Lincoln National Corp (LNC) 2004 Q3 法說會逐字稿

Good morning and thank you for joining us for Lincoln Financial Group's third quarter 2004 earnings conference call.

Before we begin, I have an important reminder for you about Lincoln's earnings release. Lincoln's earnings release and statistical supplement, which are available under the investor relations section of Lincoln's web site at www.lfg.com provide detailed reconciliations of net income computed under generally accepted accounting principles to income from operations. As a reminder, any comments made regarding future expectations, trends and market conditions including premiums, cash flow, pricing and lost cost trends are forward-looking statements under the Private Securities litigation reform act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from current expectations. These risks and uncertainties are described in the cautionary statement disclosures and Lincoln's most recent reports on form 8-K, form 10-Q and form 10-K filed or furnished with the Securities and Exchange Commission including Lincoln's form 8-K dated November 2, 2004 containing the third quarter 2004 earnings release.

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

This call is being recorded and will be available for replay beginning today through November the 10th and the replay will be accessed by dialing 888-203-1112. Again, that number is 888-203-1112. And enter the pass code of 238860. Again that's 238860.

At this time, I would like to turn the conference over to the Vice President of Investor Relations, Ms. Priscilla Brown. Ms. Brown, please go ahead now.

Thank you, operator.

Good morning and welcome to Lincoln's third quarter earnings call. We appreciate your participation today and invite to you visit Lincoln's web site, lfg.com, where we have posted slides as a reference for today's call and where our statistical supplement and other pertinent information can be found.

On September 24th, we closed on the sale of Dial, our London-based international investment management unit. Also during the quarter, we began the transfer of assets under administration related to the outsourcing of our mutual fund 401K record keeping business to third parties. The deposit and net flow numbers that Jon Boscia will be sharing with you this morning do not include Dial's results nor do they include the assets under administration related to the 401K record keeping business. For your convenience, the third quarter stat supplement includes pages that represent -- that present the results with and without Dial and the assets under administration are shown on a separate line. A full reconciliation of income from operations to net income is provided in our press release and in the stat supplement posted on the web site.

Now I'd like to turn the call over to Jon Boscia, Lincoln's Chairman and CEO and Rich Vaughan, Lincoln's Chief Financial Officer. The brief comments will be followed by question and answer period. Jon?

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

As I look back over the quarter, I find it one of the most intriguing quarters in a long time. Here's why. This has clearly been a period of lackluster equity markets where the third quarter performance of the S&P 500 lagged behind the last five quarters. Depressed interest rates which continued to put pressure on spreads and suppress fixed annuity sales. An industry that is struggling under the weight of unprecedented challenges on the regulatory front requiring an increasing commitment of resources and capital. And continued competitive pressures particularly in the life arena at a time when financial discipline and risk management are clearly essential to protect clients and shareholders alike. With this as a back drop to the quarter, I am especially pleased with Lincoln's results.

Despite the tough environment, Lincoln's deposits and positive net flows maintained a strong pace established earlier this year. Return on equity for the first nine months was over 14%, a level we've only previously achieved when equity markets were exceedingly strong. What should be apparent is that these gains are the result of strong performance in all three critical categories of product strength, broadening distribution and increased brand recognition. With that, let me share with you some of the highlights from the quarter.

Aggregate deposits in the third quarter continued at a strong pace. We recorded gross deposits, excluding Dial, of $5.7 billion in the third quarter, a 30% increase over the prior year quarter. Total positive net flows reached nearly $2.2 billion across all domestic businesses in the third quarter, a 50% increase over the prior year quarter and continuing the strong trend of recent quarters. In our retirement segment, third quarter variable annuity deposits were just above record levels established in the first quarter. Total variable deposits of nearly $2 billion were up 61% over the third quarter of last year driven by an 88% increase in individual variable annuity deposits, which for the quarter were just under 1.6 billion. Through nine months, variable annuity deposits and flows have surpassed results for the full year of 2003. Third quarter annuity net flows were record $716 million.

Now let's turn to the Life Insurance segment. Retail first year deposits with are $188 million, a decrease of 10% from the prior year quarter. The drop was driven by a decline in universal life sales of 21%. We have seen sales affected by competitive pressures as companies attempt to gain share with aggressive pricing. These are companies looking to compensate for weak distribution relationships, for those that have key product dependency. We understand the need to remain competitive from a pricing standpoint, which the market always demands. We also understand the implications of potential changes and reserving requirements and how that could affect product availability and consumer demand. At Lincoln, we balance these factors with our underlying discipline, risk management practices.

Going forward, we will continue to focus on distribution, which we're expanding in key channels that offer the greatest opportunity for growth, and targeted product development which leverages our underwriting expertise and focuses on our core markets.

Turning to investment management, Delaware posted another strong quarter for both deposits and net inflows. Third quarter deposits, including Dial, totaled $3.5 billion, a 35% increase over the prior year quarter. We saw double digit growth in both retail and institutional year-over-year deposits with retail posting a 28% increase and institutional increasing 46% to a record $1.7 billion. Again, excluding Dial, combined institutional and retail net inflows of $1.2 billion increased 54% from the prior year quarter driven by record institutional net inflows of $850 million.

Year-to-date net inflows of $3.8 billion more than doubled over the same period last year. Performance continues to be the key to Delaware's success. Of the largest 25 mutual funds at Delaware, the number of funds that performed in the top half of their respective Lipper category for the year-to-date, one year, three-year and five-year period all increased relative to the second quarter. In each of the categories, over 80% of the funds ranked in the top half. These 25 funds represent approximately 90% of Delaware's total mutual fund assets. We're very pleased with these results and it's the kind of track record that's an important driver of flows and long-term value creation.

Before I turn it over to Rich, I would like to briefly comment on the bid rigging and contingent commission headlines that have developed in recent weeks. We at Lincoln are disturbed and concerned, as we expect most of you are, by the allegations and the charges that have ensued. We are not currently aware of any subpoena being received related to this issue and we have very little exposure to the types of businesses where the activity seems more prevalent. We understand the gravity of the situation and that it could impact perceptions of the industry as a whole, no matter which companies or lines are the focus of scrutiny. Lincoln has a history of strong governance and a culture based on a common set of shared values. Our shared values have been in place and communicated for years and include integrity, fairness and a commitment to excellence. We will continue to conduct business in a manner that is consistent with these values. With that, let me turn it over to Rich.

Thanks, Jon.

Yesterday, Lincoln reported third quarter net income of $199.7 million, or $1.12 per diluted share. An income from operations of $178.2 million or a dollar per diluted share. As Jon mentioned earlier, interest rates and the equity markets did not help us much this quarter but despite all the noise, the underlying results were generally as expected. I will go through the results by segment but before I do that, let me provide some details on DAC unlocking, GMDB reserves, and prepayment and make-whole premiums. With respect on locking and GMDB reserves, we completed or annual review of prospective DAC assumptions in all of our businesses. Which resulted in prospective unlocking during the quarter. This is in addition to our quarterly review and retrospective adjustments to DAC amortization. We also reviewed the calculation of the benefit-reserve ratio used to develop the reserves for guaranteed minimum death benefits, as prescribed by SOPO 3-1.

In the aggregate, the net impact earnings from all of our unlocking activities including the negative effect of the third quarter equity markets was virtually neutral. However, the results by segment varied quite a bit. For both the life and retirement segments, the majority of the unlocking impact was caused by changes to persistency and interest-related assumptions. Interest-related assumptions had an adverse impact in both segments. The long end of the interest rate curve hasn't been going up as we expected, so we reduced perspective DAC interest rate assumptions. In-force persistency was generally better than expected, and accounted for a positive adjustment in retirement and investment management segments.

As I mentioned last quarter, we continue to see a fair amount of activity related to prepayment and make-whole premiums heading into the third quarter. This year's quarterly average continued to run at close to three times the after-tax after-DAC average in 2003 of 3.2 million. October results indicate little prepayment activity, but we know of about 5 million pre-DAC and pre-tax coming in November so far. It's difficult to project prepayment and make-whole premiums but conditions remain favorable for a continuation at this time.

Now let me turn to the segments starting with retirement. Retirement reported income from operations of 110.2 million, which included a net benefit of 20.5 million from retrospective and prospective unlocking adjustments, driven in large part by changes to prospective persistency assumptions. The changed assumptions will also reduce amortization going forward and this is expected to have a positive impact on earnings of about $1 million per quarter. We did announce in last quarter's call that we were then hedging the vast majority of our exposure to guaranteed minimum death benefits. That hedge expansion was done on July 28 and because the equity markets moved against us prior to our putting the balance of the hedge in place, we did record an increase to the GMDB reserves of approximately $3 million after tax. Since we've hedged the vast majority of the GMDB exposure, we would not expect to see much noise from this in future quarters. Retirement also benefited from prepayment and make-whole premiums, although our experience in the third quarter was about half of that of the second quarter.

In the life segment, earnings of 55.4 million were depressed by an unlocking charge of 18.7 million due in large part to the reduction and interest rate assumptions combined with slightly negative lapse experience on an older block of Colley(ph) business. We expect the life segment to see a reduction of future earnings of approximately $2 million after tax per quarter from an increase in DAC amortization as a result of the change in assumptions. Other items in the life segment were higher expenses including outsourcing arrangements and branding. However, this negative variance was offset by the favorable prepayment and make-whole premiums.

Investment management earnings included a positive $2 million from prospective unlocking. Which was offset by several items in the quarter, including incentive comp accruals driven by Delaware's investment performance and a change in the value of seed capital. driven by the decline in the equity markets. Dial's contribution to third quarter earnings through the date of the close was $4.8 million, and the year-to-date contribution was $12.4 million.

Moving to distribution, the combined loss for LFA and LFD in the third quarter totaled 9.8 million compared to 15 million a year ago and 11.8 million in the second quarter. LFA benefited from higher revenues and lower expenses as compared to a year ago as it works on the final stages of redefining its business model. At LFD, revenue growth outpaced the increase in expenses as our investment in wholesalers and emphasis on key partners continue to drive sales growth. Both organizations have focused on continuous improvements in how they deliver products and services and the results validate those efforts.

We've told you in the last couple of quarters that we expect to end the year with a distribution loss of about 42 million. We would expect that or slightly lower barring any unexpected variances and sales volume or expense levels.

Lincoln UK's earnings of about $10.1 million were in line with expectations. We expect the year to end at or near the previous forecast of 38 million, assuming no unusual movements in the equity or currency markets.

In the corporate segment, we recorded an adjustment in the quarter increasing the deferred gain in the sale of Lincoln REIT. The source of adjustment was a reserve that should have been taken to the deferred gain back in 2002. So we did a reclassification in the third quarter. The cumulative adjustment of the amortization recorded in the quarter was an after-tax pickup of $9 million or five cents per share. The increase in the gain will also change the amount of the amortization going forward, increasing quarterly earnings approximately $800,000 after tax.

I'd also point out that we would expect to see some relief in our interest expense due to the call of our [908% diventures(ph)] on October 1. The pickup should be 700 basis points on the $120 million since the funds had been invested at LIBOR. That should add about 1.4 million after tax per quarter going forward.

Before I turn it back over to Priscilla, let me give you a brief update on our stock repurchase program. During the third quarter, we repurchased $73 million of Lincoln stock bringing the total amount repurchased year-to-date to approximately 286 million. Late in the third quarter, we successfully closed on the divestiture of Dial and expect to use a portion of the proceeds to repurchase stock. Including the Dial proceeds, we expect to repurchase approximately 350 million in stock for the year. We will continue to monitor the markets, changes in regulatory capital requirements, and competitive landscape, reserving a right to adjust our repurchase activity accordingly. With that, I'll turn it back over to Priscilla.

Actually, Rich, before we turn it over to Priscilla, I just want to clarify a point that I had made there, where I had indicated that the third quarter deposits of 3.5 billion included Dial. That figure actually excludes Dial.

Priscilla?

Thanks, Jon. And those were Delaware deposits that you were referring to.

We'd like to now open the call for your questions. In order to provide an opportunity for as many callers as possible, we will again take one question and then one follow-up from each caller.

Thank you, ma'am. Ladies and gentlemen, our question and answer session will be conducted electronically electronically. If you would like to ask a question, please firmly press the star key followed by the digit one on your Touch-Tone telephone. We will compute in the order that you signaled. If you find your question has been asked and answered before you could ask it and you would like to remove yourself from the question roster, please firmly press the pound key. Also, if you are on a speaker phone, please make sure that your mute button is disengaged so your signal can reach our equipment. Again, if would you like to ask a question, please firmly press the star key followed by the digit one. For our first question, we go to Andrew Kligerman of UBS.

Thanks and good morning. With regard to investment spreads in both the annuity and universal life areas, it looks like you had a slight pickup. Can you speak to what percent of your business is now at minimum credited interest rate? And what your outlook is next year if the yield curve -- let's say the yield curve stays as it is today and just doesn't change. How would your spreads be performing next year around this time?

Andrew, we'll dig out the percentage here are in a second, but we've said in the past that we expect spreads to come in 4 to 5 basis points per quarter. That obviously has a different impact between life and the retirement segments. But in the retirement segment, you can think of it in terms of, if we stay on track where we are, we'd expect to see some compression in earnings coming from that -- somewhere in the 2 to 3 million dollars per quarter area.

Sequentially would add another two to three each quarter? It would aggregate?

No, would decline. Reduce earnings.

At a run rate of that amount?

Yes. It would start bringing it down. It's about $1 million or so on the life side going forward. Some of that is dependent upon how much business we actually have that is lapsed where we are able to in effect retain the underlying securities and therefore not cause the compression to take place. If we have a lot of new business, fixed business, going on the books and we're investing, obviously in the current rate environment, it could bring it down faster. That's where our expectations are today. Obviously there's a lot of moving parts around it, so it's very, sort of loose, around those numbers.

But staying in this interest rate environment would certainly put more pressure on your four to five basis points per quarter. Is that a fair assessment?

Right. And on the percentage of the business overall, we've got about two thirds of the business across life and retirement at this point. Different percentages for each but on a combined basis, two-thirds of the business is at minimum and/or guaranteed rates.

Great. Thank you.

We go next to Colin Devine with Smith Barney.

Thank you very much. I thought I would talk a little bit more about what you're seeing in the variable annuity business in terms of competitive pressures. Obviously, Jon, you talked about the life business. You're continuing to sequentially build the VA deposits. Maybe you can bring us an update there.

Yeah, I think, Colin, what we're seeing in the VA deposits really is the results of the combination of expanded shelf space - the building out of wholesalers over the last couple of years as we went from a couple of hundred wholesalers to now approximately 400 wholesalers just providing the real coverage to the shelf space we've achieved. And then we have the guaranteed minimum withdrawal benefit product, which, you know, has been a popular product in the marketplace. That, at least, gets us to the table, but I think it's the distribution buildout that is delivering the results.

What percentage of your deposits this quarter had the GMWB feature?

I'm going to have to refer that one over to the life and annuity area, Jon.

This is Todd Stevenson. About 53% of our variable annuity departments had the GMWB feature in the quarter.

Jon, my thought is going to be -- you mentioned the bid rigging and such in your opening comments. What is the status of the subpoenas you received from the attorney general's office with respect to the variable annuity business?

We continue to respond back to all the regulatory inquiries. There hasn't been any type of, you know, action. It's just a communication back and forth answering their questions.

Okay. Have they been asking questions about revenue sharing agreements as they have in the mutual fund business?

I'm looking over at Dennis Schoff here on that one, who is our general council.

Colin, they have been asking a lot of broad questions about a lot of the industry. I would have to go back and look at the various inquiries themselves for specificity. But based on the broad nature of their questions we have been supplying them information along those lines.

Okay, thank you.

We go next to Nigel Dally with Morgan Stanley.

Great. Thank you. Good morning.

First with prepayments. I just want to clarify how much prepayment income - if we take out tax, adjust for DAC, add it to operating earnings this quarter, and I think you said there was roughly 3 times the (indiscernible) to 2003, just wanted to clarify that? Then, second, just on hedging. Was there any cost of hedging this quarter for your GMWB rider? Thanks.

On the prepays, I think what I said in my comments was that we're running about three times last year's average and last year's average per quarter was 3.2 million. You could probably do the math in there pretty simply.

And that was after tax after-DAC number?

Yes, it was.

Thank you.

Other ones? What was the other question?

The hedging. Was there any cost of hedging for this quarter for your GMWB rider?

There's always a cost of hedging, but it had virtually no impact or offset the -- First of all on the GMWB, we're still in position where we don't have hedges covering that so the hedging cost there is just the infrastructure in place. But we do have hedges in place on the GMDB side. That obviously does have a cost. And obviously, this quarter after the full hedge was put in place, we have very little impact net of the change in reserve as you would expect it to be offsetting the change in reserve. But as I said, GMWB currently does not have a hedge in place because we are still generally in position where the markets are -- have been stronger during the periods -- since the introduction.

That's great. Thank you.

We go next to Jimmy Bhullar with JP Morgan.

Hi, thank you. I have a question on your variable annuity sales. Have you made any changes, in terms of product features or product pricing, within the last couple of quarters because your sales have been a lot stronger than the industry? And second, also, if you could just discuss growth in the Legacy product versus the ChoicePlus product.

I'm sorry, I didn't hear the second part of the question. I was thinking about the first part.

Just sales versus in Legacy -- American Legacy versus ChoicePlus.

On the first part of it, we have continued to make modest changes to the product design, but as I indicated on a previous question, I think the main reason for the significant sales increase has been because of the continued distribution expansion and success that we're having out there. We are seeing very consistent year-over-year gains coming out of -- sales gains coming out of both American Legacy and ChoicePlus. It typically is not a situation where people choose one or the other in a competitive situation. It's if they want all cap research management, they will typically pick the American Legacy product and if they want multiple manager, they will typically pick the ChoicePlus product. But we're seeing good results in both.

Okay. And then just a question on your life business. I noticed that the admin expense line was a lot higher, about 6 million higher than it's been in the past few quarters. Anything causing that?

Todd, can I ask you could to answer that one?

Yes. During the third quarter, we had some increases and expenses due to branding. Some additional costs that were related to regulatory implementation, Sarbanes-Oxley being included. We also increased, during the quarter, our accruals for incentive compensation, incentive comp being based on a combination of factors including profitability and sales growth. In addition, our results net for the quarter which continued to include impacts positively from the realignment efforts begun about a year ago. So there were several one-time costs and seasonal increases impacting the quarter.

So the higher branding would be something that would revert back to a normal expense?

Third quarter's typically our highest cost quarter from a branding because we have the battle of bridges as well as the stadium events kind of things that drive the cost of slightly.

Okay, thank you.

And we go next to Joan Zeif with Goldman Sachs.

Thank you, good morning. My first question is about the GMWB hedging. You implied that you do not hedge that. Do you think that puts you at a disadvantage once the c-3 phase two reserving is going to be implemented? That's my first question. And the second question is could you talk a little bit more about your change in assumptions that led to your DAC adjustments? You talked about the lapse rates changing. What was it that precipitated that change? Can you give us a sense of the magnitude of the change in the lapses? Was it in any particular product? Why now versus last year or why now versus the end of the year? And I guess just on that same question, should we expect another review at year end? So could we see further adjustments to the assumptions?

Joan, on the first part of your question, the GMWB, just to avoid any confusion there, we do hedge that, it's just that the current position right now of market value relative to guaranteed values is such that there isn't anything to hedge. But it is a hedge strategy surrounding that. And Rich will answer the rest of your questions.

Joan, last year, we changed our annual DAC unlocking timing to the third quarter really to get it away from year-end because typically any time we have the unlocking review, we end up with some noise. We got really tired of having to do that in the fourth quarter with usually all of the good news that came out of the fourth quarter. So last year we moved to the third quarter DAC unlocking. We do, do it in the third quarter now on a regular basis. That is why it was done this quarter.

And no, we wouldn't expect, unless we'd have something very unusual to happen, anything from a prospective unlocking in the fourth quarter. That could be triggered by any kind of substantial move that would change our assumptions going forward. Wouldn't anticipate it again until the third quarter of next year.

On the lapse side, as part of the process that we go through, we look at our persistency and we have basically bands that we welcome at across all of our products. And we had gone outside of a band, in effect. Our businesses is staying on the books longer than the outside limit of our previous assumption band on how long the business would be on the books. So we unlock to get back within that band. That created a positive DAC unlocking.

Which product was that?

Which products? It's primarily our annuity business. That's where it would positive persistency. Across the board whether it's multi-fund, ChoicePlus, it's our annuity business including employer-sponsored business. It was positive DAC unlocking as a result of business staying on the books longer than we'd assumed in the past.

Do you think that is a function of interest rates? Could that adjust back?

Most of the business is variable business, so no I wouldn't think interest would be an impact of a substantial amount. But on the fixed side, potentially, yes. But for the most part, we think we've got good business written for the right reasons and it could have to do with a lot of things including regulatory actions these days because obviously a lot of the individuals selling this business are seeing what's going on from regulatory perspective and are probably a little less likely to 10:35 exchange business. So there's lots of things pushing in the direction of business staying on the books for a longer period of time than originally assumed.

Okay. Thank you.

And for our next question, we go to Vanessa Wilson with Deutsche Banc.

Thank you. Rich, I just need some help with your answer to Andrew's question. The two to three million per quarter of hurt from the four to five-basis points drop, should we think about the four basis points in the fourth quarter then 8 in the second then 12 then 16, is it a cumulative issue?

That's -- yes, that is what we're facing over time. It will obviously tail off so it's not going to be repetitive at that level, but in the short-term, we would see that kind of magnitude. Obviously as you got get further and further, it doesn't keep reducing earnings but it does stay at a lower level point forward.

And then just guidance of 2-3 if we took the low end, it means 2, 4, 6, 8. That's cumulative as well, although reducing?

That's correct. And obviously there's a lot of assumption built into that as far as flows, interest rate levels, et cetera, that we're my highly likely to be wrong. The question is, what is our best guess today? That is our best guess today.

One more clarification Your answer on the conversation with regulators over market timing, it sounded like you've had a lot of conversations recently. Could you give us a sense of -- it was my understanding that the subpoenas and a lot of the requests for information were actually sent a year ago. Has there been a lot of activity recently?

No, Vanessa, there hasn't been a lot of activities recently.

Okay. Thanks very much.

We go next to Steven Schwartz with Raymond James.

Good morning, everybody. I want to touch on the universal life sales, the UL, NLG product. I believe you have that. Do you sell that on a minimum, annual payment type of chassis? Do you use a shadow account chassis? How do you think that's playing into your competitiveness, the competitiveness of the market? And do you see some possible change as it seems that the NAIC, at least led by Boner, moves against the shadow account product?

Steven, we do have no-lapse guarantee products out there, and in our comments, we had noted the significant drop that we've had in universal life sales, and that's largely reflective of our relative product competitive positioning in that area versus other company's competitive products. We have not made our product a leading edge highly attractive illustration type of a product. We've been foregoing market share out there.

We are, as so many else are, interested in seeing what's going to be happening with the NAIC. They are collecting a lot of information right now. Our belief is clearly that it is possible that there are going to be changes that come out of the NAIC review when they are finished. Up until they complete that, we will continue to set our reserves in full accordance with Actuarial Guideline 38. We are in compliance with that now and have no intention of falling out of compliance with AG 38. And if as the NAIC goes forward and comes out with changes, we will adjust our products and our strategies to be consistent with those changes.

Okay. I appreciate that, Jon. But you didn't answer the first part of the question. Were you using a shadow account chassis or minimum payment chassis?

We do use the shadow account, sorry.

Your sense of what you're looking at, vis-a-vis, the competition, that would be primarily product on a shadow account chassis as well?

I think you're looking at all of the products as the competition, yes.

Great, thank you.

And for our next question, we go to Mario Mendonca with CIBC World Markets.

Sort of a follow-up to the last question. When you were talking about persistency and the changes in persistency assumptions as part of your annual review, you refer to the impact really on Colley and essentially persistency not being as strong as you'd expect. Were there any assumption or DAC impacts on the life side essentially related to this lapse-supported product?

The only change in assumptions that we made there was really true up in one of our systems to get the business model more effectively in the system, but nothing from a negative lapse perspective. The negative lapse unlocking it was in the life side was focused on the Colley business, not on LPR, lapse protection rider business.

And you refer to sort of bands of persistency, what have you --

That was on the annuity side of the business where we have positive persistency experience.

What I was going to follow up with was, in the context of this product, where do you lie in your bands?

It's modeled differently. We're obviously very early in this product's life cycle. Whereas on the annuity business, where we had the big impacts from unlocking, we're very mature in most of those products. So there was no unlocking relative to persistency on the LPR products, which are the shadow account products that we've had for a number of years but still relatively young in its life cycle.

Just finally on the UL. Do you imagine having to drop your pricing a little bit or are you going to stay very disciplined in this business?

Our intent at this point in time, Mario, is to maintain a financial and risk management discipline. You know, going out of your way to buy market share on Life Insurance is a product or is a decision that stays with you for a very, very long time because of the nature of Life Insurance persistency. So that's not anything that John Gotta or I feel compelled to do.

Thank you very much.

And for our next question, we go to Ed Spehar with Merrill Lynch.

Good morning. I wanted to just make sure I understand sort of the pieces here, the unusual pieces maybe this quarter. Would it be correct to sort of categorize all of the different adjustments you've made in terms of unlocking and GMDB reserves as a wash? And then, if I wanted to think about the five cents from the deferred gain adjustment, and then it looks like if the overall prepayment income was maybe three times the norm at average, that that might be another four cents a share? Are those numbers roughly correct?

The 5 cents certainly is right on the deferred gain. Prepays would be in the neighborhood of 4 cents for the quarter but once again, I wouldn't expect those to go away.

I'm sorry. I just want to make sure the 4 cents is sort of the excess above the run rate, not 4 cents in total.

No, 4 cents in total.

Okay, well then the 3.2 million that we said --

-- was last year's average.

Right. So we're running at three times that level today, right?

Correct.

So we're running at about a $6.5 million higher level today?

About $6 million higher level today.

Okay. So that's about 3.5 cents, a little over 3 cents a share.

3 cents over last year's rate, yeah.

Okay. The follow up is, I'm wondering, have you looked at or could you give us any idea of what the impact on earnings would be sort of either on both operating earnings and maybe sort of the economic cost of hedging with more of an options-based strategy versus the futures based strategy employed today? Thank you.

Let me turn that one over to Todd. I don't know whether you've got an answer to that one or not, Todd. What do you think?

Well, no direct answer. It obviously, as we look at our continuing level of sales of GMWB, you know, we're focusing on appropriate hedging and we've obviously -- we obviously have a rider charge that for the long-term would we expect will cover our cost of hedging. And we expect that the economics of those rider charges would appropriately cover our hedging costs. Continue to monitor all of the variables that will ultimately drive our experience, and prove our rider charge appropriate for the policyholder behaviors and all of the other attributes that affect the ultimate economic and accounting costs of those riders.

We're obviously in a very strong period right now where we've had equity markets generally improving. While we've had this product on our books and being sold, so we are in the positive side and effect of that experience and at some point, we would expect the cost of the hedging program will obviously be greater than what it is today, which will impact earnings somewhat because right now we are collecting and recognizing the fee revenue from those riders that had been elected.

And when you talk about the cost of the hedging program, is that something that's going to be, you know, if it does go up, something that will be apparent to us in operating earnings or is it something we'll have to sift through in the below the line adjustments for like FAS 133 or something?

It will be in the operating earnings piece.

Thank you.

Ed, on your third part of your question to Rich, actually, did everything else net out, the answer to that was yes, so you had the correct assumption on that or the correct read.

For our next question, we go to Jason Zucker with Fox-Pitt Kelton.

Thank you. My questions have been answered.

For our next question, we go to Jeff Schuman of KBW Assets Company

Good morning. I was wondering if we could dig a little deeper on the DAC-related and GMDB-related items. You talked about the netting of the retrospective and prospective adjustments. I guess what I'm thinking is the retrospective adjustments that are attributed to actual market performance during the quarter is something that we all try to anticipate in our estimate. You know, the prospective things that came out of the assumption review will be something different. Is it possible for to you kind of segregate those impacts for us?

Sure. Which piece do you want or which pieces do you want? There's lots of them obviously.

I'm wondering if you could segregate anything retrospective versus anything prospective and by line of business would be helpful, please.

On the retirement side, the retrospective unlocking was a negative of 800,000 pretax, and on the life side of the business, we had about a $5 million retrospective negative unlocking, pretax. Those two lines would be the biggest.

On the prospective unlocking, you had about 32 million positive on the retirement line and a 23.7 million negative on the life line. We can give you more detail if you want it, but we probably ought to do it offline.

That's very helpful. Thank you.

We go next to Thomas Gallagher with Credit Suisse First Boston.

Good morning. Just just a follow-up on AG 38. I know it's probably a bit preliminary, but just if you could give us a little color it would be helpful. Can you talk about, you know, based on what's been I guess presented so far. Should this only be an issue for new sales and pricing on new sales or do you think it will also apply to existing reserves or in force? In other words, would it require more capital in your business? Also, as there's some uncertainty here, are you looking at any capital market solutions or reinsurance solutions that would allow you to sort of maintain your position in the UL business?

Tom, on the first part of it that's one of the biggest issues that I think the NAIC is wrestling with. If they do change their interpretation, should it be on a prospective basis or retrospective basis? And you know, we just don't know what the answer would be. If they were to do something retrospectively, it will have a different impact than prospective application would.

The second part of your question on are we doing anything either in the capital markets or reinsurance to deal with it? The answer to that is yes, but I would emphasize that it's really only those pieces that are clearly the redundant surplus pieces, not the base product surplus components.

Okay. And then just one follow-up. Do you have any idea on timing on this. I would imagine '04 implementation is not likely. If it does go through, would this be an '05 event?

We don't know the answer to that one either yet at this point, Tom. Sometimes there's indications that the NAIC would wait until '05 and then any retrospective type of an impact would be minimal and at other times we get indications that their timetable may have it be '04. And then in each situation, we see that they have some scenarios where it would be prospective only and somewhere it would be retrospective. So we have all four variables out there and we really don't have much more information than would probably all the rest of you have as to what the NAIC may likely do with this.

And then Jon, just one last question. If you look at a worst case scenario on this, is there any way to quantify? Could this be a hundreds of millions of dollars of capital issue for you? Is that sort of the worst case scenario we'd be looking at?

I don't know that we have looked at that worst case type of scenario. I'm going to look to Rich.

I don't know of a worst case scenario that we've looked at. One of the things we are being very cautious with the capital that we have right now until we get some resolution of this. And you know, that conservatism is built into the numbers that I gave you on our share repurchase program. So until we know more, we will be more cautious and we're running on the high side of 300 RBC at this point, 320 was where we were at the end of the second quarter, 323. I would expect this to be in that neighborhood although I haven't seen any numbers yet for the third quarter. We've got the proceeds from the Dial sale. We're being cautious with that. And, you know, we're managing around this issue until we get some clarity on it.

Okay, thanks a lot.

For our next question, we go to Eric Berg with Lehman Brothers.

Thanks and good morning to everyone. With respect to this universal life issue, it seems to be lots of companies that consider themselves very upright and respectable are reporting significant increases, you know, not fringe companies but big, famous companies that we've all heard of. My first question is, what is it underlying this more aggressive pricing, these lower prices than yours? What is the bet that they are willing to make that you are not? I'm looking for, you know, essentially an actuarial answer. Is it they are more hopeful about interest rates, about persistency? What's going on here beneath the pricing that sets Lincoln apart from its peers?

And I will have one follow-up.

Eric, I really don't know that we can provide an actuarial answer to that because that would assume we have insights into their product pricing assumptions which we don't have. When I look at some of the differences between the way the companies illustrate relative to one another, what I see coming through far more than any type of what might be on the actuarial side is just market play considerations. Where some big companies, as you've said, that we've all heard of are making newly expanded forays into Life Insurance and they're picking popular area of Life Insurance and putting very aggressive products on the shelf. I don't think it's an actuarial answer but Gary Parker, if you know something different, then that will have a different perspective, please share that.

No. This is Gary. Jon, I don't have a different perspective. I think you're right on. And the only guidance I might say is if you look at the Moody's report that looked at the primary pricing assumptions of these products, those are the areas, if any companies are getting aggressive that they might be getting aggressive with pricing. As John said there's no way we could know exactly what they're doing from a pricing perspective.

Okay. My follow-up question is, I believe you said that you had a very significant reduction in earnings in the quarter in your Life Insurance business owing to a prospective unlocking related to interest rates. I think the figure was 18.7 million after tax was the hurt to earnings in the life business. If I have that right, if you are taking a more cautious view of interest rates, such a more cautious view of interest rates prospectively in the Life Insurance business, why didn't you do it to the same extent in your annuity business?

We did have financial straight prospective in both retirement and life. Spreads reduced on a prospective unlocking in the retirement side about $8 million pre-tax. It was about $17 million in the life side pre-tax. So we had negative unlocking in both lines due to interest rate assumptions.

Thank you.

And as a reminder, ladies and gentlemen that is star one if you would like to ask a question and if you are on a speaker phone, please make sure that your mute button is disengaged. Again, that is star one to ask a question. We go next to Bob Spiegelglass with Langen Mcalenney.

Bob Glasspiegel. Good morning, everyone.

We knew who you were, Bob.

I'd like to follow up on, pile on the secondary guarantee question and go at it a different way. Before times were competitive, this is a line of business that's been cranking out 9 had 10% top ROEs over the last couple of years. I think if you add back the charges, it looks like you are about 9 1/2 this quarter. If life sales stay down, you are going to be hard pressed to get double digit ROE prospectively in an environment where spreads are working against you as well. In the absence of much more significant cost cutting than you've done, or taking capital out of the business, am I overreacting or should we just think about this business as just short of an anchor over the next couple of years.

Sales don't add much --

I know.

Or anything to earnings as they take place.

Right.

If you look at the ROEs of the business without the good will it is generating, a 15% ROE, that's the way the business is typically written. The drag that we have there is the good will that's on the books. That doesn't go away under the current accounting structure.

And that's where you're seeing the lower ROE. And that will not go away. If we can't grow the business, then we're not going to be able to grow the ROE likely, either. So that is a concern, but right now, we've got a very competitive environment and we still have substantially strong sales. They are just not growing as they had been in this competitive environment. And there's a lot of companies that are reacting differently. We're hearing about products that are being revisited, pulled, et cetera right now. So there may be over the next few months more rationality coming back to this business. As that happens, we think our distribution channels, our product design, will continue to put us in a fairly good position.

You're still wedded to the secondary guarantee product as a key chassis in that marketplace?

It is one of our key chassis and our money guard UL product is also one of or key product chassis that doesn't have anything like that as far as issues.

And we also believe, too, Bob, that we're going to see with some more continued stability in the equity markets the variable universal life product become more anticipated and utilized in the market. We have very, very strong VUL. product line. So part of the, I think, attractiveness of the Lincoln life portfolio is, in fact, the breadth of it. Whichever way markets go and product demands go, we have historically had an attractive, well positioned product for that. And I think John Gotta and Gary Parker will continue to keep us positioned that way.

Thank you, Bob and all of you for great questions today. As always, we'll continue to take your questions on our investor relations line at 800-237-2920.

Also as a reminder, Lincoln will be hosting its annual conference for investors and bankers starting with the reception on Wednesday evening, November 17th followed by an all-day meeting on Thursday November 18th. We look forward to seeing you there. Thank you and have a good day.

And ladies and gentlemen, this does conclude Lincoln Financial Group's third quarter 2004 earnings conference call. You may disconnect at this time.