Lincoln National Corp (LNC) 2008 Q1 法說會逐字稿

Good morning and thank you for joining Lincoln Financial Group's first quarter 2008 earnings conference call. (OPERATOR INSTRUCTIONS). Today's call is being recorded. At this time I would like to turn the conference over to the Vice President of Investor Relations, Mr. Jim Sjoreen.

Good morning and welcome to Lincoln Financial's first 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 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 and return on equity to the most comparable GAAP measures.

In addition, we have for one more quarter posted a general account supplement to our website that includes additional information and expanded profiles of certain asset classes held in our general account. Let me also point out that we have added two new pages to the statistical supplement that provide a market-based view of the account values for our Defined Contribution business, and an additional split of Delaware's assets under management between intersegment and external assets.

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.

Good morning to everyone on the call. Our news release itemized the significant impact on current quarter earnings results related to the Capital Markets. Despite these Capital Markets impacts, the quarter's results also highlighted the payoff on the investment we had been making in building our core businesses during the last year or so.

These investments include significant new product introductions, a combined headcount expansion in our individual and employer markets wholesaling force to about 900 people, a 30% increase, technology investments to improve efficiency and service quality, and an 8% increase to 7,300 active retail producers within Lincoln Financial Network.

Product introductions and distribution expansions contributed to account balance growth first quarter over first quarter in each of our life, annuity and DC businesses. In addition, we achieved significant increases in net flows in the annuity and DC businesses. Our group benefit premiums grew by double-digit.

Contributing to our capability to invest for future earnings growth is the strong credit quality of our general account. We are comfortable with our overall credit exposure and do not -- do not see an interruption to business investment or share repurchase plans due to credit losses based on current conditions. Given the possibility of a recession, we're not taking significant risk on our new investments and our cautious in our capital management.

Looking forward in 2008 for earnings improvement levers, we have increased our focus on expense management, which had already been tightened up in anticipation of a year where equity markets were likely to be a factor. Having said this, we will continue to invest in areas where we can see near term revenue enhancements, such as the distribution expansion, particularly where new relationships or shelf space have been added and new sales are likely in the short run.

In short, the building the business investments that are ongoing, the quality of our general account, and a healthy capital position make us confident that we will continue to see improvements in fundamental long-term drivers of earnings growth, and as equity markets recover, additional earnings boost.

Turning to our businesses, let me cover some brief highlights starting with individual market annuities. First quarter total individual annuity deposits and net flows were up 7% and 57%, respectively, over the prior quarter. During the quarter we introduced our new guaranteed withdrawal benefit lifetime income advantage to the market, and also launched Choice Plus, our multi-manager VA product into Edward Jones Adviser Network. Combined, these two initiatives attracted almost $300 million of deposits, so we're very pleased with the early success of these two offerings.

VA net flows remained strong at $1.3 billion, driven by the continued success of our products and the effectiveness of our wholesalers. Lapse rates did come in lower for the quarter.

Net flows on our fixed annuity business remained modestly negative, but improved almost 50% from the prior year quarter, the result of declining surrenders from fixed annuities with expiring multiyear guarantees.

Our individual life segment reported a decline in total sales of 29% from the year ago quarter. Other than a difficult comparison due to the near record sales a year ago, some of the quarter's decline is due to price competition, which developed after we introduced the new unified product portfolio.

A key advantage of having moved to a single product platform is our ability to implement changes quickly and efficiently. We will be responding to the markets with new product introductions next month. In addition to some UL pricing changes, we're making improvements in our term portfolio to expand our presence in the adviser-driven age 45 to 65 demographics, and will be introducing a new variable universal life product.

We're disciplined in our pricing and remain comfortable in achieving a 13% or better return on total new business life sales.

We're also in the final phase of our industry-leading underwriting initiative, a business model change designed to enhance our underwriting effectiveness and distribution partner relationships. Looking ahead, we expect life sales to ramp up due to seasonality and the benefits of both product revisions, new product introductions, and the enhanced underwriting model.

At Lincoln Financial Distributors we're continuing our focus on expanding shelf space and wholesaling support for our individual markets and asset management products. Earlier this month we launched VA products in SunTrust Bank and Wells Fargo. We anticipate signing another large bank in June. To support this and other activities, LFD increased its wholesaler comp by another 5% in the first quarter, and is on pace to reach the targeted 18% growth for 2008.

Our retail distribution arm, Lincoln Financial Network, continues to successfully execute its key strategy of recruiting and retaining productive advisers, growing as I mentioned. This growth resulted in an increase in proprietary product sales quarter over quarter.

Turning to employer markets, it was a good quarter on many fronts. And our DC business sales of $0.5 billion in the micro-to-small case market were up 8% over the prior year quarter, and 37% from the fourth quarter 2007. We view these results as evidence that we have now turned the corner on replacing the third-party wholesaling relationship we terminated in late 2006.

We still have productivity gains to achieve with our new in-house wholesaling teams. And it is important to point out that the first quarter is typically the strongest quarter of the year due to new plan enrollment; however, we do expect strong, year-over-year comparisons to build gradually throughout 2008 as our product and distribution initiatives gain momentum and as wholesaler tenure increases.

We have been successful in leveraging the strategic partnerships at LFD, recently signing two of the largest distributors of retirement products in the wired channel. Commiserate with the increased shelf space, we will be adding wholesalers later this year as we prepare for a 2009 launch in these firms.

Sales in the mid-to-large case market were up 8% over the first quarter '07, driven by record sales in the Alliance program. We experienced a 150% increase in proposal activity in first quarter versus the fourth quarter of last year, which underscores our success in this market. We enhanced our positions in the midsize market with the launch of SmartFuture, a retirement program that fills the gap between Alliance and our group variable annuities.

Our Group Protection business delivered another solid quarter. And while sales were down 11% from first quarter '07 levels, this was primarily the result of a soft January, and February and March sales have been rebounded.

In the quarter we added sales reps, which along with expanding the availability of long and short-term disability policies in a number of states, will provide additional growth opportunities over the course of the year.

Turning to asset management, Delaware's performance in the quarter was clearly affected by the equity markets. Both retail and institutional inflows and net flows were soft in the quarter. Our current focus at Delaware is to regain momentum in fixed income with the high-quality team we have put in place, build retail sales off the fixed income products we have with strong ratings, and to enhance Delaware's sales within Lincoln's separate account products as we buildout our asset gathering businesses.

Last year proprietary separate account sales were in the $3 billion level, and we saw an increase in those from first quarter '07 to first quarter '08. We believe the broad range of fund styles offered by Delaware will provide significant opportunities for leveraging its expertise in our VA and DC products and participate in the expected growth of these businesses.

To summarize, the quarter highlighted the continued strength of our products and distribution capabilities, the quality of our balance sheet, and the benefit of a strong capital position. Continued focus on these fundamentals, along with prudent expense management, is our top priority as we look to the future to grow our businesses.

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

First, let me correct an error we uncovered in our press release issued last night. We will be updating our average diluted share count for the period from 259.9 million shares to 262.8 million shares. While having no impact on our reported income from operations in the quarter of $333 million, we will report $1.27 per diluted share for the quarter versus $1.28 in yesterday's release. We have issued a brief release and will update our statistical supplement accordingly.

Our results in the quarter include a number of notable items detailed in our press release that combine to reduce the quarter's earnings by about $8 million or $0.03 per share. Not included in these items, but worth highlighting, is alternative investment income, which came in well below our expectations. I will touch on that in a moment.

Our reported earnings also included merger expenses of $15 million pretax. Net income included $27 million of net realized losses on investments, down from the fourth quarter, and the onetime effect of adopting FAS 157 coming in at $16 million loss after-tax and DAC.

The story of the quarter for Lincoln and the industry were weak equity markets and overall market volatility. So I will comment briefly on the main areas of impact to our operating earnings, that being fee income in our asset gathering businesses, our variable annuity hedge program, and alternative investments.

With the daily average of the S&P down nearly 10% in the quarter, the market impact alone drove our period-ending assets under management down by nearly $12 billion across the enterprise. This impacting fee-based earnings by approximately $9 million in the quarter.

The hedge program performed well in a period of extreme market conditions. The natural basis risk embedded in the program was offset by the final installation of FAS 157. The hedge program contributed $8 billion to our annuity earnings before associated DAC unlocking. This excludes the onetime adoption impact noted earlier in my comments. The new accounting standard does introduce an added level of volatility in our reported results.

In terms of alternative investment income, we budget according to our long-term return expectations of 10 to 12% pretax, recognizing this will be volatile in any particular quarter. On average we would expect to generate around $20 million of quarterly pretax income off this $800 million portfolio. This quarter experienced a modest loss of roughly $5 million pretax as compared to a $20 million gain a year ago, and on a smaller portfolio. This amounts to an after-tax and DAC swing in earnings over last year's quarter of roughly $13 million.

Setting aside the markets, our underlying fundamentals remain in overall good health. Let's focus first on individual markets businesses. In individual annuities, isolating the market impact alone, drove period-ending variable account values down by $4.8 billion in the quarter. This offset somewhat by positive flows in the period.

Expense assessment revenue was down 4% from the fourth quarter, but up 20% over the 2007 period. Revenues benefited from over $6 billion of cumulative variable annuity flows over the last year, and the popularity of our retirement guarantees, which served to increase the average fee per account value.

Removing the impact of FAS 133 on indexed annuities, spreads came in a little north of 200 basis points. As compared to the first quarter of 2007, fixed margins were down 30%, with roughly half of that decline due to accounting adjustments and the mark-to-market on indexed annuities. The remaining is attributed to negative fixed flows and weakness in alternative investments and prepayment income.

Fixed annuity outflows are down over 40% from the levels experienced in 2007, a favorable development as we move forward.

Turning to individual life, the fundamentals remain solid with average universal life in-force of 6% and account values up 5%, respectively, over the comparable quarter in 2007. Unusual items in the quarter were primarily related to negative unlocking and poor mortality.

The life savings is especially impacted by the alternative investment returns I noted earlier, and a reduction in prepayment income along with that. Both impacted fixed margins when looking at period comparisons. The relative impact of the two items on the segment's operating earnings was essentially no contribution this quarter as compared to a $9 million gain in 2007.

Another important item when assessing the earnings trends in our life segment is to recognize the impact of reserve securitization and other statutory reserve reductions throughout 2007. These items contributed to weakness in net investment income, reducing statement earnings by roughly $8 million as compared to the 2007 quarter. These activities in turn bolster our statutory capital position and share repurchase capacity.

Our defined contribution business is exposed to the same market dynamics that drive earnings in our variable annuity business. For the quarter positive net flows of approximately $300 million were more than offset by the market impact on ending accounts values of roughly $2 billion. Overall fee income was down 8% from the fourth quarter, and flat as compared to the first quarter of 2007.

Recorded spreads of 210 basis points are down roughly 10 basis points from the fourth quarter, a result of higher yielding securities rolling off our books and the negative impact of excess investment income in the quarter. This decline was helped somewhat by a modest decrease in crediting rates.

In our Group Protection business loss ratios performed as expected across all major lines. While loss ratios can still be volatile at times, disciplined field underwriting and productivity improvements in our claims operation have resulted in loss ratios falling more consistently in the lower end of our stated range. We continue our trend of strong revenue growth with net earned premium increasing nearly 12% over the comparable 2007 quarter.

Delaware was obviously impacted by the weak markets, but came in roughly as we guided when adjusting for the mark-to-market valuing of seed capital investments through operating earnings. Normally our $55 million of seed capital investments do not move the dial in terms of quarterly earnings, but as we have seen with other asset managers this quarter, this can be more pronounced in a period of volatile markets, and impacted our earnings by about $3 million in the quarter. As with all asset managers, seed capital investments are critical to establishing a track record for products that will later be sold to our investors.

We expect Delaware's earnings to be in the range of $11 million to $13 million for the second quarter, once again somewhat dependent on the markets.

In terms of overall expenses, our runrate merger savings through the first quarter are approximately $190 million. And while the integration efforts continue into 2009, we're now in a mode of continuous improvement looking across the new organization for opportunities to reduce our cost structure, particularly important in the face of weak capital market conditions. After adjusting for the markets and strategic investments, we continue to see improvement in our normalized expense ratios.

We expect merger expenses to be in the range of $15 million to $20 million in the second quarter, remembering the exact timing of these costs can be tricky to estimate.

Turning to asset quality and capital, in the quarter we recorded gross realized losses for impairments of $92 million. Of this amount, roughly $43 million is attributed to securities where we may no longer have the intent to hold to recovery. These mark-to-market losses have less of a capital impact in that there is no statutory impairment. The majority of true credit impairments in the quarter were concentrated in the financial sector.

As shown in our general account supplement, unrealized losses widened considerably at the end of the quarter, and somewhat concentrated in the higher rated classes, a sign of poorer overall liquidity. We have since witnessed spreads partially recover in the month of April. We're monitoring our assets closely, and overall have not experienced significant underlying credit deterioration since year-end.

We repurchased $286 million of stock in the first quarter. And we successfully closed on the sale of our TV stations in Charlotte Radio, collecting roughly $650 million pretax.

We are carrying a strong capital position into these markets, and would size our current excess capital position in the $700 million to $1 billion range. We remain committed to our repurchase target of $200 million to $300 million for the remainder of 2008.

With that, let me turn it over to the operator for Q&A.

(OPERATOR INSTRUCTIONS). Andrew Kligerman, UBS.

Just a couple of quick data points. The cost savings you mentioned, $190 million, I think the goal is $195 million to $205 million. Were you implying, Fred, that you can get well past that, and if so where?

Then just Dennis was mentioning the wholesalers growing by 18% by year-end '08. What would be the LFD wholesaler account by year end?

And lastly with regard to Delaware, what was the performance, the Lipper performance on the one, three and five-year basis for your retail funds? And is that the reason why the flows have been so weak, more so than the volatile equity markets?

This is Fred. Just real quickly on the merger-related savings. Yes, we have achieved runrate savings through the end of the quarter of $190 million towards our targeted range of $195 million to $205 million. I think I can comfortably say we will come in at a higher end of that saving range related to the merger.

I would only note that those are savings as it relates specifically to the integration efforts and merger efforts of the Company. They don't necessarily include other efforts that we may take on as a Company in the form of continuous improvement, as mentioned in my script. And that is something we're paying careful attention to.

On the Delaware performance, which by the way has improved this quarter over the fourth quarter prior period. Just the statistics are that the number of funds in the one-year performance that outperformed their peers is 49%, and the three-year 59%, and in the five-year 68%. Again, that is up from the prior quarter.

What was the second question around Delaware?

Do you think that the one-year -- well, just seeing these numbers, do you think that the one-year number falling off might be responsible for the weaker retail flows?

I'm going to turn that question over to Pat Coyne.

In terms of flows, our best-selling mutual funds in the quarter were our fixed-income funds. Actually we gained market share on the competition in terms of fund flow into our fixed-income funds. I think if you look at the publicly traded asset management shops they are heavily equity oriented. Their returns and their net flows were extremely negative. Although our performance slipped in the fourth quarter of 2007, it rebounded nicely in the first quarter of 2008. And I think even if we had the best performing equity funds in the world in the first quarter of 2008, there was no money going into equity funds just due to market volatility. So the fact that we have a broad-based product lineup, including a lot of fixed-income funds was extremely a positive from that perspective.

On Lincoln Financial Distributors we would be projecting about 773 external and internal wholesalers and managers by the end of 2008.

That is across both life and annuities, right?

Yes, most of that is in -- most of the growth is in the VA -- well, it is in the life space as well -- across the Board.

Jimmy Bhullar, JP Morgan.

I just have a couple of questions. The first one is on variable annuities. I think in your commentary you mentioned sales were strong, but as I look at the preliminary industry numbers the industry is down about 10% sequentially. You were down twice as much. So I just wanted get your comments on why the results were a little bit weaker than the overall industry, given that you have been gaining share consistently for the past couple of years?

Then secondly, on your capital position you mentioned the excess capital that you have on your balance sheet right now, I think $700 million to $1 billion. What is preventing you from doing more in buybacks than your goal that you have established for the year, given your capital position and the multiple that the stock is trading at right now? That is all.

Let me speak to the VA market share without getting into specific numbers in the first quarter. In any particular quarter competitor new product introductions can affect market share again. So that is an issue. Our goal though is through a combination of well priced innovative product introductions, distribution expansion, to build this solid growing base over time.

I have mentioned in my remarks that we introduced a new writer, expanded shelf space, and added wholesalers this quarter. And that the combination of these have a significant increase on our production. And even though those were added later in the quarter, so we would expect to see your production coming out of them as we move forward in the year.

I would like to share with you also that we do exhaustive annual market surveys, which tell us that the quality and quantity of wholesalers is the key differentiator to building share over the long term. And that is where, as you have heard me say, much of our focus is centered.

In terms of the excess capital position we have, we carried a very strong risk-based capital into 2008, up north of 470%, which is among the highest of the RBCs that we have carried really in recent years, and that was deliberate. That was really recognizing that we're entering into some potentially weak credit conditions.

So I would characterize the excess capital position as safely supporting our repurchase estimates, and more than likely resulting us being in the higher end of the range that I mentioned today in terms of share repurchase. But the reason for hanging onto that excess capital position has everything to do with being careful while we watch the credit markets sort themselves out, and also being mindful of the fact that the rating agencies, I would tell you, are more of a concern nature these days. They haven't necessarily all gone to a negative outlook on the industry, but there is certainly concern. And so you want to be careful in how you manage the capital in that respect to protect your ratings. So we are being cautious is the answer.

Can I actually ask just one clarification. Your merger cost saving or merger related expenses in the first quarter were I think $15 million. Your guidance had been $20 million to $25 million for the first quarter. Has the guidance for the full year changed at all, or is it still the same as before?

No, we're sticking with the same guidance for the full year.

Which is $50 million to $60 million?

That's right.

Bob Glasspiegel, Langen McAlenney.

You indicated that you're going to step up your expense saves. Where do you see that, can you expand it?

This is Dennis. In the near term you've got a couple of challenges in dropping expense saves to the bottom line. That is some of the expense saves that you make would otherwise have been DAC, so they wouldn't have dropped to the bottom line in any event. Similarly you can make expenses that are capitalized and written off over time in other areas. So the amount of money that you can actually get to the bottom line isn't as large as the total improvement that you can make in watching your expenses.

Having said that, there is a lot of areas, not any one of which is worth mentioning, but in the aggregate you can cut back on -- I guess I will mentioned a couple of things. You may defer some expenses that look like important things to do over the long-term consulting expenses, but don't have a short-term impact, so you might differ some of those.

You can put tighter controls around headcount increases, again particularly in those areas that aren't customer facing areas. You want to keep the quality of your service up. I think there is a variety of -- I shouldn't say think, I know there is a variety of areas that we can look at to cut back expenses in the short run. My guess is we can only pick up middle single digit earnings per share type numbers in 2008, but over the long term we can do better.

I would point out that over the last three years we were able to improve our expense margins by 21%. Over the next three years we think we can improve on that improvement. So short term there is less that you can do. Long term we have a continued commitment to improve our expense ratios, and I'm comfortable that we can accomplish that.

Are you willing to articulate a goal when you think that flows could turn positive at Delaware? Are we talking quarters or years?

Flows at Delaware turning positive?

Right.

The biggest net flow that we had outflow in the quarter was related to our managed accounts, and so we need to do some work there. Otherwise the institutional flows, there were soft, but not in larged dollar amounts net flows.

Retail, in between our proprietary position with our DC and VA businesses in retail were essentially flat. We have to focus our efforts predominately in the managed account area. Some of that is wholesaling improvement and working on keeping the money that is already there. I don't think we're going to try to project net flows for the year at this time.

So we are several quarters away from turning positive in your mind?

I don't think we're going to try to project net flows at this time.

Ed Spehar, Merrill Lynch.

I had a couple of questions. I guess first could you give us some sense on the VA sales trend through the quarter, and maybe even some early indication in the second quarter? Are we starting to see the positive -- the benefit of the guarantee aspect of the product offsetting any of the negative aspect of just concern about equity linked products?

The general trend for us is up, and we would expect over the course of the year to grow sales over what we achieved last year. We're pretty optimistic. And again this gets into the specific issues that I have discussed and we have been talking about for quite some time, shelf space additions. I mentioned we have a new bank coming on that could be significant. Introduction of products, such as we did with our Choice VA into the Edward Jones channel. Our new writer, the link that I have talked about, which was very well received. It is all those things that are unique to Lincoln that gives us comfort that over the course of the 2008 that we will increase sales over last year. And we are seeing that in the current numbers.

The second question is on hedging. What happened from I guess late in the quarter -- what happened late in the quarter where I think the comments that you had made I think intraquarter about the hedge program and some negative impact on earnings and suddenly turning positive?

And I guess specifically can you help us understand a little bit the FAS 157 impact for you? Because I think we're sort of hearing different things from different companies on this topic.

I'm going to ask Fred to get into the details of that question, but if I can just step back for a minute and make a general observation on this hedge program. I think probably everybody understands it, but it is worth repeating.

Breakage reflects the differences in the present value of our potential claims that may develop over a 25 to 30 year period, and the asset value which we're building to create cash to pay the ultimate claims. So it is just simple present value claims and the assets that we're building. It doesn't surprise me that on four days each year, representing the quarter end, that markets would move in such a way that the two amounts would be somewhat different.

Having said this, when there are differences, we move quickly and we manage to be sure that over that 25 to 30 year life of the claim obligations we have built the assets adequate to meet the claim. The ability to manage the reserve assets over a long period of time, some flexibility in the product to adjust pricing, or forced asset allocations, gives me comfort that we can manage the long-term profitability of the business to our 15 to 19% IRR target. Long-term profitability is the issue, certainly not any serious capital concerns reflected by the breakage amounts. So that is my big picture view on this. Now let me ask Fred to answer your specific question.

I would just say that you are going to have trouble, you being generically the investing public, in understanding how to sort out the differences of impact one company to the next since this adoption. I think a lot of that has to do with in some cases the size of the underlying exposure under these programs and so forth. But it also has to do with the assumptions that were carried into the 157 process to start with. And then frankly, and maybe somewhat unfortunately, the interpretation of 157 as financial executives, like myself and others on my team, interface with our auditors and sort through the best way to apply this.

In our particular case, and this is really all I can speak to, is what is our situation. Let me separate the onetime from the ongoing in the quarter. The onetime impact was relatively straightforward. And that is once adopting 157 and taking the cumulative adjustment up through January 1, we ended up with about a $28 million or so increase in the reserve. That is quite a bit lower than you would find from others that have potentially reported on the cumulative impact.

But that is the result of the couple of things. One is we already had certain behavioral risk premiums embedded in the calculation of our reserve, so it wasn't quite as a dramatic change for us on that component when adopting 157. We also had a slight positive counterbalance in terms of our indexed annuities when adopting 157 that had the effect of dropping the reserves on that side.

In terms of the actual quarter itself, you are absolutely right. In and around mid-March I talked about the fact that our hedge program, for good reason given the volatility in the market, was heading towards another period of modest breakage. I think we were estimating at the time around $10 million to $12 million of negative impact to earnings from the hedge breakage.

What turned that corner was the final adoption of 157. But in particular for us, the final adoption of a feature of 157 involving the nonperformance risk, or Company nonperformance risk, which essentially tracks the creditworthiness of Lincoln, if you will, or the issuer. Because spreads had gapped out it turned out to be a particular material item for us, serving to lower the reserve pretty considerably in the quarter. And that is what resulted in the $8 million contribution to the quarter's earnings that I have spiked out for you.

That is you were able to use the higher discount rate because your credit was trading at a higher yield in the market?

Yes, and I don't know that I would call it "you are able to". It is really a matter of when sitting down and discussing the interpretation of 157 with our auditors we concluded that you have to play that Company performance or nonperformance risk essentially off your -- I would say a derivative, if you will, of your credit default swap, or your underlying credit risk. That appears to me, from what I am reading, to be potentially different than what others have done. I can only say in our case, yes indeed, it resulted in an increase discount serving to lower the liability and resulting in a gain in the period.

Can you give us any sense -- and sort of it is a bit perverse I guess in the sense if tomorrow the market thought that you had risk of the U.S. government that there would be negative impact on your earnings, correct?

Yes.

Can you give us any sense on how to think about the relationship between spread -- basis point spread widening, spread tightening in CDS market and how we can think about earnings impact?

I think -- here's what I can tell you, is that generally speaking, yes, the way we have adopted the provision as Lincoln's credit default swaps go, there will be implications to this particular feature of 157. And it will move the liability around.

For example, in the late part of the first quarter, which is what you saw across our bond portfolio and across our industry, you saw spreads gap out even for very highly rated companies like ourselves and others in our peer group. That was -- we did not adopt such a sharp reaction to 157 to incorporate that spike in spreads, but it absolutely influenced the ultimate provision that we put on the table. So we will be sensitive to that.

Probably as important is it is not a piece of the equation that we hedge to. In other words, we're not hedging to a liability that is going to move around with something like the nonperformance risk factor, because it really doesn't involve economic issues over the long run for the Company. As a result, you end up installing a level of inherent volatility in the program. And that is something we've got to review very carefully going forward.

Jeff Schuman, Keefe, Bruyette & Woods.

I wanted to follow-up a little bit on the defined contribution businesses. Dennis, you talked about some product and distribution expansions. I am wondering if you can kind of bottom line it for us. How is that overall effort progressing relative to the plan that was established last year?

We're moving in concert with the plan that was established last year. If you recall in previous conversations we've had either investor meetings or our RIB meeting, that the expectation is that we're ramping up fairly significantly in our target markets in the DC business this year. We would expect to continue to see earnings flat this year, and the earnings lift coming from this ramp up beginning in 2009.

You also talked more generally about continuing to invest in businesses, but also being somewhat more careful. If we take that guidance to the DC business is there any impact at all in terms of your investment plans for the DC business?

No.

Colin Devine, Citi.

I had a couple of questions about the new products. First, on the life products, Dennis, you mentioned you had some new features coming up, but also that they were priced to at least a 13% return. That is obviously a ROE that is well below where Lincoln has been. It is well below where you ran Jefferson-Pilot. So are you effectively telling us you're willing to take the ROE down? It would seem to be at odds with your stated goal, which is to get it up. And this is your biggest division.

Then secondly, if you can expand a bit more on what you have done on the VA side. There's a lot of hot new features out there right now. What did you do this quarter to improve Lincoln's products, and what else do you have coming down the pipe?

Let me touch first on the issue of ROE. The ROE that we talk about, and are committed to achieving, of 15% is a levered return on equity that manifests itself in the aggregate Company. The 13% plus that I'm talking about in some products in the life business could get as high as 15%. But in the product we're talking about this morning, probably just a little north of 13%. So the 13% is consistent with the 15% guidance on Company ROE.

Back to your comment about old JP, the 13 to 15% were the same targets and the same thing that we achieved at old JP, and levered that up on the balance sheet to get to the 15 and 16% that you saw there. So that is the answer to that question.

On the VA products --.

And also on the features. What features are you putting on the products that will make them different to get sales going again?

This is on the VA or on the life?

Both.

On the life what is going to move sales is more competitive pricing on UL in certain sales, where we lost a little share in the first quarter. We're offering on variable universal life an asset accumulation focused product, which is very popular in the marketplace today. And as I mentioned, we're refocusing our term products in the sweet spot of the 45 to 65-year-old segment. So it is a combination of those three things that we think will help produce sales increases over the course of the year.

On the BA-linked product, that is a fairly significant improvement in the income features for the product. And roughly it is a compound annual growth of 5 to 7%, ratcheting up for income purposes. There is some features that permit you to get your money back at the end of the seven years, if you want to do that. But there is very strong improvement on the income feature of the product.

Maybe, Dennis and Fred can explain. Genworth has talked about having to take prices up because of not having access to the securitization market. You are talking about being able to more competitively price. What is it about Lincoln that you're able to do that?

I'm sorry, you broke up there.

Genworth talked on their call about having to take prices up because of not having access to the securitization markets now because of how things have changed. How are you able to more competitively price -- and I assume that is take prices down -- when it would seem that the funding costs of other securitization markets are actually going up?

One comment on just the pure securitization as a spread that I would make is -- one is not all securitizations are created equal. I say that just because my understanding of what they're facing has something to do with the overall structure of their program and how it is funded, and the fact that those funding costs are going up on that program.

In our particular case, we have locked in a longer term cost of funding through the $300 million plus deal we did last year. And then we also continue to use longer dated Letters of Credit, which again are also locked in from a cost perspective.

I would say it is true over time that the returns that Dennis is quoting on universal life are reliant upon efficient reinsurance/securitization vehicles to help meet those returns. As we sit here today we feel pretty good about the position we're in.

We will need over time Capital Markets to cooperate to allow us to do efficient securitization going forward. But I just want to point out I think, and I'm certainly not in a position to talk about their situation, but to just advise that look specifically at the type of securitization and what the issues are in terms of funding. And we feel pretty good where we are right now.

Thanks, that is very helpful.

Just an expansion on that a little bit. Fundamentally as we have looked at our reserve release, we have tried to lock in the cost of that over the long term. And again I don't know exactly what other companies have done. But some of these reserve release programs that were predicated on variable cost of funds I think are causing problems for some of our competitors. We just simply have never done that.

Suneet Kamath, Sanford Bernstein.

Just a quick clarification on the FAS 157 versus the variable annuity hedge. As we think about the offset provided by FAS 157, is it fair to consider the fact that this was a cumulative adjustment as opposed in the hedge program, which was sort of a per period? I just want to make sure I understand that.

My question is, as it relates to Fred's comments about the rating agencies I think getting a little bit more maybe even nervous or uncomfortable, are you seeing any sense, or getting any sense from the rating agencies or your auditors for that matter, in terms of how they're viewing your other than temporary impairment methodology? Given the environment that we are in, are we looking at a situation where perhaps the rating agencies or the auditors might want you to be more aggressive with respect to taking other than temporary impairments versus sort of what you might do in a more, call it, normal environment? Thanks.

It is Fred. On the 157 I think what is important is to really split the two, that we have a onetime cumulative adoption that we take through net income this quarter, and that is the $16 million negative. Then on an ongoing basis each quarter we will be calculating the liability under 157. And the degree to which the hedge program keeps pace with that liability calculation or not will result in any level of breakage positive or negative.

There is really two components to it in this particular quarter. Going forward you'll no longer see, obviously, the cumulative adjustment taken through net income. It will just be -- it will just simply be the GAAP methodology of calculating the liability up against the hedge assets. And that is on an ongoing basis.

In terms of the OTTTI methodology and the rating agencies, it is interesting question. What I would say is this that I can tell you absolutely without qualification that the accounting firms are spending as much time on the OTTI process, and impairment, and even really just the security valuation on your balance sheet, whether it be broker quotes or models, or what have you, as much time and energy on that as they ever have before. And we are spending a lot of time with them in doing it as well.

From our particular case, they are quite comfortable with the way we approach it. I would tell you that we have not been in a dialogue that has given rise to forcing some sort of bright line test or anything like that. I think it is more been the mode, which I think is appropriate that you look at the securities and you do the analysis on it. You certainly need to be mindful of pricing, if that pricing in our case will draw securities to a watchlist, for example. But it is the underlying credit conditions of the security that will give rise to eventual impairment. And as long as we are able to have good, solid research on that and analysis, and as long as that is supported with the audit firm, we are in good shape. And that is the case thus far.

The rating agencies I would tell you they absolutely are surrounding asset quality, without question. The degree to which they have dived deeply into the OTTI process, there has absolutely been dialogue around that, but I wouldn't characterize that as having been a concentrated effort on their part, at least not to my knowledge.

I would just simply say that they are reading what you all are reading. And that is that in the financial Capital Markets, with as volatile as they had been in recent times, they certainly are more of a concerned look. Again, as I mentioned, they made or may not have changed their outlooks necessarily, but I can just tell you in conversation that they obviously want to dive deeper in, among other things, asset quality.

I would come back to the statement I made at the outset here, which is we are quite comfortable with the overall credit quality in our portfolio based on current market conditions. We're being cautious because there is concern that there would be a deeper possibility of a recession. If that were to occur, we just want to be cautious with our capital.

As things improve in the economy and the Capital Markets, the illiquidity that is in large part causing these gapping of spreads improve, we may get more comfortable with more share repurchases and things like that. I think at the moment, until we see things evolve in the Capital Markets and the economy, it makes sense to be cautious.

Eric Berg, Lehman Brothers.

Two questions. First Fred, I was hoping we could return to the discussion of impairments that appeared in your news release and that you referenced. What is the difference between -- of the $92 million of impairments, you specifically mentioned $43 million on the one hand that you do not -- that you are uncertain of your intent to hold.

Is the point here that with respect to that $43 million less concerned with the number and more understanding -- more interested in understanding how you think about impairment -- is the point here that these $43 million represent securities that you think will recover over time in value to their amortized cost? You just aren't certain of your intent to hold it until that recovery? Is that the point?

You saved me and others a lot of time, because that is the point. It really is the point. This really dates back to an EITF, if you will, 03-1 that was really trying to clarify the OTTI process as it relates to FAS 115, where you had to -- you really have to assert, if you will, that you intend on holding a security to recovery if it is in an unrealized loss position and you done the analysis and determined that you don't -- you aren't going to take impairment on it.

But there are from time to time securities that you may have -- you may not have an intent to hold to recovery, and you need to classify those securities and frankly take the markdown on them. Mindful of the fact that you don't get a markup, it is only marking down.

So you end up creating what amounts to a sub portfolio, if you will, of these securities that you have flagged, if you will, as intentless, for lack of a better word. And those securities will move around. It doesn't impact [staff], because that is just not the way the OTTI process has been adopted on a statutory basis. So it doesn't have an implication for staff capital. That is why you are seeing some companies in our sector talk about them in the -- some will describe them as accounting-based losses, for example, as opposed to real impairments.

Second question, final question, relates to your Alt-A portfolio, which as I recall is actually larger than your subprime portfolio. In your general account supplement that Jim said you updated, and that I have in front of me, you actually divide your Alt-A portfolio between RMBS and ABS. What is meant by Alt-A ABS?

I will --.

Eric, we are going to turn that over to [Steven Quick], our Chief Investment Officer for a quick answer, and then follow-up if we need more.

The difference between RMBS and ABS is really the market that it serves that the securities were sold in. It may be to similar type assets, but because of how they were securitized in the market they were sold in, they were classified into different categories.

I guess what I'm just trying to get at is the collateral in both instances mortgages?

Yes, they are mortgage-related assets, yes.

Tom Gallagher, Credit Suisse.

A couple of questions. First Dennis, just in response to your comment about more caution in terms of what you're buying right now in terms of fixed-income securities, can you talk about where your new money yields are trending? Are you moving much higher up on the quality spectrum, and what is that likely to do to your new money yields?

The related question to that is I noticed your net investment income yield declined sharply. It was 5.46. I believe that is just for this quarter. Down almost -- were around 50 basis points from last quarter. Can you talk a little bit about the outlook for that yield in lieu of what you're doing in terms of new money? Thanks.

Yes, when I said we're being cautious about taking on risk in the investment portfolio, I was specifically referring to not jumping into the high yield bond area. We have been reducing that position over time. So we don't want to increase the proportion of big investments at this moment in time.

The money that we're putting out otherwise has a yield -- new money yield across the board of in and around 570 to 575. And with respect to the decline in net investment income I'm going to turn -- the yields, I'm going to turn that over to Fred.

I think what you're picking up on in our statistical supplement is from the consolidated investment data where you see that decline. And really what is embedded in that decline is the performance of our alternative investment portfolio, along with also prepays and make wholes. Both of those things end up having a more material impact on that number.

You do have in our defined contribution business, you do have a bit of the rolling off of some higher yielding securities, which has given rise to some level of spread compression in the DC side. We're not seeing that same level of compression in some of the other businesses, but you do have some of that weighing down on the investment yield as well. But it would be the combination of those factors.

Just coming back to investment yield, again, I think this is something that everybody understands. Particularly in the life area we still have flexibility to reduce our crediting rates. So as new investment yields impact the overall portfolio rate, we have the capacity to take some credit rate reductions, in fact, have done that in the last three weeks or so trying to hold margins.

That's helpful. But, Dennis or Fred, if we thought about enterprisewide spreads, considering 546 includes a negative alternatives return, plus you're in the process of reducing crediting rates enterprisewide, plus considering new money spots 570 to 575, we should be seeing relative to this quarter spreads going up, is that fair to say?

I would say we're probably stopping any of the bleeding, would be what I would be more comfortable with. I would be reluctant to move forward into spread widening. We have seen interest rates move around quite a bit. We have seen spreads, as you know, really do a lot of interesting things this last quarter. Right now I think we feel comfortable with the size of the portfolio and with our ability to take credit rate action that we can defend any additional slide in portfolio yields. But I don't know that we're ready to declare victory on spread widening yet.

Then just one question related to capital management. Is there any contemplation right now of keeping dry powder for M&A? In addition to being cautious about the environment and managing capital to higher levels, can you just comment on whether or not you might be likely to be potentially looking at something on the M&A front?

It is Dennis again. We have been pretty public about having an interest in making acquisitions, primarily in the defined contribution space, and then at the same time selectively looking at retail investment management opportunities. I can't say that anything is imminent -- wouldn't if it was. But we are working hard to try to see if we can't advance our organic growth strategy in those two businesses with some acquisition opportunities.

Mark Finkelstein, Fox-Pitt Kelton.

Just real quick, I wanted to follow-up on the DC business. Flows are obviously better sequentially. But if I actually exclude the Alliance and think about the withdrawal rates, withdrawals are still pretty elevated. And I guess what I'm curious about is are you continuing to see impact of withdrawals related to the change in distribution there? When do you think that would subside, if that is the case? Do you continue to think that flows should be positive towards the back half of '08?

The most important point is particularly on the small case business that flows and sales were affected by disengaging from that third-party marketing organization. Sales slowed, and they also took some of their customers with them. As I pointed out in my remarks, we think most of that impact is behind us, and that positive sales increases from our wholesalers will occur. And most of the slide of customers being taken away by that marketer has -- again, is behind us. But with those comments, let me ask Wes Thompson to expand further, if you want to, Wes.

I would just reinforce what you have said. I think the first quarter -- fourth quarter '07 and the first quarter this year we really saw -- began to see the bottoming out of what we would have expected from the termination of that third-party relationship. And you're beginning to see now the impacts of the buildout of our salesforce that has taken over from that in that micro-to-small marketplace.

We would expect the tenure of that group to improve, because it is still about 1.25 years in tenure, as you know from the LFD experiences, and currently we would expect about a two to three-year period where we really begin to see the kind of dramatic improvements in productivity that we will then drive to the bottom line overall in terms of gross [sales].

With that, Mr. Sjoreen, I will turn the conference back over to you for any closing remarks.

We just want to thank everybody for joining us this morning. As always, we will take your questions on our Investor Relations line at 800-237-2920 or via email at www.InvestorRelations@LFG.com. Again, thank you, and have a good day.

Ladies and gentlemen, this does conclude the Lincoln Financial Group's first quarter 2008 earnings conference call. We do appreciate your participation. And you may disconnect at this time.