Great. I think we'll go ahead and get started here. First I'd like to say welcome and thank you for being here, Dennis Glass.
Thank you for inviting us. We're delighted to be here.
Yeah. I've got Dennis Glass, CEO and President of Lincoln. Maybe if I could just start with a higher level question around business mix. Following the Liberty Mutual acquisition, are you happy with where the business mix stands today and the different contributing businesses, and where do you see the growth opportunities going forward?
Yeah. Let me step back, Alex, in the context of big picture strategy.
Yeah, go ahead.
Three or four years ago, we set out to accomplish what I refer to as two overarching strategies. One of which was to change the mix of our new business sales from products that had guarantees in them, such as GUL and guaranteed lifetime income, which we still like both products, to more products that were on the shorter term end of the liability structure. In five years, we went from, just round figures, total company, something like 30% of our products were non-guaranteed products, and 70% were guaranteed. We flipped that upside down organically over the last five years, and today, I think last quarter year to date, only 20% of the sales that we make this year have long-term guarantees, and about 80% are short-term guarantee business.
On that strategy, it was helped by the Liberty acquisition because all of those sales are on the shorter end of the spectrum of duration. That was one overarching strategy. The other overarching strategy was to emphasize from a source of earnings perspective. All insurance companies generate earnings three ways, fees on assets under management, spread earnings, and then mortality and morbidity. We were sort of the middle 20s on mortality and morbidity, and we were able to move that up with the Liberty acquisition to 30%, 33%. We've achieved those two overarching strategies, which put us in a very good position to continue to grow the business in a profitable way, obviously. We're excited about that. That's the business mix part of the question. In terms of where we see growth opportunities, let me set that up again.
Between low interest rates and what products work better in low interest rates and what products don't work as well. The products in our RPS business and in our group business aren't as significantly impacted by low interest rates as some of the products in our annuity and life insurance business. We see good growth in RPS in the segments of the market that we participate in there. The government segment, the health segment, small case 401(k). We've introduced a really strong product concept that's sort of a takeoff on target date funds, and that's driving sales across those segments. That's good. In the group business, we're seeing very good growth, very good pricing. We're emphasizing a lot the voluntary business, where the margins are a little bit better, and we're seeing good growth there.
In those two businesses, all of our businesses, I suggest that they're in the 5%-7%, in the middle single digits growth perspective or growth potential. If you come over to the individual businesses, life and annuity, and let me set the stage on this. Low interest rates are a headwind, and I'll just say a headwind. We'll overcome those. The strategy is around repricing products that aren't achieving their hurdle rates, shifting the emphasis of sales to products that are already achieving their hurdle rates, and then in the longer term, adding new products. Let's talk about repricing and redesign. We've done a lot of that over the years. Take guaranteed universal life, for example. That used to be 66% of our sales when we were selling $700 million a year. Today, it's 4% or 5% of our sales.
We're working to be $850 million in total sales. That was a shift away from a product that as interest rates continued to decline, just didn't provide the right return for our shareholders. There's an example of a shift. More recently in the variable annuity business, we're seeing a little bit of a slowdown in guaranteed lifetime income product sales. Overcoming that slowdown is this new product that we introduced. It's been in the market for a little while. It was new for us over the last 18 months, indexed variable annuity. That's doing extremely well, not only absorbing the decline in guaranteed lifetime income, but actually increasing sales. I think all the businesses have the potential to grow in that middle single digit plus or minus range over time.
Of course, the way we get to our 8%-10% is other components of growth, share buybacks as an example. In general, we're pretty optimistic that the business model that we have And the franchise strength that we have will continue to produce good returns, good growth.
Maybe if I could dig a little more into the annuities piece of the growth.
Yeah
that you mentioned. I think over the last couple of years, there's been some initiatives around expanding wholesalers and some work you've done on distribution that has resulted in a really better momentum for your annuities business than probably anybody else from a flow standpoint. I'd just be interested to hear, looking forward, how much benefit are you getting from that? And how does that balance out with interest rates? Do you think you can still grow and achieve positive flows?
The answer to the question is yes. Let's go back three or four years. Three or four years ago, I think distribution and our independent distribution partners and our own strategy really was around being the guaranteed lifetime income annuity company. We decided, again, three years ago, strategically, that was too narrow of a focus. We decided to participate in other segments of the market. We didn't do much in the fixed annuity business three or four years ago, and because of that strategy change, we do today. One of the things that people talk about when they talk about the strengths of Lincoln's franchise is the very significant amount of distribution that we have. I think every 24 months, something on the order of 90,000 different consultants, advisors, independent agents choose Lincoln.
With that vast number of people that sell our products, and behind that 90,000 is probably 100 customers for every one of those 90,000. You can see we're selling it to a large pool of consumers, all of whom have different needs. As we have to shift away from a product that's not getting the returns into a different product, there's this big opportunity with the people that know and sell Lincoln. That's why we're able to do shifts in our product mix successfully, the strength of distribution. To your point, though, different distribution organizations may have different focuses. It may take us time to build the distribution that is the appropriate distribution for a particular product. An example of that would be, we are doing a lot more fixed indexed annuity. A lot of that's done in the bank channel.
We've expanded our bank channel partner distributors quite substantially. The franchise is built around really good product development capabilities and really, really good distribution. As market conditions change or consumer preferences change, we always have an audience to sell as we shift, and it's worked out pretty well for us. I'll repeat what I just said. If you look at Guaranteed Universal Life, and now I'm going back to my grandfather's company, which, in 2006, 2005, when we merged old Jefferson-Pilot and old Lincoln, again, I think we were selling $700 million of life insurance. 66% of that was Guaranteed Universal Life. Today, we'll sell $850 million of life insurance, pretty close to the number one seller of life insurance in the U.S., and only 5% of that will be Guaranteed Universal Life.
We've demonstrated an ability to shift, again, for consumer value reasons or preferences, as well as capital markets' effect on return on capital.
The next one I had for you is on some of the investments that you all have made in the strategic initiative, I guess, of the digitization of some of the elements of your business.
Yeah.
Can you provide an update on where that stands? I think you've been investing for a little while, and I think there's some benefits that are beginning to come through.
Yep.
Just be interested on any color you can provide around it.
Yeah. Let me tell you how we started that. There's sort of three things that came together at one point in time, about three years ago. One, we were seeing spread compression, we had to ask ourselves the questions for the benefit of our shareholders, how are we going to replace those earnings? Because you can't just let it disappear and not react to it. We had that issue, and we saw about $150 million of earnings over a three- or four-year period disappearing from spread compression. The second issue was digital experience in consumers, mostly from the born digital companies, Amazon, Google, companies like that, were setting the customer experience expectations for all industries. We were no longer competing against MetLife or Prudential on a customer experience. We're competing against Uber, Amazon, companies like that.
The third issue, we'd already in some of our business lines, decided that we're having good digital investment and results. With those three things in mind, we decided to invest several hundred million dollars to accelerate the digital program. That is achieving two things. One, the customer experience is improving dramatically, and we're cutting costs down. On the digital cost saves, and there's some other saves in this number, we're about, again, my experience in doing deals and making investments to change run rates Permanently. You have to invest about a buck to two bucks to get a buck worth of run rate savings. Trying to get to $150 million of run rate savings out of our digital program is going to cost about $150 million.
In the stage of this program, we've been sort of break even on investment and savings this year. Next year, we'll get $40 million net difference between savings on a run rate and investment. We'll get another 40 the year after that, which takes it to 80, then we'll get another 40 the year after that, which will take it to 120. We've given guidance around $90 million-$150 million, what I've just said. As you exit 2021 and go into 2022, we think we'll be at $120 million. That's worked very well. The good news is that when we started this three years ago, I like to use this example. A lot of the way you get cost efficiency is taking people and paper out of the system and replacing it with optical character recognition and robots.
When we started our program, I think it cost $150,000 to install a robot in a customer service area or in some process. That required three headcount reductions to justify the investment. Over three years, that $150,000 has come down by half or more. We can go back in and do it again and make more investment in digital, and increase our run rate savings. Now, this probably won't happen until later 2021 and 2022, but we're going to do it again because I think the economics work better now than they did when we started.
Interesting. I guess related would just be the Liberty Mutual acquisition and some of the integration that's occurring there. I think that tied into it a little bit, but it's also separate in ways as well. I'd just be interested in any update on how the integration's going. Just from an earnings standpoint, it seems like it's gone quite well. How much of the expense synergies and so forth have you realized, and how much of a tailwind is that going into next year?
Yeah. In my 25 years at Lincoln, I think I've done 10 deals, all of which have been successful. The Liberty acquisition had great challenges but has been executed by the group team under Dick Mucci and others. I mean, we've had mistakes, but not big ones. Let me talk about a couple of pieces that are important, specific answer to your question. I think at the time of the announcement of the deal, we said that we'd get about $100 million worth of cost savings over some period of time. We're going to get that $100 million maybe six or 12 months earlier. By the end of this year, we'll have the first $100 million in our pocket. In the next year, we think we'll get another $25 million.
On the cost save basis, we're going to do better than what we presented when we did the deal. The second thing, when we merged the properties, and we announced this at the time of the deal, old Liberty was in the process of repricing because they got a little bit ahead of themselves. Happens to a lot of people in the group business. I think we said it was going to take three cycles of repricing to get the margins that we needed. I think we did it in one and a half cycles. We were way ahead on the repricing that we had set out in the original presentations to our investors, and we're 25% ahead on cost saves.
Just in terms of integrations, when you buy something that's technologically plugged into a different parent, the biggest integration challenge is to unplug from the parent, the old parent into the new parent, and that takes years. We just unplugged from the big Liberty Mutual and plugged into all of Lincoln's technology in the past 30 days. It went very well. That huge integration activity and something that could really mess up an integration if it wasn't done effectively, that's behind us. That's why I say of all the things that I've seen over the years, this is one that had its challenges, but the execution has been as good as any.
I guess the point at which you kind of changed the plugs is typically the point at which there's some shock lapses. From your comments, I mean, is it right to take from that you're not seeing much of that at the end of this year?
What happens is people fear, Alex, that when you unplug and replug
Yeah
that there's going to be a huge customer service billing problems. The brokers put any company in sort of a penalty box for 18 months or so. Why take on the risk of a company that's going through a major integration when you can sell to somebody else? We saw a little bit of that, and when we priced the deal, we put shock lapses in. We actually experienced less shock lapse, and I would say 100% were out of the penalty box with our brokers.
Again, we'd still be in the penalty box if, for example, this plug and a replug thing didn't work, but it did. All of the integration risk that was perceived to be a problem by brokers is behind us, and the brokers are treating us just as if there's one new company.
I guess just thinking one more under benefits, just thinking about a higher level pricing, including the existing block, there's been some fear that the margins, as strong as they've been, that they're maybe not sustainable. Are you seeing any pressure on pricing, or has the pricing been pretty stable this year?
The answer to that question is it's a remarkably rational pricing environment in the group business. It actually pretty much across all of our businesses. Sometimes any one of us can get ahead on pricing because we want to enter a new market, and with our eyes wide open, we might take a lower return on sales just to get into that market. You see logical, aggressive pricing from time to time. Sometimes you see people just made mistakes, as Lincoln did 4 years ago. We just missed it on pricing. The industry is in a very rational pricing mode right now, and I don't see that changing.
Now, I will say that from a margin perspective, historically, in strong economies and low unemployment, you have better loss ratios on disability, short and long-term disability, because there's no incentive for people to make up a problem because they only get part of what their paycheck would be if they stay working. When they start getting laid off, you're going to see a little bit of pickup in loss ratios just because there's that sort of activity that goes on. I'm not suggesting people are bad. Things happen when you're not employed.
Sure. Okay. Maybe switching over to life insurance. I've noticed the term life insurance in force has been growing at a pretty rapid pace.
Yep
particularly just in the last few quarters.
Yep.
Just be interested to hear what you're doing there. Is there anything that's changed that's creating the incremental growth?
Yeah. Similar change in strategy in the life business regarding the segments of the markets that we're going to participate in as happened in the annuity business when we decided to broaden our definition of who we are from just a guaranteed lifetime income into a broader provider of solutions. In the life insurance industry, historically, we sold to a more affluent marketplace, which meant an older age marketplace, higher base amounts, estate tax planning, business planning, those kinds of needs. Several years ago, again, back to technology, we decided that we were going to go after a different segment, which is lower face amounts, millennials, selling through distribution organizations. One of our partners is headquartered here in New York, Policygenius, and their whole business model, startup, is an internet-based selling of term insurance, some other products, to the millennials.
We've plugged into them as a distribution partner, and we've plugged into other distribution partners who are approaching segments of the market that we weren't in before. Again, it comes back to the combination of product development and distribution strength and where you want to add sales. Sometimes it takes a little longer because you've got to build these distribution relationships. Again, one of our strategies is to be so big in the markets that we participate, that if somebody wants to do manufacturer, our name comes up first because we're just the go-to company on a lot of products and strategies for distribution partners. That's what's happening with term. Back to digital, in order to be able to economically enter these low-face markets, you have to go from a person-based underwriting program to a machine-based underwriting program.
Over the last three or four years, we've made substantial progress in being able to automatically underwrite mostly lower face products. When you automatically underwrite, there's a whole series of things that you have to do. Fundamentally, you have to have a machine, if you will, that will allow you to take the personal underwriting out of it and just do it by the rules that you put into the underwriting algorithms. That's been quite helpful. Today, again, back to digital and the need for digital over time, we can digitally take an app, underwrite it with a machine, and issue it digitally, and in many instances, no human involvement in the whole process.
Maybe moving back to annuities quickly. One of your peers has had ROA decline a bit, I think specifically related to some of the riders and fee tiers and so forth. I'd just be interested in hearing, do you think you have any of those issues that would cause a decline in ROA? Or do you think that that's maybe idiosyncratic and that everything you're seeing from an ROA standpoint suggests more stability?
On the business, on the product lines where we have higher ROA, and part of that is because they're typically products that require bigger front-end investments, so you have more capital. The earnings on the capital, along with the other parts of the profit pieces, give you a higher ROA. On guaranteed lifetime income products, as an example, we've been getting 80 basis points of ROA. We don't have any product designs in significance that as they age, that ROA necessarily goes down. Actually, it's a new question for me, and I had to be educated. Apparently, we have some products that have that characteristic, but not very many at all. From the ROA of a product, guaranteed lifetime income in particular, that 80 is pretty solid, both on a new business basis as well as in force business.
Now, we are doing some product designs where there's less capital, and the ROA would be lower because there's less capital than the 80 basis points. That just gets into consumer demand and preferences. There's products that have low ROA, but none of those are affected over time very much either. Once you get the ROA, it should be steady over the life of the contract.
That's helpful. I guess some statutory cash flow testing. This is the time of year that you're wrapping up all of that work. Given some of the changes that were made on a GAAP basis at 3Q, do you have any update on what we should expect from your year-end flow testing, AAT?
Obviously, I don't know. Let me step back and address the headwinds of low interest rates. 3 categories. 1, product design. I talked about because some products don't make their hurdle rates, so it's the reprice shift, the emphasis, the products that are achieving their hurdles, to the extent the increased pricing drops volume, add new products. We're doing that in the life business, we're doing that in the individual business, that's really good. That's the first big issue of low interest rate product profitability. I'm very confident that the franchise that we have will overcome those headwinds with low interest rates. The second headwind from low interest rates is spread compression. As I mentioned, the digital program is going to absorb the spread compression, at least the spread compression that we had in our last three-year plan.
Interest rates have gone down a little bit more. We'll have to do more, I think we can work on other programs to replace the earnings from spread compression. To your question, the third issue is what happens to your need for increased reserves in low interest rate environments? It's kind of simple. Sometimes you just have to sit back and say to yourself, "This is a complicated industry, but it's not that complicated." You take a premium, you invest the premium, you pay a claim. Well, if interest rates are going down, the premiums have to go up to pay the claim. If you're in a guaranteed business, you can't move the premiums up, you have to make sure that when you put up your reserves, that you're pretty conservative. Our guidance on this, I think it's very good guidance.
By that, I mean we know the numbers. Also, I think it ought to be comforting to our investors. There's no cash flow testing challenges, to my knowledge, at current interest rate levels. There might be a pocket or two where it's a problem. Publicly, we've said that if the ten-year drops to 1%, there's about $350 million of extra capital required to build reserves. If the ten-year goes down to 50 basis points, it's about twice linear. It goes up to $750 million. If we go from where we are today all the way down to the 50 basis point ten-year, our cash flow testing would require another $700 million of capital. That's one year's cash flow. It's a very manageable amount of increased capital needs. We make $2 billion a year. We have $2 billion a year in statutory cash flow.
Some of that goes, 50% of it goes for product sales, 50% comes back for dividends and share buybacks, and that'll move around depending on product returns and so forth. It's a very manageable number.
Okay. At this point, let's see if there are any questions from the audience. Do I have any?
With opioids and obesity and suicide rates like they are the actuarial tables wrong? What are your expectations for mortality trends?
Yeah. The national statistics that we've seen are what they are, but then you have to, for each company, what markets have you been selling into? The markets that I just mentioned a short time ago that we sold into from a life insurance perspective mostly are affluent markets where the opiate crisis is not as great as it is in other segments of the marketplace. Our in-force business shouldn't be affected too dramatically by that. We did say at the end of the third quarter, and in part of our unlocking, that our old age mortality expectations that we set 10 years ago were a little bit aggressive versus what's happening with old age mortality, and so we took a charge for that.
At the margin, the present value of that change was large, but the actual incremental increase in mortality expense on a yearly basis already in the numbers for the most part, not a big transaction. Having said that, who knows where some of these medical issues will pop up? Generally speaking, the demographics that we sold into over the last 20, 30 years is not where the most significant impact is from some of those things that you talked about.
All right. Maybe if I could ask one last one. I guess just thinking through the cash flow, you already talked a little bit about how much statutory earnings you generate and how much is available to the holding company. Could you just talk about priorities for capital deployment, and if there's anything like an annuity transaction like you did last year, or anything like that would potentially accelerate some of that capital deployment?
Let's talk about the Athene deal that we did. There's two sides to those deals. What is the buyer getting, and then what can the seller do with the proceeds? When we did the Athene deal, there was sort of a match in the marketplace. They could pay enough because of where interest rates were at the time that it made sense for us to do the deal. Since that time, interest rates have dropped dramatically, the math on both sides of the equation just doesn't work today. We continue to look at things like that, I don't think there's anything at this moment. Could change tomorrow but right now from a sale of a block of business, just the math doesn't work on both sides. Again, that could change tomorrow. How could that change tomorrow?
People who are buying it might lower their return expectations because interest rates are down and may not need as much as they thought they needed the last time they did the transaction. It's a tougher environment. In terms of the $2 billion in available cash for either supporting sales or share buybacks, at the margin, that's always a return on capital decision. Lincoln has cut sales back dramatically where products weren't getting the return, and we've used that money to accelerate share buybacks. It's always a discussion inside the company, what's in the best interest for our shareholders? Do we continue to build sales and cut back on our share buybacks, or do we slow sales down a little bit and increase our buybacks?
The number that we use is that in the individual life and annuity business, a 10% increase or decrease in sales absorbs about $175 million worth of capital. To put that into perspective, I guess we talk about $850 million to $900 million of capital available for share buybacks and dividends. You can either add $175 or subtract $175 from that number based on sales growth.
Capital.
That's a capital management decision, I think we've been pretty disciplined-
Yeah
around those decisions.
Okay. Well, I'll leave it there.
Good.
Thanks, everybody.
Thanks, everybody, for attending.