in the middle or the high end of the range?

Randal J. Freitag

Yes, Eric, it's always a balance, right? We've talked about capital usage and how we are being very cognizant of all returns available when we use capital. And what we've said is that on new business, we're going to price those products so that we get a return when you view everything that goes in to the future for Lincoln and the future value that's going to drive shareholders. Things like protecting the franchise. So we take all of those into account. And when we do that right now, when we look at the marketplace, and we strike that balance, as Dennis said, the pricing changes we've made have put us well out of the marketplace in a number of areas. And we take all that into account, and I think about the return I'm comfortable with defending on Life sales, that's exactly where we've moved to. So Eric, I think we've made pricing changes, that when you think about a total balance, get me very comfortable with the returns we're getting on those new business sales. Now the industry is going to respond, and you'll see this all shake out, so that those returns will move up over time. But for a period of time, when I think about that balance, I'm very comfortable with the returns we're getting, that it represents a reasonable return on capital, taking into account all the potential usages. Now, all that aside, been very aggressive on the share repurchase front because I realize that is a compelling return from a capital usage standpoint.

Eric N. Berg - RBC Capital Markets, LLC, Research Division

But my question, Randy, was a little different from the one you answered. I think, I appreciate your answer, but I was actually trying to hone in on something a little bit different, which was that and maybe I'm making a -- maybe I'm inferring something that you didn't intend. But here is my thinking that in the news release as well as today, you were saying there's more stuff going on the life insurance business today besides just low interest rates. It's an overall, difficult environment for life insurance. If I'm reading you folks correctly, what are you saying is going on structurally in the life insurance business beyond low interest rates, that we need to understand?

Randal J. Freitag

Yes, Eric, I mean, I would say that, whatever is going on in the marketplace derives from interest rates, right? So life products, in general, perform better at a higher rate environment than they do in an environment that we're in today. So all of the dynamics that are going on in the marketplace, derive from the fact that rates are low and that's causing companies, we believe, are in the forefront of these changes, to adjust their products, to move into and out of certain markets to make all sorts of changes. So you just have a lot going on in the marketplace. But it's all deriving from the fact that rates are lower and companies are adjusting to that fact.

Operator

At this time, I'd like to turn it over to our speakers for any closing remarks.

Dennis R. Glass

I want to thank you all for joining us today. As always, if you have any follow-up questions, please contact us at our Investor Relations line at 1 (800) 237-2920 or via e-mail at our website. Again, thanks for taking the time, and have a good day.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Lincoln National's CEO Discusses Q4 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts