Good afternoon, and thank you for joining Lincoln Financial Group's fourth quarter 2011 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. If you should need assistance at any time during the call, please press star and then zero, and someone will assist you. At this time, I would like to turn the conference over to Senior Vice President of Investor Relations, Jim Sjoreen. Please go ahead, sir.
Thank you, operator, and good morning, and welcome to Lincoln Financial's fourth quarter earnings call. Before we begin, I have an important reminder. Any comments made during the call regarding future expectations, trends, and market conditions, including comments about liquidity and capital resources, premiums, deposits, expenses, and income from operations, are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from current expectations. These risks and uncertainties are described in the cautionary statement disclosures in our earnings release issued yesterday, and our reports on Forms 8-K, 10-Q, and 10-K filed with the SEC.
We appreciate your participation today and invite you to visit Lincoln's website, www.lincolnfinancial.com, where you can find our press release and statistical supplement, which includes a full reconciliation of the non-GAAP measures used in the call, including income from operations and return on equity to their most comparable GAAP measures. Presenting on today's call are Dennis Glass, President and Chief Executive Officer, and Randy Freitag, Chief Financial Officer. After their prepared remarks, we will move to the question-and-answer portion of the call. With that, I would now like to turn the call over to Dennis.
Thanks, Jim, and good morning, everyone. In the fourth quarter and the year, we drove solid sales and net flows, the result of our consistent approach to product and distribution and a continuation of what we achieved in each of the last several years, including throughout the financial crises. During 2011, we took steps to strengthen our franchise, including reducing asset risk by investing in high-quality corporate securities, escalating share repurchases and debt repayment, repricing life and annuity products to ensure profitable new business, and investing significantly in Retirement Plan Services and Group Protection to increase earning power in future years. Randy will speak to our goodwill review and in his comments. In short, we incorporated a tough economic and competitive environment for several years in our assumptions, and the remaining goodwill asset is a solid number for the foreseeable future.
We accelerated our share buybacks in the quarter with another $200 million of shares, bringing our total repurchases to $575 million. As the year progressed, we did increase our plan for share repurchases, reflecting the good outcome of our balance sheet stress testing and the very low valuation of our shares. We ended the year with a very solid balance sheet and deployable capital, permitting share repurchases to remain a strong option for capital usage in 2012. Turning to highlights from our underlying businesses, sales in our individual life business were up 10% in 2011. We saw a shift in the mix of sales over the course of the year, with increases in variable universal life, indexed universal life, and MoneyGuard, accompanied by a decline in secondary guarantee universal life.
The lower SGUL sales, more pronounced in the fourth quarter, are related in part to repricing actions that de-emphasize single-premium type SGUL policies. Our analysis showed that we would need to accept very low single-digit returns on this business in order to remain in the upper quartiles of competitive pricing. This would not be selling on our terms. Our sales mix and emphasis in 2012 will be similar to what we saw in the quarter on our core products. Total annuity sales were flat for the year as we saw a 6% increase in VA sales offset by a 20% decline in fixed annuity sales. Low interest rates affected fixed annuity sales. We know annuities are important planning tools for consumers, and we are confident in our ability to grow and manage this business profitably.
Steps we took in the fourth quarter to improve the risk profile and hedging cost variable annuities included implementing a managed volatility investment strategy on nearly $3 billion of in-force assets. Additional changes we are implementing in April will encourage new sales to move into these low-volatility options. These changes will allow our clients to choose the benefits and investment flexibility most suited to their needs. Late last year, we announced a relationship with Primerica to be the only provider of indexed annuities on their platform, and this quarter marks the launch of this program across the entire Primerica system. In Retirement Plan Services, sales increased 5% for the year and 16% quarter-over-quarter, momentum building in the latter half of the year. We also saw our second consecutive quarter of positive net flows, bringing total net flows to more than $500 million for the year.
Our investments in distribution, technology, and marketing are beginning to take hold, as evidenced by the sales results, along with improved retention across all markets. In addition, all new mid-large plans are now being onboarded to our new record-keeping platform. We expect to see the considerable progress we've made in 2011 carry into 2012. Our Group Protection business also turned in an excellent quarter. Sales increased by 33% for the quarter and 12% for the year, helped by our enhanced distribution structure and our expanded product suite. Voluntary sales, an area of emphasis for us, increased significantly in the quarter, and we are well-positioned to capitalize on opportunities in this growing segment. Finally, we are very pleased with how well the actions we took in pricing and claims management at the end of 2010 and early 2011 created a significant turnaround in results.
From a distribution perspective, we expanded the strength and reach of both our wholesale and retail systems this past year. At LFD, our wholesale organization, the number of advisors recommending Lincoln solutions increased to more than 57,000, and the number of advisors recommending more than one Lincoln solution, a key measure of the depth of our relationships, grew by 7%. Lincoln Financial Network continues to execute on its strategy of retaining productive advisors and attracting experienced recruits, which help LFN to meaningfully contribute to Lincoln's sales results in the year. When you add up our robust product portfolio, our proven distribution muscle, the actions we took in 2011 to strengthen the franchise, and our strong balance sheet, we are well-positioned to grow our business in the coming years. With that, I will now turn the call over to Randy for more detail on the quarter.
Thank you, Dennis. Last night, we reported income from operations of $303 million, or $1 per share for the fourth quarter. Overall, the quarter served as a high-quality endpoint to a very strong 2011. Inside the operating earnings numbers, there are a couple of items that I'll comment on. First, operating revenue declined 2.4% for the quarter compared to full-year growth of 4.5%. The full-year results are more indicative of what I'd consider to be normal results, as the fourth quarter had a few unusual items, including alternative investment income and income from prepayments was down approximately $65 million from an unusually high fourth quarter in 2010. As you remember, we had a fair amount of line item noise in prior period results as we converted valuation systems in our life area. This negatively impacted the quarter-over-quarter comparison by roughly $50 million.
Lastly, sales in the group business were skewed to the last half of the year. Revenues from those sales won't fully emerge until 2012. The second item I'd note is that there was very little noise in the quarter. There were a couple of items that offset each other, but at a high level, normalized earnings came in at $1, right on top of reported results. Turning to net income, we reported a loss of $514 million that included a goodwill impairment of $747 million, $650 million in our life business, and $97 million in the media business. Let me share a few thoughts on this year's goodwill analysis.
In media, we wrote down the remaining balance of the $97 million goodwill asset to reflect the fact that with growth in the current recovery somewhat muted, we have not seen, nor do we expect to see the turnaround in media valuations that we've experienced in past recoveries. In life insurance, we went through a very thorough process that involved a detailed review of assumptions affecting the valuation of the business, including sales expectations and related profitability. Reflecting the difficult environment that exists today, we made the decision to hit all of the key assumptions that go into the goodwill analysis pretty hard for the next several years before we returned to more normal expectations. The tough assumptions for the next several years is what drove the goodwill impairment.
While I believe in the long-term value of the life franchise, I think that it was a prudent decision to take an impairment at this time as it best represents the expected economic climate and leaves us with a life goodwill asset that is supportable for the foreseeable future in a range of potential scenarios, both good and bad. After the goodwill impairment, book value per share, excluding AOCI, stands at $40.19, down 2.6% on a sequential basis, but up 5.3% for the year. Other items affecting net income included net realized losses on investments and the results in our annuity hedge program. Neither delivered any surprises. Net after-tax realized losses totaled $28 million, in line with recent quarters, and the hedge program had excellent performance in the quarter, recording a small gain.
The NPR-related reserve change caused a loss of $47 million as our credit spreads narrowed during the quarter. As a reminder, the NPR is pure accounting noise that will fluctuate between positives and negatives with no connection to the real economics of the annuity business. Turning to segment results and starting with annuities. Reported earnings for the quarter were $134 million. Revenue declined 4% from the fourth quarter of 2010 on lower investment income from prepayments and equity markets that were relatively flat compared to 2010. Net flows came in at $345 million, down somewhat from last year as deposits dropped modestly while lapse experience remained fairly level. We continue to have ample room to manage annuity interest spreads and expect to have little economic spread compression.
Any decline in reported spreads will be largely due to the fact that the products we sell today are priced to earn a lower spread than the in-force book. In Retirement Plan Services, earnings came in at $35 million on good momentum in deposits and flows as investments in this business began to pay off. Similar to annuities, revenues were down relative to the prior year quarter on lower prepayment and alternative investment income and lower expense assessments as average separate account values declined quarter-over-quarter. Unlike the annuity business, we have relatively little room to lower credited rates in the retirement business. This led to some spread compression in the quarter. Moving forward, I would expect to see three to four basis points of spread compression per quarter in today's earned rate environment, part of the overall spread compression guidance that we've given previously.
I'd also note that all products that we sell today are sold at very low guaranteed interest rates in the 1.5% range, so that the impact of spread compression is something that should decline over time. Turning to our life insurance segment, earnings of $154 million, or $150 million normalized, remained relatively stable relative to prior quarters after giving effect for notable items. Our earnings drivers performed as expected during the quarter, with life insurance in force up 3% and average account balances up 5% quarter-over-quarter. Early in 2012, we made some additional rate cuts that should maintain interest spreads through the first couple quarters of the year. After that, I'd expect to see three to four basis points of spread compression per quarter in today's environment. Once again, this impact was included with our previous guidance on the impact of low interest rates.
Group Protection delivered another strong quarter and much improved results for the year. Non-medical net earned premium grew 5%, and the non-medical loss ratio for the quarter came in at 72.2%, driving a more than three percentage point improvement in full year loss ratios. Earnings of $22 million were up 25% from the fourth quarter of last year, but were down sequentially due to higher expenses as we got an early start on the strategic investments that we discussed at our November investors conference. Before moving to Q&A, let me do a quick overview of 2011 and what I see as we move forward. By any number of measures, 2011 was an excellent year that demonstrated the strength of both our balance sheet and business model.
To name just a few, operating earnings per share grew 33% as earnings grew 27%, and our average share count benefited from active capital management. As I mentioned earlier, book value per share, excluding AOCI, grew over 5% despite the goodwill impairment we took during the fourth quarter. Return on equity grew to 10.7% for the year, benefiting from both strong earnings and share repurchases. We were very active on the capital management front with $575 million of share repurchases, $225 million of net deleveraging, and strong growth in shareholder dividends. I would note that capital usage benefited in 2011 from strong reserve financing performance and continued improvement in the credit quality of the investment portfolio.
Overall capital remains strong with life company capital ending 2011 at $7.6 billion, up $500 million for the year, a year-end RBC in the 500% range, and $600 million of cash at the holding company. As we move into 2012, let me provide a few comments. We will continue to be prudent with our capital usage. This means that you will see continued pricing adjustments in the life and annuity space to ensure that our returns on new business are competitive with other uses, including share repurchases, which we will continue with in 2012. Absent other impacts, I would expect capital usage on share repurchase and deleveraging to be governed by free cash flow, which I'd size at about $400 million.
While operating earnings growth will be tamped down by the implementation of 09-G, investments in our Group and Retirement businesses, and the headwind of lower interest rates, I expect that earnings per share growth will benefit from share repurchases. With that, let me turn the call over to the operator for questions.
Thank you. If you have a question at this time, please press star then one on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Please limit yourself to one question and one follow-up. Our first question comes from Edward Spehar with Bank of America.
Thank you. Good morning. Randy, on your last comments, could you be a little bit more specific when you talk about the $400 million of free cash flow? I think that has been the number that we've thought about is for equity holders in terms of buybacks or dividends. Could you talk about, is that the number, or are you talking about that number is going to be to pay down debt as well?
Yeah, Ed. Thanks for the question. First, let's talk about 2011, because I think it serves as a good platform for 2012. We had a very strong 2011 from a capital usage standpoint. $800 million on combined share repurchase and delivery. That benefited from a couple factors that I don't think will necessarily repeat in 2012, although we'll do our level best to try to make that happen. Those two items were multiple reserve financings, which we did over 2011, and improvement in the credit quality of the general account assets. Those are items that you can't necessarily count on repeating. Like I said, we'll do our level best. We'll do the best we can on those items. As in any year, looking forward, the starting point for capital usage is free cash flow. That's roughly $400 million a year.
That's capital usage for both share repurchases and de-leveraging. I don't think we're going to be doing huge de-leveraging as we go forward. It's going to be modest de-leveraging. I would say that the majority of that $400 million, I would anticipate going into the share repurchase side. $400 million, Ed, it's the combined number. I'd say it's skewed towards share repurchases, and we'll do our level best to try to outperform on that number just like we did in 2011.
Just one follow-up. Considering what your outlook is for life sales now over the next few years, could you just give some sense of how much that might affect the free cash flow emergence over that period of time? If you're right about the environment for life sales, I would assume there has to be some impact on statutory cash flow that would be favorable over that few year period.
Yeah. Ed, Dennis, it's about one to one. Just to pick a number, if sales went down $100 million, free cash flow would increase $100 million. If that were the case, that would be one of the levers that we'd use to increase our share repurchases.
Can you give us any sense of what the expectations are for sales that are built into the goodwill action?
Ed, I'm not going to get into the specifics of what's behind the sales levels. Just let me reiterate, we took a good, strong run at all of the assumptions that surround the goodwill analysis, including sales.
Thanks.
Our next question comes from the line of Suneet Kamath with Sanford C. Bernstein.
Thanks, good morning. Just one follow-up to Ed's line of questioning on the RBC ratio. I think Dennis, in the third quarter call, also at the IR Day, you kind of talked about the 500% RBC ratio and perhaps dipping into that a little bit. I'm forgetting the exact terminology you used, but essentially allowing that to come down to fund additional capital redeployment. I didn't get the sense that that's what you were alluding to in terms of your comments and Randy's comments earlier today. Is that still something that's on the table, or how should we think about that?
I think what Randy is saying is that we're guided every year at the outset of the year by free cash flow. That's just the fundamental approach that we take. We certainly are very comfortable with the amount of, or the strength of the balance sheet. Don't have any hard and fast rules about not dipping into that if we think it's appropriate.
Okay, great.
The excess capital.
Understood. I guess my other question just, again, goes back to the Investor Day, where you showed those scenarios for a low rate environment and your statutory reserve redundancy, which if I recall, was pretty significant. I think in one scenario, $8 billion, in a more adverse scenario, maybe $6 billion. I guess my question is, I'm not sure that the market truly is reflecting that level of cushion in your valuation. I'm actually pretty certain it's not. I'm wondering if there's something that you could do maybe securitizing some of those excess reserves just to sort of prove to the market and to investors that these are truly redundant sort of by way of a third-party affirmation. Just wondering if you had any thoughts on that.
Suneet, of course, we're always looking at all aspects of our balance sheet to optimize capital usage. I'd point out one of the comments I made. When we do these reserve financings, that's essentially a reflection of reserve redundancy. We're essentially front-ending what are redundant reserves. We did multiple reserve financings in 2011, generating roughly $500 million of capital over the course of the year. We will look at all aspects of our balance sheet, look to what we have done as a reflection of the fact that there's definite redundancy in our balance sheet. I'll go on to say I haven't seen anything different in the results from this year's cash flow testing process so far. Of course, we're in the middle of it. I haven't seen any change from what we talked about at the investor conference in November.
Are there any constraints in terms of how much of that you could finance?
Suneet, I can't think of any constraints on what we could do with our balance sheet. There are a number of different options that companies have out there. I don't have any anticipation of using large pieces of our balance sheet. I'm pretty much guided by the fact that we have been looking at the redundant reserves, specifically on secondary guarantee UL, as an option for creating capital.
Okay, thanks.
Our next question comes from the line of John Nadel with Sterne Agee.
Hey, good morning, everybody. It's still morning. A question on universal life. I'm just wondering, Dennis, if you have any update on the status of the NAIC's review of this sort of blended UL term product and the reserving requirements around that.
Yes. There was quite a bit of action toward the end of the year. Consistent with some of my comments in November, it continues to feel pretty good. The NAIC is certainly looking for a solution that appropriately gets the level of reserves to the right amount. At the same time, it doesn't so much increase reserves or change reserves that it's not a good consumer product. Everybody's got the right view, which is let's get the right reserves, but this is a valuable product in the marketplace, and let's not do anything that would change that. The other thing I would say is that they've taken a bifurcated approach, at least at this moment in time. This is what they've conveyed to us. That is that there would be a different outcome for new business versus in-force business, and the industry was behind that bifurcation.
To summarize, I think it's going in the right direction. The NAIC has got a lot of good people thinking about this. The industry is actively participating, and I'm expecting a result that is good for the regulators, good for the companies, and good for consumers.
Thanks for that update. Just one more question. I was interested in your commentary earlier about the continued push toward these low volatility investment options that you mentioned, I believe it's inside the VA accounts. This is something we keep hearing about. We keep hearing a big push into these types of funds across the variable annuity industry. I'm curious if you've done any study or risk assessment as to just how much assets can move into these low volatility type of funds before these types of funds begin to break down around that mandate of continuing to hold the volatility levels low. I'm not sure if I worded that quite right.
Is it still a good consumer value?
I guess just more the risk of these low volatility type funds. How much in the way of assets can they truly manage and still maintain that type of low volatility performance? Is there a tipping point?
I'd have to have our experts give us an answer on that. We'll go into more detail on that question. It's a pretty deep market for the type of derivatives that we use inside the sub-accounts. There's also choice. Let me tell you what we're doing next year. I alluded to it in my remarks. Again, back to this concept of giving our consumers flexibility and choice. The action that we're going to take in the second quarter is that we would lower the limited benefit income guarantees by roughly 50 basis points, and that would vary by income start age, for those clients who do not allocate 100% of their assets to the protected funds. Our actions go in the direction of quite a bit of money being put into these funds and our ability to manage it.
John, I would just add, as you're well aware, one of the items we're very proud of is the hedge team we have here. The hedge team has done extensive analysis of the protected fund product that we have developed and will roll out a little later in 2012. It definitely does reduce the risk profile of that product from Lincoln's standpoint. We're happy with that. In terms of the runway, I think as with anything, there's probably an ultimate amount that you can't get over, but I think the runway ahead of us is pretty long in terms of the amount of that product that we can manage on our balance sheet.
Okay. That's the point I was trying to get to, is at what point does an industry chock-full of assets in low volatility funds, because you hear this from pretty much every one of your major variable annuity competitors, just trying to understand how much runway is there. Thanks.
Yeah. I'll come back to just from that question in, again, my earlier comments. We'll have two choices. You can have more investment flexibility If that's what you would like. The guaranteed income will not be as high as it would be if you go into 100% in these protected funds.
Makes a lot of sense. Thank you.
Okay.
Our next question comes from the line of Joanne Smith with Scotiabank.
Good morning. I have a follow-up to John's question there. Just with respect to the rapid increase of these types of low volatility funds and funds where a lot of the hedging is being done now at the contract level or the fund level. I'm wondering what the real drive to these products, and I understand risk management by product design. I'm wondering if this has anything to do with the potential for the Volcker Rule to impact the overall derivatives market, or does it have something to do more with just the high cost of hedging, and your desire to reduce those costs or maybe diversify the types of hedges you're using? I'm just trying to figure out why this rapid move into product design hedging versus derivatives hedging.
I can't speak for everyone, but let me come back to our value proposition, which is about choice. What we are providing is choice. To repeat what I just said, if you want to do 100% in protected funds in your subaccounts, you're going to get a higher income guarantee than if you don't. Some people will opt for the more flexibility in the subaccounts. Of course, we're well positioned for that. You may remember that at the investor meeting, we talked about having the highest percentage of high Morningstar-rated funds in our lineup than any of our competitors. Again, an example of what we're trying to do from a flexibility standpoint. I can't speak to the entire industry. I think generally, industry is trying to tighten up on risk, but still provide a very good consumer value over the long term.
I think those of us who have been responsible about the way we've built these products over time, continue to believe in it. It's just the normal evolution of risk and consumer value, and where's the right crossover point.
Okay. I guess as a follow-up, just in terms of the life insurance sales, when you're talking about the non-MoneyGuard UL, your run rate based on the third and the fourth quarter is now at about $300 million in sales a year. Is that kind of the run rate that we're looking at, or you think that you're going to pull that back even more?
Well, we offer a variety of solutions in our portfolio. Again, we talk about this breadth of solutions to meet different customer needs. At this moment in time, we are shifting our emphasis in our sales, customers are buying a little bit more of our other parts of our product portfolio. We're looking, again, we don't give sales projections, but we're looking to continue this concept of, it's not all about SGUL, it's not all about variable universal life, it's not all about MoneyGuard, but it's a combination of products that meet changing needs of the consumer over time, with our powerful distribution and product innovation, that's what we're going to continue to focus on.
Thank you.
Our next question comes from Jimmy Bhullar with J.P. Morgan.
Hi, good morning. First, I wanted to just follow up on Randy's comments on free cash flow. The $400 million that you mentioned, that's after whatever you're planning on paying out in terms of dividends on the stock, right?
Yes.
Okay. On my question, given the pace of buybacks recently, should we assume that the M&A market's not that attractive? Because I think, Dennis, you've mentioned Group Protection and Retirement Plan Services as potential areas that you're interested in. If you could just comment on what you're seeing out there in terms of available properties, and should we assume that since you've been buying back at a decent pace, the opportunity's not there right now?
I think the M&A market in the insurance industry, except for those big deals that were done overseas, has been fairly muted. That's because as the volatility that we've all experienced in the industry has, again, come down somewhat, it's still fairly volatile. I think managements in general are more comfortable with what they're doing than trying to go out and buy things. At a high level, that's what I would say. I also would say that when so many of the companies are selling at a discount to book, the hurdle rate for doing M&A gets higher. A combination of just the uncertainty, higher hurdle rates, has chilled, in large part, M&A transactions. Having said that, we continue to look for properties, again, against those constraints of hurdle rate on share repurchases.
Over time, there will be opportunities for Lincoln and other companies in the industry.
Just on your goodwill charge, if you could just give us some idea on what were the main drivers behind the charge, whether it's lower sales expectations or low interest rates? You've still got a billion and a half of goodwill in the life business. What gives you comfort with that remaining number?
Yeah, Jimmy, this is Randy. Let's go through the whole discussion here. Let's start with what we know, that's that we're a market leader in the U.S. life industry. We expect fully that the life business is going to be a steady, growing, profitable, and valuable part of what we do over the long term. Think about what a goodwill analysis is. It's a point in time estimate of what is a 30-year projection of future profits from new business, and it's subject to a variety, a large number of assumptions, including the ones we've talked about, future sales levels, profitability on those sales, and the best discount rate to apply to that income stream. In our analysis, we hit all the key assumptions pretty hard for the next several years, really reflecting the difficult environment that the industry finds itself in.
We return to more typical expectations in the out years. The tough assumptions for the next several years is primarily what caused the write-down. I think as everyone's aware, as we've talked about a number of times, we've made several pricing changes in the market. As we look at it today, the market has been somewhat slow to follow, even though you see it starting to pick up. This affects our near-term competitiveness, and we expect this to impact us in the near term, the near to medium term. We think that will even out over time. If you look at overall conditions today, we expect that the profitability on those new sales is going to be towards the lower end of our target range. You've seen our target range. You've heard us talk about our target ranges. Mark talked about it extensively at the IR Day.
We expect, given what we see in the environment, that we'll be at the lower end of that range. You've got a competitive environment, you've got profitability at the lower end of our range, and then you have the additional fact that even though market interest rates were down, we didn't see the discount rate that we would apply to this business follow. Even though the market rates were down, which would have normally implied that your discount rates would come down, we didn't see that impact occur. All of those things we took into account. As I mentioned, we hit pretty hard as we went through the analysis. Again, the goodwill charge that we took does not alter in any way our view of the long-term viability of Lincoln's life franchise.
Just to put an endpoint on that, we think this is a good asset for the foreseeable future. We hit the assumptions hard. To repeat what Randy and I have both said, there's no algorithm here that you stick in one level of sales with one discount rate and you get an answer. You look at everything in the aggregate and decide what's the best goodwill number. That's what we've done. We think it's a good number. We don't expect it to change in the foreseeable future. That concludes my comments on it.
Thank you.
Our next question comes from Randy Binner with FBR.
Hey, thanks for the comments on the goodwill. I guess I'm going to hope to try and follow up for a little bit more quantification. As far as hitting the market dynamics hard, is it possible for you to give us a little more color on how long you held rates low at what level? Maybe, I guess you don't give sales guidance, but give it a little more parameters around that. I guess the final piece I'm looking up to follow up on is just to explain how these assumptions got worse relative to the previous assumptions, but why there's no necessary impact to the GAAP or statutory outlook for the same book of business.
Yeah, Randy. Once again, I'm not going to get into the specific actual numbers, but let's go over some of the facts again. I think your first part of your question revolved around the discount rate. Just by its very nature, the discount rate is something that gets applied for the entirety of the 30-year projection. We didn't assume a higher rate and then go down in the out years. The discount rate, as I mentioned, did not follow market rates down. That impacts the entire 30-year stream of income that we discount. In terms of actual sales numbers, once again, we don't give sales guidance. We link our goodwill analysis from a sales standpoint very closely to our plan. We have a strong history of hitting our plan.
I'm very comfortable with where we ended up in terms of the sales that are inside of the goodwill analysis. Once again, it was a near to midterm thing. We believe that when you look in the out years, you'll have seen those competitors start to respond, raise their prices, et cetera. You'll see that competitive positioning coming back, and you'll see all those sales return. The strength of the life franchise isn't changed one bit by what we've done here from a goodwill analysis standpoint.
Just to follow up, why specifically did the discount rate not follow prevailing rates down? What was the mechanism for those to separate?
Yeah, it's really judgment at the end of the day, right? You
Can simply do a capital analysis, market-based analysis of the discount rate. We do that. We actually hire an outside firm to come in and do that analysis. They look at the risk-free rate, they look at our beta and all the items that go into an analysis like that. Their input back to us was that the discount rate had actually fallen. Against that, we need to look at the overall marketplace that we live in today. When we look at that marketplace and we talk to other market experts, it was our belief that the market discount rate just hadn't come down like the capital markets model would've said. In fact, we felt that it had gone up a little bit, and we reflected that in our model.
Okay, great. Thank you.
Our next question comes from Andrew Kligerman with UBS.
Hey, good morning. Just around the sales. The variable annuity products came in down 8.5% in the quarter. Noticing that a lot of your competitors are kind of retrenching on the generosity of their product. I would have expected maybe an uptick. Can you comment around why you think the variable annuity sales were off and where you see them going over the course of the next year or so?
Yeah, Andrew, it's Dennis. Taking market share in this business is easy if you want to provide a very competitive and rich product for the consumer. We haven't done that as we've talked about. We continue to make changes which give good consumer value and options to our consumers but continue to improve risk/reward trade-off for the company and our shareholders. The comments about competitors. Again, there's always going to be competitor movement in the marketplace. I think the fourth quarter, you may see some bigger numbers from some of the competitors, as you point out, because the products are coming back to where we are, if you will, in terms of richness. While they weren't, you were seeing big numbers. What I would say is the demographics are strongly behind this product.
Lincoln, I think the rest of the industry, is doing a better risk/reward trade-off in their product design. I think Lincoln and the industry is going to continue to see good profitability and good growth from these products in the coming years. Coming back to the importance of them to the consumer for guaranteed income and the demographics.
Okay. Maybe on the Retirement Plan Services, a little more color on why the mid-markets product was so strong, up 29%, or the mid large markets rather, why maybe the micro product and the multi-fund product were weaker. Maybe just a little color around that.
Yeah. Andrew, the momentum that we picked up across the market really is a direct result of our new administrative platform, a direct result of the increase in feet on the street, more people talking to more people about Lincoln, we won some big cases. I think it's just fundamentally the investments we're making, and we're beginning to see the payoffs. It's the way I would explain the year in the fourth quarter. I also think it's important to mention or repeat what I said in my remarks, not only are sales better, but our retention numbers are quite a bit better. This comes back to how we're managing distribution right now because retention is part of distribution salespeople's compensation. That's helped. If you look at the overall retention rates, this year it was 12.8%, down from 15.3%.
I give these examples as just trying to create the whole picture, which is momentum building because of the investments we're making and the payoff from those investments.
Just a little color on maybe some of the weakness in the other fund sizes, micro and multi-fund, though?
Multi-fund is not an active product. The only sales that come through from multi-fund are existing clients' renewals, individual employee renewals.
That should taper off. Then on the micro?
Excuse me?
Then on the micro funds?
Yeah. Again, a lot of expansion going on there. We'll see good results coming out of that.
On it?
Eventually. Distribution expansion. Does that help?
Perfect.
Okay.
Our next question comes from Steven Schwartz with Raymond James.
Hey, good morning, everybody. I guess a couple of follow-ups here. First, referring back to the VA and the low volatility funds, I guess my question is it cheaper for you, less expensive for you to be hedging on a sub-account basis rather than, I guess, for lack of a better term, more macro hedging that you've historically done?
Yes. It's absolutely less expensive to hedge these protected funds than the broader portfolio of equities and bonds.
Okay. Just going back to the SGUL discussion, sales discussions, and what we have, just, I guess my question here is, to what extent pricing has reflected and maybe to what extent, and obviously how that fits into the goodwill impairment, the bifurcation approach that the NAIC looks to be taking. Clearly, if they use our new business, the LATF methodology, you'll at least have to do more. You'll have more statutory reserves. You'll have to do more financing. That will affect GAAP, I would imagine. You may be hopeful, but I think there's a better chance of the great pumpkin showing up than principle-based reserving. Did that play a role in all of this that's going on?
Well, there's quite a few questions in there. Let's speak to AG 38 and what might be the outcome of AG 38. First, I just want to put us all on the same page. The AG 38 interim solution that's being developed right now is simply that. It's an interim solution. It's going to apply, again, retroactively. There's one approach in new business going forward, there's another approach. That in itself, the new business going forward, the reserves are going to be based on principle-based reserving. It's been the expectation for the last five to seven years that principle-based reserving will increase the pricing on some products and lower the pricing on other products. At least historically, the expectation is that it would likely lower the reserving on guaranteed universal life.
At this point, I would make the comment that we've got to look to principle-based reserving for the long-run reserving practice on the business. This interim solution, if it's a little bit harsh on new business, if it were, I don't know that it would be, it would be corrected by principle-based reserving. That's what's going on. Let's back up. This is one of the best products in the industry for key planning purposes, particularly estate tax planning. There's going to be pricing elasticity. As I said, the focus throughout this entire process has been the right level of reserves and a good consumer product. I think at the end of the day, this will work out fine from those perspectives.
Okay, Dennis, if I can paraphrase what you just said and tell me if I got it right. Basically, the message here is we're not doing anything, haven't done anything with regards to this temporary bifurcation approach because we're confident that something will happen on PBR, and in the end will be great. Is that fair?
Say that again, please.
What I'm hearing from you is there's a bifurcation approach. It may be harsh on new business, that's going to be temporary. PBR comes in, things will be fine. The profitability will be there. We don't have to do anything in the meantime with regards to pricing.
Well-
All else equal.
All else equal, our repricing does anticipate some increased reserving requirements. I think I'd like to separate this AG 38 issue out from just the general reserving and the conservatism that we use. There is an indirect link, but you really don't know what's going to happen with the NAIC solution. We're continuing to build our products around what we think the right reserve level is. I'll say again, we've increased that somewhat in our new pricing. I think that we're pretty good at what we do, and I wouldn't expect what's going on on the regulatory side to be too far different from what we're doing over time.
I'm sorry to keep beating this, now I'm hearing something else. Because historically, the argument from your point of view is we got plenty of excess reserves. In fact, as Randy mentioned, we can finance these things. Why assume reserving is going to be higher in the future? Why build that in-
Yeah
if you're looking at PBR?
Yeah. I'm trying to weave the whole story here, maybe you're picking pieces that belong to one story or the other. Let me ask Randy to answer that question.
Yeah. Let's break this down. We're pricing a new product. When we price that product, we need to assume a level of reserves that we're going to hold. We've increased the assumed reserves that we're going to hold as part of pricing. Separate from that, if those reserves are above some economic level of reserves, you can finance those reserves. Financing of reserves isn't free. It also has a cost. You have the base level of reserves that you've assumed inside pricing, that effectively has an equity-type cost, right?
Anything above that, if you felt that level was above economic, you could assume a financing cost, which is lower than an equity cost. In terms of what we're putting in pricing, that base level of reserves, which gets an equity-type cost inside of your pricing model, we have increased that because we believe that the amount of required reserves as part of the new approach will go up. We don't know what the final number is, we'll adjust to whatever that final number is, we'll adjust quickly. For right now, we've assumed that it will go up some, we've reflected that in our pricing.
Okay, the cost of the base level reserves that you would have to hold is going to be greater than-
Yeah
the financing, basically.
Effectively, if you think about how it works in a pricing model, that base level reserves, that amount you don't finance, has an equity-type cost.
Okay. All right. Thank you.
Our next question comes from the line of Bob Glasspiegel with Langen McAlenney.
Hello, everyone. I'd like to follow up on Randy versus Randy's exchange, specifically on interest rate sensitivity to your assumptions. If the 10-year stays at two for 10 years, and the credit spreads stay where they traditionally have been, what sort of return on capital are you getting on new business in the life business today?
Bob, let's talk about this. We've been chasing over 2011 rates down, right? We've made multiple assumption changes and pricing changes inside of our life products. When we've made those changes, we've targeted getting a return in the low double-digit area. As rates have continued to fall, we've needed to continue to adjust our pricing. We've trailed that a little bit through 2011. Now, looking forward, as I mentioned, we've repriced our products in today's interest rate environment to get a return at the lower end of our target range. Based upon the rates that sit here today, we are pricing our products to get a return at the bottom end of our targeted range, low double digits. That's the entire book of business. Remember-
Right. No, the other business has been priced at different interest rate environments.
We don't just sell a secondary-
Right
or UL or MoneyGuard where we sell a broad book of business, some of which gets 13%, some of which may get 10%. It all blends together into a low double-digit type of number.
You're assuming there's a discount rate of 2% plus credit spreads over the life of the product that you're pricing today. That's sort of the inherent question.
Yeah, Bob. We're looking at pricing in a number of different ways. We're looking at pricing if rates stayed level, if they followed the forward curve, if they followed our J curve. We're looking at assumptions that cover the breadth of potential outcomes, and we're trying to make sure that we get a reasonable return in all of those scenarios. Based upon what we're doing today, we expect that we will get returns, just as I said, Bob, at the lower end of our target range in the low double digits.
Okay. If the 10-year stays at 2% for 10 years, there wouldn't be any charges related to business that you're writing today.
I'm going to go back to the Investors' Conference, where we were very clear with the impact of a lower interest rate environment for an extended period of time. We don't see any hits to capital outside of the potential need to lower our long-term earn rate assumption inside of our DAC models. We talked about that. The impact of that last time was about $150 million. There's the potential that we would do that again should rates stay low for a long period of time. In terms of the reserves, we don't see an impact on the reserves due to the interest rates staying low for an extended period of time.
Okay, last question. Corporate, what's the run rate?
Corporate earnings?
Just the Corporate line, yeah.
Yeah, I'd put them in the negative 35 range.
Thank you very much.
Yeah. Maybe I'll just, Bob, if you don't mind. I understand the question. It's been a little tough for the life business. We continue to make pricing changes to improve the new business ROEs. As we've said, for the next couple of years, we might be at the lower end. I'd also like to remind you and others on the call that we're getting very good ROEs in the balance of our businesses. The annuity business, the VA still is in the mid-teens. We're getting low teens overall. In the Group Protection business, we're in that 12% range. And in our Retirement Plan Services, we're pricing for and getting pretty close to 12%-15% ROEs. Yeah, we're working hard to get the life ROEs up, but we've got balancing and better ROEs in the other business lines.
Thank you for the follow-on. Appreciate the thoughtful answers.
Okay.
Our next question comes from Mark Finkelstein with Evercore Partners.
Okay, good morning. I'll make this quick. I think everything was hit pretty hard. Just a question on group insurance. I was a little surprised by the strength in sales there. Can you just talk about what rate increases you're pushing on that and whether those were part of the Q4 sales or really Q1 2012?
Let me talk about renewal pricing, and Mark touched on this at the IR meeting. We get non-dental, we're 4% improvement, a little bit north of 4% improvement during the year. On our dental product, we were targeting 8% and we got up to 9%. We've seen nice improvements on renewals. It's a little more difficult to translate that into new business, but it's not going to be too far away from our new business results. The strong fourth quarter was really driven by, again, we talked about this change in our rep structure. We've got quite a bit more alignment with our reps, quite a bit more activity. The fourth quarter, we saw growth across our products and segments, so there was no reliance on any one facet of the business.
As I noted, we're seeing continued success in selling employee paid solutions, what we call voluntary, both our traditional group products and our new worksite products. We also remain focused on our core strength in the other 1,000 lives. I would say it's a very good, solid, across-the-board result, which did include pricing increases.
Okay. Just outside of dental, no real range around kind of the average rate increases?
Outside of renewals, you mean?
No, outside of dental. I think you gave 4% on dental.
Non-dental, 4%.
Oh, non-dental. Okay, I'm sorry.
Dental, 9%, to give you price increases on new business.
Yeah. No, I meant renewal. That's fine.
Okay.
Thank you.
Our next question comes from Eric Berg with RBC Capital Markets.
Thanks very much. A couple of questions. Good afternoon now. A couple of questions regarding the life business that follow on the earlier questions. First, it's my sense from hearing from and talking to lots of life insurance agents, that price increases are taking place broadly throughout the industry. If I'm right about that, and I've heard it from several agents, I tend to think I am, why does Lincoln think it's going to lose share? If everybody's in the same boat, so to speak, why are you predicting lower sales than you had been predicting? I have a couple of real quick follow-ups.
Yeah, Eric. What I've said is that the industry hasn't been as quick to follow our pricing changes, we would expect over time for them to do that. There's a lot of different sales, if you wish. On single-pay deals, in the fourth quarter, we were off as much as, say, a male, 55. We were off as much as 17% from the price leaders. We expect those to change in 2012. That was the reality, and that affected our competitiveness in the quarter. Because we don't know how fast the industry's going to move and catch up with us. We have more pricing changes coming in the first quarter. We think eventually, and that may be by mid-year or later in the year, that this will all even out. Right now, not unusually, we're leading the market on pricing changes.
A couple of real quick follow-ups. In the narrative of your news release describing in detail the goodwill write-down and in your comments today, you discuss not only the effect of lower interest rates and your need to raise prices as a result, but just the, these are my words, not yours, but I think I have the right idea, the generally tougher environment for life insurance products. I'd like to know, one, what did you mean by that, the generally difficult environment for life insurance products, apart from the interest rate issue? Relatedly, why can't you price? Why are you contemplating or why are you pricing your new products at the lower end of your targeted range? What prevents you from pricing in the middle or the high end of the range? Thank you.
Yeah. I think that, Eric, it's always a balance, right? We've talked about capital usage and how we are being very cognizant of all returns available when we use capital. What we've said is that on new business, we're going to price those products so that we get a return when you view everything that goes into the future for Lincoln and the future value that's going to derive to shareholders, things like protecting the franchise. That we take all of those into account. When we do that right now, when we look at the marketplace and we strike that balance, as Dennis said, the pricing changes we've made have put us well out of the marketplace in a number of areas.
When we take all that into account, I think about the return I'm comfortable with defending on life sales, that's exactly where we've moved to. Eric, I think we've made pricing changes that when you think about that total balance, get me very comfortable with the returns we're getting on those new business sales. The industry is going to respond, you'll see this all shake out so that those returns will move up over time. For a period of time, when I think about that balance, I'm very comfortable with the returns we're getting that represents a reasonable return on capital
Taking into account all the potential usages. All that aside, been very aggressive on the share repurchase front because I realize that it's a compelling return from a capital usage standpoint.
My question, Randy, was a little bit different from the one you answered. I think I appreciate your answer, I was actually trying to home in on something a little bit different, which was that, maybe I'm inferring something that you didn't intend, here was my thinking that in the news release as well as today, you were saying there's more stuff going on in the life insurance business today besides just low interest rates. It's an overall difficult environment for life insurers. If I'm reading you folks correctly, what are you saying is going on structurally in the life insurance business beyond low interest rates that we need to understand?
Yeah, Eric, I would say that whatever is going on in the marketplace derives from interest rates, right? Life products, in general, perform better in a higher rate environment than they do in an environment that we're in today. All of the dynamics that are going on in the marketplace derive from the fact that rates are low, and that's causing companies, we believe we're in the forefront of these changes, to adjust their products, to move into and out of certain markets, to make all sorts of changes. You just have a lot going on in the marketplace, but it's all deriving from the fact that rates are lower and companies are adjusting to that fact.
Okay. Thank you. I look forward to circling back.
Thanks, Eric.
Thank you.
At this time, I'd like to turn it over to our speakers for any closing remarks.
I want to thank you all for joining us today. As always, if you have any follow-up questions, please contact us at our investor relations line at 1-800-237-2920 or via email at our website. Again, thanks for taking the time, and have a good day.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may-