Good morning, thank you for joining Lincoln Financial Group's first quarter 2011 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 should need assistance at any time during the call, please press the star key followed by zero, and someone will assist you. I would like to turn the conference over to Vice President of Investor Relations, Jim Sjoreen. Please go ahead, sir.
Thank you, operator, good morning, and welcome to Lincoln Financial's first 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 at www.lincolnfinancial.com where you can find our press release and statistical supplement, which include a full reconciliation of the non-GAAP measures used in the call, including income from operations and return on equity to the most comparable GAAP measures. 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. I would now like to turn the call over to Dennis.
Thanks, Jim, good morning. In aggregate, we had another good quarter of operating results. Gross deposits of $5 billion plus and net flows of $1.4 billion were both up in the 12%-13% range, and along with rising equity markets, drove account balances to $162 billion, up 11%. Interest margins across lines are strong. Life and annuity mortality margins were very strong, and our G&A expense ratio improved modestly over the fourth quarter. Operating revenues of $2.7 billion were up 7%. We were a little more aggressive on capital management, repurchasing $75 million of equity during the quarter, about the same amount as we did all of last year. In summary, strengthening fundamentals, steady to somewhat improving margins, and capital management drove the strong ongoing operating earnings that we reported.
Net income per share came in close to operating income as we saw less investment loss, hedge fluctuation, and other noise. Looking at the pieces. Sales in our individual life insurance business of $159 million were up 12% over the year-over-quarter, driven by our well-rounded product portfolio and multi-channel distribution system. MoneyGuard sales helped overall growth, benefiting from increased shelf space and wholesaler support. Other recent actions to strengthen the life business and build sales included repricing our survivorship product and increasing our maximum mortality retention for new business. Turning to annuities. Individual annuity sales were up 16% over the prior year quarter, with VA sales up 17%. Our strategy in the annuity market is to lead with strong distribution, maintain a diverse suite of products that provide good consumer value, but not the most aggressive features, to remain consistently in the market.
As an example, our living benefit guarantees remain among the lowest of those offered by top-selling VA writers, a solid guarantee that provides good consumer value. Also, we have been ranked in the top five for VA sales since 2006, and we are the only top VA provider that is also ranked in the top five for indexed annuities. Less rich and well-priced VA product features lower the product's risk. Multiple products and distribution reach allow us to pivot to the best solution for the consumer in different market environments. Market consistency pays off in better profitability and stronger distribution relationships. We continue to make progress on this strategy in the quarter.
We launched our repriced income rider, introduced a fee-based variable product into a major planning firm, prepared for our second quarter launch of VA long-term care, and substantially enhanced our B2B technology for fixed and indexed annuities in the wired channel. Our defined contribution business produced a solid quarter with account balances of more than $40 billion. Total deposits up 3% over the prior year period and positive net flows. Net flows in this business fluctuate based on the timing of larger plans rolling onto our platform and rolling off over the course of the year. We expect that to continue in 2011. We are implementing our strategic investment plan in DC, including building out distribution support for our small and mid to large market business, and we'll begin to add plans to our new record-keeping platform in the fourth quarter.
We believe these investments will increasingly contribute to DC's results through 2011 and 2012. Progress in the group business. Non-medical net earned premiums grew by 7%. We saw improvement in our disability loss ratios in the quarter. For example, our long-term disability incident rate was the lowest that we have seen in the last four quarters. We are continuing to manage to better overall loss ratios through renewal and new business price increases and extra resources in our claims management area. Sales were somewhat softer overall, tracking slower group protection sales industry-wide. We expect muted sales near-term given the current economic environment. We continue to build out the capabilities that will position this business to take advantage of opportunity in the voluntary benefits, including introducing new products, enhancing the sales team structure, and transitioning to a leading-edge technology platform. Turning to distribution.
At Lincoln Financial Distributors, we continue to execute our growth strategy by focus on increasing the number of advisors who recommend Lincoln solutions, increasing wholesaler productivity, and attracting top talent to LFD. We saw good success in each of these areas in the first quarter, including attracting additional advisors to Lincoln and achieving a 10% increase in wholesaler productivity, the eighth straight quarter of productivity improvements at LFD. Our strategic expansion efforts, including deeper partner relationships, new firms, and targeted wholesaler expansion, will continue to generate lift throughout the year. Lincoln Financial Network continues to grow its population of experienced advisors with a total of more than 8,000. The consistent ability to retain top advisors and also attract new advisors has enabled LFN to contribute a meaningful portion of Lincoln Life and annuity sales throughout both challenging and favorable market cycles. Turning to the balance sheet.
We continue to hold ample capital and liquidity to support investment in growing our franchise and returning capital to shareholders. Overall investment credit quality is good, and we have taken steps to reduce credit risk at the margin by rotating into higher-rated securities as we wait for further signs of recovery. Overall, I am pleased with our progress and momentum in the first quarter. I'm confident that our franchise strength, our healthy fundamentals, and ability to execute, along with active capital management, position Lincoln for a strong year. With that, I will now turn the call over to Randy for more detail on earnings and the balance sheet.
Thank you, Dennis. Last night, we reported income from operations of $349 million or $1.08 per share for the first quarter. Overall, the quarter's strong results reflect some key themes that we have discussed in recent quarters. First, the execution of the business model and tailwinds from the capital markets will and are driving strong results across many areas, including deposits and flows, investment income, equity-based fees, and an improving and solid risk profile. Second, that our consistent approach to selling and distributing high-quality products with strong risk and return profiles is benefiting the bottom line. Third, that a strong capital position is allowing us to become more proactive with our capital management activities. Strength in investments and underwriting were the major contributors to $0.14 per share of earnings outperformance.
The main contributors to the strong performance were detailed in the press release. I will not be repeating them as I go through business unit results. Turning to interest spreads. Spreads across all businesses benefited from strong income from alternative investments and prepays. Excluding that impact, I describe spreads as solid. While spreads will not be a tailwind as we move forward, I do believe that any downside is very manageable. Consolidated return on equity for the quarter was 11.5%, or about 10% after adjusting for the favorable earnings results, up from 9.5% for 2010. I'll speak to our segment ROE performance throughout my comments without the impact of corporate actions, that is excluding goodwill, leverage, and excess capital. Overall, a very strong and positive beginning to 2011, demonstrating strength and growth throughout the company. Turning to segment results and starting with annuities.
Positive flows in markets produced another strong quarter, driving a 14% increase in total account balances to a record $88 billion and a 16% increase in revenues over the prior year quarter. The annuity business reported a return on equity of 23%, 20% after normalizing earnings and up from 19% in 2010. In our defined contribution business, strong deposits in markets drove account value and revenue growth of 10% over the prior year quarter. The DC business reported a very strong return on equity of 18%, 15% after normalizing earnings and in line with our long-term expectations. Turning to our life insurance segment. Earnings drivers performed as expected with life insurance in force up 4% and account balances up 6% quarter-over-quarter. The life business reported a return on equity of 11%, 10% after normalizing earnings and in line with our near-term expectations.
Turning to the Group Protection segment. Non-medical net earned premium grew 7%, a solid result as some of the factors that are contributing to a challenging sales environment benefit in-force premiums. The non-medical loss ratio of 74% is down from last year's first quarter ratio of 75% and a full-year 2010 ratio of 76%. LTD incidence rates, which have been driving elevated loss ratios, came in at 3.95 per thousand in the first quarter, up from 3.57 in the first quarter of 2010, but down from 4.36 in the fourth quarter. While we continue to watch this key metric and manage it closely, we are encouraged by the improvements. Group Protection reported a return on equity of 11%, somewhat below our long-term expectations, but up nicely from the 2010 full-year ROE of 8%. Expense ratios in the first quarter improved over 2010 levels.
As we move through the remainder of 2011, we do expect expense ratios to increase, primarily the result of growth in strategic investment related spends across the company. We estimate the impact at $0.01-$0.02 per share when compared to the first quarter. Let me wrap up with a few comments on risk management and capital and liquidity. Pre-DAC and pre-tax net realized gains and losses on investments of $6 million for the quarter were down from $59 million in the prior year quarter. Current quarter losses were focused in lower rated RMBS and CMBS securities. While some ongoing stress will likely continue in these asset classes, we expect any stress to be at very manageable levels. The variable annuity hedge program continued its history of strong performance and ended the quarter with hedge assets of $750 million, well in excess of the hedge liability of $175 million.
Estimated RBC increased from year-end levels of 491% to approximately 500%, supported once again by improving credit quality and continued capital generation. Total adjusted capital of $7.2 billion was up nearly $100 million for the quarter after taking dividends to the holding company of $150 million. Quarter-end net liquidity at the holding company was approximately $700 million, level with the year-end amount and in excess of our targeted level of $500 million. During the quarter, we continued our capital redeployment activities with the repurchase of $75 million of common stock. Looking ahead, we expect to commit another $100 million-$150 million to buybacks over the remainder of 2011 as our businesses continue to generate free cash flow and as the environment continues to stabilize. All in all, a good quarter and a healthy position for the company at the start of the second quarter.
Earlier, I referenced our improving and solid risk profile. Before we move to Q&A, let me provide some proof points around that comment. Without getting too exhaustive, as we have moved through and out of the financial crisis, we have repriced and restructured two of our key product lines, UL and VA, to reflect market conditions and capital dynamics, adjusted our long-term assumptions on equity markets and interest rates, establishing DAC and reserves at conservative levels when compared to current markets, extended financing under our corporate credit facilities into 2015, and reduced its usage in support of reserve financing by approximately $1 billion, continued to allocate capital in support of the VA hedge program, opportunistically reduced risk in the general account, biasing purchases to higher quality securities and selling out of more volatile holdings on pricing strength.
Finally, we have built our capital and liquidity position to absorb stress conditions without disrupting ratings. Importantly, we've been able to accomplish all of these things while at the same time making strategic investments in our business model. With that, let me turn the call over to the operator for questions.
Thank you, sir. Ladies and gentlemen, if you have a question or comment, please press star then one on your touch-tone phone. If your question has been answered and you wish to remove yourself from the queue, you can do so by pressing the pound key. We ask that you please limit your questions to one question and a follow-up so that all participants may be able to ask their questions. Again, if you have a question or comment, please press star then one on your touch-tone phone. Our first question is from Suneet Kamath of Sanford Bernstein. The line is open.
Thanks very much. Good morning.
Yeah.
My question's on capital redeployment. I guess Randy's comment about the $100 million-$150 million of incremental buybacks in the balance of the year would obviously put you above what your original guidance was, which I think was $125 million through the end of 2011. My question is, given the increase in buybacks, should we take off the table in our minds any potential increase to the common stock dividend over the 2011 timeframe? Thanks.
Suneet, just on that last question. We, first of all, want to register that we believe in increasing the dividend over time when appropriate. That's certainly a goal for Lincoln. We make our annual dividend decision, and it's a board decision, in November, and so we certainly won't be making any decision before that time. Again, our hope is, and our intention is, to continue to increase the dividend.
Suneet, on the capital deployment, we have upped our previous guidance. Of our original guidance, which totaled $125 million over 15 months, we've accomplished $100 million, and we've now guided to an additional $100 million-$150 million. Essentially a doubling to a little more than a doubling of where we were before. That's consistent with the businesses that continue to generate free cash flow. We continue to see improvement in the overall economy, general economic conditions, and it makes us more comfortable contributing more of this capital to activities like share buybacks. As we continue to see those dynamics in place, continued capital generation, continued improvement in the economy, we'll continue to look to these sorts of capital activities.
Got it. My follow-up question, again, on the buybacks is, so as we think about the remaining three quarters, should we sort of expect that buyback pattern to be fairly even across those three quarters or sort of like you did in the first quarter, perhaps an acceleration earlier in the year to sort of benefit from a timing perspective in terms of equity in the share count? Thanks.
Yeah, I think it's dependent on market conditions. Let's start with the assumption that it will be level, and we'll go from there as conditions evolve.
Okay, thanks.
Thank you. Our next question is from Steven Schwartz of Raymond James. Your line is open.
Morning, guys. A couple, if I will. A lot of things going on in the VA market with deferral bonus rates changing, risk charges changing, whatever, and of course, you de-risked yours a bit. I'm just interested, your VA sales were very good. Dennis, do you have a sense maybe what your market share looked like? Do you think you picked up any or just kind of went along with the group?
Steven, the numbers aren't out yet, so I don't know if we've picked up market share or not. Let me say that this is not a business where we're really focused on market share. You can build a lot of market share very quickly. You can do that if you have very aggressive features. As we continue to repeat, we're not going to do that. I would say that we're very pleased with the growth. We have a lot of runway for further growth in the VA business, and we're selling product and features on our terms that we think are good values for the consumer and a good risk-reward proposition for our shareholders.
If I could just stick with the annuities for a sec. Dennis, you mentioned it twice, indexed annuities. I think that's twice more than normal. I think, kind of interested maybe if you could tell us what you think you're going to be doing in the broker-dealer channel. That's kind of the holy grail of that market. I'd be interested in kind of how you plan on attacking that.
Yeah. First of all, let me say once again, we have very well-structured indexed annuity products. So much so that I think we're one of a few, and perhaps the only manufacturer that are currently in the warehouses. That's a recent development that the warehouses would sell this product. It's a good product because it provides downside protection, 100% downside protection, and depending on market conditions, can provide a pretty comparable upside potential. We're going to stay in the market. It's a good product. Again, it's part of our overall comprehensive portfolio of annuities. Again, we continue to make investments in all of the products. This product is, again, something that's more popular with some distribution systems right now, and that's why we've mentioned it.
If I may, the product in the BDs, are you looking at a registered product or unregistered?
Unregistered product.
Unregistered. Okay, thanks, guys.
Thank you, sir. Next question is from Jay Gelb of Barclays Capital. Your line is open.
Good. Two questions. First, could you give us a bit more sense on why the group disability loss ratio improved so much versus 4Q? I think it went from 78% to 70%, so big improvement there. If you can also just kind of square up your ROE expansion outlook for the rest of 2011. Thank you.
On the loss ratio front, it was really driven by the incidence rates. As these incidence rates have come down, you'll see a comparable decrease in loss ratio. That's really the primary driver. I think as we said last quarter, this has been all about incidence rates, which we really believe are linked to the economy in total. As we continue to see the economy stabilizing, I would anticipate that you would continue to see that improvement in those incidence rates.
Yeah, on ROE, I wouldn't say there's any dramatic change in our expectations. We continue to keep this as one of our highest priorities. Increases, as we've said on several occasions, are going to be resulting from an increase in the mix of business to higher ROE businesses. New business ROEs are stronger than in-force capital redeployment and margin management. We're very pleased with what was a little bit of an acceleration in the first quarter of our expectations, and frankly, hope we can continue to see that kind of improvement.
Are you thinking about that 10% normalize that we saw in the first quarter or more like 11%, sort of as reported?
I'm thinking about the 10% normalized.
Okay, thank you.
Which is up 50 basis points from the fourth quarter.
Thank you. Our next question is from Jimmy Bhoola of JP Morgan. Your line is open.
Hi, good morning. Just first one, Dennis, on your remarks on just the potential buybacks through the rest of the year, is it fair to assume that the M&A pipeline looks relatively dry if you are buying back this much stock?
Well, let me answer the question about the pipeline. I don't think in the financial services industry, broadly speaking, or at least in the insurance business, there's not a lot of activity right now. Having said that, as we all know, Fred is spending a large majority of his time trying to find opportunities. When I think about share buybacks, just to get back to the share buybacks or acquisitions, share buybacks are really more about ongoing generation of free capital than they are anything else. You've heard Randy say this, our increase in our share buyback program has to do with improving fundamentals in our core businesses and therefore increasing cash flow or at least better comfort in our free cash flow at the holding company.
Okay, just a question on your, in the group insurance business, maybe if you talk about what drove the margins in group life and dental lower, and then also just competitive environment in that business, given that your sales are relatively weak, if you could talk about competition in the group insurance market.
Maybe I'll ask Mark Condon, who's sitting next to me to give a little more in-depth answer to that. I would say that, just at a high level, the group market is industry-wide weak. On the loss ratios, Randy's already addressed the issue of LTD incidents being better this quarter than in the last four. At a high level, those are just observations that maybe Mark, you'd want to add to that.
Sure. Jimmy, just a couple of detail points on your specific question. First, on dental. Dental, as you might expect if you think about that product line, has a fair degree of seasonality to it in which the first quarter, and to some extent the second quarter, are the highest usage quarters for that product. You'll see the loss ratio spike up in the first quarter and then come down over the balance of the year in a normal year. That's what I think drove the dental loss ratio up this quarter. If you compare it to first quarter 2010, we did see some improvement in the loss ratio year-over-year, which is something we've been working on in the dental line.
On the life business, again, life mortality was pretty good, but what also comes through that line, just because of the peculiarities of how the accounting works, is life waiver, which again is driven by disability and disability incidents, and that was slightly elevated.
Okay. Lastly, you are transitioning to a new technology platform, I think later this year in the DC business. Should we expect your sales to be weak as a result of that? Should there be any disruption in your business, in terms of inflows as a result of this?
Yeah. It's interesting. There's really two reactions in the marketplace. One is very happy to see the improvement in the technology, and we want to be part of it. A lot of the sales cycles are six months long, so by the time the big to large case in particular, by the time you get the sale and the money in, we can be putting it onto that platform. On the other side of that coin, a little sentiment about waiting to see. On balance, we don't think it is a negative or a significantly positive issue for our sales for the balance of the year.
Okay, thank you.
Thank you. Our next question is from Edward Speer of Bank of America. Your line is open.
Thank you. Good morning. Dennis, I wanted to go back to the dividend. I guess if I look historically, Jefferson-Pilot, and Lincoln both had very high dividend payout ratios
The run rate earnings that we would come to for this quarter would be about 5%. If we think that the marginal returns in your business are close to the high levels that Randy cited, I think you'd probably agree that the overall secular earnings growth rate for this business is in the single digits, can you tell us why wouldn't the dividend payout ratio be potentially five or six times the current level? Why wouldn't we be potentially getting to that type of number fairly quickly?
Everything you say is true on a historical basis, Ed. You're right about those things. I'll come back to what drives, in our mind, the level of dividend, and that is free cash flow at the holding company. Right now we have approximately $300 million of free cash flow at the holding company. We expect that to grow over time. That's what drives dividends. You can see there's more room there. When we absorb that amount of room, the timing of that, again, is a director's decision. Let me reinforce my point, which is we think growing the dividend is an important objective for the firm.
Could you talk about what you think the normalized, if we think going forward, what the normalized level of free cash flow at the holding company is relative to your GAAP earnings level?
Well, let me ask Randy to do that, but before I ask him to do that, it's statutory income as a percentage of GAAP income, then there's some other pieces. Let me just turn it over to Randy. Randy?
Sure. Ed, if you look at cash flows at the holding company, we generate, on an annual basis, about $700 million of cash from our operating companies. As Dennis mentioned, the cash needs, primarily from interest expense, run right at about $300 million or a little above that. That gives you, as Dennis mentioned, free cash flow in that $300 million-$400 million range, which is used to support things like dividends, things like share buybacks, things like de-levering, which is a theme we've talked about in recent quarters, and I think a theme we'll continue to talk about some more de-levering as we move forward. When you look at what drives that with GAAP earnings running in the $1.2 billion-$1.3 billion range, you're talking about free cash flows above about 25% of that.
When you look at the stat earnings, which ultimately derive the amount of cash you can send to your holding company, I think we're still consistent with what we've always said, which is we have stat earnings running about 60%-70% of our overall GAAP earnings.
I guess, Randy, when you talk about de-levering, though, why couldn't you use, I think you've talked about maybe 400 RBC being the kind of the new target. Why couldn't you use the, I guess that would be about $1.5 billion or something of $1.4 billion of capital above what you are telling us that is the sort of required level?
Right. Let's talk about excess capital. Based upon a 400% RBC and holding company liquidity requirement of $500 million calculates out to $1.6 billion. I believe that over time that we are going to move towards those levels. There is going to be an interim period where we're going to operate at a high level for a couple of reasons. It's a fact that we are only a short time from one of the worst financial crises since the Great Depression, when capital markets shut down and a number of other things occurred. We are, as I mentioned, not that far from that point in time, and it's reasonable, in my opinion, to sort of continue to watch those markets recover and stabilize a little more before you move ultimately to that final level.
There's the additional item of the rating agencies whose views are also somewhat slow to respond, which really isn't surprising with what the financial industry experienced. Their views are going to evolve just like I think our views will evolve, and they'll meet at some point in time, as I mentioned, in or around 400% RBC and $500 million of holding company liquidity for a company like Lincoln.
Let me just come back. I, again, want to re-emphasize that increasing our capital management activities is a goal, and the better economy that we're in and continuing good results, which we expect at the company, will accelerate our perspective on that, on capital management.
Thank you.
Thank you. Our next question is from John Nadel of Sterne Agee. Your line is open.
Hi. Good morning, everybody. It's still morning. I have two questions. One on mortality and the other on capital. I'll beat the dead horse. My question on mortality, which was favorable in both your life and annuity business this quarter, is it just a function of the right people are living longer in one business and not to be too morbid, but dying sooner in the other? Would you characterize that as a normal fluctuation in the results or are you perhaps seeing maybe some impact in the life insurance side from a more active life settlement market now?
No, we don't see any impact from the life settlement market. Now, you're exactly right. The impact in the quarter, which was positive in both life and annuities, indicates that mortality moved in a favorable way in both segments, which is exactly opposite, right?
Unfavorable for the wrong people. Yeah.
Right.
Okay
It's just one of those quarters. Just went the wrong way.
Okay. All right. Then let me go about the capital question maybe a little bit differently. Maybe perhaps the opposite perspective of Jimmy earlier. If I level set for that ultimate 400% risk-based capital ratio target, it looks like today you're sitting at around $2 billion of excess capital between the life company and the holding company. I know you've got some level of capital both at the life company and the holding company that you want to keep. My question is when we look at that and we look at the capital generation from ongoing earnings, compare that with your buybacks of $100 million-$150 million from here, should we take that to mean that you actually do see something, some other competing use for excess capital over the intermediate term?
Not really, no.
Okay. This is just we were all around the boardroom table not 18, 24 months ago trying to figure out if the world was going to survive.
Yeah. John, let's go to your numbers. I think you mentioned $2 billion, and as I mentioned, just mathematically, it's $1.6 billion based upon 400% RBC on the life companies and $500 million of liquidity at the holding company. Let's start there.
Okay. $2.1. I calculate $2.1, take out the $500 million. Okay, got it.
Correct.
Okay.
Yeah.
All right.
Thank you. Our next question is from Chris Giovanni of Goldman Sachs. Your line is open.
Thanks so much. A couple questions on DAC. I just wanted to get an update in terms of where you're sitting in regards to the DAC corridor, and then also if you guys have done any early work in terms of quantifying what the potential impact is of adoption of EITF 09-G.
Yeah. On those 2 items, on the corridor, looking at the variable annuities, I'd estimate the after-tax impact in the $200 million-$250 million range right now.
Hello? Hello?
Thank you. Our next question is from Thomas Gallagher of Credit Suisse. Your line is open.
Hi. I'm not sure what happened there, just had a question about where you're pricing business today. I know there was a discussion about having repriced variable annuity business and universal life business. Are you still pricing products at a 350 RBC, or has that bar been raised to 400? If so, how do we think about you eventually getting to ROE targets if there's still a disconnect between how much you hold versus where you're pricing?
Sorry, Mr. Gallagher, can you repeat the question again?
Sure.
Tom, just real quick. We have to apologize. Weather conditions here caused our line to drop. We have missed the last, call it two minutes of dialogue. We apologize for that. We are back online.
Okay, no problem. I guess first question is just to reiterate Chris's question on 09-G, what you see as a potential impact there, whether you have done any early work. The second question is just an update on, I know you have repriced some universal life business and variable annuity business. Are you still pricing it at 350 RBC? If so, how do you reconcile that between holding high 400s RBC, eventually, what does that do to your ROE? Do you need to get down to a 350 RBC in order to hit your ROE targets?
Hey, Tom. First on the 09-G, this is obviously a very important accounting change. We do have a full team working on this very topic. I do not anticipate it will be until later in the year until we are talking more fully about numbers. I really do not expect our results to be directionally different from our peer companies. If you think about 09-G, just to go over sort of the main impacts again from this thing. We are going to have lower capitalization, which will reduce earnings. We will have a reduction in equity and thus reduction in the amortization expense, which will help earnings. Thus, we will have an uncertain or more muted impact on ROE.
One other impact I will talk about, which is sort of just a result of all those dynamics, is that I would expect that you would see an increase in the growth rate after all that is said and done. Those are the main impacts. We have got a full team working on this. It will be later in the year. We will give a little more guidance on the impact.
Randy, if you had to guess in terms of the timing of when we would find out, is that likely to be in your third quarter queue or when do you think we might hear something on that?
I think that's a reasonable timeframe.
Okay.
The second question was on pricing on life products. Let's think about products in total. Any product that we're pricing today, we're pricing with capital standards that are consistent with the 400% that we talk about. When you look at a life book, you would have some products being sold today that were priced at 350%. Anything that we're repricing today, like the secondary guarantee or survivorship product, would be priced using capital standards that are consistent with our stated goal of 400%.
Okay. Got it. Thanks.
Just to add to that, the guidance around ROE development certainly takes that comment into consideration.
Thank you, sir. Our next question is from Chris Giovanni of Goldman Sachs. Your line is open.
Thanks so much. Wanted to see about end user exemption on swaps. It looks like the industry might get exempted for that use, just wanted to see how you guys were thinking and positioning around this, to the extent that it doesn't go through, sort of what you perceive as the risks to your business.
Yeah. We're paying attention to this, as you would expect us to do. I don't think anybody knows what the final answer is. I would make the general comment that the comments coming out of Washington seem to, in most instances, keep excluding the life insurance industry from their heavier regulation. That's not a specific comment about your specific question, the trend seems to be one that would leave the insurance industry in a good condition from a regulatory standpoint.
Is that a comment related to this specific topic, or is that a broad comment related to a number of regulatory matters?
It's a broad comment related to a number of regulatory matters, but it includes this one.
Okay. Thank you very much.
Thank you. Our next question is from Colin Devine of Citi. Your line is open, sir.
I just want to commend you and your team on another very solid quarter in getting Lincoln back on track. I was wondering if I could get one clarification from you, then I have a deeper question for really Mark and Randy. First on the clarification. I certainly am encouraged by your comments not to chase the feature war, and Lincoln hasn't done that in the past. Met is taking their step-up guarantee up to 6% in May. Is it your intention that Lincoln will not follow that? That's the clarification.
With respect to sort of ROE, as Randy walked through, if we think of the annuity business and the DC business and the returns on those, which I sort of think of having come from the Lincoln side of the house, and compare that to the life businesses in groups, the returns are almost double on the annuities in DC. As I look at the life, and you said you repriced your products, how much can you do to improve the returns on the older business, which as you noted, is priced at a lower RBC than the 400. To get that up to the overall 400 you're trying to run the company at now, when you put that all together, how much lift can you really get on this ROE over the next few years?
Colin, I'll have, as you suggested, Randy talk about the second one. I'll handle the first one. Let me see. It's not our intention to increase our roll-up rate. That's not to say that what other companies are doing is good or bad. It's just that our value proposition is lower roll-up rates, strong distribution, we think that makes sense. Randy, do you want to-
Sure
follow up on the rest of that?
Talking about ROE at the highest level in total. ROE growth is going to be driven by a number of items, including entering makeshift to higher ROE businesses that you referenced, VA, DC, and group protection. New business ROEs that come on across the board, and that's really primarily a life item because the life ROEs that we put on the books today in that 12%-14% range are significantly above the reported ROE in the 10% range. Capital redeployment and management, which we've talked about pretty fully on the call today, and then margin management, primarily in the group space as we continue to see these loss ratios recover. All those items mixed together to give us total ROE growth. When you look at the life business in particular, as I talked about, we have a near-term ROE expectation in the 10%.
It's true that it's going to be evolutionary with that ROE is it increases gradually over time as we continue to put on this 12%-14% ROE business. It's not going to suddenly jump up to 12%. It's going to happen over a period of years, as we continue to put on new business, and that new business becomes more prominent in the overall mix of earnings.
Aren't you also, though, fighting the XXX comp? I know you've been able to do some alternative funding for that, but you're facing an inherent reserve build here that isn't it just going to require more capital? This means you've got a meaningful drag here on your capital for the near to immediate term, I would think. Is that a fair way to characterize this?
Well, Colin, I'd break that up into a couple pieces. First off, the product we sell today and the product we've been selling for about the last year on the secondary guarantee side is a product that earns those returns that I referenced without a capital solution. Right? We do not have a need to go into the capital markets with those. On the other side, I would mention that that build has been occurring over the years, it's not like there's a sudden change in the growth rate of that build. In fact, that build will decrease as, once again, these new products become a bigger part of the mix. In terms of where we are today from a solution standpoint, we've actually pretty dramatically shifted our reserve financing mix.
If you go back two, three years ago, the mix was primarily that we were using our short-term corporate credit facility for most of our reserve financing.
We had limited long-term solutions in place, about $400 million. If you look where we are today, that mix has completely shifted. We have about $2 billion of long-term facilities in place, and our usage of our corporate credit facility has declined by $1 billion, as I mentioned, into the $750 million range. A pretty dramatic change there. Now, in terms of what we have on our balance sheet, I'd size that in the $1 billion range, and we'll continue to work on working off that existing amount. I don't see that as a huge issue, quite honestly.
Colin, it's a good question. I would just come back to all of the issues embedded in your question are baked into our projection of aggregate ROE improvement.
Okay. Thanks, gentlemen.
Okay.
Thank you. Our next question is from Joanne Smith of Scotia Capital. Your line is open.
Hi. Good morning. I just wanted to go back to the indexed annuity question because I'm a little perplexed about why the sales are strong and why it's even a desired product at this point. All I remember is when the product was first developed and the participation rates were quite high and there was a lot of profits associated with it. It was very attractive to risk-averse clients. Then we had the crisis and the volatility in the markets, and the cost to hedge the product became so expensive that it was not even considered a viable product in certain circles. I'm wondering what has happened. I understand the impact of lower volatility, but I had thought that participation rates had come down well below 50%, and that, to me, doesn't look like it's a great value proposition to the customer.
Can you just talk about the characteristics of the product and what type of a customer it is appealing to?
Yep. Again, it's 100% downside protection against equity markets with a little bit of participation in the upside of equity markets. Specifically at this point, we have two products. One we call a trigger, and what the trigger product says is if the S&P 500 is above the level one year down the road from where it is today, you get a rate of 3.5%. If it's the same or down, you don't get that. The other product is a two-year total performance, and it can, depending on total performance, somewhere between 8%-12.5% over the two-year period, so 4%-6%. Those are not bad returns. I may have misspoke about that first one a little bit, but in general, those are reasonable returns in this environment with 100% downside protection for some part of some people's overall portfolio.
Okay. So then, what you're saying, the product has been completely restructured now, it's not a % of the return in the market anymore. It's now a fixed return based on a given % that the market has to perform in order to even get that %. Is that correct?
Well, on the first one, the trigger, that's correct. On the second one, it's a % of appreciation in the marketplace, with caps at those 2 levels.
Okay. You said 8%-12.5%. That would be 8%-12.5% of the total return? % of a %.
No, I'm saying the upside potential is from 8%-12.5% over two years. The annual rate is 4%-6%, depending on the particular features of a product.
Got it. This is really a product that's appealing to clients that would normally buy a fixed annuity, but because interest rates are so low, those are unattractive, but they're not willing to buy a variable annuity.
I think that's-
Probably fair for the majority of the purchasers of this.
Okay, thank you very much.
Thank you. Our next question is from Darin Arita of Deutsche Bank. Your line is open.
Thank you. I just had a question here for Randy. I think you mentioned that you didn't think spreads would be a tailwind, and I was wondering why there wouldn't be upside to spreads.
Well, I think if you think about where rates are today, they're not too different from where they were last quarter when we talked about this. Even though they had rallied, we still talked last quarter about if rates stayed in or around this level, that we would have some negative impact as we moved into 2012. I think we sized that about $20 million. That comes through spread. Where we're investing money today, which is in the low fives, is still modestly below our portfolio, and that implies some level of spread compression. Against that, if you go through the businesses, on the life side, we have some room, but not a lot of room to adjust creditor rates. On the annuity and DC side, there's a little more than on the life side.
I just think as you move forward with rates at this level, there's the potential that you would see some spread compression. As I mentioned, I think it's at very manageable levels inside of the overall growth that we're experiencing as a company.
Understood there. Just a numbers question here, looking at the life insurance segment. The DAC amortization seemed lower than normal. Was there something that happened here this quarter?
We had some adjustments on some different line items that really impacted three primary items in the life space, the expense assessments, the benefit line, and the underwriting acquisition expense line. If you summed them all up, they came up to about exactly zero. Going through the three, the expense assessment line was artificially lowered by around $30 million pre-tax. The benefit line was raised by about $45 million pre-tax. The acquisition expense line would have been lowered by about $75 million. You add those impacts up, you get to zero, but those three lines did have some impacts as we adjusted some books and moved some books onto a new accounting platform.
Great. Thank you.
Yep.
Thank you. Our next question is from Eric Berg of RBC Capital Markets. Your line is open.
Thanks very much. Still morning. Good morning to everyone, but about to be noon. Just one question. In your prepared remarks, you cited repeatedly and highlighted divisional return on equity, a disclosure that is not unique, but I would say is more the exception rather than what most companies do. My question is this, since investors cannot invest in any of the divisions of Lincoln, they either buy the whole company or they don't buy it at all, and since the allocation of capital to divisions is by its very nature subjective, I may look at your allocation of capital to a division and decide that it's either conservative or not conservative. Why is this a helpful disclosure? For that matter, why does it matter? Why shouldn't I be looking only at the company-wide return on equity?
Yeah, Eric, I guess I don't completely agree with your point. First of all, the return that you're getting on the products that you're selling is a very important issue, we talk about that. The returns that you're getting in the line is very important and added up start with what your overall bottom line ROE is going to be. That's why we talk about it. At the same time, your point is well taken with respect to total ROE, and that is what shows up on our books, and that's what we talk about all the time in terms of improvement over the next three years. I think the inside the line of business conversation about ROEs is very important. As you point out, the bottom line is also very important.
Would you agree.
The aggregate company is important.
Would you agree, though, I mean, certainly I agree with you, and I didn't want to give the impression that returns on a given product basis don't matter. Of course, they do. Would you agree with me that it presupposes if you're going to look at that number and assign weight to it and importance to it, that it presupposes a proper allocation of capital to the divisions?
Yes. I think we do that pretty vigorously, and I don't think that I mean, there is judgment involved in it, but it's based on a great deal of analysis and experience in the business. I think from company to company, you might have some differences in who allocates how much to what line. Certainly within Lincoln and comparatively from line to line, there's quite a bit of rigor used to establish what we think the appropriate level of capital is that we are calculating the ROEs off of.
Thank you.
Okay.
Thank you. Our last question is from Colin Devine of Citi. Your line is open.
Okay, just a quick follow-up. Guys, could you compare what your commission rates are on the equity index product versus the variable. Also, what percentage of your equity index sales would be made by registered reps?
Well, the latter one. Let me hold on that for a second and see if we can pull that information. What was the first question again, Colin?
Just understanding if there's a difference in your commission levels on an equity index product versus a variable.
Yeah. We can get back to you on that specifically, they're low on the equity indexed annuity. On the VA product, they're middle single digits. I think on the equity index annuity, it's sort of in the same ballpark, Colin. Let us get back to you.
Okay
to you with specifics on that, please.
Okay. Thank you.
Will, do we have a number on registered rep selling versus non-registered?
We don't have an exact number for the call today, Dennis, but the primary distribution channel for fixed index is our bank channel, which is a channel with registered reps. The channel where we see expansion in is the registered rep channel as we enter the wirehouses and the regional broker-dealers with our B2B feeds.
Yeah.
Okay.
Just tie that comment into your commission comment. One of the reasons that we're in institutions with this product is because our commission structures are quite modest relative to some of the other manufacturers of these products. Okay?
That's what I was looking for you to clarify. Thank you.
Yep.
Yep.
Thank you. This ends the Q&A portion of today's call. I'd like to turn the call over to Jim Sjoreen for any closing remarks.
Thank you. Again, we would like to thank all of you for joining us this morning. As always, if you have any follow-up questions, you can contact me at our investor relations line at 1-800-237-2920 or via email at www.investorrelations@lfg.com. Again, thank you for joining us. We apologize for dropping off earlier, we can't control the weather. Again, have a great day, and talk to you later.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program.