Lincoln National Corp (LNC) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the third quarter 2003 earnings conference call for Lincoln Financial Group.

At this time, all lines are in listen-only mode. Later we will announce the opportunity for questions and instructions will be given at that time. If you should need any assistance during this call, please press star then zero and someone will help you.

This call is being recorded and will be available for replay through Wednesday, November 5, 2003. The replay can be accessed by dialing 1-800-642-1687. Again, 1-800-642-1687 and entering the access code of 1348904. Or on www.lfg.com/webcast.

At this time, I'd like to turn the conference call over to the Vice President of Investor Relations of Lincoln Financial Group, Priscilla Brown.

Thank you, operator. Good morning and welcome to Lincoln's third quarter earnings call.

You heard the Safe Harbor cautions while you were in queue so I won't repeat them. We appreciate your participation today and invite you to visit Lincoln's web site, lfg.com, where an updated equity market guidance spreadsheet will be posted in the next 10 days and where our statistical supplement and other pertinent information can be found. Lincoln also plans to file its 10Q within the next week. A full reconciliation of income from operations to net income is provided in our press release and on the lfg.com web site.

Now I'd like to turn the call over to Jon Boscia, Lincoln's Chairman and CEO and Rich Vaughan, Lincoln's CFO. Their comments will be followed by a question and answer period.

Jon?

Thanks, Priscilla and thanks to all of you for joining us this morning.

I am pleased to share with you the highlights of what was a very strong quarter in terms of reported earnings and underlying results. The third quarter was noteworthy for the fact that it was the first time in several years that the performance of the equity markets took a back seat to business fundamentals.

That's not to say that sales, net flows and earnings did not benefit from the positive movement in the equity markets. Indeed, the investment performance of the funds inside of our products generally surpassed the performance of indices we use to calculate the equity markets impact on earnings. That helped us in terms of the direct impact of earnings.

More importantly for the long-term, the results derived from new products and distribution strength provided strong evidence that the underlying fundamentals built into Lincoln's manufacturing and distribution platforms are driving growth. Much has been done to get to this point and we continue to implement the expense and growth iniatives started earlier in the year. Collectively, our management team and our employees have worked diligently and systematically to create a more efficient and responsive infrastructure to support the products and services needed in today's markets. Now let me give you some highlights from the quarter.

Sales for the quarter were very strong overall and higher in most of our product lines compared to the prior quarter. We had record retail deposits of almost $3.4 billion. Total variable annuity sales were up 23% and individual variable annuity sales rebounded, posting a 31% increase over the second quarter as principle security, our guaranteed minimum withdrawal benefit, gained wider distribution exposure. In total, variable annuity sales were within $50 million of our best quarter ever.

Life sales remain strong. During the quarter we set a new record for 3rd quarter retail and total life sales despite the seasonality that typically suppresses third quarter life sales.

Investment management had record quarterly inflows. Not only did LFG have excellent gross deposits, we recorded record domestic net flows of $1.8 billion during the third quarter. This represents nearly a 100% increase over the prior quarter and a 76% increase over the second quarter. This performance in both gross deposits and net flows is very exciting since it demonstrates the continuing momentums we are experiencing across all of our lines of our business.

Let me turn to the business segments starting with life. Retail first share premiums were $208 million, up almost 20% over the second quarter, driven by strong sales in our fixed universal life products and up 18% year to date versus 2002.

Worth noting is that the growth was spread among of most of our retail distributors, an indication that our wholesaling support had been effective across all channels.

Variable universal life sales, which had been declining, showed modest improvement in the third quarter compared to the second quarter.

In the retirement segment, total annuity deposits were just under $1.6 billion for the quarter, up almost 16% over the second quarter of 2003. In the second quarter call we mentioned that we were happy to see variable annuity sales increase in June and again in July resulting from the introduction of the principle security guaranteed minimum withdrawal benefit rider. During the third quarter, sales of Choice Plus and American Legacy, the two products that have the optional GMWB rider, grew 40% over the second quarter.

Net flows benefited from the jump in sales increasing to $280 million, the second highest quarter in the last five years.

Turing to investment management, we had positive net flows of nearly $1.2 billion in the third quarter. What is encouraging about this record quarter is the fact that both retail and institutional net flows are growing. Further validation that the investment performance of Delaware is attracting assets. We realize that the asset base needed to achieve our target margins is formidable goal, however, the progress made in the last several years has been remarkable.

Our wholesaling distribution results through Lincoln Financial distributors saw favorable increases in the quarter as well. Third quarter sales through LFD of $1.8 billion were up overall compared to the prior quarter with retail life, annuities and investment management all showing double-digit gains. And mutual fund sales of half a billion dollars set a new LFD record.

We believe the third quarter was an important one in the sense that it represented a return to normalcy in the equity markets and provided an indication of what Lincoln is capable of when product, service, investment performance and distribution capabilities are aligned. We will continue to implement the growth in savings initiatives announced last quarter and are confident the direction we have chosen will continue to drive growth.

I'll now turn it over to Rich so he can spend a few minutes on the financial results for the quarter.

Rich?

Thanks, Jon.

Yesterday Lincoln reported third quarter net income of $133.3 million and income from operations of $156 million or 87 cents per diluted share.

With respect to the equity markets, the third quarter change in the S&P 500 came as close to our growth assumption as we have seen in recent years with the quarter-over-quarter growth rate of 2.2% just 5 basis points below our assumption. If you applied the market sensitivity guidance filed in our 10Q, or used the market volatility spreadsheet provided on lfg.com, your calculations would show an estimated impact that was slightly less than the positive $9.6 million after tax that we experienced in the third quarter from the growth in our customers' accounts. The actual segment results were slightly higher, due in part to the funds performing better than the indices.

Turning now to the realignment. Third quarter net income included a net pretax charge of $17.1 million. The portion recorded in operating income was a positive $2.7 million, pretax, as expense savings exceeded reinvestment for the quarter. Restructuring charges recorded below the line for the life, annuities and investment management segments and LFA were $19.8 million pretax or $12.9 million after tax.

Based on a year to date results and a review of the current status of the realignment, our projections for the aggregate savings and costs, as announced in August, remain unchanged except for an additional savings pickup of $5 million that we expect to realize this year. From a timing perspective, we now expect that $20 million of pretax realignment cost, originally projected to be incurred this year, and $5 million expected to occur in 2005 are now expected to occur in 2004.

On a pretax basis, the net amount of the realignment for 2003 is a negative $60 million, a negative $5 million for 2004 and a positive $65 million for 2005. This initiative is expected to produce pretax savings of $70 million in 2006 and beyond.

For the fourth quarter of 2003, taking into consideration the changes I just mentioned, we expect to incur realignment charges of around $35 million pretax with less than 20% of it above the line. Expense savings, net of reinvestment, in 2003 are now estimated at $15 million pretax of which $7 million has been realized year to date.

There have been a lot of questions on what to expect in 2004 and how much will be above or below the line. Our best estimate at this time is net pretax savings of $50 million and pretax charges of $55 million with about half of the pretax charges going above the line in operating and the other half falling below the line in net income.

Let me now turn to the DAC unlocking. Looking at DAC, included in operating income, was a net charge of $6.4 million attributable to the perspective unlocking completed for our product manufacturers as part of the annual DAC review. This amount reflects the aggregate adjustment to the deferred acquisition costs, the present value of enforce and the deferred front end loads on LFG's balance sheet. We conducted a review of all the underlying assumptions and took a hard look at our models, particularly the logic associated with the long-term projections. This was an in depth process involving a large number of people that just wrapped up the week before last.

Now let me turn to reviewing the underlying run rate. We had several unusual items, mostly positive, if you exclude the life DAC unlocking, which we can cover offline. We had prepayment penalty income, a true-up in co-insured death claim recoverables, a seasonal increase in branding expenses, and other miscellaneous items recorded in the quarter that were not part of what I would call core earnings.

Looking that the underlying run rate in each of our segments, I'll start with retirement. We reported earnings of $94.3 million in the third quarter. The items I would characterize as unusual in the quarter totaled a positive $15 million, which when backed out, resulted in an underlying third quarter run rate of $79 million.

In our life insurance segment, we reported earnings of $58.7 million. Our estimate of a third quarter run rate is about $72 million. Investment management reported earnings of $9.7 million and based on third quarter asset levels, Delaware should produce earnings of approximately $6 million. But yet, in the U.K., our expectation for 2003 earnings of about $40 million remains unchanged.

With respect to distribution, Lincoln Financial distributors had a loss of $7.5 million in the third quarter and LFA incurred a loss of $7.4 million for a combined distribution loss of $14.9 million. We now anticipate that the loss in the fourth quarter will be around $12 million, but this is highly variable with the level and mix of sales which is hard to estimate. The remaining part of corporate other was indicative of the underlying run rate.

In summary, the overall run rate underlying the results of the third quarter appears to be about $151 million or about 84 cents a share.

Last quarter I mentioned the upcoming implementation of FASB interpretation number 46, including that it would have an effective date in the third quarter. This reporting requirement affects the consolidation of collateralized debt obligations where we manage the assets in our investment management operation. On October 8th, the FASB agreed to postpone the effective date of FIN46 until the fourth quarter. It's possible that there could be changes to the reporting requirements under FIN 46, but in the meantime we will be updating our disclosure in the third quarter 10Q.

With that I'll turn it back over to Priscilla.

Thanks, Rich.

The press release and statistical supplement were made available yesterday, which hopefully provided additional time for you to review this quarter's results. We'd like to now open the call for your questions. Operator?

Thank you. At this time, I'd like inform everyone if you would like to ask a question, please press star 1 on your telephone keypad. If you would like to withdraw your question, press star 2 on your telephone keypad. We'll pause for a moment to compile the Q-and-A roster.

Your first question comes from Jason Zucker with Fox-Pitt Kelton.

Great, thank you and thanks for shortening the commentary and leaving more time for questions.

I would like actually focus on fixed annuities. And I was curious on what the spread is between your minimum crediting rates and your average rate on the book? And then I was also wondering if you can give us some color with respect to the DAC analysis that you did and did you look at scenarios when interest rates spiked? And -- and perhaps, you know, what were your conclusions from that scenario? And, you know, really what I'm getting at is, you know, what were your assumptions for a spike and when that might trigger higher surrenders? Thank you.

Todd, would you like to take that one?

Yes, the first part of the question was related to the spread between minimum crediting rates on fixed annuities and the -- I'm searching for that exhibit. If we look at where we are today, we have 32% of our fixed annuities at contractual minimums.

Okay.

And then another 29% is within 50 basis points of contractual minimums. I would also add there are certain significant portions of our business that are in fixed products with multi-year guarantees or under a fixed annunitization program for which there would be no issue relative to minimum crediting rates. That subset would represent about 23%.

Okay. And then on the DAC review?

Yes, if you could briefly repeat that question.

I guess was I curious on the fixed annuity portion of DAC and when you did some sensitivity analysis, what your conclusions were with respect to a spike in interest rates?

Well, we looked at and modeled all sorts of scenarios and determined that, based upon a mean number of views of potential interest rate scenarios, we were -- we remained essentially very comfortable with the DAC asset underlying our fixed annuity products.

And even in some of the more extreme situations where interest rates might go up, you know, 100 or 200 basis points in the next 12 months, the DAC assets still looks very defendable?

I can't give you a specific answer as to what the DAC asset would look like under specific interest rate scenarios, but under most all scenarios that we would consider reasonable, our DAC asset is reasonable.

Todd, you might also mention the level of interest rate caps that we have in place which in effect gives us some cushion in spiking interest rate environments even though those are bought substantially out of the money. I think there's about $2 billion of interest rate caps at this point in place that would help, in effect, cover income generation during a period of unusually high interest rates.

That's correct.

All right, good, thank you.

Thank you. Your next question comes from Tom Gallagher with CSFB.

Good morning. First question is on the variable annuity sales momentum. Can you just talk about how it progressed during the quarter? And possibly an outlook for 4th Q?

Todd, do you want to take the sales question on that?

Well, obviously we were very pleased with the level of variable annuity sales in the third quarter, as I believe in Jon's comments, pleased to see that after introduction of our Principal Security living benefit or withdraw benefit, particularly on our Choice Plus and legacy products, we saw 40% increases over what had been the prior run rate. You know, we have no reason to believe that we can't see that type of momentum be sustained.

And so I guess my specific question is, are we likely to see sequential growth over what was a nice pop over the 2Q number in 3Q, in other words, looking ahead to 4Q.

I guess I wouldn't at this point be prepared or want to speculate that the growth rate would accelerate. It could, but then again there could be marketplace dynamics that would drive it -- that would keep it stable or even lower that growth rate, relative to the sequential growth rate in the third to second quarter.

Okay. And then just a few questions on fixed annuities.

If we look at where your spreads are trending right now and realizing you got significant boost from [ INAUDIBLE ] this quarter and if we assume interest rates remain about level, where would you see the spreads trending next year? Would they be potentially dropping down well below 200 basis points? Or maybe if you can just give us some characterization there.

We wouldn't, Tom, see that type of a large drop happen with interest rates sustaining at about the level they are. We can expect, however, to see over the short-term, perhaps a few basis point drops -- drop in the annuity spread.

Okay.

And I guess just as a follow-up there, if we look at, I guess, less flexibility on a go-forward basis with lowering contractual -- lowering crediting rates since you're at the floor, doesn't that sort of prevent you from managing spreads if rates remain low?

Well, it certainly, you know, creates a dynamic that net spreads can and will go down. That's why I would characterize the likelihood of seeing the net spread even after considering make holds(ph) and prepays adjusting that out, would likely see that go down. I would mention, however, that as we look at and would anticipate some continued inflows of fixed annuity money, a decrease in spreads might not necessarily equate to a decrease in operating earnings because of the larger fixed annuity base.

Gotcha. And then one last question for Jon.

Can you just comment on your views on M&A and the competitive landscape, especially given that some of your life insurance competitors have come together. Do you think it's going to be a bit more challenging? And, you know can you just update what you would think in terms of Lincoln potentially getting together with another company over the near-term?

Tom, I think that as far as industry dynamics themselves, I think we are going to see some external catalysts primarily coming as a result of both regulatory and rating agency pressures for stronger capital bases in the marketplace lead to consolidation, up pressures in the insurance sector in the same way that it did a decade or so ago in the banking sector when capital requirements were increased.

With regard to what type of a roll Lincoln may engage in during that period of time, I'm sure you remember that it's our long standing practice not to speculate or comment or anything on what we may or may not do.

At this stage in the game, just as a follow-up, given that more competitors are getting bigger, at least a few of them, you know, does that pose an issue for Lincoln or do you still feel from a scale standpoint you're in fine shape?

Yeah, if I look at scale, Tom, clearly the important measure of scale is your market share type of a major, not your market capitalization, because market share is what allows you to have efficient operating cost structures. It's what permits you to be able to have the broad distribution platforms that you need to be able to grow and I think this quarter clearly shows that Lincoln's positioned very, very well in the important aspects of scale.

Okay, thanks.

Tom, this is Rich. I wanted to add one other comment on the variable annuity sales, especially in the products that carry the GMWB, the American Legacy and the Choice Plus.

As the quarter progressed, we saw a nice pickup in July as was indicative of the comments we made in the last earnings call. On just those two products we had a 22% increase in July over just the month of June. Now, June had a little bit of sales of the GMWB, August being the vacation month was flat with July. Then we got to September, we saw another 18% pickup in the sales over the August level for about a 43% increase in September over the level of sales in June. So, there was some nice progression there and hopefully indicative of where, you know, sales could continue going.

That's helpful, thanks.

Thank you. Your next question comes from Andrew Kligerman with UBS Securities.

Thank you, two questions.

First, your life insurance sales were very strong and I wasn't aware of any new products like a GMWB that would bring it up 19% year-over-year. Could you talk about the competitive environment in individual life and, you know, I think the MIB index indicated that ad count in the second - in the third quarter was down 2% for the industry. So, could you talk about the competitive environment and what you're doing to be so strong in the individual life area?

John Gotta and Gary Parker, would you like to comment on those?

Yeah, Gary if maybe you could talk about first product and then related to the competitive environment and how it impacted sales, give him both perspectives.

Andrew, this is Gary Parker.

If you look at our growth in sales, obviously in the current environment it's driven to a great extent by fixed universal life sales and our product. We've tried to continue to make competitive in the marketplace. It's been a little bit more of a challenge this year from previous years as a result of guideline AXXX, and the reserve requirements associated with that. But I think because we've been a stable long-term player in that marketplace we've been able to continue to grow sales. Even though our product may not be as competitive today as it was maybe this time a year ago.

I think our sales are also being driven this year, as well, by Money Guard, which is a somewhat unique product in the industry and maybe a little -- little less price-sensitive as a result, but we've seen a significant pickup this year in that business, which also has driven the increase in our universal life sales growth.

Money Guard has the long-term care?

Riders associated with it, yes.

Okay.

We've also seen some pickup in term, which, of course, is not near as much of a driver as our UL business and at least in the third quarter, as Jon mentioned earlier, our VUL business was not -- at least it wasn't off as much as it was in earlier quarters this year.

Andrew, I would just add to that, this is Wes, that what we're seeing also is a good balance of business between our multiple distribution channels. So, our distribution read in the life area has been more mature and really continues to pay out for us.

Interesting.

And then I just have a follow-up question on this whole market timing issue. I've received so many questions about variable annuity riders. Could someone comment on their thoughts about market timing in the variable annuity industry? And then how it would affect Lincoln National?

Yeah, Andrew, I think it's accurate to say that during the past few weeks, ever since trading activities in the mutual fund industry have been on the front page news, we've been contacted by oversight bodies for additional information. We're highly, highly confident that all of the inquiries that are taking place are a part of a broad inquiry directed towards the entire industry rather than a specific concentration, as an example, directed towards Lincoln. Continue to follow internal policies and practices to curb any activities if they've occurred. We have not found any patterns that indicate a systemic problem of activities within Lincoln or any questionable trading activities by our internal money managers.

And would you think that the variable annuity product is more or less conducive to market timing than mutual funds?

That's -- I don't think there's enough data in the marketplace out there right now, you know, to give us a good view on that. I think basically most people are going to buy a variable annuity, you know, for a retirement type of a benefit and I think more people buy mutual funds for an investment-type of an activity. So, if I were just to look at those two things, my intuition would tell me that a variable annuity would be less likely than a mutual fund to be, you know, abused or taken advantage of.

Thanks a lot.

Thank you. Your next question comes from Jeff Hopson with AG Edwards.

Hi, good morning. Could you drill down a little bit more on the life insurance? Specifically, you know, you had two programs in Salomon and then Payne Weber, you know, are those contributing a significant amount? Are those still ramping up? And then SEI indicated that they're out of the variable annuity business and have those -- and some flows came out. Has that affected you yet?

Wes, you want to take the first part of the question?

Sure, in both of firms that you mentioned we continue to see good sales growth in our life business for the initiative that we have had in the past. We have some dedicated wholesaling forces in both of those organizations. We are very pleased with the results and our year to date results in terms of sales growth in life insurance has been and continues to be impacted by those initiatives.

Okay. Any plans to extend that type of program to other firms?

At this point we -- we're just really focused on continuing to increase the sales results in those firms and increase our market position [INAUDIBLE] We will look at opportunities as they come up, but nothing under way currently.

Okay.

Jeff, on the SEI piece, I don't have in front of me what the remaining assets are there, but I do recall that a few quarters back, at their peak, there was a total of $130 million of SEI annuities on the books. So, there isn't that much to lose and we would expect it to come off, you know, somewhat gradually but we would expect over time that it would probably move.

Okay, great, thank you.

Thank you. Your next question comes from Vanessa Wilson with Deutsche Banc.

Thank you.

Just back on the life insurance sales, you said that you felt today your product is not as competitive as it was a year ago. Could you -- could you narrow down the timing a little bit? When did the product become less competitive, was it three months ago? Six months ago? Or just in the recent weeks?

Gary?

Gary?

Vanessa, I -- I'd say that it's been a gradual thing. As you know, anytime you come out with new products there's leapfrogging that goes on in the industry. And I would say that over the first half of the year there were several of our primary competitors that, even though there was a reserve increase as a result of guideline AXXX, actually improved their products, and so it was over that time period that we saw the deterioration.

And when I say deterioration, I'm -- it's not been hugely significant, I mean we -- we've always prided ourselves on being one of the top tier companies competitively in our market and I would say it we're still pretty close to top tier. It's just maybe not quite as high in the rankings as we were before.

I guess, Gary, in the press release it states you're currently in the process of rolling out an enhanced UL product. Is that going to have a higher price?

It's actually -- it kind of depends on the sale. We've made some improvements in some sales with regard to the guarantee requirement, the funding requirement to get the guarantee on our secondary guarantee UL products. And other sales where it's not quite as good. We think overall, though, the product is somewhat improved.

Okay.

And just separately, also on the life business, Rich, is there any color could you could give us on when you did your DAC study, what assumptions in the life business you were focused on? Or -- the assumptions that got changed?

There was an awful lot of assumptions that we looked at. The one that had the biggest impact that caused us to, in effect, have the negative unlocking on life, had to do with the long-term assumptions on the reinsurance costs. And it wasn't that we changed the costs it was that our modeling in 10-plus years out was not as refined as it needed to be. The net piece -- or the net cost of that on an after-tax basis was in the neighborhood of 20-plus million dollars. So, the $10 million negative or so unlocking that we had in life was more than all caused by our modeling refinement in our reinsurance costs associated with the life block.

Other areas were obviously looked at were immortality lapses, surrender charges and various other things and we looked at all of those. But, you know, net-net, those all would have netted to a positive without the refinement on the reinsurance costs.

And the reinsurance cost assumption just addresses a tighter reinsurance market today?

No, it really doesn't. It addresses how we modeled out the reinsurance costs in the future. We were doing it on sells that were too broad and it wasn't getting the accuracy out there necessary.

So, what we ended up doing is taking our reinsurance system and linking that to our DAC modeling system. Therefore, causing us to, in effect, be locked in lock step with what reinsurance costs will be based on the reinsurance program that is tied to specific policies and or sells. So, we've got very much more refined in the application and that's what resulted in the unlocking that was negative. As it did not have to do with any changed pricing in that particular component. We did look at all -- obviously, reinsurance pricing and there was a piece of that, but the big piece was this modeling piece.

Thanks very much.

Thank you. Your next question comes from Ed Spehar with Merrill Lynch.

Thank you. A couple of questions.

Rich, I wondered if you could go over again, when you were talking about the restructuring and I think you said about $19.8 million, pretax, below the line and a $2.7 million benefit above the line, where was that $2.7 million benefit? And did that include -- what was really the driver of that?

And then in terms of your life run rate earnings calculation, I wondered if you could tell us what, other than the negative DAC unlocking you're adding back to get to that number?

On the savings we've -- what we're looking at basically is, we've got savings that are merging from the realignment activities and we're also spending money related to that. And what we're getting to, basically, is we had savings in the third quarter of about $8 million. We had increases in expenses associated with -- these are all above the line, therefore they're non -- they don't qualify as restructuring costs, although they're associated with the realignment, of about $4 million. The net was $4.3 pretax or $2.7 after tax, that was in the third quarter. We'll have a slide that we can fax out to you on the details if you're interested. It'll give you the broad numbers by year.

That might be helpful.

And the second part of the question was?

The adjustments that you're making beyond just adding back the DAC unlocking in life to get to your run rate calculation.

Okay, just give me a second to flip to the right page.

Besides the DAC unlocking, which in total both prospective and the one time, sort of, impact from the retrospective, that total was $11.5 million for DAC unlocking. In addition to that we had about $1.7 million of additional branding and advertising cost in the third quarter.

You may recall we did the battle of bridges this quarter and we also had the opening of Lincoln Financial Field and the various things we did to make sure that theme recognition came out with that was sort of a spike up in the third quarter. Those were the two big items in the quarter. In fact, accounts for basically all the difference between the 58.7 and the 72.

Okay, then just one last question on life insurance.

I appreciate the fact that because you built this up through some acquisitions that goodwill is sort of a drag on the reported return on capital. But I'm wondering if you could talk a little bit about, if you look at the ROC numbers that you disclosed for us on the life segment, and if we make the adjustments that you're suggesting to get to a run rate earnings. The return on capital has been pretty flat at about 10% really since 2000 and you've been growing the business. I'm just wondering if you could talk about why haven't we seen the return improvement that I think you would expect given the returns that you guys talk about at the margin in the life business.

Todd, do you have any comments on that before I weigh in?

No Rich, go ahead.

One of the things that has hurt us most recently is -- I'd say is actually a couple, last year we talked a little bit about the face amount reductions that had an impact on reducing the growth rate in earnings. We've also had an impact from spread compression in the last year or two there, both of which have put some downward pressure on the earnings.

At the same time, we obviously, from a reserve and capital perspective, we've been in a period where we've been carrying additional capital in the business. We've seen our risk based capital ratios go from under 300 to over 320, a lot of that obviously adds to the capital base of the life operation. So a little bit of pressure on earnings and additional capital being carried during these, in effect, rating agency difficult times. I think are the combination that has caused us not to see the expansion in the ROE that we would have otherwise had.

And when you're hitting numerator and denominator both, as Rich just described, you're going to end up with a level type of an outcome.

Thank you.

Your next question comes from Steven Schwartz with Raymond James and Associates.

Good morning, can you hear me?

Yes.

Can you still hear me?

Yes we can.

Okay, good. Rich, you were going a little fast. I just want to go back over the restructurings and what we should expect and then I want to ask a couple of quick questions.

You had, if I got this right, $95 billion for 2003 in charges, $15 million for investment spending, $25 million for savings. Where are we now on this?

Instead of going through those, because I think this is very hard to do, just getting the things in the right bucket. We'll fax out to you a one pager that shows you where the charges are at this point in time. Some of you have seen the same page as it was before but we'll give you an update that you'll see the pieces. That's the easiest way to do it.

Okay. I want to go over life insurance again and I want to talk about your DAC amortization and your PVIF amortization.

We had about an extra $15 million, $16 million or so pretax in DAC amortization, yet DAC amortization between June and September went down by $8.4 million and PVIF amortization only went up, call it $10 million.

Okay. I'll let Doug Miller our Controller dig into the details of that with you.

Hi, Steven, this is Doug.

Hey, Doug.

Included in the PVIF line of the amortization is the results of the DAC, part of the DAC unlocking that we talked about.

Right.

Actually the number that you described, the $10 million, that's the fluxation in the PVIF amortization line.

Okay but wasn't that $10 million after tax?

The $10 million is pretax. PVIF. On the DAC you have a number that was around $9 million pretax that was positive unlocking related to the initiative.

Doug, this is Todd. If I could jump in and maybe put a little more color on it.

As Rich described, there were some modeling refinement adjustments generating an impact negatively on reassurance calculations there were also some other positive adjustments. It happens so that, depending on the nature of the block of business for which the DAC or PVIF is in place, we had different directions relative to the unlocking as it is reflected on the income statement.

For example, I think Doug described this, I'm talking pretax numbers now. It was actually a positive unlocking impact on DAC amortization of about $9 million offset by negative PVIF amortization of about $10.5 million, and then a further negative reflected as part of our benefits line for the related impact on the amortization of front end loads, and that was about $14.5 million.

Okay, that actually was going to be my next question, having to do with the benefit line being up.

You gotta look at this as the benefit line having been negatively affected by this on a kind of one time basis, the DAC being benefited on a one time basis, but the PVIF if you add it all up it comes to the $10.5 million after tax number?

Correct.

Okay, got it. And then just one other question I want to go back and follow up with Andrew's question on market timing.

I am wondering if Delaware has been subpoenaed? If so, what have you been doing in terms of internal investigations and has anything -- I don't know if Jude is out there or not but if he is maybe he can address this.

Steve, this is Jon.

As I indicated, we have, at Lincoln, now been contacted by a broad array of oversight bodies. There is one subpoena that has come in. I think it is from the New York Attorney General's Office. It is not a subpoena that is directed in any way back to Lincoln specific. And the reason that I'm confident in saying that, is when we called the Attorney General's Office the nature of the question and the dialogue was a very general, very broad question as we sought clarification about things in there. But that's been the only subpoena, the to others have been inquiries.

Okay. And have you undertaken an internal investigation?

Well, we have and that's what I tried to indicate before.

We have looked at our own investigations we've not found any patterns that indicate any systemic problems inside of Lincoln with regard to our treatment or handling of things. As we have had one-off occurences, we have followed our internal practices and policies to curb those. We have not found any questionable trading activities by our portfolio management group or our money managers at all.

Okay. Alright. When Andrew's question, when you answered that, I thought you were just referring to variable annuities.

No, I was actually trying to make it more inclusive.

All right. Thank you, guys.

Thank you. Next question comes from Michelle Giordano with JP Morgan.

Good morning, had some questions about variable annuities with the GMWB feature.

Right now it looks like in addition to Hartford and yourselves, there are other players out there with a GMWB. Have you had a chance to look at these other features and do you need to make any adjustment to your feature or do you feel like yours is still very distinguished in the marketplace?

Secondly, I was wondering if you can share with us any other product initiatives you have going on for variable annuities?

And then third I was hoping you could address some distribution initiatives and targets you have for 2004 vis-a-vis either agent recruiting, financial planner recruiting, new relationships or additional wholesalers.

What I'd like to do, Michelle, is ask Gary Parker to comment on the BA product features ,and then for Bob Dineen to comment on the planner activities that you asked about. Then Wes Thompson, you may also wish to make comments about things that you have going on through our wholesaling operations.

If we start with Gary.

Michelle, this is Gary. With regard to our principle securities feature that you mentioned, uhm, we're very comfortable with the way it's structured, the way it's designed and the way we're handling it from a financial standpoint right now. But we also recognize that the marketplace is in a state of evolution, so we're continuing to model the marketplace and we're looking at the directions the marketplace is headed, and we're also thinking about where we need to be in the future from a living benefit standpoint.

And Bob Dineen, I think Michelle asked about planner recruiting.

Yeah. Generally, Michelle, planner recruiting is down 1%, September over September '02 to '03. I would account most of that to the field reorganization that has taken place within LSA, responsible for most of that. I do anticipate, however, there is some opportunistic situations that are coming up in fourth quarter and historically, our recruiting in fourth quarter tends to pick up as well. So I'm a little bit more optimistic for fourth quarter than I otherwise would be.

And Wes, if you want to talk about wholesaling activities.

We do have a couple of major firms that we are working very closely with them to extend our product offerings on those shelves in a preferred basis as we look towards '04. And we're very pleased to be able to have that opportunity in our position. Ending shelves, the time when many of these are actually narrowing down the number of companies that they would be doing business with.

Thank you.

Thank you. Next question comes from Nancy Benacci with McDonald Investments.

Good afternoon. Just a couple of cleanup questions here.

Back on the variable annuity product. You indicated on the last call, as you rolled that out, that you had really strong growth out of Edward Jones market. Any others particular from where you're seeing substantially better numbers? Or is it just across the board?

Todd, do you have any specifics on that or Wes?

I think that we've seen really good growth across what we would refer to as all of our key accounts - top 5 to 10 accounts by each channel. Certainly, we have been very pleased with our list that we have seen in Edward Jones because that is a very long term and very strong relationship for us, particularly as it relates to our American Legacy variable annuity product.

Okay, and then.

We are still seeing a good increase in sales within our own planning, Lincoln Financial Advisors. Also, obviously good - a great trend for us.

Okay. When - I think Richard, given the numbers for September, sales were up about 43 - 46%. Was that off of the - in comparison to June did you say? It's up 43% relative to June for the combination of the American Legacy and Choice Plus annuities, which are the two at this point that have the GMWB rider on them.

And would you be willing to indicate what we've seen so far as we've moved into the - almost through the whole month of October?

I don't have that information available currently.

Okay. and then just the last question regarding the marketing and advertising. You indicated it was certainly spiked up because it's the two events you mentioned, any indications that we should see that still being higher than normal as we look out to the fourth quarter into next year?

Not in the fourth quarter. Although we are, as we indicated, we're going to be increasing our investment in the business from both the marketing and wholesaling in 2004. That's part of what we've said, is reinvestment in the business.

So, as we get into 2004 I would expect part of that, depending on how you've handled the realignment numbers, I wouldn't double count it, for instance. The additional $1.7 million in both life - separate $1.7 million so a total of $3.4 after tax, both life and annuity had about $1.7 million extra each in the third quarter. We would expect to see that, the reason we quantify it that way is, that's the amount that's over and above what we would expect a normal quarter to be.

So I wouldn't expect it to repeat in the fourth quarter or I wouldn't have taken it out of the run rate for you.

Okay. Thank you.

Thank you. Your next question comes from Suneet Kamath with Sanford Bernstein.

Hi, two quick questions. Number one on the risk based capital ratio. Given all the strong growth in the variable annuity and then in particular on the UL products, what is your outlook for the RBC ratio at year end 2003?

And then second, just on the realignment. What determines in your mind whether something goes above the line or below the line? Thanks.

Maybe we'll go backwards at your question on the realignment. It's very clear whether the item meets the requirements of a restructuring charge under current accounting literature, and we had a change in that beginning of this year, determines whether or not it qualifies for restructuring and therefore below the line. If it is related to the realignment but doesn't meet the definition of restructuring in the accounting literature, then it goes above the line. And that's the only distinction.

Either way we have been identifying for you, in effect, the cost of realignment, which we certainly wouldn't expect to see continuing long term. This is a program that's gonna go for the most part 2004 and then the benefits start really coming out strongly in 2005.

I don't have a prediction on the RBC ratio for the end of the year. We have been building capital the last couple of quarters, about $75 million on average a quarter for the last couple of quarters which has been very positive obviously.

We've had a little bit friendlier credit market, so the gross losses from our investment portfolio, both from impairments as well as realized, have been coming down.

Sort of the trend line has - first quarter was about $160 million, the second quarter was about $100 million, the third quarter was about $55 million, so we've got a nice trend line there. We can't predict what the fourth quarter is going to be. It will depend on sort of how the economy continues to come along and whether there's any shocking events in effect that hit us. But assuming that we don't have any, that we continue to see some improvement, we would expect the RBC ration to improve.

I think we're building capital at least in the current environment that we saw, like in the third quarter, at a rate that is faster than what capital we're tying up with the sale of new business. Because most of that is variable business and most of the reserve requirement associated with a lot of that business is, in effect, being taken care of by our hedging program.

So there's less net net reserve required for the risk in that because of our hedging program and taking those risks offshore. So I'd say we should expect some improvement but how much, I wouldn't want to put a number on at this point.

Okay. Thank you.

Thank you. Your final question comes from David Lewis with SunTrust Robinson Humphreys.

Thank you. Good morning.

Good morning, David.

A couple of questions. Can you, one: talk about, you couldn't tell us where the RBC might be, but what are you feeling about your overall capital position? Going back a year or so ago, Rich, you said you thought it might be able to restore the repurchase program, once you saw the improvement in profitability within your businesses, which I think you're feeling a little more comfortable about.

Two, can we talk about where the long-term ROE objective goes with the saves that comes in 2005 and 2006? Can we get back to that 15% ROE target if we had a normalized 8 to 10% growth in the market?

And third, can you give me an idea if what all has driven the 84 cents of run rate in the third quarter versus the 77 cents of run rate in the second quarter when the market was up only 2.2%? And is it all sales plus market?

Is that all the questions you have, David?

That's it.

Oh, okay! Ha ha ha! On the capital position, we are feeling better about our capital position. I do want to see us sort of get to a point where the rating agencies take the industry off of negative outlook. Right now they've continued during 2003 with the -- the downgrades outpacing the upgrades by a factor of, I think about 4 or 5 to 1. We want to make sure that, you know, right now our capital base is very strong, the reason we didn't get singled out with most of the rest of the industry with downgrades or outlook negative, et cetera, is because we've got a very strong capital position.

I think as I've told you all in the past, the thing that's most important from a capital perspective for us is to make sure we maintain our AA ratings with the rating agencies for our life company. That keeps us in the marketplace, in the right group of individuals and organizations selling our products. So, I think it's a little bit of time here in the future, we have another good quarter in the fourth quarter, I think we'll be looking at things in a much more positive view.

I'll obviously have, at that point, our financial plans tied down pretty strongly for 2004, which should also give us clarity. So, those are things that I'm looking for on that piece. On the ROE target, we continue to target a 15% ROE. I think you still have to take into consideration where we are from a number of perspectives. We've had huge capital losses over the last two years that have put a lot of pressure on earnings.

All you see at this point, you know, you see $600 million of gross losses last year, something in the $300 million range year to date this year. That's not -- you know, $900 million of assets that were earning a nice return for us and our policyholders. So, there's been some pressure on earnings from those.

Our partnerships and hedge funds are concurrently under performing, I haven't talked about those the last couple of quarters. I don't add them back in the run rate, but we have about $300 million invested in venture capital and hedge funds that have been producing little to no return. Those, obviously, need to kick back in. The savings from the realignment, will be a very positive factor. Continued growth in the markets also contribute and all of that, at a time when the risk in the business, we believe, will be recognized by the rating agencies as declining and therefore enabling to us do something from an "E" perspective in the ROE. I think there's a lot of things that point us to the fact that we should be able to get to a 15% ROE in the not too distant future. Without putting a target date on it as such.

Rolling forward, the 77 cents to the 84 cents, let me flip to that information. A number of items. Equity market would be $5.5 million out of the -- for the quarter. Going, which would give us probably about 3 cents a share.

We've got mortality in the retirement pension business where we had reserve true-ups, that's about $1.3 million. Distribution was about $4.5 million of improvement and then a number of small items, things like our realignment, growth in the business, would be the other contributing factors that would take you up to the $84.

But the biggest items there is obviously the equity markets and then the distribution piece and modco(ph), mortality issues, within the retirement, which was a positive $1.3 million. And what that basically is saying is that the correction on the reinsurance receivables not only has a positive impact in the quarter, but because it goes back for a number of prior quarters, in effect, it's an add to the run rate of about $1.3 million going forward, as well.

The only thing different it sounds like the distribution for LFA and LFD might actually improve in the fourth quarter so you get some benefit from the 84 cents, from the distribution as well as any market change?

We've had, you know, basically some improvement distribution from the second to the third, which is what I just described and typically we would expect some improvement in distribution in the fourth. Typically because we end up with more life sales, which is a bigger contributor to the bottom line in effect of our distribution operation.

I understand. Thanks very much.

Uh-huh.

Thank you. Operator? Is that all?

Yes, ma'am.

Okay.

I'd like to thank everyone for participating today and also like to remind you that on November 19th, we have a reception and on the full day of the 20th we have a meeting for investors and bankers in Philadelphia. If you have not registered and would like to, please let us know.

And as always, we will take your questions on our Investor Relations line following this call at 1-800-237-2920. Thank you and have a good day.

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