Lincoln National Corporation
Q4 2020 Earnings Call Transcript

Published: 4 Feb 2021

[Operator:]

Good morning. And thank you for joining Lincoln Financial Group's Fourth Quarter 2020 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we will announce the opportunity for questions and instructions will be given at that time. I would now like to turn the conference over to the Vice President of Investor Relations Al Copersino. Please go ahead, sir.

[Al Copersino:]

Thank you, Catherine. Good morning and welcome to Lincoln Financial's fourth quarter earnings call. Before we begin, I have an important reminder.

[Dennis Glass:]

Thank you, Al. Good morning, everyone. During 2020, Lincoln responded well to the immediate health, economic and capital market challenges. We also took steps to add new products, and build distribution, improve cost-effectiveness, and strengthen the balance sheet. Fourth quarter earnings were affected by elevated pandemic-related claims, in our Life and Group businesses, which was partially offset by another quarter of strong returns from our alternative investment portfolio. Given this year's circumstances, we saw quite a bit of variability in earnings. When normalizing for several items in 2020 the largest of which were charges from our third quarter annual review and pandemic-related claims, we view our EPS for the year at approximately $9.30, and ROE, excluding AOCI, at 13%. Based on our current views, we are poised to deliver 8% to 10% EPS growth off this level over the long-term. Focus items during the year, included three initiatives, one, executing our reprice shift and add new product strategy. Two, achieving expense savings, while improving the customer experience. And three, maintaining a strong balance sheet and maximizing our financial flexibility.

[Randy Freitag:]

Thank you, Dennis. Last night, we reported fourth quarter adjusted operating income of $346 million or $1.78 per share. There were no notable items within the current or prior year quarter. However, this quarter's result was impacted by a number of items. First, pandemic-related claims reduced earnings by approximately $187 million or $0.96 per share. This included a $174 million mortality impact and $13 million from disability claims.

[Al Copersino:]

Thank you, Dennis and Randy. We will now begin the question-and-answer portion of the call. As a reminder, we ask that you please limit yourself to one question and one follow-up, and then re-queue if you have additional questions. With that, let me turn the call over to Catherine, to begin Q&A.

[Operator:]

Thank you. Our first question comes from Andrew Kligerman with Credit Suisse. Your line is open.

[Andrew Kligerman:]

Hey. Good morning, everyone. I wanted to focus on the Individual Life segment. And starting off with sales in the quarter, and I understand you repriced many of your Life products. But interest rates really aren't a big factor with term life, and per our producer survey, there was an expectation in the fourth quarter for mid-single digit sales growth, whereas your term sales were off 17%. So I'm wondering, did you reprice the term product? And why might you think it kind of dropped off in sales?

[Randy Freitag:]

Andrew, this is Randy. Well, thanks for the question. Andrew, I'm going to get to that question, but Al, let me know this morning that there were a number of questions concerning a report that you recently published on Lincoln. And so let me take this opportunity though, hopefully, clear up some of the confusion that I think has been...

[Al Copersino:]

You just told you about it morning. Wow, long time.

[Randy Freitag:]

That has been created by that report. So, let me make just a few points on that before I get to your sales, your term sales specific question.

[Andrew Kligerman:]

Sure.

[Randy Freitag:]

First, just a belief that we face a sizable charge in our Life business, as we've only taken $500 million of charges since 2011, and the report represents that this is too small a portion of our reserves versus charges that our peers have taken. Unfortunately, from my standpoint, I was correct the estimate of prior charges by noting that we've actually taken charges of nearly $1 billion since 2011. Including charges for mortality, which you can find in our SEC filings, those mortality charges have been focused on resolving many of the industry issues that are referenced. And the end result is that as we sit here today, we have mortality assumptions covering our business that are aligned with our credible experience and reflect the latest industry data on future mortality expectations. So in short, I'd say we're very comfortable with all our assumptions, including those pertaining to mortality, I think that additionally, I just say, I've seen this use - try to be used in other areas. You're using peers as the sole data point and driving expectations for - so Lincoln, it's really a blend estimate approach. I think that really ignores the fact that every year assumptions are trued up for experience and go through a significant amount of internal and external audit review. So that's the first, I think, confusion that I want to clear up. The second thing, it's really just broadly on the adequacy of reserves. As it pertains to GAAP just remind everybody, 95% of our life reserves are governed by FAS 97. And they've been reviewed and updated every single year. When you turn to the small amount of business, that we have that is governed by FAS 60, we review those sufficiency of those reserves every year. And without getting into specifics, I'll note that there's a significant amount of sufficiency. When you turn the lens to statutory reserves, our cash flow testing results indicate an overall sufficiency of $14 billion at the end of 2019. And additionally, the new factor I'd point out, with rates have increased somewhat, but I note that we now expect little to no impact from cash flow testing subtests at the end of 2021. So that's the second item I wanted to clear up some confusion on. The third is on this discussion around the potential for large price increases on reinsurance and or recaptures. We've discussed this extensively. I think we've discussed this more than any other company out there, actually. And in fact, we noted that our 2019 Investor Day that this issue is part of a $250 million annual headwind that was embedded in our earnings. As we sit here today, we've reached resolutions covering 70% of our seated face on. And I note that an additional 20% represents recent reinsurance treaties that are meeting all parties' expectations for that remaining 10%. For that remaining small 10%, we've accounted for likely outcomes as part of our assumption setting process. So I really think we're in pretty good shape there. The fourth item, I really dig into one of the re-insurers specifically, so as it relates to Scottish Re. It's - that 3%, it's a small piece of our YRT reinsurance. It's included in that 10% that I noted as remaining. And I'd also point out that we did take charges on both GAAP and FAS and in 2020 to account for likely outcomes that might come from Scottish. So on this, and I know it wasn't a specific question you asked, but I really think there was some confusion that I wanted to clear up. So just maybe wrap-up by saying that these represent the facts from Lincoln, in fact, that we've really talked about over the years, and we'll gladly discuss any of these issues further, any one of them, many meetings that we do with investors and analysts over the course of the year. So with that, hopefully, that clears up that confusion that I believe was put into the marketplace. So let me get around to your question on Life sales broadly and Terms specifically. I think the Term market itself is one where it's a price-sensitive market. So a little movements here, a little movements there by companies, we'll push sales up and down. I think, broadly speaking, in Terms, we have continued to increase our position in that marketplace. Our share of the Term market has continued to grow, I think, driven by our digitally focused ability to both issue and deliver policies. Our automated underwriting capabilities, especially for policies under $1 million. So I think we're very happy with where we're positioned. We did make some small pricing tweaks here in the first quarter that I think will have a favorable impact. Broadly on Life sales, what you saw in the fourth quarter was what we believe is a trough. I think we, at Lincoln, believe that when it came to repricing products that really needed to be repriced, given the environment, specifically low rates. We think we moved first on MoneyGuard. We moved first on other products. And I think that negatively impacted our level of sales. I do think that others followed. And so you saw a little bit of fire sale going on at some of our peers in the fourth quarter, and that probably negatively impacted our sales a little bit. I think the real key to Life and what we're really excited about is the work we did over 2020 to create whole new value props, especially in the MoneyGuard space and in the variable space, those products were rolling out here in the fourth quarter - in the first quarter, excuse me, of 2021, we'd expect sales of those products to - as usual, things start a little slow, but we'd expect them to ramp up over the course of the year. But I think those are products that really speak to the environment, right? You're using the separate accounts as the driver of value. You're shifting some risk to the consumer when doing that and away from Lincoln, and you're shifting products away from products that are negatively impacted by interest rates. So Andrew, that's what I broadly say about Life sales and specifically about Term.

[Andrew Kligerman:]

Okay. And then I guess just for my follow-up question, I think I'll just reframe from it because we're absolutely, there's no confusion on our part with this. Number one, the term insurance under FAS 60 does get marked. So that could be - does not get worked. So that could be a real issue. Number two, with regard to the assumption reviews, it absolutely came out to $500 million. There could have been other stuff. And then thirdly, in terms of looking over a 10-year period and saying don't look at your comps and you didn't mention the statutory numbers over 10 years, which was widely different from you versus all of your peers. I mean, the earnings were just outsized. So I think over a 10-year period, given that we don't have the data, this blunt indication is quite a jump out given Lincoln's exposure. And then thirdly, you mentioned that you recaptured most of the business. And the points of our research were that the companies that did recapture were anti-selected against because re-insurers had outsized information and ultimately recapturing the business and not leaving it with the re-insurers over the long-haul should be problematic. With regard to Scottish, I get that it's small relative to everything else, but over $12 million in-force on an absolute basis re-insured with a company that's in rehab and could experience severe problems. That's a lot of money on a stand-alone basis. So I'll just leave it at that, but there's absolutely no confusion on our end. And I appreciate your feedback.

[Randy Freitag:]

Andrew, let me say just a couple of thoughts. One, I own these financial statements. I can add, and you can add up $500 million - I'm telling you, factually, its $1 billion. So on the financial statements. I looked at the numbers, its $1 billion. So you can continue to say its $500 million, but just let me say, you're wrong, period end of starting on that topic. Once again, on this whole concept of FAS 60, it's 5% of our reserves, significant amount of sufficiency reserves really don't expect any issues when it comes to LDTI around that small component of our business once again. So I'm just going to beg differ. In terms of the stat earnings concept, I mean, if you look at our stat earnings over those years, and by the way, my numbers are a little different than yours? It's not materially different. They represent just a fraction of GAAP reserves, which is what you would expect, right? It's roughly 40% to 50% of GAAP reserve. That's what you would expect - our GAAP earnings, excuse me, is what you'd expect, there is strain in issuing business, and we're one of the leading writers of life insurance. So the results, to me, look right in line with what I would expect on Scottish. I noted at the end, we did put up impacts in our financial statements in 2020 for potential impacts from anything that happens there. So yes, I hope that the answer. Andrew, you are - as with any analyst, you are - it's your job to go and assess companies and you're open to come up with any opinion you want. I'm just trying to correct some of the confusion created by some points in there. But I just don't think are correct, and I tried to give the facts from Lincoln side. So I appreciate your thoughts. And thanks, Andrew.

[Andrew Kligerman:]

No, I appreciate it on my end as well. I mean, again, term life is $600 billion, $700 billion in-force. It's a lot of money. We'll see how it plays out, but I appreciate the feedback.

[Randy Freitag:]

It's interesting on this whole concept of post-level term. I'm not really sure who your experts are. Let me tell you, we work with every leading re-insurer in America, and there's a huge amount of relief interesting research done by some of the biggest re-insurers around what's called post-level term optimization. So yeah, I'm not sure who your industry expert is, but you might want to ask them those questions because there's a lot of very interesting research around optimizing post-level term results. Well, thank you.

[Andrew Kligerman:]

We did and there were multiple concerns.

[Randy Freitag:]

Thanks, Andrew.

[Operator:]

Thank you. Our next question comes from Tom Gallagher with Evercore. Your line is open.

[Tom Gallagher:]

Thanks. That's a tough question to follow, so I'll - mine will probably be a little more benign. So Dennis, I'd like to just follow-up on what you're thinking on risk transfer? Are you thinking just from a product standpoint, more likely on fixed annuities, life insurance or variable annuities based on the work you've done so far? And based on kind of the work you've done so far, are you anticipating a sizable transaction or something more modest?

[Dennis Glass:]

Tom, thanks for the question. Let me start by saying that just when I look at the market for risk transfer, it's pretty active. And it's active across a couple of spectrums. And not only is it active, but more capital is coming into the industry from players that haven't been in the industry before. So overall, it's a pretty active market. In terms of kind of activity, it includes block transactions, Lincoln has done one as you know. It includes strategic transactions that have been going on, asset management companies. And there is been some flow transactions. And again, as you know, we have done those in the past, both on our fixed annuity portfolio and our variable annuity portfolio. So active market Lincoln has participated in all dimensions of it over the past, and we'll keep looking at each of those components. In terms of sizing, I think we'll have to wait and see on that. It's sort of hard to - what's big and what's small. But we'll be looking at meaningful transactions, I guess, is the way I would respond to it. So I'm quite encouraged that there will be opportunities of the time we've transacted in the past for Lincoln.

[Tom Gallagher:]

Okay. That's helpful, Dennis. Just my follow-up question is, I know historically, Randy, you've converted GAAP to distributable free cash flow in the 50% to 55% level, I think. Given the product mix shift that Lincoln has gone through, and then, - and I know now you're talking about some recovery in those sales, what kind - when we get to the other side of the pandemic, what kind of conversion do you think we're looking at? Are we likely to be back in that 55-ish range? Or do you expect it to be lower or higher?

[Randy Freitag:]

Hey, Tom. Thanks for the question. Yeah. I'm not going to update the range right now, but let me make a couple of points, that hopefully help. If you look at the pricing actions that we've taken and the impacts that's had on, the capital we allocate to new business. If you think about sort of the mix of sales that we have today, being a little less capital intensive. And I think it's fair to say that the amount of capital that we allocate to new business is lower today, than it was a couple of years ago. So I think overtime, that will definitely be a benefit. Now I think you have to look through 2021 here, because I think the pandemic is going to be providing some negative impacts to distributable earnings, for at least the first half of the year. But yeah, I think over time, when you think about, how we're allocating capital, we're allocating less to new business. And I think that could have some positive benefits on distributable earnings overtime. And we'll try to give more guidance later. Thanks, Tom.

[Tom Gallagher:]

Okay. Thanks.

[Operator:]

Thank you. Our next question comes from Erik Bass with Autonomous Research. Your line is open.

[Erik Bass:]

Hi. Thank you. I wanted to focus on the Group business. And you noted that, I think even ex-COVID, Group results were a bit below your expectations this quarter. So I was hoping you could talk about, where you're seeing the biggest variances? I think you also mentioned some planned actions to improve margins. So hoping you could go into some more detail there?

[Randy Freitag:]

Yeah. Erik, it's Randy. So if you look at the quarter, right, let's start with the quarter, we reported a loss of $42 million. And if you listen to my script, I spiked out items that totaled 90 - low 90s to mid-90s. If you sort of added that in, you'd be sort of at a normalized number of $50 million to $55 million and that 5% to 5.5% range, which if you look back to last year is kind of where we were - last year, we exited 2019 in that 5% to 5.5% range. What I think that, the pandemic really sort of right shifted. What is our belief, which is that when you start at the 5% to 5.5% a little, we have clear vision on growing that to 7% over a planning cycle? And it's really driven by four big elements, really executing on fours things. It's pricing, its expenses, its claims management and it's underwriting. So we, inside of Lincoln, have a clear vision from going where we are today, sort of in that 5.5% range towards that 2% to 7%, which is our ultimate target, as Dennis mentioned. And then I think COVID sort of caused it to be right shifted one year from where we were last year. So that's how we think about the Group business as we sit here today, Erik.

[Erik Bass:]

Thank you. And then maybe just if you could go into a little bit more detail and the drivers of the increase in the group disability loss ratio and I think you mentioned some higher STD claims, some seasonality, as well as some social security impacts and maybe if you could just dig into that a little bit, bit more please.

[Randy Freitag:]

If you think about the quarter, we reported a disability loss ratio of 86.2%. And I spiked out two items. Specifically, COVID, and social security slowdowns - social security approval slowdowns if you add those two items together that's roughly 4.5%. And then when you think about the seasonality which we typically see in fourth quarter we saw this year in the fourth quarter, we saw last year in the fourth quarter, which you factor that in I think you'd get down to a range of 70.5% to 79% and that compares to roughly 77.5% to 78% in the third quarter when you adjust for COVID. So I think we're a little above where we were, but you know underneath the noise that's being driven by COVID, social security approvals et cetera and the seasonality, I think we're just a little worse than what our target would be and I think that's really driven by one big factor, which is that we did lower our discount rate in the LTV business this year. That's had a little bit of a negative impact. Now, the good point there is that, we had clear insight early in the year that that was something we were going to do and so we've been putting it in into price, all year, all the bids we've put out and all the nature of the group is a lot of those cases will hit on January 1st, so you got to feel good, that's the price that cover that discount rate decrease is coming in the first quarter which hopefully can put us back into the more normal range outside of any negative impacts that we might see from COVID.

[Erik Bass:]

Got it. Thank you. That's helpful.

[Randy Freitag:]

Yeah.

[Operator:]

Thank you. Our next question comes from Suneet Kamath with Citi. Your line is open.

[Suneet Kamath:]

Thanks. Good morning. I just want to circle back to the 8% to 10% long-term EPS growth you guys are talking about. I think back in 2019 when you had your Investor Day you talked about a four-to-five-point impact, positive impact from I guess net new business. I know there's a lot in motion now with new products. But would it be fair to think about, sort of 2021 as a transition year and then as you get into 2022, they need to get back to something like that four to five points from that new business?

[Dennis Glass:]

Suneet, its Dennis. The 8% to 10% growth, sort of traditionally as you point out has 4% coming from sort of the new business versus the run-off a business, some amount of margin improvement. So, I think we get up to 5% from management actions, and we've net out capital market, growth and equity markets offset by spread compression, one to two points, and then share buybacks and all that adds up to 8% to 10%. And so over the long term that's our I think in the near term, and we've demonstrated our success in accomplishing that, some of those bars are higher, some of them are lower, because of circumstances. So I think as we rebuild sales that 4%. And put a little bit of time will be a little bit lower. And but the expense saving bar and margin improvement bar is going to be higher. So each of the bars can change given the circumstances that we find ourselves in macroeconomic conditions, pandemics and so forth, but management, driving toward that 8% to 10%. And to repeat, what Randy and I have both said, we can, see ourselves getting for that off for the $9.30. And again, how we get there, might be a little bit different, over the next six months to 18 months, but we can get there.

[Suneet Kamath:]

Got it. And then sort of related to the same chart, I think when you guys talked about expense reduction in the past, you were looking to offset, I guess the spread compression or at least that was one way to think about it. I would imagine the spreads compression impact today is probably worse than what it has been, what it was in 2019. Is that the goal of this new plan to try to offset that spread compression, as we think about getting more information, I guess maybe in 1Q?

[Randy Freitag:]

It's me, Randy. Yeah, I think when we think about spread compression, while back we talked about - we talked about a 2% to 3% range and we were at the low end of that, sort of coming out of 2019. And then as rates dipped significantly the beginning of this year we talked about, how we might have moved a little above that. I think where we sit today and as we look out over our planning horizon, I think we see it in that 2% to 3% range, probably in the upper half of it 2% to 3% range, but I think we're back inside of that range, albeit a little higher than we were back in 2019.

[Dennis Glass:]

Hello, Suneet. It's management's job, when there's pressure like, there is from this sort of continuing spread compression, but at a lower amount. You know, it's our job to replace those earnings. And so that's very much in our mind, as we get into this next financial plan, as we move into the next couple years.

[Suneet Kamath:]

Okay, thanks.

[Operator:]

Thank you. Our next question comes from Jimmy Buehler with JPMorgan. Your line is open.

[Jimmy Buehler:]

Hi, good morning. So first, just for Randy on changes in accounting LDTI coming up in a couple of years, do you have better insight and to how you'll be affected and if not, then, when do you think you'll start sort of rolling out guidance or indications on what the impact might be?

[Randy Freitag:]

Yeah, Jimmy, other than the, comments I made a little earlier that we don't see a large impact from the FAS 60 component. I really don't have any insights that I can share with you today, Jimmy. I really think it's going to be 2022, maybe in the middle of 2022 range, before we have numbers that we can really start sharing. I think there's, if you go back to the FASB, there's as reason that they differed the implementation of LDTI a year, it's because there's a lot of work. And that work was, somewhat influenced by everybody shifting to work from home environment. So, yeah, I think we're in that somewhere in the 22 area, we'll start sharing data with - be able to start sharing data then.

[Jimmy Buehler:]

And then just on your Retirement business, your flows have been pretty good. And I think your business is holding up better than some of the 401(k) businesses. And it's just the makeup, if you could just talk about what you're seeing in terms of trends on deferrals on matching contributions? And I guess, talk about the customer segments that you're in and how susceptible or not as susceptible to the economy there?

[Dennis Glass:]

I mentioned, Jimmy, some of the statistics on contribution rates early in the year and later in the year from employees and matches and so forth from employers and that seems to be improving, has improved over the course of the year. The markets that we participate in are less susceptible and large part to the pandemic, education, health and government, but more stable employment in those areas. So yes, we've had a good run here, and we expect it to continue.

[Operator:]

Thank you. That's all the time we have for questions. Management will follow-up with those in the queue later this afternoon. I would like to turn the call back over to Al Copersino for closing remarks.

[Al Copersino:]

Well, thank you all for joining us this morning. As always, we're happy to take any follow-up questions that you have. You can e-mail us at investor relations at lfg.com. Thank you all, and have a great day.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day. Speakers, please stand by.