Lincoln National Corp (LNC) 2010 Q3 法說會逐字稿

Good morning and thank you for joining Lincoln Financial Group's third-quarter 2010 earnings conference call. At this time, all lines are in a listen-only mode. Later, we'll announce the opportunity for questions, and instructions will be given at that time. (Operator Instructions).

At this time, I'd like to turn this conference over to Vice President of Investor Relations, Jim Sjoreen. Please go ahead, Sir.

Thank you, Operator, and good morning and welcome to Lincoln Financial's third-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 liquidity and capital resources, premiums, deposits, interest rates, and income from operations, are all 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 their most comparable GAAP measures.

Presenting on today's call are Dennis Glass, President and Chief Executive Officer, and Fred Crawford, Chief Financial Officer. After their prepared remarks, we will move to the question-and-answer portion of the call. At this time, I would now like to turn the call over to Dennis.

Thanks, Jim, and good morning to all of you on the call. Our third-quarter sales, net flows and operating results reflect the year's continuing positive trends and are attributable to our core franchise strength, including strong distribution, innovative and well-priced products, a consistent market presence, expense discipline, and risk management. As you have seen, the quarter's earnings had several assumptions and model-related impacts, which Fred will cover.

Looking at our operating performance -- sales and net flows accounted for about half of the 10% increase in our record-setting, ending account balances of $150 billion -- again, reflecting the effectiveness of our franchise and our commitment to consistency of product, distribution support, and service over market cycles. Consistency enhances profitability and distribution relationships.

Our distribution system is among the largest and most diversified in the industry, and our ability to execute the model efficiently creates value for the enterprise across all three platforms -- wholesale, retail, and work site. At Lincoln Financial Distributors, we continue to focus on increasing productivity and reducing costs.

We saw meaningful year-over-year growth in wholesale productivity, up 11%, and a growing number of advisors recommending our products, up [6%] to more than 48,000 advisors in the first nine months of the year. In addition, our strategic distribution expansion efforts, which include introducing new products to distribution partners and adding new partners like banks, are responsible for 17% of sales over the past two years. This is a clear measure of how we are maximizing the size and scope of LFD to spur top-line growth and drive a diverse mix of business efficiently.

Lincoln Financial Network continues to attract and retain seasoned advisors. The number of active LFN advisors is up again this quarter by almost 100, net new advisors to a total approaching 8,000. Our experience shows that consumers remain risk-averse but are seeking professional advice and security in greater numbers as they rebuild their savings. LFN is well-positioned to take advantage of these trends.

Both LFN and LFD ran within pricing in the quarter. This reflects a significant improvement at LFD, where we have evolved the model to focus on productivity rather than headcount increases over the past two years.

Finally, we are making good progress in our goal to increase productivity in our worksite sales and service organizations. During the quarter, we updated enrollment capabilities in our Group Benefits business, and announced a new partnership to enhance our recordkeeping and Web technology in our Defined Contribution business.

Life insurance sales were up 2% over the prior year quarter, fueled by a strong increase in our Lincoln MoneyGuard UL Long-term Care Linked Benefit product. We are the industry leader for hybrid solutions with Lincoln MoneyGuard and expect our momentum to continue, as a growing number of consumers look for more flexible ways to plan for and fund their retirement needs.

The introduction this quarter of the Duration Guarantee UL, our new limited-coverage guaranteed Universal Life product, was well-received by advisors and distribution partners. This is a product that combines the flexibility and guarantees of Universal Life with the affordability of term insurance. And we expect the product to make a meaningful contribution to life sales in coming quarters.

In anticipation of the opportunities that will arise with the likelihood of more clarity around federal estate taxes in 2011, we will introduce new pricing on our guaranteed survivorship UL product early next year, reflecting a lower interest rate environment while maintaining our historical value proposition that has made us an industry leader in this space.

Variable annuity sales were up 11%, while fixed annuity sales were dampened by the weak interest rate environment, thus driving our overall annuity sales down slightly from a year ago. As market conditions change, the versatility of our products and our distribution teams allow us to pivot to the right solution for our clients.

Recognizing the need to continue to balance competitive positioning with sound financial and risk management discipline, we are launching refreshed versions of our patented i4LIFE Advantage Immediate Income Solution as well as our guaranteed withdrawal benefit Lifetime Income Advantage in the fourth quarter. We are increasing pricing on both solutions and making other changes to increase capital efficiency, while maintaining consistency for our distribution partners and value to the customer.

Capitalizing on our leadership in designing hybrid product offerings, we expect that the roll-out of our fixed annuity Long-term Care Linked Benefit product in November will further differentiate our annuity portfolio, much like Lincoln MoneyGuard differentiated our life insurance portfolio. This will be followed by a variable offering in early 2011.

Total deposits on our Defined Contribution business were up 14% over the year-ago period, benefiting from both new case sales and renewal deposits. Helping drive our strength in renewal flow was an increase in average contributions for individual participant, possibly a sign of growing confidence after the disruption of the financial crisis. The business is inherently lumpy, and we lost a few large cases this quarter due to client consolidation as well as some competitive pressure. We are making significant investments in technology and intermediary and worksite distribution to continue to grow and retain the business.

Sales in our Group Benefits business were down from last year, although both traditional group and voluntary sales were up modestly over the second quarter. The team continues to position the Company to take advantage of the growing trend toward voluntary benefits with the launch of a new Accident product in August.

I'd like to pause here for a moment to address non-medical loss ratios, which remained elevated in the quarter, primarily due to higher disability incidents. We've been in this business for many years now and we know that loss ratios fluctuate. The business has outperformed for most of the last decade, and the last two years have been particularly strong years with loss ratios well below our expectations. In short, we expect a recovery in profitability based on our experience.

At the same time, we are studying the situation closely to isolate any contributing factors and take action as needed. We see nothing in pricing or underwriting that is negatively affecting loss ratios, and the elevated incidents was spread across all issue years, size [bands], and industries. We are experiencing elevated caseloads, however, so we have brought in additional resources to manage the increased volume, rolling out more case management training and new tools to improve outcomes and support claimants as they return to work.

What isn't changing is our approach to the market, our risk management discipline to effectively balance both top-line and bottom-line growth, and our flexibility to adjust pricing as we monitor this elevation in incidents. This is a very good business for us and, again, we are confident that we can bring loss ratios back into line over the next several quarters.

Now a little bit about the balance sheet. We continue to hold significant levels of capital and liquidity, with an estimated risk-based capital ratio in our life subsidiaries above 500% and nearly $800 million in cash at the Holding Company. I believe the 500-plus-percent RBC is qualitatively somewhat stronger this quarter than in previous quarters, based in part on a slowly improving economy and an unrealized gain position in our investment portfolio of $5 billion, which should, to some degree, point toward lower credit loss expectations. Low interest rates and our decision to invest cash in mid-2009 at good returns also explained the unrealized gain position.

Our increased confidence in our excess capital position contributed to our decision to purchase $48 million of warrants this quarter.

Now, before I turn the call over to Fred, I do want to comment on macroeconomic factors briefly. First and foremost, we believe that we are well-positioned from an operational and capital position to sustain solid footing in almost any realistic economic scenario. With respect to today's conditions, we took proactive steps to address the balance sheet headwinds of lower interest rates this quarter. Importantly, macroeconomic events are also creating tailwinds for us -- witness our end-of-period account value growth this quarter.

Company-wide, gross operating revenues climbed 9% year-to-date compared to the year-ago period, reflecting both tailwinds and headwinds. Our job, as always, is to drive that number higher organically while bringing top-line success to the bottom-line. And I'm confident that we have the right tools to make meaningful progress on this front.

At our upcoming investment conference, we will focus on actions management will take to further drive top-line growth, strengthen an already strong franchise, and improve earnings.

Now let me turn the call over to Fred.

Thank you, Dennis. We reported income from operations of $206 million or $0.63 per share for the third quarter. During the quarter, we completed our model review project and the annual prospective assumption review. In addition, we booked estimates for the impact of our valuation system conversion in the Retirement segments.

Focusing on the model review work, this was a significant undertaking launched late last year and I'm very pleased with the outcome. While resulting in a few line item adjustments, the overall impact on income from operations was negligible in the quarter.

The more significant impact came as a result of our annual review of long-term actuarial assumptions guiding DAC amortization and reserving. As is always the case, there were offsetting items. However, the most notable impact to the operating earnings was an adjustment to our long-term portfolio yield assumption in the Life segment. I'll spend more time on this specific assumption change in a moment.

Looked at in total, the model work valuation systems conversion and change in actuarial assumptions had a negative $72 million or $0.22 per share impact on the quarter's operating income. If you adjust for all the notable items in our press release, including tax benefits and negative mortality, our run rate earnings came in at around $0.86 a share. This makes no adjustment for unfavorable loss ratios, which we expect to recover somewhat in the fourth quarter.

Net income per share of $0.75 benefited from mark-to-market gains on investments. Gross losses and impairments on general account investments came in at $65 million pretax, offset to a small degree by realized gains in the quarter. Concentrations included RMBS and select corporate bond holdings.

Mark-to-market adjustments, which included our credit-linked notes, credit default swaps, and certain trading portfolios, combined to generate $106 million of pretax gains in the quarter; these gains, driven by spreads coming in on corporate CDS and declining interest rates. The underlying hedge program performed as expected, generating gains as volatility recovered in the quarter; these gains offset by the unhedged FAS 157 adjustment. There were other items that ran through our hedge results but had little impact on earnings.

Hedge assets continue to track in excess of our GAAP liability and comfortably above our statutory reserve needs.

Turning to the segment results and starting with annuities, our results continued to benefit from increased average account values up $1 billion from the second quarter. Market appreciation, together with $1.3 billion of positive flows, resulted in ending account values exceeding $80 billion for the first time in our history. The sharp increase in account values was the principal driver of improvement in segments' run rate earnings. In fact, October average separate account values are up 8% over third-quarter levels.

We sit comfortably towards the favorable end of our DAC corridor, which guides our perspective account value assumptions. Unlocking our corridor assumption today would result in a $270 million pretax gain in our annuity business. Another way to think about this is our current assumption calls for a roughly 15% immediate drop in separate account returns, followed by an annual recovery of 9% going forward. In short, we are comfortable with our current annuity DAC assumptions.

Fixed margins were stable during the quarter, with normalized spreads of 200 basis points, consistent with the last several quarters. We do not see signs of spread compression in our annuity business.

Turning to our Defined Contribution business, a solid quarter overall, with stable account values in the period. We booked an $11 million gain, reflecting the impact of converting to our new valuation system, a result of a more granular approach to estimating gross profits. Fixed margins and spreads held up nicely in the quarter, with normalized spreads approaching 230 basis points, a result of crediting rate actions taken in the third quarter, with additional moves planned in the fourth quarter as a result of the low interest rate environment.

This was obviously a noisy quarter in our Life segment, the result of completing the bulk of our model work in this area and adjustment to our prospective assumptions. There were two over-arching areas of adjustments we made during the quarter. First were model refinements, which had little net impact on our results, but more significant on a line item basis.

The second area of adjustments focused on our annual prospective assumption review. We had adjustments related to surrender, mortality, and premium persistency assumptions, which taken together had a $33 million positive impact on the segment's earnings. This was more than offset by a change to our new money investment yield assumptions, which alone negatively impacted the segment's results by $114 million. There were other less material adjustments, but these are the more significant ones.

Focusing on portfolio yields, the revised assumption embeds current new money investment yields, expected cash flows, and actions we have taken to defend portfolio yields. Portfolio yields are currently hovering around 6%. Our assumption change results in those yields falling over the next five years and not recovering back to current levels until 2020. We assume new money rates will recover only gradually over several years; arguably, a conservative position, but prudent, given current markets. Recognizing this as an adjustment guided by our best estimates, we believe the move lowers the risk profile of our future life earnings.

Turning to mortality, gross mortality was fairly stable and what we would expect in the quarter. The issue was where mortality occurred -- namely on blocks of business with less reinsurance in place, recognizing our retention limits and reinsurance programs differ by block of business. This is an unusual outcome and we don't believe it to be indicative of expected mortality margins looking forward.

Fixed margins remain steady, helped by investment strategies deployed last year to lock in higher yielding assets. Normalized spreads are running at around 190 basis points and have been fairly consistent over the last few quarters.

Before leaving the Life segment and understanding the challenge in modeling our results, our underlying earnings drivers remain healthy and we expect to return to historical run rate earnings levels in the fourth quarter in the $150 million range.

In Group Protection, our non-medical loss ratio came in at 79%; 78% when adjusting for the lowering of our reserve discount rate, but still up from the already elevated levels experienced in the second quarter. Dennis commented on our review of loss ratio developments, so I'll not add to his comments.

Poor disability results were driven primarily by unfavorable incidents, which also impacted life loss ratios. We expect loss ratios to remain elevated relative to our long-term expectations, but recovering in the fourth quarter to the 75% to 77% range. As a reminder, every one percentage point of loss ratio is about $2.5 million of earnings in a given quarter. Net earned premium continues its strong trend, up about 9% over last year's quarter, with premium growth rates benefiting from improved retention.

I want to refresh last quarter's interest rate sensitivity analysis to reflect a more severe scenario of new money rates, which are currently running about 100 to 125 basis points below portfolio yields, remaining in place through 2012; said differently, freezing the 10-year treasury at 2.5% for the next two years.

The earnings drag from spread compression in our Retirement business is largely concentrated in Defined Contribution with little impact to Individual Annuities. Looking at our Defined Contribution business, we would expect an annualized earnings impact in the range of $5 million in 2011 and $15 million in 2012, entirely spread compression-driven.

In our Life segment, we benefit in the short run by the proactive investment strategies we detailed last quarter. As noted in our comments, we do not need to purchase a single asset in support of our UL secondary guarantee portfolio until mid-2011. Under our two-year low-rate scenario, we estimate an impact of about $25 million in 2011 and $45 million in 2012. These numbers appear similar to what we disclosed last quarter, but are skewed towards pure spread compression as the quarterly DAC unlocking and reserve build is reduced by our prospective assumption change this quarter.

The Group business will be impacted to a lesser degree. We would expect an annualized impact to this segment's earnings of up to $5 million a year.

Finally, on capital, we continue to believe cash flow testing will result in no material impact to capital and reserve levels. We hold considerable excess capital in our insurance companies, should testing dictate modest reserve strengthening, and do not view interest rates as a near-term capital issue to manage.

Turning more specifically to overall capital conditions, our insurance subsidiaries remain in a strong position, with an RBC ratio in excess of 500% and just under $800 million in net liquidity at the Holding Company. We estimate our capital margin to be approximately $1.9 billion if solving for a 400% RBC at the insurance company level, and approximately $250 million above our Holding Company idle liquidity target of $500 million.

As a result of improved capital conditions, we repurchased $48 million of our warrants participating in the US Treasury auction process in September. The purchase had little impact on our diluted share count in the third quarter. We estimate the repurchase will have about a 1.5 million share equivalent impact next quarter, this holding all else equal, namely share price.

General account conditions continue to improve. Our unrealized gain position increased over $5 billion, pretax. Capital charges associated with our general account holdings have stabilized, with positive trends in overall credit quality. Impairments, while improved from 2009 levels, ticked up a bit, related to a few select securities; but we would expect this number to come back down in future quarters. Overall, strong capital position, as we monitor market conditions for the remainder of 2010 and entering 2011.

Now let me turn it back to our Operator, Huey, to start the Q&A session.

(Operator Instructions). Andrew Kligerman, UBS.

The primary question would be around the interest rate assumptions. Fred, I think what I heard you say is that the portfolio yield is around 6% and you're moving it down over five years, and then it won't recover until '20. Fred, can you provide the specifics on where that rate or yield goes?

And then, secondly, in that same vein, how can we -- can you give us some confidence that another unlocking such as this one will not occur over the next year or two, should interest rates remain exactly where they are, which is what you're saying is the case for the 10-year treasury?

Yes. Let me kind of make sure we level-set here a bit. So what was the actual assumption we changed? The actual assumption we changed was our new money investment rate assumption. And that assumption, that new money rate assumption, expectation over the next several years.

And what we did is we dialed that down to our current experience in investing new cash flows across our life insurance portfolios. And then we only gradually increased that over several years back up to approaching our current portfolio levels. When taking that kind of a severely reduced new money rate assumption over time, that has the effect of dragging down our portfolio yields over the next five to seven years, then slowly recovering on back up around 2020.

What ends up happening is you see a bleed-down in portfolio yields of around 25 to 30 basis points over time, and then a gradual recovery. Part of the reason for that relatively slow drop-down in portfolio yields and gradual rise is the fact that these are fairly long-duration portfolios, so you only have so much rolling off each year into those new money assumptions. Also recognize all of the actions we've taken to lock-in or forward-buy much of that high yield environment, which serves to moderate the near-term reduction in portfolio yields over time.

So, overall, we think -- and you can obviously argue whether or not we're being overly conservative in our approach to the new money rate, but what we felt was prudent here was recognizing an additional 50 basis point drop in rates since the third quarter, reviewing our reinvestment strategies in the portfolios throughout the quarter, and recognizing that conditions suggest there could be a more sustainable low-rate environment, we simply felt it was prudent to go ahead and make this move.

I'd also note that the size of the impact was a bit larger than what we had talked about under our assumption of 50 basis points in the past quarter. But what's very important to understand is it's not so much that ultimate assumption, although that plays a role; it's really the path of your assumption over time and the fact that we really dropped that ultimate portfolio assumption fairly significantly by taking this new money, low new money rate environment and stringing it out more slowly over time.

But that's the difference in what you were thinking three months ago, is that you dropped it more and you held it down longer? Is that why last quarter you were much more comfortable that a DAC charge like this would not be likely?

Yes, it was really a combination of rates down, a growing view that they may stay down for longer, and then as we got into the actual process of really dialing in the assumption -- you have to pay as much attention to the path of portfolio yields as much as the ultimate yield itself that you expect in the portfolio. And that shape of our forward-looking portfolio yields is as important as the ultimate rate. And those had implications.

So for at the bottom-line, confidence that over the next few years we don't need to expect another DAC hit?

Yes, certainly the way I would phrase it, Andrew, is that we feel very good about having lowered the risk profile of interest rate-related charges as we go forward. Obviously, there still needs to be a level of cooperation in the capital markets, but we feel as if we took a very prudent step here. And as a result, feel much more comfortable with the risk profile of our forward earnings.

Great. Thanks a lot.

Tom Gallagher, Credit Suisse.

Fred, just back on that question, just so I understand it. So, by 2020, you're assuming you're back up to [6]. And the starting point today -- did you say it's about 120 basis points below that, is kind of where we level-set this and then move up just very gradually over the period? Is that the right way to think about it?

Yes, the 100 to 125 points below current portfolio yields, the new money yields, that's about on average, as we look across our life portfolios. Note that there'll be some differences portfolio by portfolio; so, for example, on the longer duration portfolios, which would contain the secondary guarantee product, because we're investing in longer duration securities, you'll tend to be able to achieve something a little better than that. In fact, we have achieved better than that as we looked at our year-to-date purchases. But on a blended basis, looking across all portfolios, that's where we dial it in.

And Fred, the old -- was the old assumption that rates moved up sharply within a year or two, and now the change is maybe just a little more granularity, is it 10, 20 basis points a year? I just wanted to understand what the slope of the recovery change was, just so I can conceptualize this better.

Yes. Probably the biggest change was really just that new -- again, that new money assumption, which you have to remember a year ago this time, we were actively investing at levels that were in excess of our portfolio yields. And a lot has changed in a year.

So not surprisingly, the type of assumption we had, while we believed to be conservative and prudent, was that we were able to invest at new money rates approaching our portfolio yields and building out over time. What we've really done is adjusted that new money rate down much more severely to reflect current, actual current investments. And that's what's really changed the slope and the ultimate performance of the portfolio as it relates to our assumptions.

Okay. Understood. Was there a statutory reserve impact to this or was this a GAAP-only issue?

This was GAAP-only. And we have to be attentive to cash flow testing results on our block of business as we approach year-end. Typically, those are done around the year-end timeframe.

And as I said, however, in my comments, that at this juncture, we don't see cash flow testing pressure as a result of the current low-interest rate environment. That's in large part because we happen to carry a fair amount of excess reserving on those blocks of business, which provides a level of comfort that they can really absorb a level of strain for a period of time.

And so, we haven't done that cash flow testing work. That's something we start into as we head into the year-end process, but we're obviously paying very close attention to rates and the effect that could have. At this point in time, we don't see it as having a reserve and/or capital implication for the Company. And obviously, we sit in a good position right now.

Okay. Thanks.

Ed Spehar, Bank of America.

Fred, just again on this interest rate issue -- so we're starting at [6%]. We're assuming new money is [4.75%] to [5%] for the next five years. And then we assume a new money rate that's going to get you back to [6%] in -- by 2020. Is that correct?

A little bit different. As I mentioned, the 100 to 125 basis point new money is really when looking more broadly across our life business. And so you really have to look at the specific portfolios.

Our UL portfolio, for example, has about $22 billion of reserves behind it. The more newer age secondary guarantee products have another $3 billion or so of reserves behind it. And so when you look at those portfolios specifically, for example, and the longer duration of those portfolios as well as the pre-buying we've done, we've been able to actively invest at our new money rates that are more in the 75 basis point or so area, in terms of lower than the portfolio yields, if you follow what I'm saying. So as a result, that's more or less what we have installed into our new money assumption.

I'm giving you an aggregate point of view to just give you the information that's necessary to understand our results. But realize this was done in a more granular basis on a portfolio-by-portfolio basis, annualizing new money rates by portfolio, duration, the roll-off of cash and reinvestment. And so it does differ by portfolio.

But just to be clear, you're saying the -- for the overall Life Insurance segment, that the portfolio yield drops from about [6%] to [5.70%] to [5.75%] over five years?

Right. The portfolio yield does and that's being driven down by a new money investment assumption that is in the 75 basis points or better below portfolio yields currently. And then a gradual recovery over time. This is really specific to UL portfolios in particular.

Okay. And then a question about statutory versus GAAP. Is there a scenario where you would see a statutory reserve increase before you would have a K-factor at [100] on a GAAP basis?

I'd have to think about that. I haven't thought about a question posed in that way relating K-factors to cap stack capital. I think what you're saying is if recovery of DAC -- if things get severe enough to where what recovery of DAC becomes more of an issue, is it related to a capital issue?

Right. I mean, I guess what I'm trying to envision is I can't come up with an example over the past 20-plus years where there's been a statutory reserve increase for a life company before there was a GAAP reserve increase. And I don't think you would see a GAAP reserve increase until you had blown through all the DAC. Isn't that correct?

Well, I mean, keep in mind that our adjusted tier to interest rates had implications for the SOP reserve in this business, which is a reserve, a GAAP reserve issue related to interest rates. So I guess your theory would hold, that as our assumption change had implications for the reserving and DAC and came before the risk of any statutory reserve issue.

Okay. Thank you.

Randy Binner, FBR Capital Markets.

Yes, I guess I am trying to hit the goodwill angle of this. I mean, obviously, the goodwill review happens in the fourth quarter. And so I'd just be interested now that this set of assumptions that's been described for the life business has been laid out, how this magnitude of the impact or the result of the impact would potentially affect how the goodwill for the Life segment is reviewed in the fourth quarter?

It really doesn't have implications for the goodwill review. The goodwill review is largely -- that asset review is largely tested around the franchise or new business generation, new business profitability environment of the Life business. And our sales patterns, our market share, our mix of sales, the expected profitability on what we sell -- very importantly, our ability to adjust the pricing, which we have a proven ability to do, for either capital strain or interest rates, and still maintain market share and drive product sales -- all of those components allow us to feel very comfortable with the valuation of our Life business.

Now, we have to go through the testing, as any company does, and we have to incorporate all the assumptions, including discount rate assumptions on the business, once you settle yourself that the cash flows are holding up nicely, which they are. So we have to go through that review, but the condition of the franchise remains very strong.

What we're talking about here today in terms of earnings impact is more to do with in-force. And really what we have done is impacted the assets or the carrying value of the Life business where spread compression takes place. So, in other words, DAC assets, VOBA, reserve increases, all effectively reduce the carrying value of the Life business, but more oriented around where spread compression has an impact and that's on reserves, and DAC, and VOBA. The goodwill asset is all about that franchise, that new business, and your confidence in being able to maintain and improve profitability levels in what you sell on a daily basis.

Alright. That's fair. So I guess the follow-up question in my mind would be -- well, I guess, one, if there is a little bit of more subjectivity, I guess, to the goodwill test, what would that be based on?

And two, I guess, why would we not -- you know, if I looked at what happened with DAC, you know there was all the -- there was a lot of assumptions that were kind of $33 million negative and then there was $114 million negative -- I'm sorry, a $33 million positive and a $114 million negative. So, I guess what -- the business value, is that based on comps? I'd be curious about that. And then why you wouldn't have a similar disproportionate hit of interest rates lower versus everything else?

So, when looking at goodwill, the analysis we do is really when we think about the new business we're booking going forward, and the -- let's call it the embedded value of that business or the value of the cash flows, and we look at our ability to price or reprice if given a change in economic conditions or policyholder behavior, et cetera, when we look at the costs associated with securitizing or financing reserves on the business and how that plays into the future profitability of returns, your pricing power in the marketplace, which has a lot to do with your market share, which as you know, is significant at Lincoln -- all those things play into your views of those cash flows if any of those things were to go negative on you, it becomes more expensive to reserve for the product; capital costs increase beyond your assumptions; sales fall off.

If those things start to happen, that's where you'll see sensitivity around goodwill. The more -- I guess I'd call it more subjective element, is once you have isolated those cash flows, which really need to be proven out in your experience -- particularly your, obviously, your recent experience -- once you've settled in on that, you need to go about the business of discounting those cash flows. And as I mentioned last quarter, there's good news and bad news on that front.

Certainly, if the view of the risk profile of the business has increased, you would suggest a higher risk premium and a higher discount rate applied to the business. However, given the risk-free rate environment has dropped so significantly, that has a counter-balancing or offsetting pressure lowering discount rates. And you're starting to see a little bit of that, I think, even in some of the transactions that have taken place in the industry, although there's not a lot of great examples.

And so that will go back and forth, and it's not necessarily a bad thing in terms of the interest rate environment. But what will guide you there is a reasonable expectation for discount rates applied to your business; comparables in the market will guide your thinking; and as we've mentioned before, the reason why you do additional testing on your goodwill when your stock is trading at a discount to book, is because the suggestion in that is that there's a higher discount rate being applied to certain businesses, and so you've got to go that extra step of really analyzing on a segment-by-segment basis.

Again, we feel comfortable with the overall conditions of the business, but we do have to go through the process, of course.

Alright. Thank you very much.

Eric Berg, Barclays Capital.

Not to minimize the importance of the DAC accounting change, but to make sure that I understand it for what I think it really is, am I right, Fred, when I say that it's accounting only? Meaning it will have -- the DAC adjustment and the change in your assumptions amount to a change in your forecast and will have no economic effect on the Company? Or maybe I'm missing something. It just -- it feels like an accounting issue only that will have no bearing on what Lincoln earns in the bond market in the future.

Well, I think that's right because, at the end of the day, what you're really doing is you're just accelerating or decelerating on the amortization of an intangible. You're not necessarily suggesting anything about the underlying cash flows or net present value of the business.

What I would say, however, is that if what's driving your prudent move to unlock DAC is the notion of the risk of spread compression going forward, that obviously has economic implications for estimated gross profits and the net present value, if you will, of the business or the cash flows you've sold.

So, Eric, there is an economic element to it that's driving you towards unlocking or accelerating the amortization of DAC or building an additional SOP reserve. But in terms of the actual DAC element of it, at the end of the day, it's a timing issue of when you recognize your earnings, by and large.

Yes. I guess my point was, it sort of feels like this is a change in your forecast for what the ultimate economics will look like, but you don't determine interest rates; interest rates and, therefore, the spread compression, whatever it is, will be determined by the market -- you know, will be determined by market interest rates. That's all I'm saying.

(multiple speakers) That's right.

Your change in the DAC (multiple speakers) --

That's right.

Right. Okay, good. So, I (multiple speakers) --

That's exactly right. Yes. (multiple speakers) I think we all understandably want to orient ourselves about understanding the assumption and understanding what the risk of future unlockings could be. And again, we feel pretty comfortable with what we've done. But lost on that conversation is the other end of that coin, which is the other side of that coin, which is, we very well could be in a position of outperforming these assumptions, in which case you'd start to take positive retrospective unlocking through your earnings.

What I look for when I'm redialing these assumptions, what I believe to be best estimates is where I have put the Company's assumptions in a position where there's roughly equal opportunity for both outcomes. And that you can sort of look at it and say, this is certainly prudent under almost any level of scrutiny.

I appreciate that. And I guess my second and final question is this -- it's a little bit surprising that this is happening in the Life business, because after all, this is the business that you've worked so hard to shield yourself from the effect of lower interest rates in orders by pre-funding the purchase of assets.

Why haven't you been able to -- or did not choose to, whatever the case may be -- pre-fund the purchase of assets in the Defined Contribution and Annuity business? And why aren't we seeing, in general, similar DAC activity in those two businesses? That's it.

Yes. The reason really is that we simply, from a risk return trade-off perspective, the risk to our earnings and capital associated with spread compression in our Retirement businesses overall was just simply less. In fact, honestly, Eric, where we've been really focusing, frankly, is making sure that in this period of time, we actually are putting in place protection against a rising interest rate, which would be more detrimental to those businesses. And we've been actively putting protection on in that regard.

But also importantly is to note that, on the Defined Contribution business, which is really where you find most of the spread compression, it's because of relatively older business with high guaranteed minimum interest rate guarantees, and that's really where we're seeing the spread compression -- it's in select blocks of business.

It just so happens to be the case that because in part of the age of that business, we have very little DAC asset left on those businesses that are more susceptible to spread compression. So as a matter of mechanics, there simply was less DAC to impact. Otherwise, there would be a level of impact. So that's why it's purely a spread compression.

Thank you.

Yes.

Helpful. Thanks very much.

John Nadel, Sterne, Agee.

Fred, may as well beat the horse to death, right? The question I have for you guys, though, is along this line -- I know we're -- any time we invest in the stock, right, we're making certain assumptions about a macroenvironment by definition, whether we want to admit it or not.

But I guess my question for you is this -- it seems to me someone by definition looking to buy your stock right now is making a bet on rising rates. If you guys made the assumption of the new money yields forever, as opposed to for the next four or five years or whatever the case may be, and then that sort of modest increase back to the current portfolio yield by -- I don't know, by year '10, if we just kept it low, what's -- can you give us a sense for what the severity is, of what the sensitivity is around that sort of assumption? So that folks can sort of take the risk of, what if rates don't rise, out of owning your stock right now?

Well, I mean, the way I attempted to do that, John, which you can appreciate that if I attempt to run our block of business against every economic point of view that's out there -- particularly, interestingly, because I just was looking at it, you've got -- in fact, many of your shops on this call have very sophisticated economic outlooks for interest rates. And I've got to tell you, the 10-year outlook over the next year ranges in your own shops from about 2.25% to 3.75%. So there are wild ranges on what folks' point of view is around forward-looking interest rates.

So there's a danger in dialing-in one point of view in the world. Rather, I'd like to settle into something that most observers would look at and say, that was prudent, perhaps even conservative in your approach to it.

But the other thing I would say about your opening comment is this -- I think what we're really looking to drive here is retirement and protection assets under management, recognizing that, while we may have an environment, as Dennis mentioned, where spreads are weighing down on our returns, that may also be an environment, this quarter being a good example, where markets are driving retirement-based asset returns significantly.

And so our mission is to build products and distribution that drive retirement and protection assets under management, put in protections against tail risk related to the markets, but we don't want you to necessarily have to be investing in our stock with some sort of bet attitude relative to a particular macro condition.

Okay. I understand. I get the response, too. I appreciate where you're coming from, Fred.

My second question is just -- can you give us a -- and maybe more for Dennis -- can you give us an update on -- and I don't mean this with any disrespect, Fred -- can you give us an update on your CFO search?

(laughter) That's -- we are working hard. It's a great opportunity for someone. We have a lot of interest in the position and at the same time, it's a very, very important decision for me and the management team. And so we're making sure that we've explored all opportunities and would expect in some reasonably -- some reasonable period of time to have come to a conclusion.

Okay.

I'd like to come back to the other -- this issue about interest rates, which is an important issue and I'm glad we've had the time to talk about what we think is a pretty prudent decision this quarter.

The other point I would make -- and this gets back to headwinds and tailwinds -- remember, there's only -- we may have to update this number, but from some past lives that we've used, only one-third of the Company's total earnings are driven by interest rate margins. The other parts of our earnings margins are made up in -- at one point, it was about one-third/one-third/one-third between equity-driven fees and mortality and morbidity.

So I understand again the importance and the significance of the focus on interest margins and long-term interest rates, but just to add to the conversation, there's tailwinds and headwinds, and this represents only about one-third of our earnings.

Thank you. If I could sneak one more in, just on the $1.9 billion of capital cushion above a 400% RBC, is there any -- should we have any expectation of any portion of that being deployed? I mean, it feels to me like we're getting told by a lot of companies that we're sitting on a lot of excess capital, and yet stocks are very cheap by historical standards. And there's little, if anything, being done by the companies to -- I mean, other than your -- obviously, your warrant repurchase this quarter. Can you give us a sense for deployable capital and expectations there?

Yes, a couple of things. And you've probably heard this from other management teams, but I'll just come back to a comment I made and then you can qualify that.

I do feel better about the quality of our excess capital position this quarter than I did a quarter ago, because, again, for the reasons I stated. At the same time, when I look forward, we're not completely out of the woods on a double dip recession. The rating agencies remain cautious about the industry. Potentially, although I don't think so, there's some regulatory issues that are floating around.

So, yes, I'm more comfortable. Yes, we want to put this capital to work. We did a little bit this quarter, $48 million. We are very conscious of the concept of getting idle capital put to work, either returning it to the shareholders in some way or shape or investing it in the business. I can just say that our confidence continues to improve and we'll just continue to watch the environment and the opportunities that we might have.

Are you pricing at a risk-based capital ratio of 400% new business? Or is it still lower than that?

It's roughly in the same category -- area.

Okay. Thank you.

Steven Schwartz, Raymond James.

I just want to quickly follow-up on the capital question. Dennis, you still have a lot of retail investors from the JP days that are in the stock -- any thought to the dividend?

That would be one of the ways to return capital to the shareholders. That's a Board-level decision. But certainly, it's something that we think about.

And then if I may, just what is the takeaway here on the Group Protection? It kind of sounded to me like you're all over the place. Maybe it was just one of those things, maybe it will come down, but we've got higher caseloads, we're looking at repricing -- I mean, what's the takeaway here?

I think -- the principal takeaway is that this has been a very profitable business for us for a decade. And there may be some of you that have been around long enough to know that we had this type of a discussion with the people who were following at the time Jefferson Pilot, because I forget when -- 2004, 2005, we saw the same type of spike. Now let me try to parse out some of your questions.

With respect to the issue of bringing more resources, that's a responsive management action to deal with, frankly, more claims coming in the door and having to be managed. So that helps us get, if you will, the claims to the right position, either off the books or keep them on the books. But even if we keep them on the books, try and work hard to get the people back to work with either long or short-term disability. So put that in the bucket. We're taking actions to deal with a larger inflow of activity. And that will subside as we get the inventory claims down. So that's one issue.

The second issue is, where is it coming from? And what I've tried to explain is that it's coming from all different -- excuse me, completely across the board. So it's not new business that might somehow have been mispriced; again, it's from all cohorts of sales, all industries. And so that would lead us to believe that in some way, shape, or form, this incident spike is externally driven. So that would be another issue.

Now, just to put some perspective on it, incidence ratios historically run from [3.89] to [3.9] per 1,000. In '09, when we had a spectacular year, they were at [3.7] per 1,000. In the current quarter, they're at [4.1].

So now let me come back to the pricing issue. If we think that there is something that's happening externally that causes us to raise pricing, we will do that. In fact, we probably raised pricing on some of the blocks or some of our new business already in the 3% to 4% range.

So, to put it in perspective, we think it's predominantly externally driven, working very hard and adding resources to deal with the increased activity. We're watching what has been a spike, we hope, temporary in nature in incidents, but if it isn't temporary in incidents, then we will be more aggressive with our future pricing. And remember, this is by and large, short-term pricing business, so that you can get out of bad blocks and reprice it pretty quickly.

If there's a need to reprice this, can this be feathered in over a year? Or is there some longer guarantee periods so maybe it goes over two or three years?

Most of the business is priced in the one to three-year range. And certainly, the new business that we'd be putting on the books would be priced immediately -- increased if we thought it was appropriate to increase.

Okay. Alright, thank you.

Bob Glasspiegel, Langen McAlenney.

Sticking with Steven's theme on protection, you did grow your sales 15%, 14% last year, which is faster than some of the bigger competitors that we're saying it was competition. So, as you postmortem, you're still pretty sure it wasn't underpriced sales effort from last year?

Yes, that's a great question. What I look at and the team looks at over time as one indicator of our pricing, is sales close ratios. So, if I look back over the last 36 months, our sales close ratios ran, in the first 24 months of those 36 months, roughly around 10% and now they're down to 9%. So there's nothing -- that being one pretty good indicator -- there's nothing to suggest that we were taking market share disproportionately in this period of time.

Okay. As you guys do your modeling for the future, when does a more active normal capital management dividend become part of your plan? Are we sort of three to six months away? A year to two to three years? What sort of macrovariable would accelerate buyback being --?

I guess the fair answer to that question is, although we have a longer-term view, we look at it just sort of in real time and make decisions as we go along.

So you can't envision buyback in the next year as being an important lever?

We've already bought some shares back, (multiple speakers) so there's evidence that we would do that. But we're not prepared to announce at any point a large share buyback, even though that doesn't preclude something from happening.

We're watching a lot of things evolve, Bob, as Dennis has mentioned. We're watching -- economic conditions have obviously evolved, which you've heard from most companies in the industry. There's still a little bit of evolving going on at the rating agency environment; to a lesser degree, but some regulatory change taking place as well.

And I think many in the industry are trying to pause a little bit on their excess capital positions and watch a few of these things unfold and crystallize; and then get about the business of utilizing the excess capital to build returns in the business.

So I know it's a frustrating period of time and I know you're getting a very similar answer from many companies in the industry, but it's because we're all staring at the same set of dynamics. So it's difficult to talk to about the endpoint of that, but certainly we would expect and hope a lot of that to clear up in 2011.

Thank you, guys.

Mark Finkelstein, Macquarie.

I guess this is a follow-up to a whole bunch of questions. I think I understand the reserve adjustment and what was done and the yield assumptions, but I guess the one thing I'm still a little confused about is -- I think, Fred, you mentioned that earnings in the Life business kind of should revert back to the $150 million range.

But I guess theoretically in this change, we're adjusting our assumption around long-term earnings or EGPs, and so I guess what I'm confused about is why isn't there an ongoing earnings impact going forward, whether it's just narrower spreads -- or maybe that's accounted for in the $25 million and $45 million you talked about earlier; but definitely a higher DAC amortization rate. So -- and if I didn't understand this correctly, clarify, but what am I missing here?

Well, first, there are some run rate adjustments related to the many changes we've put in place, but a number of them offsetting as it pertains to DAC amortization levels going forward. So, for example, the interest rate change in of itself had both a DAC impact and an SOP impact.

There are other positive adjustments that were made in the period, which is commonly the case when you're reviewing all your assumptions adjustments around mortality, for example, based on mortality studies we've done internally -- a finer, more exacting approach to surrender activity and how to model that from a profit perspective.

So, on a net basis, you didn't have quite as dramatic a change in some of the DAC balance-related issues. You had more of a dramatic change in the SOP reserve on a -- again, on a net basis. So there are some implications for forward-looking earnings, but on balance, not a material degradation in the run rate expectation for the Company.

Okay. Alright, I may follow-up on that. Thank you.

Thank you. We have time for one final questioner, and it comes from Darin Arita with Deutsche Bank. Please go ahead.

Going to stick with the low interest rate discussion here. And was wondering if you ran this analysis you did on the Life segment -- if you ran it on the Annuity business, how would that turn out, as we think about both the fixed annuities side and also your VA guarantees?

We don't -- as a matter of general practice, we don't pick and choose where we're going to have an outlook. It wouldn't make sense for us to have one interest rate outlook for one business and a different interest rate outlook for another. And so you can assume that we've applied this discipline across all our businesses; but there will be very different impact, based on the nature of the business.

So as I mentioned earlier, on a fixed annuity basis, because we have ample room in our crediting rate structures and a bit more of a matchbook environment, plus, obviously, an ability to reprice or adjust our crediting rates very rapidly weekly, as is commonly done in the industry, we can really react quickly to low interest rates and mitigate the potential for spread compression in any related DAC, unlocking our assumption changes related to it.

On the variable annuity side, what's important to note, which I think is what's driving your question, and that is that when you're looking at separate account returns, you have both an equity return and a fixed return. And what allows us to be very comfortable is our corridor approach -- you tend to want to think of that corridor as an equity market assumption, but it's really not. It's a separate account value assumption. It's what our expectations for growth in those separate account values.

And as I mentioned during my comments and when I was talking about the corridor, we sit here today with an account value assumption going forward, where the returns on those account values are going to drop immediately 15% and then recover very slowly at a 9% annualized rate. This is why I personally -- and we have grown fond of the corridor process. It does what you would expect it to do.

After a series of quarters where the equity markets have been hot and rising, it would stand to reason that you would want to lower your forward-looking expectations. In an environment where the markets had dropped significantly, it would stand to reason that your forward expectation for market recovery would be more robust.

The corridor process, okay, sort of encapsulates all that and doesn't run our results up and down for those shorter-term movements. And so, that's what gets me comfortable. So if you apply your low interest rate assumption to the fixed portion of the variable annuity business, that's really incorporated in the overall corridor account value approach. And we feel comfortable with it.

And as you were thinking about a lower interest rate environment for the annuities, what was the corresponding assumption on where lapsed rates would go?

Lapsed rates were kind of a different story. We did adjust our lapse rate assumptions on the business predominantly on our variable annuity business. This didn't actually have to do necessarily within the moneyness or what would more commonly be discussed related to lapsed rates on annuities.

This had more to do with just a pattern of better persistency over a number of years now, that has led us to bring down, particularly the last assumption, once our product is outside the surrender charge period. And so we brought that assumption down. That had a positive DAC impact in the quarter on our Annuity business. You didn't see that in the results on a net basis because it was offset by a negative impact from our valuation conversion estimate. And so it netted out to have very little impact in the quarter, a couple of million dollars of negative impact in the quarter.

So we did make an adjustment to the lapsed assumption. That also carries through to some adjustments made related to the hedge program, that will move that around and are embedded in our results this quarter. So that's really where we worked the lapsed rates. It wasn't so much an impact item on the fixed side.

Alright, thank you.

Thank you. That concludes our time for Q&A. I'd now like to turn the program back over to Jim Sjoreen for any closing remarks.

Thank you, Operator, and thank you for all joining us this morning. As always, we will take your questions on our Investor Relations line at 1-800-237-2920 or via email at www.investorrelations@lfg.com. And as a reminder, we will be hosting our annual conference for investors, analysts, and bankers on November 18, and that will be available via webcast. Again, thank you for your time today.

Thank you, sir. Ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may disconnect at this time.