Lincoln National Corp (LNC) 2005 Q4 法說會逐字稿

Ladies and gentlemen, please stand by, we are about to begin. Good morning and thank you for joining us for Lincoln Financial Group's fourth quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS].

Before we begin, I have an important reminder for you about Lincoln's earnings release. Any comments made regarding future expectations, trends and market conditions, including premiums, cash flow, pricing and loss 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 and disclosures in Lincoln's most recent report filed with the SEC.

At this time, I would like to turn the conference over to the Vice President of Investor Relations, Ms. Priscilla Brown. Please go ahead, ma'am.

Thank you, Rufus. Good morning and welcome to Lincoln's fourth quarter earnings call. You just heard the Safe Harbor cautions; I won't repeat them. We appreciate your participation today and invite you to visit Lincoln's website, LFG.com, where our statistical supplement and other pertinent information can be found. A full reconciliation of the non-GAAP measures used in the call including income from operations and return on equity to their most comparable GAAP measures is provided in our press release and in the statistical supplement posted on the web site.

Now, I'd like to turn the call over to Jon Boscia, Lincoln's Chairman and CEO. Jon?

Thanks, Priscilla, and thanks inform all of us for joining us this morning. I have a bit of a cold here so please pardon the quality of my voice and any breaks that may occur.

In large combinations, there is always an element of skepticism or worry on the part of investors that if the integration goes well, then the new business pipeline will suffer and vice versa. Well before the announcement of the transaction with Jefferson-Pilot, significant resources were focused on the transaction. Whether in due diligence, negotiation, communications or now closing and integration planning. A decision was made early on to keep the integration support separate from new business support.

We communicated to you back in October that the majority of expense savings would not come from those areas directly linked to the acquisition of new business. This core approach has stayed with us during the last six months and has been fostered by Dennis Glass and members of our integration steering committee who are overseeing the integration planning process. Growing the business remains our number one priority, and you can see that from the results we released last night and the comments we'll share with you this morning.

The majority of our employees here at Lincoln, and I'm sure Dennis Glass would echo my thoughts about Jefferson-Pilot employees, as well, have continued to keep their minds wrapped around our businesses and their attention focused on customers. The performance and commitment of employees continues to exceed expectations at a time when distractions have become routine and difficult decisions are required every day. We have significant work ahead of us to integrate our two great companies, but we are encouraged by the results to date. Our new branding tag line, hello future, not only captures the essence of the markets we serve, it embodies the excitement that our employees are bringing to the new Lincoln.

With that, let me review some of the highlights from the quarter. In the quarter, Lincoln reported aggregate gross deposits of $10.4 billion, which were up 29% over the prior year quarter. For the full year, record gross deposits of $40 billion were up 31% over 2004, up 55% if you adjust for the sale of Delaware Investment Advisers Limited, or DIAL, which occurred just prior to the end of the third quarter of 2004.

We continued to see strong levels of net flows. Domestic net flows of $4.4 billion in the fourth quarter were down 5.5% from the prior year quarter due to a few large employer-sponsored and institutional out-flows. We expect some variability in net flows from these businesses when looking at results on a quarterly basis. On a year to date basis, aggregate net flows were a record $20.2 billion, far exceeding the $14.5 billion reported in 2004 by a 39% and that's including DIAL. To put 2005 perspective into perspective, we experienced net outflows of $7.3 billion in the year 2000, and just about broke even in 2001. In the following four years, and excluding the results of DIAL, we have recorded cumulative net flows of almost $41 billion in 2005 contributed 50% to that number. This simply underscores my opening remarks about our focus and commitment to driving growth as we prepare to combine the two companies.

Let's take a look at each segment, starting with retirement. In the fourth quarter, gross deposits in our retirement segment of $2.6 billion, were up almost 11% over the prior year quarter, and tied the record set earlier in the year. Year-to-date gross deposits of $10.3 billion were up over 2004 results by 14%, driven by record deposits in variable annuities and our alliance program sold in the employer-sponsored market. Included in our variable annuity results were record i4LIFE elections in the fourth quarter of $321 million, bringing total 2005 i4LIFE elections to over $1 billion. 85% of which was new money. We continue to believe that it is the best solution for those beginning to take income, given the flexibility and control it offers the client. The message is getting out there and the market is responding.

Retirement net flows in the quarter were $621 million, down 22% from the prior year quarter. Included in the quarter were net outflows of approximately $200 million in our employer-sponsored business. We do see lumpiness in this business from time to time and we do not believe the outflows are a result of lack of competitive product.

Turning to the life insurance segment, excuse me, our retail first-year premiums were up significantly in the quarter, increasing almost 14% to $262.6 million. Retail life premiums for the full year were a record $845.4 million, up 4% on 2004, despite a year-over-year drop in MoneyGuard premiums where we have seen an increased amount of competition through the the year. Retail VUL sales have been strong relative to last year, up 26% versus 2004. Growth has been driven by our hybrid Lincoln VUL 1 product, which was updated in May. That, coupled with the recovery and universal life sales provided a boost to the period's results.

From a distribution standpoint, we enjoyed the benefits of diversifying our life insurance base across multiple channels through Lincoln Financial Distributors. We did experience some seasonal pickup in life sales through Lincoln Financial Advisers looking at it on a sequential basis, but sales were down year-over-year. However, 2005 was a pivotal year at LFA as they implemented the third phase of their Consistency of Excellence initiative, which was the introduction of a national support and affiliation plan. Bob Dineen, the employees, and the planners at LFA, worked diligently through the the year, and now that this phase is in place, we are confident that we're beyond the most difficult part of the transition. LFA has emerged a more focused, more viable organization than at any time in its history, and all are to be commended for the hard work and cooperation that were needed to make it happen.

In the investment management segment, Delaware delivered its second-highest quarter on record for total deposits, driven by a continuation of their strong investment performance. Fourth quarter retail and institutional deposits increased to almost $7.4 billion, up 40% over the prior year quarter. For the full year, combined deposits increased 41%, to a record $28.7 billion, and 84% increase over the prior year if you adjust for DIAL. Net flows for the quarter were $3.3 billion, level a year ago, owing to the loss of a few large institutional accounts in the quarter. Net flows for the year were almost $16 billion, a 55% increase over 2004, and more than double if you exclude DIAL. Third party assets under management, that is, excluding the Lincoln life general account assets, reached $77.1 billion, a 38% increase over the prior year end.

2005 has been a defining year for Delaware, in the numbers it has produced, its first full year without DIAL, and more importantly, in the actions it continues to take to strengthen itself as a top tier investment management firm. Jude Driscoll has attracted some of the best talent in the industry and added it to an employee base that was already recognized for its performance and service. Without a doubt, Delaware is well positioned heading into 2006.

In a slight departure from our normal schedule, I've asked Terry Mullen, Senior Vice President and Head of Sales at Lincoln Financial Distributors, to spend a few moments on the 2005 accomplishments at LFD and to share with us what he is seeing in the various channels. Terry?

Thanks, Jon.

As you know, distribution is a prominent part of the LFG strategy and combined with our manufacturing partners, we have been successful in establishing LFG as the partner of choice for life, annuity and investment management products in top firms across the country. Our customers, that is the financial intermediaries we do business with, are an integral part of our success story. I want to spend a few minutes providing you with an update on the progress that has been made in growing our strategic relationships. I'd also like to share with you what I'm seeing in the various channels and products and the key indicators that show we have a model for delivering sustainable growth.

First, our sales growth. Jon pointed out the record deposits for LFG and the same holds true for LFD's year-over-year sales. A 24% increase in variable annuities, a 9% increase in life insurance, and a 55% increase in mutual fund sales on a combined product basis and looking at our top 10 key accounts which represent about two-thirds of LFD's total sales, we had a 28% year-over-year increase.

Excluding LFA and drilling down a bit, we had five firms with aggregate sales in excess of $1 billion. Three of those firms had double-digit growth over 2004. Of those three, two were in in excess of 70% and one in excess of 40%. These are firms that are selling all three product lines, life, annuities, and retail investment products. How did we accomplish that?

Well, this is where the second indicator comes in, managing our wholesaler force. Part of the answer is the number of wholesalers, but if you look at the absolute number of wholesalers at the beginning and the end of the year, it's not obvious. We started 2005 with the combined count of internal and external wholesalers of 356 and ended the year with 364. Clearly, not the growth we've seen in the past. But what's not apparent in these numbers is how we manage the wholesaling force across products and across firms. We have concentrated our wholesaling efforts on those strategic partner relationships that offer us the greatest opportunity to grow market share across our major product categories.

The effectiveness of our wholesaling forces also influenced by tenure which has increased. In November of 2004, at our last investor day meeting, we said that 49% of our wholesaler force had been with LFD less than a year. As of year-end 2005, that number was 28%. Tenure of our one year to two year wholesalers has doubled from 14% to 31%, and those with us greater than two years, it was 37 and is now 40%. This shift in tenure at LFD has provided a big lift to productivity and effectiveness within these firms.

A third indicator is sales through producers who are new to Lincoln's products. Over the course of 2005, we had over 50,000 producers who sold Lincoln Financial products for the first time in over two years. In fact, one of our most significant strategic partner firms reported that the highest number of these first-time sellers in 2005 came from those selling Lincoln Financial products, including our variable annuities that contain the i4LIFE rider.

Before I turn it back to Fred, let me touch on what we saw in channel sales this year, last year, year-over-year, and the upcoming merger with Jefferson-Pilot. Starting with our warehouse channel, 2005 sales were up 43% over 2004, in the independent planner channel, sales were up 21%. In the bank channel, sales grew by 16%. 83% if you exclude fixed annuities. And sales in the MGA channel were up 13%.

I'm excited about the Jefferson-Pilot merger. Joining forces will allow us new opportunities such as cross-selling leading products like MoneyGuard into MGA relationships on the Jefferson-Pilot side and offering our strategic partner firms Jefferson-Pilot's mass inflow and products suite. On a combined basis, the new Lincoln will have a broader range of products and an increased number of wholesalers and stronger relationships in key channels.

Fred?

Thanks, Terry.

Yesterday, Lincoln reported fourth quarter net income of $225.3 million or $1.28 per diluted share. And income from operations of $232.3 million, or $1.31 per diluted share. Operating return on equity for the quarter was 16.1%, 15.4% for the year. Clearly one of the big drivers of earnings growth for the quarter and year were deposits and net flows, both delivering record results, as Jon shared in his comments. For the full year, revenues from fee-based assets were up 25% in our retirement segment over 2004.

This driven by a 19% increase in total variable product account value. A combination of strong net flows, and market appreciation. A similar story emerged at Delaware with advisory fee revenue up over $19 million, year-over-year. Significant when you consider we have not only replaced the $47 million of lost revenue from the sale of DIAL, but gone beyond to show annualized growth.

Looking at the fourth quarter, earnings benefited from a few tax items running through corporate and other segments including releasing the $4.3 million remaining balance of the deferred tax asset valuation allowance that we discussed last quarter and through the the year. The majority of you reflected this amount in your estimates so you won't adjust for this again. We also recorded a positive tax adjustment of $7 million related to the Company's 401K plan. We currently don't expect an adjustment of a similar magnitude in 2006.

Investment income in the quarter benefited from the receipt of back interest on airline bonds, together with an above-average prepayment in bond make-whole income totaling roughly $6 million. This is after tax and after DAC with most of it running through the retirement segment. There were a few other earnings items which I'll cover in the segment highlights starting with retirement. The retirement segment reported income from operations for the quarter of $117.3 million, versus $100.5 million a year ago.

The quarter included about $8 million of favorable items. In addition to the $6 million of investment income noted earlier, the hedge program supporting the change in GAAP reserves for our GMDB and GMWB riders performed better than expected, running a positive $1 million on a net basis versus our expectation of a net quarterly cost of $1 million. The performance was within our normal tolerances for the hedge program, and we would continue to expect a $1 million cost per quarter from the hedge over the long run.

Spreads in our fixed annuity line on the other hand, saw little in the way of change, either sequentially or compared to the prior-year quarter. After adjusting for prepayments and make-wholes, and the airline's default interest, spreads came in at approximately 219 basis points. As I explained last quarter, we have benefited from several levers, most notably, low fixed product net flows, and modest adjustments in our investment strategy and liquidity management. As a result, we've been able to enjoy stable spreads for several quarters now. However, we are not adjusting prior spread guidance.

In our life segment, we reported operating earnings of $80.2 million versus the prior year quarter of $74 million. In the fourth quarter, we benefited from positive developments in several key drivers. An uptick in permanent insurance in force, the result of improved universal life sales in the second half of the year, and better persistency across all products. We also experienced favorable mortality, all of this resulting in an increase in revenues and mortality margins over the prior year quarter.

Also contributing were account values, which grew by 7% year-over-year including a 14% increase in variable universal life balances. Embedded in these increases is an element of seasonality. We typically see higher sales during the fourth quarter resulting in a larger block of policies hitting their anniversaries in the quarter and therefore we see a pickup in expense assessments driven off of the higher premiums. Combined with favorable mortality in the quarter, this seasonality contributed about $3 million to earnings. Earnings are starting to benefit from an increase in permanent sales and the revenue drivers associated with growth in net amount at risk. That said, we remain somewhat guarded as we wait to see how companies respond to the new AG38 reserving requirements.

Turning to investment management, we reported earnings were $14.6 million, a meaningful improvement over the same period last year, which was the first quarter without DIAL's results. A driver behind the considerable increase in earnings is the boost in investment advisory fees from external clients, which were up 41% in the quarter, reflecting the significant growth in assets Jon noted earlier. There were offsetting items contributed modestly to the quarter's results but overall a fair representation of Delaware's earnings engine.

Looking at distribution within corporate and other, the results of Lincoln Financial Advisers and Lincoln Financial Distributors shows considerable improvement in the fourth quarter with a reported combined loss of only $300,000, compared to a $6.6 million loss in the prior year quarter. Despite the distractions that LFA faced through the the year, they reported earnings of $3.2 million in the quarter. The quarter did include approximately $2 million of net favorable items, primarily tax related, that we would not expect to recur in future quarters.

It's important to point out that while expense reductions played a large part in the return to profitability, LFA was able to avoid the level of revenue erosion that might be expected during a transition of this magnitude. A significant accomplishment. LFD's loss of $3.5 million was down from the prior year loss of 6.3 million driven by strong life sales, the improved productivity Terry outlined earlier and expense management.

As you look towards 2006, it's important to factor in the seasonality that usually occurs in Distribution. Productivity and top-line revenue are generally strongest in the fourth quarter and weakest in the first quarter. Lincoln UK's operating earnings in the quarter of 13.5 million, were above expectations due to a reduction in future pension contributions and related PVIF unlocking. This partially offset by a modest increase in missed selling reserves. The net of these added approximately $2 million to the quarter's earnings.

In 2006, we expect to continue to deliver value from the management of the in-force book while writing some new business with the aim of offsetting the natural runoff of the book. Although somewhat dependent on foreign currency movements, we would expect to deliver annualized earnings in the mid-to-upper $30 million range for 2006.

We did not repurchase any stock in the fourth quarter as our read of the SEC rules suggest to us that it is prudent to stay out of the market prior to closing on the Jefferson-Pilot merger. During 2005, we returned $361 million back to our shareholders in the form of stock repurchase and dividends, while at the same time, growing book value excluding other comprehensive income by 11.5% to $33.66. A sign of strength in our earnings, cash flow, and overall capital quality.

Before I turn the call back over to Jon, I'd like the make a few comments on segmentation. While we are not prepared to go into any detail at this point, I realize you are all starting to prepare your models for the upcoming combination. Assuming no unforeseen delays in closing, we expect to release a template in advance of the second quarter earnings release, which will be the first quarter of operations as a combined company.

At a high level, we will be creating a new employer markets division headed by Wes Thompson. This segment will include the fours -- that is, 401K, 403b and 457 plans. The segment will also include COLI and Benefit Partners with additional detail, recognizing the very different earnings and market dynamics of these businesses. We will create a new individual market segment led by Mark Conan of Jefferson-Pilot, and that business will include individual annuities and retail life, reported in a fashion similar to the way we report life insurance and annuities today.

A notable change, we will no longer be reporting Distribution results as a stand-alone component of Corporate. Cost associated with Distribution will now be in the results of the various manufacturing segments. The remaining segments will be Lincoln UK, Investment Management, and the communications company that JP now manages. As a result of the new segmentation, there will be some shifting of earnings, which we'll cover with the new template. We will dedicate quality time with all of you as we head towards the second quarter reporting dates.

With that, I'll hand it over to Jon for an update on closing activities and overall merger comments. Jon?

Thanks, Fred.

We continue to make great progress towards our anticipated closing, targeting the end of the first quarter or early April. We have received the necessary approvals with the Nebraska Department of Insurance, and Fred recently testified at a hearing with the New Jersey Department of Insurance. Our filings with New York and North Carolina are pending. All SEC approvals are on target, and expect to be in hand by closing. Our work on permanent financing is continuing, and to give us additional flexibility in terms of timing, we have put bridge financing in place.

Finally, you are by now all aware, we and Jefferson-Pilot have called a special shareholders' meeting for March 20th, seeking approval to move forward with the transaction. As the integration planning process unfolds, we continue to feel enthusiasm around the opportunity to create a more powerful, more responsive company, one better positioned to thrive in today's competitive environment.

The two industry-leading capabilities that still serve to define the transaction are Lincoln's distribution strength and Jefferson-Pilot's operational efficiency. Both Dennis Glass and I are excited about the opportunity to leverage these trends at a time when both are critical to near term, as well as long-term success of an enterprise in today's environment. With that, let me turn it over to Priscilla for questions and is answers.

Thank you, Jon. As usual, we will ask that we have one question and one follow-up from each caller so that we give time for all callers to ask questions. Rufus, please start the Q-And-A.

Thank you, Ms. Brown. [OPERATOR INSTRUCTIONS].

We will pause for just a second to assemble the question roster. And for our first question, we go to Tom Gallagher with Credit Suisse.

Good morning. First question I had and then I'll have a follow-up, was just on the variable annuity product. I know the Income for Life benefit has been very successful, it seems to have driven momentum here. And I guess as I listen to other companies, it seems like the market's getting a lot more competitive and that's no longer a unique feature. So I'm just curious, if you share that view and do you think momentum may begin slowing here as a result of competition and if you have any new product launches planned.

Tom, i4LIFE has continued to have very strong momentum in the marketplace. We have seen the sales accelerate as we went through 2005. There are a couple of similar products that are out there, but as we've tried to say in past calls, more than just product, it's product is perhaps the starting point, an entry point, but then you have to have distribution strength, you have to have relationship strength on top of it. And we're not seeing the competition out there result in us needing to change.

Okay. Got it. And just a related question on the earnings in that segment. Fred, I noticed the benefits went down 10 million sequentially. Was that partly due to the hedging positive or was that related to a lower variable annuity reserve? Is that a normal result? Should we assume that that will continue at that should that level going forward?

It was indeed partially the result of the positive implications of the hedge program. We run the hedge results through the benefits line item and as I mentioned, we had a net $2 million over what we would normally expect to see in that line item. So that was certainly part of it. I would have to do a little bit of research to maybe see where the other variances are in that line item, but that was a major contributor.

But I shouldn't take that to mean that the $8 million kind of adjustment, I presume the $8 million is the fully loaded stripping out all one-timers that you think is kind of the run rate in retirement. Is that still a fair comment?

Yeah. You're talking about the $8 million variance in the total results for retirement. In that particular case, it not only included the hedge variance, but it also included the income we received on defaulted securities, airline securities, as well as a modest uptick in prepayments and make-wholes.

So there was really three elements of that $8 million bump in earnings that I noted earlier. Roughly, $4.6 million related to the defaulted securities, prepayments were up a little north of $1 million over what we would expect. And then the hedge program on top of that.

And for our next question we go to Andrew Kligerman with UBS.

Hey, good morning. I was curious, Fred, you mentioned that you're no longer going to break out the distribution line upon the merger of the two companies. Why is that? And I was very encouraged by the improvement in earnings of the two distribution operations.

Andrew --

Let me just -- you know, so do you think you can continue that type of improvement going forward?

Andrew, not breaking out distribution should not at all be confused with not still having a very strong management focus on the P&L of distribution. However, the reason that we decided to no longer break it out is we found that when it came to distribution, we were talking probably 90% of the time about why is the number $3 million instead of $6 million. And we weren't spending any time talking about the types of things that Terry Mullen went through earlier in terms of what's our approach to distribution, why are we having the success that we're having?

And it was much more tactical earnings impact rather than strategic long-term positioning. And since no other company breaks out distribution, in the way that we had, it made it difficult for investors to know is our distribution good, bad, or indifferent? And we just want to put the focus on the strategic aspects of it. Not a few million dollars here or there.

That sounds fair. And then with respect to the ability to maintain that type of progress, in terms of maybe even getting to what we won't see, but would it be that you could get beyond break-even and actually be profitable, especially given now that you've got a big integration ahead of you?

I think as Jon mentioned, Andrew, we're still going to manage to what now will become a pricing GAAP analysis as opposed to a full P&L. They're essentially very similar in design as it relates to holding management's feet to the fire. And from my perspective as it pertains to watching expense management, which now effectively this will become part of, I would hope to still communicate with all of you on what progress is being made or lack thereof on controlling these types of expenses. So I don't expect that go away. We'll continue to manage that.

In terms of breaking down LFA and LFD, there's two very different dynamics there. LFA, as you know, is continuing to make progress on managing their expenses through their consistency of excellence program. You've seen year-over-year they brought that down in this year's results by in and around $4 million. While going through a tremendous amount of change during that period.

LFD's a different animal, as you know. LFD oftentimes, their loss is somewhat misleading, oftentimes it's more an investment on our part to build out wholesaling, where we see opportunity. We would expect to continue to see opportunity to build out wholesaling and so the discussion of that pricing gap if you will, will be different than LFA.

To answer the other portion of your question, do we see Distribution becoming a source of profits at some point in time? Right now, just strategically, we're looking to operate Distribution within the allowables that are inside of the product. Not to add an additional profit component on top of it, because doing so may result in poor decision-making relative to future growth and continued investment in the distribution operation. So we would not want to have a short-term benefit that has a long-term detraction associated with it.

And I would also urge you to remember Fred's comments, where he said, the fourth quarter is always the best quarter in distribution and the first quarter is always the worst quarter in distribution. So as you're thinking about your models and everything for next year, and coming out of the first quarter, bear that in mind.

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

Thank you very much. Could you just talk a little bit about the universal life sales and sort of what you're seeing in the market in terms of how you're going to respond to AG38 and how we should think about this very nice quarter? Is it a fire sale before products change? Or are you already ahead of the game?

Vanessa, it's Fred. I'll make a couple comments, but then I'll ask Gary Parker to jump in and perhaps provide more color. But you're right, we did see Universal Life sales up quarter over quarter about 26% on the year. We had really sales down in LFA, somewhat the result of the realignment activities taking place there. But up considerably in LFD and also up through our other relationships including M Group.

We don't believe it was a fire sale type atmosphere. We believe it was really the result of a longer line of changes we've made within the product and marketing of the product. There have been some market changes. Gary, I might ask that you maybe provide some color on what you're seeing in terms of the quarter.

Sure, Fred. Vanessa, we've actually seen our universal life sales improve over the whole second half of the year, actually the last three quarters of the year. On a gradual basis. And a lot of it, obviously, depends on the evolution of the marketplace and what our competitors are doing. And the impact of AG38 reserve requirements which were effective in the middle of '05.

Yes.

The, we've seen two of our most aggressive competitors raise price during the second half of the year. We've seen, as you know, the investor-owned/stranger-owned life insurance evolution, which we think may be now people moving back to us as a result of more companies refusing to take that business, and a movement back towards more traditional sales themes. I think we're also beginning to get more and more success from our MGA channel model, which is focused on our most important partners, and distinguished between point of sale and non-point of sale distributors.

And as Fred and Jon have said, we had a great fourth quarter from LFD and also M Group in the fourth quarter. So I don't think it's a fire sale. I think the marketplace will continue to evolve over the first half of 2006 as companies react to AG38.

So the products you're selling right now, you'll continue to sell in '06? It's not like you need to make changes from here?

We will be making some changes in the first half of '06.

And any sense of what that will do to your competitiveness?

We've, the design that we've chosen, we think, will have a minimal impact on our competitiveness in the marketplace.

Thank you.

[OPERATOR INSTRUCTIONS]. And we go next to Joan Zief with Goldman Sachs.

Thank you, good morning. My question has to do with the earnings leverage that you're seeing in the asset management division. Pre-tax margins relative to the industry still look a little low. And I was wondering, what you think could be the potential here as you continue to have good flows and continue to grow the assets and gain scale.

Well, as I mentioned, Joan, it's Fred, as I mentioned earlier in some of the comments, the drivers of this of course is the $16 billion of net flows in 2005. And that results in a 37%, 38% increase in third-party assets under management and a 41% in advisory fees. That's compared to on a similar period, only a 10% increase in operating and administrative costs. So we are starting to find some leverage in the growth of assets under management and the fees while keeping the best we can a lid on some of the operating expenses. This year, if you look back on it, was a pretty significant year of change, which you'll see a lot of that running through the P&L

The year experienced a sizable amount of what I would call one-time or nonrecurring expenses associated with severance, legal-related expenses, et cetera. Associated with bringing on the new teams. So going forward, what I would expect is, put it to you this way, cleaner earnings going forward. That is, having a lot of this noise behind us associated with the new teams. And now generating what you would expect from increasing assets under management.

So what you're saying to me is that you base it, there's nothing structural going on here that would preclude this segment to earn pretax margins similar to peers.

We don't, I can't really answer that relative to our peers. As you know, we've talked about EBITDA margin and so forth. What I would note is this: To keep something in mind, that we do have a product within Delaware called the Director product, which is really an employer-sponsored-type product. And it would be our expectation that that product will move into the employer markets division. And that will give rise to a change in the P&L, the earnings mix, if you will, at Delaware. That's one of a number of topics that we'll spell out for you and cover in much more detail when we turn to our segmentation conversations in the coming quarters.

My follow-up question, just sort of related to profitability as well, relates to the valuation allowance reduction that was in the corporate.

Yes.

All right? I guess I just wanted to ask you, I'm assuming that that benefited this year will not benefit next year, because it's done. But basically, wanted to ask, why it's flowing through earnings as opposed to just impacting the paving capital or impacting the balance sheet.

Well, first of all, your first premise is correct. That we have indeed brought the valuation down, allowance down to zero. Will not be a factor going forward. But keep in mind what this was: We had net operating loss carry forwards that were established in our Lincoln Barbados subsidiary, we had a deferred tax asset set up to account for those NOLs, but then, put up a valuation allowance when, after selling Lincoln Re to Swiss Re, we felt as if it was unlikely to be generating the amount of income necessary to fully utilize the NOLs. Now that we have made some changes, notably using Lincoln Barbados in part as a captive reinsurance vehicle plus other activities, we've been able to generate a modest amount of income in Lincoln Barbados, such that we can utilize that NOL, therefore bring the valuation allowance down the DTA. The net effect of all that, Joan, bringing you through all that, is that it serves to run through earnings, the lowering of that VA, the lowering of that valuation allowance, you have to take it through earnings through the tax reduction.

We go next to Jeff Schuman with Keefe, Bruyette & Woods.

Good morning. I was wondering if you could you talk a little bit where general expenses are at this point. If you look at operating and administrative expenses on a consolidated basis, you're at about $235 in the second quarter, $239 in the third quarter and $217 this quarter. Fred you talked about some of the expense patterns at Delaware. Just more broadly, what should we think of as being more normalized in terms of consolidated general expense at this point?

Essentially what you saw running through those line items in the third quarter in particular, was increasing a number of the accruals related to incentive comp programs. We took that action and that served to spike some of those expenses. There were other items that also contributed to it.

For example, the third quarter tends to be a larger than normal branding period for us with the battle of bridges. And other related items I could schedule for you in more detail when we have the time. So I would not characterize the third quarter, for example, as being representative of the steady state or normalized operating earnings pattern for the Company. I would suggest to you that the fourth quarter to be more representative of the go-forward operating expenses for the company.

And last year, the fourth quarter was relatively low expense quarter as well. Is that natural seasonality or should we ignore that pattern?

I wouldn't read that into the number.

Okay. Thanks a lot.

We go next to Tamara Kravec with Banc of America Securities.

Thank you, good morning. Quick question on your Variable Universal Life sales. And if could you just talk about what's going on there. They were higher than I would have expected and seemed to really jump sequentially.

This is Fred. I can again toss to Gary for better color on the market, but essentially what you're seeing is the popularity of our new VUL 1 product, which really started to gain traction back, I would say, Gary, around three quarters ago or so, maybe four quarters. Aside from the attractiveness of the product, and what it offers in the way of flexibility to the client, we also really worked to simplify the VUL sales story on the product. VUL, as you all know, is a very complicated product to sell and explain and wholesale. And we really worked hard to simplify it in addition to make something product changes. Gary, before I go any further, why don't you add any color you may have on VUL?

All good points, Fred. This VUL 1 product was actually introduced back in '04 and it was enhanced with some new features in may of '05. So Fred's right, it really gained traction during this calendar year and has had momentum throughout 2005 and continued in the fourth quarter and is we're very optimistic about its future as well. It's really, we think, driving a return to Variable Universal Life in the industry now.

Would you expect that pace going forward, then? Or for it to continue to grow from there?

Yes, we would.

Okay great. Thanks.

Gary, I was just going to add for Tamara's benefit that in general I think what we have seen, in VUL, is after we got beyond the 2000 to 2002 market scares and corrections that were out there, with a couple of years pushing people started again feeling comfortable with putting life insurance into the markets themselves. So VUL or Variable Life sales in general in the industry the last couple of years, have done pretty decently out there compared with fixed product sales. And then the competitiveness of our product, again to combine with the effectiveness of distribution and the simplified sales story that Fred referred to really has allowed us to gain market share in a market that is already a nice growth area.

We go next to David Lewis with SunTrust.

Thank you, good morning. Back on the investment management, the effective tax rate was down. Is that just a true-up or is that something else unusual going on there?

I think it's related primarily to a true-up, David.

Okay. And just back on Joan's question on the investment management, is there anything, barring significant volatility in the market, that wouldn't allow the investment management to continue to run at a $14 million plus earnings quarter?

No. As I mentioned, David, I think we are now climbing into quarters of what I call cleaner results. That is, we've got a number of the one-times behind us. Now, obviously, institutional flows will tend to be choppy. It's a lumpier business for us and so the degree to which those institutional flows contribute going forward, that will go up and down depending on our success in the marketplace with those flows. But just to give you an idea, I was looking through some data in preparation of the call, in 2005, we received 110 new institutional mandates across 14 different asset styles.

And what that tells me is that despite the natural lumpiness in institutional flows, we're really finding success across a number of different categories with a number of our teams contributing to the success you're seeing. So, when I think about the sustainability of the results, while I wouldn't expect to repeat some of the quarters on the institutional side that we experienced flow-wise, I do think we have a platform, both retail and institutional-wise, that will continue to deliver consistent results.

Just follow up, Fred, can you discuss any of your plans for Jefferson-Pilot's broadcasting? Is there anything that would preclude you from potentially selling that, from a tax perspective? I guess that gets written up and/or is that something that you would rather use as a branding tool for Lincoln Financial Group?

David, this is Jon. All of the parts of Lincoln that exist today and all of the parts of Jefferson-Pilot that exist today will be a part of the new Lincoln when the combination is completed here. And consistent with our longstanding practice, we're not going to comment on what we might do or what we might not do with any of the individual businesses or segments.

What I also like David to add one more piece to Fred's comments about the investment management business there. Delaware, on the retail side, hit a very attractive milestone at the end of December, at the end of last year, when for the first time, its 10-year trailing investment record has more than 70% of its mutual funds outperforming the prepared group average.

I think you may remember that we've talked previously about the shorter term periods up to five years exceeding it. And now we have the 10-year record that goes along with it. So as LFD's wholesalers are out there working with planners, that 10-year record is a very attractive additional benefit and feature to have out there and speaks to our comfort with the sustainability of the momentum that we've achieved with Delaware.

We go next to [David Styblow] with Bear Stearns.

Hi, good morning, this is Saul Martinez. A couple -- I wanted to start on the funding of the $500 million in stock buybacks. Should we expect the buyback to be done under an accelerated share or purchase? I don't know if you've commented on that publicly. And also I think in the past you've mentioned that the 500 million would be funded with high equity content hybrids, but in the S4s, you indicate that it will be funded with subordinated debt. So if you can give us a sense as to what you're thinking about in terms of funding, I had assumed it would be perpetual preferred stock.

First on the stock buyback question, we're going to look at what is the best approach, the most efficient and effective approach to buyback the stock that we discussed when we announced the merger. And what we discussed and what you're referring to, Saul, is the $500 million of repurchase at or shortly after closing to impart produce a new capital structure for the company after closing on the merger. So we are looking at all of the avenues available to us, including ASRs and what they bring to the table, but have not made any final decisions on that front as to how best to execute on it.

In terms of the overall funding of the merger, we have been meeting very recently with a small group of banks, including half-day sessions where we've walked through the best way to optimize our funding of the transaction. And also on a backdrop of the broader capital structure going forward, we're balancing the desire, the obvious desire to lower our funding costs, where possible, but balancing that against the needs of the rating agencies and is our credit quality. And also the fact that we expect to be investing in growth initiatives as a combined company and want to have the strength a balance sheet cash flow, et cetera, to be able to fund those activities. So all of those things currently be being balanced.

We're not in a position at this time to update any of the previous comments we've made as to the financing, both when we announced the deal and when we, what we have put in the S4 registration statement. Much of that will depend on a combination of things, including the market conditions at the time we go to market, we're currently reviewing some of the newer engineering that's taking place in the high equity content securities, some of which you referenced. And as we sort through all of that material, we'll come out to you later with certainly more specifics on the funding but we're not prepared to do that right now.

You are right, though, Saul, in your original point, you are right that we indeed expected to fund some of that share repurchase with the use of high equity content securities. Either in the form of subordinated debt or the perpetual preferred stock that we've referenced.

Okay. That's great. Just a clarification on the communications business, obviously, under purchase accounting, you step up the cost basis to fair value. I just wanted to confirm that you don't do the same for tax purposes? I hope you can appreciate, I'm not asking for a commentary on what you intend to do, I just want to understand the tax accounting.

The advice received at this point is you do not step up the basis for tax purposes.

Great. Thanks a lot.

Bob Glasspiegel with Langen McAlenney

Good morning. I guess it is morning. The commentary on the merger sounds to be really optimistic in tone and you've got increased confidence. I suspect there's no updated guidance on either expense savings targets or revenues, but maybe you could comment on where your increased confidence is coming from.

Yeah, there is no updated guidance on any of the numbers at all, Bob, you're correct with that. Our tone is positive. And it's based upon the amount of work that is taking place in the organization. We have made a lot of management decisions at this point in time over the course of the next several weeks there will be significantly more decisions that will be made and communicated to employees. And as we see the organization just really rallying behind this combination and as they see all of the potentials in the opportunities for both efficiencies, but probably even more significantly, synergies in growth opportunities, it just is creating a very nice atmosphere for all of us.

Okay. And my quick follow-up is, after the post deal acquisition of shares, not the ongoing junk, what is the pro forma shares outstanding for EPS calculations?

I don't know that we've talked about that, but essentially what you have right now is roughly 134 million shares Jefferson-Pilot shares outstanding right now. And as you know, the exchange ratio is 1.09 on those shares. And so --

24% cash?

Right, right. So I would ask that you could probably do the math on that. We currently have just approaching 177 million shares on a fully diluted basis outstanding here at Lincoln.

Right, okay. That's what I was using. In the 500 million buyback what's the timing, your answer to Saul's question, but what's the timing on that chunk?

The timing of that chunk would be very shortly after closing, would be the anticipated repurchase timing of that.

So that would be the subtracted out would be close to the run rate?

Of shares outstanding?

Right.

I think that's a good process to go through what you've just described.

Okay. Thank you.

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, Ms. Brown, I'll turn the conference back over to you for any closing remarks.

Thank you, Rufus and thank you all for joining our call today. As usual, if you have any questions, feel free to give us a call on the IR line. Have a good day.

And, ladies and gentlemen, this does conclude today's conference call. We do appreciate your participation and you may disconnect at this time.