Lincoln National Corp (LNC) 2007 Q3 法說會逐字稿

Good morning and thank you for joining us for Lincoln Financial Group's third-quarter 2007 earnings conference call. At this time, all lines are in listen-only mode. Later, we will announce the opportunity for questions and instructions will be given that that time. (OPERATOR INSTRUCTIONS).

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

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

Thank you. Good morning and welcome to Lincoln's third-quarter earnings call. You have just heard the Safe Harbor cautions, so I won't repeat them.

We appreciate your participation today and invite you to visit the investor relations page of Lincoln's website, www.lincolnfinancial.com, where you can find our press release and statistical supplement, which include a full reconciliation of the non-GAAP measures used in the call, including income from operations, return on equity to their most comparable GAAP measures.

Presenting on today's call are Dennis Glass, President and Chief Executive Officer, and Fred Crawford, Chief Financial Officer. After their prepared remarks, we will move to the question-and-answer portion of the call.

I would now like to turn the call over to Dennis Glass. Dennis?

Thanks, Jim, and good morning to everyone on the call. You all have had a chance to review our third-quarter results. The results reflect a mix of positive trends, as well as the emerging challenges in both production and earnings. We have shortened our prepared remarks to allow time to answer all of your questions. Also, at the upcoming conference for investors and banker, we will have the opportunity to dig deeper into our plans, issues and opportunities.

My high-level view is that of our largest businesses, the individual lines are generally performing well, and have very positive job production trends, and that our biggest challenge in the Defined Contribution business. On the DC business, I view the issue as more time needed to see the benefits of the investments we are making, rather than systemic problems.

Digging a little deeper, production results in the quarter were strong overall, with several businesses posting double-digit sales growth along with positive net flows, and particularly strong in our retail products, including individual life insurance, annuities and retail mutual funds. The combination of product performance and an increase in the size of our distribution platforms at Lincoln Financial Distributors and improved productivity at Lincoln Financial Network, our retail distribution arm, continued to deliver impressive results.

Total retail domestic deposits in the quarter of just under $8 billion were up almost 27% over the prior-year quarter, and we also saw a significant improvement in quarter-over-quarter net flows, which increased at a rate of 200%. The results in Employer Markets and Institutional Investment Management were mixed, with strong production, net flows and earnings in pockets of those businesses partially offset by softer results in others. I'll speak to that in a moment. We are continuing to make necessary investments in people, distribution and technology to further our growth, with distribution remaining a key priority.

Let me look at the Individual Markets and Annuity businesses first. Third-quarter total annuity deposits of $3.5 billion were up almost 28% over the prior-year quarter, driven by record variable annuity deposits and an increase in fixed annuity deposits.

We saw strong double-digit growth over the prior-year quarter in each of our key variable annuity channels. Sales in warehouses were up 28%, independent planners were up 37% and banks up 58%, as both wholesaler expansion and increased productivity contributed to an exceptionally strong summer quarter. We are two-thirds of the way to meeting our wholesaler growth target at LFD of a 17% increase, and expect to reach that target in the fourth quarter. Third-quarter i4LIFE elections set a record as well, at $616 million for the quarter, a 49% increase over the last year's third quarter.

A key factor to our success to date has been on our focus on anticipating developing needs of our clients with product innovation. An example of this is our recently introduced Lincoln SmartIncome inflation annuity and income annuity that protects against inflation, with annual adjustments to lifetime income payments based on the changes in the consumer price index. We also need to be looking for ways to manage the risks that we are assuming on behalf of our clients, as guarantees play a larger role.

During the quarter, we entered into a reinsurance transaction for variable annuity guarantees covering rider sales up to $4.5 billion. This is a first for Lincoln and, we believe, evidence of the discipline we bring to product development and design and risk management.

Turning to Individual Markets Life. Individual Life sales of $180 million were up 18% over the prior year, and is expected flat with the prior quarter, as we continue the transition to the new unified product portfolio. During the quarter, we also launched a new version of our Variable Universal Life contract and MoneyGuard reserve in New York, a first for a linked benefit product. During the quarter, we will continue the transition of our Life products with the introduction of new survivorship versions of our Variable Life policies.

While we are pleased with the success we have experienced, the volume of Life sales has translated to a significant commitment of capital, particularly on our Life business with secondary guarantees. Last month, we announced a debt offering to fund an efficient long-term financing solution for a portion of our Universal Life AXXX reserves. As we continued to grow our Life Insurance business, we will be exploring similar solutions, along with working through the ACLI to advance the dialogue on principal-based reserving.

Turning to Employer Markets segment, we are continuing to execute on our strategy to grow our Defined Contribution business by building increased capabilities in product distribution and service platforms. On the distribution front, we are employing the same approach we employed with Lincoln Financial Distributors.

From a deposit and flow perspective, we are seeing mixed results when we drill down to the various markets we serve. Sales in the mid to large-case market continued to produce excellent results, with deposits of $860 million increasing 150% over the prior-year quarter. Sales in the small-case market, on the other hand, were down a combined 10%. This drop is due largely to the wholesaling gap that was created with the cancellation of third-party wholesaling support, as part of our strategy to build our own DC wholesaling capabilities to expand our market opportunities.

As we have been sharing with you for some time, distribution is the number-one strategic initiative in our Defined Contribution business, and we have been making significant progress on that front. We started the year with a wholesaling force of 37, and as of September 30, that number was 76, a 105% increase. This compares against the year-end target of 100.

The expansion does come at a cost. The economics of DC wholesaler expansion are similar to what we experienced with LFD -- that is, the cost of supporting new wholesalers will result in a drag on earnings until such time wholesalers reach targeted productivity levels.

What is different between developing wholesaling distribution on the Employer Markets side versus the Individual Markets business is the length of time required for closed cases to translate to deposits. This is simply driven by activities involved to transfer plan assets and the periodic nature of contribution from plan participants.

Now, back to my earlier point on timing in this business. We expect the product and distribution investments we are making to begin developing the sales levels needed to accelerate earnings toward the end of 2008 and acceleration in operating earnings beginning in 2009. There are many assumptions baked into and behind this expectation, including the achievement of sales plans, surrender rates, business mix, stock market performance and others, but on the whole, this captures our expectations. Wes Thompson will provide more color on the progress he and his team are making in building up this critical part of our business at our conference.

Briefly, turning to Group Protection, this business continued to deliver solid results, with strong double-digit growth in both annualized sales and earned premium in our core small-case market. We are seeing a pickup in voluntary sales relative to the traditional group business, which is the result of a continuing strategic focus on this segment. We expect voluntary benefits to grow over time, as employers continue to look for ways to manage benefit costs.

Investment Management -- in our Investment Management segment, we had solid retail sales and institutional inflows, despite the disruptions in the capital markets. Total Investment Management deposits in the quarter were $5.7 billion, a 17% increase over third quarter 2006, and third-party assets under management grew 11% to just under $100 billion. Net flows, while down from a year ago, improved sequentially by $516 million, due primarily to a reduction in institutional outflows, which we attribute to the traditional lumpiness in this business.

Investment performance in the quarter remained strong. On the retail side, 48% of our mutual funds had performance results that were in the top half of the respective Lipper peer group for the rolling one, three, five and 10-year periods -- 66% if you exclude the one-year period. The relative underperformance in the one year period can be attributed to volatility in the fixed income arena, which had an inverse impact on our duration-neutral investment strategies.

Institutional performance was also strong. Of our eight largest institutional composites, five of the eight outperformed on a rolling one, seven and eight basis, rolling three-year basis, and four out of seven outperformed over the rolling five-year period. For the two composites which track records of at least 10 years, both outperformed their respective benchmark.

Just a quick comment on our general account, given the turbulence in the credit markets. Our general account investments continued to perform strongly. Realized and unrealized capital losses related to subprime exposure have been manageable, and credit losses continue to be lower than historical averages. We also continue to be comfortable with our subprime exposure.

While excess investment income from hedge funds and other partnerships was below expectations this quarter, long-term results in these areas have met, and in some cases exceeded expectations. Yields on new investments made for the general account have been at or near portfolio yields during the year, helping to protect our in-force interest margins.

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

Thank you, Dennis. Our reported earnings for the quarter were $353 million or $1.29 per diluted share, included a number of offsetting items in the quarter that combined to reduce earnings by about $6 million or a little over $0.02 a share. Notable items in the quarter included the results of our third-quarter prospective DAC unlocking, which together with DAC model adjustments and other unlocking activity combined to add proximately $16 million to our overall earnings. Our Group Protection business had another strong quarter of loss ratios; that contributed $8 million to the quarter.

These positive items, however, were more than offset by roughly $13 million of after-tax and DAC breakage in our hedge program and roughly $9 million from overall softness in our investment results, this including the FAS 133 impact on indexed annuity margins. There were approximately $8 million of other net negative offsetting items in the quarter, including an increase in UK mis-selling reserves.

Even if you adjust for these items, our earnings came under pressure in the quarter. Contributing to the pressure included weakness in our Defined Contribution business, a dialing down of our expectations for excess investment income and the current pace of strategic investments in our business platforms. However, the fundamentals underlying our earnings remain healthy, with strong growth in consolidated assets under management, life insurance in-force and group net earned premium all supported by the strong production results.

Let's turn to our segment results, and I will focus my comments on the significant businesses. Individual Annuities results continued to leverage off strong positive flows and strong underlying performance in our separate accounts, driving a 32% increase in average variable account balances and a 40% increase in expense assessment revenue over the comparable quarter in 2006.

Fixed margins were negatively impacted by continued fixed annuity outflows; however outflows have slowed from the levels experienced last year. The FAS 133 impact of the forward-starting options on our indexed annuities did a complete reversal in the quarter from the second quarter, reducing our margin by some $13 million pretax and DAC, after contributing roughly $10 million in the second quarter. Normalizing for this impact, spreads of approximately 200 basis points were modestly lower than the past few quarters, but in line with what we would expect going forward.

As you might expect, performance in our hedge program was affected by volatile conditions in the capital markets. The main driver of hedge breakage was a significant and sudden increase in market implied volatility, coupled with a drop in interest rates, which led to a large jump in the living benefit reserves.

We run the hedge results through the benefits line, and therefore into our operating earnings. The after-tax and DAC earnings impact was approximately $13 million in the quarter. This quarter's hedge results, which cover approximately $22 billion in VA balances, was not unexpected, given the current design of our program and the difficult market conditions.

Turning to our Life business, favorable mortality and lapse results drove the majority of positive unlocking in the period. Average permanent in-force and account values were up 6% and 8%, respectively, over the comparable quarter in 2006. Normalized mortality assessments grew by 6%, with normalized expense assessments up 14% over the prior year's quarter.

Investment margins were up over the comparable quarter in 2006, fueled by growth in fixed account value. However, income on alternative investments, which can be a major contributor to Life earnings, came in below our expected returns after a very big second quarter. Our roughly $500 million of alternative investments in this segment contributed zero earnings this quarter, as compared to a $48 million pretax and DAC contribution in the second quarter.

On a more normalized basis, this represents roughly 14 basis points of additional spread. We expect spreads in the 180 basis point range looking forward.

Turning to Employer Markets, and specifically our Defined Contribution business, setting aside the impact of negative unlocking in the quarter, earnings in this segment have been under pressure throughout 2007. While much of the underperformance can be attributed to investments back into the business, we continue to experience deterioration in fixed spread margins, due in part to poor results in our alternative investment portfolio. We also increased crediting rates coming into 2007, and have seen portfolio yields come down as higher-yielding securities have matured in the portfolio.

We reported spreads of 216 basis points this quarter, but as was the case in our Life segment, we would expect to see roughly nine additional basis points from alternative investments or spreads in the 225 basis point range going forward. In addition, success in Alliance product sales has dampened near-term earnings, recognizing that unlike annuity-based products, we expensed the acquisition costs in the mutual fund-based component of this product. Alliance deposits drove another quarter of positive net flows, offset by continued weakness in our annuity-based products. Flows, together with year-over-year market appreciation, drove average account values up $4.4 billion, as compared to the 2006 quarter, driving an 18% increase in expense assessment revenue.

In Group Protection, favorable non-medical loss ratios of roughly 69% contributed about $8 million to the quarter's earnings, when compared to our expected range. Loss ratios benefited from favorable results across all major lines, driven by favorable mortality in group life and favorable incidents and termination results in our disability lines. Our non-medical line experienced strong revenue growth, as premium increased 12% over the previous year's quarter. We expect year-over-year premium increases in the 10% range for the remainder of 2007.

Delaware posted strong quarterly operating earnings and saw continued improvement in pretax operating margins. Growth in third-party assets under management drove an 11% increase in external advisory fee income, contributing to an overall 7% increase in total revenue when compared to the third quarter of 2006. Normalized operating expenses were up only modestly, primarily related to variable expenses.

As the equity markets and trailing 12-month flows increase assets under management, we bring on more advisory fee revenue without requiring much additional cost. We have also been hard at work to rationalize our back-office operating expenses, including exiting less profitable business lines in order to drive improved margins.

Merger expenses of $29 million pretax came in below our guidance of $35 million to $40 million, as the timing related to significant systems work can be difficult to estimate with precision. We estimate our fourth-quarter pretax merger-related expenses to be in the $30 million range. In terms of overall expenses, we continue to make good progress on our goal of taking out $180 million of gross expenses. Through the end of the third quarter, we have achieved roughly $155 million of annualized savings.

This was an active period for Lincoln in the capital markets. We issued $300 million of senior debt to take advantage of rates and we monetized a portion of our BofA stock holdings, realizing approximately $145 million in proceeds.

As Dennis mentioned in the fourth quarter, we executed on an AXXX UL reserve relief structure involving the issuance of senior debt, with proceeds downstreamed to a captive reinsurance subsidiary to support a treaty with our principal insurance subsidiary. This structure releases approximately $300 million of capital for reinvestment. We repurchased $174 million of stock in the third quarter, and expect to repurchased around $200 million in the fourth quarter, utilizing the rest of the BofA stock proceeds and roughly half of the proceeds from our reserve relief project.

With that, let me turn it over the operator to begin our Q&A session.

(OPERATOR INSTRUCTIONS). Andrew Kligerman, UBS.

The first thing I would like to explore is just this alternative investment income. I felt what was interesting in looking at the Individual Life, you had a negative 4 basis point contribution versus a positive 70 basis points in the second quarter. Then when I looked at the numbers in Defined Contribution, again, it was negative 11 basis points this quarter versus positive 11 basis points.

Yet, when Fred Crawford, you were just talking about your guidance going forward, it's very similar to the solid numbers you were projecting out as we were looking into the third quarter. So the question for you, Fred, is why do think that alternative investment income will kind of get a little bit of a bounceback, and why did we fall so short in this quarter?

Well, let me answer it in a few ways, and then maybe help, frankly, everybody out a little bit with what the overall alternative investment portfolio looks like these days.

First of all, trying to predict a consistent delivery of income of alternative investments quarter by quarter is very difficult. In fact, that's just simply not the way alternative investment portfolios behave, as you know.

So when we reconcile each quarter for excess investment income -- that is, income over and above our expectations and/or income below our expectations -- what we're trying to do is dial back into what we believed to be a normalized long-term rate of investment income off the portfolios, particularly when it comes to a longer-range view of spreads, and that's what we try to do. But that, however, is a different situation than what it's actually going to do each quarter, and it has been very volatile.

Let me give you an idea of that volatility. We have about $760 million worth of alternative investments in the Company. About $500 million of that is dedicated to our Life segment, which is why you see the Life results move around much more dramatically based on alternative investments. We have about another $120 million that is related to annuities and about $140 million in our Defined Contribution/Employer Markets business, which will move those spreads around. The relative size of the alternative portfolio to annuities is so small, relative to the overall general account size, that it tends not to move those numbers around too dramatically, but obviously has bigger impact on Employer Markets, Defined Contribution and, of course, Life as I mentioned.

To give you an idea of the volatility, in the second quarter, across all of our alternative investments, we generated about $70 million of income pretax and pre-DAC offset. In the third quarter, that was near zero -- in fact, right about zero earnings off of those portfolios.

As you drift back through the last several quarters of earnings, we have ranged from a loss this time last year -- because of the AmRamp holding we had in hedge funds of about $7 million -- to a more steady-state rate in and around $20 million as you look at the fourth quarter, first quarter, second quarter type trends. Now, also impacting that is we've been ramping up this portfolio. After giving effect for the merger, we very simply had a much larger general account and we could take on a much larger holding of alternative investments.

So for example, just last year this time, our holdings of alternative investments were a little bit north of $500 million, about $550 million, and we've pumped that up by about $200 million. So you have the returns moving around and the volume impacts related to alternative investments.

So, what I would say, in terms of this quarter's earnings and its impact, is that we have dialed down modestly our expectations for alternative investment returns going forward, these being hedge funds and private equity ownership. In part, that's dialing down some of our earnings run rate a little bit. We had it a little overheated, I believe, in some of the previous quarters. Hopefully that gives you a little more color. We'll probably go into more detail on this at the investor conference.

Sure, Fred. But your dial-down is certainly significantly higher than what we just saw in this third quarter. Is that Fair?

Yes.

I would say a good 15, 20 basis points higher. If in both the DC and the Life business, we should expect on a more normalized or average basis significantly better numbers than what we saw in this quarter. Do you agree with that?

Yes, I think, in general, what we expect to achieve on these portfolios, in a conservative basis, would be a 10% to 12% return on the portfolio, after which you would then apply a DAC and tax offset, which will tend to take some 50% or so out of that from an earnings contribution. That's more or less what our long-term expectations are. But again, we've gotten gradually more conservative on that, given our outlook for (multiple speakers).

Just real quickly, the types of alternative investments -- is it mostly hedge funds, private equity?

Yes, of the $760 million, for example, approximately $350 million of that is related to hedge funds. Venture capital, mezzanine type structures would be another -- a little north of $230 million. The bulk of it is made up of energy investments of about $80 million and real estate-related venture investments of about $82 million. Then there's a smattering of others, but that would be the basic breakdown.

Then just lastly for Dennis. On your targeted 15% return on equity for 2010 -- and I know there was a fair amount of spending in this quarter. Is there any reason to expect that you won't get there now? Are you going to be spending a fair amount [more]?

Andrew, we're not changing our outlook on that. But it is -- we're going to have to work a little bit harder, I think, to get there.

A little bit harder? In what sense? What do you think you're going to fall short on?

Where I might add is what we've talked about historically is leaving 2007 with approximately a 13% ROE, this after merger expenses -- that is, excluding merger expenses from the calculation. We're tracking right on that. If you were to normalize earnings over the last few quarters, that is just adjusted for some of the special items we note.

Take a look at the ROE -- that's about where we are tracking. What we have said is that we would hope, over the course of the next three years, to position the Company to deliver on 15% ROEs. As Dennis mentioned, we've got some challenges in the form of we really need to see the Defined Contribution business spring back in particular. We've got to kind of continue the march forward on some of our larger bucket businesses. We also need capital conditions to cooperate, because that's a critical factor, obviously, in driving the ROE, particularly in our industry these days.

So, those are some of the challenges. But the idea is to have us positioned for that kind of return over the course of the next three years.

Darin Arita, Deutsche Bank.

Dennis, if you could just talk a little bit more about the defined contribution business. Can you talk about what are the key metrics that you will be looking for over the next 12 to 18 months here?

In general, the focus is on building out distribution, and Lincoln has a very good track record of doing that. The best evidence is Lincoln Financial distributors. We are applying the same philosophies and management to the expansion of our wholesaling force.

There's a variety of issues inside of this business that have to do with the relative ROAs, big buckets of product and the big buckets of assets under management. So we have to pay attention to those things. We're investing, as we have talked about quite a bit this morning; we have to make sure those investments are paying off.

But as I said, at the highest level, we have got to be successful with achieving the sales plans. Those sales plans are aggressive sales plans, but we think we have the right product, the right distribution management to get there.

Fred, can you talk a little bit more about the AXXX reserve relief, and there's opportunities to do more of that?

The reserve relief structure that we did in the fourth quarter was on a specific block of business. In fact, it was a block of UL business that was housed within the former Jefferson Pilot legal entities. In fact, when you execute on these transactions, you tend to do it block by block.

So we continue to review other UL blocks, particularly within the, again, former Jefferson Pilot businesses. The reason we're focused on those blocks of UL business is because the former Lincoln-related UL blocks have been already reinsured and supported by letters of credit, so effectively there's reserve relief already in that. So we are identifying additional blocks, and my expectation is that we will execute on additional transactions sometime in the 2008 time period, and we're actively working on that right now.

So the basic program was to do one such transaction in 2007, which we've accomplished, and another in 2008. It's too premature at this point in time to size the level of reserve relief on that, because each block, the characteristics of the products and so forth can make for differences in that amount of relief, but I would expect to do an additional transaction in 2008.

Colin Devine, Citi.

I have got a couple of quick ones. On the variable investment income or the partnership income -- and obviously I don't want to spend a lot more time on this than Andrew did. But to just sum it up, Fred, the bottom line here, this represents these investments, about 1% of the portfolio, a good quarter that might be 1.5% of your investment income and in a bad quarter, a weak quarter (inaudible) if you want to put it that way, is zero. Is that about the right range?

I think directionally, that is pretty good. We continue to increase gradually the level of partnership interest, and I would expect to do a little but more of this over time. But we're very selective, and so the pace of that I can't quite nail down. But we have given the authority, if you will, to our general account managers to do a little bit more than what we currently do.

I think your expectations around range bound in terms of returns are directionally correct, although I would remind you that it was just a year ago this time that we actually suffered an overall loss in that portfolio, and that was again related primarily to a hedge fund loss, and more specifically the AmRamp investment.

In fact, looking at last quarter's results, you actually had only three major investments, by and large, that contributed the vast majority of that $70 million. So I just warn that while directionally correct, that to be careful, it can be quite volatile. But again, over time, we expect over the long range this to be a very productive portfolio for us.

Let's move on from that to the media business. You've had five months with Merrill out there shopping it. Where do we stand? Dennis, you've had, what -- at Jefferson Pilot, I guess, what, seven, eight, nine years to sell it. You didn't there. Is this thing still for sale or not?

I'll just take the question and Dennis can jump in. I'm taking it because I now manage M&A, and I'm managing specifically our project of reviewing strategic options. What I would tell you is that we are very deep into the process, and I would expect to be making further comments updating you more specifically on the outcome of our media project and where we stand over the course of the coming weeks -- perhaps sooner; it depends on how things develop.

So at this point in time, I'm not ready to give you a specific update on that, other than to say we're deep into the process.

Mark Finkelstein, Fox-Pitt Kelton.

A couple of quick questions. On VA sales, strong quarter, up 35%. You obviously had the volatility in the market, August/September. I'm curious about what September sales or end-of-quarter sales looked like relative to early in the quarter. I mean, one of your competitors showed some kind of softness towards the end of the quarter with the volatility, and guided down a little bit on the fourth quarter, partly also due to some market competition [facts]. So I'm just curious what you showed, and maybe anything you could say about early Q4 results?

I'm going to ask Terry Mullen, our CEO of LFD, to respond to that. I think the story is positive.

In September, we did see on average daily sales a slight reduction from prior months. But remember, it was also only a 19-day month. So we did see a slight downturn from the $1 billion that we were doing in July and August. The good news is that in October, we have seen a reversal, and this will be a record month and very, very strong production across the VA portfolio.

Okay, perfect. Then just real quick on Life, the sales growth in the quarter -- do have any feel for how much of the production was from the unified portfolio versus still selling off of the old product that hasn't been approved in certain states? Just to kind of get a feel for whether some firesale elements are still occurring?

Mark Konen, could you answer that?

Sure, Dennis. What you have to remember is when you do the portfolio like that, you allow some transition time. So even after states adopt it, typically you have 60 to 90 days of transition, where they can essentially sell either product as they get familiar with the new portfolio. Also, that's all based on application date, rather than when the policy is actually issued after going through underwriting.

Having said all that, we think about somewhere between 20% and 25% of our sales in the third quarter relates to the unified product portfolio. The other three-fourths, roughly, is the older portfolio. We will see that number obviously flip in the fourth quarter, with probably more like 75%/25% the other way.

Jimmy Bhullar, JPMorgan.

I have a few questions. The first one, Fred, is on your hedge program losses. The $16 million that you have that you reported in losses -- what does that reflect? Is that the cost of hedges for sales that were made this quarter being higher than what you had priced for, or is it just fixing something -- fixing the hedge for not being properly hedged on the in-force business? Or what does that number mean? If you can give us an idea on like for i4LIFE, for instance, you're charging the 40 basis points. How much more than that did it cost you to hedge?

The second question is on Logan Circle or on your asset management business. You've lost some personnel. If you can talk about how much you expect to lose, in terms of assets? Or just give us some idea on how much you expect to lose, in terms of assets, and what sort of compensation you would get for that.

The final one is on subprime. You reported losses of $11 million this quarter. It's a very low number as a percentage of your holdings. I think you own about $860 million of subprime securities. It's hard to believe that these securities are only depressed by about 1%. If you can talk about what the $11 million really is? Is that how much you think is permanently depressed, or that how much the market value of those securities has gone down. That's it.

Let me see if I can't pound through these three, and then if we've get others here the room -- Pat Coyne, for example; we've also got Dave Bulin, who runs our hedge program -- who could weigh in if they want to add additional color.

But on the hedge program, the $13 million of after-tax after-DAC earnings item that we have talked about in the quarter -- this is what was the negative after giving effect for what we believe to be the ongoing costs associated with the program. That is, we would expect just the costs of the program, running the program, to be in and around a $4 million to $5 million quarterly cost. This would be the cost -- the burn rate, if you will -- on the options we put in place, the implied interest expense on futures and so forth, and then the overall underlying running of the program.

The breakage, if you well, is really the result of the, again, sudden and fairly sizable movement in volatility. But I would also add that there are a certain number of uncovered pieces of our hedge program -- that is, a good example would be we don't currently have the product that we sell in New York underneath the hedge program. While not a huge piece of our production, it's meaningful enough to where when unhedged, the movement in volatility was so dramatic that it will move that number around.

We actually are quite happy with how the program reacted, given the extreme movement in volatility. Having said that, we are dialing in some additional improvements into the program, as is always the case. Every time we are tossed a curveball in terms of the capital markets, we learn more about the behavior of our liability -- that is, the reserve -- and we can dial in different things in the hedge program to better capture some of that, and we're doing it. But the number we quoted is primarily that breakage after tax and after DAC -- i.e., the difference in change in reserve and the difference in change in the hedge asset.

In terms of the pricing-related issues, we don't take one quarter's worth of volatility movement as whether or not we are indeed priced right or not. This is sort of a long-range view of [vol] and all the other components that are embedded into the pricing of our variable annuity guarantees. So whether it be i4LIFE or some of the other guarantees we have, we believe over the long run that even the movements in the market that we experienced in the last quarter will fall into the range of what we expect when we price the product.

If, however, volatility would remain as high as it is and stay that high, then as is the case with most of our competitors, we would probably be reviewing the overall pricing on the guarantee, to see if we have to make some adjustments going forward. But we don't anticipate that at this time.

In terms of Logan Circle, what we have talked about historically is that the amount of assets involved in that effort range around $14 billion, and it's our expectation now that we would retain roughly 15% or so of those assets. What we are not in a position to comment on at this juncture is the precise terms and conditions of what we have structured with the other party, in terms of consideration.

What we can do, though, is give a little bit more color on what we would expect going forward, in terms of impact of earnings and so forth. In that regard, our view is that the fourth quarter will not see much of an impact on a net basis when looking at that transaction.

Let me just go further to give you just flatbed guidance on Delaware fourth quarter. We would anticipate the fourth quarter for Delaware to be in the range of $20 million or so of earnings. Again, there will be a little bit of transactional noise, but we would expect it to net in the quarter. Going forward in 2008, however, we would expect to see roughly a $3 million per quarter reduction in earnings giving effect for the transaction, and then probably settle into a pretax operating margin of in and around 19% to 20%, as we start to rebuild that business with the new fixed income team that we have that we are very happy with.

The third question you had was on subprime. The write-downs we took on the subprime part of the portfolio were really dedicated to the CDO investments we had, which tend to be backed by lower-quality subprime. Therefore, not surprisingly, we took more in the way of impairments there.

You're right -- it was a very small number pretax, roughly $11 million. We did take down an impairment on a mortgage-related company that's not directly tied to sub-prime, but they were impacted by the loss of liquidity, the dramatic loss of liquidity in the market, and we took that down by about $14 million. One could characterize that as subprime-related, although not directly.

The only thing I would say about the overall portfolio is we continue to be very pleased with it. I think the big reason why you don't see much of a problem in the subprime and Alt-A holdings that we have is because the vast majority of our collateral is fixed-rate collateral. The higher quality of that collateral, all of it, 100% of it being first lien has really held up fairly well, in terms of the various metrics we look at.

The overall market value to book for subprime, for example, is roughly $0.94, $0.95 on the dollar. For Alt-A loans, a bit higher than that, roughly $0.97, $0.98 on the dollar, give or take, blended around $0.96 on the dollar. So again, that would be consistent, in terms of our view of the quality of the collateral and quality of the securities.

Now, I pounded through three of those questions. We have some others around. If anybody wants to add any color, they can. Otherwise, we'll just move on.

Pat?

Thanks, Fred. Just a little bit more color around the Logan Circle transaction. The deal actually settled at basically 5:00 today. As Fred mentioned, there's $14 billion in assets in play and there are still some clients who are still making up their mind. We just found out this morning of a substantial high-yield account that's going to be staying with us. So there are still accounts in play that we don't have the answer for at this particular stage. Investor day, probably we can get a little bit more detail.

Joan Zief, Goldman Sachs.

I just had a few questions. The first thing is on the annuity side, if you take out all the noise and all the unusual items and you think about your basic business, what sort of normalized return on assets do you think you are pricing to? That's my first question.

My second question is, you talked about some strength in the fixed annuity business, and I was just wondering if you could just talk about the fixed annuity market. We always focus on the variable. I'd love to hear what you're saying about fixed annuities these days.

Then just lastly, what are you targeting for your excess capital, and what are you thinking about from a usage standpoint, if you do get to harvest proceeds from a media sale, harvest some excess capital from another AXXX?

Mark Konen, could you please address the first part of the question, which is ROAs on the annuity business, in-force and pricing?

Sure, Dennis. If you adjust out the items as Joan had talked about, I think -- I'm going from memory here, but I think that ROA on the in-force number would come in around in the 60 basis -- the 60's of a basis point range. On top of that, as you look at new business that we are pricing, both on the VA and the fixed side, it's again arranged by product, but it wouldn't be terribly far from that. I would say it would average into the mid-50's, probably.

Thank you, Mark. On the fixed annuity business, we did have a good quarter. This business continues to be driven by rate with our large part of our portfolio. The good news is -- and I mentioned this product, the inflation protected product. That product will help us drive annuity sales around a value proposition, and we're going to continue to build our portfolio on that strategy. So over time, fixed annuities will remain a part of what we are doing, but it will be more feature-oriented, which will help us tie it into our distribution capabilities, wholesaling distribution capabilities, widen the places where we're selling the product. So over the long term, that's the strategy.

You asked about excess capital, and the picture I would paint for you at the moment is as follows. One is we were dialing in an additional $200 million of share repurchase in the fourth quarter, which by definition means that capital is excess and able to deliver back to the shareholders.

In addition to that, as you know, we have other forms of excess capital. We hold a remaining interest in -- that is, the interest in the BofA stock that we have not yet done a monetization program on. That probably would be, after tax, around another $150 million.

We also have what we would call capital margin. This would be the difference between the risk-based capital we dial in our insurance subsidiaries and where we are today, and also the leverage capacity we have at the holding company. I would put that number at in and around the $400 million to $500 million range.

In terms of AXXX-related reserves -- redundant reserves that are held captive, if you will, in our life business -- we have, and as I mentioned earlier, we will be looking at another transaction, but we haven't yet sized the amount of redundancy in that portfolio. My guesstimate at this point is that the sizing of that will not be too terribly different than what we executed on in 2007, but that's based on an early read. You have to get into a substantial amount of actuarial groundwork to really come up with that number, and we'd simply update you as we move forward and look at sizing up that issue.

One other thing I would comment on, relative to overall capital conditions -- and we'll talk a little bit more about this at the investor conference -- is that it's very, very important that we continue to support the strong growth we're seeing in the Company. That's strong growth obviously on the annuity side that you're seeing, but it's also particularly strong growth on the life side, and life products, as you all know, will take up more capital, if you will, from a risk-based capital standpoint to support. So part of what you see us doing is not simply dialing in excess capital, but also making sure, when we do create that capital margin, that we're reinvesting it back into supporting the strong growth in the Life business. You will see that be the case as we come through the latter part of 2007 and in 2008.

Something I don't want too big a deal about, but I would say most CFOs of life companies these days also have one curious eye towards the credit markets, and that is while our general account continues to do very well, as mentioned earlier, it is a period of time right now to be marginally cautious and watching how those securities are reacting, watching what is happening in your troubled and concerned portfolio lists and so forth, and being a little bit more cautious. So that's the current climate I would paint on excess capital.

Bob Glasspiegel, Langen McAlenney.

If the [VIC] stays at 20, roughly where it is, which is below sort of where it was for most of the last quarter but above where it ended, are we going to hear that hedging costs is going to be a negative in Q4?

The way I would look at that, and Dave could maybe comment on it, is certainly if the VIC stays high for a sustained period of time, where you in particular have options rolling off and new options rolling on, you will gradually see an increase in the cost of hedging. Fortunately, most of us in the industry, Lincoln included, has been putting on option coverage for quite a while, including fairly far out onto the curve. That helps to, on a quarter-by-quarter basis, hold down the overall average cost of the hedge program.

But yes, a sustained period of time of high volatility, where you're growing your business or you're putting more options on, as well as having some option maturity and rollover, if you will, impact would gradually increase the hedge program cost over time. But there again, that's why most of us in the industry, including Lincoln, file our products with the ability to increase pricing over time if necessary on new business, to accommodate those higher costs of hedging.

Two other quick questions. Restructuring costs are $103 million, I guess, using your $30 million for Q4. What are they expected to be in 2008? Remind me.

Secondly, just understand the delta in DC expectations today versus a quarter ago seems to be related to better sales from Alliance Mutual and the expenses that you are spending on wholesale, it seems to be right on track. It's not that you're spending more money than you thought you were going to. But maybe I'm missing your point there, Fred.

In terms of the merger-related expenses, right now, what I've been doing is just giving the more precise forecast on merger-related expenses for the coming quarter. As I mentioned earlier, we dialed that into the $30 million range. When I get to the investor conference, I will give you, along with other parameters, a little broader outlook for 2008. So at this point in time, I don't want to go further into that direction.

Part of the reason is not because we don't have a handle on it, but I want to be particularly careful about timing. That's probably the biggest issue, is the timing of the spends and how that trajectory is rolling out. So I want to take a little more time on that, but you can expect to get an update.

In terms of the Defined Contribution business, the picture I would paint around earnings -- if this is what you mean by the delta, if you will. The delta in the quarter, as opposed to expectations, is really around the following, and in some of the comments I made. Yes, there's continued investment that we're making into that business, and you'll see that some of that investment, particularly the investment associated with distribution expansion, you'll see somewhat of a DAC offset, which will calm down some of the expenses. But not all of it is DAC, so you will still see some level of expenses coming on down through earnings, particularly as it relates to investments on the infrastructure or architecture of backing that business, which we also are currently investing in to build out.

The other thing is the Alliance product, from both a mix of business as well as just the sheer acceleration in deposits. There is the drag associated with expensing acquisition costs, because it's a mutual fund-based product. So you experience a similar pattern of earnings almost that you do in an investment manager, for example.

But also, that is a product that has, on a relative basis, a lower ROA than what you would find on annuity-based products. While that ends up being ultimately a good guy on the capital side, because it also carries lower capital, you will see a depression, if you will, in the earnings because of the lower relative ROA, this relative to annuity-based products like our small-case director product and multi-fund product.

So when you are seeing a slowing of sales and negative flows on the annuity-based products, supported by positive flows on Alliance, you have a real mix of business change going on there, in terms of your earnings profile. Again, over time, as we build out these businesses -- A, as we turn around the annuity-based products, with all the initiatives that Wes has underhand and that Dennis mentioned earlier, we'll start to see that turn. Then Alliance, of course, will end up eventually turning a corner, whereby the account value buildup will more than compensate for the acquisition cost expensing over time, similar to an asset manager.

The only other thing I would say is the gains we're making on equity market-related increases and expense assessments have been offset, and in some cases, particularly sequentially this quarter, more than offset by losses in our fixed margin. Again, that's a bit of a headwind that we're finding in the DC business that we have to fight. This has to do a little bit with alternative investments, but also crediting rate action we've taken and the maturing of higher-yielding securities in the portfolio.

So that's what we're looking to battle at. That's the delta, and that's what we're going to work on.

Jeff Schuman, KBW.

I wanted to circle back to the issue of the three-year ROE improvement and Defined Contribution, to sort of put the Defined Contribution piece in perspective. My impression would be that you would give the ROE improvement via a number of sources or levers -- mix shift, efficiency opportunities, capital management and then maybe some lift from better growth in some businesses like DC and Delaware. So, as we sort of look at that whole program to move the ROE, how big is the DC piece?

The way I would characterize it is that what's most important in driving lift in that ROE over time would be disproportionately growing, as a percentage of your overall earnings component, those higher ROE businesses. Now, that's a real simple statement, but if you break that down, what that means is continued strong growth, particularly in our variable annuity business, which tends to be a higher ROE business. Then the DC business becomes so vital, not only because it's been a near-term drag on earnings, but it also is a business that carries higher ROEs, much higher ROEs than traditional insurance businesses.

So getting that thing back on a growth path has more to do with absolute earnings. It also has a great deal to do with moving ROE over time. Asset management, same sort of story -- another component of the Company that would deliver outside outsized ROEs. As we've talked about in previous quarters, reaching some capacity issues and so forth, we have seen a slowing of the positive flows in that business, and so it's living more largely off of market movement. As Pat has talked about, and will talk about at the investor conference, we've got plans in place to really work that and turn that around.

So you've got to grow those higher ROE-contributing businesses, and that's where we're focused. That's really the end result of our retirement income focus in delivering what we hope to be one of the better retirement asset gathering engines in the industry.

Now, the other businesses are major contributors. The Life business, you have to do the following. You have to first steady as she goes, and that is don't trip over yourself and continue to deliver the predictable returns there. But you've got to go hard at work at capital management, in order to help those returns out. Therein lies the AXXX securitization type structures to really work the denominator in that business.

I think your opening description of all of the levers that we have to pay attention to was a very good one. I will just amplify on Fred's comments. We have to work -- and back to Andrew's question of me, we have to work hard on each of those levers to get to this 15% ROE, and that's where we're setting out to do.

Just to drill a little bit again on one of the -- we can look today at the ROE for the overall Annuity business, Fred. But what should we think about in terms of the marginal ROE on the Variable Annuity business, which is growing so rapidly at this point?

The marginal ROE on the Variable Annuity business is not altogether inconsistent with the ROE we're reporting. Now, again, I would caution that you first have to normalize the overall earnings components when getting to that ROE, so you need to be careful about adjusting for positives and negatives in the period when looking at it. But the marginal ROE that we are bringing on is roughly consistent with the ROEs we're generating in the business.

Tamara Kravec, Banc of America Securities.

Two quick questions. First, do you have a $2 billion share buyback authorization? I was curious if that is independent of any proceeds you would get from the sale of the media business, and how you would think about the use of any proceeds you would get from that?

Then the other question was on investment management, and if you could address what you think the expense ratio trend should really be there. It was quite a bit lower this quarter, and kind of wondering what really drove that and how sustainable you think that is.

The share repurchase authorization we have in place is $2 billion, irrespective of where and how we generate proceeds to use that. So in other words, should we bring in proceeds from exercising on a sale of the media company, any share repurchase we do would go against that $2 billion of authorization capacity.

In terms of use of proceeds, I would say we're not there yet to give details. We are still in the process, and again, I'll be updating you hopefully in the coming weeks with where we stand on that. Certainly, I would say to the degree you model proceeds, one of the options for us certainly would be share repurchase, and that would be detailed for you in any form pro formas that we do should we come to conclusion there.

Your other question was --? (multiple speakers). Expense ratios in Investment Management. Just a couple of comments I will make, as it pertains to their pretax operating margins and expenses. One is that when, in particular, the business is growing with the market's growth year over year, you do not have to put on much in the way of additional expenses to manage that business, so you start to see a marginally more or greater amount of those earnings dropping to the bottom line and expanding margins.

The other thing I would say is that the team at Delaware has been very hard at work actually for several years now, but it's paying dividends on really rationalizing various elements of their back room -- investment accounting and administration, shareholder services platforms and the like. That has really gone a long way to not only hold down but in many cases reduce the overall expense structure of Delaware.

Pat, I don't know from your perspective if there's anything in addition you would add.

Fred, I think there's three factors, as you mentioned. As we've talked about in the past, justifying our business lines and deciding whether or not we can repeat in them -- as you all will recall, we had proprietary DC business which we sold or outsourced (inaudible). We were actually in the [529] businesses (inaudible) compete from a scale standpoint. So justifying our lines of businesses is certainly a big part of that.

I think we had some extraordinary expense items in the second quarter, which frankly I don't have off the top of my tongue. The third thing from this particular year is because of some changes in Washington concerning our stock option program, we weren't able to make any allocations this year, and we will probably be doing that in 2008. But that won't be a major driver from an expense ratio standpoint.

Yes, in the second quarter, as you're looking sequentially in the second quarter, you really have to normalize for the expenses associated with the closed-end fund that we offer, and we had a fair amount of acquisition costs expensed in that period, and then we also hiked up litigation reserves in the period, which was another item that would typically normalize out, obviously.

We have time for one final question from Steven Schwartz, with Raymond James & Associates.

Hey, it's better to be lucky than good. Very fast question. Just so I want to make sure that I understand the hedge issue, guys. The $13 million after DAC, after tax -- that does not reflect higher costs associated with actually buying the options. Is that correct? The options and the futures.

No, it does not.

So then is it fair to say that presumably, if we don't go through a period of volatility like we had this quarter or the first quarter and so on and so on, that that $13 million goes away?

It would be our hope that we do not repeat the third quarter market conditions for starters, but we'll have to see what happens in the marketplace. That's out of our control.

What I would say more directly, in terms of what is in management's control, is dialing in and making certain adjustments and improvements to both where and how we cover volatility, and also some additional modeling adjustments to try to better capture movements like this in the future.

So presumably, Fred, there might be some extra expense on the margin associated with doing this better, but that $13 million, for all intents and purposes, should not recur unless all hell breaks loose again. Yes?

That's right. We make those improvements and we would expect much better conditions going forward. Again, we can't control the capital markets, and as is always the case, the capital markets can toss you a curveball that you're not ready for. As a result, we end up learning from that and making adjustments accordingly.

Thank you and that will conclude the question-and-answer session. I would like to turn the conference back over for any additional or closing remarks.

Again, we would like to thank you for joining us this morning. As reminder, our investor banker conference will be held in Philadelphia on Tuesday, November 13th, and information regarding the meeting can be found on our website. As always, we will take your questions on our investor relations line at 800-237-2920 or via e-mail at investorrelations@lnc.com. Thank you again, and have a good day.

Thank you and ladies and gentlemen, that will conclude today's conference. We do thank you for your participation, and you may disconnect at this time.