Good morning, everybody. Welcome to the RBC Global Financials Conference. Thanks for coming out. It's a little bit odd doing this remotely and not being able to see all of you smiling faces out in the crowd. We're excited this morning to have Randy Freitag, Executive Vice President, Chief Financial Officer of Lincoln National with us here today. Just as a couple bit of housekeeping items at the beginning, there's a question box up on the left-hand side of your video display. If you have some questions that you'd like me to relay on to Randy in the course of our discussion, type those in there. Those will pop up on my screen, and I'll ask them when we get to that part of the show.
I'm going to start by turning it over to Randy just to maybe say a few words, we'll duck into some Q&A right after that. With that, Randy, up to you.
Mark, I appreciate you taking the time and effort to pull this conference together, look forward to interacting with you and any questions that come from the audience. Mark, no opening statements from me. Let's get going.
All right. Well, people always like to start these things off by talking about stuff that you guys hash over pretty often, like reinsurance contracts and buyback programs, we'll probably get to those down the line. I thought we'd start with something more company specific. You've talked a few times about some of the changes, some of the product revisions that you're planning or have begun to get underway. I was hoping maybe you could start by just kind of taking an opportunity to talk through some of that, what some of the sales dynamics have been so far and how you see that unfolding as 2021 gets underway.
Broad question across all the businesses, Mark?
Well, maybe start first with the annuities and life insurance. That seems to be where the greatest change has been. We'll drill down into the other segments as we go along.
Sure. I'll start with the annuities business. I think 2020 was really a year when we demonstrated a lot of the things that differentiate us, we believe, in the marketplace. Go back to 2019, we were fairly evenly split from a sales standpoint across really three buckets, variable annuities with guarantees, variable annuities without guarantees, and fixed annuities. 2020 happened, we made some decisions driven by the economics, that led to what we'll talk about here in a bit. The first really decision we made was really focused on the fixed annuities, it was driven by what we believe during an environment like 2020, what appropriate levels of return on capital are.
I know that everybody has a little different view on this, I have long said that the fixed annuity business, when you take into account expected credit losses, et cetera, has been a 10% business since dinosaurs roamed the Earth. It's a direct quote I've used over the years. I freely admit that not everybody holds to that's my view. When we looked at 2020 and things we should do with our capital, we felt it was appropriate to push up the bar on fixed annuities. We pushed up the return bar on fixed annuities, it really drove sales down. We went from $5 billion of fixed annuities to $1.2 billion of fixed annuities last year.
That's reflective of our view that we should be pushing for a higher return on capital in that across all of our businesses, and in the case of fixed annuity business, that drove our sales down. I think whether or not those sales come back will be around what we see in the marketplace, right? Does that marketplace, as you move forward, does it allow to get a 12% return and sell more business, or does it not? Or at some point, does the market stabilize to the point where we can push our return threshold back down for that particular business? That was the fixed annuity decision.
Fortunately, really demonstrating some of the things we're very good at, we were able to take a product like indexed variable annuities, buffered annuities, known by a number of different names, and really grow them tremendously by flexing our ability to get on distribution channels, flexing the strength of our wholesaler group and flexing the strength of our product innovation. We still see that area. We saw that variable annuity without guarantees, which the IVA product falls into, grow very nicely in 2020 and replace some of those lost fixed annuity sales. I think that market is a very exciting market with attractive growth and innovation opportunities as we look forward. It's getting more competitive. A lot of companies are coming into this space.
Sure.
I think there's a lot of I see that product as relatively young in its life cycle, and I think there's a lot of innovation to come. I think what the IVA market basically did is it basically looked at the fixed indexed annuity and said, "What could we do to make a little better mousetrap?" What it noticed essentially was that the value of taking on some downside risk was a very valuable commodity. If consumers were willing to take on a little bit of downside risk, that value of taking on that risk could be sold in the marketplace, and you could get much more upside potential. You're able to create this product with pretty attractive upside potential, as long as the consumer is willing to accept some level of downside risk.
Which is different from the index annuities, where it's guaranteed principal, but in our view, very limited upside.
It's certainly more capital efficient. I likewise think that very often it's sold with relatively shorter buildup periods. People like that, not having their money inside of these contracts for quite as long of a period of time in a lot of cases as well. Just seems like it's something that we're in tune to the times.
We will see. It's an attractive place. We can get the strong returns we look for. The VA with guarantee market is just interesting. We still find it to be an attractive place. It's our highest return business in terms of what we price to, and you can still get those returns. You get them in the context of that's a market that's been declining, in decline for about 10 years, right? Last year, once again, industry sales came down, Lincoln sales came down on VA with guarantees. I'm a guy who believes in the market, I guess just reflecting that the price we have to charge to get the returns we believe are appropriate aren't as attractive to consumers anymore today. It's a bit of a puzzle to me.
I think the product should resonate so much with consumers, the product, just factually, the sales of that product have been falling across our industry for some time now.
Yeah.
That's the annuity space. We think we really bottomed sort of in the fourth quarter, we can start to sort of trough there and start to grow as you look forward. That's our expectations. The life business, it was a very dramatic year last year in terms of we're a company who believes in pricing using interest rates as they exist, then the forward curve, right? We use current interest rates as opposed to what's known as portfolio interest rates. That made some products very difficult to create compelling value propositions. If you're using very low interest rates, it's very difficult to make compelling value opportunities for the consumer. We took the opportunity to really go out and do a significant amount of innovation last year in our MoneyGuard space, a product we just rolled out February 16th.
In our VUL guarantee space, a new product we just rolled out on February 16th, obviously with VUL, but on MoneyGuard, completely shifted the product from general account, where we just couldn't create a compelling value prop when we're investing money at 2.5% to 3%.
Yeah.
By giving the consumer the opportunity to invest in the equity markets, hopefully get more accumulation, you can create a greater benefit pool. Now, in doing that, obviously we can't give that same level of guarantee that we can give when we're investing in the general account. It's a very different product. It's upside potential without that level of guarantees. We think it's super exciting, especially for younger individuals. We rolled it out on February 16th. We see last year as a year of innovation. We'll now, once again, demonstrate our ability to get these products on platforms, get these products introduced to advisors, something we're very good at. Once again, we kind of see in the life business, sales sort of troughing and then growing from here.
Okay. That's a great update on those two businesses. Interesting. I got a question from the line, which happens to be pretty much my next question, so I will ask it on behalf of both of us. It's really to kind of take some of that same analysis over to the group protection business. That was one that was hard hit in a lot of different ways by COVID and by employment, et cetera. Maybe talk about some of the trends that you're seeing there, whether things are starting to look any better now as first quarter rolls around with case counts declining and so forth. Then, I guess, likewise, kind of same discussion, any changes you're making to products or claims management in response to the pandemic and just business conditions in general?
Again, a very wide-ranging question, you can fill in that canvas however you like.
All the business that went on our books on January 1st is business that we would have been working on pricing over the preceding 12 months, right? You are making assumptions about the world that is going to exist 12 months out when you're doing a lot of the pricing, especially as the cases get a little bit larger. There were two big decisions we made, and that drove some level of impact on new business pricing. First, rates were very low. They're still low, but they were even lower last year. We believed we needed to reflect that lower interest rate environment. This is primarily in the disability pricing. The other thing is we believed there was going to be some pressure on the disability business associated with the higher levels of unemployment.
We put those items in the price that we put in the marketplace. The first quarter is our big sales quarter, or it gets reported in the fourth quarter, but they go on the books on January 1st. That's our By a long way, our biggest quarter. We did make some pricing changes for lower interest rates for potential impacts, and we'll see what happens in that regard. Right? We'll see if those sorts of pricing impacts need to come back out or whether they were really needed. We'll know as the year and the years roll out. The business was definitely impacted by the pandemic. It was primarily at the life business, right? 360,000 U.S. deaths last year. Looks like we're on track for a couple hundred thousand in the first quarter. Pretty big life business.
That business inside of our group business was definitely impacted. There was a much smaller impact in the STD business that's primarily associated with hospitalizations, and hospitalizations really peaked, I guess, in early January at roughly 130,000 some. Now they've come down dramatically. I think last time I looked, they were down to about 40,000, so they've come down by roughly 70%. Life, yes, elevated mortality impacted the life results. Disability, a little bit impacted. Not much impact yet in the LTD business. There's a small single-digit impact in our LTD business if you look in the fourth quarter. Overall, I think we spiked out $74 million of impact from the pandemic. That was $61 million in the life business and $13 million in disability with the bulk of that in STD.
Okay.
From a sales standpoint, in terms of the business, I think that business was a bit disrupted. HR departments were very busy last year, you saw sales, if you look at the full year, sales were down roughly 6%, 7%. On the other side of that, you saw persistency because companies weren't taking their business out to bid. You saw persistency really sort of offset that. We actually saw premium growth last year.
I suppose the good news is you didn't lose any business or would lose less because the persistency was higher. The bad news was it was hard to win any business because everybody else had the same thing working for them.
That's exactly what we saw.
It probably will open up more as those staffs get back to work for this year. I think, I would imagine businesses in general have learned a lot about their disability and their programs in general, and probably a number of companies would contemplate changes that they might not have previously contemplated, which hopefully will work to the benefit of your business and others.
I think the value of insurance in general was demonstrated by 2020, whether that was the direct impacts of life insurance or a product like disability or the ability to have a guaranteed stream of income. I think the value of what we do, and I've been in the business a long time, and in my personal life, I've experienced the value of our product. I'm very passionate about the value and what we provide to American consumers. That's why this industry's been here for well over 100 years.
No, indeed. Moving on to the one business we haven't spoken about yet. The retirement business. It was a good year for AUM growth. When we were at AFA a couple of weeks ago, I asked you just how that business fits in, and you had a really good answer. Maybe share with the group just how RPS fits in at this point in time, what you're doing there in terms of product growth, where you see that business progressing over time.
It's interesting. If you look from the outside, you would just say $85 billion asset retirement business must be subscale, but that's not the reality inside. If you come in and you look at that business that size, by leveraging the capabilities of Lincoln, and this is primarily about the ability to get on these distribution platforms. Our retirement business on its own would struggle to get on a Wells Fargo or a Merrill Lynch or these other big platforms. With LFD, we can leverage those relationships and get on all those platforms. We're able to deliver a level of sales that really reflects the strengths that our business is able to derive through LFD. The other thing that we do is we focus like a laser beam on the places we want to compete. Right?
Full service, small market, mid large, no jumbo, admin only, low ROA business. It's a very focused and disciplined approach. By doing that, we find that we can be competitive from a cost standpoint. If you look at our cost per participant, we've brought it down dramatically. That's a trend I think you'll continue to see in the future. By leveraging the other things that Lincoln has, by being very focused, it's a great business. It's a great business that continues to earn attractive ROE. An attractive ROA. That doesn't mean it's like any business. It's got its challenges. It's somewhat impacted by low interest rates, for instance. There's some spread compression, but there's a lot of reasons to really like that business.
Okay. That's helpful. I'm going to remind the audience if you have a question, feel free to type it into that Q&A box to the left-hand side of the picture of our two beautiful smiling faces. We'll get to those in the order we receive. I do have one here, which was one that was coming up on my list anyway, but the question is: does the rising interest rate environment change your thought process for participating in a risk transfer type deal? Maybe I'll just expand on that in general. You have commented in the past, and you have done risk transfer deals in the past. Just your general, the overall thinking, how you think about those as a concept and where they would make sense and where they would make less sense.
Yeah. I don't think the question mark isn't do rising interest rates make me more interested. It's what rising interest rates do. Right? Just the fact that rates are up isn't what does it. It's the fact that with higher levels of interest rates, the values offered for businesses should increase, right? A big component of an appraisal, and I started out in this business doing appraisals, buying companies, is the investment income, and that's driven by the yield assumption. I think that the fact that rates have gone up could be an indication that the values that companies are willing to pay for some of these businesses have gone up, and hopefully that will make that more attractive.
I think at the end of the day, for us, it all comes down to, it's about capital allocation and can, by freeing up some capital by doing something like that, can we put that capital in another place and do something that's accretive to shareholders. We've been doing that for a long time. You'd mentioned we've done a number of transactions over the years, and we're actively engaged in looking whether something like that makes sense now.
Yeah, I guess, the last time you did it was particularly timed or associated with a related share buyback opportunity that you guys undertook. I would suppose that ends up being part of the equation as well. You would weigh the capital freed up against whether a buyback, which is relatively more visible, is the best use or alternatively, investing in other products or whatever, which are a little less visible, but they're probably higher ROE in many cases.
We don't have other needs for capital. We have a very strong balance sheet. We ended the year with a 450 plus % RBC ratio. We have a very strong balance sheet. We're not doing anything to strengthen the balance sheet or anything like that. Yeah, it's about what would we do with that capital. I think if you're talking about smallish deals, yeah, it's pretty easy. It's a $100 million deal. Put it all in buybacks. I think the bigger the deals get, then you have to start thinking about, okay, do I have to allocate some to debt repurchase? You got to-
Right
factor in that sort of math. I guess that's how I'd think about it. Yeah, absolutely. What is the math on share buybacks? Depending on the size of the deal, if you think about debt reduction, what does it mean from an EPS accretion standpoint?
I guess as long as we're on the topic sort of buybacks. You've made fairly clear, I think, the philosophy is at least to start the year. It was covered on the fourth quarter call and other venues. If you could just talk through that again for any of those who have missed any of those updates, just in terms of the near-term view on buybacks and what might cause you to ramp that up or down as the case might be going forward.
Yeah. I'll go all the way back to last year. First quarter last year, $225 million of buybacks, then the world changed, right? There was a not unreasonable worry that we were going to have a big credit event across America. There was potentially other losses that were going to occur. Prudently, we are in the business of making promises and deliver on those promises decades in the future. Prudently, we cut off buybacks for two quarters. The world sort of healed itself. Credit losses or the view that credit was going to be an issue faded. Our balance sheet continued to strengthen. We started the year at 415%, and by the end of the third quarter, we had grown by 15 points through all that. The balance sheet was strong. The risks were diminishing at least.
We entered the buyback market again with $50 million, I think, which is a prudent way to go. We announced on our call that we'd go back to $100 million in the first quarter. It's just a fact I'd point out that hopefully the first quarter is peak pandemic. We'll likely see a couple hundred thousand deaths in the U.S. That's the biggest quarter that we've seen to date from this horrible virus. I think it's an indication of what we believe is the strength of our balance sheet, that during what will hopefully be the peak of this pandemic, we're stepping up to $100 million, which is still a little below the $150 million or so we've averaged for a long time. Like I said, this is hopefully the peak pandemic.
Yeah. No, I hope you're right about that as well. Hopefully as the numbers keep going on and the results continue to come in solid, there's opportunity to improve that if, again, assuming that that makes the best sense. At some point, the stock price reaches a level where that isn't necessarily even your best use. It's always a balance, as you well know. Another question that we had related to kind of expenses and benefits that you may have received from reduced travel and entertainment expenses last year. Just how are you thinking about expense management? I know your expense ratios have always been very competitive and very good. Are there opportunities to make some of those reductions permanent, or would you expect to see that slide back higher as the year unfolds? How are you thinking about just expense run rates in general?
Well, Mark, let's be fair. I think our expense ratios are industry-leading. Let's start there.
I said they were very competitive. I thought that was a fair way of saying it.
I only want-
That's okay.
Life annuity definitively industry-leading. I think retirement we're competitive. I think Group is maybe the only one. I think that more has to do with the fact that we've been very focused on integration. We can switch to digital or whatever, and I think bring those expenses down nicely over the next few years. We're very competitive. Look, if you think of what's going on, a while back, we started a project called Project Ambition, which was about digitization. That is a couple more years of net savings, roughly $40 million a year of incremental savings. You still have that program going on. I mentioned, I think, in the Group business, we can shift our eyes to digitization technology now that we're pretty much done with the integration.
Last year, when we looked at what was going on, we shifted very quickly and took $100 million of expenses out of the organization. As you mentioned, some of those were associated with reduced travel, et cetera. Now we have committed to keeping that $100 million out. $100 million is like 4% or so of our G&A, and we just took it out, and we've committed to keeping it out forever, right? I don't know. That seems pretty good to me. We always are focused on expenses, we continue to think there's additional opportunities, and we'll be very focused on working to harvest whatever opportunities that exist. I think as a broader answer, you think about what's gone on over the last decade, the amount of spread compression our industry has faced. Things like higher costs of reinsurance and all these things.
We've still managed to grow at Lincoln our EPS, it's like 10%-12% over the last decade. I think if you had asked investors 10 years ago, "If this is going to be the rate environment, can Lincoln grow its EPS 10% a year?" Zero people would've said yes. I mean zero. What people forgot is our ability to do things like manage expenses, right? Lincoln, and I think the industry, right, to be fair. I think there's a perpetual underestimation of the levers that we at Lincoln and our industry has. It leads to where we are today, which is just, I think, valuations that are woefully below where they should be.
I would agree with you on that. We got about one minute or so left. I'm going to ask you the sum up question. What makes you most optimistic about your business? What makes you excited to come to work each and every day and take Lincoln forward?
I said earlier that I have personal experiences with our products. The products we provide fill real needs for American consumers. They have done that for, in Lincoln's case, 115 years. If you look forward, there's a higher recognition of life insurance. There's a continued movement of securing your retirement to the individual. Do people need guaranteed streams of income? Do people need ways to accumulate for their retirement? Do people have to fill gaps through disability coverage, dental, Group Life? Every one of our products has a strong secular reason to exist looking forward. Secular growth along with a business that has, it's a good lobbying in this business. I'll get to hear stories about when we pay a claim, and even though that's not good for earnings, the social good that is served when we give a surviving spouse a path forward.
When we send kids to college with life insurance, no other industry can touch it.
That's a great answer. I agree with you entirely. Often, we as analysts, we look at that as part of the expense ratio or the benefit ratio or whatever it might be, and forget about the fact that there's somebody out there whose life was exactly what you do.
Mark, one of my most favorite memories growing up is sitting on the right-hand side of my mom. My brother was on the left-hand side, because my father passed away very young, and we were at the benefits desk at the post office where my dad worked, finding out about his one and a half times life insurance and the other benefits he was going to get. I can tell you today that my mother still draws $1,000 out of Western's proceeds. I'm very passionate about this business.
I think that's probably exactly the right place to end. Thank you very much for your time. I guess that'll end this session. Thanks very much to all for attending and your questions.
Thank you.