Lincoln National Corporation (LNC) CEO Ellen Cooper on Q2 2022 Results - Earnings Call Transcript

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Lincoln National Corporation (NYSE:LNC) Q2 2022 Results Conference Call August 4, 2022 10:00 AM ET

Company Participants

Al Copersino - VP, IR

Ellen Cooper - President, CEO

Randy Freitag - CFO

Conference Call Participants

Elyse Greenspan - Wells Fargo

Erik Bass - Autonomous Research

Jimmy Bhullar - JP Morgan

John Barnidge - Piper Sandler

Josh Shanker - Bank of America

Mike Ward - Citi

Tom Gallagher - Evercore ISI

Operator

Good morning, and thank you for joining Lincoln Financial Group's Second Quarter 2022 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we will announce the opportunity for questions and instructions will be given at that time. [Operator Instructions]

Now, I will turn the conference over to Vice President of Investor Relations, Al Copersino. Please go ahead, sir.

Al Copersino

Thank you. 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 expectations, including those regarding deposits, expenses, income from operations, share repurchases and liquidity and capital resources 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 include those described in the cautionary statement disclosures in our earnings release issued yesterday as well as those detailed in our 2021 annual report on Form 10-K, most recent quarterly reports on Form 10-Q and from time to time in our other filings with the SEC.

These forward-looking statements are made only as of today, and we undertake no obligation to update or revise any about to reflect events or circumstances that occur after this date. We appreciate your participation today and invite you to visit Lincoln's website, www.lincolnfinancial.com, where you can find our press release and physical supplement, which include full reconciliations of the non-GAAP measures used on this call, including adjusted return on equity and adjusted income from operations or adjusted operating income to the most comparable GAAP measures.

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

I would now like to turn the call over to Ellen.

Ellen Cooper

Thank you, Al, and good morning, everyone, and welcome. As you all know, Lincoln has been providing financial protection and security to millions of Americans and their families for 117 years through 2 pandemics and numerous recessions. Over those years, we have built a powerful franchise with a reputation and brand grounded in integrity and trust, and we are a destination employer known for our great culture, talent development and commitment to diversity, equity and inclusion.

We pride ourselves on our many strengths, including innovative and agile product manufacturing, world-class distribution and industry-leading risk management capabilities. We have consistently delivered on our financial performance objectives and we are committed to continuing to enhance shareholder, customer and employee value as we move into our next chapter, and we will do this as we always have, with the right strategy and consistent execution.

Effective execution starts with leadership, ensuring we have the right people in place to drive the organization forward. I am pleased to share that we have assembled an incredibly experienced and talented senior leadership team, including the recent appointment of Matt Grove as Head of Individual Life, Annuity and Lincoln Financial Network. Matt joined us with deep experience running retail businesses, including all aspects of individual life, annuity and wealth management. Bringing these businesses together enables us to leverage opportunities for synergies across product manufacturing best practices, in-force management optimization and enhancing the customer experience.

Additionally, we recently announced the addition of James Reid as Head of Workplace Solutions which includes group protection and retirement plan services. James joins Lincoln as an established group protection leader with deep group experience, which is critical as we continue to deliver strong results and grow this integral part of our business. Chris Neczypor is our newly appointed Chief Strategy Officer and his organization is quarterbacking all aspects of the build-out of our longer-term strategic framework. Jayson Bronchetti, as our new Chief Investment Officer; and of course, our long-standing CFO, and Randy Freitag is a key partner to me in this next chapter. I am confident in our senior team and excited about Lincoln's future.

Regarding strategy, we are on the right path to continue to deliver shareholder value in the near term, and we are also focused on developing a longer-term strategy to accelerate the pace of value creation for all stakeholders. In addition to having the right people in the right roles, we also optimize our deployment of capital balancing capital allocated to build long-term value to support new business, investing in our future, for example, direct investments in our Spark program and, of course, returning capital to shareholders. And we also acknowledge the critical importance our investors place on cash flow generation and capital return as we evaluate deepening our strategic focus on distributable cash flow generation alongside our long-standing goal of generating strong ROE and growing operating earnings and sales.

To that end, we have an excellent track record of setting strategy and executing against it as demonstrated in part by having delivered compounded underlying EPS of 11% over the past decade. Despite the recent market headwinds, as we look forward over the next few years, we continue to expect to grow underlying EPS in the 8% to 10% range. I will touch on the key strategic initiatives that have and will continue to drive results.

First, product strategy. Sales remain robust as we continue to benefit from our reprice, shift and add new product strategy. New sales are generating returns at or above targeted levels while contributing to an ongoing strategic shift to a broader diversified mix of products that provide a range of customer value propositions and away from traditional long-term guarantees. This shift has also contributed to a more capital-efficient new business mix as the capital per dollar of sales and overall capital to support new business have continued to decline.

Second, Spark. We are on track and making substantial progress in the implementation of this enterprise-wide efforts. In addition to the expense run rate saves of $260 million to $300 million we expect to achieve, Spark is designed to accelerate delivery of results with increased agility and innovation. We have made about 1/3 of our planned direct investments and will continue to deliver, to accelerate our execution capabilities, modernize our technology, improve operational processes and create expanded opportunities for our employees as well as further enhance our customer experience.

Third, Group protection margins. We are making excellent progress, and in the quarter, achieved an underlying 6.8% margin and remain confident in sustaining the top end of our targeted 5% to 7% margin range through continued pricing actions, improved claims effectiveness and Spark expense savings.

Fourth, balance sheet resilience. As Randy will mention in his remarks, we did see a decline in our risk-based capital ratio in the quarter of about 15 points to approximately 400%, which was expected given the equity market downturn. We maintain a solid balance sheet, including our high-quality investment portfolio and remain comfortable with our RBC level.

Turning to the quarter's results. Despite market headwinds, second quarter underlying earnings were solid, and we are seeing positive developments, improving group protection results, a significant sequential decline in pandemic claims and a meaningful rise in interest rates year-to-date, supporting future earnings growth and new business returns.

In Annuities, we saw flat sequential sales that included growth of indexed variable annuities and fixed annuities of 16% and 40%, respectively, offset by a drop in traditional VAs, not surprisingly during a stock market downturn. The combination of this downturn and higher interest rates are shifting customer preferences towards IVA and fixed products. This marks the third consecutive quarter of sequential IBA sales growth. This change in consumer preferences has been boosting a strategic mix shift that has been underway at Lincoln for several years. For the eighth consecutive quarter, more than 70% of total annuity sales were of products other than variable annuities with guaranteed living benefits. This sales mix shift is in turn contributing to a shift in our account value mix as products other than BAs with GLBs represented 53% of our total annuity account value, up 5 percentage points compared to the prior year period.

Retirement Plan Services continues to deliver as our proven strategy, competitive product offerings and differentiated high-touch, high-tech customer experience model drove another quarter of excellent results. Compared to the prior year period, total deposits grew 6% and withdrawals improved 11%, demonstrating our focus not only on sales, but also persistency. Net flows were again favorable this quarter at over $900 million.

In the Life Insurance business, second quarter life insurance sales grew 53% from the prior year period and 25% sequentially. Sales of all product categories and sales across all major distribution channels were up compared to both the second quarter of 2021 and the first quarter of this year. All products are priced to generate new business returns in line with or above target levels.

Following the introduction of 7 new products and features in 2021, we continue to innovate and expand our offerings as part of our reprice, shift and add new product strategy. Lastly, on group protection, as I mentioned, our margin expansion efforts are gaining traction, and I am pleased to report that group achieved strong earnings this quarter. Premiums were up 7%, driven by solid persistency, organic growth and price increases.

Most importantly, we remain disciplined in our pricing approach and are meeting or exceeding our targets for both new sales and renewals. In what is typically not a big seasonal quarter for sales, sales were up 61% over the prior year period with increases across all products and case sizes. We are also achieving a healthy mix of both employee paid sales and sales to existing customers.

By continuing to focus on pricing discipline, claims management effectiveness and expense efficiency supported by our Spark program, I am confident that our margin expansion plan is on a solid path to achieve and sustain our margin expectations. Across these 4 businesses, our broad and diversified set of products to meet a range of customer value propositions, expanded digital capabilities to enhance the customer experience and industry-leading distribution strength position us to continue to generate profitable growth in the quarters and years to come.

Moving to investment results. Our credit performance and the quality of our investment portfolio remain excellent. You may recall that we began derisking our portfolio well before the onset of the pandemic. And today, fixed income assets are comprised of 97% investment grade holdings. Our credit outlook remains solid as net positive ratings migration continued for a fourth consecutive quarter and credit losses remain benign. We recognize that the risk of recession has been increasing with the Federal Reserve tightening financial conditions. One of the many benefits of our multi-manager investment model is that we leverage our entire suite of managers to perform scenario analysis on a name-by-name basis across all asset classes in our portfolio. Based on our current views, we would expect any potential credit impacts from a near-term recession to have a modest impact on our balance sheet.

New money yields have risen sharply as we invested new money at a rate of 4.2% in the second quarter, up 90 basis points sequentially and 20 basis points above our fixed income portfolio yield. In fact, our total fixed income portfolio yield rose 5 basis points sequentially. At these levels, we expect to see spread compression shift to spread expansion and support EPS growth over the coming years.

Briefly on our alternatives portfolio, despite declines in the public equity markets during the prior quarter, our highly diversified alternative investment portfolio delivered a positive 1.5% quarterly return. In closing, we are a financially strong organization that provides our customers' financial security and peace of mind. We have a long-standing, proven track record of discipline and consistent execution and are committed to continuing to achieve strong financial performance. Our leadership team is excited and energized to continue to deliver on our strategy with actions to continue to produce strong results while we also develop our vision for the longer-term business of tomorrow with the objective of accelerating growth and value creation for our shareholders, customers and employees.

I will now turn the call over to Randy.

Randy Freitag

Thank you, Ellen. Last night, we reported second quarter adjusted operating income of $391 million or $2.23 per share. There were no notable items in the current or prior year quarter. However, this quarter's results included pandemic-related claims, which reduced earnings by $39 million or $0.23 per share. Alternative investment income that was $19 million or $0.11 per share below our target return levels and unfavorable onetime items of $14 million or $0.08 per share in the Annuity segment.

Net income for the second quarter totaled $238 million or $1.34 per share. With the difference between net income and adjusted operating income, primarily the result of hedge breakage. The hedge program was 98% effective in what was a volatile quarter for the market. With the increase we have seen in new money rates, we have reached the point where interest spreads have become a positive contributor to earnings growth. As these earnings accumulate over time, they will work to offset and eventually overcome the negative impacts we have seen from equity markets in the first 2 quarters of 2022.

Nine months into the implementation of the Spark initiative, we have already made about 1/3 of the investments and generated about 40% of the expected savings. As previously disclosed, Spark is expected to achieve $260 million to $300 million in run rate savings by the end of 2024 and is expected to begin boosting EPS growth next year.

Touching on the performance of key financial metrics relative to the prior year on a consolidated basis. Adjusted operating ROE came in at 11.6%, adjusted operating revenues, not including resolution and alternatives were down 2%, negatively affected by the stock market decline. G&A net of amounts capitalized declined 4% as Spark savings, lower incentive and deferred comp expenses and ongoing expense management more than offset an increase in Spark investments. Shares outstanding declined 10% and book value per share, excluding AOCI, stands at $79.49 up 5% and an all-time high.

Now turning to segment results, starting with Annuities. Operating income for the quarter was $256 million compared to $323 million in the prior year quarter. The decline was driven by a drop in average account values, lower variable investment income and the $14 million of unfavorable onetime items I noted upfront. The decline in the equity markets during the quarter increased our net amount of risk for living benefits and death benefits to 5% and 4% of account values, respectively. We expect these figures to remain at the low end of peers.

G&A expenses net of amounts capitalized declined 11% from the prior year quarter, leading to a 30 basis point improvement in the expense ratio. Looking at return metrics, Annuities return on assets was 67 basis points compared to 78 basis points in the prior year period, and return on equity was 18% compared to 25% in the prior year period. During what was a tough quarter for the markets, the annuity business delivered over $250 million of earnings, the result that we would expect to improve as the market stabilize and return to growth.

Retirement Plan Services reported operating income of $54 million compared to $62 million in the prior year quarter, with the reduction driven by lower variable investment income. Average account values declined 4% compared to the year ago quarter to $91 billion, is $1.5 billion of positive flows more than offset by market headwinds.

G&A expenses that month capitalized were down $4 million or 6% versus the prior year period. Interest spreads, excluding variable investment income, expanded 3 basis points versus the prior year quarter as our ongoing crediting reductions continue to take hold and the benefits of higher new money investment yields emerge. Looking forward, we expect expansion to continue.

The retirement business continues to produce profitable new business growth and to manage expenses effectively, while also benefiting from an improved interest rate environment. This combination positions the retirement business to deliver long-term growth.

Turning to Life Insurance. We reported operating income of $114 million compared to $255 million in the prior year quarter. The drop was primarily due to lower alternative investment income when compared to the year-ago quarter's record results and $10 million of reduced earnings associated with the resolution block deal. Pandemic-related claims impacted results by $18 million.

Outside of the pandemic, mortality was in line with expectations. Average account values, excluding the impact of last year's block reinsurance deal fell 1%. Reflecting the impact of lower equity markets, while total in-force face amount grew 11%, driven by strong term sales.

G&A expenses net of amounts capitalized decreased 9% from the prior year quarter. Contribute to an understanding of the long-term benefit of alternative investments, we have added a new item in our [staff], which shows that when using our 10% annual target at returns, life spreads have stabilized on a year-over-year basis. Strong sales growth, good underlying mortality experience and stabilize the spreads, position the life business for future growth.

Group Protection reported operating income of $59 million up from $46 million in the prior year quarter, driven by strong top line growth, improved underlying profitability and lower pandemic-related claims. Pandemic-related claims were $21 million, substantially improved from the first quarter and representing the smallest impact on the group business since the pandemic [indiscernible]. This includes $13 million in our group life business and $8 million in group disability. Excluding pandemic claims, and adjusting for below-target alternative investment income, the group margin was 6.8%. On the same basis and further excluding unfavorable items in the prior quarter, our total loss ratio of 75.9% improved 130 basis points sequentially as an improvement in disability results more than offset a tick up in life loss ratio.

Moving to the product lines and excluding pandemic impact. The life loss ratio of 77% rose 370 basis points from the prior year period and 400 basis points sequentially and driven by an increase in the number of larger claims.

Looking at results over an extended period of time, we are confident this past quarter's experience was an outlier and not likely to repeat in the third quarter. Group's disability loss ratio of 75.2% improved 230 basis points from the prior year quarter and 520 basis points sequentially, as we benefited from what is typically our seasonally strongest disability quarter and new disability claims that return to within a range of historical levels.

Driven by our strong top line growth, the expense ratio of 12.5% was down 50 basis points compared to the prior year quarter. While we are excited about the progress we have made in improving group's profitability, we are well aware that there's still more to do, continued pricing actions, improvements in claims management, and executing on Spark are all components of what will allow us to deliver on our long-term goals for this business.

Turning to capital and capital management. We ended the quarter with $9.6 billion of statutory surplus and estimate our RBC ratio at approximately 400%, while cash at the holding company stands at $756 million. The approximate 15-point sequential decrease in the RBC ratio was in line with our expectations and driven by weaker equity markets and noneconomic limitations on the deferred tax assets. Taking into account the strength of our capital position, our high-quality investment portfolio and an improved view on potential credit losses, we intend to continue to repurchase our stock in the third quarter.

We look forward to getting together with you next month for a holistic discussion about the impacts of LDTI, not to front run that discussion as we continue to assess the impact, I will note that as of 6/30, we would currently expect to see only a modest impact from LDTI under total book value.

In closing, in the face of a challenging equity market environment, our second quarter earnings performance remained solid. We are confident in our balance sheet and pleased to be continuing buybacks in the current market environment. Finally, we see continued opportunity for earnings growth through our group protection margin expansion efforts and the Spark initiatives.

With that, let me turn the call back over to Al.

Al Copersino

Thank you, Ellen and Randy. We will now begin the question-and-answer portion of the call. [Operator Instructions]

With that, let me turn the call over to the operator to begin Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Elyse Greenspan of Wells Fargo.

Elyse Greenspan

My first question is on share repurchase. Randy, you said that you guys will continue to buy back stock in the third quarter, typically, you pointed to $150 million. I know that Q2, you had said, would be a little bit light of that and came in at $100 million. So how should we think about the third quarter level of buybacks that you guys are targeting?

Randy Freitag

Elyse, thank you for that question. Al had mentioned to me that this is topical last night from the call. So I spend a little time thinking about this. The short answer to your question is up to $100 million. But I think it would be helpful to give you a little more context around how we think about that. We have -- obviously, like every company, we have a philosophy on how we allocate capital. And philosophically, we believe that buybacks are primarily in our growth of capital generation and really should reflect the facts and the circumstances around capital generation in any given period. I think a good way to think about this is if you look at last year, there were a few outside influences or abnormal influences in last year's in 2021. On one hand, we paid out about $642 million of pandemic claims. That's a real use of capital. On the other hand, we had record all its performance and the equity markets that were up over 25%. You sort of added those things together, and it put us back at $605 million buybacks right in line with what you've seen for a few years.

Now when you look at 2022, the facts and circumstances of what we see this year are -- I won't get all of them but at a high level, right? The pandemic is receding. We expect, as you look forward, that will continue to recede. But the reality is, in the first quarter, we had $150 million of cash used for the pandemic. We had $39 million this quarter. And so you project that out roughly speaking, just round numbers, let's call it, $250 million of pandemic-related claims this year. The equity markets are down 21 points at 630. The reality is we expect this. It's in all of our models. But when that happens, we get some reserves that pop up across the organization. It's primarily in the Life Business, which is being valued under PBR and PBR reserves are more sensitive to the movements in the capital markets. Both in the capital markets move up and down, by the way, so it's not just one sided. So that was an impact this year.

And then as Ellen mentioned, this is the peak year or I've mentioned and Ellen has mentioned, this is the peak year for Spark Investments. When you look at the long-term benefits of Spark, $260 million to $300 million run rate benefits, right, just a huge IRR on those investments. So anybody would look at that and say that's a wise thing to be doing at a time like this.

On the other hand, once again, Ellen mentioned, credit performance is just tremendous this year. So better than our expectations, and that's supportive of capital generation. And I had mentioned with the powerful benefit of interest rates. But I also noted that interest rates are something that sort of accumulates over time, you don't get the sort of the immediate impact of the equity markets. Sort of add all those things together and -- from our standpoint, the $100 million we did last quarter, off to $100 million we just talked about for the third quarter, we'll talk about the fourth quarter when we get there. I think it's just very reflective of what we see this year. I'd also remind you in terms of capital generation and how we use that capital. We'll also pay out $300 million of -- over $300 million of shareholder dividends this year. And we'll continue to allocate capital, roughly $1.5 billion to new business. And we've talked about the very strong returns we're getting on new business, which is ultimately the lifeblood of cash flows in the future.

So I think that this year is very reflective of what we see this year. I don't think it says anything about what you might see in a normal year, but it says everything about what we're seeing this year. We remain committed to returning capital to shareholders. We've done a tremendous amount of it over years. That doesn't mean it's been a level amount every year, but -- the reality is at least over an extended period of time, and it's been fairly level over time. We've bought over 50% of our shares back. We're very proud of that. It's something we'd expect to continue looking forward. So I hope that helps.

Elyse Greenspan

It does. And then my follow-up, can you -- what are your expectations for dividends that you expect to take over the balance of the year? And would that come from L&L or from the captive?

Randy Freitag

We took a dividend from LNBar back in the first quarter, I believe it was roughly $125 million. In the second quarter, we took a dividend out of LNL of roughly $280 million. So I think that we have plenty of dividend capacity. We're very comfortable with where RBC is today. So I'd expect that the majority of dividends would come out of LNL over the remainder of the year. We have had a couple of breakage in LNBar and it think about that in the context of how we manage that entity, and we've managed that entity to maintain very robust capital also. So I think a lot of capacity will come out of LNL and will be supportive of the buybacks we've talked about, the shareholder dividends we've talked about and other corporate needs like debt interest expense, et cetera.

Operator

Your next question is from Erik Bass of Autonomous Research.

Erik Bass

In your script, you mentioned wanting to deepen the focus on cash flow generation. Can you expand on what you're thinking about here and is increasing the free cash flow conversion ratio over time a strategic priority?

Ellen Cooper

Absolutely. And Erik, you and yes, clearly a priority. And I want to just spend a moment really stepping back and make a couple of comments to be able to address your question. The first one is that I spoke about our near-term strategy. You all know that I've been part of the senior management team for a decade. I feel very comfortable about all that we are focused on as it relates to near-term strategy and also that we are well on the path in terms of delivering results around that. And at the same time, now with the new team in place, we are focused on our longer-term strategy.

And of course, this is all going to take some time and is all new. And some of the overall objectives that we continue to focus on here are around how we accelerate growth and how we enhance shareholder value. And a big part of that, we believe is around a further emphasis around distributable cash flow generation, of course, around capital return to shareholders, and to have those in combination with our long-standing focuses around ROE and EPS growth. So when we think about that and just to make it a little bit more tangible and a big piece as well is to really think longer term around how we continue to diversify our sources of revenue and earnings. So let me make it a little bit more tangible for you in terms of some of what we're thinking.

So when we talk about product strategy and our reprice shift and a new, a very large piece of what we're doing there is really focusing on making our products more capital efficient. And I mentioned that in my script as well. And Randy talked about the fact that we allocated, for example, $1.5 billion of capital to those new sales that are all generating returns that are at or above our targets. And that is as well looking at capital efficiency there. I would expect that we're going to look at ways to really accelerate that capital efficiency as we look at our overall product suite.

The second area is really around looking at our overall in-force and how we can further maximize the value there and really maximize our present value of distributable earnings at the end of the day under a range of economic scenarios. So here, as an example, you know that we have been very much involved historically in doing transactions. We did one in the third quarter of 2021. We have a team that is fully dedicated and staffed up. There are no commitments here. There are no time frames. But if something was to be the right opportunity at the right price, we certainly would look to do something here.

And then the other piece of this is really looking at the optimal long-term business mix. And so an example here is that some years ago, we talked about the fact that we were focused on increasing our source of earnings mix and looking at getting our mortality, morbidity source of earnings to 30%. We were able to achieve that by acquiring the Liberty business and putting that together with our existing group business.

And so I would expect, as we think about longer term, that -- and we have James Reid coming on board, who I mentioned to the deep group expert that we're going to look at ways that we can continue to grow that business in our Workplace Solutions business overall in general. And then we have other opportunities where we believe that there also could be sources of earnings and revenue that could be further grown. An example of that is that we have a managed account business. We haven't really talked about it very much. It's grown to $30 billion in assets under management, and we are strategically looking at over the longer term, whether or not there's opportunity there.

And then the final pillar that I'll mention is really around what I would call emerging trends. And so here, and I talked about how can we accelerate innovation and agility. And the Spark program is a perfect example of enterprise-wide, a foundation around how we're doing that and we're going to be looking at other opportunities here that potentially over the long term could be enhancing value. So you put it all together and we will have a further emphasis on distributable cash flow generation. As we do it, we're going to focus on capital efficiency. We are going to be strategic as we always are. It's going to take some time. We will be back to all of you with more as we work through this with the new team. At the moment, we are in process of really strategically evaluating all of our businesses and really looking for those growth opportunities where we're leveraging current capability. So I hope that addresses your question.

Erik Bass

Yes. And then my second question is just around your SGUL exposure. And I was hoping you could talk a little bit about your current lapse assumptions for the block and maybe provide any color on how the compared to the industry or maybe how they've changed over time?

Randy Freitag

Erik, thank you for the question. I think this question is probably more trying to get a third quarter assumption reviews. So let me take your question and expand and start with just. In general, Erik, our assumption view process is very robust. It's got a huge number of controls around it. They are done -- have really done people that are involved in that process. I'm not going to front run that work. We'll go through our assumption review, and we'll talk about it on next quarter's call.

So what I can tell you is that at a high level, the setting of assumptions is something that gets better, the more data you have, the talented people you have. And as a leading player in the life business, we have a lot of data. That data gets incorporated. We've been adjusting all of our assumptions every year reflecting that data. We did participate in a study, an additional study this year. By the way, we do that all the time around assumptions, but there was a particular study this year focused on GUL. We participated in that. So we have that study. And I'm sure the team will incorporate any new things they can learn from that process.

When it comes to lapses, I'm not going to specifically discuss geo, but I think there have been some things that have occurred over the last couple of years have been discussed across the industry. So let's just remind ourselves of what those were. The pandemic raised in the minds of consumers, the value of life insurance. And almost immediately with the onset of the pandemic, you saw lapse rates fall across every product, every type of life insurance.

And then after about 3, 4 quarters, you started to see them tick back up, and that's what you've seen. They haven't recovered all the way back to pre-pandemic levels, but they have come back up. So at a high level, I think that -- hopefully, that gives you some context around what has been a pretty interesting couple of years in terms of lapse experience and how you should think about the future. For instance, will it recover back to pre-pandemic levels. will level out at some point. I think those things all go into the pot. But Erik at a high level, we have a lot of data. We seek any data we can and we incorporate that into our assumptions every year.

Operator

Your next question is from Jimmy Bhullar of JP Morgan.

Jimmy Bhullar

I just had a question on your RBC ratio decline in 1Q and in 2Q as well. How much of this is purely because of higher required reserves with the market going down, which might potentially reverse as the market recovers versus other factors such as hedge breakage that might or might not necessarily come back.

Randy Freitag

Jimmy, we started the year at about 427, as I mentioned, we're at roughly 400. About 2/3 of that is really associated with capital markets-driven reserves that pop up. About 25% is associated with a little bit of limitations we experienced in our DTA. So our non-admitted DTA went up a little bit. That was at least 6 or 7 points. So those are the drivers of the decline this year, Jimmy.

Jimmy Bhullar

And then as you think about buybacks, you mentioned up to [$100 million]. I don't know, was that comment more about 3Q? Or was that more about the rest of the year or just generally near term for the next several quarters?

Randy Freitag

The comment was specifically about the third quarter, and then we'll talk about the fourth quarter when we get to that call.

Jimmy Bhullar

Okay. And then is it fair to assume if your RBC -- or fair to assume that unless the RBC recovers, given what's going on, then your view would not change too much on the upside in terms of buy backs.

Randy Freitag

Yes. I'll just go back to my answer with the lease. It will really be controlled by the facts and circumstances that we see over the back half of 2022.

Jimmy Bhullar

Okay. And then just lastly on RBC. Is there a level that you want to let it not go below? Like is 400 the base you'd want to keep it at? Or how do you think about how far down would you be comfortable having a drop?

Randy Freitag

I think as Ellen and I mentioned, we're both very comfortable at 400 where we are today. Just a couple of additional points around that if this was last year, 400 would have been 420, right, because the C1 factors lowered at about 20 points, but didn't change the actual economics of how we think about appropriate capital. So 400 this year is on a relative basis stronger than it would have been last year. The other sort of once again philosophy when we think about capital is -- and why we don't talk about a single target.

Philosophically, we believe that the right amount of capital is something that moves over time or the right RBC ratio is something that moves over time. At a very high level, immediately after a full-blown stress, we expect to be below our sort of average travel rate, right, maybe 50 to 70 points below. And if you get it exactly right, the day before you have that full blown stress, you'll be probably 50 points or so above your average travel rate. And so -- over time, we think about the right, I mean, I've got air quotes I'm making here in the room. Number has been something that changed over time. But where we sit today, 400, I think we're very comfortable at that level.

Operator

Your next question is from John Barnidge of Piper Sandler.

John Barnidge

The NAIC is considering increased RBC charges on investments in CLOs to address what it argues as a capital arbitrage benefit? What are your views on the proposal and discuss the potential impact of the proposal or maybe required capital in the RBC ratio? And maybe if it's in what that would do to appetite for CLO assets?

Randy Freitag

We're actively engaged as we are with the NAIC on all their topics. I think it really is a good partnership and relationship that Lincoln and the industry has with the NAIC as they work through these projects. Just as with any project, it's big, I feel very good about how we're positioned. I think you're well aware, our CLO Holdings skew very high from a rating standpoint. So it's a high-quality portfolio and I don't see a material impact in terms of anything they might do with CLOs.

Ellen Cooper

Yes. And John, I would just add that yes, we have always been very actively involved in all of the AOCI efforts and in particular, also around capital and C1. We also were very much involved in the first round. We have our Chief Risk Officer that is chairing this second round. To Randy's point as it relates to CLO, the majority of all of our CLOs that are ours are single A and above, they're predominantly AAA. We're really -- at the end of the day, we're really working across the industry as we always do to ensure that there's a good model that appropriately really correlates the losses with the capital and recognize that given the growth of CLOs on insurance company balance sheets that it is good to take a fresh look at that and ensure that the capital levels are appropriate.

John Barnidge

Okay. Great. And then my second question, you talked about a recent new hire, James Reid. Can help notice he was previously working in a place that had a sizable dental and vision exposure. As you talk about increasing some of that group business, should we be thinking about dental over time and even vision to becoming a larger portion of Lincoln's group story?

Ellen Cooper

So great question. And as James comes on board and we look broadly at group in general, we do believe, first of all, that -- this is a really important strategic business for Lincoln. And we think, first of all, that putting the old Lincoln and Liberty businesses together really gave us breadth in terms of size in market. And so we're in the smaller markets, and we're in the larger markets. And we also have introduced a range of new products. So we know that traditionally, we've been in the life areas and in the disability areas. We have been increasing our focus on supplemental health for a variety of reasons. And in there last year, we introduced a new product hospital indemnity.

We do have a dental business right now. It is fairly small as it relates to the overall business over in -- on the group side. I would expect that as James comes in and gets his arms around our current business and our current capabilities and we think about the long-term value of the business. Certainly, the types of products that we are offering and where we're doing business is going to be part of that overall strategic review that I mentioned earlier. And so we'll be back to with more in terms of whether or not those are areas that we believe that we could build scale and then therefore, participate in or if it will be some other direction. Most importantly, we recognize the importance strategically of this property. We're going to do everything that we can to continue on the path around restoring our margins and looking to grow this part of our business.

Operator

Your next question is from Josh Shanker of Bank of America.

Josh Shanker

Thanks, Randy, for the comment about the modest impact from the change in LDTI numbers. Obviously, you guys do stat accounting for your own books and you have a lot of internal goals. But LDTI is going to cause more volatility in GAAP outcomes and whatnot. Would you spend any more money on derivatives in order to manage GAAP expectations following LDTI? Or is it -- or would you describe it as cosmetic to your risk management procedures?

Randy Freitag

Josh, when I was in my script, I used the word holistic. So I think when we get together later in September, I think we'll discuss a lot of topics, including the hedge program. Look, at a high level, we have a super robust and expansive hedge program today. it has a significant amount of expense, and I wouldn't expect those costs to change, right? But that's all about what we do today, which we spend a lot of money to create this world-class hedge program. And I don't expect material change. But it's going to be a great discussion. I look forward, as I mentioned, to get in together with you at least virtually around the end of September.

Operator

Your next question is from Tom Gallagher of Evercore ISI.

Tom Gallagher

Just -- just coming back to the SGUL question and how you're thinking about things now. And Randy, I'm not going to ask you to front run the balance sheet review. But I'm just trying to think about capital implications because Peru mentioned that their charge also result -- GAAP charge also resulted in a corresponding statutory charge. I think in the past, you've indicated you feel very good about statutory reserves for SGUL. But I've always taken that to be an interest rate comment, not on mortality and lapse rates.

So any -- what would you say about overall your current view of capital adequacy and potential impacts there because I -- if there is a GAAP balance sheet review charge and there were a statutory impact, I presume that would impact your ability to keep buying back stock. But anyway, long-winded question, but anything you could comment on would be appreciated.

Randy Freitag

Tom, a few comments. So I think about the topic. So statutory reserving is primarily formula-based and develops reserves at a high level are meant to be conservative, right? It's a solvency-based reserving standards. So feel very good about that, it's very supportive of the sufficiency of reserves. SGUL itself then has some separate tests, right? And we've talked about these over the years, they go by the monikers [HC and HB]. And those are the things that we've talked about in the past, where if we were to see any impact on statutory capital, it would have come through those subtests. You can go back, gosh, a number of years, and we talked about if rates drop to a certain amount, we saw a potential risk, which has declined over time, right? It's declined over time because the base reserves continue to grow. So inside of HC and HB, each test is a little different. But were you to make big assumption changes. You do those inside those models also. So that can modestly impact those. But once again, at the end of the day, we've seen the potential impact from an HC and HB decline over the time. We haven't even talked about it for at least a year, near as I can remember. So at a high level, we feel good about there. But the reality is in those tests -- to the extent you change your assumptions about the future, you reflect those changes into those tests also.

Tom Gallagher

That does. Okay. And then my follow-up is just on VA hedging and LNBar. Just based on the performance you saw in 2Q and overall capital levels, any any chance you either have to make contributions in the LNBar. Or do you feel good about those capital levels? Or alternatively, any chance you might take dividends out?

A –Randy Freitag

Yes. Look, we took a dividend out in year. Historically, we’ve been sort of 1 time a year. So I don’t think – I wouldn’t expect any dividends over the remainder of the year.

Yes, Tom, you’re right. We’ve had elevated breakage for a couple of quarters in a row. A couple of other comments are on LNBar itself. It does have earnings, right? So we tend to talk about the breakage, but it does have a level of earnings that is meant to cover sort of a normal level of breakage and build capital over time. So that’s the entity structure. Just like any ongoing enterprise. I’d also point out that if you look back at last year, we came into the year in a pretty good place because we really didn’t have elevated breakage last year. I think I’m remembering like the middle 2 quarters of last year added up to actually to a small positive. There was no breakage. So we came into the year in a pretty good spot.

That being said, 2 quarters in a row of elevated breakage. I would we have to think about that. That’s real capital. That’s a real use of capital, and we’ll have to manage around the reality of that outcome. But once again, I think we came into the you’re in a pretty good place. The entity has ongoing earnings. We’ve taken our dividend up for the year, the earliest we would contemplate doing another devitability next year, and then we’ll have to see what the reality of these first 2 quarters and the reality of the back half of the year brings to us.

Operator

Your next question is from Mike Ward of Citi.

Mike Ward

Just had 1 question. I was wondering if you could comment on what you're seeing in terms of wage inflation. This has been a topic, but I think the growth for higher wage earners has been a little bit more recent. I think this is of course, a product of inflation in general. But just wondering if you're seeing that in the higher wage earner demographic and how that might be impacting how you're thinking about the kind of near-term outlook?

Ellen Cooper

So Mike, I'll start and comment and then I'll hand it over to Randy. So I suspect that when you talk about wage inflation that you're really thinking in terms of how that might impact in terms of our overall employees. And we have been seeing in this war for talent and in attrition and in general, just a lot of movement that we've seen here at Lincoln and attracting a lot of new people. We have overall continued to really keep pace with what we're seeing as it relates to wage inflation. And so when you see our overall numbers, and Randy talks to you about our overall expenses for the last, I would say, probably 12 to 18 months. We have been, in terms of our hiring, we've been increasing wages in terms of our higher performers inside and we have been increasing wages. And also we have been looking at appropriate market adjustments to be able to keep pace. And then the other comment that I'll make is that we also see a benefit as it relates to overall wage inflation in our workplace businesses as well. So we know and I talked about in my remarks earlier, that we've seen overall broad-based increase in terms of deposits on the RPS side. We've seen broad-based increases as it relates to employee paid the group protection business. And we believe that one of the contributors there is more dollars in the employees' pocket and they're able, therefore, to allocate more to savings and also to protection. And Randy, why don't I hand it over to you?

Randy Freitag

Ellen, I think you did a great job. Mike, we've been responding to higher wages for over a year now, so sort of in the numbers. I always remind people that we're like any company, right? You don't think about things in a vacuum, right? When you see wages go up a little -- I can tell you, as a management team, you dig a little harder to get a little more productive. So I tend to think about wages is just a part of the overall expense pie. And as I talked about, we had really good expense performance, which includes somewhere in there, the element of inflation.

Actually, just for societal thing, I think you mentioned specifically the Highway juniors. I think one of the really good things about the inflation we've seen it's been across the spectrum. So I think the increases we've seen have not just been about higher wage owners. It's really been across the spectrum. And actually, you can argue that the lower wage owners have actually seen more of the outsized growth. So Mike, I hope that helps.

Mike Ward

Yes. No, absolutely guys. I was actually focused on the potential positive impact to top line and maybe margins without a super helpful perspective. And yes, I was pointing to the idea that looking at the growth in wages, and it looks like more recently, it started to tick up for the higher wage earners, which is a key demographic, but appreciate it guys.

Operator

Lincoln Financial Group will follow up later this afternoon for those remaining in the queue. I will now the call over to Al Copersino for closing remarks.

Al Copersino

Thank you all for joining us this morning. As always, we are happy to take any follow-up questions that you have. You can e-mail us at investorrelations@lfg.com. Thank you all, and have a great day.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.

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