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Lincoln National Corp. (NYSE:LNC)

Q1 FY08 Earnings Call

April 30, 2008, 1100 AM, ET

Executives

Jim Sjoreen - VP of IR

Dennis R. Glass - CEO and President

Frederick J. Crawford - CFO

Patrick P. Coyne - Delaware Investments

Analysts

Andrew Kligerman - UBS

Jimmy Bhullar - JP Morgan

Bob Glasspiegel - Langen McAlenney

Ed Spehar - Merrill Lynch

Jeffrey Schuman - Keefe Bruyette & Woods

Colin Devine - Citigroup

Suneet Kamath - Bernstein

Eric Berg - Lehman Brothers

Thomas Gallagher - Credit Suisse

Mark Finkelstein - Fox-Pitt Kelton

Operator

Good morning and thank you for joining Lincoln Financial Group's First Quarter 2008 Earnings Conference Call. At this time, all lines are in listen-only mode. Later, we will announce the opportunity for questions and instructions will be given at that time. [Operator Instructions] Today's call is being recorded. At this time, I would like to turn the conference over to the Vice President of Investor Relations, Mr. Jim Sjoreen. Mr. Sjoreen, please go ahead sir

Jim Sjoreen - Vice President of Investor Relations

Thank you, operator. Good morning and welcome to Lincoln Financials first quarter earnings call.

Before we begin, I have an important reminder. Any comments made during the call regarding future expectation, trends, and market conditions, including comments about 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 visit Lincoln's website, www.lincolnfinancial.com where you can find our press release and statistical supplement which include a full reconciliation of the non-GAAP measures used in the call, including income from operations and return on equity to the most comparable GAAP measures. In addition, we have for one quarter posted a general account supplement to our website that includes additional information and expanded profiles of certain asset classes held in our general account.

Let me also point out that we have added two new pages to the statistical supplement that provide a market-based view of the account values for defined contribution business and an additional split of Delaware's assets under management between inter segment and external assets.

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

I would now like to turn the call over to Dennis Glass, Dennis?

Dennis R. Glass - Chief Executive Officer and President

Thanks, Jim and good morning to everyone on the call. Our news release itemized the significant impact on current quarter earnings results related to the capital markets. Despite these capital markets impacts, the quarter's results also highlighted the pay-off on the investment we have been making in building our core businesses during the last year or so. These investments include significant new product introductions, a combined headcount expansion in our individual and employer markets wholesaling force to about 900 people, a 30% increase. Technology investments to improve efficiency and service quality and an 8% increase to 7300 active retail producers within Lincoln financial network.

Product introductions and distribution expansion contributed to account balance growth first quarter over first quarter in each of our life, annuity and DC businesses. In addition, we achieved significant increases in net flows in the annuity and DC businesses. Our Group benefit premiums grew by double-digits. Contributing to our capability to invest for future earnings growth is the strong credit quality of our general account. We are comfortable with our overall credit exposure and do not see an interruption to business investment or share repurchase plans due to credit losses based on current conditions.

Given the possibility of a recession, we are not taking significant risk on our new investments, and are cautious in our capital management. Looking forward in 2008 for earnings improvement levers, we have increased our focus on expense management, which had already been tighten up in anticipation of a year where equity markets were likely to be a factor. Having said this, we will continue to invest in areas where we can see near term revenue enhancements such as distribution expansion particularly where new relationships or shelf space have been added and new sales are likely in the short run.

In short, building the business investments that are ongoing, the quality of our general account and a healthy capital position make us confident that we'll continue to see improvements in fundamental long-term drivers of earnings growth, and as equity markets recover additional earnings boost.

Turning to our businesses, let me cover some brief highlights starting with individual market annuities. First quarter, total individual annuity deposits and net flows were up 7% and 57% respectively over the prior quarter. During the quarter, we introduced our new guaranteed withdrawal benefits, life time income advantage to the market, and also launched Choice Plus, our multi-manager VA product and the Edward Jones Advisor Network, Combined, these two initiatives attracted almost $300 million of deposits, so we are very pleased with the early successes of these two offerings. VA net flows remain strong at $1.3 billion, driven by the continued success of our products, and the effectiveness wholesalers.

Lapse rates did come in lower for quarter. Net flows in our fixed annuity business remained modestly negative, but improved almost 50% from the prior year quarter. The resulted declining surrenders from fixed annuities with expiring multiyear guarantees.

Out individual life segment reported a decline in total sales of 29% from the year ago quarter. Other than the difficult comparison due to the near record sales a year ago, some of the quarter's decline is due to price competition which developed after we introduced the new unified product portfolio. A key advantage of having moved to a single product platform is our ability to implement changes quickly and efficiently. We will be responding to the markets with new product introductions next month. In addition to some UL pricing changes, we are making improvements in our term portfolio to expand our presence in the advisor driven age 45 to 65 demographics and will be introducing a new variable universal life product. We are disappointed in our pricing and remain comfortable in achieving a 13% or better return on total new business life sales.

We are also on the final phase of our industry leading underwriting initiative, a model change designed to enhance our underwriting effectiveness and distribution partner relationships. Looking ahead, we expect life sales to ramp up due to seasonality and the benefits of both product revisions, new product introductions and the enhanced underwriting model.

At Lincoln Financial Distributors, we are continuing our focus on expanding shelf space and wholesaling support for our individual markets and asset management products.

Earlier this month, we launched VA products in SunTrust Bank and Wells Fargo. We anticipate signing another large bank in June. To support this and other activities, LFD increased its wholesaler count by another 5% in the first quarter, and is on pace to reach the targeted 18% growth for 2008.

Our retail distribution arm, Lincoln Financial Network, continued to successfully execute its key strategy of recruiting and retaining productive advisors, growing as I just mentioned. This growth resulted in an increase in proprietary product sales quarter-over-quarter.

Turning to employer markets, it was a good quarter on many fronts. In our DC business, sales of $0.5 billion in the micro to small case market were up 8% over the prior year quarter and 37% from the fourth quarter 2007. We view these results as evidence that we have now turned the corner on replacing the third party wholesaling relationship we terminated in late 2006. We still have productivity gains to achieve with our new in-house wholesaling teams. And it is important to point out that the first quarter is typically the strongest quarter of the year, due to new plan enrollments. However, we do expect strong, year-over-year comparisons to build gradually throughout 2008 as our product and distribution initiatives gain momentum and as wholesaler tenure increases.

We've been successful in leveraging the strategic partnerships that LFD recently signing two of the largest distributors of retirement products in the wired channel. Commensurate with the increased shelf space, we will be adding wholesalers later this year, as we prepare for a 2009 launch in these firms.

Sales in the mid to large case market were up 8% over the first quarter '07, driven by record sales in the Alliance program. We experienced a 150% increase in proposal activity in the first quarter versus the fourth quarter of last year, which underscores our success in this market. We enhanced our position in the mid-sized market with the launch of SmartFuture, a retirement program that fills the gap between Alliance and our Group variable annuities.

Our Group Protection business delivered another solid quarter, and while sales were down 11% from first quarter '07 levels, this was primarily the result of the soft January and February and March sales have rebounded. In the quarter, we added sales reps, which along with expanding the availability of long and short-term disability policies in a number of states will provide additional growth opportunities over the course of the year.

Turning to assets management, Delaware's performance in the quarter was clearly affected by the equity market. Both retail and institutional inflows and net flows were soft in the quarter. Our current focus at Delaware is to regain momentum in fixed income with the high quality team we've put in place, build retail sales off the fixed income products we have with strong ratings and to enhance Delaware's sales within Lincoln separate account products as we build out our assets gathering business.

Last year, proprietary separate account sales were in the $3 billion level and we saw an increase in those from first quarter '07 to first quarter '08. We believe the broad range of fund styles offered by Delaware will provide significant opportunities for leveraging its expertise in our VA and DC products and participate in the expected growth of these businesses.

To summarize, the quarter highlighted the continued strength of our products and distribution capabilities, the quality of our balance sheet and the benefits of the strong capital position. Continued focus on these fundamentals along with prudent expense management is our top priority as we look to the future to grow our businesses.

With that, let me turn over to Fred to discuss financial highlights in the period. Fred?

Frederick J. Crawford - Chief Financial Officer

Thank you, Dennis. First, let me correct an error we uncovered in our press release issued last night. We will be updating our average diluted share count for the period from 259.9 million shares to 262.8 million shares. While having no impact on our reported income from operations in the quarter of $333 million, we will report $1.27 per diluted share for the quarter versus $1.28 in yesterday's release. We have issued a brief release and will update our statistical supplement accordingly.

Our results in the quarter include a number of notable items detailed in our press release that combine to reduce the quarter's earnings by about $8 million or $0.03 per share. Not included in these items but worth highlighting is alternative investment income, which came in well below our expectations, I will touch on that in a moment. Our report earnings also included merger expenses of $15 million pre-tax. Net income included $27 million of net realized losses on investments, down from the fourth quarter and the one-time effect of adopting FAS 157 coming in at $16 million loss after tax and back.

The story of the quarter for Lincoln and the industry, were weak equity markets and overall market volatility, so I will comment briefly on the main areas of impact to our operating earnings; that being fee income and our asset gathering businesses, our variable annuity hedge program and alternative investments. With the daily average of the S&P down nearly 10% in the quarter, the market impact alone drove our period ending assets under management down by nearly $12 billion across the enterprise.

This impacting fee-based earnings by approximately $9 million in the quarter. The hedge program performed well in a period of extreme market conditions. The natural bases risk embedded in the program was offset by the final installation of FAS 157. The hedge program contributed $8 million to our annuity earnings before associated DAC unlocking. This excludes the one-time adoption impact noted earlier in my comments. The new accounting standard does introduce an added level of volatility in our reported results.

In terms of alternative investment income, we budget according to our long-term return expectations of 10% to 12% pre-tax. Recognizing this will be volatile in any particular quarter. On average, we would expect to generate around $20 million of quarterly pre-tax income of this $800 million portfolio. This quarter experienced a modest loss of roughly $5 million pre-tax as compared to a $20 million gain a year ago and on a smaller portfolio. This amount to an after tax and DAC swing in earnings over last year quarter of roughly $13 million.

Setting aside the markets, our underlying fundamentals remain in overall good health. Let's focus first on individual markets businesses. In individual annuities, isolating the market impact alone drove period ending variable account values down by $4.8 billion in the quarter. This offset somewhat by positive flows in the period. Expense assessment revenue was down 4% from the fourth quarter, but up 20% over the 2007 period. Revenues benefited from over $6 billion of cumulative variable annuity flows over the last year and the popularity of our retirement guarantees, which served to increase the average fee per account value.

Removing the impact of FAS 133 on indexed annuities, spreads came in a little north of 200 basis points. As compared to the first quarter of 2007, fixed margins were down 30% with roughly half of that decline due to accounting adjustments and the mark-to-market on indexed annuities. The remaining is attributed to negative fixed flows and weakness in alternative investment and prepayment income. Fixed annuity outflows are down over 40% from the levels experienced in 2007, a favorable development as we move forward.

Turning to individual life, the fundamentals remain solid with average universal life in-force up 6% and account values up 5% respectively over the comparable quarter in 2007. Unusual items in the quarter were primarily related to negative unlocking and poor mortality. The life segment is especially impacted by the alternative investment returns I noted earlier, and a reduction in prepayment income along with that. Both impacted fixed margins when looking at period comparisons.

The relative impact of the two items on the segment's operating earnings was essentially no contribution this quarter as compared to a $9 million gain in 2007. Another important item, when assessing the earnings trends in our life segment is to recognize the impact of reserve securitization and other statutory reserve reductions throughout 2007. These items contributed to weakness in net investment income, reducing statement earnings by roughly $8 million as compared to the 2007 quarter. These activities in turn bolster our statutory capital position and share repurchase and share repurchase capacity.

Our defined contribution business is exposed to the same market dynamics that drive earnings in our variable annuity business. For the quarter, positive net flows of approximately $300 million were more than offset by the markets impact on ending account values of roughly $2 billion. Overall fee income was down 8% from the fourth quarter and flat as compared to the first quarter 2007. Reported spreads of 210 basis points are down roughly 10 basis points from the fourth quarter, a result of higher yielding securities rolling off our books and the negative impact of excess investment income in the quarter. This decline was helped somewhat by a modest decrease in credit increase.

In our Group Protection business, loss ratios performed as expected across all major lines. While loss ratios can still be volatile at times, disciplined field underwriting and productivity improvements in our claims operation have resulted in loss ratios falling more consistently in the lower end of our stated range.

We continue our trend of strong revenue growth with net earned premium increasing nearly 12% over the comparable 2007 quarter. Delaware was obviously impacted by the weak markets, but came in roughly as we guided when adjusting for the mark-to-market valuing of seed capital investment through operating earnings. Normally, our $55 million seed capital investments do not move the dial in terms of quarterly earnings. But as we've seen with other asset managers this quarter, this can be more pronounced in a period valuable markets, and impacted our earnings by about $3 million in the quarter. As with all asset managers, seed capital investments are critical to establishing a track record for products that will later be sold to our investors.

We expect Delaware's earnings to be in the range of $11 million to $13 million for the second quarter, once again somewhat dependent on the markets. In terms of overall expenses, our run rate merger savings to the first quarter are approximately $190 million and while the integration efforts continue into 2009, we are now in a mode of continuous improvement looking cross the new organizations for opportunities to reduce our cost structure, particularly important in the phase of weak capital market conditions. After adjusting for the markets and strategic investments, we continue to see improvement in our normalized expense ratios. We expect merger expenses to be in the range of $15 million to $20 million in the second quarter, remembering the exact timing of these costs can be tricky to estimate.

Now turning to asset quality in capital, in the quarter, we recorded gross realized losses for impairments of $92 million. Of this amount, roughly $43 million is attributed to securities will may no longer have the intent to hold to recovery. These mark-to-market losses have less of a capital impact in that there is no statuary impairment. The majority of true credit impairments in quarter were concentrated in the financial sector. As shown in our general accounts supplement unrealized losses, widen considerable at the end of the quarter, and some what concentrated in the higher rated classes.

A sign of poor overall liquidity, we have since witness spreads partially recovered in the month of April, we are monitoring our assets closely and overall have not experienced significant underlying credit deterioration since year-end. We repurchase $286 million of stock in the first quarter, and we successfully closed on the sale of our TV stations in Charlotte radio collecting roughly $650 million pre tax. We are carrying a strong capital position in to these markets and would size our current access capital position in the $700 million to $1 billion range. We remain committed to our repurchase target of $200 million to $300 million, for the reminder of 2008.

So with that, let me turn it over to the operator for Q&A.

Question And Answer

Operator

[Operator Instructions]. And for our first question we go to Andrew Kligerman with UBS.

Andrew Kligerman - UBS

Hi good morning just a couple of quick data point, the cost savings you mentioned $190 million, I think the goal is $195 million to $205 million, where you implying Fred, that you can get well past and if so, where? And then just Dennis was mentioning the wholesalers growing by 18% by year-end '08 what would be the LSD wholesaler account by year-end? And lastly, with regard to Delaware, what was the performance, the life [ph] performance under one, three and five-year basis for your retail funds? And is that the reason why the flows have been so weak, more so than the volatile equity market?

Frederick J. Crawford - Chief Financial Officer

Andrew, this is Fred. Just real quickly on the merger-related savings. Yes, we've achieved run rate savings through the end of the quarter of $190 million towards our targeted range of $195 million to $205 million, I think I can comfortably say will come in at a higher end of that saving range related to the merger. And I would only note that those are savings as it relates specifically to the integration efforts and merger efforts of the company, they don't necessarily include other efforts that we may take on as a company in the form of continues improvement as mentioned in my script and that's something we are paying careful attention to.

Dennis R. Glass - Chief Executive Officer and President

Andrew, Dennis. From the Delaware performance which by the way has improved this quarter over the fourth quarter prior period. Just the statistics are there's a the number of funds in the one-year performance that outperformed their peers its 49%, and the three-year 59%, and in the 5 year 68%, again that's up from the prior quarter. What was the second question around Delaware?

Andrew Kligerman - UBS

Just that do you think that the one year... seeing these numbers, you think that the one year number kind of falling off might be responsible for weaker retail flows?

Dennis R. Glass - Chief Executive Officer and President

I'm going to turn that question over to Pat Coyne. Pat Coyne?

Patrick P. Coyne - Delaware Investments

Andrew, in terms of flows, their best selling mutual funds in the quarter were our fixed income funds. Actually we gained market share on the competition in terms of fund flow into our fixed income funds. I think if you look at the publicly traded asset management shops, they were heavily equity oriented, their returns and their net flows were extremely negative. So although our performance slipped in the fourth quarter of 2007 and rebounded nicely in the first quarter of 2008 and I think even we had the best performance equity funds in the world in the first quarter of 2008, there was no money going into equity funds, just due to market volatility. So the fact that we have a broad-based product lineup, including a lot of fixed-income funds was extremely a positive from that perspective.

Dennis R. Glass - Chief Executive Officer and President

Andrew, Lincoln Financial Distributors, we would be projecting about 773 external and internal wholesalers and managers by the end of 2008.

Andrew Kligerman - UBS

And that's quest [ph] both life and annuity, right?

Dennis R. Glass - Chief Executive Officer and President

Yeah most of that is in the, most of the growth is in the VA... well, it is in the life space as well... across the board.

Andrew Kligerman - UBS

Thank you.

Operator

We go next to Jimmy Bhullar with JP Morgan.

Jimmy Bhullar - JP Morgan

Hi, thank you. I just have a couple of questions. The first is on variable annuities. I think in your commentary you mentioned sales were strong, but as I look at the preliminary industry numbers, the industry is down about 10% sequentially. You were down twice as much. So just wanted to get your comments on why the results were a little bit weaker than the overall industry given that you have been gaining share consistently for the past couple of years.

And then secondly, on your capital position you mentioned the excess capital that you have on your balance sheet right now, I think $700 million to $1 billion, what's preventing you from doing more in buybacks than your goal that you have established for the year given your capital position in the multiple that stocks trading right now, that's all.

Dennis R. Glass - Chief Executive Officer and President

Let me speak to the VA market share without getting into specific numbers in the first quarter. In any particular quarter, competitor new product introductions can affect market share again, so that's an issue. Our goal though is through a combination of well priced innovative product introductions, distribution expansion to build this solid growing base over time.

I have mentioned in my remarks that we introduced a new rider, expanded shelf space, and added wholesalers this quarter and that the combination of these had a significant increase on our production and even though those were added later in the quarter. So we expect to see bigger production coming out of them as we move forward in year. I would like to share with you also that we do exhaustive annual market surveys, which tell us that the quality and quantity of wholesalers is the key differentiator in building share over the long-term and that's where as you heard me say, much of our focus is centered.

Frederick J. Crawford - Chief Financial Officer

In terms of the excess capital position, we have and we carried a very strong risk based capital into 2008 up north of 470%, which is among the highest of the RBCs that we have carried really in recent years, and that was deliberate. That was really recognizing that we're entering into some potentially weak credit conditions and so I would characterize the excess capital position as safely supporting our repurchase estimates, and more than likely resulting us being in the higher end of the range that I mentioned today in terms share we purchase, but the reason we are hanging onto that excess capital position has everything to do with being careful while we watch the credit markets sort themselves out and also being mindful of the fact that the rating agencies, I would tell you are of more of a concerned, nature these days they haven't necessary all gone to a negative outlook on the industry but they are certainly concerned and so you want to be careful on how you manage the capital in that respect to protect your ratings so we are being cautious Jimmy is the answer

Jimmy Bhullar - JP Morgan

Okay thank you, can I have actually just one clarification your merger cost... merger related expenses in the first quarter were I think $15 million; your guidance had been $20 million to $25 million for the first quarter. Has the guidance for the full year changed it all or is still the same as before?

Frederick J. Crawford - Chief Financial Officer

No we are out sticking with same guidance for the full year

Jimmy Bhullar - JP Morgan

Which is 50-60

Frederick J. Crawford - Chief Financial Officer

That's right

Jimmy Bhullar - JP Morgan

Okay thank you

Operator

And for a next question we go to Bob Glasspiegel with Langen McAlenney.

Bob Glasspiegel - Langen McAlenney

Good morning you indicated that you are going to step up your expenses saves where do see that can you expand it

Dennis R. Glass - Chief Executive Officer and President

Bob, this is Dennis, the... in the near term you have got a couple of challenges in dropping expense saves for the bottom-line and that is some of the expense save that you made would otherwise have been DAC so they wouldn't have dropped the bottom-line in any event, similarly you can make expenses that are, capitalized and written off of time in other areas, so the amount of money that you can actually get to the bottom line, isn't as large as the total improvement that you make in watching our expenses. Having said that there is a lot of areas, not any one of which is worth mentioning but in the aggregate you can back on I guess I will mention a couple of things, you may differ some expenses look like important things do over the long term consulting expenses, but don't have short term impact so it might differ some of those you can put tighter controls around headcount increases again particularly in those areas that are customer facing areas, you want to keep quality of your service up, I think there is the variety of I should say, I know there is a variety of areas that we can look at to cut back expenses in the short run my guess is we can only pick-up middle single digit earnings per share type number in 2008. But over the long term we can do better I would point out that over the last three years, were able to improve our expense margins by 21% and over the next three years we think we can improve on that improvement. So short term there is less that you can do long term, we have a continued commitment improve our expense ratios and I am comfortable that we can accomplish that.

Bob Glasspiegel - Langen McAlenney

Are you willing to articulate a goal, Dennis or when you think that flows could turn positive for Delaware, I mean we are talking quarters or years?

Dennis R. Glass - Chief Executive Officer and President

Flows at Delaware turning positive, the biggest net flow that we had out flowed in the quarter was related to our managed accounts. And so we need to do some work there. Otherwise the institutional flows were soft but not in large dollar amounts that flows retail in between our proprietary position with our DC and VA businesses, and retail were essentially flat so we have to focus our efforts predominantly in the managed account area. Some of that is wholesaling improvement and working on keeping the money that already there. I don't we are trying to try to project net flows for the year at this time.

Bob Glasspiegel - Langen McAlenney

So, we are several quarters away from turning positive in million [ph]?

Dennis R. Glass - Chief Executive Officer and President

I don't think we are going to project net flows at this time.

Bob Glasspiegel - Langen McAlenney

Thank you.

Dennis R. Glass - Chief Executive Officer and President

Okay.

Operator

We go next to Ed Spehar with Merrill Lynch.

Ed Spehar - Merrill Lynch

Thank you, good morning. I had a couple of questions, I guess first could you give us some sense on sort of the VA sales trend through the quarter and may be even some early indication in the second quarter, are we starting to see sort of the positive the benefit of the guarantee aspect to the product off setting any of other negative aspect of just concerned about equity linked products.

Dennis R. Glass - Chief Executive Officer and President

Ed, the general trend for us is to start [ph] and we would expect over the course of the year to grow sales or what we achieve last year. So we are pretty optimistic and again this gets into the specific issues that I have discussed and we've been talking about for quite some time, shelf space additions. I mentioned we have a new bank coming on could be significant introduction of product such as we do with our choice VA into the Edward Jones channel our new rider the length that I talked about which is very well received so followed those things that are unique to Lincoln that gives us comfort that over the course of the 2008 that we will increase sales over last year. And we are seeing that in the current numbers.

Ed Spehar - Merrill Lynch

Okay. And then the second question is on the hedging. What happened from I guess late in the quarter what happened late in the quarter where I think the comments which you had made I think enter quarter about the hedge program and some negative impact on earnings and suddenly turning positive? And I guess specifically can you help us understand a little bit the FAS 157 impact for you because I think we know we sort of hearing different things from different companies on this topic.

Dennis R. Glass - Chief Executive Officer and President

Yeah, I'm going to ask Fred to get into the details of that question, but if I can just step back for a minute and make a general observation on this hedge program and I think probably everybody understands it but its worth repeating. Brakeage reflects the differences in the present value of our potential claims that may develop over 25 to 30 year period and the assets value which we're building to great cash to pay the ultimate claim so just simple present valued claims in the assets that we are building. It doesn't surprise me that on four days each year, representing the quarter and that markets would move in such a way that's two miles would be somewhat different. Having said this when there are differences we moved quickly and we managed to be sure that over that 25 to 30 year life of the claim obligations. We built the assets adequate to meet the claims. The ability to manage the reserved assets over a long period of time some flexibility in the product to adjust pricing or forced asset allocations, gives me comfort that we could manage the long-term profitability of the business to our 15% to 19% IRR target. Long-term profitability is the issue certainly not any serious capital concerns reflected by the breakage amounts, so that's my big picture view on this. Now let me ask Fred to answer your specific question.

Frederick J. Crawford - Chief Financial Officer

Well, I would just say Ed that you are going to have trouble, you being generically the investing public, in understanding how to sort out the differences of impact one company to the next in terms of adoption, I think a lot of that has to do with in some cases the size of the underlying exposure onto these programs and so forth. But it also has to do with the assumptions that we have carried into the 157 process to start with and then frankly and maybe some what unfortunately the interpretation of 157 as financial executives, like myself and others on my team, interface with our auditors and sort through the best way to apply this.

In our particular case and this is really all I can speak to is, what's our situation? Let me separate the one time from the ongoing in the quarter. The one time impact was relatively straight forward and that is once adopting 157 and taking the cumulative adjustment up through January 1 we ended up with about $28 million or so increase in the reserve that's a quite lower than you would find from others that have potentially reported on the cumulative impact but, that's the result of a couple of things. One is we already had certain behavioral risk premiums embedded in the calculation of our reserve, so it wasn't quite as dramatic change for us on that component, when adopting 157 we also had a slight positive counter balance in terms of our index annuities when adopting 157, that had the effect of dropping other reserves on that side.

In terms of the actual quarter itself your absolutely right, in an around mid March I talked about the fact, that our hedge program for good reason, given the volatility in the market, was heading towards another period of modest breakage I think, we are estimating at the time around $10 million to $12 million, of negative impact to earnings, from the hedge breakage, what turned that corner was the final adoption of 157 but in particular for us, the final adoption of a feature 157 involving the non-performance risk, or company non-performance risk which essentially tracks the credit worthiness of Lincoln if you will or the issue, because spreads have gapped out it turn out to be a particular material item for us, serving to lower the reserve pretty considerably in the quarter and that's what resulted in the $8 million contribution to the quarters earnings that I have spiked out for you,

Ed Spehar - Merrill Lynch

So that is you are able to use the higher discount rate because your credit was trading at a higher yield in the market,

Frederick J. Crawford - Chief Financial Officer

Yeah, I don't know that I would call it, your able to, it's really a matter of when sitting down and discussing interpretation of 157 with our auditors we concluded that you have to play that company performance or non performance risk essentially, of your, I would say, a derivative if you will, of your credit default swap, or your underlying credit risk, that appears to me from what I am reading to be potentially different then what others have done, I can only say in our case yes indeed, is it resulted in a increase discount serving to lower the liability, and resulting in a gain in the period,

Ed Spehar - Merrill Lynch

Can you given us any sense, its sort of... it's bit perverse I guess in the sense that if tomorrow the market thought that you had the risk of the US government that there would be a negative impact on your earnings correct can you give us any sense, of how to think about relationship between spread, basis point, spread widening, spread tightening and CDS market and how we can think about earnings impact?

Frederick J. Crawford - Chief Financial Officer

I think, here is what I can tell is that generally speaking yes the way we have adopted the provisions as Lincolns credit default swaps go there will be implication to this particular feature of 157 and it move a liability round and so for example in the late part of the first quarter which is what you saw across our bond portfolio and across our industry, you saw spreads gap out even for very highly rated companies like ourselves and other in our peer group, that was we did not adopt such a sharp reaction to 157 to incorporate that spike in spread but it absolutely influenced the ultimate provision that we put on the table so we'll be sensitive to that probably as important Ed as is its, its not a piece of the equation that we hedge to, so in other words we are not hedging to a liability that's going to move around with something like the non performance risk factor because it really doesn't involve economic issues, over the long run for the company as a result you end up installing a level of inherent volatility in the program that's something we have got to review very carefully going forward.

Operator

We go next to Jeffrey Schuman with Keefe Bruyette & Woods

Jeffrey Schuman - Keefe Bruyette & Woods

Good morning, I want to follow up a little bit on the defined contribution businesses Dennis you talked about product and distribution expansion I am wondering if you could kind of bottom-line for us, how is that overall progressing relative to kind of the plan that was established last year.

Dennis R. Glass - Chief Executive Officer and President

One more thing in concert with the plan that was established last year, Jeff and you if you recall in previous conversation we've had either investor meetings or IRB meetings that the expectations is that we will be ramping up fairly significantly in our target markets in the DC business this year we would expect to continue to see earnings flat this year and the earnings lift coming from this ramp up beginning in 2009.

Jeffrey Schuman - Keefe Bruyette & Woods

And you also talking about generally about continue into invest in businesses but also being somewhat more careful if we take that guidance to the DC business is there any impact at all in terms of the your investment plan for the DC business.

Dennis R. Glass - Chief Executive Officer and President

No.

Jeffrey Schuman - Keefe Bruyette & Woods

Okay, thank you very much.

Operator

We go next to Colin Devine with Citi.

Colin Devine - Citigroup

Good morning. I've got a couple of questions about the new products. First on the life products Dennis you mentioned you have got some new features coming up, but also that that they were priced to at least a 13% return and that's obviously an ROE that's well below benefit where Lincoln's been, it's well below where you range out some pilot. So, you're effectively tying up share willing to take the ROE down. There seem to be at large with your stated goal which is to get it up and this is your biggest division. And then secondly, if you can spend a bit more on what you've done on the VA side, there is lot of sort of high new features out there right now, what did you do this quarter to improve Lincoln's product or what else you have coming down the pipe.

Dennis R. Glass - Chief Executive Officer and President

Let me touch first Colin on the issue of kind of ROE. The ROE that we talked about and are committed to achieving 15% is a levered return on equity. That manifests itself in the aggregate company. The 13% plus that I'm talking about in some products in the life business get as high as 15%. But in the products we're talking about this morning probably just a little north of 13%. So the 13% is consistent with the 15% guidance on company ROE. Back to your comment about old JP, the 13% to 15% were the same targets and the same thing that we've achieved at old JP and levered that up on the balance sheet to get to the 15 and 16% that you saw there. So that's the answers to that question. On the VA products --

Colin Devine - Citigroup

And also on the features, Dennis. What features are you putting on the products that will make them different that will make them different to get sales going again?

Dennis R. Glass - Chief Executive Officer and President

This on the VA or on the life.

Colin Devine - Citigroup

Both.

Dennis R. Glass - Chief Executive Officer and President

On the life what is going to move sales is more competitive pricing on UL in certain sales where we lost a little share in the first quarter. We're offering on variable universal life an asset accumulation focused product, which is very popular in the marketplace today. And as I mentioned, we re refocusing our term products in the sweet spot of the 45 to 65 year old segment. So it's is a combination of those three things that we think will help produce sales increases over the course of the year. On the VA link product I would say fairly significant improvement in the income features for the product and roughly it's a compound annual growth of 5% to 7%, ratcheting up for income purposes. There is some features that permit you to get your money back at the end of the 7 years, if you want to do that. But it is a very strong improvement on the income feature of the products.

Colin Devine - Citigroup

Maybe Dennis, Fred can explain Genworth has talked about having a take prices up because of not having access for the securitization market. When you are taking about being able to more competitively priced what is it about Lincoln that you are able to do that.

Frederick J. Crawford - Chief Financial Officer

I am sorry you broke up there, Colin.

Colin Devine - Citigroup

Okay, Genworth talked on their call about having to take prices up because of not having access to the securitization markets now because [indiscernible] have changed. How are you able to more competitively price and I say that take prices down, would it would seem that the funding cost without the securitization markets are actually going up.

Frederick J. Crawford - Chief Financial Officer

Well Colin, just the pure securitization is spread Colin. That I would make is one is not all securitizations are created equal and I say that just because my understanding of what they're facing has something to do with the overall structure of their program and how its funded, and the fact that those funding costs are going up on that program. In our particular case we have locked in a longer term cost of funding through the $300 plus million deal we did last year and then we also continued to use longer dated letters of credit which again are also locked in from a cost perspective, I would say it is true over time that the returns that Dennis is quoting on universal life are reliant upon efficient reinsurance/securitization vehicles to help meet those returns. As we sit here today we feel pretty good about the position we're in. We will need over time, capital markets to cooperate to allow us to do efficient securitization going forward. But I just want to point out I think, and I'm certainly not in a position to talk about their situation, but to just advise that look specifically at the type of securitization and what the issues are in terms of funding, we feel pretty good where we are right now.

Colin Devine - Citigroup

Thanks that's very helpful.

Frederick J. Crawford - Chief Financial Officer

Yes.

Dennis R. Glass - Chief Executive Officer and President

Yeah Colin, just a expansion on that a little bit. Fundamentally as we have looked at our reserve release, we have tried to lock in cost of that over the long-term; again I don't know exactly what other companies have done. But some of these reserve release programs that were predicated on variable cost of funds I think are causing problems for some of our competitors. We just simply have never done that.

Operator

For our next question we go to Suneet Kamath with Bernstein.

Suneet Kamath - Bernstein

Thank you just a quick clarification on the FAS 157 versus the variable annuity hedge. As we think about the offset provided by FAS 157 I mean is it fair to consider the fact that this was a cumulative adjustment as opposed to the hedge program which was sort of per period, I just want to make sure I understand that. And then my question is, as it relates to Fred's comments about he rating agencies I think getting a little bit more maybe they are nervous or uncomfortable, are you seeing any sense, in terms of rating agencies or your auditors for that matter, in terms of how they are viewing your other than temporary impairment methodology? Given the environment that we are in are we looking at a situation, where perhaps the rating agencies or the auditors might want you to be more aggressive with respect to taking other than temporary impairment versus sort of what you might do in a more call it normal environment? Thanks.

Frederick J. Crawford - Chief Financial Officer

Yes, on the 157 I think what's important is to really split the two that, we have a one time, cumulative adoption that we take through net income this quarter, and that's the $16 million, and then on an ongoing basis each quarter we will be calculating a liability under 157 and the degree to which hedge program keeps pace with that liability calculation, are not, will result in any level of breakage positive or negative, so there is really two components to in this particular quarter going forward you will no longer see, obviously the key motive adjustment taken through net income it will just be simply be the GAAP methodology of calculating reliability, up against the hedge assets and that's on an ongoing basis.

In terms of the OTTI methodology and the rating agencies it's an interesting question what I would say is this, that I can tell you absolutely without qualification that the accounting firms are spending as much time on the OTTI process in the impairment and even really adjust the security valuation on you balance sheet, whether it be broker quotes or models or what have you as much time and energy on that is they ever have before, and we are spending a lot of time with them in doing it as well, from our particular case they are quite comfortable with the way we approach, I will tell you that we've not been in a dialogue that's given rise to forcing some sort of bright line test or anything like that I think it's more been the mode which I think is appropriate that you look at the securities and you do the analysis on it, you certainly need to be mindful of pricing, in fact pricing in our case will draw securities to a watch list for example, but its the underlying credit conditions of the security that will give rise to eventual impairment and as long as we are able to have good solid research on that, and analysis and as long as that supported with the audit firm we are in good shape and that's the case thus far.

The rating agencies I would tell you they absolutely are surrounding asset quality without question. The degree to which they have dived deeply into the OTTI process, there has absolutely been dialog around that but I wouldn't characterize that as having been a concentrated effort on that part, at least not to my knowledge I would just simply say that they are reading what you are all reading and that is in the financial capital markets with as volatile as they have been in recent times they certainly are more of a concerned look again as I mentioned they may or may not have changed there outlooks necessarily but I can just tell you in conversation that they obviously want to dive deeper and among other things asset quality.

Dennis R. Glass - Chief Executive Officer and President

I think I will come back to the statement I made at the outset here which is, we are quite comfortable with the overall credit quality in our portfolio based on current market condition, we are being cautious because there is concern that there would be a deeper possibility of a recession and if that were to occur we just want to be cautious with our capital. As things improve in the economy and the capital markets liquidity that is large part causing these gaping of spreads improve we may get more comfortable with more shares repurchase and things like that but I think at the moment until we see things evolve in the capital markets and the economy it makes sense be cautious.

Suneet Kamath - Bernstein

Got it thank you very much

Operator

We'll next to Eric Berg with Lehman Brothers

Eric Berg - Lehman Brothers

Thanks very much and good morning two questions first Fred I was hoping we could return to the discussion of impairments that appeared in your news release and that you referenced. What is the difference between... of the 92 million of impairments you specifically mentioned 43 million on the one hand that you do not... that you are uncertain of your intent to hold. Is the point here that with respect to that 43 million less concerned with the number and more understanding, more interested in understanding how you think about impairment... is the point here that these 43 million represent securities that you think will recover over time in value to their amortized cost? You just are uncertain of your intent to hold it until that recovery? Is that the point?

Frederick J. Crawford - Chief Financial Officer

That's you saved me and others have lot time because that is the point. It really is the point Eric. This really dates back to EITF, if you will, or 3-1 I was really trying to clarify the OTTI process as it relates to FAS 115 where you had to... you really have to assert, if you will, that you intend on holding a security to recovery. If its in an unrealized loss position and you done the analysis and determine that you don't... you aren't going to take impairment on it, but there are from time to time securities that you may have... you may not have an intent to hold to recovery, and you need to classify those securities and frankly take the mark down on them mindful of the fact that you don't get mark up it's only marking down. And o you end up creating what amounts to a sub portfolio, if you will, at these securities that you have flagged if you will, as intentness, for lack of a better word.

Eric Berg - Lehman Brothers

Right, right.

Frederick J. Crawford - Chief Financial Officer

And those securities will move around. It doesn't impact staff, because that's just not the way, the way the OTTI process has been adopted on a statutory basis. So it doesn't have an implication for the staff capital that's why you are seeing some companies in our sector talk about on in... some will describe them as accounting-based losses, for example, as opposed to real impairments.

Eric Berg - Lehman Brothers

Second question, final question relates to your Alt-A portfolio, which as I recall is actually larger than your sub prime portfolio, in your general account supplement that Jim said you update and than have in front of me, you actually divide your Alt-A portfolio between RMBS and ABS what is meant by Alt-A ABS?

Dennis R. Glass - Chief Executive Officer and President

I will... Eric, let me turn that over to Sean [ph], our Chief Investment Officer.

Unidentified Company Representative

Hi Eric.

Dennis R. Glass - Chief Executive Officer and President

Hi Eric quick answer and then follow up if we need more.

Unidentified Company Representative

Hi Eric.

Eric Berg - Lehman Brothers

Good morning.

Unidentified Company Representative

Good morning. The deference between RMBS and ABS is really the market that it serves that the securities was sold in. It may be similar type assets, but because of how do they securitized in to the market that were sold in, you will partly [ph] find the different categories.

Eric Berg - Lehman Brothers

But I guess what I just trying to get at is, is the t is collateral in both instances mortgages.

Unidentified Company Representative

Yeah, they are mortgage related assets. Yes.

Eric Berg - Lehman Brothers

Thanks very much. I am offset. [ph]

Operator

And we will go next Tom Gallagher with Credit Suisse.

Thomas Gallagher - Credit Suisse

Good morning, couple of questions, first Dennis just in response to your comment about more caution in terms of what you are buying right now in terms of fixing cum securities can you talk about where you need money yield or trending, or yet [ph] moving much higher up on them, on the quality spectrum and what does that likely to do to your, the money yield. And related question to that is I know that your net investment income yield declined shortly it was 5.46 I believe that's just for this quarter down almost... or around 50 basis points from last quarter and can you talk a little bit about the outlook for that yield in lieu of what you're doing in terms of new money? Thanks.

Unidentified Company Representative

Yes, when I said we've been cautious about taking on risk in the investment portfolio, I was specifically referring to not jumping into the high yield bond area. We've been reducing that position over time. So that we don't want to increase the proportion of big investments at this moment in time. The money that we're putting out otherwise has a yield new money yield across the board in and around 570, 575. And with respect to the decline in net investment income on return the yield, I am going to turn that over to Fred.

Frederick J. Crawford - Chief Financial Officer

Tom I think the thing, I think what you are picking up on in our statistical supplement is from consolidated investment data where you see that decline. And really what is embedded in that decline is the performance of our alternative investment portfolio along with also prepays [ph] and make wholes. Both of those things end up having a more material impact on that number. You do have in our defined contribution business you do have a bit of the rolling off of some higher yielding securities, which is giving rise to some level of spread compression in the DC side. We're not seeing that same level of compression in some of the other businesses. But you do have some of that weighing down on the investment yield as well. But it would be combination of those factors.

Unidentified Company Representative

And just coming back investment yield [ph] again I think this is something that everybody understands particularly in a life area, we still have flexibility to reduce our crediting rates. So as new yields impact the over all portfolio rates, we have the capacity to takes some credit rate, reductions in fact have done that in the last three weeks or so, so try to hold margins.

Thomas Gallagher - Credit Suisse

That's helpful, so Denis or Fred if we though about enterprise wide spreads considering 546 includes a negative alternatives return, plus your in the processes of reducing crediting rates enterprise wide, plus considering new money 570 to 575 we should be seeing relative to this quarter, spreads going up, is that fair to say,

Unidentified Company Representative

I would say, we are probably stopping any the bleeding would be what I would be more comfortable I would be reluctant to move forward into spread widening. We have seen interest rates move round quite a bit we have seen spreads, as you no really do a lot interesting things last quarter so, right now I think we feel comfortable with the size of the portfolio and with our ability to take credit rate action, that we can defend any additional slide in portfolio yields, but I don't know we are ready to declare victory on spread widening,

Thomas Gallagher - Credit Suisse

Okay, and then just one question related to capital management, the... is there any contemplation right now of keeping dry powder for M&A, you know in addition to being cautious about the environment and managing capital at the higher levels, can you just comment on whether not you might likely to be potentially looking at something on the M&A front thanks.

Unidentified Company Representative

Denis again, we've been pretty public about having an interest in making acquisitions, primarily in the defined contribution space and then at the same time selectively looking at retail investment management opportunities, so can't say that anything is eminent wouldn't if it was but we are working hard to try to see if we can advance our organic growth strategy in those two businesses with some acquisition opportunities.

Operator

And for final question we go Mark Finkelstein with Fox-Pitt Kelton.

Mark Finkelstein - Fox-Pitt Kelton

Hi just real quick I wanted to follow up on the DC business. Flows are obviously better sequentially But if I actually exclude the Alliance and think about withdrawal rates, withdrawals are still pretty elevated. And I guess what I'm curious about is what, are you continuing to see impact of withdrawals related to the kind of a change in distribution there? When do you think that would subside, if that is, if that is the case? Do you continue to think that flows should be positive towards the back half of '08.

Unidentified Company Representative

The most important plan is particularly on the small case business that flows and sales were affected by disengaging from that third party marketing organization. So sales flowed and they also took some of their customers with them. As I pointed out in my remarks we think most of that impact is behind us and that positive sales increases from our wholesalers will occur and mostly with slide of customers being taken away by that that marker has. Again it's behind us, but with those comments let me as Wes Thomson to expand further if you want to Wes.

Unidentified Company Representative

Sure Dennis. Yeah I would just reinforce what you have said I think the first quarter, fourth quarter 07 and first quarter this year we really saw the began to see the sort of bottoming out of what we would have expected from the termination of that

third-party relationship and you're beginning to see now the impacts of the build out of our sales force that has over from that in that micro to small market place and we would expect this tenure of that group to prove that there is still about 1.25 years and tenures as you note from the LSE experiences and currently we would expect about a two to three-year period where we really begin to see the kind of dramatic improvements in productivity that we will learn to the bottom-line overall, in terms of gross profit.

Unidentified Company Representative

Thank you.

Mark Finkelstein - Fox-Pitt Kelton

Okay.

Operator

And with that Mr. Sjoreen, I'd like to turn the conference back over to you for any additional or closing remarks.

Jim Sjoreen - Vice President of Investor Relations

Well we just want to thank everybody for joining us this morning. As always we will take your questions on our Investor Relations line at 800-237-2920 or via e-mail at www.investorrelation@LFG.com. Again, thank you, and have a good day.

Operator

And ladies and gentlemen this does conclude the Lincoln Financial Groups first quarter 2008 earnings conference call. We do appreciate your participation and you may disconnect at this time.

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