Lincoln National Corp (LNC) 2007 Q4 法說會逐字稿

Good morning, everyone, and thank you for joining Lincoln Financial Group's fourth quarter 2007 earnings conference call. (OPERATOR INSTRUCTIONS). At this time I would like to turn the conference over to the Vice President of Investor Relations, Mr. Jim Sjoreen.

Thank you, Dana. Good morning and welcome to Lincoln Financial's fourth-quarter earnings call. 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 our earnings release issued yesterday, and our reports on Forms 8-K, 10-Q and 10-K filed with the SEC.

We appreciate your participation today and invite you to visit Lincoln's Web site, 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 and return on equity, to their most comparable GAAP measures. In addition, you will also find a general account supplement posted to our Web site that includes additional information and expanded profiles of certain asset classes held in our general account.

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 Q&A 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. 2007 was a good year, reflecting the strong fundamentals in our underlying businesses and operations, even as we faced headwinds in the capital markets that intensified in the fourth quarter.

The fourth quarter capped a solid year of production results for Lincoln. Sales in the quarter and for the year were strong overall, with record annual results established in core businesses, including variable annuities, life insurance and group protection. Year-over-year, we saw sales growth rates at or above 20% in each of these businesses, as well as 20% sales growth in our defined contribution business and 32% growth in our retail mutual funds. These results reflect our substantial investment during 2007 to expand our world-class distribution platforms in the individual and employer markets, as well as a robust product portfolio. Along with this strong production, we also reached merger integration cost save targets, and we are making significant progress on consolidating multiple systems, which will improve productivity and enable easier access to customer information.

As you saw in yesterday's press release, the volatile capital markets lowered fourth quarter's net income, we believe, well below the aggregate underlying earning strength of our businesses. Fred will dive into this in his remarks.

Despite the challenges presented by the economy, I am very pleased that our enterprise risk management, including credit risk management, in fact worked well. We made solid decisions in regard to our exposure to volatility in the variable annuity hedge program, and are seeing the benefits of this emerge in the first quarter. Overall, Delaware has skillfully managed the general account assets.

Evolving economic and capital market conditions cannot be predicted, and worsening conditions could have further impact on the portfolio. But in general, we have a strong portfolio, and currently do not anticipate credit losses that would materially affect our future investment income or significantly erode our capital position. Our capital position at year-end was strong, and after financing our expected strong growth in 2008, we will have capital available for share repurchase, acquisitions, and for other business development purposes.

Let me move to distribution. Lincoln Financial Distributors, the wholesaling group supporting our individual retail products, had a very significant year, reaching a record $20 billion in total sales, up 14% over the prior year. Supporting these results was a wholesaler force of 654 at year-end, representing roughly a 25% increase over the prior year. Average VA productivity increased in '07, and LFD's revenues exceeded expenses. Our '08 expansion plans call for increasing wholesaler count by another 20%, focusing on the Independent planner and bank channels, where we have the greatest opportunity for growth and taking market share. More specifically, a portion of this expansion will support two recent significant shelf space additions -- the first adding SunTrust Bank, a large generator of variable annuity sales; and second, placing our ChoicePlus VA product in the Edward Jones Independent Planner system.

Lincoln Financial Network, our retail distribution group, also had a significant year, with product sales increases in life, variable annuities and retail mutual funds, while growing the number of advisors. LF revenues also exceeded expenses for the first time, a significant accomplishment. LFN expects to further expand its 7000-strong advisor group in '08 with a targeted focus on growing the population of advisors delivering top-tier production amounts.

From a manufacturing perspective, Lincoln has clearly become an industry leader in annuities. Fourth-quarter total annuity deposits were up 23% over the prior-year quarter, driven by record variable annuity deposits in both ChoicePlus and American Legacy. When the industry data is published, we expect to have meaningfully increased our market share during the year. Our i4Life rider remains a compelling option for retirement income, and it continues to gain momentum. i4Life elections in the fourth quarter set another record, with a 54% increase over last year's fourth quarter. In fact, in the seven years we have been offering the i4Life rider, elections have exceeded $5.5 billion, and over 80% of those elections have been new money.

Leading-edge product development, alongside shelf space additions and wholesaler expansion, will support continued good growth in '08. Product development in '08 is focusing on a February launch of enhancements to our income and withdrawal benefits. The enhancements both address the competitive environment and achieve our objective of high-teens ROE development. We will also add new investment fund options, improving both our VA and VUL products.

In our life business, Lincoln's strategy is to leverage scale and cost advantage, strong underwriting capabilities, competitive products and distribution breadth to drive growth and to develop low to middle-teen ROEs. For 2007 we delivered a 20% annual increase in sales, even while launching our unified product portfolio and beginning the implementation of our industry-leading underwriting initiative.

In the fourth quarter we were at the tail-end of the transition to the new unified product portfolio. As a result, sales for the quarter were down about 17% from the prior year, and flat with the prior quarter. Product introductions of this magnitude have a learning curve associated with them as clients and distribution partners familiarize themselves with the products and their relative competitiveness. We will continue to see tough comps in the first few quarters of '08, but we expect to achieve above-industry year-over-year sales growth in 2008.

2007 was a very aggressive year of product development work in the life area that produced a robust and competitive product portfolio. Our product people will be spending time early in the year helping distribution market the new portfolio. In addition, in the first half of the year, we are launching updated VUL and term products, and later in the year, further enhancing the UL secondary guarantee products.

In our employer market segment, 2007 wraps up a rebuilding year in which we made significant progress in positioning our defined contribution business. We identified the markets offering the strongest growth opportunities -- mid to large healthcare markets and the small to mid corporate markets; we launched new or updated products specifically designed for these markets; we invested in distribution, more than doubling the wholesalers from 37 to 80; we began the consolidation of our service operations and made progress in enhancing our customer-facing capabilities. But this is still a work in progress. Sales in the mid to large case market continued to produce excellent results, with deposits increasing 33% over the prior-year quarter. Sales in the small case market, on the other hand, were down 4%, mostly due to the transition of replacing a third-party wholesaler organization with our own internal wholesaling group. We did see an appreciable pickup in proposal activity during the fourth quarter in the small case market, which can be a leading indicator of sales. In fact, January sales are up significantly over last year in this area. I want to be cautious about allowing one quarter's data to signal a turnaround, but these are the results expected as we build out the wholesaler team.

Looking forward to 2008, we will be increasing the wholesaling force by 40%, focusing product development on increasing our competitive position in the small to mid corporate 401(k) markets, capitalizing on the opportunities provided by the new 403(b) regulatory changes, enhancing our delivery of education and (inaudible) plan participants, and we also will increase service capabilities to intermediaries, employers and plan participants.

In group protection, the fourth quarter capped one of its stronger years. Annualized sales and earned premium on our key businesses for the quarter were up over 25% and 10%, respectively. Annualized sales for '07 were a record 326 million, up 20%. We are encouraged by the fact that this sales trend occurred in our core small case markets, and that loss ratios were favorable throughout 2007. All in all, a very good year in group protection. 2008 will see focus on voluntary product development and targeted wholesaler expansion.

Delaware's financial performance this year was exceptional, as we posted record earnings, record revenues and record pre-tax operating margins. On the production side, we saw very strong gross sales and net mutual fund flows, driven in part by the success of our four-star rated diversified income fund. We also launched our first closed-end fund in over a decade. Total retail sales were up 2% for the year, as managed account sales were down, reflecting capacity constraints and equity market weakness in the fourth quarter.

The institutional fixed income business was disrupted by the Logan Circle transaction. However, we hired talented people to replace the group that left, and expect to see progress and proposal activity and mandates as we move through 2008. In 2008 at Delaware, we'll be focusing on the following.

Leveraging Delaware funds inside our VA, VUL and DC variable products, which is a significant growth opportunity, given the growth in these products. We are making a significant investment to provide a chassis for managing international funds, continuing to build performance track records, increasing the exposure of our new fixed income team, already known and highly regarded by many institutional clients. At the margin, we are reopening our emerging markets equity fund in 2007, and are proposing to reopen our small cap value fund next year. A lot of activity underway at Delaware.

Let me wrap up on Lincoln's year by saying that we have a strong overall business platform with significant momentum as we move through 2008. To reiterate, in 2008 we expect to complete the cost save program and focus on continued unit cost improvements; continue to expand aggressively wholesale distribution support for both the individual and employer markets, and grow our retail planner base; successfully roll out our new variable product enhancements and execute on our product development plans throughout the organization; see the results of our investment that we've been making in the DC business and stronger sales; and we'll rebuild Delaware's fixed income institutional business and put more resources behind product development.

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

Thanks, Dennis. Our reported income from operations in the quarter of 312 million, or $1.16 per diluted share, excludes approximately $9 million of media income moved to discontinued operations, or $0.03 per share, in addition to a number of items noted in our release that reduced earnings by about $48 million, or $0.17 per share. Reported earnings also included merger expenses of $28 million pre-tax coming in as we guided in the third quarter.

Notable items in the quarter included volatility in our hedge program related to DAC unlocking, FAS 133 adjustments on indexed annuities, and various expense items running largely through our other operations line. In addition, we had higher-than-expected mortality in our individual life business, largely offset by another favorable period for loss ratios in our group protection business. Normalizing both quarters for the items identified in our press release, and excluding merger expenses, EPS grew by about 10% over the same period in 2006.

This is an important quarter to look carefully at the health of the underlying fundamentals, fundamentals that shape our outlook for 2008.

Individual annuity fundamentals are very strong, with positive net flows in the quarter of 1.8 billion, a combination of continued momentum in VA deposits and a slowing of fixed annuity outflows. The markets, together with over $6 billion of positive variable flows for the year, contributed to a 32% increase in expense assessment revenue over the comparable quarter in 2006.

Removing the impact of FAS 133, fixed margins and spreads came in as expected, recognizing year-over-year fixed account values were down 4% due to negative flows. These underlying fundamentals were masked by volatile hedge program results, which I will touch on in a moment.

Our individual life business continues to deliver consistent results, with average UL in-force and account values up 7%, respectively, over the comparable quarter in 2006. Normalized mortality assessments continue to reflect the steady build in in-force, growing by 7% over last year; however, we did experience a higher-than-expected mortality quarter, and expect this to normalized heading into 2008. Fixed margins and spreads came in as expected, with weakness in alternative investment income offset by strength in prepayment income.

Our defined contribution business performed as expected in the quarter. For the year, positive net flows, together with market appreciation, drove average variable account values up over $3 billion and fee income up 11% in the quarter. We continue to experience headwinds in terms of negative flows in our director 401(k) product and fixed margins, but we see both trends flowing slowing as we move through 2008. Progress on flows will be a critical success factor in 2008, as we have invested heavily in product and distribution to support our market strategy.

In group protection business, loss ratios, both in the quarter and for the full year, performed favorably across all major lines. We experienced strong revenue growth again in the quarter, with net earned premium increasing 11% over the comparable 2006 quarter. This is a strong business across the board, with solid production, underwriting and earnings (technical difficulty).

For the year, and as Dennis noted, Delaware Investments posted record revenues and earnings with expanding margins as asset growth, together with restructuring efforts, emerged throughout 2007.

As we look towards 2008, our quarters' earnings results need to be adjusted, not only for favorable expense items in the quarter, but for the transition of our fixed income assets. Recognizing the impact of January equity markets, Delaware's earnings should be in the range of 13 to $15 million for the first quarter.

In terms of overall expenses, we continue to make consistent progress on our goal of taking approximately $200 million out of our gross expenses. Through the end of the fourth quarter, we have achieved roughly 175 million of annualized savings. After giving effect for strategic investments and increased business activity overall, we continue to see improvement in our enterprise-wide expense ratios.

In the quarter we recorded gross impairments of approximately $193 million. As detailed in our release, the majority of impairment was taken on financials, sub-prime and Alt-A RMBS, and structured credit notes, where the underlying collateral is preferred stock issued by financials. We believe there is an opportunity to recover a portion of the non-credit related impairment in these securities.

This quarter we provided supplemental information on our general account. Overall, I'd simply highlight the following. Over 90% of our $9 billion in exposure to residential mortgages is rated AAA, with about 60% of the portfolio agency-backed. Of the non-agency-backed holdings, approximately 97% of our holdings are rated AA or better. Our CMBS portfolio totals 2.7 billion, with over 86% rated AA or better. Our holdings are predominantly 2005 and earlier vintages. As disclosed previously, our sub-prime and Alt-A exposures totaled 2.1 billion, with 95% rated AA or better.

Our direct exposure to monolines and insured bonds is relatively modest at just over 500 million, as is our exposure to consumer loan backed securities of only $160 million. We do have some indirect exposure to both classes of securities in credit linked note structures referenced in our supplemental.

Our $7 billion direct commercial mortgage loan portfolio is well diversified, both in terms of property type and geography. It has overall strong loan to value metrics, and little to no delinquency issues. We are monitoring credit market conditions closely, but feel good about our overall general account position.

Turning to capital and risk management, let me first make a few comments on our VA hedge program. At our investor conference we noted that through October, we experienced similar conditions to that of the third quarter. The drivers of the hedge breakage in the fourth quarter included a combination of items, including a decision to purchase longer-dated volatility protection to better match liability calculations under FAS 157. We were also exposed on our New York variable annuity business since January now captured under our hedge program. These two items alone accounted for fully half of the $20 million earnings impact in the quarter.

We also were modestly short volatility, closing that gap gradually throughout the quarter. These efforts have thus far proven beneficial in the month of January, with only modest breakage despite volatile conditions.

We repurchased $300 million of stock in the fourth quarter, a bit more than the $200 million we guided to, essentially accelerating our planned repurchase for 2008 in anticipation of receiving our media proceeds. We are carrying a strong risk-based capital into 2008, ending the year in excess of 425%. Including proceeds from our media company sale, we expect to repurchase [some] 500 to $600 million of stock throughout 2008.

In summary, we're pleased with the overall quality of our hedge program, and our capital position is very strong.

We have provided in both our comments this morning and our press release an outlook for the business as we enter 2008. I'd like to comment on a few items.

Excluding any impact from the hedge program and DAC unlocking, we believe our annual earnings to be impacted approximately $7 million for every 1 percentage point move in the equity markets. This guidance involves a complicated interplay of estimates beyond simple impact of fee incomes, so I caution that this guidance is directional in nature.

We ended the year with just under $800 million of alternative investments, namely hedge funds, private equity and partnerships. We expect long-term returns of roughly 10 to 12%, last year earning 15% on this portfolio, albeit with significant quarterly volatility. As we sit here today, we expect alternative investment income in the first half of 2008 to come under pressure, falling below our longer-term expectations.

We have moved a portion of our media earnings into discontinued operations and out of operating earnings. We also recorded a loss on the sale as a result of the low tax basis on the properties currently under agreement for sale. We have officially ended the media process and will manage the remaining radio properties as part of other operations, no longer identified as a specific business segment.

Finally, we will be adopting FAS 157 in the first quarter, and expect to take a charge of between 25 and $75 million. The accounting adoption will impact net income, but will not be included in our definition of operating earnings for the period.

Now let me turn it over to the operator to start us in Q&A.

(OPERATOR INSTRUCTIONS). Andrew Kligerman, UBS.

The initial question is with regard to -- let me just get this in front of me -- your 193 million pre-tax, pre-DAC gross losses from write-downs and impairment. I'm not 100% clear on the pieces of this. You defined one piece as financial institutions, another as structured products with exposures to financials. Fred, I think you were referring to something equity related. Could you break out each of those three pieces specified in your press release, and maybe even give us a sense of the magnitude of the losses there?

Absolutely. Let me break apart the 193 as follows. First of all, we did take impairment on what I would call pure financial exposure to pure financials, meaning direct holdings in financial institutions, of about just shy of $36 million pre-tax and DAC. That included names like Northern Rock, where we have some exposure, ResCap or Residential Capital Corp., just to name a couple of the more significant in that pool of securities.

These are equity holdings?

No. These are the debt holdings (multiple speakers). So this is just direct debt exposure to financials.

The second major category, which also was around $35 million pre-tax, would be exposure to sub-prime and Alt-A related collateral securities backed by sub-prime and Alt-A related collateral. And it was a mixture of facilities, no particular piece of it significant, and tended to be of the lower rated tranches where we had holdings, and some CDO holdings, albeit very, very small. By lower rating, meaning more in that BBB to A category; that is, lower than the AA, AAA-type holdings that makes up the predominant amount of our holdings. Again, about 35 million.

The biggest piece of it, and where you may have some level of confusion in understanding what it is, are structured securities that -- where the underlying collateral is essentially preferred stock issued by financials. That was about $110 million pre-tax. And what these are, this is a conduit that essentially holds preferred stock issued by large and typically highly rated financial institutions; it includes, for example, names like Freddie and Fannie, as well as Goldman, Merrill Lynch and some others. These preferred stock holdings issue certificates out to investors, both A certificates and B certificates. The A certificates are issued into the asset-backed commercial paper market, and the B certificates are what we hold as an investor.

What has impaired these securities effectively is the liquidity issues involved in the asset-backed commercial paper market. Because our cash flows on these securities come after payment to the asset-backed security holders, any lack of liquidity and increased pricing of rollover impacts our coupons, impacts the dividends we receive on these securities. And that has lowered the underlying pricing of these structured products to a point to where we felt it necessary to take impairment.

When I talk about there being an opportunity to recover economically some of these holdings, it is these securities that I'm predominantly focused on. Because the pricing is a bit more severely impaired, and predominantly due to liquidity conditions, which we expect to improve over time. And so that is the color, if you will, Andrew, on our realized losses. Hopefully that

That definitely helps. And just sort of looking at your portfolio into the first quarter, do you expect any further write-downs?

Right now, as you probably know, and probably traditional with most companies, we go through a pretty exhaustive other than temporary impairment process or write-down process each quarter. So we'll wait and see how that quarterly process works. As we sit here today looking at the portfolio, we feel as if it's in good position. But we are watching those securities that are particularly exposed to either illiquid conditions, or exposed to financials or other forms of collateral where the pricing is depressed and we're in an unrealized loss position. So we're watching those more carefully. But again overall, as we step back from the general count, and particularly as we step back relative to our capital position, we feel very comfortable in the general account portfolio and the overall quality of the balance sheet.

One last quick follow-up on the alternative investment income. I calculated about a 6.5% yield, less of course than the 10 to 12% that you're -- you're saying it's going to be in the 10 to 12% long-term. You're forecasting less than the 10 to 12 (inaudible). What's kind of holding down the return there? Where is the weight on these returns coming from in alternative investment income?

No one category is completely weighing them down. I think our holdings, as you may know, are largely made up of hedge fund investments and private equity. And we expect there to be dampened returns in both those categories. As you probably know, and certainly realize, from time to time there can be one or two partnerships in either category that can pop and have a very strong quarter and help with the returns. But our general view is we expect weakness across those two categories.

You're right; we did about $12 million or so pre-tax in the quarter, representing an annualized return of roughly 6%. It's frankly that fourth-quarter result that we're staring at, if you will, when we look at rolling forward into 2008, and therein lies my comment relative to falling below our longer-term expectations. Again, it's very important to note, though, Andrew, that the reason why we have longer-term expectations that are up around 10 to 12% is because over time, as we look back historically, that is in fact what this portfolio of securities has yielded, if not slightly better. So it would be our hope, certainly, and our intention in making these investments that we'd find our way back to those longer-term returns, but with some quarterly volatility.

Thanks. Most appreciated.

Steven Schwartz, Raymond James.

Andrew just asked the question I wanted to ask on alternative investments. I did want to touch, though -- Fred, if you can go back over these -- the structured securities that you just talked about, the linked notes. I'm afraid I didn't understand the last part with regards to liquidity and how that affects the price of these things. Are you still getting the cash flows that you expected to get all along? I'm really confused.

To clarify, again, the underlying collateral for the securities we hold is perpetual preferred, essentially, mostly preferred stock issued by financials. And the first -- the water flow, if you will, of cash flows coming off those securities goes first to service the asset-backed paper holders on the A certificates. Then the residual -- in fact, some term these residual interest trusts -- the residual cash flows then come to the B certificate holders. Because of the illiquidity in the marketplace on the asset-backed commercial paper side, and the increased costs associated with rollover, they're absorbing more of the perpetual preferred dividend than they have before, which has impacted negatively our cash flows on the securities, and thus depressing the pricing.

So what you're saying here is that the A certificate holders are getting more of the flow because of the liquidity of what?

Because generally illiquidity in the market, and the fact that the borrowing costs, if you will, are going up because of the illiquidity.

I think I get that. And then a quickie. The assets transferred to Logan, when did that occur?

That occurred in the October timeframe and it was roughly $14 billion.

Thanks.

Sorry; $12.3 billion (inaudible).

Ed Spehar, Merrill Lynch.

Fred, I have questions on the hedging, I guess a few. First, could you tell us, are you sort of caught up on volatility now in terms of hedging for the in-force book? Because I think from your comments it suggests that you perhaps didn't hedge as much vol as what you now are hedging. So I want to know if you've sort of caught up on the in-force. If you could talk a little bit about equity market sensitivity, or potential breakage, if we had long-term implied volatility stay near what I think is around 27 right now. And finally, on FAS 157, I guess it's a little bit troubling when we hear companies talk about changing economic behavior based on accounting. So I'm wondering if you can help us understand a little bit more why we buy more options because of a FASB change? Thanks.

No problem, Ed. I'll kind of hit them in order. In terms of are we caught up on the in-force? Yes. When we entered into, frankly, the third quarter and the fourth quarter, we had an intentionally short position volatility, meaning we were -- we had not covered 100% of our vol exposure. And over the course of the tail end of the third quarter and throughout the fourth quarter, we went about the business of gradually -- I would characterize it as almost dollar cost averaging our way into closing that gap on volatility, so that as we head into the first quarter, while there is maybe a bit of a shortage in volatility, it is largely closed and relatively minor.

I would also note that from just a practical standpoint, we didn't have our New York variable annuity business under the hedge program. That was about $1.3 billion of variable account value not under the hedge program. About 5% of our total balance is under the hedge program. While seemingly small, obviously, dramatic changes in volatility it still could have an impact. As of January we now have the New York business installed in the hedge program, and don't expect that to be an area where we're short vol, if you will, or exposed to volatility. So we think we've made a lot of progress on that front, and as a result, would expect exposure to volatility from that position to be calmed down quite a bit.

In terms of the equity market sensitivity, with volatility being up -- yes, I would say, because of the actions we've taken in the quarter, we would expect to be able to keep pace with change in volatility better than what we have in the past couple quarters. But also particular to what I would call the shape of volatility, meaning that we have been buying longer dated volatility in our hedge program, which better marries up to the new accounting related to 157 as we move into the first quarter. That had a negative effect in the fourth quarter, because we're essentially dialing in our hedge program a little bit differently than the accounting on the liability side. That will close up a bit as we move through the first quarter.

And that in lies your third question, essentially. Let me just say it this way. We have always intended the hedge program to have as certainly one of its primary missions to quiet down the earnings volatility associated with dramatic movements on the liability side if volatility were to change. And that remains a fundamental of the program. But it's always had a dual role in our thinking, and that's included the economic benefit that the hedge program provides in covering us in the case of cash outflows related to the guarantees we offer. And while we have dialed in or adjusted our hedge program according to 157, it still is the case that we have moved the dime forward, so to speak, on covering as much or more economic risk than we have going forward. I do want to caution, Ed, that while it does provide reduction of earnings volatility, it also very much provides us an economic support as well. And we're quite focused on that.

Fred, just one quick follow-up. Can you give us some sense for sort of what the range of expectations we should have in terms of this breakage number? We had, I guess, 20 million this quarter. I think it was 13 million last quarter. It had been kind of a couple million, plus or minus, I think, previously. Is there any way you can help us understand that two-thirds of the time we're going to see it between plus or minus 20, or is there something you can do to help us in terms of our estimates going forward?

I realize, particularly because we have defined our operating earnings as including the effects of the hedge program, it's of a greater focus when you're looking to dial in, even though all companies, I believe, account for it the same way when it comes to net income and book value. Unfortunately, I do want to be careful in suggesting that no matter what the capital markets tosses at us, we somehow have it covered no problem. What we've learned in the last couple quarters is that the capital markets -- whether it be equity market movement, interest rate movement, volatility, or the combination of all of the above -- can toss curveballs at you that in some cases your hedge program can't catch up to in time. And we've taken great strides to try to calm down particularly the after-tax and after-DAC implications on the hedge program, and we would expect that to pay dividends going forward. But I want to be careful in sort of predicting for you a range of hedge breakage going forward, other than the goal of the Company is to certainly keep it to a minimum.

Thank you.

Jimmy Bhullar, JPMorgan.

Thank you. I just have a question on your capital situation. If you can talk about what your excess capital position is right now. And then secondly, just on your progress on selling the remaining media business, and also your intentions with the Bank of America stock, the 4 million shares you have.

Let me answer the first two questions, but I did not hear your third question.

The third one was just your intention with the Bank of America stock that you own.

In terms of excess capital, as I mentioned on the early part of the call, we're carrying a very strong risk-based capital into 2008, which I think is very good, obviously, given market conditions and the like. I am quite comfortable with our stock repurchase estimate for the year. And I would suggest to you that after giving effect for that share repurchase we dialed in in 2008, that we will very likely retain around $0.5 billion of excess capital throughout 2008, that excess capital position housed in our regulatory entities; that is, part of that excess risk-based capital I mentioned.

In terms of the remaining media assets we have, we own radio clusters now in four major cities, San Diego, Atlanta, Denver and Miami. And our intention now is that we have ended the process on looking to sell those properties, and we are going to manage those properties into the future. The way I would characterize it is we are not all that dissimilar than a private equity owner, where we're going to look to make investments where it makes sense and drives good valuation in these properties. At the same time, like any private equity owner, we're also going to keep one eye to understanding the exit strategy when it's appropriate and when we can maximize the value for shareholders.

So if an attractive offer comes along, you would consider it, but you're not actively shopping them right (multiple speakers)

Right now, very importantly, the market conditions are such that it's not in the best interest, in our view, of our shareholders to move forward with outright sale. So it's very important for us to work with the general managers in our radio stations to really concentrate on running the business the best we can and improving the value of it. So I don't want to leave the impression that we're going to sort of perpetually have a for-sale sign out there. We also have to pay very careful attention to running the business properly, like any other private equity owner would do.

In terms of the B of A stock, right now the B of A stock represents utility value to us, meaning it's excess capital, if you will, held at the holding company. I think the market value now is in and around $110 million. And it [serves as a] liquidity backstop for us; it serves as excess capital if necessary. And as has always been the case, we'll look for what the appropriate use of those proceeds will be, depending on our needs as a company and depending on what opportunities the marketplace offers us in terms of the value of those securities and the use of the proceeds.

Thank you.

Darin Arita, Deutsche Bank.

Thank you. Fred, can you share with us additional metrics, and the approach, underwriting approach, on the commercial mortgage loan portfolio? I know you talked about how it's diversified; you've seen very little or no delinquencies thus far. But is there anything else you can share to make us feel more comfortable in the portfolio?

Sure. I've got with me a few members of our asset management team. But as I mentioned earlier on the call, we have a very diversified portfolio, both geography as well as property type. And we've experienced little to no delinquencies of any note. And we've also taken a very conservative, in general, loan to value approach. We tend to underwrite to about a 75% loan to value, and that has allowed us to maintain the quality of the portfolio during this period of time.

We have a very, I'd call it, fragmented portfolio. The average loan size of our commercial loan portfolio is about $5.5 million. So we have terrific diversity in that respect. And again, as we look at all of the metrics in terms of the percentage of loans where we have either weak loan metrics is very, very low; less than 3% of our portfolio we'd characterize as having some either low loan to value or low occupancy or weakness in terms of a major credit tenant, what have you. So those securities tend to be on our watch list. We watch them very carefully. But again, a very small proportion of the loans, and very high-quality. So that would be some of the highlights I would give you. I don't know if there's any additional color you want, Darin.

That's very helpful. Just turning towards the variable annuity-type thing, can you give us a sense of what the incremental costs would be in 2008 for hedging via the New York business and also FAS 157?

Yes. On a quarterly basis, I'll give you an idea just to get your bearings on it. This quarter, for example, we brought in about $37 million pre-tax of revenue associated with these riders. And of that, we have been amortizing the cost of the puts or the options that we buy, as well as carrying costs on the futures. That tends to run, pre-tax and pre-DAC, about $8 million a quarter. After tax and after DAC -- there's a pretty large DAC offset to these costs -- that will run around 3 to maybe $4 million. That incorporates having bought a fair amount of long-dated volatility to close the gap throughout the fourth quarter, as I mentioned earlier.

And obviously, as volatility remains high, you will find that cost creeping up over time, but still manageable from a total return perspective. In fact, even after giving effect for the higher hedge costs, we still enjoy unlevered returns in the mid-teens for that product. Still quite comfortable. So the New York business will have some impact on the cost of hedging. But I wouldn't characterize it, particularly after tax and DAC, as material.

So that 8 million and that 3 million number you gave includes the effect of FAS 157 going forward?

Yes. We've started to bleed our way into FAS 157 throughout the quarter. And so I would say it may tick up a little bit, but not in a material way.

Thank you.

Nigel Dally, Morgan Stanley.

First with the capital, can you discuss the sensitivity of your excess capital to changes in the equity market? And also, the 5 to 600 million of buybacks for next year, are you likely to make those repurchases through an accelerated repurchase plan or a regular way? Thanks.

Sure. I think -- I definitely -- you were breaking up a little bit, so I apologize. But I think your second question -- [I don't know if you had] one or two questions in there, but your second question was a little bit of color around share repurchase, and whether or not we would do an accelerated share repurchase.

Yes. And the first part was just the sensitivity of your capital to changes in the equity market.

I would say our sensitivity to capital on the equity markets is really not the issue, meaning that even though we do have earnings sensitivity to the equity markets, in the grand scheme of things, a company that is -- just using 2007 as an example -- doing in and around $350 million plus of operating earnings a quarter, a $7 million up or down with the market up or down 1%, while definitely having a dampening effect headwind if the markets are down considerably as they were in January, is not really what I would view as a capital item. In other words, I don't necessarily redial or recalibrate my capital plans for that environment.

In terms of share repurchase, I would say this. We have dialed in about 5 to $600 million for 2008. That includes the proceeds of the media company, and recognized that also has embedded in it that we accelerated about $100 million of repurchase into the fourth quarter that otherwise would have been done in 2008. I'm not going to do an ASR on that; we will basically buy on the open market throughout the year. We have plenty of volume in our stock to be able to do that, and do that quickly if necessary. So we won't be executing an ASR. I would say this, though, Nigel. We'll probably front end a bit of the repurchase. I would expect to do in the first quarter between 2 and $300 million of repurchase.

Very helpful. Thanks.

Tom Gallagher, Credit Suisse.

Can you talk a little bit about the way you're evaluating risk as you move forward here on the credit side? Have you formed a watch list? Maybe you could give a little color for total amount of securities that are now trading below 80% of par. And I guess as I think about the main area of concern here, if I just look at your disclosure over unrealized loss just as a percent of par, it looks like the biggest unrealized loss position is the CDO's and credit linked notes, which has a little over 200 million. Is that fair to say that's what we should be focused on in terms of near-term loss expectations? Anyway, anything you can give us on the way you're evaluating this.

In terms of pricing, I might just -- I think the question you had, Tom, the first question you had, was really related to pricing across the board and how it's holding up. Obviously, the report we gave last night shows that for the most part, as of year-end, with very few exceptions we don't have sizable unrealized loss positions, which obviously suggests that book and market are tracking reasonably well. I'm not aware, as I sit here today -- albeit I am not on the trading floor -- I'm not aware of any material swings in that pricing in terms of pricing quotes we're getting from the pricing services and so forth.

What I would say is your second observation is correct, that we have an unrealized loss position in these so-called CRE or credit linked note exposures. And these are highly structured instruments that -- where essentially we own a AA rated tranche that is backed by collateral. That collateral is essentially highly rated -- or investment grade is probably the best description -- corporate, where we have CDO -- essentially credit default swaps with investment-grade players, coupled with a cash bond instrument held in effectively a trust, and we own a AA rated security that is issued out of that trust. We have a subordinated position below us that helps shelter us against first losses. We also are junior to a tranche that is above us as well. And we're watching those securities carefully, because the pricing of those securities are indeed below book value; that is, we're carrying an unrealized loss position.

So you're right in saying that those are among the securities that we're watching carefully. I should say that we have experienced no defaults in the underlying collateral. There have been a few downgrades, but no defaults. We currently feel comfortable with these securities; that is, we don't believe them to be compared. But if you're familiar with the accounting rules of the road, if you will, as time goes on, if the pricing remains depressed on these securities -- and I would say on average we're talking about $0.70 on the dollar, give or take; that moves around -- but if the pricing on these securities remains depressed for an extended period of time, and there is not some level of recovery, then impairment starts to come into play and you have to give some thought to that. So those are among the securities that we're watching carefully.

Fred, just so I understand kind of the overall methodology that you're using to record impairments, is the key determinant here from this point forward evaluating securities that are trading below some percent of par? Is it 80? Is it 70? And do you have any number -- depending on whatever that bright line test is, can you give us any metrics for the overall portfolio? Are there $1 billion, are there 2 billion that are trading below whatever that level of par is that you're using for the test? Thanks.

I think the securities that I've identified with you, plus a few others, probably fall in the category of where we have our eyes on the unrealized loss position in the pricing. I think the numbers you're quoting are quite large. I would not put it in that kind of a category. We don't have what I would call a strict bright line test. What we do have is thresholds where we start to drop these securities onto a watch or concerned list, and we watch it more carefully for potential impairment. And one of the triggers that will do that is where the security is in fact being priced below book, and particularly materially below book; that is, approaching sub-$0.80 on the dollar or $0.70 on the dollar is where we'll start to pay a lot more attention.

The other element of it that we look at is how long it stays priced at that level. So if we're talking about a depressed pricing level for several quarters, for example, even if we believe there to be a level of recovery, you start to have to spend more time focusing on whether or not we're talking about an other-than-temporary impairment to the security, in which case we'll take impairment. What is often the case as well is when you do decide you're going to take impairment, you take it down to that market. And as a result, we may not always agree with the mark provided on that bond, depending on circumstances. And that's where you can have a situation where even though there hasn't been a credit-related impairment, there's more of a liquidity pricing issue, and we would expect there to be some level of recovery going forward.

Thanks.

Mark Finkelstein, FPK.

I've got a few detailed questions. I guess, Fred, firstly, with the S&P down about 5% year-to-date, and assuming you kind of grew in line with expectations from here, should we expect a first-quarter retrospective DAC unlock in the annuity business? And do you have any assumptions about what that would be, or how we should think about modeling that?

The answer is I don't have any gauge to give you on the possibility nor the magnitude of retrospective DAC unlocking related to the market. I would say this, that we do have a weapon available to us when it comes to the equity markets being down, and that weapon is just what you alluded to, and that is generating positive flows in our core businesses. Of the $7 million, for example, of equity market exposure that I mentioned, 5 million (technical difficulty) 5 million of that is in our VA business. And that also happens to be the business where we're generating significant strong positive flows, which helps us fight that battle. But I would not want to wager a guess or an estimate on what could be a retrospective DAC unlocking. That's, as you know, a very complicated process.

Just on the annuity hedging, we talked a lot about kind of changes in implied volatility. Do we need to at all be worried about kind of further declines in long-term interest rates and how that's going to affect the hedge program? I guess specifically, are we fully hedged on [ROE], and how should we think about that?

I have my friend Dave Bulin here with me, who runs our hedge program, and I'm, honestly, Mark, glancing his direction. What I would tell you is ROE can have a deceivingly large impact on your hedge program. It tends to be the case that we all focus on vol, and we all naturally focus on just movements in the equity markets, or delta. But ROE has proven to be as big an element in the last year and last several quarters, in particular the interplay between ROE and the other factors as well. Dave, I don't know if you have any color on that, other than --

I guess directly to your question is we're definitely fully hedged on ROE; that's one of the things that we pay a lot of attention. Not only hedged from a sensitivity, but also from a term structure perspective. But as Fred said, as interest rates move around, that also has an interplay with some of your other sensitivities. So as interest rates move up or down, that's also going to affect how sensitive you are to both the equity markets and to implied volatilities. So it may not be as straightforward, but I would say that interest rates are definitely one piece that we keep a very, very close eye on to both the first order of facts and any secondary effects.

Moving to the small case 401(k) business, kind of the director, are we past, or are we kind of getting past the point where the impact of termination of the third-party distributor has flowed through? And do you still feel good that you should start to see the turn into positive net flows at some point in 2008 in that business?

There may be some residual impact left. It's affected us in two ways. One, the sales team has been building, so we've had to replace the sales team. That third-party organization was able to grab a few dollars of account balances and customers. We think most of that is over. That is grabbing the account balances. So we are expecting, because of the increased size of that force, the fact that a good number of them have been with us now for quite some time, that we'll begin to see positive sales development in the small case market next year.

Thank you.

Eric Berg, Lehman Brothers.

My first question regards sort of how to think about what the right measure of stock market performance is in terms of thinking about the impact on Lincoln. There's been a lot of talk on this call, and indeed on the principal call proceeding this one, about the stock market. But I think the fact is that in the month of January, between the first trading day and the last trading day, it looks like, I'm thinking, it was only about 2 or 3%. So my question is when we talk about how tough January was, and we're already off to a bad start, what exactly do we need mean by that? Are we talking about the average level of the S&P? Are we talking about another index? Are we talking about the average level of the S&P versus the average in a previous quarter point-to-point? Exactly how do you arrive at this conclusion numerically that it was a tough -- we're already off to a tough start?

You raise very good observations. It's important to focus on the following. I'll tell you what I focus on. I focus on the average to average change in markets. And I do that because the vast majority of our business is priced on a daily basis, if you will; that is, we get our fees calculated off of a daily account value balance. So while point-to-point can move around on you dramatically, it's important to focus in on the average reduction in the stock market when thinking about the relative impact to your financials.

There is a piece of our business that is an exception to that rule. We have some elements of the institutional asset management business that ends up priced, if you will, or fees are charged off of a quarter-end-type balance. But it's a relatively small element, if not a very small element, when considering -- stepping back and considering Lincoln's overall exposure to the equity markets. So that is in fact what I look at. I look at the averages, because that's ultimately what's driving that assessment revenue.

My second and final question relates -- actually relates back to an earlier question about excess capital and the stock market. I was a little surprised, Fred, to hear your response, simply because in the Hartford call -- and I realize the situation may be different at Lincoln -- I think it was said that if the stock market were to perform poorly in 2008, that that would affect your risk-based capital score of your insurance company under the so-called C-3 Phase 2 rules of the NAIC, that some of your capital would be, so to speak, tagged, or needed to meet this increased capital requirement for variable annuities, thus reducing the amount of excess capital. So I would have thought, based on that observation, that in fact there is a link between excess capital and the stock market.

What we have done is we have effectively reinsured our hedge program riders to a captive reinsurance entity in the Company, such that movements in the equity market do not have as dramatic an impact on our risk-based capital. So we don't have that same potential significant sharp move in our RBC calculation that you might find under the VA carve-in type rules that are out there in calculating it. It doesn't mean, though, that we don't understand the look-through implications of the stock market on what it may mean to the generating of earnings off the accounts, and what it may mean in the potential payment out to the captive reinsurer under the hedge programs; that is, the economic impacts of the program. If those were to deteriorate, then we would have to think about capital. But that would be quite a significant and really long-lasting move in the equity markets, in my view, to cause that to be a problem.

So even though -- just as a final question, just to make sure I'm clear on this. Even though this reinsurance -- reinsurer is captively owned, this still dampens under regulations the -- under state regulatory rules, let's say, the capital requirements associated with a declining stock market, even though you own the reinsurer?

It has the effect of not causing us as dramatic a movement on our underlying principal insurance company, Lincoln National Corp. of Indiana, which is what drives the RBC and drives our cash flows out.

Thank you very much.

Jeff Schuman, KBW.

Fred, I want to talk a little bit more about the credit outlook, and sort of relate that to your comments about excess capital. If we do see, I guess, continued difficult credit markets from here, some additional impairments of as we roll through '08, to what extent would those be funded from the 500 million of sort of residual excess capital you talked about, versus at some point sort of going [against] being funded from your intended 5 to 600 million of share repurchase?

I think a way to think about it is this. First and foremost, just from a very practical standpoint, if we suffer significant -- as with any insurance company -- significant impairments, gross impairments, that will have implications for how you think about and how you manage your capital going forward. If they were to be severe enough, then we would potentially find ourselves in a position of having to retain more of the capital to support our ratings. Let me be very, very clear; we're not going to sacrifice our ratings or put ourselves in a position of having difficult balance sheet conversations with the rating agencies.

Having said that, as I mentioned, we're carrying a very strong risk-based capital into 2008. And we're doing that because we have been somewhat defensive in our management of capital, recognizing the poor credit conditions were brewing in the marketplace. This didn't happen just all of a sudden. We have for quite a while as a company been viewing the credit markets as eventually reverting to the mean, if you will, after several years of very strong conditions. So we've positioned our risk-based capital to account for heightened levels of realized losses throughout 2008, while still maintaining our share repurchase estimate.

So I would first let it bleed through in the form of risk-based capital, looking to defend our share repurchase activity. And again, for AA rated companies, its traditional to dial in something around a 375 to 400% risk-based capital. We're carrying north of 425 into the year-end; that allows us some cushion, if you will, or capital -- excess capital position to weather realized losses. So I feel reasonably good sitting here today, but we're watching very, very carefully, obviously, the credit markets, as we've mentioned earlier.

I think you've drawn the distinction I was looking for. So the cushion really is a cushion? It can be used to some extent to fund a little bit of [rain] in '08?

Very practically, I wouldn't do that right now. I think right now, as an insurance company with a $70 billion general account, you're wise to be watching your excess capital position and retaining it while the capital markets, particularly credit markets, look to calm down.

Thank you.

Mr. Sjoreen, I'd like to turn the call back over to you for any additional or closing remarks, sir.

At this time I'd just like to turn it over to Dennis to wrap up the call.

Thank you for your participation and interest today. All of the questions are appropriately around some of the volatility in the capital markets and how that's reflected in our hedge program, and what impact, if any, will it have on our credit loss position. I think Fred has summarized it very well in his comments. I would tell you as we sit here today, we remain very confident in the underlying fundamentals of Lincoln. With respect to all of the investments in our operating businesses that we've talked about, expanding distribution, additional product development and the like, there's certainly nothing that I've seen in the capital markets which would prevent us from doing any of those things. So we think 2008 will be a continuation of the building and strategy that we did in 2007. And again, thank you very much for your interest today.

Thank you, operator. Thanks to all for joining us today.

Thank you, sir. That does conclude today's conference call. Thank you for your participation. You may disconnect at this time.