Thank you for joining Lincoln Financial Group's fourth quarter 2010 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 need assistance at any time during the call, please press the star key followed by the zero, and someone will assist you. At this time, I'd like to turn the conference over to the Vice President of Investor Relations, Jim Sjoreen. Sir, please go ahead.
Thank you, Karen, good afternoon, 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. The 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 include 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 for the first time as Lincoln Financial's Chief Financial Officer, Randy Freitag. After their prepared remarks, we will move to the question-and-answer portion of the call. With that, I'd like to now turn the call over to Dennis.
Thanks, Jim, good afternoon. Results from the fourth quarter demonstrated momentum in our operating platform and capped a year in which we took steps to set the stage for growth and improved earnings. 2010 reported earnings per share include a few notable items and higher share count due to equity raises. Taking a closer look at our results, you will see a picture that reflects Lincoln's growth markets and franchise strength. Indicative of this is the 9% increase in operating revenues and 10% increase in operating income for the year. Revenue growth was helped by an increase in account balances of 11% for the year to $157 billion, driven by $6 billion of net flows and higher equity markets. Net flows made up more than one-third of account balance growth.
Overall results continue to be driven by a combination of sales through multiple channels and a complete product portfolio in each of our businesses. This combination drove life sales up by 6% for the quarter and 4% for the year. The mix of life sales shifted, with secondary guarantee UL dropping from 61% to 49% of total sales as other products such as Term and MoneyGuard saw strong growth. On the channel front, we saw double-digit sales growth in the wire and bank channel, where we expect continued lift. Overall, our life market position is very strong. Lincoln today is ranked number one for individual life sales in the top two wirehouse firms and ranked number one or number two in all the top 15 MGA relationships. Individual annuities had a solid quarter.
Variable annuity sales were up 7% for the quarter and 15% for the year, while low interest rates slowed fixed annuity sales. We see evidence of consumers and their advisors focusing more closely on flexible solutions for maximizing income in retirement, which we believe led to a 59% increase in i4LIFE elections to more than $2 billion. We will continue to expand annuity offerings this year with the launch of our long-term care VA product following the launch of the long-term care fixed annuity product late last year. Defined contribution had strong deposits, up 17% in the quarter and 7% for the year. Net flows were roughly flat with last quarter due to the lumpy nature of the institutional business. We expect to return to positive net flows next quarter.
Our strategic investment in DC is beginning to show results in our small case 401 business, as first-year deposits grew by 40% over the prior year quarter and 34% over full year 2009. In addition, we're also seeing good results from our focused effort to support better retention rates for these plans by leveraging our LFD relationships with positive net flows in this segment for the first time in several quarters. Group protection results reflected better loss ratios from the third quarter, but loss ratios are above prior year levels. We made pricing adjustments on new and renewal business starting late last year and also added resources to our claims area to expedite claims handling. We are confident that these moves will help to improve loss ratios over time. Our expectation is that loss ratios will remain above our targets well into 2011.
The group business is important to our long-term trends. As we work to address current issues, we are also adding product and distribution in the voluntary part of the business, where we see the most favorable growth prospects and investing across our operating and distribution platforms. At LFD, the heart of our strategy is improving productivity, deepening and adding to our strategic partnerships, and expanding the number of advisors recommending Lincoln solutions. In 2010, we saw a 7% increase in wholesaler productivity, along with increases in advisors, leading to a substantial base of more than 57,000 active producers and agents selling a Lincoln product, our highest level as a company. Over the past two years, our strategic efforts to expand shelf space, launch new products, and increase cross-selling have contributed 16% of total sales.
We believe disciplined execution of this strategy over time will continue to generate meaningful top and bottom line growth for Lincoln. Lincoln Financial Network continues to attract and retain seasoned advisors. Total advisors grew by more than 300 in 2010 to just over 8,000. Our experience shows that consumers remain risk-averse and are increasingly looking for professional advice and security. This will benefit large independent broker-dealers like LFN. Turning to the balance sheet, our substantial financial flexibility and the capital-generating capacity of our core businesses support investment in growing our franchise and active capital management. We ended the year with strong capital and liquidity levels and took action to return capital to shareholders, including buying back $70 million of equity and announcing a dividend increase to $0.05 per share per quarter.
Asset quality improved significantly throughout 2010, as measured by realized losses, our unrealized gain position, and overall portfolio quality. Returns have been strong in our alternative investment portfolio, and proactive moves to lock in higher yields have paid off, helping us to maintain interest spreads across our business. As we sit here today, we are pleased to see investment yields gradually recovering, and although there are some potential economic potholes, we see no areas of significant credit concern. ROE expansion continues to be a focus for this management team, and given our earnings trends and capital flexibility, we expect to add 25 to 30 basis points of ROE annually through 2013. In a moment, I will turn the call over to Randy Freitag for his first quarterly call as CFO. First, I'd like to thank Fred for his six years as CFO.
Fred remains a valued advisor to me and the company as he shifts his focus to seeking strategic opportunities and critical investment risk management. Turning to Randy, I worked with him closely for many years, and Lincoln has benefited from his perspective on the industry, our company, and his deep financial experience. I'm delighted to welcome Randy to his new role. Randy, go ahead.
Thank you, Dennis. Last night, we reported income from operations of $266 million or $0.82 per share for the fourth quarter. Overall, the quarter's results and the underlying fundamentals were solid, with rising equity markets and interest rates, along with strong investment income results providing a lift to earnings during the quarter, and a nice tailwind as we move into 2011. Offsetting these positives during the quarter was a $41 million or $0.13 per share after-tax charge related to the settlement of an outstanding legal matter with Transamerica. Precise terms of the settlement are bound by confidentiality, importantly, the charge taken in the quarter puts this issue completely behind us. Various line items in the income statement and balance sheet were impacted during the quarter as we continued the process of consolidating our valuation systems to a single platform.
Viewed in total, the impact of this work on the quarter was small but did create some noise in certain line items. Notable positive and negative earnings impacts are detailed in the press release, and I will not repeat them as I go through business unit results. When viewed in the aggregate, the notable items in the quarter negatively impacted results by $32 million or $0.10 per share. Adjusting for all notable items, our run rate earnings came in around $0.92 per share. For the full year, return on equity, including goodwill, came in at 9%. ROE for the full year was impacted by a few larger items, namely our interest rate assumption change in the third quarter and litigation expenses. 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.
In all, our segment results paint a positive story around year-over-year ROE growth and support our guidance for continued growth. Turning to segment results and starting with annuities. Positive flows in markets produced a strong quarter, driving a 14% increase in total account balances and a 15% increase in revenues over the prior year quarter. At $85 billion, ending account balances stand at record levels, have driven the net amount at risk in variable annuity guaranteed living and death benefits to their lowest levels since the second quarter of 2008. Strong investment income results added approximately 27 basis points to annuity interest spreads. Adjusting for notable items, normalized spreads continue to be steady in the 190 to 200 basis point range.
The annuity business reported an excellent full year return on equity of 19%, up from 15% in the prior year, and reflecting the importance of selling through the economic cycle, an advantage given to companies with strong distribution and a disciplined approach to product design and risk management. In our defined contribution business, strong sales results and markets drove account value growth of 10% and revenue growth of 6% over the prior year quarter. Robust investment income results added approximately 22 basis points to DC interest spreads. Adjusting for notable items, and when taking account for continued credited rate actions, normalized spreads continue to be steady in the 220 to 230 basis point range. The DC business posted a healthy full year return on equity of 15%, up from 13% in 2009 and in line with our long-term expectations for this business. Turning to our life segment.
Our earnings drivers performed as expected during the quarter, with life insurance in force up 4% and average account balances up 5% quarter-over-quarter. Both of these items in line with our longer-term expectations for this business. Solid investment income results added approximately 20 basis points to our life interest spreads. Adjusting for notable items, normalized spreads continue to be steady in the 185 to 190 basis point range. Moving into 2011, I note that the fourth quarter, as is often the case, experienced some seasonality, which benefited results by $4 million, compared to what we would expect to see in the first quarter of 2011. Life's full year return on equity of 8% was below near term expectations in the 10% range as the third quarter unlocking process hurt full year results. Turning to the group protection segment.
Non-medical earned premium grew 8%, a solid result considering the challenging environment. The non-medical loss ratio of 76% was down 3% from the third quarter, in line with expectations, but above our long-term target as disability incidence rates across our book of business continue to run at elevated levels. Group Protection's full year return on equity of 8% was down from expectations as loss ratios hurt full year results. When taking into account Dennis' comments on loss ratios, we would expect that earnings and returns would grow modestly from fourth quarter levels as improving loss ratios are mostly offset by strategic investments into the business. Let me wrap up with some comments on risk management and capital and liquidity. 2010 was the year when the strength of key risk management programs and capital generation was demonstrated.
A few key items of note include pre-DAC and tax net losses on investments of $83 million for the quarter were down from $159 million in the prior year quarter. Current quarter losses were focused in lower rated RMBS and CMBS securities. While we remain concerned with certain key economic indicators such as housing and employment, we expect that improvement to continue into 2011. The variable annuity hedge program performed very well during the quarter and ended the year with assets of $1 billion, well in excess of the hedge liability of $450 million, demonstrating that both our hedge program and the subsidiary where we house that program remain in a strong capital position, well situated to handle market volatility.
During the quarter, we locked in treasury rates on $1 billion of secondary guarantee UL related assets at rates in excess of those required by the product. These locks, which mature over the 2012 to 2016 period, in conjunction with previously discussed ALM related actions and last quarter's lowering of our long-term new money assumption, has served to further strengthen the risk profile around life earnings. A brief update on spread compression risk across our businesses. With rates at year-end levels and taking into account credited rate actions taken subsequent to our previous disclosure, we see little earnings impact due to spread compression in 2011, with approximately a $20 million impact in 2012, primarily in the life business. Those impacts down in both years from our third quarter estimate of $30 million and $60 million for 2011 and 2012 respectively. Importantly, this estimate assumes no recovery in rates from year-end levels.
While not finalized, year-end RBC of 490% was up from 450% at the beginning of the year, supported by improving credit quality and strong capital generation. With year-end total adjusted capital of $7.1 billion, up $400 million for the full year, after taking dividends to the holding company of $675 million for the year, including $400 million in the fourth quarter. Year-end net liquidity at the holding company was approximately $700 million, well in excess of our targeted level. During the fourth quarter, we put a portion of our capital margin to work as we repurchased $25 million of common stock, redeemed $150 million of trust preferred securities, and increased our dividend to an annualized rate of $0.20 per share. Bringing life company capital and holding company liquidity together, we estimate our capital margin to be approximately $1.5 billion, up from $1.4 billion at the beginning of the year.
A year in which we decreased our net debt by $1.1 billion, repurchased $73 million of stock and warrants and continued to invest in and grow our businesses. All in all, a good story around risk, capital, and liquidity for both the quarter and the year, and a strong position as we head into 2011. With that, let me turn the call over to Dennis for some final comments before we go to Q&A.
Thanks, Randy. As I think about 2011, we are entering a year with very healthy account balances, historically high capital and liquidity, and a franchise that has proven its ability to generate significant revenues and net flows through challenging economic and capital market conditions. The quality of our execution, along with improved capital markets and a stronger domestic economy, gives me confidence in Lincoln's outlook and our ability to deliver value to our shareholders. With that, let me turn the call over to the operator for Q&A.
Thank you, sir. Ladies and gentlemen, if you have a question at this time, please press star followed by the number 1 key on your touch-tone telephone. If your question has been answered or if you decide to remove yourself from the queue, you may press the pound key. Our first question comes from the line of Andrew Kligerman of UBS Securities.
Hey, great. Thanks a lot. Just a clarification item first. Randy, you said what would be the impact from spread compression in 2011 and 2012 respectively?
Yes, Andrew. Given the increase in interest rates, if you go back to our third quarter disclosure, we noted that we were investing at about 100-125 basis points below our portfolio yield.
What we saw is interest rates increased about 75 basis points at the points where we invest over the quarter. The impact of that increase, along with some subsequent credit rate actions that we've taken, have reduced the impact for 2011 to zero, for 2012 to approximately $20 million.
Down from $30.
Down from $30 million in 2011 and $60 million in 2012.
That's terrific. Thanks a lot. A number of people were questioning whether Lincoln might take a goodwill charge in the quarter, just given the interest rate environment in general despite the 70 pip increase. What went into your analysis? What was the thought process and why was there no goodwill charge?
Sure. As I started the process, I noted that there were two primary drivers of goodwill impairment, both of those items that we noted in our 10-K disclosure. Those items being the level of discount rates applied to insurance businesses and the level of new business that your production engine was producing. As we entered this process, and it was a very rigorous internal and external review of goodwill with external inputs provided along with a thorough external review by E&Y. With the basis of those two items performing very well, I had a sense that goodwill would probably be supported. Nonetheless, we went ahead and did the rigorous process, and at the end of the day, the results supported the value of the assets.
That is, the discount rates were truly stable over 2010 and new business, and if you saw, I'll talk specifically about Life now, new business grew 4% over the course of the year. The new business engine continued to produce new business. When we ran the analysis, the fair value of the assets continued to exceed the net asset value on our balance sheet. Now, I'll note that that cushion did come down somewhat due to the fact that we ran the analysis as of 10/1, right when interest rates were at their low point, which had a negative impact on the value of the business. The cushion did come down, so we moved to step 2, and that's when those key items of discount rates and the amount of new business we're producing really came into play.
At the end of the day, the analysis supported the asset, we made the decision to not write down the goodwill. I'll note in the past, when we've done these analyses, we have a record of doing the analysis, and if the analysis says take an impairment, we take an impairment. We've done that on the annuity business. We've done that on the media business. When the analysis says don't take the impairment, we don't take the impairment, and that was the case this year.
Very helpful. Just lastly, a little color on the variable annuity business. Roughly looking at the surrender rate, it was about 8% in the year ago quarter, and it's kind of drifted up to 10% now, which seems like a more normal number. What's transpiring there? Are we getting just to more, as the equity markets rally, surrender ratios are getting more normalized? Could we see an even further pickup in that?
Andrew, Dennis, I think you hit the nail on the head. The account values are up at the same level. You'd see a little higher surrender ratio, and we've seen it hit the surrender activity just rise a little bit, as you pointed out. We don't see anything unusual in that. We're comfortable with the level that it's at, and just feel very good about the VA business.
Thanks a lot.
Thank you. Our next question comes from the line of Jimmy Bhullar of JPMorgan.
Hi, thank you. I had a couple of questions. The first one was on your DC business. The flows were negative this quarter. I think you've had 2 straight quarters of negative flows, and I think you'd mentioned that you were seeing some lapses of large cases. Just wanted to get into what was driving that, and if it was driven by price, what the differential is between what you had been charging and what the new companies coming in are offering. Secondly, on M&A, you have indicated an interest in the past, on the benefits and pension markets, but just maybe we could talk about, where you'd like to expand via M&A and whether there are properties out there that fit your criteria.
Thank you. With respect to the net flows in the DC business, really for the year and for the quarter, it amounted to 1 large case that we lost in the Q4, it being the negative flows for those 2 periods. Not really overly disappointed in the loss of that case because it was lost because it didn't meet our pricing expectation. It was a big dollar amount, $321 million. It was in the medical industry and our 403 business. I don't see anything systemic about it. The institutional business is lumping. As I said, we'd expect return to positive net flows next quarter. I would also come back to your question on M&A.
As we've said, we build our business plan and our comments that you hear today about the strength of the platform and operating revenue growth and expectations going forward are built entirely on organic growth. At the same time, if we can find opportunities and in the priority of opportunities, group protection and DC would be the highest. If we can find an opportunity that makes sense, and accelerate our core business growth plan, we'd be happy to do that. In terms of deal flow these days, over the last 24 months, because of disruption in the marketplace and people being worried about what's on the other person's balance sheet, there hasn't been that much activity.
I continue to think that over time, companies will decide to get out of businesses where they don't have scale, and those who are trying to beef up scale will have opportunities to look at those things. You can never count on M&A as a source or a driver of your shareholder growth. We're pretty much focused on our organic growth plan.
The business that you lost, was it purely price, or was it a shortcoming or something else in your platform where you need to invest more in technology or something else in your 401 business or in your 403 business?
Yeah. In this instance, it was strictly price. As we've talked about, Chuck mentioned at the IRD, we are making substantial investments in the DC business, including the back office administrative system. We'd expect that over time, actually, obviously to help us out. Sometimes there's questions in buyers' mind when you're going through a transition like that might give them pause. Generally, the investments that we're making, the progress that we're making, we expect to be sustained.
Thank you.
Thank you. Our next question comes from the line of Thomas Gallagher of Credit Suisse.
Hi. Question for Randy. I just want to understand how I should be thinking about how you're going to build capital and what your future plans would be for your capital structure. I think at your Investor Day, there was commentary about potentially de-leveraging. Question number 1 I have is, should we think about that being a plan to just not replacing debt as things mature? That's looking out maybe over a multi-year period, or would you look to take out some of your more expensive debt? Because it looks like you have some 7% capital securities out there, which to me looks like might be a reasonable option here to take out some of that debt. That's question number 1. Question number 2, can you just comment on how I should think about statutory earnings power?
Looks to me like you're earning at least this year about $600 million. About half of it would go to pay interest and dividends. Would the rest of it, assuming a little bit needs to be retained to grow the business, would the rest of it be free cash flow, or do you need to fund the VA captive? Anyway, why don't I stop there and let you answer?
Sure. Starting with the capital question. At the highest level, we ended the quarter with a capital margin of $1.5 billion. Just as a reminder, using 400% RBC and $500 million of holding company liquidity as the basis for the estimate of that capital margin. As we move forward in the near term, I think that level of capital margin sounds sufficient as we work through the economy, as we mentioned, housing, employment. As those items provide some instability in the marketplace, we'll continue to run with some level of excess capital. The addition of the rating agencies, working with them on required capital. I see us running a little high for a period of time here in the near term. You will see us start to work that excess capital position down over time.
In fact, in the fourth quarter, you saw us put about $400 million of capital margin to work. In terms of the debt or the de-levering process, over the course of 2010, as I noted, we de-levered to the tune of about $1.1 billion. As to future plans for de-levering, when and how it may occur, we'll take the best and most efficient approach to the extent we do further de-levering. I think there'll be decisions as those points in time approach. Our next maturity for debt isn't until the end of 2011. As we approach that point, we'll make a decision on how exactly or what exactly we want our plan to be at that point, given all of the options that we have available to us, including potentially refinancing. We've done a fair amount of de-levering. It remains a potential option for the future.
We're going to look at the highest and best use of capital as we approach all of those decision points. In terms of statutory earnings power, a focus on stat capital generation. As I noted, stat capital grew by $400 million over the course of the year. In a year when we took dividends of nearly $700 million to the holding company, about $1.1 billion of overall capital generation. That would include the statutory earnings, which continue to run about 60%-70% of our GAAP earnings, consistent with a company that is selling a significant amount of new business. You do have some level of statutory strain. In addition, we have the lever of ongoing reserve financings, which generate additional capital over the course of a year.
With that sort of capital generation capability and a need at the holding company for approximately $300 million to cover debt interest expense, I think you have a significant level of capital generation to put to use to, once again, whatever the highest and best use may be as we generate that capital.
That's very helpful, Randy. Thanks. The reserve financings that I could think about adding to stat earnings on sort of an annual basis, at least a potential opportunity, is that a couple of hundred million a year?
Yeah, I think that's a decent estimate of the growth in excess reserves over the course of the year.
The last question I have is the VA captive. Is that requiring any funding? What's happening there? Is it actually generating capital? Is it level, or is it requiring you to inject capital?
As I noted, at the end of the year, we ended the year with $1 billion of assets inside the hedge program and a hedge target of about $450 million. The actual statutory reserve actually was lower than the hedge target. It was right around $400 million. $550 million-$600 million of capital behind that business, which we would define as sufficiently and well capitalized. We did end up putting $100 million before the end of the year because you really do know until you do the calculation on statutory reserves exactly what that number is going to be at the end of the year. We did put an additional $100 million down there before the end of the year. The entity remains very well capitalized at this point in time.
Okay, thanks.
Thank you. Our next question comes from the line of Steven Schwartz of Raymond James.
Hey, good afternoon, everybody. A couple of questions. First, on the ROE guidance, which hasn't really changed, yet you've got a new estimate for the effect of the interest rate environment. Basically, Randy, is what you're saying here is that, yeah, this is going to help. That's a big difference. Yeah, this is going to help, but we're going to spend it elsewhere?
Let me take that, Steven.
Okay.
As I said, we are focused on the ROE and expansion. You're right. We've been saying 25 to 35 basis points, 25 to 30 basis points in that range annually. Most of that is driven by some key factors. One, the earnings mix shift to higher ROE businesses as we look forward. New business ROEs being very high across the board. Capital deployment and management opportunities. Then business by business margin management.
On that last one, yes, we got a little better margin expectations over the next couple of years. I think when you step back, the message is improving ROEs incrementally each year, high focus, and trying to get down to a dollar. I don't mean a dollar exactly, but to focus on one margin, interest margins That could hurt elsewhere. Something else could happen elsewhere. We're going to stick by the 25 to 30 basis points driven by these things that I just mentioned.
Okay, fair enough. Dennis, maybe you can comment on what's going on currently in the VA market and how that looks. You've made some changes to your VA product. MetLife has made some changes to its crew, recently adopted some changes to the HDVA platform. I think Jackson National hasn't made anything, but I'm not 100% sure of that. Do you have a sense of how all this is working out?
Yeah. Your observations are correct. From our perspective, we mentioned last year that we'd increase pricing on our core VA products. We decreased the features a little bit, and a lot of the effect of that is going to take place in the first quarter. So far, we haven't seen any significant changes. What I would say is we're selling the VA business on our terms. In other words, we're very happy with the product, its features, its profitability. We're very happy with that. As we've discussed on numerous occasions, we've got very strong distribution that's telling our story about the value of our products. That's strong. We have a consistent and significant position in the marketplace, and I expect that to grow over time. Where we end up, plus or minus a couple of basis points in market share, is of not serious interest to me.
We're not a market share grabbing company. It would only become important if I saw us grabbing a lot of market share or if we saw ourselves losing a lot of market share, we just try to understand that. Selling the product on our terms, good distribution, significant and continuing presence in the marketplace. As Randy touched on, we're getting pretty good ROEs on the business right now.
Yep, great. Okay, thank you.
Thank you. Our next question comes from the line of Randy Binner of FBR Capital Markets.
Hi, thank you. I'd like to go back to the goodwill review. I was wondering if it's possible, if you could quantify how much that buffer between the estimated fair value, and the asset changed in the analysis.
Sure. We're still doing the analysis, but if you go back to last year's disclosure, the buffer was, if I remember correctly, $600 million to $800 million. A significant portion of that cushion went away.
Okay. It was close. Because the cushion, we're talking about the $2.2 billion in goodwill at the life insurance business, right?
Yes.
It was kind of a close test, it sounds like, but still a pass. I guess my follow-up question would be, since you ran it at October 1st when the 10-year Treasury was right around 250, how much of the closeness of that analysis do you think was driven by that? Is there a way to think about, you ran the analysis when rates were there. We know our rates are about 100 basis points higher than that now. Is there any way you can kind of give us a sense of how much of that close call maybe recedes away?
Let me take that question for a minute. We continue to be, and appropriately so, asked about ROE. Excuse me, about goodwill. Let me just repeat two points that Randy made. When you're looking strictly at goodwill, the two key issues are the assumptions about the capacity to generate new business, and as Randy has said, the amount of new business that we're generating is well inside of the expectations in the model. The second issue is discount rates, which we don't control, but we get outside advice on, and as Randy said, those things, interest rates stay level. I am comfortable that the goodwill asset, based on the analysis that we're doing at year-end, is a very supportable asset. On a go-forward basis, I think overall, all of the assets that we have on a balance sheet are supportable, absent some significant change.
I guess the point I would make is, we're comfortable with the goodwill assets. There's a lot of tests that on any particular month might show a little increase here, a little decrease here. I think this goodwill asset's a good one based on the work that we've done and my understanding of the strength of our franchise. I just wanted to say that. Randy, I don't know if there's anything more that you want to add. No. I would note that the level of cushion we had in last year's analysis was probably run in a similar interest rate scenario to what existed at the end of the year. That provides some guidance.
That is very helpful, I appreciate that commentary on the value of the asset. I guess that with the stock trading below book value, I know we covered this at Investor Day, and you've already discussed it here, but is not having a goodwill impairment there a milestone at all for you, Dennis, in thinking about share repurchase versus the other ways of managing capital? I guess I'll leave it at that. Thank you.
Thank you.
No.
Thank you. Our next question.
I was still asking that question.
Oh, sorry.
Sorry. Is the defense of that goodwill, now that we know that if the book value is indeed good and the stock is indeed that far below book? Is that a milestone in thinking of share repurchase versus other forms of capital return?
I think they are two separate issues. I'll come back and say that we're comfortable with goodwill. Obviously, at some level of discount to book, that question gets raised, but it's not something that is bothersome right now. Let me talk about capital management specifically. As we've said, we raised the dividend in November, and we're going to stay with that probably most of the year. It's unlikely that we would off cycle do a dividend increase. Share repurchases, we announced maybe $125 million of capacity. We've used $25 million of that. I'm comfortable that we'll spend the other $100 million. My mind is open to the idea of maybe increasing that if circumstances suggest that it would be the right thing to do for shareholders and the right thing to do for the long-term strength of the company.
Thank you.
Thank you. Our next question comes from the line of Chris Giovanni of Goldman Sachs.
Thanks so much. Related to the annuity business, can you just provide an update in terms of the ROEs you think you generated on new business in the fourth quarter? Talk some about where you currently sit in terms of your DAC corridor, and if you were to unlock your assumptions, what that could mean from an earnings perspective.
Sure. In terms of new business in the annuity business, it's within the range that we disclosed at the IRD, which is in the mid-teens sort of ROE for the business. Good, strong returns on the new business sold. In terms of the DAC corridor, with the markets up again, we've started to approach the interior corridor that we look at that sort of guides management or gives management input as to whether or not it's time to look at the DAC corridor. Where we sit today, we have a potential unlocking of approximately $300 million-$350 million in the annuity business were we to unlock the corridor as we sit here today. I don't see that as an imminent need to do that, we're still safely inside our corridors with a significant cushion.
In fact, I think the implied return inside the DAC model right now is a negative 20% return in the first year.
Okay. Then related to the DC business, can you just comment in terms of the earnings pickup that you'll get in 2011 from the VOBA that drops off from the old Unum acquisition?
Yeah. The impact of that VOBA book running away was about $3 million-$4 million a quarter.
Okay. Thank you.
Thank you. Our next question comes from the line of Joanne Smith from Scotia Capital.
Oh, I'm sorry. Good afternoon. I have a couple questions, one of which is just a follow-up.
Joanne, we can't hear you.
From the goodwill. I was wondering if you could just
Operator, we can't hear Joanne.
Pardon me, Ms. Smith. Are you currently using a speakerphone?
When you calculated the buffer last year.
She does not seem able to hear us. Should I mute her and move on to the next?
Say that we're back at about that level now.
Just try one more time. Joanne, can you hear us? We're going to have to move on. I'm sorry.
Hello. Oh, I'm sorry.
Hey, Joanne. That's all right. We could not hear any of your question, we can hear you loud and clear right now.
Okay. Yeah. I was technologically inept. Anyway, the question is for Randy about the goodwill buffer. I just missed the last part of your question or the answer to the previous question about when that was calculated at year-end 2009. I wanted to know if you said at the very end that interest rates today are about where they were when you calculated that buffer.
I think they're in the range of where they were when we calculated at the end of the year. There's a lot of things that occur over the course of the year. We sell new business, new profitable business. Some in-force profits roll off. As a guidepost, I think it's something to look at. Going back just to the general comment, the goodwill asset was supported by all the analysis, and we'll go forward from here.
Okay. I just have two more quick questions. One is on the alternative investment portfolio. The returns on that have been far exceeding your built-in expectations. Can we expect that kind of $18 million per quarter number that you've been disclosing is going to go up this year just because of we've had strong markets and interest rates are up, et cetera?
I think broadly speaking, when you think about a stabilizing economy growing at the level it's growing, M&A starting to pick up across the environment, I think it's reasonable to expect, and we expect that the returns will be right in line with our long-term expectations for this business, which is 10%, which equates to $18 million-$19 million a quarter on this $750 million book of assets.
Okay. All right. You're remaining consistent with what you've been saying all along.
Yes.
Last question, just going back to the negative flows on the VAs. It looks to me like the number is a lot higher than it had been, and you explained that part of it was obviously a more normal level of withdrawals. Is there anything going on the death benefit side?
Yeah, Joanne, let me expand a little bit on my earlier comment. I guess the first thing I would say, I don't know how many quarters, but it must be 12, 14, even higher than that, 18 quarters where we've had positive individual annuity net flows. We're consistently in the positive net flow range. The weakening this quarter actually had to do with the fixed annuity business, in part related to lower sales, as I mentioned, which are related to the interest rates. There's a specific issue, which is that we had a block of fixed multi-year guarantee business that reached the end of its guarantee, and that popped up the surrenders on the fixed annuity business. Back to the variable annuities, lapses are up, as I said, from historically low levels. The higher withdrawals due to some higher account values.
Again, as account values grow, we experience higher withdrawals even if the lapse rates stay level. We expect net flows continuing around $500 million for the first quarter and rebounding slowly.
There's nothing on the benefit side that we should be concerned about?
No.
utilization has not increased?
No.
Okay, great. Thank you.
Thank you. Our next question comes from the line of John Nadel of Sterne Agee.
Hi, good afternoon, everybody. I have two questions on two of the separate businesses. On defined contribution or 401(k), Dennis, I was hoping we could follow up on maybe on Jimmy's line of questioning earlier in the call. I say this with all due respect. I hear you telling us that you're okay with the loss of this larger case because you didn't find the pricing to your return hurdles to keep it.
I suspect the vast majority of your sales are being won from other incumbent players where, if I ask them why they lost the case, they'd say, "We didn't like the pricing either." I guess my question for you is this: how are we on the outside, especially in a very competitive business like 401 has become at all market segments, whether large, mid, or small, how are we supposed to feel confident that this pricing is right here?
Well, I guess I would answer the question on the pricing being right in the broad context of we understand the business, we understand the current issues, just like all of our products, we believe and have been pretty comfortably inside of our pricing assumptions so that we expect to get the returns that we talk about. I know that it's absolutely true that we've had this negative outflow, again, it's one case. I guess I wouldn't want you to lose sight of the fact that we're a major player in this business. We have $39 billion in assets under management. We're a leading 403 player. I just talked about the growth that we're getting in the small case market. We're making great penetration there, leveraged by this multi-channel and LFD capability. This year, we're showing double-digit earnings growth on a 15% ROE.
Pre-tax margins were on 20%. We've got a very significant business. We're continuing to invest in the business. I think over the long term, it will prove to be a very good business for Lincoln.
Okay. Thank you. Just a question on the group insurance business. The all-important January renewal season, I know you guys are out there like many of your competitors trying to get a little bit of price here, especially on the disability side. Can you give us a sense for how that January renewal season has gone and what the pricing actions have done and what it means for persistency of your business?
I would in general say that the market continues to be very competitive. On our renewals, we're seeing some improvement in rates. We're not seeing significant improvement in close ratios back to the point that it continues to be a pretty tight market. We're a player in the market, particularly in the under 500 employee segment. Year in and year out, we get our fair share of business. As I mentioned, we're growing the voluntary business. We're investing to grow the voluntary business. Over the long term, this is a good business.
Just to follow up on that competitive comment, Dennis, is there a way to sort of at least put that in some perspective for us? In today's environment, a much tougher environment, can you compare competitive today to competitive, let's say, a year or two ago?
Yeah. I think we said in the third quarter, I believe this to be the case, that one good measure of how competitive we are is our close ratio.
I think the close ratios continue to be at about the same level as we've experienced them over time.
Okay. Thank you very much.
Thank you, sir. Our final question comes from the line of Mark Finkelstein of Macquarie.
Good afternoon. Couple, I think follow-up questions, actually. Just going back to Tom's question about the life captive. I think, Randy, you talked about a well-capitalized position, I think $1 billion in assets, $0.5 billion in liabilities. How sensitive is the asset to a rise in interest rates? Or how sensitive is that gap? If we had a 10-year that went to 4%, how would that move that margin?
I think that without getting into the specifics about what that asset moves as we move forward, I would note that when you look at the fourth quarter and the movements in the various items, that included interest rates that were up, as I noted, 75 basis points, an equity market that was up 11%-12%. Volatility, which is a significant driver of our asset value, that came down a few points. What you saw is the asset value over the course of that quarter drop from approximately $1.8 billion down to the $1 billion level.
Okay. That's interesting. Okay. Then maybe just a clarification if you already answered it, I apologize. I guess I was surprised that on a core basis or in the VA business, I think we actually had a DAC hit, not a gain. I guess I was surprised that there wasn't maybe a little bit of a DAC benefit and maybe even a GMDB benefit. Can you just explain why we had a hit versus ordinarily we'd expect a gain?
Could you repeat the beginning part of the question again?
I think, correct me if I'm wrong on this, but I thought in the variable annuity business there was actually a little bit of a DAC charge. Kind of a one-time DAC charge. Ordinarily, I would expect a gain, and ordinarily, I'd expect maybe a GMDB benefit with rising markets.
Yeah, that was really related to the conversion of the systems where we had some line items move around. I noted in my comments that we had some movement in individual items, but the net impact was very small. That was one of those items. The conversion caused a little bit of that impact.
Okay. All right. Thank you.
Thank you. We have no further questions in the queue at this time. I'd like to turn the conference back over to our speakers for any final remarks.
No, I just want to say thank you for joining us today. As always, if you have any follow-up questions, you can either give us a call or contact us via our website at www.lincolnfinancial.com. Again, thank you for your time today, and have a good day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a great day.