Going along. It is my pleasure to welcome Dennis Glass, President and CEO of Lincoln National. The first analyst meeting I attended after taking over the life insurance group was a Lincoln event at Lincoln Financial Field in Philadelphia. We got to see the Philadelphia Eagles' locker room, walk out onto the field, and I really thought covering life insurance was going to be a lot of fun after that. I thought I hit the payday. I peaked early on Lincoln Financial Field. Dennis has been CEO since 2007. Prior to his role at Lincoln, Dennis was President and CEO of Jefferson Pilot, which merged with Lincoln in 2006. Under Dennis' leadership, Lincoln has delivered stable double-digit ROEs for the last five years with a significant amount of capital return to shareholders. The track record is clearly there.
Let me start with kind of a big picture and just really open it up to you to see if you want to make some opening remarks, maybe reflect on 2019, look into 2020, just in general. We will start from there.
Jay, thank you, and good afternoon, everybody. Delighted to be here. I was saying to Jay, I have been coming to this event since 1993, so I am a regular. The response to your question is, I guess I would just like to make the point that Lincoln's business model has demonstrated good results and resiliency in a variety of different macroeconomic conditions. I have every confidence as I look forward that our sort of long-term growth rate expectation of 8%-10% can be achieved and will be achieved. The latest example of the resiliency of the model was the fourth quarter. We had strong top-line revenue growth quarter over fourth quarter last year in every one of our businesses. We had record earnings per share for the quarter, and our ROE is among the highest in the industry.
Again, another quarter demonstrating the strength and resilience of the business model. As we look into 2020, I think, again, with a step down in interest rates last year, a lot of focus on capital management, making sure that we are getting appropriate returns on our new business sales, which we did all last year, but greater attention to that, and capital management in general. Then we have been talking about the development of incremental expense saves for some time now, and I think we have invested $150 million into digital type of programs. We are going to begin to see in 2020 a positive $40 million of expense saves, 2021, another $40 million for a total of $80 million, 2020, 2021, 2022, another $44 million, up to $120 million. Those are not just sort of pie in the sky numbers.
Every one of those dollars has a name behind it, and it's in the financial statements, and I know the program and the execution of the program that's behind it. Those are good numbers. We had another $25 million worth of savings coming from the further integration of Liberty. Strong business model, another quarter demonstrating the strength of the business model and some initiatives underway that will help earnings as we move forward.
Anything last year that you were disappointed with by the end of the year? Where you said, "Gee, I wish we had done that a little bit better or differently.
Jay, we've got pretty good execution. As you all know, in the third quarter, we had assumption changes with the balance sheet a little bit, but interest rates are down, and a lot of that had to do with interest rates. There were a couple other components. You never like to see a lost quarter related to events like that. In our history, actually, had been almost for decades, we had very little, if any, third quarter assumption change noise in the income statement. I was a little disappointed on that, but understood exactly. I was sort of disappointed in what happened but understood that it was what it was. In fact, our assumptions that drove some of the outcome were on the more conservative side in the industry. Again, demonstrates the overall discipline that we have at Lincoln.
Other than that, strong sales, good earnings growth. I had one large alternative investment, which I call a unicorn, that we wrote down as well in the third quarter, which hurt operating earnings for the year. That was a investment that we had a $10 million cash investment in. It rose up to $140 million, and then fell back to about 20. We still have a decent cash-on-cash return, but it affected the third quarter earnings. Remove those two things, and that was a pretty good year.
My question is, I've kind of broken it down, I guess, by product or by segment. I'll go about it this way, and maybe I'll start with annuities. You, over the past several years, expanded your annuity products, moving into fixed income variable index annuities. Talk about the initial rationale for doing it, and then maybe as importantly, a postmortem. In other words, how have those product introductions gone relative to what you had hoped for?
Yeah. Come back to the strength of the business model. The strength of the business model is in our space, I think most everybody recognizes Lincoln's distribution is as strong as anyone's, if not stronger than everyone's, and that our product development is strong as well. Three years ago, the annuity business was defining itself as a guaranteed lifetime income business. We decided that was much, given the strength of our product development, given the strength of our distribution, that was much too narrow of a definition of our business strategy. We decided to diversify our sales, further grow our distribution partners, add wholesalers, and the result of which has been phenomenal with great sales and a more diversified product. It was a good strategic decision to broaden the view and definition of what we were in the annuity business.
From a return standpoint, has it matched your expectations?
Different products have different return profiles and appropriately so. On the VA with living benefits, your target returns are sort of mid-teens. The fixed annuities are lower double digit. Over time, you have to manage to ROE and things like that. We've got a diversified business mix that's going to move back and forth in terms of the distribution of product. We're comfortable that we'll continue to grow good sales, profitable sales, and good ROA and ROE development.
The growth in the business, obviously some of it comes from new distribution partners. You're expanding with current partners. Is there one that you see as being more important? Is it coming up with new channels?
Well, let me be specific in responding to that. This past year, we have a couple of specific channel expansions. We got into a relationship with Allstate, which has a tremendous potential, that's a specific distribution expansion where we can sell existing products into that channel. That worked very well. We added some independent marketing organizations on the annuity side, and to get them as partners in distribution, we had to customize some products and make it attractive to that particular marketplace. Then, sort of a more general comment is that when you introduce a product like an index VA, where we've gone from zero to, I think, $1.8 billion worth of sales in about 18 months, pretty good.
That's a combination of attracting new financial advisors to sell the product, adding the product to existing shelf space, and that takes a little while, as well as adding new distribution partners. Yeah.
What's hard to see from my seat is your distribution partners, they're seeing a wide array of products from different companies. The question always comes up, why would they choose Lincoln over someone else? What are your distinguishing features? Why? Because obviously you've had success with a lot of these partners. If I went and asked them, "Why Lincoln?" What would the answer be, typically?
Well, I think there'd be a variety of answers. One, of course, we've been in this market forever. We have a strong track record of success and consistency, so they can rely on us as a product provider. I'd put that in one category. Another category is we run distribution at Lincoln both as a business and a career. Because we run it as a business, there's a whole surrounding support, marketing activities, leadership development. Because it's a career, distribution reports directly to me, you attract people who can see a career path that's very strong and with high potential. We end up getting a lot of really good people in our distribution wholesalers in particular. That would be a piece of it. Because we sell different products-
Not only good, but they stick around for a while, it sounds like, too.
Oh, yeah.
Which is important.
Yes, exactly.
All right.
Yeah. We have some numbers on that, but I think we have some of the longest tenure in the industry with wholesalers. The last point is, for example, right here at Merrill Lynch, B of A Merrill Lynch, the distribution organization or your product people wanted to add another small market defined contribution manufacturer. Well, they really didn't need another manufacturer, but they needed somebody with the distribution strength that Lincoln had, so that not only could they build a better 401 market distribution, but because we were in all of their offices, we could cross-sell to other products. It was not just the 401 defined contribution business that they brought us in for, but it was the ability to cross-sell to other products. That's the type of thing that is attractive to companies like Merrill.
How would you characterize the competitive environment now? What's the latest read on it for annuities specifically?
I would say that across our businesses, it's a pretty rational marketplace. Products that are interest rate sensitive with the drop in interest rates are being repriced so that you have a lot of repricing going on. Generally, across all of our business, it's a rational marketplace. I have this conversation with people all the time. There's two reasons why it can be irrational. One is because people make inadvertent mistakes, and we've made some, and we're selling products from time to time too cheap for whatever reason. It's happened to us once. The other issue would be that if somebody wants to take market share, they intentionally get very competitive pricing in order to establish a market position. They might do that for 12 or 18 months. I think in general, it's a competitive marketplace.
Not a lot of irrationality at all, or to say it differently, it's a rational marketplace.
Assuming for that latter, people going for market share intentionally. I'm assuming you don't see that too much these days to begin with. Is that?
Not much, but you've seen it over the years.
Yeah.
That's an intentional thing. You say, "I'm going to accept 12% instead of 14% for 18 months." That's an investment to get into a market.
Any questions on the annuity business at Lincoln? If you have one, just raise your hand, we'll get you a mic. I'm going to shift over to, I guess, retirement. Where are you seeing the greatest growth in this business at this point?
Well, we're leaders in four segments of the market. The health market, we're seeing good growth there. The small case 401(k), Invent Tomorrow, we're getting good growth there. The government market. Those three markets where we actually have strong market positions, we're seeing good growth. We entered into the stable value marketplace. We've seen good progress there and a little bit of book value wrap business. All of those together are driving pretty good outcomes.
Is this something we should continue to see in 2020?
it's hard to make predictions about sales.
Absolutely.
We expect to see a good year in our businesses. Back to capital management, let's take the life business, for example. We had a very strong year in 2019. As we go into 2020, there's a couple of reasons why we think sales in our life business, maybe even our annuity business, might not be quite as strong. Intentionally not quite as strong. One is back to this idea of appropriate return on capital. There's some cost increases in the life insurance industry in particular that have to do with principle-based reserving, affecting MoneyGuard, as an example. We have to increase prices of MoneyGuard because of the new reserving requirements effective on January 1st.
That also contributed a little bit to the strong sales in the fourth quarter because our advisors knew that we were going to raise prices, they pushed a little harder with their customers to take advantage of a price that they knew that was going to go up. By the way, our costs didn't go up until this year, everything we sold in the fourth quarter was above our pricing or at or above our pricing expectations. That would be an example of a little bit of excess in the fourth quarter that won't repeat next year. Because of the capital requirements, we'll have to raise prices, that'll push sales down. Probably that's true in one or two other of the annuity products. We have to pay very close attention with lower interest rates to proper return on-
Yeah
new business.
On the retirement business, is it fair to assume there should be more consolidation in this business scale, given how important size and scale is?
Size and scale in most of our businesses, for example, I think this year our life sales will make us the number one seller of life insurance in the United States. Obviously we have a lot of scale there. I haven't seen the final numbers, but our $1 billion of sales has never been done before in the industry. We have a lot of scale there. In our group business, I think our LTD and short-term disability sales are among the top in terms of volume, one or two in the industry. With the acquisition of Liberty, merger of Liberty, we have a tremendous amount of scale there. In the annuity business, we are equally strong in terms of sales standings, probably fourth or fifth. When I think about scale, I think about do you have enough scale to have the low-cost position in the industry?
Do you have enough scale back to distribution that if a distribution partner wants a new partner, they think of Lincoln first because we're so big and comprehensive, and we have such a strong distribution. We have that in those three marketplaces. We don't have to do anything there. Coming back to our RPS business, there we've chosen to be strong in three segments, not across all segments of the industry. We have expense saving programs in place to get our cost per participant down to industry average or better. I think we've got enough scale in the RPS business as well. That's how I think about it from Lincoln's perspective. What other companies are trying to do in terms of get additional scale and for what reason, we'll have to wait and see.
Could additional scale in the retirement business be helpful to you? We've seen a couple deals happen in this space.
It comes back to our distribution model. We have a solid enough distribution to make small case 401 sales a big part of our growth strategy. It's because of distribution strength. If we were just competing against players where we didn't have that distribution advantage, we'd have to fall back on price or something else. For us, because we're at industry average cost, a little better than that, and given our distribution strength, we are exactly the right size to achieve what we want in the RPS business.
Got it. You had mentioned the sales growth, I guess, fourth quarter, we were surprised by the sales. Talk about the opportunity behind why was the growth so high?
Yeah. Two reasons. One, fourth quarter, the highest sales quarters of the month. You had this pricing increases that we were going to have next year and people taking advantage in the fourth quarter before it went up. Like tariffs. Tariffs increase the cost of business, you have to raise prices. That example. Those would be the two issues contributed to the strong sales. Again, I want to emphasize that at or above our expected returns, so there was no pushing with cheap prices. We'd been making our returns all year long and the fourth quarter seasonality and of the benefit of knowing that the prices on those two products are going to go up next year.
The reason, again, the life side had been somewhat volatile. Is this time maybe ceding less to reinsurance companies? What's volatility?
There's two pieces of volatility in the life business. One would be variable, which is a combination mostly of our hedge program and our private equity investments. We have a little of that asset class into that business. It matches well with the liability structure of the products in the business. You're going to see a little more volatility from alt performance. The second issue is that a lot of claims that we pay on an annual basis, I think it's 1.5 of life claims, and in any quarter there can be variability claims, the size of the claim, the amount of reserve claim. That volatility is just normal. It intentionally bigger than it may have been certainly than it was 10 years ago.
10 years ago, we were small, and we retained, if we sold a life insurance policy for $10 million, we'd only retain $2.5 million, reinsure the other $7.5 million. The pricing for reinsurance was very cheap for quite a while. We're more comfortable today with our current retention or reinsurance, I guess, because 25% of the piece of business that we sell insure, we keep 75%, and $2.5 million we might go up to $9 million on one case. In some special circumstances, I guess the lack of reinsurance capacity in for the particular, up to 20. You're going to see a little bit more volatility. It's a good business than just a normal someone's going to when we have to pay a claim.
Right. The ROE of that business then?
New business target?
Yeah.
Yeah. The targets are all for that business, 12% ±.
Okay. Reasonably good and not too far off your company ROE.
Correct.
Yeah. Any questions on sort of Retirement, life insurance that I missed you guys want to throw out there? Let's talk about group protection. I spoke with a number of companies today, what you hear is results have been good, competition's reasonable. It sounds true. Each company has a different experience, from my comment, are you seeing any changes in this environment?
Not really. I think I would agree with what you said, that the market is rational. We actually probably be increasing prices in some of the segments and expect to be able to maintain our sales volumes. There's a smaller group of players, all who are return on capital and managers of the business. It's a good environment.
I assume the kind of the bigger players has helped a little bit.
It's not been a perceptible change in the marketplace. I think over time, again, the people who are buying the business, our life guys are going to be concentrating on good business. The other transaction was hands. Ours ended up in good hands. I think it's positive.
Yeah.
I guess what my team is telling me is that when you price a group product, a fixed price for three years. I guess if there's an area where they'll get slightly more aggressive fixed prices longer, not materially so, that would be the only example where there's a little bit of competition.
As far as claims trends, that also seems to have been. I mean, there's always quarter-to-quarter volatility.
Yeah.
In general.
Yeah, it's been pretty good all year long. We had a little spike in severity and incidents in the fourth quarter. Again, we think it'll go away in the first quarter, we think.
Yeah. Where is it going to come in this business? What are the obvious sources of growth?
In the group business?
Yeah.
We get a lot of growth out of cross-selling, let me that path. We might start with a product, let's say, long-term disability. The sense we have from that company is long-term disability. We'll then try to sell employee-paid to the existing employees, you get voluntary sale, try to sell to the employer and to the employees life, dental, critical illness. I think last year about 39% of our sales volume came from cross-selling to customers in that way.
This competition.
Got it. The integration of this business, is it basically complete at this point?
Major deals, I would say that this is one of the best executions that I've seen that's close to it. Dick Mauk , retired, and his team really did a great job in integration. One of the important points when you do a deal like this is exiting something called a trans agreement, essentially, angry at me when I say this. We had to unplug from its parent technology systems and plug into our technology systems. They sort of get upset. It sounds so simple, plug in and unplug, when in fact it's thousands and thousands of systems transitioned. We went through that, I think about 90 days ago, very smoothly.
We had one complication, which was when we were on the claims processing system, that piece of it, and plugged it for a short period of time, the amount of data to pay claims and manage claims slowed down. We're past this. Very good.
The effect of into described, is there some lessons you can learn? In other words, is there a roadmap you can develop, assuming that if you do future deals, you can replicate some of this? Or is it just different for every deal?
Again, I've managed eight major acquisitions at Lincoln. We have sort of proprietary intellectual capital around. We employ that every time. You learn something new. Obviously, all of us learn on a daily basis. Fundamentally, integrations are big projects. You have to start with the assumption that you're going to pick the best people, the best operating systems, the best products. If you start with that open-mindedness rather than just, "Hey, I'm the acquirer, we're going to do what I do," you have a great project management, it works out. Of course, let me back. Most of the effective integration comes from an extremely detailed work around getting to the point of making the acquisition. You know exactly in integration to be able to achieve your objectives because you've been so thorough during the due diligence.
Yeah. We're getting a little low on time. I want to just jump around a little bit. I got to ask this question. Can prioritization, I mean, it's obviously central to what you do. Just lay out your priorities as you look at 2020 and 2021.
This is an art and a science. You have to have the sciences, the math, or new business sales, and appropriate assumption that goes into it. Overlay on that, I talked about the strength of our distribution. A lot of the value proposition and manufacturing is a level of sales. Back to corporate size and the ability to cover corporate costs. Making adjustments to volumes, it has to be done with an eye toward preserving. You don't have unlimited flexibility in increasing and decreasing sales. Having said that, and as I started my comments with the interest rates, with a new business, we're doing three things. Very good plan. We're products that need to be repriced, such as MoneyGuard, because in that case, increase in risk to principle-based reserving. Increase prices by 8% to get to our returns.
None of our products, sort of elasticity of demand, if you increase prices, volumes are going to go down. The first one is reprice. The second is shift. Excuse me, the second, Stratus. Here would be a perfect example of that. Two examples. One is indexed variable annuities. I may have the total volume wrong that I mentioned, but it went to 0 to a lot. And some of that variable annuities with living benefits. The index VA has much better return profile because the product's price and what it depends on for its investment engine than the VA does right at this moment. Emphasis. We can do that because of the strong field force we've got.
The third thing we're going to do, and we've done this successfully in the past, is we just did a scan of all of the countries that had large life industries, interest rates. Interestingly, the growth in those countries in the life is sort of at the same level that the U.S. is, but they've shifted the emphasis on their products, more annuity products. The good news from our perspective is product that's selling in any of these countries that are suffering from 0 interest rates that we don't sure comes back to emphasis. Again, I come back to my business model. Let me make one more comment on this. We did the merger in 2006.
About 60% of our sale insurance was guaranteed universal life because interest rates have been declining on a secular base around through that whole period of time, we've had to shift emphasis to other life insurance products. We went from 60% of ours being guaranteed UL to 5% in 2019, $600 million-$700 million of sales to $1 billion. We can shift and grow the top line, and that's why I say this model is so successful. Let me just make one more point on that. 90,000 independent agents who can choose any life insurance in the U.S. choose to sell Lincoln in a 24-month period. You've got 90,000 people that choose us. That's up eight this year. Behind those 90,000 financial advisors are I don't know how many customers a financial advisor have.
Take 90,000 times 50, and that's the pool of existing people, customers that we have. As we make pivots with our products, we shift emphasis. Pretty much the advisors that we have are already have customers that might need that product that we're shifting to.
Run out of time. Dennis Glass, thank you very much. Fantastic.
Thank you, Jay.
Appreciate it.
Okay.