All right. We'll go ahead and get started. We're very happy to have Lincoln National CEO, Dennis Glass, with us today. Lincoln's in the business of annuities, life insurance, group protection, retirement here in the U.S. Dennis has been with the firm as CEO since 2007. In terms of the format today, we're going to be doing a fireside chat. I'll save a little bit of time at the end just to open it up to questions. With that, I'd like to say thank you very much for being here, Dennis.
We're delighted. Thank you for inviting us, and always like to attend the Goldman Conference.
Appreciate it. Maybe start with the annuity business. Can you discuss the index-linked annuity product that's planned to be launched during 2018 and the size of the opportunity you see in the market?
Yeah. The market size on that, by other competitors right now, is about $6 billion, and that can get bigger. It's kind of an interesting product. The way it works is that it's an indexed annuity crediting rate put on a variable annuity chassis. The importance of putting it on a variable annuity chassis is that you can let the customer take a little bit downside risk, in other words, break the buck a little bit. Maybe you'd set the minimum guarantee of principal at 90% of what the customer puts in. The opportunity then is to increase the participation rate on the indexed crediting factor. A little bit more opportunity for upside for the customer. That contrasts to a fixed indexed annuity, where you can't break the buck, just by law. Importantly, we always talk about the significance of our distribution channels.
It's sold in channels where we are already selling. Good product, consumer acceptance of where we operate in.
Got it. I guess just on the planned expansion of the wholesalers and annuities specifically, can you talk around some of the timing, how you'd expect that to unfold during 2018, and how it sort of flow through to sales?
Well, it's hard to predict how it'll flow through to sales, but let me talk about the strategy. We're increasing the wholesaler sales force, I think about by 15%, about 30 people. Most of that is going to be supporting product expansion in the bank channel. I think two-thirds of that, 30%. That's, Elyse, that's typically what we do with wholesaling. We get extra shelf space or we get another product, and oftentimes that's associated with expansion of the wholesaler force. Again, I don't think I can tell you that's worth $X million in sales, but I can tell you it's a positive opportunity for us. Just sort of on the other side, when sales are down, the VA or any product channel, sometimes you have a reduction in your sales force.
The fact that we're going up, the fact that we're selling a broader product line in existing channels calls for wholesaler expansion.
Okay.
Sort of our playbook.
Maybe on the DOL, the fiduciary review kind of going on, how do you see it playing out with the harmonization just between DOL, SEC, NAIC, Annuity Suitability Working Group, et cetera?
Yeah. We're at the front end now that the second phase of the DOL has been delayed until July 1st of 2019. One of the key opportunities is just what you're talking about, is to get more of a harmonization among the key regulators. You mentioned them, the SEC, FINRA, the Department of Labor, and the state regulators. Each of those groups, or the leaders of each of those groups have made positive statements about trying to get to a harmonized standard. We're encouraged by that. We certainly will continue to work for that to happen. Obviously, having multiple different rules on a single product doesn't make sense.
If you have it looked over by the DOL, it's looked over by the state regulators, and they don't have the same sort of view on a harmonized best interest standard, that gets complicated. Anything that can happen among those, again, repeat what I said, seems to be the positive direction that we're hearing from each of those groups.
Some of the life insurance products have been repriced for principle-based reserving. I think in certain cases it's changed. Think about the annuities of business and some of the things that are going on with the NAIC changing the VA capital framework. Do you see any need-
Moving parts. Specific answer to your question is, at this point, we don't see significant repricing driven by the captive issue and the other things that are going on. There's a couple of pieces of that that we're watching. As a general matter, the NAIC is going in a positive direction on captives with VA. We are encouraged by that. Again, I'll qualify that by saying there's one or two things out there that could change. Even with that, I just don't see a big repricing effort as a result of the captive work that's being done by the NAIC.
Turning to life insurance, some of the guaranteed universal life sales have declined in recent years, the MoneyGuard product has really picked up much of the slack with term life as well. Can you just discuss the hybrid LTC market? Do you think there's still room for growth there? What's sort of the strategy with the planned increase in wholesalers, and how you'd expect it to kind of play in there as well?
Yeah. The hybrid LTC life product is going to continue to be driven by the demographics in the United States. We all know the numbers, 10,000 people turn 65 every year. A large portion of those people need some type of LTC protection. That market's just going to get bigger and bigger. What we're also seeing is that financial advisors, to an increasing extent, are seeing the need for that product. They are more likely to show it these days than maybe so in the past. The demographics, the need for the product, financial advisors getting more comfortable with the product, I think they are all powerful tailwinds to make the LTC market a strong and robust market as we go forward.
Maybe shifting gears to tax quickly, just with the House bill, the Senate bill now out there, do you have any updated views you'd provide on the impact of the tax?
I've been spending a lot of time with other CEOs on the Hill there because there's been so much ongoing change. Let me start by saying nobody knows what the final bill is going to be. Therefore, anything I say in the next couple of minutes has got to be qualified by it's an ongoing process. Big changes keep occurring. On the Senate bill that was passed on Friday, if that's the bill and the provisions in that bill were retained in the final rewrite. There's two issues for most companies and then an industry issue that I'll talk on. The two issues are first, do your cash tax-- so that's different than your effective tax rate. Do your cash tax payments change?
Based on what was passed Friday by the Senate, Lincoln's tax cash payments would go up moderately over the 10 years, creased as affecting our current capital deployment plans. A little bit up on cash tax, but not affecting our capital deployment in a material way. That's the tax cash piece of it. The next piece of it is what happens to GAAP operating income and GAAP operating income per share. Again, based on the Senate bill, we expect to see a moderate accretion as a result of the bill. We think our tax rate will go down somewhat. Not going to try to quantify that other than somewhat. A little bit up in terms of accretion. I think that's a positive outcome. Again, if you don't mind me qualifying this, that's the Senate bill passed on Friday.
More things are going to change, that could change as well. Slight increase in cash tax payments, manageable, doesn't change our view on our capital deployment plans and some modest accretion on the GAAP operating income per share side. There's a third issue that we all have to pay attention to. When I say we all, I mean, broadly speaking, the insurance industry. A lot of my counterparts and our competitors have talked about this, but that's the effect of the change in the tax rate on RBC. As a general matter, if the tax rate goes down, if you have a loss and you have less taxable benefit versus where you are today, that'll have a effect on the RBC ratio.
The magnitude that people have come out with that, I don't know what it is for the industry in general, but there's downward pressure on RBC. I think a couple of things. Let me talk about that for a minute. I think a couple things. One, because it's an industry issue, if it goes down, I think there will be a recalibration in part about what's a good RBC ratio. What's Lincoln's versus Pru and so on and so forth. That RBC actually is sort of just mostly important as a relative measure of different companies' capital strength. I think there might be a recalibration. Lincoln, and I suspect most companies, but let me just limit it to Lincoln. We do our stress testing around the objective, not so much of RBC, but around the objective of maintaining our ratings.
Recalibration because of a downward drift where they sort of measure the impact of these bills. They haven't really come out and talked about it. They have their own capital models. They have their own capital, excuse me, investment loss models. It's different than the RBC. The more important issue, I think, for the industry handling is how do they change? Don't know the answer to that. Even if there was some pressure to increase capital because of this issue, the rating agencies would incorporate that over time. Even during the crisis, if you count. Then just back to will there actually be a change in RBC? That's not 100% clear because it's a sort of locked-in factor by the NAIC in the model. They would have to change their model assumption.
Just be aware that there could be some downward pressure, and there's a lot of different players. It remains to be seen.
Okay. That's very helpful. Maybe moving on to the digital initiative. A fair amount of focus on sort of how that could translate to some expense saves over time. Could you also kind of help us think about how it could contribute to the underwriting process, the margin kind of embedded in new value, and maybe some of the products that that would impact?
Investing in digital for Lincoln is because we think that the customer service experience is being set not by our competitors as it has been in the past, but by the born digital companies. If you're accustomed to interacting with Uber or Amazon, that same kind of experience with all your providers of services and products. Our goal is to move up the scale, and digital has a lot to do with that in terms of the customer experience. We're pretty excited about that. In the digital program, there's many dimensions to it. Just to list a few. Cost reduction comes from the utilization of optical character recognition and robotics. We have people reading them and then taking the data off of the paper and incorporating it into, say, an administrative system. That can be done using optical character recognition.
A machine reads the paper rather than the person. Robotics can be used to enter it into the systems. That's a very powerful cost reduction, and while you're improving the overall customer experience. We're working on that. Dropping down to your specific question, Alex, yes, there will be digital in on and underwriting, reaching out into the social networks to get data that otherwise you'd have to get through a doctor's report. That's happening. There's automated underwriting that makes it more cost-effective to do products that have narrower margins, such as term products. That's in place, and we're doing that. There's quite a bit. I think it's hard to isolate digital as a component of dramatically reducing the margins there.
When you add everything that's automated underwriting, digitization, which would be sort of from app to issue, there's no manual participation in that. We have some products that do that already. All of these things help with the margins on particularly term insurance. That's where our first focus has been because we see that as a big opportunity moving into sort of the millennial market. In general, it's positive, but there's so many pieces to it's hard to say that digitization all and of itself is going to have a big impact. It's a very powerful opportunity for Lincoln and others to take advantage of this whole digital world.
One of the positives that I came away from the Investor Day with was I think the digital initiative was, I think, supposed to be neutral as we kind of look into 2018. What are some of the other things that can kind of help drive margin improvement, I guess, before we start seeing the digital initiative start to flow through?
Yeah. I think the way we've characterized this is I think we have isolated about a $50 million investment in digital over the next couple of years. The actual number will be a little bit higher, but there will be benefits from digitization and the other programs that lower our overall G&A cost. I think we're sort of talking about $50 million a year, $40 million a year. That 40 is a net number as every year we're going to get some improvement. Lincoln has always been a company that focuses on, I think, effectively on expense management. It really starts with the basic requirements of the business units and the staff areas, the corporate staff areas, as you enter into the budgeting process. That fundamental requirement is your costs have to go down 2% about more or grow 2% less than your revenues do.
If your revenues are growing at eight, your costs can only grow at six. Just sort of embedded in the day-to-day management of the company, we would see margin improvement because of that requirement. Then you do special deep dives where you think you can get even more from that, the digital, more than just that 2%. Examples of that would include, separate from digitization, our retirement business costs have historically been a little bit higher than the industry. We've got a very powerful program to bring those costs down, some of it from digital, just some of it from process improvement, separate from digital. That would be an example.
On the investment cost side, I think we've talked about this, we've reduced the fees that we pay our money managers on the general account, which has generated a pretty significant reduction in our general account management fees. I think it's in the neighborhood of $20 million. I think we've talked about that. Then we're also negotiating with our mutual fund companies inside of our separate accounts. There, we increased the revenues from our administrative fees that provided us more income. It's not a fees with each one of our mutual fund partners trying to get those down a little bit. That'll create some opportunity. I'm speaking about the ongoing, you start with 2% improvement, then you deep dive where there are obvious opportunity to even do more.
Section. The expansion into supplemental and voluntary, just mentioned with critical illness, I think, in 2018. Could there be an M&A element to further expansion in this business?
Let's talk about the product. Yes, we continue to emphasize increasing our opportunity within the traditional sense of just buy-ups. If your employer provides you $10,000 a year in life insurance, you can buy up and maybe get $15,000. That's a typical way in the past that you have benefited from the employer-paid side, critical illness, other sort of severe cancer insurance and things like that. In that respect, we've talked about the administrative platform changes that we're making, sometime in 2018, the platforms will permit us to products, we see that as a very positive lift to the top line in the employer-paid side. Administrative changes help try to penetrate this and keeps going up.
Okay. When we think about the group protection business, you guys are developing some of your products here. You're kind of hitting some of the margins that you had laid out as targets. Is the need less necessary at this point?
Well, I would say that we're at scale in the market segments that we are focusing on. There's no need to do, from a scale perspective and the ability, there's no need to do M&A to achieve those sort of organic growth and margin improvements. Separate from that, we've had a goal at the corporate level to increase our profits coming from non-capital market earnings drivers, non-equity market, non-interest rates. That's really mortality and morbidity, because we already are so big in the mortality business. Over time, if we could achieve something on the group side from an M&A perspective, I'd like to see that happen.
Sure. One of the things in the U.S. Treasury report that they put out on asset management and insurance regulation, there was a recommendation in there, I guess, to make group annuity sort of guaranteed income benefits a greater portion of the menu that's available to 401 investors. I was wondering if you had any thoughts or kind of view that as potential growth area as you look at your retirement business.
We have a couple of products that provide guaranteed income inside of 401s. They haven't taken off. They've been in there for two or three years. In the DOL, there's this one provision that sort of puts the burden of measuring the solvency of the insurers that provide that protection on the shoulders of the plan administrators. They're really not rating agencies inside corporate America.
401 departments. I think to get any real traction on guaranteed lifetime income inside of 401s, that impediment has to be removed. I think it probably is on the list of the things that the DOL would give consideration to removing. The answer is, it may be a group variable annuity contract, it may be another chassis, but the most important thing is, I believe Americans ought to have access to guaranteed lifetime income within their own existing 401 plans, 403(b), and so forth.
This one, I guess just on capital. An item more companies are grappling with is just the value proposition of share repurchases versus other opportunistic uses of capital. Can you provide some commentary around what drove the decision at Lincoln to reduce the targeted cash flow as a percent of GAAP operating earnings for the cash flow?
Yeah, Alex, I think let's get on the same page because I think it's the other way. We have not reduced our targets for share repurchase. As a matter of fact, we've increased them. Historically, we provided a range of 45%-50% of GAAP net operating income as what's available for discretionary use of capital, share buybacks. Increased that up to 50%-55%. We actually increased the target. This year we've said that we might be above that 50%-55%, I think predominantly because we always talk about the fact that when a particular line of business sales go down, that frees up capital. Capital that would have otherwise this year gone to support the variable annuity business is being used to buy shares back. That's why we're above our 50%-55%.
To summarize, we were at 45%-50%, we moved to 50%-55%, 50%-55% is our ongoing target.
Got it.
When there's opportunities, either this shift in sales of guaranteed to non-guaranteed frees up capital because the non-guaranteed products are less capital-intensive. The 50%-55% is a good number for everybody to use in their models and specific reasons as we go down the road.
Got it. I'm sorry. I should have made that clear.
Yeah. That's okay.
Now we got about five minutes left. I just wanted to make sure if there were any questions from the audience we had an opportunity to ask them.
Dennis.
The microphone.
The pension risk transfer business that some of your competitors are active in. How do you look at that business as a sort of mortality-driven business or maybe an investment management business? How do you think of it as a potential opportunity for Lincoln?
That's a question that there are different views on. Here's my view, it'll be challenged by people who are in that business. I view it as a credit risk business. In order to make it work, you have to take excess credit risk. Certainly there's some mortality and morbidity to it, but I think bottom line, it's a credit risk deal. Having said that, there are companies that we compete with that have a much, or sort of historically have had more in-house sourcing capability to approve or met. They have these vast employee systems that raise middle market loans, or they raise, or they can source, or excuse me, less liquid assets in the middle market. They can source mortgage loans.
They have sort of an in-house capability to take incremental credit risk that a Lincoln would not have because we don't have that same in-house capability. We do on the mortgage side. Bottom line is, I don't view that as a retail product, I view it as driven more by credit risk than by sort of the broader distribution, product breadth, risk management, connectivity that we do that I think makes our franchise more competitor resistant. Good business for some people, but not for Lincoln.
Dennis, within the Scott Amendment of the Senate tax bill we talked about before, it looks like the industry kind of got product neutral for most of what was put through from the bill there. Do you agree with that in general? Is there anything else that you might see that might be affecting a line of business more than others with at least
There are two or three different spots that sort of raise revenues that seem to me that any particular line of business is materially benefited or materially hurt by what's in the Scott Amendment or what's in the Finance. Maybe you'd make an argument that the group business has a little bit in some of these other factors that are the DAC tax and reserves, long-term guarantee products. Let me summarize. I think it's fairly neutral across businesses in aggregate, which is not to say that there's not a company that could have a better or worse outcome depending on their specific business mix. Generally it's and intentionally on the part of the industry because we've been advocating for a set of changes that were just that, mostly neutral across business lines, business models. This is so fast-moving that anything can change at any hour.
It could turn out that one business model or the other is more dramatically affected, that's not the case right now to the best of my knowledge.
Maybe I'll sneak in one last one. Can you provide any kind of update on just what you're seeing in terms of fourth quarter annuity sales as it relates to maybe the partnership with Athene? I think there was some commentary at the investor day, the Max 6 Select product you'd sort of gotten going.
I believe at the IRD, we indicated that we're seeing strength across individual annuity product lines and across channels from a sales perspective. That has continued for the last couple of weeks. We're quite pleased that results are better than what we've been seeing. We're very excited about the fourth quarter sales without getting into more detail and consistent with what we said at the IRD.
Okay. Very helpful. Thank you.
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