Lincoln National Corp (LNC) 2002 Q3 法說會逐字稿

Good morning. My name is David and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Lincoln financial group third quarter 2002 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone key pad. If you would like to withdraw your question, press the pound key. Thank you. Miss Brown, you may begin your conference.

Thank you, David. Good morning and welcome to Lincoln's third quarter earning laws. You heard the safe harbor cautions while you were in cue, so I won't repeat them. The information filed in the second quarter will be updated and filed with our 10-Q filed in a few days. Lincoln as endeavored to provide current and complete disclosure on the methodologies and practices that govern our practices with respect to debt and G.M.D.B. earnings. We ask you to avail yourself of the data found in the slide presentations and statistical data given during our second annual series of investor meetings. They can be found in the investor relations section on our website. I'd like to turn the call over to Jon Boscia, Lincoln's chairman and CEO, and Rich Vaughan, Lincoln's Chief Financial Officer. Their comments will be followed by a question and answer period. Jon?

Thanks, Priscilla. Thanks to all of you for joining us this morning. I'd like to start off by saying that I am extremely pleased to have the dispute with Swiss Re resolved and for an amount that is below what many investors expected. The settlement we reached and announced late yesterday will reduce the deferred gain on sale by about $127 million after tax and we will transfer the funds supporting the 65 million after tax indemnification reserve. Future earnings will be marginally reduced by the loss of the interest on the $192 million after tax being transferred. We no longer have any underwriting risk associated with personal accidents, uni cover, or any other lines that were a part of the reinsurance business we sold to Swiss Re. The accounting for any feature reserve changes will have no economic impact on the company and will be recorded in net income. In short, given the increasing volatility associated with this business, we believe that this resolution is simply the best course of action for our shareholders. So with that behind us, let's turn to the quarter. While Lincoln's fundamentals remain very strong, there is no question we continue to be disappointed with the equity markets performance and the impact on our earnings. Within that context, I'd make two points. First, while we can't direct where the market goes, we are managing many things within our business to drive value. I said this before, but it continues to represent our guiding philosophy through this downturn. We have sharply focused on things like net flows, product features, investment performance, and expense management as well as maintaining our strong capital position. You'll see this focus in related progress as I touch on each of the businesses. Second, we can provide guidance to help you understand our business and assess our performance. Particularly in this volatile market. On this point, application of the equity market guidance that we provided on August 1 was in line with the actual market impact on our earnings. The S and P 500 was down 17.6% in the third quarter, affecting our earnings by $73.8 million versus the second quarter of 2002. If you applied the market sensitivity guidance filed in an 8-K last quarter, your calculations would show that the impact from the equity markets would have been $70.6 million. The market guidance would have projected earnings of 46 cents for 40 cents actually reported. In a moment, rich will discuss the non market-related items that make up the 6 cents difference. We'll continue to refine our approach and remain committed to ensuring that you have comprehensive information to analyze the company. Witness a few days - within a few days, we intend to post a spreadsheet to our website that will enable you to plug in your own equity market assumptions and see the projected impact on each significant area of the business. The fact is, we continue to battle one of the most difficult and volatile equity markets we have ever seen. In simple terms, the S and P 500 was down 29% year to date through September 30. But we are not looking back, we are looking forward, and the most important leading indicator of our future growth is that we gain market share through the first nine months of 2002. In the third quarter, we continued to maintain momentum and sales and business retention. Total net flows were a positive $639 million for the third quarter. Some specifics. Net flows were positive in all of our domestic segments, both for the third quarter and for the trailing 12 months. This is the fifth consecutive quarter of positive flows for our reinsurance segment and the 3rd consecutive quarter of positive net flows at Delaware. The life insurance segment also continues to have very steady, positive flows as has been the case for several years. Despite the significant downturn in the market, assets under management are actually higher today than a year ago as a result of hard work and managing net flows. This is a claim we believe few of our peers, if any, can make. Let's talk about both components of this organic growth driving new sales and retaining existing assets. In the third quarter, enterprise-wide deposits were strong with domestic deposits of $3.1 billion. With respect to redemptions within our retirement segment, we remain below pricing. The most recent mutual fund redemption data provided by investment company institute through August show that Delaware's mutual fund redemption continued to be significantly better than industry averages, and in fact, the spread versus the industry rate widened even further during this period. Not surprising, considering the outstanding investment as a result, which I'll discuss shortly. In our life insurance segment, we continue to report consistency in line with or better than pricing. The strong consistency is the attributable to the means based selling and sense of conservation effort. Now let me briefly comment on more specifics in each of our business segments before turning it over to rich to continue the discussion relative to operating results in the quarter. The retirement segment had positive net flows of $69 million in the third quarter. We were able to remain positive despite the loss of $294 million in assets from the state of Indiana's deferred compensation plan, which we announced several weeks ago. The good news is that Delaware investments received $150 million of a transferred asset to manage in the stable value account contributing to their positive net flows. Retirement net flows remain positive through the strong sales and choice plots and our alliance products, but were slightly offset by $60 million surrendered by market timers as we enforced the policy to close these type of trading accounts. As mentioned on previous calls, we have also implemented a more stringent control policy on internal transfers. In fact, we have reduced our level of internal transfers on our core annuity product, American legacy and choice plots, by over 70% since the third quarter of last year. While we know this policy has caused redemptions or transferred to other manufacturers, we are pleased to see higher levels of new sales in some products. Incremental annuity deposits have increased 11% versus last year's third quarter, and have even exceeded by almost 4% the strong results of the second quarter of 2002. Choice plus variable annuity sales increased an impressive 56% over last year's third quarter, and we expect them to continue to maintain this momentum as each month's productions outpaces the month before. Fixed annuity deposits for $595 million up 14% from the third quarter of 2001 and up 30% from the second quarter of 2002. We were able to offer competitive rates while maintaining margins due to portfolio securities freed up by surrendered contract. We believe that Lincoln retirement has increased market share this year in both fixed and variable businesses while importantly maintaining pricing discipline and continuing to avoid those product features that will prove to be harmful to clients, to the industry, and to shareholders in the long run. We believe that the trend in industry practices continues to be very aggressive pricing, including the use of high bonuses, high commissions, and living benefits. Further equity market decline combined with the lower interest rate environment in a capital stream at some firms will make it difficult for them to continue inappropriate pricing, and we expect you'll see product changes that will reflect the real cost of some of these features. That should have the effect of leveling the playing field a bit as it relates to new deposits. As you have observed, we have had quarters where fixed annuity sales were high and others where it was quite low. Our current view of the potential for market growth in fixed annuities is less optimistic due to the low interest rate environment, required contract minimums, and commission rates. In addition to product and pricing discipline, we are maintaining stringent controls on the expense side. Retirement segment G and A expenses were down slightly more than the third quarter and down 7 percent from a year ago despite a higher transaction and call center volume in this business climate. In the life insurance segment, the breadth and balance of our product portfolio continues to drive strong sales growth despite the impact of the down equity market and some regulatory uncertainty. Retail life sales were up over 31% from last year's third quarter driven by strong sales in universal life, which was up 97%, and whole life, which was up 13%. Life insurance in force increased to 248 billion, up 9% from one year ago, as major bites face amount reflecting strong sales and favorable persistency. I was pleased to see that retail life sales had double digit sales growth in both the third party channel and through our own Lincoln financial advisors. As I touched on earlier, despite everything going on with the market, as a result of positive net flows, account values grew to $11.7 billion, up 5.8%, versus a year ago. This is a good testament to having a strong fixed product life insurance business. We are also pleased to see that we are gaining traction across all of our new distribution alliances. This is no accident. As we mentioned last quarter, Lincoln's product expertise was recognized by its peer firm survey. Our hallmark has been and will continue to be providing a broad range of life insurance products with exceptional features that are responsive to the needs of our market. As in the other segments, we continue to aggressively manage expenses in our life business. Third quarter G and A expenses in the life segment were down 4% from the third quarter of 2001 and down 7% on a year to date basis from 2002. Delaware's good performance and balance distribution contributed to positive net flows of $397 million in the third quarter. The breadth of our capabilities can be seen on both the retail and institutional side. The retail business has positive net flows of 48 million, the institution business, which had positive net flows of 349 million, won 16 new institutional mandates across six different asset classes during the quarter. With respect to performance, over the trailing 12 months, 19 of the 20 knife largest funds in the Delaware investment family earned the top half of the LIBOR universe. A truly outstanding and rarely matched performance. LIBOR leaders expanded their categories to include total return, tax efficiency, and expense, to go along with the previous categories of consistent returns and capital preservation. 54 of Delaware's funds have been labeled a LIBOR leader in at least one category and 26 funds have been selected in multiple categories. Managed account flows continued to be strong with year to date deposits up 90% versus last year. Delaware kept the pressure on with regard to expense management. Year to date expenses were down 6.5% versus last year, and about flat with the last five years when adjusted for the accounting change for goodwill amortization. Obviously, any discussion of Delaware wouldn't be complete without touching on the announced departure of Ed Haldiman. Ed played a valuable role in getting Delaware on track and we are disappointed to losing him. The good news is that our strategy has been to develop boutique firms and the assets they manage. In each area, we have a strong team of investment and research professionals in place, and there is a strong sense of ownership in each boutique. You'd be interested to know that in the first few days following Ed's announced departure, we won three out of four finals for institutional mandates. Before I turn it over to Rich, I'd just like to say a few quick words on distribution, which given the environment, performed well. Lincoln financial distributors is the wholesale distribution arm of LFG, that we established in 2000. Its actual ramping up and traction didn't begin until 2001. This two-year-old now accounts for 40% of LSD's retail sales, even when you exclude sales through Lincoln financial advisors. LSD's variable annuity sales are up 41% year to date, versus an industry that is flat according to most recently available data from Bairds (ph). Retail life sales are up 30%. The best industry data we can get indicates sales up 3% through the second quarter. Mutual fund sales are up 17% versus the industry, being up only 5% according to the most recent investment company institute data. Managed accounts are up 90%, the comparative data isn't available. Suffice to say, if this is what a 2-year-old does, what will a 5-year-old do? At Lincoln financial distributors, we continue to leverage our technology and deep relationships to drive performance. LSD is winning market share in every manufacturing segment. Going forward at LSD, our focus is develop our existing strategic alliances to their greatest potential. Lincoln financial advisors, or LFA, is a comprehensive financial planning firm. At LFA, we saw product cash flow improvements across all three Lincoln manufacturers. LFA continues to manage head count and general expenses to a level better than planned. Excluding the impact of mark to market deferred compensation accounts, LFA's distribution loss was lower by 1.2 million when comparing third quarter 2002 to the same period last year. Year to date, the loss improved by 6.2 million through September. We are also seeing the results of our active recruiting during the past 24 months, with substantial increases in our majors of productive planners and in our planner productivity. I'll now turn it over to rich so he can spend a few minutes on the major changes in earnings. Rich?

Thanks, Jon. Lincoln reported income from operations of $73 million, or 40 cents per diluted share. I'd like to offer a word of thanks to those aft Lincoln who worked to provide the 8-K guidance on the impact of equity on market earnings as well as those analysts and investors who took the time to apply it to their estimates. It was a complex document for us to create and for you to digest, but we continue to refine it in an effort to bring better clarity to the complex discussion of equity market impacts on our results. As Jon stated, the primary impact on operating earnings was the significant drop in the equity markets, which affected results by $73.8 million. Immediate impacts of the market drop resulted in DAC and PBIF unlocking and GMDB reserve increases in the third quarter totaling $63.8 million or 35 cents per share. Income from operations before the immediate impact of the equity markets on DAC, PBIF, and GMDB payments and reserves was $136.8 million or 74 cents per share in the third quarter. Retirement is the Lincoln segment that is most affected by equity market changes and in the third quarter, operating earnings were reduced 52.8 million by the equity market drop. This was within about 6% of the application of the market guidance given in our 8-K filed last quarter. As you well know, we use reversion to the mean in computing the DAC asset and GMDB reserve. As of September 30, the impact of using reversion to the mean was a $45 million higher DAC balance and a $42 million lower GMDB reserve. A total of $87 million or $57 million after tax. At September 30, our retirement DAC assets, including the FAZ 115 adjustment was 1,000,000,073 and represented 2.46% of the annuity account values. This ratio of DAC asset to account values is one of the lowest in the industry. We're also pleased to see that our lapse experience continues to run better than pricing and better than DAC assumptions. As per our normal practice, we are performing our an newly, in depth review of DAC assumptions, includes lapses, amortization periods, mortality and equity market returns and expect to report net results with fourth quarter earnings. Regarding the GMDB impact on earnings, as we've stated before, we are one of the few companies who currently reserve for the liability caused by the equity market's decline. The end of the third quarter, our net amount at risk was $5.6 billion. And our GAAP reserve was 68.6 million. Our stat reserve was 162 point 9 million. In addition to that stat reserve, we assign after-tax capital to cover future downside risk of an additional $243 million for the retirement segment. LNC's annuity policyholders overall average attained age is just over 53, with only 13% over age 70. We believe that LNC's average is lower than the industry average, largely due to the mix of business that includes a significant amount of qualified and employer-sponsored business. However, LNC's average nonqualified contract holders attained age is also slightly lower than the industry. You might recall from last quarter's conference call that there is no method prescribed under generally accepted accounting principles for guaranteed minimum death benefit reserving. Some companies recognize the cost of GMDB's on a pay as you go basis. We use a more conservative method that recognizes that there is an amount at risk that will result in future payments and that over time the market growth will reduce the payment stream. Our approach is expected to cover future payment activities. Simply stated, we think this is the right accounting approach and we also think our conservative approach to the business currently remains the right one. Currently, 52% of Lincoln's variable annuity account balances have the most conservative type of GMDB, called the return of premium. As you are aware, there are two other primary types of GMDB's in the industry. The high water mark, which represents 24% of our account balance and the more aggressive guaranteed return features. Our 5% step up product accounts for only 7/10 of 1% of our account values and currently represents only $44 million of net amount at risk. We will be conducting more extensive analysis of it in our other contract features to be certain that risks are properly priced. This review could result in pulling certain features to changing prices for those features or just leaving things unchanged. In the U.K., the foot see performed the assumptions underlying the present value of future and DAC by 22.5% during the third quarter and that along with lower fees had a negative impact on earnings of 15.7 million. This was consistent with the guidance we gave you. In Delaware, the drop in the equity market lowered earnings by 3.5 million. Their results were slightly better than previous guidance largely because the growth in net cash flows. As Jon mentioned, it bears repeating, Delaware has more assets than they did a year ago. What we believe to be a rare accomplishment among competing asset management firms. In the life segment, the equity markets caused DAC unlocking, which negatively impacted earnings by 1.8 million. The 8-K that we issued in August provided guidance for the effects of the equity markets on our earnings using the second quarter as a base, we will be updating the guidance in our 10-Q, which will be filed in the next few days. The new guidance will reflect equity market variances from September 30 market levels. Now let's talk about other items which affected the segments earnings during the quarter. In addition to the market impact, the life segment experienced other net retrospective and prospective DAC unlocking of $2 million unfavorable in the current quarter versus $7 million of favorable unlocking in the second quarter. Looking beyond the equity market impact, the life segments earnings versus second quarter 2002 were also impacted by higher mortality totaling $1 million. The life segment also experienced margin compression in the third quarter, due to declining investment yields, which impact earnings by 2.2 million versus the second quarter. As of October 1, we reduced our portfolio contracting rates - crediting rates on two of our blocks by 15 and 30 basis points, which should help offset declining investment yields. Lower earnings also resulted from a nonrecurring tax benefit in the second quarter of $2 million and a drop in partnership and hedge fund performance lowered earnings in the life segment by $900,000 versus the second quarter. Moving on to the retirement segment, there we had an underperformance of partnership and hedge fund investments, they hurt earnings by $3.7 million versus the second quarter. Retirement benefited from the growth in its fixed business, improved product mix and some spread improvement. Combined, they added 3.9 million to earnings. Other contributors were lower taxes of 2.7 million and lower expenses. With the third quarter market decline, we were very close to having triggered impairment abandon a resulting write-down of the contingent deferred sales charge asset in our investment management segment. We will be adding disclosure in our 10-Q on the potential impact of further market declines on the $58 million contingent deferred sales charge asset. With that, I'll turn it back over to Jon.

Thanks, Rich. In just a couple of quick points before we open the lines for questions. During the second quarter earnings call, we noted management's focus on putting to work the remaining proceeds from the sale of Lincoln re. Given what we believe to be depressed valuations on our stock, we focused our efforts towards share repurchase. As a result, we repurchased 7.2 million shares utilizing $248 million of our Lincoln Re proceeds in the third quarter. At the end of the third quarter, Lincoln has put to work approximately 950 million of the roughly 1,550,000,000 in after tax proceeds from the sale of Lincoln read. The $950 million represents approximately 590 million of share repurchase, and 360 million of debt reduction and holding company cash flow needs. The remaining 600 million of proceeds resides in Lincoln life insurance company, our principal insurance subsidiary. We expect to transfer assets as part of the statement with part of Swiss Re and will dedicate the remaining capital to supporting our business. The third quarter had unprecedented moves on the part of the rating agency. S and P recently commented they have 40% of companies in our industry on negative outlook or watch with negative implications. Guaranteed minimum death benefit reserve increases, shifts in business mix, and realized investment losses have contributed to the negative ratings environment for many of our peer companies. Lincoln believes our strong capital position both safeguards our ratings and positions the company for growth as much of the industry is forced to rethink their strategy. We plan to resume share repurchase activity as the market and earnings improve. In a strong market, even weak companies will appear to do well. However, it is during these down markets that only strong companies will show strong underlying fundamentals. What we can control, we believe we are controlling well and we are continuing along the path of improvement in all of the areas that will ultimately drive future earnings growth. We are not happy with the actual numbers delivered this quarter, but remain confident that the fundamentals of our business remain strong and we are competitively well positioned for long-term growth. We'd be happy to take your questions now.

At this time I would like to remind everyone in order to ask a question, please press star, then the number 1 on your telephone key pad. We'll pause for just a moment to compile the Q and A roster. Your first question comes from David Lewis of Robinson Humphrey.

Good morning. Rich, can you give us an idea, since a lot of us missed it with your previous guidance that if the equity markets stayed up 8% relative to September 30, what the earnings level would be for the company in the fourth quarter? And make sure I understand Jon's comments, excess capital basically of 600 million from the sale will be used for the Swiss Re and supporting the current business segments and therefore until cash flows pick up, you will not be repurchasing additional stock; is that correct?

To your last question, yes. Where we are right now basically is in a wait and see perspective relative to developments in the credit and equity markets and what we're basically looking at obviously over the last year or so, we've had huge costs associated with credit defaults and with the markets and the economy still somewhat in a difficult position, the $300 million or so that we would have relative to excess capital at this point is what we think is prudent to be in effect, in a wait and see mode on, so as earnings develop going forward, with the market improvement, we would expect to feel more comfortable about using those excess capital positions for things other than supporting the business, but right now, we are in a wait and see, let earnings develop, and as earnings develop, be able to use those positive cash flows that are generated from the earnings for share repurchases

Rich. Real quick on that. Do you have an estimate of what you might guess free cash to be in a range for next year or next 12 months?

At this point I do not because one of the biggest impacts that we get or two areas where we get impacted significantly on free cash flow is credit write downs and GMDB reserves in this kind of market, and it's very difficult to predict what either one of those are going to do since they are dependent on activities in the marketplace that I haven't figure out a way to project. Relative to the fourth quarter, really haven't given guidance relative to that, but what we're basically telling you when we say you can add back. In the third quarter there's about 35 cents of one-time impacts caused by the drop during the third quarter that if you would expect the market to be going up, would certainly not be there in the future, so the underlying earnings in effect for the third quarter were in the neighborhood of 75 cents per share.

The other thing that I would just comment on there is I had indicated that we will be posting an electronic spreadsheet on our website in the next few days. With that electronic web sheet will do is it will take essentially the table that we put in the second quarter's 8K (ph) and will allow to you do what you specifically said. It will allow you to put in an 8 percent for the third quarter and give you a calculation then.

Great. Thanks very much.

That will be there in the next few days.

Jason Zucker of Banc of America Securities is the next question.

Just to follow-up on the earnings for 2003. So rich, if I'm hearing you right, if I'm thinking equity markets continue to edge up and you know, a lot of us use that 2% a quarter appreciation, then the 75-cent run rate is a good number to think about looking into 2003, would that be a correct way to sum up your statement?

I think that's a good way to sum it. There's other details you could throw up against it relative to expectations of growth in the block of business, and the fact that the fourth quarter is typically a much stronger quarter just because sales volumes pick up and distribution losses are therefore reduced substantially.

Okay. I also was hoping just to clarify more on the excess capital number. Excluding the repurchase, the debt reductions an then these new payments to Swiss Re, we think we end up with probably somewhere around 300 million of the Swiss Re proceeds after all said and done?

That's about right.

Okay. Great. Last question, can you just talk about why the tax rate was so low in the quarter and then thank you?

The items underlying the reduced tax rate typically don't move very much as the earnings come down, effectively what you've government basically is the net impact of that. You have your deductions remaining the same but your earnings going down, your tax rate automatically goes down.

Great, thanks.

Your next questions comes from Ed Speher (ph) of Merrill Lynch.

Ed Speher (ph): Good morning. I had a couple questions. First of all, rich, on the comment you made about the additional capital that you hold for GMDB beyond the stat reserve, could you talk about how much of that is required and how much of that is just your decision to hold an additional amount? I wasn't 100% clear on that. And then secondly, I wanted to talk a little bit more about the comment I think Jon made, about your ability to maintain competitive crediting rates in the marketplace and still earn your spreads because of portfolio securities that were freed up by surrendered contracts. And I guess the question that I have is that if you have a bond on the balance sheet and it's a good yield and you have a contract surrender but you then right a new piece of business that's matched up against that existing security, don't we have an ALM issue in that we have a shorter security perhaps than what you would normally match up with a fixed annuity liability and that there's some reinvestment risk as we go down the road with that new piece of business? Thanks.

Let me have Todd Stevenson take the first question on how much is in quote, voluntary reserve versus how much is a statutorily rate reserve.

Yeah. The current NEIC risk based capital guidelines do not require any additional surplus to be carried for the GMDB risk. What we do at Lincoln is for internal capital purposes, allocate and identify the amount that was indicated, 248 million, as additional capital to support the risk inherent in the GMDB exposure, over and above importantly the statutory reserve of 168 million that is being carried in addition to the capital that is additionally allocated.

Todd, you might have also add what the confidence level of the combination of those two reserves brings us to relative to likely outcomes from the scenario testing.

Yes. Based upon the statistic type testing we performed, we believe the combination of those two puts us at about 95 to 96% confidence level.

Thanks, Todd. Ed, with regard to the second question on the freed up security, what we do is we do not take it on a dollar per dollar type basis. Let's say we had, as we indicated, the big state deferred comp plan that surrendered. And you know, we might have $300 million of assets there. What we will do is take that $300 million of assets, we will combine that with whatever the appropriate amount is of new dollars of assets in there, those new dollars combined with the old dollars give us the level of interest rate and duration that we need and then we will sell new business against that particular level of duration. So if that surrendered amount happens to be a shorter duration type of fixed investment, then we'll combine it with new dollars of long duration to be able to give us the asset liability matching capability that we still have to have, so we won't create a duration gap between the assets and liabilities. We'll continue to run a match book.

Ed Speher (ph): And just if I could follow up. I think, I guess, that that - I think by definition means that you had been taking more of a mismatch on the asset side historically than what you're willing to take now. I think that's the only way the math would work.

No, that's not necessarily the case, Ed, because let's say, you know, the plan that surrendered might have had, just for argument's sake here or illustration sake, a 5% duration or a five-year duration with it at the time that it was originated. At the time that it venders, let's assume that maybe that's done in the four year duration area, so we were still matched four years by four years, and until the point in time that it was surrendered. Now, at the time that it surrendered, you have in different contracts different market value adjustments mechanisms that come into play so that the duration mismatch that is there by allowing somebody to take their money out does not result in them getting a gain that could result in them having a book value loss going out. And again, that's contract specific associated with it. Then when we sell the new business, we match it again against the existing assets with the appropriate amount of new money coming in. Now, to the extent that we were holding a four-year duration asset and somebody surrendered the contract, then - in its purist form, you have a mismatch of assets and liabilities, except that the cost of that surrender, the market value adjustment is typically borne by the contract holder and you don't have that exposure.

Ed Speher (ph): Okay. Thank you. Just quickly, on GMDB, I'm assuming the extra capital you hold on a stat basis is factored into your pricing model; is that correct?

That's absolutely correct, yes.

Ed Speher (ph): Okay. Thank you very much.

Your next question comes from Vanessa Wilson of Deutsche Bank.

Thank you. Could you give us a little more color on 2003? I think Jason had asked if 75 cents is a good base for the earnings. Should we also think about options cents and pension costs and things like that in looking at a 2003 number?

There's a couple of things I think considered in that. Options is currently one of the things that we are working on for the future as to whether we'll be using options in our compensation models. There's a lot of indications that would say that the value that is assigned to an option by the recipient is nowhere close to the value that we would have to expense, which means they don't have the same economic value to the company as they do to the individual. And when you've got that kind of a mismatch, I think you really do have to reconsider whether options is the best way to compensate and insent (ph) people. Since that's under consideration, it's difficult at this point in time to predict what impact, if any, option expensing will have going forward, depending on the transition approach we end up taking, which we obviously haven't committed to at this point in time.

But if you replace options compensation with another form of compensation, there would still be a cost it, right?

There would, but typically it would be lower, Vanessa. The reason being if I received $100,000 worth of options in my compensation package as far as what we reported as an expense in the past, if you look at what that package is typically valued at by the employee, it would probably be something closer to a third to a half of that, so now if you're going to replace that with cash or stock, you have to look at the relative value of that in their compensation package, so if I instead would get $33,000 in cash, instead of $100,000 worth of expense of stock options, that's the kind of considerations we're currently looking at as to what we'll be doing going forward. What I think that says is there is likely to be a net increase in expense, but I don't think it will be of the magnitude of the stock option expenses that have been reported in the past in the foot notes.

Okay.

Let me move on -

Just remind us of the stock options expense? I think we have it in 2001 of 21 cents; is that right?

I'll have to pull that out and get back to you. It's in the second quarter Q it's very clear. 39 million for the full year.

And that included reinsurance.

That was around 6 million?

I don't know that.

Rich, separately, I wanted to ask you on your statutory position, you seem to be highlighting caution on, you know, needing to sort of pull back on share repurchase because of guaranteed minimum death benefit reserves and credit losses. Could you give us a sense of what your statutory earnings looked like in the third quarter, because I assume your credit losses were a little better sequentially, unless there was something going on with the growth losses?

I don't have the number handy, Vanessa. We'll see if we can get it and get back to you on that one. I wanted to finish the earlier question because you did mention beside stock options, pension plan expense.

Yes.

And in that regard, this year, 2002, we're expensing about $18 million pretax for pension expense, and based on where the markets have done - have what they've done so far based on the returns we've gotten in our pension plan assets, what we expect to see as far as future assumption changes and discount rate changes, I expect to see that expense go up from the $18 million level in 2002 to something in the $32 million level for next year. That's a $14 million pretax increase or about $9 million after tax, and we won't finalize what those numbers are until we see what the actual results for the pension plan were for the full year and at that point we will obviously do our planning with a, in effect, another full year of experience behind us, but that's what the early indications are on the pension expense side.

Very helpful. Beyond the 75 cents run rate, the benefit, whether it's options for stock and the pension, is there anything else we should think about for 2003?

Investment partnerships do a lot better than they did in 2002 or we shouldn't stay in them, so that would be another positive relative to both the 75 cents in the third quarter as well as what we've seen for the first nine months of the year. That's probably the biggest, you know, area, and then the interest rate environment will obviously be a very important factor. If we continue to see spread compression, that is a potential negative that we have to consider going forward, but if rates come back up, that may decline pretty quickly as well, so it's a number of moving parts, but, you know, net-net, I think the investment partnership piece is a pretty good-sized positive relative to what we've seen so far this year?

And you'll have more guidance on the spread over time?

We'll put additional disclosure in the 10-Q that you'll hopefully get later this week. As to the minimum crediting rates and our portfolio of life and annuity fixed business and how those minimums compare to where we are today so that you can see where - how much of the account values might suffer compression in future interest rate environments.

Thank you. And thanks for all the new line items in your supplement. It's really great.

Okay.

Your next question comes from Joanne Smith of UBS Warburg.

I just have a follow-up to Vanessa's question on the investment spreads. I'm looking at the spreads in the third quarter of 211 basis points and I'm seeing that the investment yield is coming down. Given the comments made by nationwide and I don't know if you list end to their conference call yesterday about their investment spread guidance for 2003 and given the size of your fixed annuity portfolio, which is relatively small versus the variable annuity portfolio, and taking into consideration the growth in fixed annuity deposits, I was wondering what you can tell us about spreads going forward because it looks to me like you are taking action on the crediting rate side, but the yield seems to be, you know, your biggest enemy right now, so if you could comment on that. Also, on the investment portfolio, you don't break out in your supplement the - the amount of bonds that are in BBB right now, could you just talk about that and give us some level of comfort with those securities, especially if the economy is now potentially going into double debt, where do you think that portfolio is going to go? And I think I'll have one more follow-up up that, thanks.

Joanne, I didn't have time to listen to nationwide's call yesterday, we had a few other things going here, but on the spread management piece, we actively managed the spreads, we continue to see portfolio yields coming down 6 to 8 basis points per quarter, and where we have the flexibility to reduce crediting rates, we have been doing that on an active basis. The disclosure that you'll see in the Q has two aspects to it. It has the floor rate, which is a temporary rate, that's based on a beginning of year in effect minimum guaranteed rate for the current year, and then it also shows the amount of account values that have minimum guaranteed rates and what levels relative to current crediting rates. If interest rates remain in this low environment, we're going to continue to see some spread compression. There is no doubt about that. What I don't know is how long or how deep it will go and that's why we're laying out in the Q in effect for anyone to be able to analyze in effect how much of the account values have a lot of room left, i.e., over 100 basis points, how much has more than 200. How much has only 15 or 20 basis points left, in effect of active management capability relative to contract minimums. We did have some spread improvement in the fixed annuity block of business this quarter, but we had some spread compression in the life side, so it's somewhat of a mixed bag and depends on where we can and have taken action relatively to dropping portfolio rates. It's 6 to 8 basis points per quarter is what I've been seeing recently in the portfolio yield coming down.

Rich, in the third quarter it looks like it went down 24 basis points versus the second quarter.

That may end up -

It went from 711 to 687.

Maybe the simplification of the calculation, but - I'm just going back on what we've been seeing period to period in investment reviews.

I'm just concerned about it because yesterday, you know, we saw of the same thing in nationwide, and I think, you know, people were very concerned about the fact that the spreads are coming in, you know, and how long can you maintain a 200 basis point spread or better.

Well, that's what the disclosure is trying to layout. There will be quite a bit of information there. The bonds we have in BBB, about 32% -

We currently have about 33.5% and this is the reductions from 35% in the previous quarter.

And can you just talk about the level of comfort that you have with that portfolio and you know, what - you know, what could happen under a scenario where the economy kind of slips back into a recession?

I don't think I've got the crystal ball to do that, Joanne. Obviously if we did into a recession and we have more surprises from an accounting and reporting perspective, you could end up with large - continued large credit defaults and that's one of the reasons we've continued to try to move the quality of the portfolio up. As Z indicated, we've gone from a 35% in BBB down to 32. We don't do anything quick with a portfolio the size we have that it's in effect on the margin that we're taking action. We have 20 plus credit analysts that are constantly looking at the credits we have in the portfolio as well as what we're buying, and we believe we're staying ahead somewhat of the future market impacts that we may suffer.

Maybe just from a different angle, can you tell us in terms of the BBB's, even though the actual percentage of the total portfolio has come down in the third quarter versus the second, can you tell us approximately, you know, how much of those BBB's are actually bonds that have been downgraded over the past year?

Certainly some of the reductions may be due to downgrades. Let me tell you the whole story here. I think the story here is that we have been - we have been biased with investing the higher quality part of the grade spectrum. If you look at our A holdings, in the second quarter it was 29.7%, versus 39.9% in this quarter and our A market remains the same and our AAA market went up from 16.7 to 18.7%.

The AA remains the same.

Okay. My final question is, just on annuity flows, I was just wondering if the outflows of 516 million, did that include any of the 294 million Indiana contract?

It included all of it.

Thank you very much.

Your next question comes from Colin Devine of Salomon Smith Barney.

Follow up on comments made by Ed and Vanessa. First, with respect to using I guess bonds that you happen to hold from contracts that I guess have lapsed early and using the yield there, aren't you in effect subsidizing your sales of new investments, because certainly you couldn't get the same kind of yield if you were going out today to buy the bonds? That's question number one. Second, on the option cost issue, in terms of the numbers you provided last year, wasn't that under the ramp-up, so we're really looking at a fifth of what the option costs would have been and certainly then I presume no matter what you do, rich, net-net, the number is going to be up even from that? And then if we could talk about, you know, you didn't go with the I guess fresh start approach of nationwide on the DAC. How do you justify a 13% market growth assumption? If we don't have that, then why aren't we looking at more unlocks? And then, four, as I'm trying to understand the accounting and the conservatism in it, on the GMDB's, as you laid out, you happened to hold a 68.8 million GAAP reserve and yet you've put aside capital, as near as I can tell, to cover the same exposure on a stat basis, and what you've tucked aside, of what, 400. Perhaps you could reconcile that for us. And also, when you're doing that, explain why the GAAP GMDB reserve only went up from 27 million at the end of the second quarter to 68.8 this quarter, why not taken it up to 100. That would have caused more of an earnings miss, but what exactly is going on here?

On the first question, are we subsidizing in effect new business? Yes. We could have obviously taken the capital gains that would have been in those securities instead of using new cash flow in effect to pay out the Indiana plan, and recognize those gains, but instead we in effect held the securities and are using the interest in effect to in effect keep higher rates on new business, and therefore generate new business. I don't think there's any question whether that's, quote unquote, subsidizing new business. I think it is. As far as the ramp-up in option expense, the expense we disclosed is not on a ramp-up basis, it is the full cost in effect of the options. Moving on to the fresh start on the reversion to the means, since we haven't - we've had a pretty good return so far this quarter, and obviously this quarter is only barely started, but, you know, we've been using reversion to the mean. We believe it's an appropriate methodology. Others have, in effect, said they're going to do a fresh start on reversion, which I'm not sure how that substantial Yates using reversion to the mean, but we will be taking a look at all of our underlying assumptions on our annuity business in the fourth quarter as we do the annual review of the underlying assumptions and how appropriate they are. And if we end up coming to a conclusion that lapse rates are better than what we've assumed, that life of the block of business is longer than we've assumed, that market assumptions that we're currently using are lower or should be lower than what we're currently using, then we will true those up. We just haven't done it yet. We don't know what the net impact of all that might end up being or what ultimate assumptions we will end up making. That's what the process is all about. On the GMDB, the amount of capital that we're carrying on a statutory basis, takes you in effect to a 96% confidence level that you wouldn't suffer anything more than that. That's not a best estimate, which you should be using for GAAP reporting purposes. We're using expected mortality, expected market returns, and calculating the expected amount of future claim costs that we need to put up today, and that's what's underlying the $68 million that we carry on the GMDB reserves for our GAAP reserve purposes. The statutory methodology is different and obviously getting a reserve that's adequate to cover 96% of all potential scenarios is a reserve level that isn't typical anywhere in the United States, and I understand that Canada does kind of carry those kind of reserves. At least one company up there carries them at about that level, but that is not what we do nor is it where I think we'll end up going or our generally accepted accounting principles will go. If we had to in effect guess what the application of the expected SOP would be, we believe it would be very close to or slightly higher than the GAAP reserve we're currently carrying. I think that covers it.

Okay. So just to understand. A couple quick follow-ups. You're saying the best estimate of this is 68.8?

Correct.

And yet the 96 percentile estimate is 400 million?

Correct.

Okay. Second, two quick follow-ups. In terms of the dividend, is that at any risk right now, given it's pretty rich, pardon the pun, versus everything else? And then also, on the average age of your nonqualified book, are you - you referred to it that it's above or I guess something relative to the industry average, you didn't specify a number there. I'm not so sure the relevant number that you gave of 53 including the qualified piece is really what people are interested in. On the nonqualified, what's the average age of attained age of your policyholders?

Well, as Todd digs out some of the information on the average age piece, I'll address the dividend. The dividend at this point is very secure. We are, as I indicated, curtailing share repurchases and we do have excess capital and also available sources of capital at the current company wile in effect the capital strains of the credit markets, GMDB reserves and the capital associated with the fixed annuity business we're writing right now puts some capital strain on the life insurance company. Had it not been for the excess capital that we had from the Lincoln Re sale, we would be probably in more difficult straits, but having that excess capital puts us in strong capital position and our dividend is not under consideration for anything other than recommending to the board continuation in effect of the patterns we've had in the past.

Before Todd comments on the specific age, Colin, I don't understand the comment that people are only interested in what the death benefit exposure is for one portion of our annuity business because our GMDB covers the entire block of our annuity business and all the questions that we have had beforehand were along the line of on an all-in basis, where do you stand, what's your average annuitant age or policy holder age so we can get a sense, since most people, you know, don't really understand actuarial science, some people could see what really is the likelihood of large amount of debt or whatever, so that's what that age 53 is intended to indicate. If our average annuitant age were 60 or 65, it would obviously be a different consideration when you look at the NAR that we have on any given quarterly basis. But let me turn it over to Todd for the specifics.

Hold on for a second. Are you saying that you are providing a guaranteed minimum death benefit on your qualified annuities? Because I had understood that back per your slide, they didn't cyst exist on 15% of the block, which is the qualified portion? Is that correct?

Lori? I believe we have guarantee of principal on most of our business. There may be some qualified contracts that don't, but let me turn it over to Lori Stenzaru.

This is Todd. We do have a significant portion of our employer sponsored or equal tied business that is with a contract that does provide a simple return of premium death benefit. The question about the average age for our nonqualified, at Lincoln we have an average age of 63, with 27% over age 52. This would compare to an industry average of 65 - of 72, and compares to an industry average of at 65, with 35% over age 72.

Could you give me those one pour time. I think I have just sort of lost the number.

Lincoln, nonqualified, 63, 27% over age 72. Industry, 65, with 35% over age 72.

Thank you.

Colin, also some of the qualified business that has return of business, those are products still being sold in the marketplace today.

What's also important there, they're sold in the marketplace. The periodic nature of the business results in premium flows every two weeks and in essence, we've got a natural dollar cost averaging, which occurs and helps mitigate over time our death benefit exposure on the employer-sponsored blocks.

Great. Thank you.

Todd, what percent of the portfolio has no GMDB of any kind on it?

23%.

Thank you.

That's increased, Colin, from the numbers we talked about on the DAC meeting. I think this also concludes our meeting and at that our time is well up. We appreciate those of you who have hung in here a little longer than we've scheduled. We'll also always, as always, be happy to take your questions after the call. Thank you and have a great day.

Thank you for participate in today's Lincoln financial group conference call. This call will be available for replay beginning at 12 noon today through 11:59 p.m. eastern standard time on Wednesday, November 6, 2002. The conference I.D. number for the replay is 584-6049. The number to dial for the replay is 1-800-642-1687. Or 706-645-9291.

Certain statements made in this press release are forward-looking statements within the meaning of the securities litigation reform act of 1995. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and may contain words like believe, anticipate, expect, estimate, project, will, shall, and other words or phrases with similar meanings. Forward-looking statements involve risk and uncertainties that may cause actual results to differ materially from the results contained in the forward-looking statements. These risks and uncertainties include, among others, subsequent significant changes in the company acquisitions and divestitures of legal entities and blocks of business, directly or by means of reinsurance transactions, including the recently completed divestiture of LNC's reinsurance business, financial markets, E.G., interest rates and securities markets, competitors and competing products and services, LNC's ability to operate its businesses in a relatively normal manner, legislation, E.G., corporate, individual, estate and product taxation, the price of LNC's stock, accounting principles generally accepted in the United States. Regulations, E.G., insurance and securities regulations, and debt and claim paying ratings issued by nationally recognized statistical rating organizations. Other risks and uncertainties include the risk that significant accounting, fraud, or corporate governance issues may adversely affect the value of certain investments, whether necessarily regulatory approaches are obtained, E.G., insurance, heart Scott (ph) and if obtained, if they are obtained on a timely basis, whether proceeds of divestitures of legal entities and blocks of business can be used as planned, litigation, arbitration, and other actions, adverse decisions including but not limited to extra collateral and class action damage cases, new decisions which change the law, unexpected trial court rulings, unavailability of witnesses, and newly discovered evidence. Acts of God, hurricanes, earth quakes, and storms, whether there be any significant charges or benefits resulting from the contingency described in the footnote to LNC's financial statements, acts of terrorism or wore, the stability of governments in which LNC does business, and other risks, mortality and morbidity. The risks included here are not exhaustive. Lincoln national corporation's annual reports on form 10-K, quarterly reports on form 10-Q, current reports on form 8-K and other documents filed with the security and exchange commission include additional risks and factors which could impact LNC's business and financial performance. More offer, LNC operates if a rapidly changing and competitive environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors. Further, it's not possible to assess the impact of all risk factors on LNC's business, or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results or a projection of earnings. This concludes today's Lincoln financial group conference call.