Lincoln National Corp. Q2 2008 Earnings Call

| About: Lincoln National (LNC)

Lincoln National Corporation. (NYSE:LNC)

Q2 FY08 Earnings Call

July 30, 2008, 11:00 AM ET

Executives

Jim Sjoreen - VP of IR

Dennis R. Glass - President and CEO

Frederick J. Crawford - Sr. VP, CFO

Terrence J. Mullen - Lincoln Financial Distributors

Analysts

Darin Arita - Deutsche Bank

Eric Berg - Lehman Brothers

Mark Finkelstein - Fox-Pitt Kelton

Suneet Kamanth - Sanford Bernstein

Colin Devine - Citigroup

Operator

Good day, and thank you for joining Lincoln Financial Group's Second 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].

At this time, I would like to turn the conference over to the Vice President of Investor Relations, Jim Sjoreen. Please go ahead, sir

Jim Sjoreen - Vice President of Investor Relations

Thank you, operator. Good morning and welcome to Lincoln Financial's second 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 supplements, 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 more 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.

Presenting on today call are Dennis Glass, President and Chief Executive Officer and 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 - President and Chief Executive Officer

Thanks, Jim and good morning to all of you on the call. We posted a solid operating quarter with retirement and insurance product deposits climbing 5% and net flows up 37% year-over-year. These results reflect ongoing investments to expand our retail and wholesale distribution forces and the introduction of new products and services to the market. Our overall asset position remains strong. We have excess capital to make business building investments, fund more share repurchases and provide a cushion against additional asset impairments, should we see further economic weakening.

It is worth mentioning that unlike many non-insurance financial companies, our core business model of providing retirement products, investment management and individual life and group protection products remains intact. In other words, we don't have earnings holes to replace because some or all of the business model no longer works.

To further improve our opportunity for profitable growth, we realigned our insurance operating segments into retirement solutions and insurance solutions. This change was driven by a strategic assessment of how best to serve our customers.

We expect the top-line in each segment to benefit overtime, primarily through coordinated product and services development and also expect some efficiency improvements to emerge.

External factors continued to target top and bottom line earnings results. Our reported income from operations per share was $1.32 compared to $1.36 last year. Taking into consideration notable items, merger expenses and adjusting for the swing in alternative investment income, we view quarter-over-quarter growth at about 4%.

Weak overall capital market conditions have held back more robust growth. We would of course expect this growth rate to be significantly boosted by both the recovery and equity markets and economy and some internal growth and effectiveness initiatives.

Our operating income ROE remained flat, relative to the first quarter at 12%. We still are confident that our business mix will deliver a 15% ROE in a reasonable timeframe. The 15% target is based on strong un-leveraged new business ROEs that we are achieving, combined with a 9% equity market growth rate. A significant recovery in the equity market would be necessary to see this 15% as early as we had expected.

Net income was affected by asset impairments, primarily related to a more conservative view in our models of the severity of defaults on sub-prime and Alt-A investments. We also wrote down our media holdings, largely due to an industry view that the recent substantial drop in the industry revenues will not bounce back quickly. We are well positioned in recovery because our individual radio properties in markets remained some of the strongest in United States.

Expense management has been excellent. Second sequential quarter G&A has been flat and down 7% from second quarter of last year. We are not compromising investment in our growth initiatives but are certainly taking a prudent approach on those that we fund.

Let me drop down now to few more headlines by area starting with individual market annuities. Total individual annuity deposits and net flows in the quarter were up 5% and 40% respectively over the prior year. Last quarter's introduction of our new guaranteed withdrawal benefit Lincoln Life Time Income Advantage was well received and represented almost one-third of the second quarter's deposits.

We are very pleased with the momentum achieved in such a short period of time, particularly given the competitive features now available in the marketplace. Annuity deposits in total were flat over prior year which we attribute in part to market conditions at the client level.

Our second quarter and first half results will likely outperform the industry, a testament to our strong competitive product portfolio sold trough multiple channels by an experienced and motivated sales force.

Fixed and index annuities reported sales of almost $0.5 billion, a 54% increase over the prior year as competitive interest rates improved the products positioning, primarily against CD's and the bank channel. The bank channel, where our penetration continues to grow for all annuity products.

Let me turn to life; in our individual markets life segment, we reported a decline in total sales of 15% from the year ago quarter but a 5% sequential increase. As mentioned on our last call we launched updated versions of our UL and term products in the second quarter and we are currently on track to launch our new the BUL [ph] product asset hedge in the third quarter.

Consistent with my prior comments, we expect to see at further pick up in sales through the balance of the year. Sales of MoneyGuard our universal life product with long term care benefits were up 25% from the prior year quarter, driven by expanded distribution efforts.

During the quarter, we completed the transition to our customer centric cross functional teams in underwriting and in the third quarter we plan to introduce our next generation illustration platform. These activities are aimed at enhancing the ease of doing business with Lincoln and making the sales and underwriting process more effective.

Distribution; as Lincoln Financial distributors, the strategy and story is unchanged in that we are continuing our focus on expanding shelf space and growing our market leading wholesaler ports. An excellent example of this strategy is the very successful launch at Edward Jones of our multi manager variable annuity ChoicePlus. The product was added to their system in 2008, LFD [ph] dedicated a 24% wholesaling team and in just two quarters sales, went from zero to $340 million.

During the second quarter, several additional initiatives were completed or launched, including American Legacy and ChoicePlus variable annuities and some trust bank variable annuities and Life Insurance and Washington Mutual and Delaware firms were added at pre-asset allocations fees [ph] on Edward Jones managed account platform.

As part of the realignment I mentioned, distribution for prime contribution has been moved to LFD which now has a combined wholesale account of approximately 800, up 8% for the year. We plan to grow this number over the balance of the year.

At Lincoln Financial Network, recruiting has continued the positive momentum built in 2007, and they are on track to have another record year, although top line production is slightly down, it has been helped by better life sales and the LFA and ABGA channels.

The bottom line story remains strong at LFN, as they are tracking ahead of 2007 results for the first six months.

Employer market second quarter continued to build on the favorable trends that began to emerge last quarter, taking in to consideration the seasonality that exists in the Defined Contribution business. We saw improvements over the prior year quarter in Defined Contribution production, with aggregate deposits up almost 12%.

Sales in both the micro to small and the mid to large case markets were up over second quarter '07, 3% and 27% respectively. We are seeing the benefits of distribution focus and expansion begin to yield results and we believe we are well positioned heading into the selling season, starting in the fall. We are also seeing increased proposal activity in the 403(b) market which we believe is direct result of regulatory changes that will be effective in '09. Our strong position in 403(b) market combined with an enhanced service model makes us well position to capitalize on this opportunity.

Group protection delivered yet another exceptional quarter with net earned premium up 9% over the prior year quarter. The expansion of the sales force is expected to be a driver of increased sales in the second half of the year. Our unique business model, highly productive distribution group and solid risk management continue to drive favorable results.

In our asset management business Delaware continues to feel the effective weak markets with a $7 billion decline in assets under management this year attributable solely to the markets. Retail sales, while disappointing were not out of line with what many competitors are reporting. Lower fixed income sales were the primary driver of the institutional sales decline as last year we were still capturing fixed income assets prior to the July announcement of the transfer of a portion of the fixed income business.

We are seeing some promising signs in the institutional fixed income area, a relatively new team is generally out performing our key institutional fixed income competitors and this team just received its first sizeable fixed income mandate, which we'll begin funding in the third quarter.

In closing, the quarter again highlighted the continued strength of our product and distribution capabilities and the stability provided by quality balance sheet and strong capital position. We believe volatile economic conditions can offer up opportunities for strong companies to gain market share, while maintaining discipline around risk and expense management. Continued focus on these fundamentals to create opportunities for top line growth, along with prudent expense management is our top priority as we look to maintain and improve our competitive position in key markets.

With that, let me turn it over to Fred to discuss financial highlights of the period.

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

Thanks Dennis. Our reported income from operations in the quarter were $342 million or $1.32 per diluted share includes a few notable items that combines or reduced the quarter's earnings by about $7 million or $0.03 a share, this includes a positive reserve adjustment in our UK operation offset by negative DAC unlocking in our life business and a few expense items running through other operations.

Our reported earnings also include merger expenses of $16 million pre-tax and inline with our previous guidance. Alternative investment income in the quarter well below our long-term expected returns of 10% to 12% was essentially inline with our revised outlook for 2008, contributing $13 million pre-tax in DAC. It's worth noting that last year's quarter was exceptional, generating pre-tax and DAC earnings of $70 million.

In terms of market impact, the daily average level of the S&P was actually up a little over 1% helping out sequential results, but down fully 8% as compared to the last year's quarter. Its worth noting as we look forward to the third quarter that poor market performance in the month of June drove period ending assets under management and account values down below the averages for the quarter.

Reported net income of $125 million or $0.48 a share was impacted by realized losses and impairments on general accounting assets as well as impairments to goodwill and intangible assets associated with our radio properties. I'll discuss both these items in a moment.

Overall we are pleased with the fundamentals supporting our results despite continued volatility in the capital markets and soft overall economic conditions. Turning to our business segments and starting with annuities, let me comment first on the reporting changes in the quarter. Simply put we have removed hedge performance on a variable annuity guaranteed death benefits and living benefits from our income from our operations along with the mark-to-market on indexed annuity forward starting options.

As it turns out this quarter, the changes have little impact on the segments reported income from operations. Hedge effectiveness over the extended life of our product is important in the quarterly marks after adjusting for aspects of FAS157 provide a window into that long term performance.

Our new reporting and the statistical supplement provides greater transparency around the hedge results. Hedge performance was strong in the quarter delivering an overall gain of just under $1 million. Before the impact of FAS157 namely the company non-performance adjustment pre tax and DAC breakage was a negative $14 million resulting in an after tax and DAC loss of only $4 million.

Turnings to the earnings drivers, despite market declines year-over-year average VA account values increased 8% with expense assessment revenue increasing 7% as compared to the 2007 period. Weak market performance was offset by over $6 billion of cumulative VA flows over the last twelve months. Normalized spreads improved to 214 basis points and we have modestly increased our outlook as a result.

As compared to the second quarter 2007, fixed margins were down 17%, this attributed to a combination of items, including a modest reduction in average fixed account values as out flows have largely subsided and the 2007 period was a particularly strong quarter for alternative investment income and prepayment income. We would expect our fixed margins to stabilize after experiencing sequential improvement over the first quarter's results.

Turning to individual life, the fundamentals for this business continued to be solid. Net notable items in the quarter combined to reduce earnings by about $7 million and were primarily related to negative DAC unlocking due to a number of small items. Average universal life in force was up 5% and account values up 3% respectively over the comparable quarter in 2007.

The more muted account value growth is the result of reduced variable balances due to the equity markets, offset by continued mid-single digit growth in fixed balances. Adjusting for certain items, both mortality margins and expense assessment income followed a steady increase in our book of business. Fixed margins are specially impacted by the alternative investment income returns in the life segment. I noted earlier that the second quarter of 2007 was particularly strong quarter and accounted for a swing in life earnings at a little over $15 million. Also impacting fixed margins is last year's reserve securitization.

We have modestly increased our outlook on spreads up to the 180 to 190 basis point range as crediting rate action taken in the second quarter begins to take hold. Our defined contribution business showed sequential improvement in earnings with very little on the way of noise in the comparable quarters. We think our strategic investments are starting to have an impact on the bottom-line.

For the quarter positive net flows of approximately $240 million and $520 million for the first half of the year helped to soften the blow from weak year-to-date equity markets. Flows are responding not only to investments and product development and distribution, but also actions we have taken around retention, particularly in the small case and material multiform blocks of business.

Overall expense assessment income was down 6% from the comparable quarter in 2007 due largely to the markets, and are flat sequentially. Reported spread of 210 basis points in fixed margins have now stabilized when looking at sequential results. This after a year of declining fix margin contribution and higher yielding securities rolled off the books. Contributing to 2007 fixed margins was the favorable impact again of excess investment income.

Our group protection business continued its record of strong quarterly performance. The quality of earnings is not simply a segment point of view but particularly powerful when considering the diversity benefits within our broader portfolio of businesses.

Loss ratios performed better than our long-term expectations in both and life and disability lines with overall non-medical ratios coming in just under 70% as compared to an expected range of 71% to 74%. Solid revenue growth continued with net earned premium increasing 9% over the comparable 2007 quarter. Delaware's earnings came in a little better than expected, the result of effective cost control in the face of weak equity markets and negative net flows in the first half of the year.

As noted earlier the June market decline had limited impact on the second quarter results but after the sharp rebound will be a head wind to third quarter advisory revenues. As a result, we would expect pre-tax operating margins of 16% to 18%, we expect Delaware's earnings to be in the range of $50 million for the full year, once again some what dependent on the markets.

In terms of overall expenses we have achieve our merger savings goal and are focused on continues improvement across the company. Expense initiatives launched in the face of weak revenue conditions are expected to yield results for the remainder of the year. Our goal is to support investment backing the strategic initiatives while continuing to lower our consolidated expense ratios. We expect merger expenses to be in the range of $10 to $15 million in the third quarter, these expenses are starting the wind down as you might expect.

Turning to asset quality and capital conditions, the impairment to intangibles related to our media holdings as a result of poor overall economic conditions in the radio industry and a more significant fall off in our particular markets since the beginning of the year. There has been a fairly significant drop in the industry advertising revenue, along with broadcast cash flows in 2008. Further most industry observers believe any future recovery will take a number of years and may not recover to the levels experienced in 2006 and 2007.

While we are taking actions to improve cash flows and believe we are well positioned for when conditions improve, we felt it prudent to take impairment at this time. The media properties are held at the corporate level, this non-cash impairment does not impact our overall capital management plans. In the quarter, we recorded gross realized losses and impairments unavailable for sale of securities of $144 million.

Of this amount, roughly $13 million is attributed to securities where we may no longer have the intent to hold the recovery. The majority of true credit impairments in the quarter were concentrated in more recent vintage Alt-A supported residential mortgage backed securities, totaling about $73 million pre-tax.

We periodically run stress scenarios on our general account assets, focused on those assets trading in an unrealized loss position. We then bounce the high, medium low loss results of our GAAP and statutory balance sheet ratios. We remain comfortable that even under more elevated loss scenarios, our capital cushion properly defends the companies AA ratings and allows for investment back into our business.

With respect to stock buyback, we repurchased $140 million of stock in the second quarter having carried a strong capital position into these markets I would size our current excess capital position to be around $700 million. During the first half of the year, we have absorbed some of our excess position, given impairment activity and week overall equity markets. However, our overall capital position remains very solid and we expect to adhere to our original repurchase plans targeting $100 to $125 million worth of shares over the next two quarters.

Before we go to Q&A, just a quick note on our announced organizational change. From a financial reporting perspective we will be organizing our results according to retirement and insurance solutions. But that will have little impact on the reported results for annuities defined contribution, life and group protection, which all remain separately reported segments of our company with one minor exception, we will be folding the executive benefits or COLI/BOLI business into our life segment, given the now common management structure and very similar core earnings drivers.

Finally a reminder that the third quarter is typically where we review all of our prospected DAC assumptions and any model refinements required. Its simply too early at this point to provide any inside into what, if any, impact this will have on our results. So now let me turn it over to the operator for questions, operator.

Question And Answer

Operator

Thank you [Operator Instructions]. We'll go first to Darin Arita with Deutsche Bank.

Darin Arita - Deutsche Bank

Hi, good morning there. Was looking at the defined contribution business and the trends there actually seem quite favorable, was wondering if you can just talk about how the segment is positioned differently for the falls selling season versus a year ago?

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

Generally speaking, the big difference is that we have a strengthened distribution force and a more tenured distribution force, so we think that's the biggest opportunity we have for continued growth in sales. At the same time we have made improvements in our overall service capabilities, some product refreshments. So it's a general expectation that the business fundamentals are moving forward and we have the opportunity to create more share.

Darin Arita - Deutsche Bank

So the...

Dennis R. Glass - President and Chief Executive Officer

I would...

Darin Arita - Deutsche Bank

Go ahead.

Dennis R. Glass - President and Chief Executive Officer

I would just add that we have also increased our shelf space and access to shelf space since the fourth or second quarter of '07.

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

Yes.

Darin Arita - Deutsche Bank

So would you still expect the earnings to increase in this business in 2009?

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

From an earnings perspective, this is Fred. From an earnings perspective obviously it's somewhat dependent upon your view of markets going forward because there is some sensitivity there. But what we have seen is really a stabilization of many of the earnings drivers in this business, most notably fixed margins which has finally I think bottomed out and started to build with a little bit of sequential improvement, since the last quarter.

You have to keep in mind that we do run a little bit of alternative investment income through the fixed margins. So, they will move around a little bit, but some of the bleed that we were seeing in fixed margins over the past 12 months has really slowed down and started to rebuild, that bleed was related to higher yield and securities rolling off the books. Now, we are investing a little above portfolio, average portfolio yields and think we can do better in that regard. And then of course positive flows having about a $0.5 billion year-to-date of positive flows certainly helps fights the advent of any sort of market decline and we would expect that to cooperate with earnings going forward as well.

Darin Arita - Deutsche Bank

Great, thanks very much.

Operator

[Operator Instructions], we'll go next to Eric Berg with Lehman Brothers.

Eric Berg - Lehman Brothers

Yes a couple of questions, first Fred, you mentioned that you distinguished in your prepared remarks between realized gains and impairments; is the second one the impairments sort of a sub-set of the larger category of realized capital gains where realized gains would also include loss on securities that have been disposed?

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

Yes, that's correct. Just to give you the break-down real quickly while I grab it, my memory is that we did about $144 million of total real life losses and impairments. About a $120 million of that was related to impairments, but rest was actually realized losses on sold securities. And then within that $120 million of impairments, that particularly spiked out that we had taken impairment on several all paid-back residential mortgage securities. These would tend to be the more recent vintage Alt-A securities and in some cases lower rated but not necessarily. And so that's the way I would break it out down, Eric if that helps.

Eric Berg - Lehman Brothers

Yes, my second... it goes that answers the question precisely. My second and final question relates to your alternative [ph] investment portfolio. It looks like and you referenced this that the biggest impact by far is in the life insurance business. Why is that or to put my question differently, why doesn't the general account of the immunity business also contain a heavy principal alternative investment?

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

Yes, the difference there is, we hold our roughly $833 million at the end of the second quarter of total alternative investment income. We hold in both end portfolios backing products as well as in the surplus account.

In fact a rough split of that would be roughly $500 million or so, $450 million to $500 million held in portfolios backing life product and remaining in the surplus account. So as you go across our various segments, you will see positive alternative investment income impacting the other segments; annuities and define contribution most notably as it relates to their participation, if you will in surplus earnings, excess earnings.

But because of the long duration nature of the life portfolios, we felt as if those portfolios could take on from an asset liability management prospective, some of these more exotic, if you will, alternative investments vis-à-vis hedge funds for example; oil and gas partnerships, some ventured capital and mezzanine. And so that's why you see a disproportionate amount for the Life. In other words, the amount of alternative investment income backing portfolios is backing portfolios in the Life segments specifically.

That's also by the way why you'll see it moves spreads around, so you'll notice that I don't really talk about the impact necessarily to spread in our other fixed businesses, only when it comes to Life, would it move around the spreads.

Eric Berg - Lehman Brothers

Bottom line, it seems you have to do, it sounds like with the duration of the liabilities?

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

That's right, decision we made several years back. I think we've been doing this now for about five to six years.

Eric Berg - Lehman Brothers

Thank you.

Operator

[Operator Instructions]. We'll go next to Mark Finkelstein with FPK.

Mark Finkelstein - Fox-Pitt Kelton

Okay, three quick questions. Just looking at where equity markets are today, hearing some commentary from other companies, can you just spread up that from where you stand in terms of DAC and how we should think about and unlocking, going forward?

Dennis R. Glass - President and Chief Executive Officer

Sure, in our particular case, our long term equity markets assumption used for the purpose of amortizing DAC and the corridor process, we used to test that long term assumption. We currently are safely have some cushion relative to the potential risk of any negative DAC unlocking related to equity markets and part of the reasons for this is really when we reset our long term assumption for our separate account of products, you would have to go back in history to remember this, but when we restart or initially put in place our corridor, it was in late 2004. And at the time we put it in place, it had the effect of an equity market assumption of roughly five percent or so for the next four years or so, then arising to a nine percent equity market.

That relatively low setting of the... of our long-term expectations really helped to build out a cushion over the proceeding years, because as you know the equity market rose quite significantly as we moved into the 2005-2006 and some of 2007. So as a result up until the last three quarters, we were actually dangerously close to coming near a positive perspective on locking, related to our overall DAC on separate accounts.

Now the last three quarters have brought that down more to the medium, but it would take a fairly significant short-term drop in the equity markets for year... from here for us to run the risk of having to unlock on a perspective basis. Now, something to keep in mind is some of this is because leading up to that 2004 period, we were in fact taking negative DAC unlocking as you might remember and so keep that in mind as you think about our future trajectory, thanks.

Mark Finkelstein - Fox-Pitt Kelton

Okay that's great. And you just, I guess as well I believe you had slated for this year kind of a second round of an A triple X solution, proving more of a kind of a debt solution, obviously than a securitization solution, but can you just give us an update on where you stand with that?

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

Sure, we have in fact slated another round of what we internally we call project relief. We did about a $300 million, one as you recall last year, in life securitization project. We have keyed up another one for the end of this year, roughly the same size although that's currently being sized as we speak. Right now, we do think the nature in which we structure the transaction, we could continue to execute on that. In other words, the capital markets while volatile, will still allow us to move forward on that securitization.

What I would say, Mark though from my prospective is our capital position affords us the patience to really time that kind of a transaction for more cooperative capital markets. And so what I am going to be on the watch for, as we proceed into the fourth quarter which is the approximate timing we would look to do this, is if I see capital market conditions in what I believe to be a short-term disruptive period of time, I may pause and wait for that right timing.

But I would tell you, we certainly have one teed up and we are intentioned to do it. It's in our plans to do it, but I am going to be watching the capital markets carefully.

Mark Finkelstein - Fox-Pitt Kelton

Okay. And then just finally on your investment schedules that you provided last night, I think one of the more interesting ones. And they are again were interesting in the first quarter as well, just the credit length to notes. Obviously the mark-to-market and that's pretty significant, can you just maybe talk about kind of the underlying collateral in there and if there has been kind of defaults et cetera that are effecting that or is it really kind of liquidity driven other factors.

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

Sure, what Mark's referring to is about $850 million worth of investments in what we call credit length notes. They are wrapped up in different three transactions. These notes invest in essentially a replicated security with investment grade companies. By replicated, I mean it takes for cash of components, a highly rate cash component and couples it with a credit defaults swapped to mimic effectively a bond investment.

Again typically in investment grade, corporate and financial type companies and so that's what the underlying collateral is. Today, we have not experienced any default in the under-line collateral and therefore don't deem it appropriate to take any form of impairment but the securities are in fact trading relatively weak. I think the unrealized loss position as of the end of the quarter was in at around $3.90 million, to give you an example and what's weighing down on that is certainly some spread widening, if you will in the underline collateral, even though there have not any defaults.

But also as you point out, liquidity and other forms of haircuts being applied to this securities because of there structured nature. Now they tend to be in the AA rated and maintain in a low to high double AA rated, lot of them I should say AA rated classes. They've got a subordinated tranche which helps protect the investment that we've made but in the case of the cash component of the securities, one of the securities is for example a secured get if you will for MBIA. This is one of the $250 million credit link notes. That one's been particularly discounted in the valuation and that's because of the haircut, fairly significant haircut being applied to the MBA downgrade.

Something to keep in note is the secured get [ph] meaning that they've got a top up collateral, if you will back in that gate, per schedule, that we receive regularly and so we feel reasonably comfortable with that but it is weighing down the pricing. So, overall we obviously are monitoring these securities carefully. They are being impacted by overall foreign liquidity and other issues but we have not seen any defaults in the underlying collateral and therefore remain positive in terms of what we view as the potential for near term defaults in the security.

Mark Finkelstein - Fox-Pitt Kelton

Thank you.

Operator

[Operator Instructions] We'll go next to Suneet Kamanth with Sanford Bernstein.

Suneet Kamanth - Sanford Bernstein

Thank you just two questions; first is for Fred to circle back on the variable annuity debt. Can you just tell us than what's the sort of required market performance is that's built into your debt model today versus the what I would call top of the quarter or in terms of how you approach it? And than second may be for Dennis, just curious about the variable annuity business in terms of how the production came in the quarter obviously, equity markets picked up back towards end of June. Just wondering if there was a significant shift in sales production as we move through 2Q and then is there anything that you can sort of mention in terms of early signs with respected to Q3. Thank you.

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

I'll, Suneet; I'll answer your first question just apologize upfront for what may be technical talk but I think many of you are familiar with the way in which a quarter works. The answer to your question is it would take a 25% drop in the equity markets for us to breach the... what we would we called the inner corridor of our DAC corridor process. It would take again another 30, a little more than 30% drop in the market of to pierce the outer level of that corridor.

The significance of the inner and outer corridor if you will and the breaching of that is that when we breach, when and if we breach the inner corridor we don't necessarily unlock its really more after there is may be a prolonged period of having breached that, that we would give consideration to unlocking. Where as the outer corridor; it would be more of the case that we go ahead and unlock, believing it to be a more persistent drop in the equity markets, causing a more permanent, if you will, correction to our expected gross profit assumption, okay.

And so quite a bit of an equity market drop is required in the short-term to be hitting that inner corridor and causing conversations to start taking place inside the company relative to the risk we are unlocking.

Dennis R. Glass - President and Chief Executive Officer

Suneet on the VA business as I have already mentioned the strength that we continue to see versus the market comes from additional shelf space, distribution growth and again as I mentioned the introduction of this new product. We have seen some shift towards the bank channel, where we have got more shelf space. For the year it's hard to predict, where we are going to be. But generally I would say we would expect to end the year, with sales ahead of where we were last year with VA. But Terry is with us and he has a very close grip on this, Terry you want to add anything?

Terrence J. Mullen - Lincoln Financial Distributors

Dennis, you're correct, the bank channel continues to be very strong and the Edward Jones launch of choice process added significantly but in the two other major channels, the wire and the independent we are holding your own and seeing market share gains and lastly as we went through the quarters Suneet to your question, our June month was our highest month of the year, we saw a progressive increase over in the second quarter each month building off of the prior month and I would expect that we will continue to see that type on momentum through the rest of the year.

Suneet Kamanth - Sanford Bernstein

Okay thanks and may be just quick follow up; any changes in terms of customer utilization of benefits, that we have been in sort of a down equity market now for quite while just wondering if you have any good data in terms of our folks using the withdrawal benefit, are they asking about it?

Dennis R. Glass - President and Chief Executive Officer

There is nothing that we've observed Suneet, that's dramatically different. May be things will change as things settle down a little bit more but so far nothing significantly different.

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

Yes, and just keep in mind that our withdrawal benefit it truly a protection the way that they were designed and our income is the income for life, our patented income rider, which is traditionally used when people want to take income. So I think you'll see that our elections in utilization are a little bit different than what our competitors are because of the fact that we have income for life and that's about 20% of our sales.

Suneet Kamanth - Sanford Bernstein

Got it thank you very much.

Operator

Thank you. [Operator Instructions] we'll go next to Colin Devine with Citigroup.

Colin Devine - Citigroup

Good morning, two questions, first with respect of non core assets and obviously with the goodwill write-down on the Brighthouse properties and they're clearly not was started.

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

They were.

Colin Devine - Citigroup

Are we getting any closer to just calling it a day and selling these outright I would throw the DOA stock into that looking where your shares of are trading now. And then Dennis can you give us upgrade, I am sorry I should say an update on where we stand with respect to the defined contribution business that you laid out at the analyst meeting last year, its really sort of three businesses, where Lincoln's really trying to build the scale, where are you in getting this thing turned around, are you on track and what shall we expect over the next year.

Dennis R. Glass - President and Chief Executive Officer

Yes, let me talk about the non-core assets first Colin. I think we've described why in our earlier comments that we think the impairment was appropriate at this time, I'll point out again, it was predominantly driven by an industry sense that we won't it bounce back the way it has in past periods. I would qualify that a little bit by saying, again as we have already said we have excellent properties. As to our intentions with respect to the sales of these properties, we did get out of the TV and one radio sold on what we thought were appropriate prices, I think it was last year and at that time we made the point that we intended to sell the remainder the properties when we think we can get value out of them. I'm certainly not, to use your words throwing in the towel in the sense that these are strong properties and strong markets and we're going to wait to find time to get value out of them. This would not be the time, with respect --

Colin Devine - Citigroup

What's your stock part inside that Dennis, stand about 35% over the past year?

Dennis R. Glass - President and Chief Executive Officer

Excuse me.

Colin Devine - Citigroup

Even with your shares down about 35% over the past year?

Dennis R. Glass - President and Chief Executive Officer

I think that we always look at I shouldn't say I think. I know we always look at the relative use of capital for share buybacks, re-investments and other businesses and what we can get out products. So, we've done a little bit work around your question.

With respect to the Banc of America, the answer's the same. We so locked, effectively a half of that last year we thought that was appropriate. Its down in value, I think all financials are down in value. Anybody's guess is to whether or not, they're come back and at what speed. Banc of America has a very good franchise they don't seem to have some of the specific problems that other, say for example, money centered banks have.

So, we'll continue to watch that effort. Again doing the analytics as to whether or not we think, we can do better by investing it elsewhere.

With respect to the defined contribution business, we continue to make great progress there as we've outlined this quarter and last quarter that we have significant developments in terms of additional shelf space that will kick in mostly in the fourth quarter and the beginning of next year. So the general development of the business is going in the direction that we thought it would. I think that the markets have held back some of the sales that we had earlier anticipated or just has it has in couple of our other businesses. So I would say on track and expect good results over the coming periods.

Colin Devine - Citigroup

All you need some M&A in there.

Dennis R. Glass - President and Chief Executive Officer

We've been very clear of that. We, in terms of what's on our M&A screen. We'd like to see primary focus scale on that business although its developing that I think scale would help but our organic plan by itself shouldn't produce very good results. And the secondary area, that we are looking at of course is building some scale in Delaware, which I think will help quite a bit during acquisition. So TC acquisitions and M&A acquisitions are at the top of our list for use of excess capital reinvesting in the businesses.

Colin Devine - Citigroup

Thanks.

Frederick J. Crawford - Senior Vice President, Chief Financial Officer

Thank you, Colin.

Operator

Thank you. With no further question in the queue, I'd like remind everyone once more [Operator Instructions].

And now no another questions at this time, I'd like to turn the conference back to Mr. Sjoreen, for any closing remarks.

Jim Sjoreen - Vice President of Investor Relations

Thank you all for joining us, this morning. As always we'll take your questions on our Investor Relations line at 1800-237-2920 or via e-mail at www.investorrelations@lfg.com. Again, thank you for joining the call and have a good day.

Operator

Thank you, everyone. That does conclude today's conference. You may now disconnect.

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