Lincoln National Corp (LNC) 2006 Q4 法說會逐字稿

Thank you for standing by, and welcome to the Lincoln Financial Group fourth-quarter 2006 earnings conference call. At this time all lines are in a listen-only mode. We will announce an opportunity for a question-and-answer session at the conclusion of the conference. Instructions will be provided at that time.

Before we begin, I have an important reminder for you from Lincoln's earnings release. Any comments made regarding future expectations, trends and market conditions, including such comments about premiums, deposits, expenses, purchase accounting and income from operating, are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties and could cause actual results to differ materially from current expectations. These risks and uncertainties are described in the cautionary statements disclosed in Lincoln's most recent reports filed with the SEC, including the form 8-K filed yesterday.

Now at this time, I would like to turn the conference over to the Vice President of Investor Relations, Jim Sjoreen. Please go ahead.

Good morning and welcome to Lincoln's fourth-quarter earnings call. You just heard the Safe Harbor cautions, so I won't repeat them. We appreciate your participation today and invite you to visit Lincoln's Web site, LFG.com, where our statistical supplement and other pertinent information can be found.

Before reconciliation of the non-GAAP measures used in the call, including income from operations and return on equity, to their most comparable GAAP measure, is provided in our press release and in its statistical supplement posted on the LFG.com Web site.

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

Good morning, everyone, and thank you for joining us. In the interest of time we won't be repeating much of the information provided in the press release and statistical supplement, which will allow more time for questions. I'm going to spend a few minutes on the highlights and then turn the call over to Dennis and Fred to comment on our sales and financial results.

At the start of 2006, we were well underway planning for the April close of the merger between Lincoln and Jefferson-Pilot. Early in the integration process planning, we said that we would not undertake any expense-related actions or make any operational changes that could impair our activities related to our new business capabilities and customer touch points. This was an overarching mandate embedded in our integration plan.

As you have seen in the second and third and quarters and now in the fourth quarter, we have not only delivered on that goal but have clearly exceeded it.

What's even more exciting is the fact that we're only nine months into the integration and have yet to fully leverage the capabilities made available through the merger. In the quarter and for the full year, we reported record sales and net flows in individual variable annuities. Based on the most recent VARDS survey data and both the year-over-year and sequential comparisons, our growth rates exceeded industry growth rates, meaning we once again picked up market share in the quarter. Our market-leading retirement income solution, i4LIFE, attracted $0.5 billion of deposits in the quarter, capping the sixth consecutive year of record deposits with a five-year compound annual growth rate of over 100%. This trend speaks to the growing appeal of annuitizations as a source of income, which historically has not been the case for the industry. I4LIFE elections represented 18% of our variable annuity deposits for the year.

Life Insurance sales were also very strong, driven by a number of factors that Dennis will comment on in a moment. In general, our life Insurance has the most to gain from the merger, and we're beginning to see how the integration is affecting our distribution and administrative capabilities in this line of business. And again, we are in the very early stages of combining the life platforms.

Our Investment Management business posted another strong year of deposits, net flows and earnings as it addressed capacity issues in some popular products and wrapped up the addition of new teams. Investment performance, always a focal point at Delaware, was again strong in 2006 when measured against benchmarks and years. In Barron's annual review of fund families just published, Delaware enjoyed a front-page top-five ranking for fund families in 2006, the second time in four years that Delaware has achieved that distinction.

On the heels of this outstanding performance Delaware enters 2007 with one of the strongest product and talent lineups in its history, supported by a more efficient infrastructure.

On the Employer Markets side of our business, Wes Thompson has brought together a distinct group of businesses under the umbrella of a seasoned management team and a focused strategic vision. Employer Markets endured considerable disruption as people, systems and processes were extracted from business units across the organization to form this new segment while integration initiatives were layered on top.

Wes and the employees of Employer Markets have now established a solid baseline and clear line of sight into what we believe will be one of the businesses benefiting the most from demographic and legislative changes in the coming years.

We're also excited about the retirement income security initiatives we're undertaking in the United Kingdom. As you know, we have had a UK presence since 1984, and, due to the regulatory environment, we discontinued selling through our direct sales force in 2000. Recent developments in UK pension laws have changed the value proposition in the UK, and we are making modest investments in initiatives that will leverage our domestic capabilities around retirement income security. We will provide more details as these initiatives develop throughout 2007.

I feel very good about the results of 2006 and the efforts of our employees that made it happen. However, 2007 is here, and we're focused on it and the future. We have three key themes influencing our actions and decisions throughout 2007. First, taking market share. We are making sizable investments in distribution throughout the organization, recognizing that sales growth will be driven by our ability to get in front of and stay in front of our distribution partners. Combined with the 2007 launch of our unified product portfolio, slated to roll out in April, we will begin to truly leverage the benefits of the merger.

Second, we will jump start our retirement income security venture. Under Dennis's leadership, we have established a team of talented individuals led by Heather Dzielak, whose primary focus is on retirement income security opportunities, including the products, delivery systems and customer servicing that will address and in some cases change the way we think about the emerging needs of the baby boomers.

Third, we will relentlessly employ financial and execution discipline throughout the enterprise. We are making significant investments in operating efficiencies while integrating and consolidating systems and operations across the Company. We are employing a comprehensive metrics-based approach to determining and evaluating those investment decisions.

Depending on which aspect of the merger you are talking about, people, process or product, we are in different stages of completion. What is clear from the results of the first nine months is that our employees are focused, committed and excited. Focused on the opportunities surrounding retirement income security, committed to innovative and efficient execution and excited about the expanded potential of the Company.

Now let me turn it over to Dennis to cover our sales growth and other highlights. Dennis?

Thanks, John. I'll briefly run through the businesses and then provide a quick update on the integration. Let me start with annuities in our Individual market segment. Fourth-quarter annuities sales of $3.2 billion posted a 39% increase over the prior-year quarter. [VA] deposits totaled $2.6 billion in fixed and indexed annuities $525 million. These strong results reflect a solid and broad portfolio of variable, indexed and fixed annuity products. The increasing consumer recognition of the value of VA living benefits, increasing shelf space and wholesaler headcount.

Evidence of the continued marketplace acceptance of our i4LIFE income feature is seen in the approximately 70% increase in elections of that feature versus the prior year. Annuity wholesalers increased from year end 2005 by 29%. The percent of wholesalers with greater than two years of Lincoln experience is 46%, up from 31% last year. The addition of Morgan Stanley organization that I talked about last quarter also contributed to the improved results.

Annuity net flows were up 16% over the prior year despite continued weakness in fixed annuities related to the runoff of multiyear guaranteed business. The '07 net flow drag from the multi-year block is expected to be half the 2006 amount, down approximately $700 million.

Moving to Life, looking at our Individual Life Insurance business, sales for the fourth quarter of $218 million were up 43% on a sequential quarter basis and 37% over fourth quarter 2005. Both comparisons were impacted by the following -- growing producer acceptance of the products that will form the basis for much of the unified product portfolio scheduled, as Jon just mentioned, to start rolling out in April; and continued improvement in the combined entity's business operations such as underwriting and new business and wholesaling into our large MGA channel. Additionally, the sequential quarter comparison is impacted by the seasonality that we typically experience each year in the fourth quarter.

Turning to Employer Markets, deposits in our defined contribution segment of approximately $1.1 billion were up slightly over the prior year with deposits in our mid to large-case markets offsetting a decline in the small-case market. Our wholesaling development efforts in support of the mid to large-case market have been paying off with 30 of the 47 cases sold in the year occurring in the second half of the year.

Sales of small-case market were down 13% year over year and 10% sequentially, due to our termination of a third-party distribution relationship. We began the expansion of our own wholesaling force for the small-case market in the third quarter and expect to see improvement in our sales in 2007.

Turning to the Group Protection business, sales of $113 million rebounded to record levels, posting a 40% increase over the prior-year quarter reported by old J-P. We saw strong double-digit growth across all products with dental and life posting the strongest gains compared to the prior quarter. I commented last quarter that we had made some moderate pricing changes in light of the favorable loss ratio performance.

Moving onto Investment Management, for the quarter, total deposits in the Investment Management segment were $8.1 billion with net flows contributing $2.5 billion to assets under management. Included in the quarter is a $1.9 billion CDO offering. The size of the CDO puts it at the high end of the market and is clear evidence of the capabilities that reside within Delaware. Delaware funds placements within variable annuities increased 31% over the prior-year quarter, driven by fund manager performance.

Managed accounts, which had declined earlier in the year due to the closing of some key styles, have rebounded nicely over the third quarter to just under $0.5 billion. A positive development heading into 2007 is that now four out of five of the major wire houses recommend a large cap value managed account product on their platform. This is a very attractive position for Delaware. By the way, we only had one out of the five at year end and had added three in January.

As Jon mentioned, Delaware's ranking in the Barron's survey underscores the firm's commitment to sustainable benchmark-leading performance, a key driver of our plan for asset growth and margin expansion.

Let me turn to the integration. In review of our integration efforts, we've continued to perform ahead of plan in terms of achieving our $90 million of run rate savings in year one of the merger and remain confident in our ability to achieve $140 million by the end of year two. While we have some heavy lifting integration activities to complete in '07, including legal entity consolidation, unified product introduction, administrative systems consolidation and a handful of critical in-sourcing initiatives, all projects are on track and have solid internal rates of return associated with them.

Just a minute on '07. Looking forward to '07, we're making significant investments to foster top-line growth. We intend to invest in LFD, increasing the internal and external wholesaling force by 17% plus. In our Employer Markets defined contribution business we are revising distribution to rely more on Company wholesalers and will have a total of 85 wholesalers by year end, up from 39 at the beginning of the year. Significant recruiting activity is underway in Lincoln Financial Network, our retail distribution channel. Product development in all lines will, of course, continue with an emphasis on retirement income security. We're off to a solid start in January, and these incremental investments will help support another strong year of growth in our business lines.

With that, let me turn it over to Fred to discuss the financial highlights in the period.

I will focus my comments today on providing some color around our key earnings drivers, our outlook heading into 2007, and I will touch on SOP 05-1.

Overall, the quarter and full-year earnings benefited from continued asset growth across our major variable businesses and Investment Management platform, the result of positive flows across the Company and favorable markets. Spreads behaved as expected with annuity and life spreads stable and modest compression in our Employer Markets defined contribution business.

In-force life insurance grew at a predictable 5% to 6% rate, and overall expenses calmed down from their third-quarter levels, when we increased incentive compensation accruals.

There is also a modest level of seasonality to our results, impacting net distribution expenses, life renewal income and even ad revenue in our media company. Our reported operating earnings of $375 million included approximately $24 million of net positive items or $0.09 per share, not accounting for the $12 million after-tax impact of the merger expenses which came in roughly as we guided. These items, both positive and negative, were detailed by segment in our release and included favorable investment returns, positive VA reserve and hedge outperformance, favorable mortality in our Life business and another strong quarter for loss ratios in our Group Protection business.

With that, a few comments on the key earnings drivers in the segments. Inside individual annuities, spreads of 210 basis points benefited from roughly 6 basis points of excess income. Normalized spreads of 204 basis points widened modestly as a result of multiyear high crediting rate product lapsing off the books. We expect spreads to stabilize in the 200 basis point range throughout 2007.

Average VA account values were up $10.4 billion or 29%, driving a 38% growth rate in expense assessment revenue with living benefit rider income providing an extra revenue kicker beyond account value growth alone.

Turning to our Individual Life business, spreads came in at a reported 192 basis points, including excess investment income of roughly 22 basis points. The excess income coming via our alternative investments together with higher than normal prepayment activity. We expect normalized spreads of roughly 170 basis points to continue into 2007.

Average in-force and account value growth was steady with in-force up 5% and account values up 6% from the comparable quarter in 2005, this after adjusting for the merger. We experienced a good quarter on the mortality margin front due to favorable claims experience.

In our Employer Markets defined contribution business we reported spreads of 245 basis points on our fixed portion of the business, with excess investment income impacting normalized spreads by roughly 4 to 5 basis points. We do not have any additional crediting rate action planned and expect spreads to stabilize in the high 240 basis point area as we head into 2007.

Average account values increased $1.8 billion as compared to their 2005 levels, driving a 13% increase in expense assessment income. The increase is largely a result of favorable markets as positive flows were fairly modest in 2006.

We expect the rebuilding effort to take shape throughout the year, evidenced by improved production. Earnings will build more gradually, with stable spreads and our planned investments back into this business. We expect account values to build off improved deposits and flows, recognizing they need to be adjusted for the market's impact.

In our Group Protection business, nonmedical loss ratios of 69.1% in the quarter were favorable to our long-term expectations, with most of our major lines contributing to the strong results. We expect loss ratios to revert to their more normal levels in 2007, in the 71% to 74% range.

Turning to Investment Management, pre-tax operating margin in the quarter was 15.2%, which also matched the year's operating margin and was up considerably from 2005 levels, where we incurred expenses associated with talent acquisitions. Assets under management excluding our Insurance General account were up 25%, that growth attributable to roughly $9 billion in positive flows and $10.5 billion in lift from the markets. This in turn drove external advisory revenues up 22%, recognizing the large CDO that closed late in the fourth quarter, has yet to impact advisory fee income.

Heading into 2007 we expect pre-tax operating margins to build towards the 16% area with earnings in the low $60 million range.

For Lincoln UK, we expect earnings in this segment to come in at the upper $30 million range for 2007, assuming somewhat stable exchange rates. Media earnings in the fourth quarter included a seasonal impact with fourth quarter being the strongest of the year, due to holiday-related retail ad spending and October-November political spending. Looking towards 2007, seasonality will give rise to an approximate $6 million swing in earnings from Q4 2006 to the first quarter of 2007. This is more exaggerated than usual, since 2006 was a political year. We expect 2007 earnings in the mid $50 million range.

Turning to Other Operations, a brief comment on merger expenses. Merger expenses impacted the quarter's earnings by $12.4 million and were in line with our expectations. As we look towards 2007, I expect pre-tax merger expenses to be in the $90 million to $110 million range with the first quarter coming in the $10 million territory. Both figures, again, are on a pre-tax basis. Interest expense of $64 million pre-tax came in a little better than we anticipated but in line with an expected range of $65 million to $70 million pre-tax per quarter.

We repurchased $150 million worth of common stock in the quarter or 2.5 million shares. Looking back on the year we repurchased over $1 billion of our stock after returning $430 million of dividends back to shareholders. This a sign of the strength in our capital and cash flow expectations. We intend on conducting $500 million of repurchase in 2007 and in the form of an ASR. I would expect to execute on an accelerated stock repurchase transaction before the end of the first quarter.

Before turning the call over to Q&A, let me comment on SOP 05-1, the accounting pronouncement dealing with deferred amortization costs on internal replacements, and expand a bit on our press release comments.

We have done significant work internally to determine what qualifies as a replacement according to the SOP. As we sit here today, we estimate the cumulative effect adjustment to be in the range of $75 million to $100 million pre-tax, split roughly evenly between our variable annuity business and our Group Protection business. This non-cash adjustment impacts retained earnings and not operating income.

In terms of ongoing earnings impact, we expect very little impact to our Group Protection earnings as the shorter amortization period on average is largely offset by an overall lower DAC and VOBA balance. On the annuities side we expect DAC amortization expense to increase by roughly $15 million to $20 million pre-tax. I, along with my accounting and actuarial team, welcome your questions and are happy to provide any detail you find helpful in understanding the SOP itself and how it is applied to our major product lines.

Important, even after all that work and extensive dialogue with our auditors, there still remains a level of uncertainty in the interpretation. We will update you if our estimates change materially as we proceed through the quarter.

So, in all, an incredible year to look back on in terms of integration activities, production results and a record year for earnings per share. Our teams are focused on implementing our retirement strategy and delivering on our earnings drivers heading into the 2007 period. As I noted at our annual investor conference, we understand and are focused on the scorecard for this merger. Production synergies, expense savings, growing book value per share and ROE while delivering an industry-leading dividend back to our shareholders.

With that I will turn the call over to the operator for Q&A. We have attempted to allow significant time for our callers; but, as is usually the case, we would ask that you limit yourself to two questions, if possible.

(OPERATOR INSTRUCTIONS). Nigel Dally, Morgan Stanley.

On life insurance, given the strength of sales this quarter, should we be concerned that you are perhaps picking up some IOLI business? Second, given the strength of sales and merger synergies, why can't earnings do better than the mid single digit earnings growth rate that you are guiding towards?

The question about IOLI was what, specifically?

Just given the strength of sales this quarter, it seemed, against a backdrop of a very competitive environment, that those are very strong sales numbers. So that naturally raises the question, are you perhaps picking up some IOLI business on the back of that?

Let me answer that with a couple of comments. The first is that, on a historical basis, both old Lincoln and old J-P have continuously tried to prevent IOLI and SOLI products from being sold by the two organizations. There has been a series of communications to our field partners both in writing and, of course, in conversation. So, over the past 18 months, we have been diligent in trying to keep that business from growing.

Having said that, there is some business coming through. We don't think the percentage of it in 2006 is significantly different than the percentage in 2005, and so, if there is some coming in, it's not creating the percentage increase in and of itself.

The second comment I would make is there is some very strong growth in the product lines in the Life Insurance business that are clearly not in the SOLI/IOLI category. Typically, the sales of SOLI and IOLI are in the over $70 million and over $2 million market. Our sales growth outside of that category has been 28%.

So yes, some of it is coming through, but we don't think it is what is sparking the sales increase. As I said earlier, it really does have to do with what we think is great product and great platform.

This is Fred. In terms of your second question, relative to earnings lift, we don't guide on specific earnings in this category, but we have been guiding on the earnings drivers. As you've pointed out, we're expecting the core earnings drivers of in-force or otherwise net amount at risk and account value to grow in that mid single digit range.

The fact of the matter is, is with roughly $256 billion of permanent life insurance in force and $242 billion of term life insurance in force, even the most dynamic of quarter-to-quarter improvements in life sales has a somewhat muted effect in terms of translating into the lift in earnings. What I would say is that what we are eagerly working on right now is the combination of those core earnings drivers remaining stable, predictable and heading north, together with anticipated expense saves coming out of the merger and efficiencies, which we hope together will bring a little more growth to the earnings on the Life segment going forward.

Tom Gallagher, Credit Suisse.

One follow-up on Nigel's question and then another one on the UK. Dennis, I just want to understand what your overall view on IOLI and SOLI is because I think, within the last couple of calls, you had commented that we should expect there to be a head wind because you either were not going to do those types of transactions anymore or there was going to be a significant reduction. I'm just curious if we should still expect that or has the pricing maybe gotten better so you're more willing to do those. That's the first question.

The second question, Jon, is on the comment that you made about making modest investments in the UK following a change in pension legislation. I just want to understand how we should think about Lincoln's UK business overall because it has been in runoff. Should we assume that you're now going to start growing that again? Could this potentially get large? How, overall, should we be thinking about your review of the UK market right now?

I'll ask Dennis to cover the first question, and then I'll cover the UK.

Our attitude on accepting SOLI/IOLI has not changed one bit, and that is we continue to tell our distribution partners that we don't want the business. Predominantly, it's a problem with ROE, taking the ROE down from our targets maybe by 1% or 2%. So it's not as profitable a business as what we would like to see. So we don't want the business.

As to whether or not there will be an impact on sales in '07 from completely closing down IOLI and SOLI, again, it's hard to even recognize some of the variations of IOLI and SOLI. So we're not quite sure at this point what total percentage are in the sales numbers. So it's difficult to say. We're counting on increasing sales next year above what we did this year, irregardless of the SOLI/IOLI impact.

With regard to the UK, it is appropriate to start thinking about the UK differently than what you have been thinking about it over the last several years. The pension legislative changes that have taken place in the UK dovetail very well with our focus on retirement income security. We believe that many of the product, distribution and service ideas and concepts that are gaining traction in the US will be transferable over into the UK.

Unlike our past UK efforts, however, we do not have any intention of rebuilding a tight agency system. All of our UK new business will be through the IFA channel. The IFA channel, as those of you that follow the UK understand or will recognize, is very similar to what we call wholesaling through independent advisers here in the US.

Our Lincoln Financial Distributors organization, our individual markets group and our new retirement income securities ventures group -- all three are working very closely with the UK to have the transference take place of knowledge and skills.

Should we be thinking about the UK in terms of potentially Lincoln just building this organically, or might that also include acquisitions in the future?

At this point in time we are focused on organic growth only. I don't foresee an acquisition over there at this point.

Bob Glasspiegel, Langen McAlenney.

How big a deal do you think this Pension Protection Act is for you guys? You sort of hint that you're going to make some investments in Employer Markets. But how do you see this playing out for Lincoln?

I think it's going to be a very big deal, Bob. When you think about what's permitted inside of the Pension Protection Act. First, on the original sign up and enrollment, where companies now can do an opt-out rather than an opt-in, I think you'll get a lot larger enrollment base with companies, particularly in the mid to small-sized market, where we're going to be focusing in.

Second, the type of additional capabilities that will be permitted in future years with regard to more active annuitization capabilities or direct annuitization capabilities, the providing of advice inside of the 401(k) plan itself, I think, all portend to be very attractive level setting for this business. That's why, as Dennis indicated, we intend on -- we first recaptured our third-party distribution arrangements, which had an impact in slowing sales in 2006, but we also intend on building significant direct wholesaling capabilities in that market as well.

There was a huge increase in wholesalers in that line. Can you repeat the number, Dennis or Jon, so I can make sure I --?

At the end of the year our wholesaler count was in the neighborhood of 35, and that would be for the mid- to large-case market as well as the small-case market products. We intend to double or perhaps a little bit more than that over the course of 2007. Substantial investment, and particularly in the wirehouse channel, where Lincoln's historical strength in distribution had been manifested.

That's behind your sort of tepid earnings growth in '07, because you're building wholesaling capability?

Yes, Bob.

You've made that move in the past, Jon, and it's paid off. I know there's a lot of criticism to your major wholesaling effort build-out over the last five years, but certainly you can see the benefit. It seems like a wise move.

Second question is on media. I think you said you wanted that reporting to you so you could get more comfortable with the rhythm to figure out where that fits strategically. Maybe you could give us -- share with -- your preliminary thoughts on what you have learned?

Well, I've learned it's very different from the insurance businesses. It does report to me, all three of the divisions. At this point in time we continue to look for ways that we can leverage the communications expertise inside of that business to help us be more effective inside of our core insurance and investment-related businesses. We have a lot of actual improvement as well as pilot activities that are taking place. We don't comment, so if you're looking for me to say what my intent is with this business as far as it remaining with us, as you know, we don't comment or speculate on M&A activities. So I will just end it at that.

Colin Devine, Citigroup.

Starting with your products, Jon, as much as we have seen some extremely strong sales, it strikes me that you are still not -- some of your key products are not licensed in a couple of major states. If you could give us some update on that and maybe, perhaps, what the real potential is of the sales force power that you have developed?

Secondly, if we could talk a little bit about what's happening at Delaware with the retail sales, which have struggled a bit the last two quarters? If you could bring us up to date there. And then perhaps I guess the obligatory just quick update on excess capital and what you're thinking. Clearly, the UK is back; it's not viewed as non-core anymore. I'm not sure where some of your other assets are.

Sure. Taking each one of those, on the product side the probably biggest area that we don't yet have full national capabilities in would be in the area of what is known as hybrid products. These are products that combine life insurance capabilities with health insurance capabilities. Our most well-known product is the MoneyGuard product, on that regard. One of the biggest states for that is New York. We don't yet have permission or approval from the New York Insurance Department to market it. We have received good signs from the life side of the insurance department, favorable overtures. It now proceeds over to the health side of the insurance department for their review, and we're optimistic that we will get the permission this year to market it.

New Jersey was a similarly difficult state to achieve that, and we were granted approval in the second half of 2006; I think it was sometime in the fall, to market it. So that's the large area for us.

Am I also correct, though, in understanding that you didn't have the [5-4LIFE] products out with the spousal benefits until late in the year, on the variable annuities?

That's correct. Again, New York was a big one for that one.

Are you licensed in New York there now?

Pardon me?

Are you licensed in New York with your 5-4LIFE now?

I4LIFE or 5-4LIFE?

5-4LIFE, spousal rider. It seems to be the rage.

Mark Konen, are you -- or Rob?

That is, it seems to have made a big difference to some of your competitors' sales as they have gotten it approved.

We are working on that actively with New York. We have got several filings there. The focus is on getting it approved, and we're making progress with it is the easiest thing for me to tell you at this point.

So the key thing being you have got new products out; some of them are not licensed in some major states, and you are still putting up the huge sales even without some of your major states having the new product. ?

Exactly, exactly.

On the Delaware retail side, as we were announcing either the soft closes or the hard closing in some of the institutional business, in 2005 and 2006 we saw significant sums of moneys coming into the portfolios or into those particular investment styles. As I look at the quarterly information, and in fact what you all don't see, the monthly information, associated with our mutual funds, I have been very pleased to see what has happened as we went into the third quarter and the fourth quarter with our mutual funds in terms of I think we had five out of the six months of very attractive positive growth on a sequential basis. And what is very encouraging is we're seeing it across a broader array of styles, too. We commented in our prepared remarks there about the growth that we had in managed accounts as well, in the fourth quarter. So I feel very positive, encouraged with what has taken place inside of the retail side of the investment operation.

Fred, I will ask you to comment on the sources of capital.

In general, let me just step back. If I don't specifically address your question, we will come right back at it. But on the topic of excess capital I would just make the following remarks, coming off the year.

Our capital position remains very healthy. We expect to end the year with risk-based capital in our major insurance businesses in and around the 400% range, if not slightly or modestly above that level. Leverage, as you can see from our posted results in the fourth quarter, is down around 21%, which is a calculation where we use the Moody's approach to that calculation, which is a more conservative approach to it. So I feel comfortable that that's in our range of 20% to 25% leverage.

In the overall credit markets, and some other elements of the business that can attack capital, if not careful, also remain healthy right now as we look at the business and look at our portfolio, our asset portfolio in the general account, et cetera.

All of that feeds into an announcement relative to buying back the $500 million of stock relative to an accelerated stock repurchase program. I feel as if that's comfortably -- our capital condition comfortably supports that.

What I would say is that, as you can see from our comments, we are heavily investing back into our business. We are doing that because we believe that to be the highest and best use of elements of our free cash flow. So, while that free cash flow is strong and healthy and building, we're seeing a growing number of exciting opportunities to put that capital back into our business, and that weighs into our thinking relative to excess capital.

I've said for quite a long time that our share repurchase guidance is more or less our true excess capital position as a company, noting that we'll carry a margin, typically, throughout the year to build space between us and any potential ratings issues as a company.

Hopefully, that gives you a little bit of clarity on where we stand.

That's factored in that you continue to hold the [BofA] position?

That's right.

Jimmy Bhullar, J.P. Morgan.

First, on excess capital, is it reasonable to assume that after the $500 million is exhausted in the first quarter that there will not be any buybacks for the remainder of the year?

On group protection, you have had very -- a turnaround in your sales in the fourth quarter. If you can discuss what is driving that? I think you have reduced prices in some of the products, but if you can just discuss distribution and product initiatives that are driving that?

Finally, in asset management, I think you have had a couple of strategies closed. I think the international has reopened now, but the Large Cap Growth products still not open. If you can just discuss the status of that?

On capital, just a couple of quick comments there, and then I will pass on the additional questions to my colleagues. Right now, what we have formally have announced is $500 million of repurchase in 2007 and doing it via an ASR. We have not and are not prepared to announce any further repurchase beyond that. What I would say is that, as we go through the year, we will do what we have done in the past, and that is continue to monitor our capital conditions. If we see them trending in the direction that's favorable, taking into account alternative uses for the cash flow, we will then make the judgment call at that time. You could expect that we will be giving updated guidance each quarter on where we stand relative to repurchase.

In the Group Protection business our sales increases were across the product lines. With respect to my comment on pricing, we made a modest pricing change in long-term -- excuse me, in the group LTC area.

LTC or LTD?

LTD; excuse me. That had a modest effect on the sales. We did have one large case contributing $11 million in the quarter, which was a little bit bigger; it was an existing customer. So I think just in general we had a good market -- excuse me, we had a good quarter. One large case, maybe a little bit of help from the pricing but not significantly.

Pat Coyne, how about if we ask you to give an update on where we are with the various (technical difficulty)?

Sure, I'll gladly do that. In terms of Large Cap Growth, I think the recap was correct in the sense that we do have a soft close institutionally on the Large Cap Growth area. We do -- have closed that product on the managed accounts side.

In terms of the future growth in the Large Cap space, there are obviously a number of alternatives, whether it be looking at other teams, creating another product lineup with a different philosophy or process. Or we are also looking at potentially feeding or bringing onboard a quantitative team that would use more financial analytics to go to Large Cap Growth product.

But in terms of capacity overall, we're extremely excited about the future here. I think, Jimmy, as you mentioned, our new international team, based in Boston, has fabulous numbers and are seeing some very positive traction on the managed account side, getting their ADR product placed.

We brought onboard at the end of September a new emerging markets equity team, and we have recently reopened that fund in January of this year. So we're excited about that team and the fabulous performance that that team has brought onboard as well.

As I think Dennis alluded to in his opening comments, we're extremely excited about our Large Cap value product. We currently have about $7 billion in assets in Large Cap value, and that product has a $20 billion capacity. So we have very high expectations for growth in that product over the next few years and specifically this year with some of the placements we got, that have been mentioned, as well as the excellent returns that they have produced over the last few years that they have been with us. So we're excited about the future in terms of asset growth on the equity side and also the fixed income side continues to put up fabulous numbers. So the future looks pretty bright from our perspective.

How much of a potential positive are the three new warehouse distribution relationships for the managed account business?

Well, that's a business question. The fabulous news about the managed account business is that sales or asset flows can be -- are rather generous in a short-term timeframe.

The other issue, however, that you have to balance it with is occasionally the fees associated with that are not the best in the business. But we feel that it's a very important part of our broad distribution platform.

I can tell you that there are tremendous success stories which we experienced with Large Cap Growth, and we sold up $3 billion in the managed account space in a year and a half. That is not, certainly, the template that we are planning here. But we feel we have very sustainable performance with the Large Cap value team and expect, frankly, over the next two years that it will probably get somewhere in excess of that $2 billion in managed accounts. A lot of it depends on the overall clients' allocation to a Large Cap value space. But being on a platform is the key to getting those sales, and we are very excited about being on that platform, those platforms.

Andrew Kligerman, UBS.

Excess capital -- could you give us the current number, where you estimate your excess capital to be, including the cushion?

Second question -- on the spreads, per the press release, you indicated that you would be stable in the 200 normalized zone for individual annuities, for life 170 plus and for DC about 240 plus. Why are you confident in these areas that the spreads will be stable? Can you give a little color around that?

Lastly, over the last two quarters, the disability loss ratio has gone from about 59% in the second quarter to 69% in the fourth quarter. Is there any trend going on there, any issues to be alerted to?

Let me see if I can kind of rattle these off one by one. In terms of the excess capital, as I mentioned, I would size that excess capital as being in line with what we have guided on relative to share repurchases of the $500 million. Now, your more particular question was, how much is the capital margin that I spoke of.

I'll answer it in this way and then ask you to perhaps performs the math. That is, we expect our RBC to need to hang into the 400% range to equate to as safely AA rating category for the Company.

As I mentioned, we're on the lower end of the leverage range as a company, down around 21%. The margin can sometimes be viewed as the differential, if you will, and where we are currently running as an RBC and where we need to target from a ratings perspective and where we are currently running at a leverage, holding company leverage, and where we are targeting.

So I think you can then do the analysis to back into what you think may be this notion of a margin after giving effect for buying back $500 million of stock, keeping earnings relatively moving forward during the year and paying out our dividend.

So in a long-winded way I did not answer your precise question, but I'm going to leave some of those calculations to you.

Now, the second question is spreads. I'll give you a little bit of color on that. When I look at annuities, right now the portfolio yields about 5.8% right now. We would expect to generate yields on new money of around 110 to 120 basis points over treasuries, which puts us right into that zone right now from a new money yield perspective and a current portfolio deal.

On the crediting rate side, on the fixed annuity front, we don't expect to be doing too much in the way of activity on the crediting rate side.

What I would tell you is that you've got two different things working against each other when looking at the spreads and fixed annuities. You have got the spread widening as multi-year guarantee, high crediting rate product rolls off the books. As Dennis mentioned, we expect that activity to start the process of slowing down in 2007, but it will continue.

Offset by that is some of the new money spreads we're offering on our newer products are thinner than our current in-force spreads that we are reporting to you. They are thinner because we've also adjusted compensation programs, commission structures, et cetera, so that the all-in returns, if you will, are not disturbed. So those two animals working against each other as you go into 2007 is where we come up with a stable 200 basis points spread environment as you head through 2007 on annuities.

Life is a fairly similar story. We don't expect much on the crediting rate side. Their portfolio yields are higher, due to the longer duration of the products, up around 6.2%. Again, we don't expect much movement on either of those members, either the yields or the crediting rate activity, as you go through 2007.

On Employer Markets defined contribution business, as you know, we have been lifting the crediting rates from a competitive standpoint in recent quarters, and that has had about a 3 to 4 basis point crediting rate impact, that is increasing the crediting rate. That has caused some squeeze in our spreads. But going forward, we would expect that to stabilize throughout 2007, both portfolio yields as well as the crediting rate. So I don't expect much activity there.

Hopefully, that gives you some color behind the spreads.

Perfect, perfect.

I think your third question was on loss ratios. A couple comments on that and Benefit Partners. One is that, indeed, we have seen a gradual trending up throughout the year. What you have here, really, is coming off high incident rates in 2005 you're seeing a somewhat natural increase in terminations in 2006, which serves to drive down those loss ratios. The reason we keep guiding you back to a more normalized loss ratio in and around the 72%-73% range, is because there is an end game to those terminations. That is, you can't terminate a person twice. Eventually, you will run out of that [spiked] determination activity, and you'll see your loss ratios climb back up to a more normalized level. We are actually seeing that modestly happen in the block, despite the fact that we recorded another strong quarter on it.

So on the disability specifically, 69% is a more normalized loss ratio?

Actually, as I climb down through the various elements you really have to break it down. On the Life side, for example, our loss ratio this quarter was around 69%, and we would expect that normally to be in the 72%-73% range. Our total disability loss ratio was just north of 69%, about 69.3%. We would expect that, as I mentioned, again in the 72%-73% range. Our dental loss ratios were just short of 69%, about 68.7%. We expect dental loss ratios to be a bit higher than that, closer to 74%.

So that busted down a bit more than we normally talk about, but it gives you an idea of why we are guiding up from our current level.

Eric Berg, Lehman Brothers.

I would have thought, Jon, that given the terrific investment performance at Delaware and the monthly trend in business that you sited in your comments just a few minutes ago, that the net flows on a full-quarter basis would be improving, but it seems they have gone from positive to negative and actually got modestly worse, it looks like. No, about the same in the December quarter as they were in the September quarter.

So my first question is, if investment performance is as strong as it has been and if the trends have been favorable on a monthly basis, why aren't we seeing this in the numbers that you are reporting out?

The redemption line has remained unacceptable to us. I think our redemption figures are running something in the low 20% area now, and we're focusing in on dissecting the redemption activity more so, so that we can better manage the results coming out of it. But it's primarily attributable to that.

My second question, my final question, relates to your group insurance business to Benefit Partners at Jefferson-Pilot. It is that despite the strong sales or the pickup in sales, it looks like since the acquisition of J-P early last spring, the premium line has been rather flat and that the -- what we're seeing here in terms of earnings improvement would clearly relate, therefore, to the better than expected claims experience.

My question -- why are we not seeing premium growth sort of from the second quarter to the third quarter, from the third quarter to the fourth quarter? It seems kind of flattish. I realize it's a short period of time, but what is your sense about the momentum in that business, the level of momentum?

A couple comments I would make. First, your observations are correct. I would note this, though. We did indeed see quarter-over-quarter premium growth of around 7%. You would have to go back to the quarter as reported by Jefferson-Pilot to track that. That sequential flatness you are talking about is somewhat a result of weakness, frankly, in sales as we're coming off the 2005 and into the 2006 period, which also spurred some of the activity that we have done both from a distribution and a pricing standpoint, bringing some of that back, as you can see in the strong fourth-quarter sales.

As we go into 2007, let me help with a bit of guidance on premium expectations. We expect a number of the moves we have taken throughout 2006 that have benefited to a strong second half to contribute to a little more lift on the premium growth side. Right now, as we sit here today, we would expect premium growth to climb towards the 10% range as you head through 2007, this benefiting off the stronger sales coming off the end of the year. So I think you'll see some lift there.

Saul Martinez, Bear Stearns.

Some of your competitors -- just a follow-up on Individual Life. Some of your competitors have obviously talked about a difficult UL marketplace and pulling back a little bit, and obviously your sales were strong. Can you just talk about why you're seemingly more optimistic than some others about the dynamics in the marketplace?

Secondly, on your defined contribution business, flows were stagnant; they have been stagnant, actually declined in '06 versus '05. I know that's an area of focus for you, and you talked about expanding the wholesalers quite a bit. But how quickly can we see sales and flows improve? Is this a second half '07 kind of issue, or are we looking beyond that?

With regard to the Life side, if we step back a little bit here and look at longer-term actions that have taken place, I believe that we were one of the first movers to adjust our pricing on the UL side of the business. As a result, we saw our sales slow down while other companies still maintained more favorable pricing in their product. We had to answer questions a couple of quarters during 2006 about the sales slowdown that we experienced versus 2005.

What we saw taking place, then, in 2006 was more competitors adjusting their product pricing to be very similar to where Lincoln's product pricing wise. So what you were left with, then, was instead of having fire sales on products you had products being able to be compared on a feature-by-feature basis. You had the differences in wholesaling capabilities allowed to come through. And you also saw, in the case of Lincoln, where there are some MGAs that in past years we did a lot of business with that we did very little business with as more of their business seemed to take on characteristics of IOLI and SOLI. So we increased our focus in other areas.

So I would say that it's a combination of other companies raising their prices and Lincoln's wholesaling and product capabilities looking very attractive out there.

On the Employer Markets business, with regard to sales, we clearly would expect to see sales acceleration in 2007 versus 2006, across the small and medium markets. However, with the increase in wholesaling that Dennis talked about, what you should not do is to take the type of sales productivity we have in the individual annuity line of business, where we now have something north of half of our wholesalers with two plus years of experience, and overlay that onto our Employer Markets business, where half of the wholesalers will effectively be twelve months or less in time with us. But I feel very encouraged that we will see sales lift in '07, and as the wholesalers gain productivity and we continue to fund new wholesaler investments, that that trend should pick up nicely as we go in the 2007, 2008 and 2009 time periods. (multiple speakers)

If I could just follow-up, I think, Dennis, in the investor conference you mentioned that you are, in the individual life business, kind of the bottom of the first quartile, top of second quartile in terms of pricing in the Individual Life side. Is that still correct, or are those the right numbers?

The pricing changes in the marketplace on a daily basis would be an exaggeration, but it changes quite frequently. We try to maintain a pricing position that's within single digits of the most competitive pricing. Sometimes a competitor will get out of whack with the market, and we'll find ourselves maybe 30% off of the most aggressive pricing, but that will be a temporary phenomenon.

Right now my guess is that across the products, across the sales, we are 5% to -- 3% to 7%, 3% to 9% off of the more aggressive prices.

Particularly in the secondary and guarantee market, the premium differentials on different cells, male age 50, have narrowed pretty dramatically.

Darin Arita, with Deutsche Bank.

Lincoln seems to have had good success with its i4LIFE product. In 2007 what are your thoughts about rolling out new living benefit features for variable annuities and also for Employer Markets?

The features for the employer -- or excuse me, adding i4LIFE to the Employer Markets products is a high priority for us. The timing of that, I think I will not comment on specifically. I might ask Mark to comment about additional benefits -- excuse me, riders -- on the individual annuity markets products. Mark Konen?

Yes, right now we have a number of things in the works, although I would say on our individual variable annuity chassis, we are in a pretty good spot, where we want to be. So I would characterize the changes we are making as fine-tuning, important fine-tuning but fine-tuning, nonetheless. You may remember in the last three to six months we have introduced something we call our 4Later advantage, which essentially allows us to leverage our i4LIFE capability into ways where people are not looking for income immediately but maybe you're looking for income more like three to five years down the road. This 4Later advantage allows them to have some certainty about what those sorts of payouts will be when they are ready to do them.

Also within the last three to six months we have made some changes to our SmartSecurity Advantage one-year product, where that product now has the ability to become a lifetime withdrawal benefit for those people who are looking for that protection.

The second question is on the other operations segment. It seems we've got some new disclosure there. I guess, besides the merger-related expenses, what contributes to the volatility and the operating and acquisition expense line? Is there some normal level to think about that on a quarterly basis?

First of all, the other operations line is indeed a grab bag of various elements that has been volatile, in part because we have parked some gains in that business over time. For example, we had a UK recovery a quarter ago which popped that line item. We have made some accounting harmonization adjustments in that line item relative to default charge mechanisms and how we treat that, which has impacted the investment income line items. So that's all starting the process of calming down.

I think the guidance, if you will, that we gave on the fourth quarter, that is, our results adjusted for what we found to be about $3 million or so of expense-related increases that are unusual, that you expect to calm down, and adjusting for the merger expenses, you should expect that corporate line item to start to become more consistent going forward.

Steven Schwartz, Raymond James & Associates.

I'm going to take a pass. Everything has been asked and answered.

Tamara Kravec, Banc of America.

Just two questions. The first is on the small-case business. You had noted that sales were down. Just curious if, really, it's just the wholesaling that is going to turn that around, or do you anticipate -- I guess, what gives you confidence that that can really be pushed higher in terms of the growth rate?

Second question, just on the ROE target. You had said at your investor day that you're targeting 13% by the end of '07, and it seems you're running ahead of schedule on that. You have been running greater than 13% for the last couple of quarters. So curious on your update and outlook for ROE going forward as well. Thanks.

On the small case market, again, the sales decline is, we think, directly related to the fact that we are bringing the wholesaling in-house. We have eliminated our relationship with a third-party marketing organization, and the effect of that is in the fourth quarter. As I said, we are substantially building our wholesaling activities, and we think midyear next year that that will begin to pay off, and we will see significant sales improvement.

That's also where we announced last year a new relationship with American Funds distributors and the creation of a Lincoln American Legacy Retirement plan that will, we believe, be very attractive to that market segment. It will be the only, I believe, 401(k) product offered that has all 27 of the AFIS sub-accounts in there plus very attractive offerings from Delaware as the two core managers, and then some additional advisory, sub advisory relationships.

So we think the product and wholesaling combination give us a lot of confidence in this marketplace or in that segment of the market.

In terms of ROE, we remain committed to the guidance we've provided on the ROE that we would expect to leave 2007 at the 13% rate.

The reason -- something I think you have to do when you're looking at our 2006 reported numbers is realize that we have taken throughout the year a number of positive items from an earnings perspective that we would suggest you to normalize out when looking at that base build in ROE, which dates back to our merger announcement. That's where management tends to be focused in on, and that is what is that sustainable, reliable ROE that drives our business, not the unusuals up or down.

So in the year we had favorable tax DRD impact, we had favorable UK gain, we had favorable loss ratios in Benefit Partners, as you know. All of those things have contributed to the higher ROE. We will, of course, take it; this is real earnings, real money, real cash flow that we invest back into our businesses to continue to grow the business. So it does make a difference, indeed. But when we speak to 13% we're talking about that sustained ROE and driving that north as we go forward.

Okay, because it seems like just on my calculation, even stripping out the benefit you had of the $0.09 this quarter and kind of what you have seen most of the year, I'm still getting to about 13.3%. So I guess I'm asking if it's possible, just given your excess capital -- I know you are reinvesting in the business -- but you have had strong sales and things are kind of humming along. I'm curious if you can push that to expand as opposed to staying flat.

At this point we are not ready to push that to expand any further. We just, as Fred indicated, believe that the 13% is a good year-end run rate number.

I think we can take off-line some of your analysis because, as we go through our ticks and ties throughout the quarter, we come in more around a 12.7-ish, 12.6% ROE. But we can walk through that. It depends on what you're doing with merger-related expenses and stuff like that.

With that, this does conclude today's question-and-answer session. I would like to turn the conference back to Jim Sjoreen for closing remarks.

I want to thank everybody for joining us this morning. If we didn't get to your calls, you can always give us a call on the Investor Relations line at 1-800-237-2920. Thanks again. Have a good day.