Good morning, everyone. I am Jay Gelb from Barclays. I cover the U.S. insurance stocks. We are very pleased to have with us today Dennis Glass from Lincoln Financial. Dennis is President and CEO of the company. Lincoln benefits from a strong presence in U.S. life insurance, annuities, retirement savings, and group insurance. The company has been able to effectively manage the sustained low interest rate environment. With that, let me turn it over to Dennis.
Jay, thank you very much, and good morning to everybody. Let me start by pointing you to, and asking you to read our forward-looking statements and cautionary language that you can find in the appendix of this presentation. This morning, I am going to cover a few specific areas. As I look in the audience, I know some of you follow us pretty closely, this will be repetitive to some extent. For new people, I wanted to touch on strategy. I am going to highlight our strong financial results and why we think they are sustainable, and then talk about the key management actions that are underway to continue the strong growth and return on capital that you have seen us produce over the last couple of years. Let us just talk about high-level strategy for a minute. We are in four businesses, annuities, group protection, life, retirement.
We are completely in the United States, and we think that the markets that we participate in the United States are good growth markets that will permit us to continue our earnings growth in the 8%-10% vicinity over time. I will talk about that in a little bit more detail. The reason that we think the U.S. markets are good opportunities for us, just a focus on U.S. markets, is because when we go to market, we are not always across the entire spectrum of the marketplace, but we select within a particular market, what we think are the high growth opportunities. Just a couple of examples of that you can see under the high growth segments. Take our group protection business as an example. In a group protection business across all company sizes and employer paid and employee paid, probably middle single-digit growth. If you concentrate like we do on the smaller end of the firm size and with an increasing focus on employer paid, you can get that 5% up to high single-digit growth rate opportunities. It is that sort of reflection on what are the strongest segments in each of the markets that we participate in gives us 2%-3% across the board better opportunity than the entire market might produce in the United States.
Adding to our high growth choice of markets, we lead with one of the best distribution strategies, best distribution organizations in America. I will talk more about that. We have retail-focused products that are innovative, big solutions. I will talk about that in a little more detail as well. We have best in class risk management. Finally, we bring it together with a strong capital position.
When you take that all together and back to my original comment, well, let me talk about one other thing before I get there. In addition to these factors, another strategic initiative that we've had underway over the last couple of years is to sort of de-risk our business by reducing the amount of sales that we have in long-term guaranteed products. I'm pleased to say that as you can see on this slide, our target is for 30% of our sales to be in the long-term guaranteed marketplace, specifically guaranteed universal life and variable annuities with long-term guarantees, and 70% of our sales in the non-guaranteed business. About three years ago, we were at 90/10, and today we've already achieved our targets of 30/70. I think that's an important diversification of risk that we've achieved in that timeframe.
A second area that we're looking at, not looking at, but we're trying to achieve, is increase the amount of mortality and morbidity earnings that we drive. As you can see here today, mortality and morbidity represents about 23% of our source of earnings, and the rest of our source of earnings, that 78%, comes from capital market drivers, the equity markets, and interest rates. By the way, I think this display is an extremely helpful display. The source of earnings display very much complements and adds to the information about a company with respect to how they make their money, not just what markets or lines of business that they're in, but how they make their money.
As you can see here in the insurance business, there is only three ways to make money, mortality, morbidity, the life insurance business, interest spread, and then fees on assets under management. We think that we can improve the consistency of our earnings as we achieve this split that looks more like two-thirds, one-thirds between capital market driven earnings and mortality and morbidity. That's going to take a little bit more than organic growth over time. We can get close to those numbers, but probably need some inorganic activity in that as well. I hasten to say on this, we're not in any great hurry to get to that two-thirds, one-third, but driving to it over a period of time.
Reducing the amount of long-term guaranteed business that we sell, increase the amount of earnings coming from non-capital market driven sources rounds out the strategy that I just talked about in total at the firm level. Let's talk about that strategy and what type of returns it has produced over time. As you can see here, our returns have been quite good. We've had 6% compound growth in operating revenue. We've controlled our expenses very well. We've had tremendous positive growth in book value per share and ROE expansion, earnings per share growth at 12%. We've done this all the while that we've been improving our capital position, and I'll get into our capital management activities in a little bit.
I think I ought to be able to stop right here with a chart like this that shows such great progress and not have to go much further. The facts are what the facts are in terms of what we've achieved over the last four or five years. Again, it's not what you've done in the past, it's what you've done in the future. We'll continue the presentation and talk about the future. We're very proud of those results. They didn't just happen. They happened because of this keen discipline focus that we've had on strategy, markets that we're in, and the other things that we do strategically. I think this is a great slide as well. I think valuation can be improved with greater transparency for investors. How do we make our money? Where are we going to see growth come from?
Let me talk about each one of these growth drivers, starting with organic earnings. You see that over time, our 8%-10% expectation for earnings per share growth starts with sales, positive net flows, and we think in the 8%-10% target over time that we should get 4%-5% in this category. I guess right now we're a little bit below that, and I would say this is an over time depiction of how we expect to get to 8%-10% growth. We think over time we can do this, but in any particular period, any one of these bars might be higher or lower contributing to the overall growth. Right now, the 4%-5% coming from positive net flows and sales, a little bit short of the 4%-5%, and let me talk you through that.
The variable annuity business, which is a helpful driver of that, is being affected by volatility in the marketplace. Our sales are a little bit lower. I'll talk about how we're going to turn that around. We're seeing good flows in our retirement business, making a lot of additional investment there to help that grow. I guess our life business is in that 4%-6% range, it's right on the target. Then finally, our group premium growth has been a little bit slower than we expect, that's coming back as well. As I sit here today, the 4%-5% might be a little bit higher over time. Looking backwards, it's been a little bit higher than 4% or 5%. Right now it's a little bit lower, and we expect to get back on track at 4%-5%.
The next one is you sell a lot of business, you sell it at price and returns. Some of your assumptions don't turn out the way you expect, you have to have in-force management. Historically, we've talked about that particular box in the 1%-2% range as representing the return of profitability in our group business. I would say that today we think about that 1%-2% from a combination of in-force management activities across three of our businesses, life, group, and RPS. I'll touch on that in a little bit more detail. The next one is expense efficiency, let me say that we have a very disciplined annual budgeting process. It starts with an absolute requirement that the business units drive expenses 2%. The expense growth has to be 2% lower than the expected revenue growth in any particular year.
Part of that's easy to come by because if your volumes are down, your variable costs go down, and that helps with expense efficiencies. Most of the time, that's not enough, and you have to year in and year out, reduce your core fixed expenses to maintain that 2%. Again, we've done this effectively over time. I think Lincoln is known in the marketplace for good expense management. I'm going to talk about that a little bit more because I think there's more on top of this 0.1% in the future. The capital markets, pretty much offsetting as you see here with a 6%-8% return in the equity markets. We expect to get 2%-4% of our earnings growth off of equity market growth, increasing assets under management, the value of our assets under management. As everybody knows, interest rates are low.
I'm going to go into this in a little more depth in a minute, but interest rates being low, you don't have to be a victim of that. You can respond to that. There's no question that it's 2%-3% of an earnings drag. Again, offset by 2%-4% if the equity markets continue to grow. It's not a balance sheet issue. Again, I'll talk about that in a little bit. Then finally, 2%-3% from buybacks. We consistently have earned that 2%-3%, and I'll talk about capital management a little bit more in a minute.
Again, I think this is a good depiction of how we expect to get to 8%-10%, and there's a lot of disclosure in our SEC statements around impact on our earnings from ups and downs of 1% of the equity markets, the impact on our earnings of a 50 basis point decline in interest rates. Really, you ought to be able to, with some confidence, get a feel for how we can grow our earnings. Let's take a look at our financial results as compared to peers. I think this is again, I ought to be able to stop here with the presentation because these are so compelling of results until you get to the bottom. Over the last period of time covered by this slide, our earnings per share has been 12%, peers 8.
Excuse me, book value per share growth 7 to peers 5. Lower volatility. I think some people think that particularly because of our annuity business, that we'd have more volatility in our earnings. That's not been the case as compared to the competitors. ROE expansion, twice of what the competitor has seen over this time period, and our capital position remains as strong as just about anybody in the industry. You would expect with that kind of relative performance, that our valuation would be better than what you see at the bottom. It can be frustrating for management to see these kind of results and this kind of valuation outcome. We're a glass-half-full management team, and we see it as an opportunity for our investors to see greater returns over time as these sort of facts get into our valuation.
Why do I think that the valuation is less than what it should be on the basis of the numbers that you just saw? There's a couple of things. One is an industry issue, and that is, for some reason, we're believed to have more interest rate exposure than the competition. Unless you do the source of earnings analysis that we do, you really can't come to that conclusion. Again, the only other company in the industry that displays their earnings by source of earnings is Voya. You can make a pretty good comparison between the interest rate exposure that we have versus Voya, but you really can't do it against any other company. For example, a closed-down pension business, that's a long-term guaranteed business that's very interest sensitive. Companies that are heavily invested in that have more interest exposure than you might think.
When I look just at our effects from interest rates, we showed this slide at our investor day. Both of the pieces of this slide are very important, but let's focus on the left-hand side. As I said, spread compression is in the 2%-3% range, it is a 2%-3% earnings drag. You saw in the preceding two slides earlier how that's overcome by the other drivers of our earnings. When we talk about interest rate risk, there's three buckets. There's earnings drag, there's profitability of your new business, there's the risk to your balance sheet of persistently low interest rates carrying on. We continue to show this information, which is that even at very low interest rates out into the future, permanently out into the future, I think we use 0.5%.
The impact, our overall capital position is still positive, or our reserve position is still positive, except there's a couple of sub-tests that pop up and are redone every year. Even at 0.5%, these sub-tests would only hit our RBC by 40 basis points. I don't think we're going to see. Well, we could see 0.5%. I wouldn't predict that. Again, we're displaying that even at very low interest rate levels, there is no risk to the balance sheet, no significant risk to the balance sheet from persistently low interest rates. I can't emphasize that enough. I still think people forget about that's a little bit of the reason our multiples are lower than they should be. The other issue that hits us from time to time is sort of company specific.
One of our competitors just had a $2 billion write-down on their variable annuity business as a result of their policyholder behavior assumptions not matching with actual policyholder behavior assumptions. We've never had that big of a hit. As a matter of fact, our goodwill adjustment at one point on our variable annuity business has been quite consistent over the years. Importantly, again, we demonstrate with this slide worst case scenarios. Well, what would happen if we had a 50% drop in our lapse rate in our unlocking? It'd only be $50 million. I mean, it wouldn't be the kinds of numbers that you see coming out from our competitors, I'll show you why that's the case in a couple of seconds.
If you had full utilization, we assume, for example, that with our guaranteed income benefit, that people start taking income at a point and how much of the income that they'll actually use. Our utilization experience has actually been better than assumption. Even so, we demonstrated that a 50% off of our assumption would only be $160 million, and then mortality would be $90 million. We're in the process of doing our DAC analysis. I think Randy has said that we don't have any reason to believe that we'll see anything significant, but I won't front run that.
The point is that even though other companies have taken billions of dollars of write-downs, and I think that cast a little bit of a pallor over the variable annuity business, the way we run it and have run it for the last decade and a half gives us these kind of good results as we look forward and do sensitivity testing. These two things, again, I think have a proportionately higher impact on our share price than they should when you look at the reality of it. Well, let's go back to the annuity business, and let me give you some explanation as to why these policyholder behavior assumptions aren't as bad for us as they have been, not for everybody, but have been for a few companies over the years.
The first reason is not precisely shown on this slide, is that when we got into the business 12 years ago, we did everything correctly. We fully hedged the position, we understood the products, we understood our distribution, we had good risk management. It really goes back to the beginning when we got into the business, the results that we're seeing today. Randy likes to point out, and I think it's accurate, that one of the big differentiators between us and the competition is that we were 100% hedged going into the financial crisis. Working through the financial crisis, unlike some of the competitors that weren't in that position, we didn't have to spend a lot of money on additional derivatives to get back into a hedged position. That's just one example of a consistent approach.
You can see on this slide here, that we haven't had the same swings in sales volumes that our competitors have had. That's driven by the value proposition that we started off with, again, a decade and a half before, which is it's account value first that matters and guarantees second. We've never been in the guarantee war that some of our competitors got into to drive sales. Very consistent sales in the market consistently. Some years we're not getting the 20% that you show are average, but over time, if you're in the market consistently with a smart business approach, this is a very good business.
That little gray box gives you a sense of the relative risk in our VA book as compared to our competitors' guaranteed living benefits net amount at risk, you can see that our book, at 0.5%, is quite a bit lower than the peer average overall of 6.1%. Again, it goes back to these fundamentals, consistency in the marketplace, driving the value proposition with account value growth first and guarantees second. From day one, your risk management being completely consistent and covering as much of the risk as you can. Our hedge position, we're pretty well-recognized for having one of the most sophisticated hedge programs in the industry.
This comes from our belief that if you're going to be in a business, you got to be in the business in a big way so that you're at scale, you can attract the right talent, you can invest in the systems, the algorithms, and everything that's necessary to run a business that does have risk in it. You can see again, over time, we've had minimal historical breakage. Again, this business, I'm spending a little bit more time on it because I think it's a much better business and a much more, less volatile business than people perceive it as. Again, mostly because of the stumbles of the competitors, we've differentiated ourselves. Even right through the financial crisis, we don't have hedge breakage going back into the financial crisis, but even during the financial crisis, the hedge breakage was not particularly large.
No real interest back to why do I think our multiple's a little bit lower. One, a perception of interest rates being more damaging to the balance sheet. They won't be. Again, the drag to the annuity business is good business for the reasons that I've talked about. I think, again, as this gets better understood in the marketplace, our metrics on valuation can come up. That's what we've done in the past. Let me talk now a little bit with a few minutes remaining about what we can do in the future. Let's come back to the issue of low interest rates. What we've displayed on this slide is the two businesses that have the most interest rate exposure to falling, excuse me, most exposure to falling interest rates.
That's the spread on our life business and the spread in our retirement business. As you can see in both those, they've fallen off quite a bit, particularly in the 2013, 2014 period of time. Up until 2013 or 2014, you could lower on the life insurance business. You continued to lower your credited rate, you could absorb some of the decline in interest rates through that mechanism. Most of the industry hit the floors sometime in this time frame, you had to do other things, we have to do other things to continue to mitigate that. The same thing in the RPS business. The minimum guarantees embedded in those products creates the explanation or the reason behind the declining spreads.
You can see the patterns here, 2012, 2013, when we saw the biggest drop in the 10-year rate was when we saw the biggest drop in our margins, our spreads. As we look out into the future, because interest rates are closer to our portfolio rate, that compression over the next three to five years will be smaller than it was certainly in 2012 and 2013. What other things do we have to do to respond to these headwinds? Now, even though on the top of the slide I am talking about the RPS business and the life business, these next comments are more general about our company and how we can react to it. One is in-force actions. Really, particularly when you could drop your credited rate, you did not really look at in-force management with the same intensity that you have to look at it today.
In our businesses, we are looking very hard at ways to improve the profitability going forward on in-force management. There is a lot of exchange policies from term to permanent commissions that we pay to our agents and activities like that. The biggest opportunity for us is in in-force repricing as we go forward, and that would occur in all of our businesses. I will talk in a minute about the in-force repricing that we have done in the group business that had 1%-2% potential growth associated with it. In our retirement business, a little bit harder, but we have an active program in trying to get the minimum guarantees in that block of business down. That does not come without other changes in benefits and expenses, but we are working on that. In our life business, we have announced recently some non-guaranteed charges.
We have non-guaranteed charges that we can increase, and we have done a little bit of that. A lot more focus on in-force management and the profitability of in-force business, which is needed today and is taking a lot more management time than it has in the past because this is the next phase of managing our long-term opportunities. Expense management, I talked about the discipline expense management. Lincoln has been pretty good at sort of this 2% lower discipline, 2% expense growth lower than revenue growth discipline. Episodically, we try to attack our core operating expenses. A couple of years ago, we did that through a technique called delayering. How many levels of management between me and the lowest level of management? What is the span of control? We have employed things like that. Procurement has added additional level of expense reduction.
I think the new opportunity, I do not think I know that the new opportunity as we move forward is in the whole digitization area. Just sort of a comment on digitization. The Ubers, the Amazons are setting the expectations for customer interaction with companies. Uber and Airbnb and companies like that were born digital. The life insurance industry was not born digital. We have a strong initiative that is underway to digitize across our entire platform. I think one of the consequences of that is not only a better consumer experience, but we will be able to get some efficiencies on the expense side. Let me hasten to say, I cannot put any math around that because we are in the stage right now of exploring this. I think without question, it will help drive down our fixed cost base over time.
In-force actions to combat the reduction in our margins from interest rates and expense management, I think there's big opportunities there to blunt a lot of the interest rate impact. Talking about further margin improvement in the group protection business. Unfortunately, for about a period of 15 months, we let our pricing controls get out of whack a little bit, and we've spent the last 24 months repairing that. The way we've done that is through our claims management improvement which had, in addition to pricing, fallen off a little bit, and then the repricing, if you will, of the entire in-force block of business. Most of that's done. We said on our last earnings call that all of the repair activity that we've had to go through over the last 24 months, 30 months is behind us. The entire in-force has been repriced.
The big changes are behind us. Of course, when you renew your business, the way the business is priced, you have to get increases on your renewal strategy to make your profits expectations when you price the business. The first two, claims management and pricing discipline, insofar as management's able to affect that, which we do, that's behind us, and I'm quite proud of. I'm not proud of the fact that we let it get out of whack, but I am quite proud of the fact that we got it back where it needs to be. As we look forward, the issue now is getting growth in premium in that business.
As we hit hard on renewal pricing, the persistency on our in-force book has dropped down to 70% and in that neighborhood, maybe even a little bit lower than that, as we've, in this last pricing effort, not had to go out for 12% and 13% or 14% and 15% price increases and what's more normal in the marketplace, our persistency is coming back. I think what we're suggesting is that premium growth, which is the last leg of the effort to get back to our 5%-7% margin, should emerge in 2017, maybe even the fourth quarter of 2016. That last leg, again, of getting back to our margins is in sight. I'm happy to be able to report to our shareholders that progress. In-force expense management, redoing the group business, these are all management actions that are underway.
Now let me come back to the ongoing creativity around product, the ongoing intensity around distribution expansion, and improving the productivity of our distribution. This is a good slide talking about from the perspective of, I said earlier that our value proposition or, excuse me, our go-to-market big distribution organization with a wide portfolio of customer solutions and the constant connection of those two things. Here it's just an interesting depiction, I think, of the breadth and diversity of our overall portfolio. You can see not any significant one product doesn't make up a significant amount of our overall sales. That's a big takeaway from that. I'm also really excited about the new business opportunities. Again, big distribution I'll talk about in a second, along with a broad product portfolio. What are we doing in product portfolio?
In the annuity business, again, where I mentioned earlier that we've seen sales come off, particularly in the VA business, pretty dramatically, we're very excited about the product development that we have underway. Just 2 points on that. With DOL in particular, the DOL final rules said commissions can be the best way to compensate an advisor, particularly on insurance products where the advice cycle is on the front, they put all their energy up front, they ought to get paid for it. The DOL is very firm that commissions can be the best source of payment for advisors for certain products. Let me just say that. Nonetheless, there's a lot of advisors that want to be compensated on a fee basis.
That's not been the case in the industry, we're putting a lot of effort into fee-based VA and fixed indexed annuity products. Another thing that I'm sure you all are more aware of than I am is that passive investment options are becoming much more utilized by the consumer over the last 2 years than active investment options. Again, that's not been the case in our portfolio. We're putting a lot of effort into passive investment option opportunities. Continuing the innovation around lifetime income. Today, a lot of when you think about product, there is the product, but then there's the overall, what I call big T product, which is the process.
In the annuity business, I'll talk about in life business in a little more depth in a second, you're continuing to see process to be more important than product or as important as product. When you're making a sale, it's not just talking to the customer about the 5% roll-up and the 5% payout, but how does it fit into their overall portfolio of investments, what opportunities, and being able to do that effectively, again, through digitization will become more important as we go forward. In the group business, we're continuing our development in accident and critical illness, absence management on top of our employer paid, employee paid stuff, big opportunities. Life, big effort, particularly focused on that. You saw that first slide in the millennials. LincXpress is a digitized end-to-end process where you can apply for the insurance policy digitally.
It goes through automated underwriting, you can issue the policy. Typically, from application to issue, the life cycle may be for more complicated products, 3 months sometimes. For term products, maybe 45 days, in that neighborhood, a little bit longer. With term, with LincXpress, we can squeeze that down to, if we can get the call in, if we can get with the customer, we can squeeze it down to almost 24 hours. Again, process, that's not a big part of our business, that's an opportunity for growth as we go forward. Lincoln TermAccel is just a term policy that's with automated underwriting for a certain segment of the millennial group. That's the kind of exciting activity we've got going on in Life. In RPS, we came out with a new product that's particularly effective under the new DOL regulations.
a lot of exciting, both product development and process development to drive that 4%-5% column that I talked about at the beginning of the presentation. Product repricing, there's no question that we need to reprice some of our longer term guaranteed products. We did that once before, guaranteed universal life and some of the other long-term guaranteed products need to be repriced, and we'll do that. I'm running out a little bit of time. Am I four minutes or is that four minutes for both of us?
You're good.
I'm good.
All in. Yeah.
All right, all in. Product innovation, we've been good at that over the years, and these things that I've just talked about will continue to push that 4%-5% growth column in terms of earnings per share development, and our distribution. Let me talk about the bottom half of this slide first. At Lincoln, we do two things differently than the rest of the U.S. life industry. One of them is, I believe so much in the importance of distribution. Obviously, it's important, but even more so in retail. The distribution reports directly to me, and that's not that I have that much impact on what goes on so much as we have the head of distribution sitting at the senior management table.
Also, what it allows us to do is, because people can see a distribution career track from entering the company as a distribution or salesperson all the way up potentially to the CEO role. When you have that type of an organization, you can really attract the best talent in the industry as compared to other companies who do it, sort of tuck the distribution under the business manufacturing unit head. We have a 200,000 strong independent distribution of people in the U.S. We get 90,000 of those people. So 90,000 people who have choices of manufacturers that they can sell product for choose Lincoln year in and year out. The strength of that distribution and the consequences to our strategies is enormous. If you have 90,000 people, they have 90,000 as value propositions for their own clients.
And so as we do pivots from one type of product to the other type of product, 90,000 strong, you can find somebody who is selling that new product and help with the pivot. That's when I talked about Guaranteed Universal Life as an example, when we were selling 90% of it, and we— 90% are life products on a guaranteed, or 65% on a guaranteed basis are Guaranteed Universal Life. Now it's only 10%. It's that distribution base and the distribution's own clients, to repeat myself, that permit that. And it's the same in each of our businesses. By the way, these are the outside independent agents. We have 1,400 people employed by Lincoln that interface with this 90,000, plus the other businesses that we're in. So what are we doing to make these producers more productive?
It's all these things that you can see, predictive analytics and tools to target, acquire, and develop producers. Just real quickly, in the annuity business, up until about two years ago, we had, I don't know, maybe 200 wholesalers out of the 600 wholesalers in LFD, and they would, on a pad of paper, they'd be going out into the region that they cover, and they've got the names of people and who they think they ought to approach to sell one of our products. Today, we have data analytics. We know who's selling the product. We know how much they sold. We know where they went to school. We know what their client base looks like. And so we're much more our wholesalers are able to quickly focus in on the right people.
Distribution, product as we move forward, are what has obviously driven us in the past and we think will drive us and differentiate us as we go forward. Active capital management, that's a big contributor to the 8%-10% growth. We talked about 2%-3%. The only thing I'd point out here, because we've talked about this so much, is that our target for free cash flow used to be 45%-50%. Today it's 50%-55%, roughly translated, that's $800 million of after we've spent a couple of billion $ supporting our new sales that get pushed up to the holding company that can be used for share repurchases or dividends. $800 million at the holding company. We pay about $200 million in dividends, leaves $600 million on average for share buybacks.
In the last two years, we have exceeded that $600 million by quite a bit, and that's related to transactional events. We did a reinsurance transaction, which helped with our capital, and we've done a lot of capital management financings. We continue to see that as a opportunity to contribute to earnings per share growth. With no time left, we have a clear strategy that's producing strong and sustainable financial results and taking decisive actions to enhance shareholder value. Jay, I'm sorry I've used all my time.
That's fine, Dennis. Please join me in thanking Dennis Glass from Lincoln.
Thank you very much.
Great job, Dennis.
Good. Thank you.
Very well done, as always.
Yeah.
Thanks again. We'll have questions in the breakout room.