Lincoln National Corp (LNC) 2013 Q1 法說會逐字稿

Good morning and thank you for joining Lincoln Financial Group's first quarter 2013 earnings conference call. At this time all lines are in a listen only mode. Later we will announce the opportunity for questions and instructions will be given at that time.

(Operator Instructions)

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

Thank you, operator.

And 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 liquidity and capital resources, 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 their most comparable GAAP measures.

Presenting on today's call are Dennis Glass, President and Chief Executive Officer, and Randy Freitag, 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.

Thank you, Jim, and good morning, everyone.

Operating earnings per share was up over the prior quarter, but operating earnings were down due to high mortality in Group Protection and individual life and low alternative investment earnings. These will be covered in more detail in a moment. Looking through to the drivers of long-term earnings improvement, we had a very strong quarter.

Including -- a comp value growth in every business with total account values at a record $186 billion; sales results up in every business segment after solid price increases in our Group, Individual Life and Annuity businesses; expense management producing no increases year-over-year, reflecting actions taken throughout last year, and the repurchase of $100 million of our shares. Reflecting these results we ended the quarter with operating revenue growth of 4% and book value per share growth of 14%.

Let me now share highlights from our underlying segments starting with Individual Life. First quarter sales in Individual Life of $150 million increased 23% from the prior year, as we maintain our pivot toward product solutions that achieve higher returns in a low rate environment. Guaranteed UL sales were down 26% from a year ago and now represent only 18% of total life sales. Sales of our pivot products, which include variable Universal Life, indexed Universal Life and term insurance, were up 82% from the same quarter last year. They also now comprise more than half of our total life sales, closing the quarter at 51%.

Crossing the 50% threshold is significant for us and serves as an excellent example of our ability to successfully deliver on the pivot strategy we have discussed with you in the past. We remain focused on improving and expanding our product line, as evidenced in the first quarter by the successful launch of our new Treasury index Universal Life product.

Launching this offering bolsters our already strong portfolio of solutions and affirms our position as an industry leader focused on bringing innovation to the marketplace. We will keep reshaping and repricing products with changes in the second quarter planned for guaranteed UL products and MoneyGuard. Underpinning it all remains the depth and proficiency of our distribution teams, which enable us to keep driving the right mix of sales.

Turning to our Annuity business. Strong equity markets and positive net flows advanced ongoing growth in account values that collectively contributed to a very positive result in the first quarter. Annuity sales of $3.2 billion drove positive net flows of $885 million up from $293 million in net flows a year ago. On the product side, our risk managed fund strategies remain an effective way to imbed volatility management inside client accounts and reduce hedging costs.

Of the $2.9 billion in sales of variable annuity gross deposits in the quarter, 78% of the deposits included a guaranteed living benefit rider built on our risk managed fund strategies. And 9% of the deposits have no living benefit guarantees at all. In the second quarter we will expand our risk managed fund strategies further. Also, we continue to improve VA margins. Importantly, we are reducing income benefits on the bulk of our joint survivorship living benefit riders.

These riders comprised roughly half of all the guaranteed living benefit rider selections in the first quarter. This action is likely to slow sales for the balance of the year, though second quarter will be somewhat elevated as product changes are implemented. We remain comfortable with our approach to the annuity business and we will maintain our consistent presence in the space.

Our focus remains not on taking market share with low-priced offerings, but on selling solutions valuable to our customers that help Lincoln achieve good returns and manageable risk. In Group Protection, the first quarter sales of $71 million increased 6% from the prior-year. We remain focused on voluntary market, where we grew sales by 61%. Looking back to 2012 and the most recent market data, we saw consistent market share and rankings year-over-year.

And we finished in the top five for the Life and Annuity -- life and disability product lines by case count. Our field force grew by 13% from the prior year end, as we continue to invest in the group business to support the 3400 brokers who currently sell our products. With this growth and this group of brokers, we expect to grow sales.

In line with what we have shared on the last few calls, we expect pricing to firm in the market. Particularly, in the disability line where we have seen some positive progress over the last few quarters. Given the market wide focus on profitability in the group's space, we will remain diligent in our focus on overall profitability of new sales and renewal actions and our expectation is that all of the steps we are taking in this business will generate profitable growth.

In Retirement Plan Services it was another excellent quarter for all leading indicators, highlighted by strong total deposits, solid retention, and positive net flows. First quarter deposits of $1.7 billion were up 10% from a year ago, driven largely by advances in our mid to large market business. Our sales pipeline is strong and continues to grow.

The successful completion of our new record keeping platform in the mid-large market has directly helped us further penetrate the consultant and advisor communities. In fact, consultant firms who previously did not place business with Lincoln now account for 50% of our active sales pipeline in the mid to large market. This has resulted in significant new sales over the past two years.

Net flows for the first quarter were $344 million, up 62% from a year ago. Strong inflows combined with no large terminations contributed to our seventh straight quarter of positive flows. It is clear to us that our investments in RPS are paying off and we will keep investing in this business to increase our competitiveness, market presence and overall growth.

Turning to distribution. As we have said, one of Lincoln's primary strengths is the size and scale of its distribution franchise. Collectively, our retail, wholesale, and worksite sales teams reach annually more than 65,000 active producers. Producers who sell one of our products. And the number of advisors recommending our solutions in the first quarter increased by approximately 25% from a year ago.

This is a tangible example of how strong -- how our strong franchise enables us to move forward key strategies, including -- the pivot in Individual Life, where we had a 52% increase from a year ago in the number of advisors recommending our life pivot products; the pivot in annuities to our risk managed fund strategies; accelerated growth in sales and net flows in RPS; and a push to stronger voluntary sales in Group Protection.

As I have said in the past, we will continue to build our strategic investments in distribution with an eye on expanding an already deep and powerful resource that includes 8,350 advisors affiliated through LFN, approximately 600 wholesalers in LFD, and approximately 550 representatives within our worksite teams. Spending a minute on Investment Management, our net realized gain in our investment portfolio was $8.7 billion or 11.6% of assets.

We maintain a strong level of net unrealized gains, the amount reflecting the long-duration of our invested assets, which is driven by our disciplined asset liability management practices. With low investment yields persisting, we continue to incrementally invest new money in high quality and well diversified asset classes, such as private placements, commercial mortgage loans, and middle-market loans. During first quarter we invested more than $700 million in these asset classes with an average yield in excess of 4%, more than a 200 basis point spread over the average ten year treasury during the quarter.

Our private equity book experienced lower than expected investment performance this quarter after a very strong 2011 and 2012. We do expect quarterly earnings volatility from our alternatives portfolio. It has over the last two years generated strong returns and we would expect good results in the future.

Let me close my comments with you today by saying once again that although we experienced fluctuations in the quarter that affected earnings, the underlying drivers of long-term earnings and ROE growth were very strong. Moving forward we will keep taking aggressive steps that help us to increase revenue and improve profitability. In 2013 expense management, product repricing to drive new product returns and active capital management are important priorities.

With that let me now turn things over to Randy.

Thank you, Dennis.

Last night we reported income from operations of $285 million or $1.02 per share for the first quarter, up 3% from the first quarter of 2012. Overall, it was a solid quarter with earnings negatively impacted by a few items of note, including $8 million of expenses that were recorded in the other operation segment. Adjusting for these expenses I would put normalized operating EPS at $1.05 per share.

In addition, we experienced $19 million of elevated mortality spread across both the individual and group life segments and $6 million from lower than expected income on alternative investments. I've chosen not to characterize the mortality and investment income experience as one-time in nature due to the fact that both of these items will fluctuate from quarter to quarter, but felt that the deviations from our long-term expectations were large enough that they should be noted.

Return on equity came in at 10.2%, as it was negatively impacted by the earnings negatives I detailed a little earlier, while book value per share, excluding AOCI, increased by 14% to $42 from the year ago quarter. Operating revenue increased 4% for the quarter and expenses were flat with the prior year. Net income of $239 million came in below operating income, primarily due to the nonperformance risk component associated with our variable annuity GLB reserves.

This component moves the credit spreads and is not hedged. Net realized losses on the other hand were minimal at just $4 million. Turning to segment results and starting with annuities. Reported earnings for the quarter were $159 million while ROE came in at 21%. Operating revenues increased 6% from the first quarter of 2012, primarily on higher fees driven by an 11% increase in average account values.

Interest spreads remain steady as we continue to be in a position to manage in force annuity spreads. Results specific to our VA guarantee riders reflect both the quality of our book of business and hedge program, as the net amount at risk associated with our guaranteed living and death benefits continued to decline to $415 million, in the case of living benefits, and $1.1 billion for death benefits, both measures right around 1% of associated account value, while the hedge program had another good quarter, with breakeven hedge performance and hedge assets $840 million in excess of guaranteed liabilities. Across all metrics this was another very strong quarter for the annuity segment. Of note, account values exceeded $100 billion at the end of the quarter, a record level for this important measure.

In retirement plan services, we reported earnings of $35 million, which included $2 million of excess investment income. Quarter over quarter revenue growth of 3% benefited from an 8% increase in insurance fees, the result of an 11% increase in average account values. Market appreciation, strong deposits and net flows again contributed to the growth in assets under management, which ended the quarter at $46 billion, an all-time record level for this key driver of growth.

Interest spread of 1.98% was down 19 basis points from the first quarter of 2012, roughly in line with our expectations for 20 to 25 basis points of annual spread compression for the Retirement business. Normalized ROA remained at 29 basis points on a sequential basis, in line with our expectations for 20 to 25 -- 25 to 30 basis points.

Turning to our Life Insurance segment, earnings of $112 million were down as a result of the fluctuations in mortality and alternative investment income. These two items reduced life earnings by $20 million for the quarter, with $12 million of the impact coming from mortality. The quarter's mortality experience was driven by a few large claims, primarily in our term insurance book of business.

To provide some context, our actual to expected mortality experience for 2010, 2011 and 2012 was 79%, 79% and 78% respectively, while this quarter came in at 86%. While we will have outlier mortality quarters, both good and bad, I expect that when viewed in the context of a longer period, such as a calendar year, that we will return to levels more in line with that experienced in the last three years.

Turning quickly to the life earnings drivers. Average account balances were up 6% and Life Insurance in force up 2%, consistent with recent performance. Reported interest spreads were down on the weakness of the alternative investment portfolio. On a normalized basis spreads came in around 185 basis points, down 13 basis points from the prior year and in line with our expectations for 10 to 15 points of annual spread compression.

Group Protection earned $14 million in the first quarter, with mortality negatively impacting the quarter's results by roughly $7 million. The mortality results for the quarter, which are similar to what we experienced in the first quarter of 2012, were driven by seasonality and fluctuations that will occur from time to time. As I mentioned with the Life segment, when viewed over a longer period, we expect to return to more normal experience.

Loss ratios in the Disability business recovered nicely on improved recovery rates and stable incidents. It is premature to extrapolate these results to the rest of the year, as incidents can trend higher and recoveries moderate. However, both metrics show well against the respective five-year averages, which is a positive development. Investments in distribution continue to drive stronger premium growth, which came in at 10% for the first quarter. We did reduce the discount rate on new claim incurrals by 50 basis points to 3.75%, which decreased earnings by $1.4 million and increased the non-medical loss ratio by approximately half of a percentage point.

Before moving to Q&A, let me comment on a few items of note. We continued with our disciplined capital management strategy during the first quarter, repurchasing 3.4 million shares at a cost of $100 million, cash at the holding Company came in at $647 million, and statutory capital ended the quarter in excess of $7.5 billion, while RBC was approximately 480%. Both measures down slightly from their year-end levels.

While guarantee UL sales were relatively modest in the quarter, they did generate some capital strain driven by the new reserve requirement that went into effect at the beginning of the year. We expect that we will be able to largely reverse this strain with the reserve financing transaction later in the year.

While as I noted, earnings were negatively impacted by a few items this quarter, we are very encouraged by the continuing strong performance that we see in key growth and operating metrics, including strong earnings driver growth, with both average account values and group premiums up 10%. Good expense management with G&A flat year-over-year; excellent sales and deposit growth, as noted by Dennis; continuing pricing increases across the portfolio; and a strong capital position that allows for continuing share repurchases.

With that, let me turn the call over to the operator for questions.

(Operator Instructions)

Steven Schwartz of Raymond James & Associates.

A couple of questions, guys. First on the mortality, which I guess we will probably hit a lot, the term was just a few -- on the term side it was just a few large claims. On the group side, did -- was there any commonality between what was going on, types of accounts, distributors, anything like that that might indicate something else than just random fluctuation?

Now Steven, this is Randy. We have looked across the entire book and it was -- I would say of the excess mortality about one third of it was seasonality. We typically see a little higher claims in the first quarter. The other two thirds really spread across the entire book.

Once again, to provide a little context around group mortality. If you look over the last three calendar years, the mortality rate is incredibly stable. It varies less than 1% year-to-year. Looking at the first quarter, we're roughly 10% above that level, with about one third of that attributable to seasonality, like I said. I fully expect that as you look forward and you look over a longer period, like a calendar year, that will return to the type of experience that we have had year after year after year.

And then just on the corporate side, you noted $8 million of after-tax expense there that you thought was nonrecurring. That would drive -- if you were to take a look at that, that would drive that commission other expense line to, certainly, lows over the last five quarters, maybe even longer. Would that be a sustainable run rate going forward, Randy?

I think that we had very good expense management across the Company. Typically when you look at expenses, historically, you will see they trend up somewhat over the course of the year as projects get rolling and production typically moves up over the course of the year. But I would note that I fully expect that account values and premiums and face amount in force also grow over the course of the year to cover that sort of expense growth. I think it just reflects very sound expense management. I wouldn't be surprised to see expenses trend up a little bit over the course of the year, but I expect revenues will continue to grow also.

Okay thank you very much.

Jimmy Bhullar of JPMorgan.

First question just on -- you mentioned limiting sales of secondary guarantee UL. Just how comfortable are you with the business that you have sold over the past couple of years given the rate environment and just given the reserving requirements? And then secondly on the dental business, the loss ratio seemed high, even ex-seasonality. So, wondering if you could actually discuss what drove that.

Let me speak to the first question about how comfortable we are with the guaranteed universal life sales that we have had over the past year. Each quarter we have been reporting that the expected new business returns on those products were in the 9%, maybe the 10% collective, when you add all sales up together.

And that those have been 1% or 2% below our targets. But the fact of the matter is it's a very difficult environment. We continue to increase our pricing, as I have mentioned. We are going to do it again pretty significantly in the second quarter. So, the answer is we are getting 10% on new business sales, our surplus is earning 3% or 4%. We continue to improve pricing. Yes, we're pretty comfortable with the sales that we have made. But, we're going to continue to improve the pricing and be very careful about the mix of sales as we go forward. Can't be more proud of the execution around this pivot strategy that we have mentioned this quarter and before. Randy, do you have something on the dental?

Yes, Jimmy, you typically see seasonality in the dental loss ratio. It is a calendar year benefit and so you see your loss ratio's a little higher at the beginning of the year as people use up their benefit and it trends down as people run out of benefit later in the year. I don't think there was anything in the dental loss ratio outside of that typical seasonality.

It seemed like it was higher than it's been typically in the first quarter, that's the reason I was asking. Normally it does pickup, but picked up a little bit more.

Yes, Jimmy, I think it was well within our expectations for the first quarter.

And then maybe I will ask another one on share buybacks. Last year you bought back a lot more in the first half than you did in the second half. Should we assume a similar pattern this year, because the buybacks were at least a little bit lower than -- what we had assumed.

Jimmy, as always, we guide to roughly $400 million of capital management over the course of the year. I fully expect that we are on track to do that again. As I say, every time that I give this answer, we always strive to overachieve and I don't expect any different this year. We're going to be working hard to get things like reserve financings done. I mentioned that we will reverse the strain we experienced on the guaranteed UL in the first quarter, I believe, with the financing transaction. I am very comfortable with the way we are using our capital to do things like share buybacks. I think we will continue as the opportunity arises.

Okay, thank you.

Suneet Kamath of UBS.

Randy, I just wanted to follow-up on Jimmy's last question on the share repurchase. Interested in your comment about wanting to overachieve again this year like I think you did last year. If you did do more than the $400 million, should we be thinking about a higher level of reserve financings being the primary driver there or is there something else that you are thinking about that could influence the pace of buyback?

I think if you look back to the last couple years, it has been a combination of strong reserve financing a couple years ago. And then last year just leveraging a bit of our strong capital position. We remain very well capitalized, a very strong capital position. So, I think it is going to be a combination of all those things if we are able to. Once again, my guidance is for the $400 million. We are always trying to overachieve on everything we do.

And then can you just talk a little bit about the reserve financing market? You said that you are going to try to reverse some of the strain that you experienced in the first quarter. How likely is it and then from a timing perspective when would you expect to pull the trigger on something?

The reserve financing marketplace from the suppliers is as strong as it has ever been as it sits today. I think the only caution I'd put out there is that we continue to work with the NAIC on captives. I believe that at the end of the day we will end up with a capita solution -- captive solution that is in alignment with how we have historically used captives, but that's the one caution note out there I'd say.

Got it. And then just another one on the Group Protection business. I think in your prepared comments you talked about the voluntary business being up. On Unum's last call, in the last hour, they talked about some pricing challenges in that business. Perhaps some competition, some impact from health insurance reform, healthcare reform. I'm just curious in terms of what is driving your growth. Is it new plans that you are adding or increased business with existing accounts? It seems like you're seeing a little bit of a different trend than perhaps they were guiding to in terms of their first quarter.

That is a good question. I think is -- well, I shouldn't say I think Unum -- Unum dominates the market and they have a very large market share. I think the dynamics for them are a little bit different than there for us, because we have smaller share and so our percentage increases don't require this many dollars of new sales, frankly. But it's a combination of a couple of things. One, as you heard me say, our sales force is up 13%. I didn't mention it again this year or this quarter, but last quarter we talked about that sales force being able to reach a lot of new brokers. And so it's driven in part by the increase in our sales force. Also, it just so happens this quarter that we had one or two larger cases than we typically get on the voluntary side. And so that helped with the increase.

Insofar as pricing is concerned, at least relative to true group, we continue to get better ROEs on our voluntary business. So, that is better business for us from a profitability standpoint. So, we are going to continue to try -- the 61% increase that we saw in voluntary I don't expect that percentage increase to continue through the course of the year, but it was a good first quarter, we are proud of it and it is good business.

Then just last one on the mortality, just so I understand the messaging, Randy. When you said the one third, two thirds, was that just for the group insurance business or did that include the Individual Life? And then I guess as we think about getting back to that -- those mortality actual to expected numbers that you were talking about, should we assume that you will probably get back the one third from the seasonality maybe as soon as the second quarter? But that the other two thirds might take a couple quarters before that comes back? Just wondering how that is going to trend as we move forward through the year. Thanks.

Seasonality and mortality are a little higher (inaudible-technical difficulty) mortality in the first quarters. It is pretty typical across -- we've seen it pretty typical across all of our businesses. Specifically, I spiked out the third in the group business. It's a little more volatile in the individual business, I would say. So, the timing of getting back that, I don't know. I think once again, on the life side at the end of the day, our A to E is incredibly steady year after year after year on a calendar year basis. There's nothing in the mortality that leads me to expect that we should expect any different going forward. As to the timing of when it comes back, I cannot talk about that.

All right, thanks.

Erik Bass of Citigroup.

Just had a question on VAs. Just wanted to get your perspective. Pricing has gone up significantly over the past few years and features have become less generous, but it still seems like we are seeing strong consumer demand for the product. Just wondering if you have any sense from your discussions with customers or through your distribution list, how much more the industry can reduce feature generosity before customers won't buy the product? Just be interested in your thoughts on that.

That's a great question. We give it a lot of thought around here. When I look at the Lincoln fact situation, we have increased pricing pretty significantly either through reducing the benefit levels or from actually increasing the charge on our riders. Collectively, we have done that over the last couple of years. Separate from the consumer, we have decreased commissions. We have also recently restricted add-on payments.

So, there's quite a bit that we have done and I think as you have pointed out, others have done the same thing. Yet we continue to see good demand from consumers. I don't think we have yet reached the point where the price changes the industry has been making is at a point where consumers don't think VA is still a good product for them for part of their portfolio. How much further we can do -- we can go, I think we will just have to see.

That is a combination of not just VA, but what other alternative investment opportunities that are available to the consumer. But, so far so good, and again, at Lincoln, we are producing 20% ROE's on a consistent basis. You heard Randy talk about the hedge fund performance and Standard & Poor's and Moody's both publicly say that Lincoln's hedge performance, excuse me, hedge strategy and risk management is singularly the best in the industry. So, we will make adjustments as we can. It's a good business and in the right amount, we're quite happy with it.

To follow-up on just that last point, when you say the right amount, how do you think about that and, I guess, if we are in a scenario where pricing alone is not enough to dictate demand, then would you consider actions on the distribution side, if need be, to manage the sales volume?

Let me put my comment to the right amount into perspective a little bit. I think because we aggregate fixed annuity earnings with variable annuity earnings that we leave the impression that variable earnings -- maybe, we leave the impression that variable annuity earnings are a larger portion of total earnings than they actually are. If you add up business segment earnings. If you add up the group business, the life insurance business, the RPS business, and the individual annuity business, variable annuity earnings are about 36% -- say a little bit more than a third of the total of those, of that aggregate. It's probably lower than what you all think. I am not uncomfortable with that level. As we move forward with our program, again, we want to see growth, but we're not looking for 15% to 20% growth year-over-year.

And how much we will do is a function of earnings mix, it is a function of, frankly, the multiple applied to that by the market over time and I think that's going to get better rather than worse. We have to look at the potential calls on capital from the size of the book that we have, but right now, we are in very good shape. I think Randy mentioned, just throwing another fact in here that the living benefit reserves and the mortality reserves are only 1% of our, not the reserves but the net amount at risk 1% of our account values. 1% of our account values, excellent risk management. Continue to change pricing.

And let me just comment and then I am running on here a little bit, but in May we are going to reduce by 50 to 100 basis points the payout on the benefit on our joint survivorship business, which represented about 50% of the business that we had in the first quarter of 2013. So, again, in the second half because of that pretty substantial benefit change, we would expect sales to be tempered from what they otherwise might be in the second half.

Erik, just let me add a little bit to that. I would say that part of the reason they have some up, the earnings that are at 36%, is because the equity markets have performed so darn well and I definitely put that in the camp of a high-quality problem.

Certainly. Thank you very much for the answers. That is helpful.

Mark Finkelstein of Evercore Partners.

Randy, I think you alluded to it a little bit, but maybe you or Dennis, can you just give us an update on where we are in the captive discussions? You guys are clearly involved in discussions that we don't see.

First of all, the starting point, if I could compare it to AG 38, is much different, because the starting point on AG 38 was both a prospective and retrospective application of the new, whatever the new reserving practice or rules would be. It ended up being just mostly of perspective things and cash flow testing retrospectively and I don't think in aggregate the industry really had to change its historical reserves in total by much, if any.

With respect to captives, I think we're pretty much starting from a perspective that a lot of good captives have been put in place. There might be one or two things that the regulators are concerned about in some of the structures, but that by and large, both the industry and the regulators are looking at this more on a prospective basis. And the discussions are ongoing. Lincoln, along with other companies in the industry are engaging directly with the NAIC leadership and I expect a similar good outcome on this as to what we saw jointly between the regulators and the industry on AG 38. What we're looking for, both of us in the industry and the regulators, want the captives to be strong. We have a focus on solvency when we do these things at Lincoln, making sure that they are substantive, they are real, there is risk transfer. I think the regulators once they are satisfied with some of the more sound structures and they can get some comparability and some understanding transparency that it will work out. But, it's in its early stages. It will take a while to work through.

I guess, just on the life changes. You talked about putting through some rate increases in SGUL and, I think, MoneyGuard as well. How meaningful are the increases that you are making and how do we think about sales levels of those two products going forward?

First, sometime in the first quarter we restricted single pay premiums completely, not completely but significantly, while we were repricing the products. On single rate product or short pay products, single pay or short pay products, we are looking at some pretty substantial increases in premium, 16% to 30%. So, those are big changes, but with the new reserving requirements and the low interest rates, that's what it takes to get a decent return.

On MoneyGuard, two things that we're trying to do. One is move more of the business to flexible pay, which has a better return pattern, and then we are also increasing the premium requirement on the single pay by 5%. We are eliminating some single pay -- we are eliminating single pay for ages over 70. So, we're doing quite a bit more at the margin, but 5% is a pretty big increase and the movement to the flexible pay versus single pay is important as well. It is a pretty significant movement on that. As you have been listening to me speak, last year and this year we're talking about strong price increases across all of our product lines. You hear us talk about 5%, excuse me, middle single digits to upper single digits in the life side, 15% and 20%. So, we are going at it aggressively and we still, as you saw, had pretty good sales results across all of our lines. We're feeling good about it.

Okay. Thank you.

Chris Giovanni of Goldman Sachs.

Just a question in terms of response from the distribution. You made the point you guys are putting through aggressive price increases. The industry is doing that broadly. How are they responding as they look for products to sell?

Let's talk about how this works at Lincoln and then we will talk about how it might be received by our distribution partners. At Lincoln, any decision about product changes or price increases is a collaborative decision between our distribution organization and our manufacturing organization. That is still very important, because as you get to the end seller of the product, the financial advisor at Merrill Lynch or the financial advisor at Morgan Stanley, we have to make sure that the changes that we're making, either in the design of the product or the pricing of the product is going to meet with their needs. And, so, everything we do takes significant input from, not only internal distribution people, but discussions with our distribution partners outside. So my answer is that we don't do anything that we don't think is a good balance between what the distribution organizations need. Again, our partners, the 67,000 different individuals that sell our product lines and what we need to get decent returns for our shareholders.

And then the product changes that you are making on the VA, Randy, can you comment maybe just how much of a boost in ROEs or IRRs are you getting on the new product versus the similar old product or comparable product?

Could you ask that again please?

Yes, just in terms of the ROEs or the IRRs that you guys are measuring for the product that you are going to be focusing on now in terms of the VA sales, the changes you're making versus what you sold maybe just a quarter or two ago?

The change in the ROE?

Yes please.

Generally, we are going up 1% to 2% on the internal rates of return across the board. That is what the objective is on all of the different products.

And then just following up, Dennis, last quarter you made the comment around smart money looking into the VA space. Curious if you can provide any more thoughts or insight in terms of what you are hearing or seeing on that front over the past three months or so.

There was a flurry of activities that were done by the private equity firms, I guess predominantly Apollo and Guggenheim. Everything we hear is that there is -- because they have been so successful and the profitability of what they have done has been high, that there is other private equity firms that are out looking for similar opportunities. So, I think private equity and the fixed and variable annuity business will be a growing phenomenon over time. And hopefully a positive impact on the business in general.

And would that be your view? And I guess you sit on a lot of boards and represent the industry. I think there are some concerns that people have on increased risks on the asset side, maybe putting companies or the industry at risk. Is that something that you would be focused or worried on or not as much at this point in time?

That's a question that I think we have to see how it evolves. Anecdotally, what we have seen is that the private equity firms are barbelling. And so that in their portfolio they are putting more private equity in, which would be a higher risk, more volatile asset, but they are compensating for that by limiting the rest of the portfolio, at least in the cases I've seen, to more like NAIC 1 type investments. And in some instances, the actual C-3 risk or the call for capital in the portfolios they structure is less than what maybe a typical insurer would do. So, that would lead you to believe that there is no more risk in what they are doing than what the average annuity portfolio is doing. Having said that, that is anecdotal and we will have to continue to watch as more private equity firms get into the market to see if there is a change in posture that would change my view on it.

Understood, really appreciate the insight.

Tom Gallagher of Credit Suisse.

First a follow-up question on the universal life product changes. The single pay and short pay SGUL that you referenced, you were changing pricing on. What percent of sales would those represent, let's say, in 1Q or the quarter before that. Is that meaningful as a percent of overall sales?

Not since we have introduced the limits on the amount of single pay business that we will let flow through the system. But we want to get out into the marketplace and have single and short pay that is profitable business. We want to have a complete portfolio of business and so it still would represent a small portion of what we do, is my expectation, but we would have a product that meets our hurdle returns.

Dennis, my question -- I just wanted to try and get the context of that change. If you're not selling much of it by changing pricing, presumably it will go close to zero. I just want to understand what is going on behind the scenes. Why flag this if it's not really moving the needle in terms of sales volume to begin with.

AG 38 has come out and, again, I am just going to repeat what I said. It's important for us for our distribution partners to have a complete suite of products. And right now, our old single pay short pay product is way underpriced for the type of returns that we want to achieve. So, as a stopgap measure and something that we don't like to do, we have essentially limited the amount of business that can come in on that basis. So, the next step is to get back into the market, even though it's a small piece of what we will be selling, but we will have a product that is a good product for the consumer, it has acceptable returns, even with the new AG 38 reserving requirements. And, again, we will build out the product suite and that's important, because people don't come to us for a single product, they come to us for a suite of products and so we want that full suite of products that strengthens the relationship with our distributors or our industry leaders.

Understood. So, the reason the sales volume is low is because you are just limiting the amount. But you don't like the profitability as per new AG 38 requirements, so, you had to get it to acceptable levels, even on that limited amount. That's the way I should be thinking about it.

Yes. I think that is a good summary.

And Randy, just to go back to the actual to expected, I just want to understand -- I fully get the message here. The 78% to 79% a year seems like a very good result. And this quarter's 86% was worse, but still certainly doesn't sound bad in the grand scheme of things. So, you had said two things. One was that if you looked at it versus a year ago in the 1Q '12, it was fairly similar. I think I got that right, that's what you said. I just want to make sure that is what you said. And then I want to understand, should we take these numbers to mean even if they do drift up to the mid-80s% actual to expected that would still be pretty favorable relative to reserving levels, even if the absolute earnings we're going to see is going to be low? I'm sorry, for the long-winded question, but I just want to try and get -- better understand this.

Sure. On the first part, I think you were mixing the two businesses. I think I said Group was similar to last year and the percentages you were referring to were the numbers I gave for the individual business. On the individual side we were higher than we were last year from a mortality standpoint. As to the second part, the mortality that we assume in our DAC models and in our SOP reserves, for instance, that reflects our experience as a Company.

And I don't see any threat to those assumptions inside of those models as we sit here today. I have no reason to expect that the assumptions we're using in our models need to change at all, because we had one quarter of bad experience. As to the theme of your last question, mortality drifting up 85%. That just is not something I would ever expect to happen. 99.9% of the people that were with us for the last three years are the same people that are part of our mortality experience today and those people haven't suddenly decided to die at a 10% faster rate. Experience is going to be what it has been in mortality. It doesn't change at a very fast rate.

And, Randy, just following up on that, in 3Q of this past year you did make some, I think it was assumptions, to your DAC model, which released some of the conservatism on the mortality side I believe. Is that too small to move the needle or is it possible we are starting to see some of that flow-through?

I don't expect that what we experienced this quarter will have really any impact on the assumptions in our models. So, I don't really see a threat from what happened this quarter.

Okay, thanks.

John Nadel, Sterne Agee.

I had a question on alternatives, just because I am so curious by the results this quarter. I think Lincoln is the first and the only company that I have seen so far this quarter across, frankly, all of insurance that is seeing alternatives investment income come in below expectations. Is there something specific, a specific fund or something like that that might have driven that?

That's a great question. You expect the performance of at least the private equity to follow the stock market in some fashion. Let me just give you some statistics that might help put this into perspective. Our total alts, the total portfolio is $841 million at the end of 2012. We are taking that up to $1.1 billion by the end of 2013. And during -- in 2012 that portfolio earned $125 million. In 2011 it earned $90 million.

But, when I look back over the last 24 months, I will just pick out some points for you. In December we had negative $2 million in December of '11. In March we had positive $42.5 million. So, year-over-year we've had pretty consistent total earnings, but in any one quarter we have seen swings as high as $45 million, quarter to quarter. So, my guess is this is just a -- just one of those quarters where you just have a bad result and there is no systemic reason for it.

It's helpful. I was going to ask you, so, you already answered with how much you expect to take this portfolio size up through this year. So, we should expect as the size of the portfolio grows, I suspect your return expectations will be similar. Is that fair to assume? So, a normal level of alternative investment income should grow with the size of the portfolio?

Yes. The only caution I would give you there is there is the same J curve concept in private equity, which is -- particularly on brand-new investments. It takes two, three or four years before you begin to see earnings development. And so we try to balance the richness of, or the age of the portfolio and not overload it with too much new stuff, because that will drive it down in the short run to earnings.

Understood. And then, Dennis, I have got a question for you just on the variable annuity business and market share. I think you have said in the past that Lincoln has been very steadily over some lengthy period of time about the number seven player in the VA market. In short-term periods of time I suppose that can move higher or lower. My guess is, it has moved higher here recently with your 35% year-over-year VA sales growth.

Much faster than what we have seen from at least the publicly traded peer group. My question is this, long-winded way of asking it, but what level of market position are you comfortable with? Are you comfortable with moving into the top five if more of those who are currently there continue to pull back as much as they seem to be doing?

If I might just correct the market position and I don't know maybe you have put more people into that bucket than we do, but we have been fifth for five years.

Okay.

And we're putting the IRB slides together and we have a very powerful slide in there that in terms of quarterly fluctuations in sales that over the last five years -- when you see this you will see that our quarterly fluctuations have been extremely modest relative to the industry. And that is because we have never chased market share by having a low priced product. Again, the way we run the business, we are comfortable. We would rather tamp down sales, but again we're not looking for 30%, 35% sales increases this year. We can't turn on a dime because we don't like to take product off the shelf. We don't think that's a good strategy vis-a-vis our partners, our distributor partners. And so we have to do it with pricing changes.

And sometimes it just takes a little longer for us to get a pricing change. It takes three, four, five months to properly redesign and then get the product approved. But this May change that we are making is consistent with our strategy. We've seen our volumes get a little bit higher than we would like them to see. We have opportunity to improve returns even above the already high returns that we are getting and expect sales to slow over the second half of the year.

Very, very helpful. I really appreciate the color, thanks.

Thank you, ladies and gentlemen, this does conclude today's conference. Thank you for your participation and have a wonderful day.