Lincoln National Corp (LNC) 2013 Q4 法說會逐字稿

Good morning and thank you for joining Lincoln Financial Group's fourth-quarter 2013 earnings conference call.

(Operator Instructions)

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

Thank you, Operator, and good morning and welcome to Lincoln Financial's fourth-quarter earnings call. Before we begin, I have an important reminder.

Any comments made during the call regarding future expectations, trends, and market conditions, including comments about sales, deposits, expenses, and income from ops, 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 last year's 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. I would now like to turn the call over to Dennis.

Thank you, Jim, and good morning, everyone. Lincoln had a very good year. With the majority of our business segments performing well, operating earnings per share reached a record level, up 13% for the full year.

Assets under management also reached a record level, ending the year at $207 billion. Operating return on equity for the full year was 12%, and book value per share was up 10%. All strong results, driven by numerous initiatives and strategies implemented throughout the year.

Touching on a few; we continue to take aggressive pricing actions across our businesses that positioned us for increased profitability. We effectively tapped distribution to drive our strategies, to pivot toward more profitable products, and diversify risk. We maintained a best-in-class risk management capability. And lastly, we repurchased almost $450 million in shares, while ending the year with a very strong balance sheet, including a record statutory capital amount and RBC at 500%.

The one piece of the year with which we were disappointed was our group protection earnings. We have already taken steps to get earnings back on track. Randy and I will share more details about this in a few moments.

Let's turn to the life business. Individual life had an impressive year with a 15% increase in sales. We made significant pricing improvements on many of our products and have a diverse, profitable solution set.

Full-year sales of our pivot portfolio, which includes indexed universal life, variable universal life, term, and flexible premium MoneyGuard increased by 51% over the prior year. This quarter, a new, repriced MoneyGuard product will be introduced, which rounds out the pricing actions necessary to address the impact of low interest rates.

Additionally, we will update our VUL product, a move that will boost already strong returns while maintaining competitiveness. With these changes, the pricing on our entire life product portfolio will be at the 12% to 15% return level, a higher level of return than in recent years and toward the top end of our expectations.

Looking forward, the depth and breadth of our distribution relationships, coupled with our proven ability to rapidly adapt to changing conditions, will enable us to keep offering smart solutions and capitalize on market opportunities. Individual annuities; our individual annuities business also had a very good year with strong sales, net flows, and an effective hedge program adding to the drivers of strong equity markets and rising interest rates.

We continue to grow the annuity business on our terms, including making the adjustments necessary to manage living benefit sales to our objectives. In the fourth quarter, non-guaranteed living benefit sales were 18% of total VA sales, up from 13% in the third quarter, due entirely to shifting our wholesale-focused toward non-guaranteed products.

Including the impact on sales covered by the reinsurance treaty with Union Hamilton RE, non-guaranteed products comprised 32% of total VA sales in the quarter. 32% is approximately our long-term target mix. We expect product design and distribution to drive our sales mix goals over time.

To help achieve this, later this year, we will introduce an accumulation based VA product with an expanded fund lineup specifically designed to grow our non-guaranteed sales. So, annuity deposits of $14.8 billion for the full year drove positive net flows of $5 billion, total account values of $115 billion were up 19% from a year ago.

Let me turn to group protection. Weak earnings in the fourth quarter were primarily the result of poor long-term disability loss ratios. These results, coupled with poor mortality experience earlier in the year, reinforce our need to continue to take aggressive pricing actions aimed primarily at our employer-paid life and disability business. We began taking more aggressive actions in mid-2013.

To put this in perspective, we have about $1 billion of the earned premium associated with the employer-paid business. More than half of this will be repriced by this time next year, and the majority in the following 12 months. In addition to pricing changes I've just mentioned, we continue to have success driving our strategy to grow the employee-paid segment, both voluntary and worksite, through our investments in distribution and by offering a diverse product portfolio.

Pivoting toward these product lines, which carry better margins, is another important ingredient in improving the earnings profile of this business. Speaking to that change in mix, fourth-quarter sales were up 30% from the same period last year, and full-year sales were up 18% over 2012, the increase driven entirely in employee-paid sales.

These increases elevated employee-paid sales to almost half of the total 2013 sales, and we expect that number to grow to more than half in 2014. A promising outlook, given the profitability profile of the business. Conversely, sales in the employer-paid space were flat year over year, and are expected to decline in 2014.

We are confident that our powerful distribution system, better priced employer-paid products, and a diverse set of employee-paid solutions will lead to restored margins. Although earnings for the year were disappointing, the momentum from the actions we are already taking have us headed in the right direction.

Retirement plan services, the business performed well and we are pleased with our ongoing progress in the space. Total deposits of $6.8 billion in 2013 were up 6% from the prior year, driven by significant new sales in our mid-large market and by the successful launch of several strategic small market initiatives, including our expanded partnership with Bank of America Merrill Lynch, and a broadened product portfolio that allowed us to reach clients at the larger end of the small market.

Account balances ended the year at a record high, over $51 billion, an increase of 17%, due to a combination of new sales, increased employee contributions, continued strong client retention, and favorable equity market performance. We did experience negative outflows in the fourth quarter due to the natural ebbs and flows of the mid-large case market.

That being said, we have been more successful in keeping profitable business on our books as evidenced by planned sponsored termination rates in 2013, and our small and mid-to-large markets improving by more than 10%. As a result, we saw a nearly $800 million of positive net flows for the year.

Looking ahead, we are optimistic about growth prospects in our retirement business. Areas where we will focus our attention include; expanding our distribution force in the small market, where we look to grow our wholesale account by 40% in 2014, continuing to build out strategic partnerships among consultants, warehouses, and independent planning firms, maintaining our push in the fast-growing mid-large market and healthcare markets, and achieving operational efficiencies through platform transformation in technology enhancements.

Turning to distribution, our retail, wholesale, and work site teams continue to deliver outstanding results and help drive our overall success. The depth and breadth of our distribution franchise remains a core industry advantage for us, successfully driving the pivot to more profitable products and segments that I mentioned earlier. We have reached an all-time record number of third-party advisors and agents choosing to sell Lincoln products, now 66,000, up 11% from 2012.

Not only did our active base expand, but productivity also climbed. In 2013, the number of repeat producers grew 21%, while the number of producers cross-selling more than one product grew 15%. Looking ahead, with all of our products at attractive return levels and our focus on shifting and diversifying the mix, we'll continue to tap into the power of distribution by expanding wholesalers in RPS, life MoneyGuard, and annuities to advance our goals and deliver strong results.

Retail distribution through Lincoln Financial Network continues to be a leading driver of our strategy. We are making investments in LFN aimed at strengthening our value proposition for independent advisors and their clients. An example is the recently announced relationship with National Financial, a Fidelity Investments company, as our clearing platform provider. Through this arrangement, we will marry the technology strength of Fidelity with proven distribution strength of Lincoln Financial Network.

And finally, in investment management, our overall portfolio is well diversified and of high quality, with an average credit rating of A minus. Year over year, our below investment grade exposure decreased by approximately 1%, primarily due to a favorable credit migration and maturities. This gives us more flexibility to continue to broaden our investment strategies.

With respect to new money, our average yield in 2013 was 4.2%. In the fourth quarter we invested new money at 4.7%, and our yield-enhancing, fixed-income strategies contributed close to 20 basis points of this yield. Our new money rate last month was approximately 15 basis points below the fourth quarter. At these levels, we are investing new money well above our average 2013 new money yield, allowing for continued easing of investment spread compression.

So, let me close my comments today by saying once again that we had an exceptionally good year. Our overall performance and the action plans position us well for 2014 and beyond.

Areas where we will focus our attention include increasing the diversification of our product sales to roughly 70% non-guaranteed and 30% guaranteed. This is across all product lines, increasing our margins over time coming from mortality and morbidity, returning margins in our group protection business to historical levels that will drive improved earnings, maintaining active capital management, and best-in-class risk management capabilities.

And finally, further distribution expansion in productivity improvements. With that, I will turn it over to Randy.

Thank you, Dennis. Last night, we recorded income from operations of $382 million, or $1.40 per share for the fourth quarter, up 27% from 2012. The quarter's excellent results capped off a strong year, which saw full-year EPS of $5.03, up 13% from the previous year. Of note, $5.03 represents the highest level of EPS that we have ever recorded for a year.

Looking at key performance metrics, we had strong top line performance with operating revenue up 7.8% for the quarter, and 5.8% for the full year, driven by drivers such as account values that ended the year at record levels, strong equity markets, and interest rates that increased steadily over the year. Across the Company, a continued focus on managing expenses led to G&A, net of capitalized expenses, being essentially flat for the year.

We saw a 10% increase in book value per share, excluding AOCI, to $45.23, while statutory capital reached an all-time high of $8 billion, with RBC coming at 500%. And last but not least, return on equity came in at 13% for the quarter, and 12.1% for the full year, with both figures up over the comparable prior period.

As noted in the press release, we had normalizing items of $25 million, or $0.09 per share, in the quarter, primarily related to some reserve true-ups and tax items. I will discuss the normalizing items in more detail during the business line comments.

A couple of other items of note during the quarter. Alternative and prepayment-related investment income came in somewhat above our expectations during the quarter, with the positive benefit offset by G&A that was above a normalized level. G&A was elevated due to incentive comp accruals, deferred comp-related expense that was driven by the increase in the share price during the quarter, and the seasonality that we typically see in G&A during the fourth quarter.

Finally, good underwriting results in the individual business were offset by poor experience in the group business. I will discuss the group results in more detail in a bit. Net income results for the quarter and full year were fairly clean and straightforward. Realized losses were largely unchanged from the prior periods, and hedge results were good, with little breakage for either the quarter or year.

Turning to segment results and starting with annuities. Reported earnings for the quarter were $199 million, a 23% increase over last year. The only item of note impacting annuity earnings for the quarter was an unfavorable $3 million dividends received deduction impact as we trued up the DRD as the final year-end data came in.

Operating revenues increased 16% from the fourth quarter of 2012, as positive net flows and strong equity markets drove an 18% increase in average account values that at the end of the quarter reached a record $115 billion. Returns in the annuity business continued to be very strong, with ROE coming in at 26% for the quarter and 25% for the year, and are indicative of the quality of the book. With our consistently sound product design and a relentless approach to risk management, 2013 was a truly great year for the annuity business.

In retirement plan services, we reported earnings of $34 million. Quarter-over-quarter revenue growth of 5% benefited from an 11% increase in fee income, as positive net flows for the full year and strong equity market returns led to a 16% increase in average account values, which at the end of the quarter climbed to a record level of $52 billion.

The pressure on interest margins from low rates has served to mute the earnings growth in this business, with normalized spreads coming in 24 basis points lower for the year, and 3 basis points from the third quarter. This is consistent with prior guidance and looking forward with rates at the current level, we expect spreads to decline by 10 to 15 basis points on an annual basis in the retirement business.

Return on assets for the quarter came in at 27 basis points, within our long-term range of 25 to 30 basis points. Overall, 2013 was an excellent year for the retirement business. Earnings grew 9% over 2012, return on equity was strong at 14.7%, and return on assets of 30 basis points came in at the upper end of our targeted range.

The life insurance segment reported its strongest earnings quarter of the year, with $157 million, or $146 million after normalizing for a reserve adjustment. Earnings drivers remained steady for the quarter and year, with average account balances up 7% and life insurance in force up 4%. As noted earlier, life had good mortality experience for the quarter.

The quarter's experience, which added approximately $9 million to the quarter, brought our full-year mortality back in line with long-term expectations, a very nice way to end another strong year of operating performance for the life insurance business. The group protection segment results fell short of expectations, earning $11 million in the fourth quarter and $71 million for the year. The quarter's results included $8 million of favorable impact, primarily from a reserve true-up associated with the accounting for LTD overpayment recoveries, offset by an accrual for unclaimed property.

Earnings were negatively impacted by bad results in the LTD business. I'd estimate the negative impact on the quarter at $12 million after tax, with the negative impact coming from three main sources with roughly equal weight. Incidence, which at 4.23 for the quarter came in above the full-year level of 4.06. We do typically experience seasonally high incidents in the fourth quarter, but 4.23 is somewhat above what we expected.

Claim size that ran above our recent experience and recoveries that came in below recent periods. In understanding the quarter's bad experience it may be helpful to dissect our group business into its component parts. We had $1.95 billion of non-medical earned premium in 2013.

That premium is spread across the business in the following way. 55%, or $1.1 billion, is employer-paid life and disability. 35%, or $700 million, is employee-paid business, while 10% is employer-paid dental. As we have analyzed the year's experience, the negative results can be attributed to our employer-paid life and disability book of business.

As Dennis mentioned, a significant portion of this book will be repriced by January of 2015. Let me explain when that repricing will appear in our revenues. Approximately $300 million of 2014 earned premiums with an additional $500 million of 2015 earned premiums, with the business nearly fully repriced by the end of 2016.

As we entered 2013, I predicted that we would earn $80 million to $90 million for the year. We actually came in at $71 million for the year, so while I'd estimate that we are six months or so behind where we thought we would be as we entered the year, we do continue to process of rebuilding the profitability of the employer-paid business to what it should be and continuing the shift in business mix to a more employee-paid book of business.

As we see things today, and assuming that loss ratios return to the 74% range that we experienced in the first three quarters of 2013, we expect to see earnings in the $60 million to $80 million range in 2014. Before moving to Q&A, let me comment on some of the highlights of 2013 and what you should expect in 2014.

2013 was another great year from a capital generation and capital deployment standpoint. Strong statutory performance allowed us to upstream over $800 million to the holding company, which led us to deploy nearly $700 million in 2013, including $450 million in share buybacks, $128 million in shareholder dividends, $100 million in net debt reduction, and grow statutory surplus by $350 million, the previously mentioned record level of $8 billion.

Speaking to the consistency of our statutory performance, over the last three years we've now upstreamed $2.7 billion to the holding company, deployed $2.2 billion, with $1.5 billion of that going into share buybacks, and growing statutory surplus by nearly $900 million. As we look to 2014, I would expect similar capital deployment to what we accomplished in 2013.

Additionally, we increased our shareholder dividend by 33% in the fourth quarter, and ended the year with $1.2 billion of cash to the holding company, which includes $500 million as a pre-funding of first quarter debt maturities. Taken all together, 2013 was another year of excellent financial performance, record earnings, earnings drivers that end the year at record levels, and a record level of statutory capital all speak to the strength of both past results and future expectations.

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

Thank you.

(Operator Instructions)

Chris Giovanni with Goldman Sachs.

Thanks so much. Good morning. Dennis, first question for you in the annuities space.

We've seen a number of the traditional fixed riders, see some nice growth here in the recent quarters. But really haven't seen any momentum in that product from you guys. Is that something with that product that you don't like currently? Or is that you are seeing better opportunities still in the VA space?

Chris, the fixed annuity business has always been one of trying to get the right returns on it. And we can turn that business -- we can increase our sales on that pretty quickly, given the distribution system that we have. So as interest rates rise, and particularly the yield curve steepens, that gives you a better opportunity to get better returns.

So I would say in answer to your question, we can do a lot more volume if the interest rate environment is helpful to us getting returns in the 11%, 12%, 13% range. A lot of the strength in fixed and indexed annuities that you see is a little bit in the segment of market that we don't play in, which is the high commission, high surrender, and long surrender charge business. We've shied away from that over the years.

Okay. I'll ask one more and then I will get in the queue. Maybe more a question for Alan, but I will ask Randy, if perspectives around the investment portfolio risk management related to the new derivative requirements that starts to come on board, in terms of what asset classes can and can't be posted?

Which I think points to probably more liquidity that the industry may need to hold over time. So just on perspective in terms of how you guys are thinking about this risk and kind of addressing it within the investment portfolio?

Yes, Chris, we've seen very little impact and expect very little impact on how we operate our business going forward. In fact, I would say no impact on how we operate our business going forward. There were some new collateral posting requirements with Dodd-Frank and such, and those have added up to a big nothing so far for us.

I don't anticipate a big change in the amount of collateral we are going to be posting, nor do I expect a change in the type of derivatives we use, either in the hedge program nor the small amount we may use in day-to-day operations of the Company.

And is that because the existing contracts are grand fathered in? Or even when new positions start to roll, you still would expect no impact?

Anything new you put on, there are new collateral posting requirements. Just factually, it just hasn't added up to much, not anything that's changed the way we operate the liquidity of the organization. And factually, the amount of additional posting we had at the end of the year I think $2 million to be specific. So, the numbers are not going to change the results of the organization or really the way we operate the liquidity profile of the organization.

Great. Thanks so much.

Randy Binner with FBR Capital Markets.

Great, thank you. Just wanted to ask a couple on the group segment. Can you quantify the degree of these price increases in the employer paid book? And is this the first time in the last couple of years that you increased pricing here? Can you give us a sense of when the last time was that pricing was applied to this book?

Yes, Randy, let me take that. And let me put it in perspective that we pre-price of renewals -- about 50% of what you do in renewals occurs in the first couple of months of the year. If you go back to the early part of 2013, the first couple of quarters, we were kind of in the mid-, lower-single digits with our renewal increases, but with increases.

As the year progressed, we moved above middle-single digits to a little bit higher on our repricing. But again, a lesser amount of the current in-force premium. And as we look into 2014, for the whole year we are starting off in the mid to higher range, and may even get up to the high-single digit range, mid-high single digit range.

I guess the follow-up --

On the way up.

-- there is, and then thanks for those comments, but the follow-up is we watch a bunch of companies in group benefit ratios, just broadly speaking. I know this is isolated to a particular type of DI, but I'd say group benefit ratios, broadly speaking, are maybe 200 basis points better over the last year. Frankly, it feels a little late in the cycle to have this issue.

I guess I'd be interested in your response to that? Because it's kind of late in the cycle relative to unemployment drag. What do think is causing this to crop up now?

You mean the higher incidence on LTD?

Yes.

There isn't anything in our underwriting or in our analysis of it, the incidence increase, that we can attribute to any particular case size or industry type. And It's popped up. It could very well pop down, but we are not waiting for it to pop down. And in the group business, this happens all the time.

You have trend lines that have volatility around them. And you have to make a decision at some point, is the volatility around the trend line raising the trend line permanently and do you need to reprice? Or is it something that's going to come back? And we just decided that we're going to increase prices because of where we saw ourselves with earnings in the last two quarters, last couple of quarters.

All right. Understood. Thank you.

Suneet Kamath with UBS.

Thanks and good morning. I just wanted to start with the life insurance business. I think, as Randy mentioned earlier, fourth quarter is one of the strongest earnings quarters and represented, I think, a bounce back from previously unfavorable mortality.

I guess my question is, should we think about the run rate going forward as similar to what we saw in the fourth quarter? Or are you expecting maybe mortality might revert a little bit back to what we saw earlier in the year?

Suneet, so we made, excuse me, $157 million in the quarter. As I mentioned, we had $11 million reserve true-up, so that puts you down to the $146 million. Additionally, I mention that mortality added roughly $9 million to the quarter. We don't normalize that out because mortality is something that is going to move around.

Just like morbidity in the group space is going to move around. I mean, morbidity went against us this quarter. So I think of those two items is offsetting. but he quarter was definitely a pretty good quarter from a mortality standpoint. As I mentioned, when you look at the full year, mortality came back in line with our long-term expectations, which is what we would expect.

Basically, when we've seen variability in our mortality results in the life insurance business over the past year, couple years, it's primarily been related to an increase or a decrease in larger size claims. And that's what we saw in the quarter. We saw large-size claims come down, which is what you would expect as we've grown to the Company and we've increased our retention of life insurance mortality experience.

So, nothing unexpected. A little bit more volatility in the year than what we'd want. I wouldn't say it's unexpected. And for the full year, we ended up right in line with our long-term mortality expectations. And that's what I would expect going forward, sort of what we experienced for the full year as a trend line.

Okay. So, maybe an average for 2013 as opposed to building off the fourth-quarter result?

Yes.

Okay. Then on a group protection, it seems that it's a pretty big percentage of your book that you are increasing pricing on. I think you gave us a split of mix by line of business, but I think you combined life and disability. Even using those numbers, it seems like a pretty big part of your book.

I'm just wondering, how are you thinking about lost business as you think about that $60 million to $80 million? Clearly, when you go back and reprice the business, you could lose some. I just want to get a sense of what your expectations are on that front?

Strengthening pricing is going to affect your sales levels. Specifically, we would guess that the employee, excuse me, the employer paid business will drop off from where it was last year. And we would expect the business, the voluntary business, associated with the employee paid business separate from the worksite, to drop off just a little bit. but we expect worksite to come up.

So, no big -- the mix will shift a little bit. We will be down, we're estimating we'll be down a little bit next year, but it's not -- the little bit is single-digit type declines.

Okay. And then just last numbers one for Randy, if I could. RBC ratio, I think you said you are estimating you will end the year -- was it above 500% or at 500%? Just wondering if you had any kind of a benefit from this change in the mortgage experience adjustment factor?

Yes. We did. We ended up the year at right around 500%. And we are not done with calculations, but it's going to be right around 500%, maybe just a little above 500%.

We benefited from two things during the year in the RBC calculation. A change in the commercial mortgage loan, mortgage experience adjustment factor, and also, the normal process that goes on at the end of the year with the PIMCO/Blackrock reprojection of the RMBS and CMBS securities. Both of those benefited us I would estimate roughly 10 points of RBC.

Is that 10 points combined or 10 points each?

Each.

Got it. Thanks.

Yaron Kinar with Deutsche Bank.

Good morning, everybody. Following up on that last question. Can we talk a little bit more about the capital position, which seemed rich and clearly it's a good problem to have, but what are your thoughts on capital deployment with this position?

And even if you adjust for that $500 million of pre-funding this quarter, still seems like the holdco liquidity is high and as is the RBC ratio. So any thoughts in terms of priorities? And then magnitude of capital deployment for this year?

Yes. As I noted in my script, I am guiding a little higher than we have in the past. If you remember back to prior periods, we've typically talked about $400 million of annual deployment before shareholder dividends, or roughly $500 million or so once you added in the shareholder dividends.

If you go back to my script, as I mentioned, we did roughly $700 million in 2013 and I anticipate that total deployment next year will be in line with that same number. Now, we have increased our shareholder dividends, so shareholder dividends and now up to roughly $170 million for the full year.

But after that, you still have another $500 million to $550 million as opposed to the $400 million that we had talked about before. So we are in a very strong capital position, $700 million of cash at the holding company after the $500 million that we are holding for the first quarter maturities. That's $200 million above our target.

As I mentioned, we are experiencing good, strong, statutory results in the life insurance company, which is allowing us to send up to the holding company, when you conclude the surplus note interest, roughly $900 million a year. So we are in a very good position to support the level of deployment I talked about.

Okay. And are there any new thoughts regarding the AG 38 and subsidiaries?

No. The results I talked about included an impact that we had in the state of New York, specifically, related to guaranteed universal life. The strong results included whatever we had to do for that particular item.

Okay. Thank you.

Joanne Smith with Scotia Capital.

Good morning. I just want to follow up on that question with respect to the RBC ratio at 500%. It seems to me that that's a bit high. And I'm just wondering what your thoughts around that are, given the fact that the statutory earnings have been so strong?

Joanne, as I mentioned a little bit earlier to, I believe it was, Suneet, I forget exactly. We did benefit at the end of the year from roughly 20 points from these two new items, items that we wouldn't have expected. The 500% was higher than I expected as we came into the area, even as we moved throughout the year. So we do have to adjust a little bit for that.

We continue to have a strong capital position. We continue to be generating strong statutory earnings and I think it's going to allow us to push strong flows to the holding company, which will allow us to be getting aggressive with our deployment this year.

Did you give a target for deployment? I must have missed that.

I talked about $700 million, which include some total shareholder dividends, which will be roughly $170 million and share buybacks and other.

Great. Thanks very much.

You bet.

Jimmy Bhullar with JPMorgan.

Hello, good morning. I just wanted to get a better sense on what really caused the deterioration in the disability margins all of sudden, because the margins had been fairly stable before, but you are seeing incidence, recoveries, everything at case size deteriorate at the same time in one quarter. How much of this is a market issue versus maybe just mispricing that is showing up now?

And then also, you are obviously raising prices on your UL block. But could you just discuss what type of returns you expect to get on the business that you sold over the past couple of years if we stay in this rate environment for a little bit?

On the group business, let me take that first. There are three main drivers of the group disability results. You're going to have your incidence, your average claim size, and your recoveries. All three of those, as I mentioned, went against us this quarter in a way that impacted the results by roughly $12 million.

It's a bad quarter when all three of those go against you and that's what we experienced this quarter. As Dennis talked about, we have analyzed the experience in 2013 and we are reflecting that in pricing, we're really started to reflect that in pricing in the middle of this year.

When you price the group product it's not any different from pricing an individual life product, and one of the main components, one of the main inputs of the pricing processes, is your experience and how that is going to impact your expectations for the future. If you go back to the 2010, 2011, 2012 period for incidence, for average claim size, you saw very steady and consistent results.

Specifically for incidence, the number was right in the high 3.9s. It was very steady, very little variability around that number. For average claim size, you saw an average claim size that was $54,000 in 2010, growing $2000 a year, right in line with salary growth. Very consistent, steady results.

That's what drove our pricing over that period into the first part of 2013. When you come into 2013, you see a change in those metrics. Incidence goes up by about 0.1, and claim size doesn't go up by that 3% to 4% level, it jumps up by 6% to 8%, by $4000.

We experience -- we get that data as we move through 2013 and we start to reflect in pricing in the last half of the year. So we changed our expectations that we're putting into the pricing. That's what's happened. That's what happened over the last half of the year and that's what will happen as we move throughout the following two years, as the business reprices along the schedule that I talked about.

The second question, again, was around life returns?

Yes, just on the business that you've sold the last couple of years. Obviously, you are raising prices on new sales. But what type of returns are you getting on that now in this rate environment?

The 2013, if we are talking about life, 2013 expected return was about 12%. And when we look forward, we are looking more on the mix of business, depends on the mix of business, but more 13% to 15% range.

Okay. And then maybe another one on re-in business. Is there more capacity in the market for reinsurance or other types of solutions, assuming that you run out of the -- or you exhaust the coverage that you have on your reinsurance contract? Do think you would be able to renew or you'd be able to get more coverage? If you could just talk about what you're seeing in the market?

Yes. I mentioned, I think, the total is about 33% of effectively non-guaranteed product sales in the fourth quarter. About $500 million of that 33% came from the reinsurance contract. When we look to next year, we actually are going to be well below the amount of, or above our targets on non-guaranteed business because of that contract.

That will give us -- that, in 2014, will give us time to work more organic ways to get to the 70%, 30% in the VA business, which is what I talked about. More training around non-guaranteed sales and incentive for our wholesalers, new products that are oriented toward the traditional mutual fund and tax deferred wrapper kind of sale of a variable annuity.

So we are pretty confident that, with or without, another reinsurance contract, we will be able to get to our targets. Specifically, with respect to reinsurance contracts, it was a good transaction for everybody based on the circumstances at the time. The circumstances continue to provide good economics for both the reinsurer and the manufacturer, my guess is there will be more opportunity to do these deals.

But that's the facts situation has to be in place.

Thank you.

Eric Berg with RBC capital.

Thanks. Randy, I wanted to review some of the numbers that you gave for the first time during this call. You said that approximately half of your group businesses is group life and group disability, is that right?

Excuse me, employee paid group life and disability.

Right. Can you review the rate of at which the -- could you repeat the rate at which the incremental revenue from the price increases will hit your revenue lines and when?

Yes. So of the premiums we receive in 2014, $300 million of them will be at a repriced level. The premiums we receive in 2015, $800 million will be at a reprice level. And by the time you get into 2016, effectively, the vast majority of the business will be at a repriced level.

All right. And so, just to -- my second question, also, just relates to the group insurance area. So just to clarify what has happened here, would it be right to say that, as you have studied this, this wasn't a case of discounting that should not have hap --?

Let me start again. It seems to me that when any life insurance product is mispriced, it could happen for one of two reasons. Either the price was too low to begin with and you are having claims experience consistent with your expectations, or there was no discounting of the price and you are getting claims experience different from what you expected.

It seems like you are seeing the latter here. That there was no discounting of pricing, it wasn't an issue of improper incentives, or of participation ratios that were too low. You charged the price that you thought was the right price and you are getting a claims level higher than you anticipated. Am I thinking about this correctly?

I think that's right, Eric. It's hard to parse out when you start talking about the net price that you have, which I think is what you are referring to as --

Yes.

-- discounting. It's hard to parse out the specifics of that dynamic. And then you have the whole question of employee paid and employer paid as sold on a combined basis.

So I think the conclusion which you've come to is the right one. Based on what we are seeing today, for whatever reason, the price we were charging a couple of years ago was too low.

And then just if I could just sneak one last one in really quick. Why should we think that profitability -- why is profitability, even the competitiveness of the voluntary marketplace, the employee paid marketplace and the associated anti-selection that can take place, and the turnover of employees with the associated anti-selection there, or write off of back and so forth, why is that business necessarily a higher margin business than traditional group insurance?

I think you've answered your own question. Because all of those things that you just said about the employer market -- excuse me, the employee market, have to be taken into consideration and therefore you have to charge more.

Yes. All right. Thank you.

Steven Schwartz with Raymond James and Associates.

Hello. Good morning, everybody. A lot asked. I did want to follow up, though, I think it was Yaron who asked question, with regards to New York and the AG 38 issue. I don't remember who answered it.

But whoever answered it seemed to suggest that that had been dealt with. Is that -- and therefore was already in the RBC. Is that an accurate statement? I was under the impression that this thing would stretch out over time?

Just like I believe most companies agreed to a rating period for the impact of five years in our case. We took this year's amount of that increase and those were reflected in the results that I talked about.

Okay. Randy, can you share that amount?

Sure. It was $90 million.

$90 million? Okay. Just still on the topic of regulation. Dennis, would you happen to know off the top of your head, maybe, how many states now have agreed, I don't know if that's the word for it, but agreed to adopt PBR and how much premium that may represent?

Not off the top of my head. But I can, with respect to the premium number, but the number of adopting states is in the teens and there is a tremendous amount of work, jointly, going on between the ACLI and the NAIC to get more adoption in 2014 in 2015. It's a, what's the expression? A long drill through a hard bore. (laughter) I mean a hardboard, a long bore through a hardboard, but we will get there.

Okay. Thanks, guys.

Tom Gallagher with Credit Suisse.

Thanks. Just to follow up on the group business. So Randy, based on the earnings guidance of $60 million to $80 million for 2014, that implies, or I guess I can infer, a little bit better than breakeven profitability from this quarter. You do view that a big chunk of that as just quarterly unfavorable volatility that you would expect to recover.

So, I assume that's the case, just because of the much higher run rate that you expect not trending 4Q. But then at the same time, I know there's a multi-year repricing strategy ahead. So I guess I just want to get a handle for -- you're clearly seeing something in your book that indicates there is a need to reprice, yet you are expecting substantially higher profitability than we got this quarter.

I don't know. Can you help me reconcile that in terms of what level of the deterioration this quarter you viewed as somewhat permanent versus the alternative?

The way I get there, Tom, is we made -- and let me apologize because my voice has a bit of a frog in it right now. We made $71 million this year. And over the course of the year, I normalized $11 million of favorable items; $8 million this quarter, $3 million last quarter. So core earnings of $60 million, normalized earnings of $60 million.

When you factor in premium growth off of that, when you factor in the favorable impact of the repricing of the $300 million of premiums that I mentioned, you are going to end up with a number in that $60 million to $80 million range. Now, if we do a little better than 2013 loss ratios inside of that, we will end up at the high end of that range.

If we do a little worse than loss ratios were in 2013, we'll end up at the low end of that range. That's just the numbers. Just to remind everybody, we estimate that 1% of loss ratio is roughly $15 million of earnings.

Got it. And so, you clearly are taking the full-year annualized earnings view, not necessarily taking some deterioration in 4Q as indicative of a trend? That's a better way to think about it?

Yes. Exactly.

And then, I guess just stepping back for a minute. And you guys gave some numbers on sales growth, I believe, between employer versus employee paid in the group business. But if I look at a higher level, the revenue growth that you've been producing on group has certainly outpaced the industry by a fairly wide margin, at least the comps that we look at, who have had flattish topline growth and you guys are in the high-single digits range.

Can we infer, is it as simple as you've been growing above market, taking some share, and that is what has driven the need to reprice here? Or is that not the right math?

Could you rephrase that question again? I'm not sure --

Sure. Dennis, if I look just at the top line statistics that you guys have, in terms of premium growth, you've been growing high-single digits. And the peers that we cover in the group business have been flattish. And so, just looking at having taken market share, do think it's just a symptom of what's going on with your group businesses?

You've taken some share, and now as a result you probably have some less profitable business that needs to be repriced. Or is it mainly just the employee paid business that has had much more dramatic growth, and the employer paid business has been more consistent with industry trends?

Yes. The big driver of the increase in sales, say since 2010, is almost 250% increase on employee paid. If you look at market share in the business, we have had a modest increase but not a significant increase. I think we've gone from 4.2 to 5 over the four-year period.

And again, most of that being driven by employee paid growth. Although employer paid growth sales did grow, as well. So, we took a little bit of market share and I think we keep coming back to it. There's no question that we should have gotten better prices a couple of years ago on the business, given what has unfolded, with respect to the trends around disability incidence and recoveries and size of claims and so forth. A little bit on the life mortality side.

So, yes, we got a little bit more share. Maybe it was pricing. But when I just look internally, we knew what we were doing and it just turned out what we thought was fluctuation in some of these key mortality and morbidity numbers, appeared to us at the moment to be higher than what we were pricing for.

Okay. And sorry, Dennis, I just want to make sure I understood that correctly. You grew employee paid 250% over what period of time?

Well let me just give you the numbers.

Yes.

The sales of employee paid went from $120 million in 2010 to $254 million. So I guess that's more like a doubling to $254 million in 2013. And you didn't see that kind of growth in the employer paid.

That is helpful. Okay. Thanks.

Final question from Mark Finkelstein with Evercore.

Hello, good morning. Two very quick questions, I think for Randy. One, Randy, do you view debt reduction, I don't know if you covered this or not, but do you view debt reduction as part of the capital deployment in 2014? I know you took $100 million of net debt out of that $700 million?

Actually, we've prefunded our only maturities for 2014. So there really isn't much we can do around the net debt reduction in 2014. So I think we are going to be definitely skewed for the share buybacks.

Okay. And just generally speaking, are you where you want to be in terms of ratios?

We feel very good about where we are. Significantly, in that we've brought our amount of interest expense down significantly over the last few years.

So we feel very good about where we are from a leverage standpoint. It's always something we look at as we look at where our capital should go. But we feel very good about where we are from a leverage or coverage standpoint.

Okay. And then just finally, I think you gave some spread outlook on retirement. I'm curious, if you said it I missed it, what is the outlook on life insurance in terms of spread compression for 2014?

Yes. At these levels of investment, we would expect mid-single digits to low-double digits. So, 5% to 10%, 6% to 11%. Somewhere in there.

Perfect. Thank you.

You bet.

And that concludes the Q&A session. I will turn the call back over to Jim Sjoreen for final comments.

We want to thank you all for joining us this morning. As always, we can take your calls or emails in the Investor Relations department. Please give me a call and we will try to get back to you as soon as possible. Have a good day.

Thank you, ladies and gentlemen. That does conclude today's conference. You may all disconnect and have a wonderful day.