Good morning, and thank you for joining Lincoln Financial Group's second quarter 2019 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. If you need assistance at any time during the call, please press the star key followed by the zero and someone will assist you. I would like to turn the conference over to the Corporate Treasurer, Chris Giovanni. Please go ahead, sir.
Thank you, Gigi. 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, trends and market conditions, including comments about sales and deposits, expenses, income from operations, share repurchase, 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 2018 Annual Report on Form 10-K, most recent quarterly report on Form 10-Q, and from time to time in other filings with the SEC.
These forward-looking statements are made only as of today. We undertake no obligation to update or revise any of them 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 statistical supplement, which include a full reconciliation to the non-GAAP measures used in the call, including adjusted return on equity and adjusted income from operations or adjusted operating income to their most comparable GAAP measures. Presenting on today's call are Dennis Glass, President and Chief Executive Officer, and Randy Freitag, Chief Financial Officer and Head of Individual Life. 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 Dennis.
Thank you, Chris. Good morning, everyone. Second quarter adjusted operating earnings per share was a record and up 17% over the prior year quarter. This quarter's results once again demonstrate our ability to deliver consistently strong financial performance, the success of strategic actions, and the benefits of our diversified and attractive business mix. All these have and will build long-term shareholder value. First, on financial performance. Strong growth in adjusted operating revenues and adjusted operating earnings in the second quarter align with the track record of success that we highlighted at our June Investor Day. This includes mid to high single-digit revenue growth and double-digit earnings per share growth when measured over three, five, and 10-year periods. Additionally, this quarter, we grew book value per share ex-AOCI by 9% over the prior year period and expanded our adjusted operating return on equity to 13.6%.
Strategic actions by management, including maximizing our diverse product portfolio, participating in more market segments, and leveraging our powerful distribution franchise, a competitive advantage for Lincoln Financial, are accelerating growth. This resulted in strong top-line results in the quarter, which contributed to operating revenue growth in every business segment. This momentum will drive future earnings and capital generation. We expect continued momentum as our sales pipelines remain robust. It's important to note that we have not only consistently grown sales but strategically tilted our sales mix. Over the last 5 years, at least 70% of our annual sales did not include long-term guarantees, and year to date, 81% do not have long-term guarantees. Further, we have benefited from our diversified businesses, including growing our mortality and morbidity sources of earnings, which are not correlated with capital markets. These now represent 30% of total earnings consistent with our target.
Within our capital market sensitive businesses, we also have some beneficial offsets that help contribute to a steady source of earnings and can support EPS growth. We believe the business diversification is helpful to recognize, knowing interest rate levels and equity market growth rates change over time. For instance, in recent years, tailwinds from the equity bull market have more than offset headwinds from low interest rates. Turning to the business segments, starting with annuities. Our strategic decision to broaden the product portfolio and participate in more segments of the marketplace enabled another quarter of robust sales as total deposits increased 22%, and net flows were once again positive. We remain focused on providing solutions that meet different customer needs and have the ability to help us sustain our growth momentum as markets or consumer preferences shift.
In addition to growth, this strategy also helps us maintain a diversified sales mix and risk profile. The quarter sales were evenly balanced between variable annuities with living benefit guarantees, variable annuities without living benefit guarantees, and fixed annuities. Strong index variable annuity sales led to an 86% increase over the prior year quarter in VAs without living benefits, and VAs with living benefit sales accelerated sequentially following the market volatility late in 2018 and into the early part of this year, consistent with comments we made on our last earnings call. Our strategy of expanding shelf space and increasing wholesalers has resulted in fixed annuity sales momentum. Total fixed annuity producers increased 44% over the prior year, and sales were up 46% as we generated sales gains in every channel, including significant growth in IMOs and broker-dealers. Another strong quarter for the annuities business.
Our formula for operating the business successfully is working. Offer a broad range of products, invest in powerful distribution, maintain a consistent market presence, disciplined pricing, appropriate assumptions, and operating an industry-leading hedge program. All of these factors position us well for diversified sales growth and continued positive net flows while delivering consistently strong operating results. In Retirement Plan Services, our high-touch, high-tech, digitally focused model creates a competitive advantage in our target markets. This differentiated service model is driving higher participation in contribution rates and an increase in both employee and employer deposits. In total, recurring deposits, which typically represent approximately 60% of annual deposits, were up 6% over the prior year quarter. Total deposits were down from a year ago, primarily due to timing of first-year sales.
Importantly, our sales pipeline is strong, and our latest product innovation, Your Path, which is our proprietary alternative to target date funds, is providing a new avenue for growth. Net flows were $307 million as we returned to positive flows after last quarter, which was the first quarter of net outflows in over three years. Our outlook for net flows remains positive. Overall, it was a solid quarter for the retirement business and continued investment in distribution, product innovation, and improving the customer experience will drive both top-line opportunities and bottom-line growth. Turning to life insurance, product breadth, and distribution expansion are allowing us to protect and expand our market reach. Sales in the quarter were up 30% compared to last year's second quarter.
Total individual life insurance increased 19% as IUL, term, UL, and BUL growth rates were in the mid-teens and above and were complemented by solid executive benefit sales, which can be lumpy. Strategically, we're investing in select markets, including the fast-growing IUL space, where sales increased 79%, and in term, where sales were up 28%, attributable to product and process enhancements, along with growing our number of active producers. We continue to maintain leadership positions in BUL and MoneyGuard, with each representing approximately 25% of our total life sales. We're using sales momentum and diversification along with disciplined financial management to overcome industry headwinds, such as low interest rates and higher reinsurance costs. Overall, it was a strong quarter for the life business, highlighted by double-digit top and bottom-line growth. Turning to group protection.
Successful execution of our Liberty integration plan has led to sequential increases in premiums every quarter since closing the transaction, significant expansion of after-tax margins, and paved the way to benefit from the sustainable competitive advantages created by the acquisition. We are leveraging our larger book of business and expanded capabilities to achieve our strategic objectives, including cross-selling additional lines of coverage and further penetrating the fast-growing and highly profitable employee-paid market. This quarter and year to date, over half of our sales have been sourced from existing customers, and the percent of employee paid sales increased six percentage points over the prior year quarter. Our sales pipeline is strong with attractive opportunities in the large case segment of over 5,000 employees, as well as down market, especially in the 1,000 to 5,000 mid-market segment, as we are benefiting from the best of both companies.
The group business had another strong quarter. We expect to grow premiums by sustaining persistency and capitalizing on significant top-line opportunities while maintaining disciplined pricing and achieving expense efficiencies. The combination of these factors make us optimistic that we'll continue to achieve attractive margins. Shifting to investment results. During the quarter, we invested new money at a pre-tax yield of 4.2%, 190 basis points over the average 10-year Treasury. As highlighted at our recent Investor Day, we continue to increase, well within our risk tolerance, our allocation to high credit quality, less liquid assets where we are achieving attractive illiquidity premiums. These assets represented approximately 60% of our purchases in the quarter, and we have ample room to grow these strategies. The investment portfolio is in great shape, and as the credit cycle extends, we have been shifting up in credit quality.
We continue to diversify and to decrease our exposure to positions with greater risk of deterioration under stress scenarios such as lower-rated BBB and below investment-grade assets, particularly within the energy and consumer cyclical sectors. As we anticipated in the first quarter, the alternatives portfolio had a sharp rebound, generating a solid 15% pre-tax annualized return. We continue to target a long-term pre-tax return of 10%. In closing, we're very pleased with our second quarter results, highlighted by top and bottom-line momentum. We recognize there is a focus in the market around low interest rates and being later in the economic cycle. Let me make a few points on this.
First, going back to my comments earlier about the benefits of having diversified businesses and sources of earnings, the current strength in equity markets is a more immediate helper and has a larger offset than the current decline in interest rates. Also, the headwind from the decline in interest rates is gradual, which gives us time to respond, and we have a proven track record of taking actions to invest in our businesses and simultaneously reap efficiency benefits such as our digital initiative. Lastly, I would note the quality of our investment portfolio as we have proactively de-risked the general account and have strong capital and holding company cash positions. As a reminder, we regularly stress test equity market interest rate and credit scenarios and are comfortable with our ability to handle significant stresses.
Bottom line, I am confident we can sustain our track record financial performance, and this was once again demonstrated this quarter. Now, let's turn the call over to Randy.
Thank you, Dennis. Last night, we reported second quarter adjusted operating income of $478 million, or $2.36 per share, a record and up 17% over the prior year quarter. There were no notable items within the current or prior year quarters. However, there were a few items that resulted in some variability this quarter. The net impact of these items was zero. On the positive side, alternative investment income was $0.09 better than our long-term expectation. However, this was offset by two items. The first was higher volume and performance-related expenses, in part related to the increase in Lincoln share price, and the second was modestly unfavorable mortality relative to our annual expectation. Touching on the performance of key financial metrics in the quarter.
Strong sales, net flows, and equity market strength resulted in all four businesses showing operating revenue growth over the prior year quarter, with total adjusted operating revenues up 10%, boosted by last year's acquisition. Adjusted operating return on equity increased 50 basis points to 13.6%. Book value per share excluding AOCI grew 9% to $70.32, an all-time high. Finally, our balance sheet remains an important source of strength, highlighted by a high-quality investment portfolio, solid capital ratios, significant cash at the holding company, and strong capital generation, which is enabling us to both invest in growth and return capital to shareholders. Net income totaled $363 million in the quarter, in part driven by below-the-line volatility from non-economic impacts. However, as we expected, the net impact from these items was significantly lower than the first quarter, totaling $68 million, down over 50%.
Excluding the non-economic impacts, net income represented 90% of adjusted operating income as the VA hedge program performed well and credit losses remain minimal. Turning to segment results, starting with annuities. Reported operating income for the quarter was $266 million compared to $275 million in the prior year quarter. The decrease in earnings is related to the reinsurance transaction completed with Athene, which reduced operating income by $14 million in the quarter. Return metrics remain strong with ROA at 81 basis points and a ROE of 22%. Operating revenues increased 5% over the prior year period. End-of-period account values totaled $134 billion, 2% higher than average account values, which should serve as a positive driver for future earnings.
Risk metrics were also solid and benefited from the growth in equity markets as net amount at risk sits below 1% of account value for living benefits and less than half a percent for death benefits. Another very good quarter for the annuities business. Given the tailwind from positive net flows combined with strong equity markets through the second quarter, we are well-positioned to continue to provide dependable financial results. In Retirement Plan Services, we reported operating income of $42 million compared to $43 million in the prior year quarter, as benefits from higher account values were offset by spread compression. Net flows totaled $1.5 billion over the trailing 12 months, which when combined with favorable equity markets, drove average account values to $73 billion, up 6%. Similar to the annuities business, end-of-period account values are 2% higher than average account values.
Operating revenues increased 2% and the G&A expense ratio, net of amounts capitalized, improved 30 basis points compared to the prior year quarter, continuing a theme of strong expense discipline as we leverage technology to drive down the cost of doing business. Base spreads excluding variable investment income compressed 12 basis points versus the prior year quarter, consistent with our expectations. The retirement business reported strong results this quarter and further momentum in sales and expense management should serve as positive drivers going forward. Turning to our Life Insurance segment. Operating income of $168 million increased 12% from the prior year quarter, driven by new business growth and year-over-year improvement in alternative investment income. During the quarter, alternatives were $12 million favorable to our expectation. This was offset by unfavorable mortality relative to our 2019 expectation for mortality experience.
Underlying drivers were solid, with average life insurance in force up 6% over the prior year quarter and average account values increasing 4%, both of which helped drive a 7% increase in operating revenues. Base spreads excluding variable investment income were down seven basis points year-over-year, once again, consistent with our expectations. A great quarter for the life business, highlighted by double-digit sales and earnings growth. We expect sales momentum to continue, and historically, our annual mortality experience has been seasonally favorable in the second half of the year. Group protection reported operating income of $68 million compared to $45 million in the prior year quarter, with the increase coming from the Liberty acquisition and continued favorable risk results. Loss ratio in the quarter was 73.6%, consistent with the first quarter.
As a reminder, the year-over-year increase in loss ratios reflect the impact of the acquisition as we combine two blocks of business with different loss characteristics. Overall, business trends remained positive, which resulted in an after-tax margin of 6.6%. G&A expenses increased at a slower rate than revenues, which resulted in a 50 basis point improvement in the expense ratio compared to the prior year quarter. We continue to benefit from acquisition synergies and are on track to generate $100 million of run rate savings by year-end. It was another excellent quarter for Group Protection, with our pricing and claims management fundamentals performing well. These favorable factors should enable us to sustain attractive margins. Turning to capital and capital management. Statutory surplus stands at $9.4 billion, and our RBC ratio ended the quarter at approximately 430%.
Holding company cash ended the quarter at $474 million, slightly above our $450 million target. During the quarter, we returned $225 million of capital to shareholders, including $150 million of share buybacks. Year to date, we have allocated $540 million toward buybacks and dividends while continuing to invest in growth to support future earnings and capital generation, particularly through robust sales in the life and annuities businesses. To conclude, second quarter results were strong and reflect many of the themes we highlighted at our recent Investor Day, including durable, dependable, and differentiated financial performance measured by our sales momentum and operating revenue growth along with a 17% increase in adjusted operating EPS. Investing in the business to support growth and returning capital to shareholders led to mid-single digit growth in pre-tax earnings compared to the prior year quarter and an 8% decrease in average diluted share count.
Lastly, the balance sheet is well positioned and our risk management framework is robust, highlighted by solid performance from our VA hedging program. As we look forward, we are well positioned to continue delivering strong financial results and driving long-term shareholder value. With that, let me turn the call back over to Chris.
Thank you, Dennis and Randy. Gigi, we will now begin the question and answer portion of the call. As a reminder, we ask that you please limit yourself to one question and only one follow-up, then please re-queue if you have additional questions. With that, let me turn the call back over to Gigi to begin Q&A.
Ladies and gentlemen, at this time, if you have a question, please press the star then the number one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. For optimal sound quality, please use your handset instead of your speakerphone. Our first question is from Humphrey Lee from Dowling & Partners, your line is now open.
Good morning, and thank you for taking my questions. A question for Dennis. Annuities definitely have a very strong quarter in terms of sales. Looking towards the second half, I believe the Allstate partnership is expected to ramp up towards the latter half of this year. Given the interest rate outlook, has your expectation for the kind of sales contribution from this new channel changed from earlier this year?
We continue to see good potential from the Allstate channel. With respect to fixed annuities and interest rates, we have seen a reduction in our crediting rates. I think we're a little bit ahead, and I'm talking in aggregate, not just for Allstate. I think we're a little bit ahead of the competition on that. That's why we saw a decline in sequential fixed annuity sales. Overall, we are optimistic about net flows continuing to grow over time in the total individual annuity business. As we talked about so much in our remarks, we're well positioned in every product line in every market segment. There's going to be shifts in consumer appetite from one to the other, but we can take advantage of the shift because we have a product in each segment and meeting every consumer requirement.
Got it. A question for Randy. You talked about in group protection, you continue to see the expense synergies coming up, and you're still on target to get to $100 million. Do you see any reason why you can't achieve that runway savings earlier than target?
Humphrey, thanks for the question. I think we're pretty much right on track with what we said, in that we expect to get to $100 million by the end of 2019. We're well on track to that. We've hit the mid-80s. I think we're at actually 87, if you look at where we are through the second quarter. I think also, Humphrey, what we've said is that when we look into 2020, we think there's some additional capacity to go above the $100 million we initially thought we could get when we entered into this great transaction. We're right on track with a little upside to what we actually originally thought, Humphrey.
Got it. Thank you.
You bet.
Thank you. Our next question is from Ryan Krueger from KBW. Your line is now open.
Hi, thanks. Good morning. On index VAs, you've had pretty substantial growth now since you launched that product. Just curious about how much additional runway you see for further growth there, just given the market size of that product.
Yeah. We think it's going to continue to take share. It's going to continue to be a growing part of our overall sales plan. It's an important product in the marketplace. Consumers are reacting very well to it, and we expect continued growth.
Thanks. G&A expenses were a bit higher in annuities and in life this quarter. I think it was partly related to the volume growth. Should we expect that to continue if volumes remain at these levels?
Yeah. Ryan, let me talk about expenses in total. If you look at expenses 2018 to 2019, second quarter 2018 to second quarter 2019, net G&A in total for the organization is up about $70 million. If you broke that up into its component parts, about a third of that increase would be the addition of Liberty for an additional month. About a third of it would be really linked to performance-related items, primarily the change in the share price of Lincoln. If you go back to second quarter of 2018, G&A was actually reduced by $11 million because the share price was down quite a bit. Well, this quarter, G&A was boosted by about $6 million by that same factor.
The other third really represents normal growth, which is a little above where we've been for the last couple of years, driven by exactly what you referenced, which is the very strong volume. Assuming performance and all those things continue to come in line, I think expenses we had this quarter are pretty much what we'd expect looking into the back half of the year.
Thanks. That's helpful.
You bet.
Thank you. Our next question comes from Suneet Kamath from Citigroup. Your line is now open.
Thanks. My first question is just on interest rate environment. Given the pullback in rates, do you still feel pretty good about where you're pricing new business, particularly on the annuity and individual life side? Or do you think you need another round of sort of repricing like you did several years ago? Thanks.
We're still seeing good returns in the RPS life and group protection business. In the annuity business, I think I've mentioned that we've reduced rates on fixed annuities to get our returns back up to where they need to be, and we're doing that. Again, I think we're a little ahead of the market on it. With respect to our variable annuity products, specifically with living benefits, we've dropped the guaranteed rate on income about 15 basis points at the margin. We've taken what we think are the necessary actions, and depending on which way interest rates drift, we'll continue to do what needs to be done to get the proper return on new business. I think at the margin, it might affect the volume of sales levels, but we don't think the modest changes that we're making is going to have a significant impact on volume.
Suneet, on the life side, it's an interesting year because unlike any year before us, this happens to be a year when we're repricing 100% of our life portfolio because of the introduction of principles-based reserving in 2020, along with the transition to a new underlying mortality table, 2017 CSO. As we've gone through the year, we've been able to actually reflect some of the impact of lower rates into the pricing of those products. Of course, as we've gotten later in the year and rates have come down a little bit, that would be more reflected in the more recently priced products. I would say we've been able to reflect lower rates in some pricing.
That doesn't mean that there isn't a little bit more to go, but feel good about the returns we're getting across our life portfolio and what we've been able to do in the face of these lower interest rates.
Got it. Just separately on sales, we've been reading of late some of the articles that have come out around regulators' views of best interest standards, NAIC reviews, and the like. Any comments about where you think we are in that process and how you think it's going?
That covers a lot of ground, but let me talk about a couple of things. The most important items for us is that a best interest standard should include choice between fees and commissions and a level playing field for various products and service models. The SEC's final ruling package, which included Regulation Best Interest, created an enhanced standard for BDs while preserving investor choice. I think what's come out of the SEC is positive for our business model. The other important regulation is the SECURE Act, which will give us opportunities when we think it'll get passed. It'll give us opportunities to put, for example, guaranteed lifetime income products within a plan, and I think that could be a great opportunity for growth for us.
I think the regulatory environment at the moment has moved pretty substantially in our direction from where it was or can still move better against the SECURE Act. The states, there was a little flurry of best interest, and the industry has been paying attention to that. That seems to have slowed down a little bit. We'll continue to, of course, react to the state regulation. Generally, I would say regulatory issues have moved pretty significantly in the industry's favor. Again, if the SECURE Act is passed, even more so.
Okay, thanks.
Thank you. Our next question comes from John Nadel from UBS. Your line is now open.
Hey, good morning. I guess either for Dennis or for Randy, I'm just curious, to your life insurance sales, even if I take out the executive benefits, which can be somewhat lumpy, were really strong, and they're really strong across essentially every product category. What do you think is driving that? Are you taking share? I assume up 19% year-over-year, you must be taking share. I'm just trying to understand, do you think this is a blip or some significant shift in market share and you're aggressively going after it?
Yes. The industry life sales are not up 19%, and we are, so we have taken some share. We talked about this at the IRB. We analyze the life business and really with a focus on what do we need to do to elevate the organic growth profile of a life business, and that's drive more sales. As we analyze the market, we found some pockets of the business where we really weren't participating in the way we should have, specifically in the smaller face term and in the IUL space. We had strategies, and like I said, we talked about this at IRB, specifically in those areas. If you look at term sales, they were up nearly 30% in the quarter. If you look at IUL sales, they were up over 70% in the quarter.
We had these specific strategies, I think the team has done a great job of executing upon them. In our other products, I think you see more normal growth just driven by investments we've made in distribution and product. We're very happy with the results, but those results are right in line with the strategies that we had for the year and the expectations that we had coming into this year. The only product, John, that is facing a little bit of headwind is the MoneyGuard product, which sales are relatively flat year-over-year. I think there's a number of factors in there, including increased competitive environment. There's been more companies enter the space. I think the second biggest player in this space had some price increases, and that may have created a little bit of a fire sale on their side.
I think there've been some MoneyGuard specific factors, but we're very happy with what we see in the life space from a sales standpoint.
John, I might just add on to Randy's comments a little bit and come back to our digital efforts. If I can use small base term as an example, we've made great strides in digital app to digital issue and machine underwriting in between. We're able to attract some more of the distribution that is helped by that. Digitally, and we're seeing the digital effect across other product lines. That would be an example of why we can take more share. It's process in addition to product.
Got you. That's really helpful. Randy, just quickly, if we could just quantify. I know you said on a net basis, no notable item. Obviously some moving parts, higher VII. I think you quantified that as $0.09. The other offsets, could you just quantify those and maybe identify where they resided?
Yes. $18 million in total on variable investment income, which is $0.09. That was offset by $12 million of adverse mortality in the individual life business, and then about $6 million of elevated expenses, as I said, related primarily to performance, especially the change in the share price. In total, $18 of VII offset by the two items that I mentioned. Inside of the most impacted business, the life business, individual life business, that would've been $12 million of positive VII offset by the $12 million of mortality.
Got it. Perfect. Thank you so much.
You bet.
Thank you. Our next question is from Jimmy Bhullar from JPMorgan Chase. Your line is now open.
Hi. Good morning. I had a couple of big-picture questions. First, just any thoughts on your upcoming actuarial reserve review. Obviously interest rates are a lot worse, but the equity market's done better than your assumptions, and I think you already had a cushion in your market corridor that you used for reserving. Also on the potential benefit of the SECURE Act, do you see most of the benefit in annuities or in the retirement business as well?
Jimmy, I'll take the first question. Not to sound like a broken record, but I'm not going to front run the process. There are a lot of people working across Lincoln as we speak on the third quarter unlocking process. With that being said, you mentioned it, there are huge number of variables that go into the process. One of the key capital market variables is the level of interest rates, they are down quite a bit from last year, we'll be very mindful of that as we go through the process. We're way too early to talk about any overall expectation.
Jimmy, on in-plan protected lifetime income, we'd probably run that through the annuity, excuse me, through the RPS business, you would see the benefit in the RPS business. It would be a joint effort, of course. As you know, we have tremendous capability in that product line inside the individual annuity business. That's where the mechanics of it is, it'd be a joint effort. To repeat myself, we'd probably run that through the RPS business.
Obviously, I think the SECURE Act gives you safeguards or safe harbors to be able to sell annuities into retirement plans. Do you have any thoughts on potential interest from plan sponsors or participants in that regard?
Yeah. I think there have been some products inside the in-plan products over the years. There's a sort of fiduciary responsibility on the plan management people, the people who run the plan, related to the solvency of the providers, which goes away in the secure plan. That also becomes, I think, a qualified default option. The atmosphere would be tremendously more powerful for the product. I think the lack of a defined benefit plan in the United States and all the pressure on the ability to have a secure source of income in retirement is going to make it very popular. It seems like it should be. That we'll wait and see.
Thank you.
Thank you. Our next question comes from Alex Scott from Goldman Sachs. Your line is now open.
Hi, I have a couple of follow-up questions. The first one's on the SECURE Act. I guess it sounds like there's an interesting opportunity there. Could you talk about some of the things that you could potentially do in terms of, Should I be thinking about partnerships with maybe asset managers that have 401 platforms but no annuity offerings? Should I be thinking about you looking to potentially scale up your operation to take advantage in a bigger way from some of these things? Is there any contemplation of those kind of actions?
I think the biggest opportunity is just selling a protected lifetime income product into existing plans. Some of that opportunity will come from our own 401 customers or our own defined contribution customers, because we have such qualifications in that product line or in that concept. I suspect we could go to plans that we're not the bookkeeper on. I just think it's a big opportunity in plan. Asset managers, there are some programs that have been announced by BlackRock working with, I think, Microsoft to do this already, because there's a demand out in Silicon Valley, to create these defined benefit type of opportunities and annuity with protected lifetime income as retention strategies. I just think it's a huge opportunity, and protected lifetime income is an important product for some portion of retirees' assets, and I think it's just going to get bigger.
Let me just add, Alex. As Dennis said, the opportunity is very large. The reality is, from a financial standpoint, this is not going to be what drives Lincoln over the next few years from a financial standpoint. That's going to be what we really have in place today. SECURE Act is going to be something that really is going to benefit the industry over an extended period of time.
Understood. Maybe one follow-up, I guess back to actuarial review. I guess one of your peers adjusted mortality assumptions that ended up resulting in a charge, but also, I guess, materially changing the impact to go forward earnings as well, to some degree. I guess I was just interested to hear if, given your concentration in interest-sensitive life, if we have any risk there around mortality and any kind of changes that you'd potentially make.
Alex, it's really way too early for me to give you any insights there. As I mentioned, all of the assumptions get reviewed as part of the third quarter unlocking. Mortality is one of those. Obviously, we have a lot of mortality risks, so it's definitely one of the major assumptions we look at, but really way too early to give you any overall insights on what we might see from that particular component. At the end of the day, what becomes ultimately important is what do all of the impacts of all of the assumption changes add up to?
Got it. Okay. Thank you.
Yep.
Thank you. Our next question comes from Thomas Gallagher from Evercore ISI. Your line is now open.
Good morning. A few mortality-related questions as well. Randy, you mentioned the change in the mortality tables that you're, I guess, implementing. Was that this year? What are those changes? Would you expect there to be any impact on cash flow or capital levels from that?
No, Tom. This change is in the mortality table that underlies new business from a tax standpoint. What it really drives is what is the amount of cash that can be put into a product and still qualify as life insurance before you become what's called a MEC, a modified endowment contract. The products that are going to be most impacted are really products that are focused around accumulation. Now, most of our products today are more focused around protection. This goes into effect at the beginning of next year. All products will need to use this new mortality table, and what it is going to primarily impact is the amount of cash that a consumer could put into a product, thus primarily impact accumulation-focused life insurance.
Randy, for more accumulation-oriented life insurance products, would that raise the initial strain on it for statutory, or is there some other impact?
No, it doesn't have much to a strain. Really, it's all about how much money a consumer could get into a contract and still qualify as life insurance. It doesn't really have any impact on any of the other mechanics of the product.
Got it. I note just on the mortality side, after going through, I would say, a good two to three-year stretch of kind of no mortality volatility, you've had two negative quarters. Not hugely negative, but modestly negative mortality quarters in the last three. Anything that you see changing right now when you do your evaluation of what's driving that, whether there's anything systemic or otherwise?
Let me talk broadly about mortality. I think you've talked about the last three quarters. I'll pull it out a little longer. If I take the fourth quarter of last year and I lump it together with 2018, at the end of the day, came in in line with our expectations. I think we ended up at 101%, my recollection. If you look at 2019, we were $25 million to the good in the first quarter, $12 million to the bad in the second quarter. We're actually ahead of our expectations through the first half of the year for life insurance mortality. I think the quarter-to-quarter numbers we talked about just say more to the fact that we're a large company. We issue a lot of life insurance. We have net death benefits that run through our financial statements in any given quarter that exceed $500 million.
The thought that you might be a little above or below that, there's nothing surprising about that. When you view mortality experience over a more extended period of time, it continues to run, I would say, in line with our near-term expectations.
That's good perspective. Final question on anything, I think in the past, you really haven't had much impact from cash flow testing because of aggregation benefits. Given where we're at now, would you still expect the benefits of aggregation of other businesses to sort of minimize anything you may have to post from a year-end cash flow testing standpoint?
Way too early. Let me remind you, we have very strong cash flow testing results overall. The only item we've really ever had to focus on are the sub-tests associated with guaranteed universal life, otherwise known as 8-C and 8-D. I think that's our best estimate going forward. Those are the two areas that we have highlighted or alerted you to that could create some potential noise looking forward.
Okay, thanks.
You bet.
Thank you. Our next question comes from Andrew Kligerman from Credit Suisse. Your line is now open.
Hey, good morning. First, a general question to Dennis and Randy. What appears to have been a pretty solid quarter, as you highlighted, the stock is underperforming in a down market. My question is, do you do an acceleration of share repurchases as you did back in the fourth quarter? Is there some business mix change that might make sense? Do you want to go out and do an M&A? Strategically, does this kind of prompt you to make a change, and what might that be?
Andrew, I don't think we can react to a 2-hour change in our share price. Obviously, we're disappointed. You guys all do a great job for the industry with your remarks. Whether we're off a cent from our estimates, it seems to be more of the focus this morning than the fact that we're up 17% with our operating earnings, the fact that we've compounded our earnings per share for 12% for 5 years, the fact that we have one of the highest ROEs in the marketplace. Our strategy is a good one. It's producing excellent results, and we can't be rethinking strategy because of 1 day.
We are a little concerned about the multiple. Yes, we will look at every strategic option, although we don't have anything major in mind, to try to get the market to recognize the VA business as a better business than what it's currently being valued at, we think. I think right now, continuing to put up the excellent performance that we've put up. Again, I think sometimes we fight against some of the missteps of our competitors, where there's been big charges mostly for assumptions around policyholder behavior. We haven't had any of that. We have an excellent hedge program. We're going to continue to emphasize the quality of the annuity earnings, the quality of the book of business.
We're going to continue to emphasize 12% compounded earnings per share growth, the source of earnings mix, which gives us options no matter what happens in the capital markets or not, no matter what happens in capital markets. We think we have a good strategy. We have a great franchise. As I've said, lower interest rates over time will affect us, but we've got time to respond to it. I come back to our digital program. That was initiated for the consumer experience, but it also came along with $120 million of expense reduction expectations. We're on track for that. That was in part motivated by the fact that we saw interest rates lower, lost earnings from interest spread, and we were going to replace it. We see this, again, a possibility, and we'll take the necessary actions.
Let me come back to 12% EPS share growth for five years, 17% this quarter, 13.6% ROE improvement, 8% or 9% increase in book value. Hopefully, the market will react to that more so than it has.
Got it. I meant valuation as well, Dennis.
Yep.
It sounds like you have a real confidence in the strategy that you're pursuing.
Yep.
Maybe more technically. Looking at normalized spreads as reported, they did come down in retirement, interestingly, they came up in the annuity line. Is there any guidance or indication of where you see spreads going over the next year or two in both segments? Do you see pressure in both?
Hey, Andrew. Thanks for the question. I think that what we did this quarter is we did a really good job of making sure that all of our cash was fully invested, you see that have a positive impact on the overall spread. I think any number between 165 and 175 is well within our range of expectations and is really reflective of primarily what I just talked about, are we able to get the cash that comes into that business, especially as it runs through, like the hedge program, are we able to get that cash invested on a timely basis?
Got it. Thank you.
You bet.
Thank you. Our next question comes from John Barnidge from Sandler O'Neill. Your line is now open.
Thank you. My question's about retirement. First year sales were a bit light. Was this more a function of timing or demand? Maybe, can you please talk about the backlog in the second half of the year?
Yeah, I think it's exactly what you said, timing. We have a very robust pipeline in both the small market sales and mid to large. Now we have to convert that pipeline into sales. We're starting with a robust pipeline, we expect better sales results in the second half. We're seeing some of that already.
Can you maybe talk about what sectors you're seeing greater demand than others?
I think in the mid to large market, we focus on government, we focus on healthcare, we focus on education. Those would be the sectors where most of the pipeline is. Then in small case market, which we sell through predominantly the wirehouses, we're seeing a pickup in opportunity there as well. I'd also come back to the point I made earlier, John, which is we're seeing 6% growth in recurring deposits, which is about 50% of total deposits in any particular year. That's a strong ballast. Again, pipeline opportunity is pretty good at this moment. We've got to convert it into sales, and we're pretty confident that'll happen.
Great. Thanks for your answers.
Thank you. Our next question is from Joshua Shanker from Deutsche Bank. Your line is now open.
Yeah, thank you. Good morning, everybody. Two quickies. One, I saw a pretty big jump, maybe over $1 billion in terms of investments in mortgage loans. As interest rates have come down, is there a pivot going on there? Are you adjusting strategy a little bit? What am I looking at?
That's part of the investment in less liquid but higher quality assets. I will tell you that I saw a statistic yesterday when we were going through some of the numbers, and I think we have, what, $14 billion worth of commercial loans, and we have four loans with a face amount of less than $1 million that are a couple of months beyond their payment. That's just an example of how strong that portfolio is. Very definitely increasing our mortgage and loan portfolio, which we've had very high quality results. That statistic I gave you, a great example of that, continues to be an emphasis for us.
There was really a second quarter change, at least in my reading of it. Should I expect that to continue to accelerate going forward?
The origination of mortgage loans is, again, it's lumpy. I'm going to just come back to my point that we have a strategy to increase the size of that portfolio. In a quarter, you might not have originations. Another quarter, you might have more. I think the more important point is longer term, that's a great asset class, and we're growing the size of it.
The second question, I apologize if you already mentioned it. The drop in dental premium or dental sales, I should say. Is that seasonal? Is that a change in a large customer? What's happening there?
First of all, let's remember that that is a very important product for some segments. Particularly, in the 100 to 1,000 employee segment, dental is bundled with other products, you have to have a good competitive product. The product in the mid to large case size, it's still important, it's not sold as much on a bundled basis. The decline in sales has to do with some rated cases in the larger case market, where we weren't getting our profitability expectations, it moved elsewhere. There's a couple of other technical things in the marketplace that contributed to that. Let me come back to strategy and importance. Dental remains important to us, and it's a volume business. You have to have scale in it.
With the bigger opportunity we have in the larger combined companies, we'll continue to stress the importance of that and I think over time, increase amount of sales and profitability, which, at the moment, is sort of pretty minimal for that line.
In that regard, should we expect that you might be non-renewing other blocks near term as you keep working through the combined group business?
Could you say that again, please?
Given the lack of profitability there, would we see more sales decline as you try and reset the book and get it right?
I'm not sure that would be the case. Again, I think the longer-term issue is building the scale in that business to meet our needs over time. We're focused on it, but it's a longer-term build to get where we need to be.
Well, thank you for running over and taking my question. I appreciate it.
Thank you.
Thank you. We will be able to follow up with those in the queue later this afternoon. I would like to turn the call back over to Christopher Giovanni for closing remarks.
Thank you all for joining us this morning. As always, we will take your questions on the investor relations line at 800-237-2920 or via email at investorrelations@lfg.com. Thank you all for joining us today, and have a great rest of the day.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Speakers, please stand by.