Lincoln National Corp (LNC) 2015 Q3 法說會逐字稿

Good morning and thank you for joining Lincoln Financial Group third-quarter 2015 earnings conference call.

(Operator Instructions)

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

Thank you, Lauren. Good morning and welcome to Lincoln Financial's third-quarter earnings call.

Before we begin, I have an important reminder. Any comments made during the call regarding future expectations, trends and market conditions including comments about sales and deposits, expenses, income from operations and liquidity and capital resources 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 you all participating today and invite you to visit Lincoln's website www.lincolnfinancial.com where you can find our press release and statistical supplement which includes a full reconciliation of the non-GAAP measures used in the call including income from operations and return on equity through 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 question-and-answer portion of the call.

I would now like to turn things over to Dennis.

Thank you, Chris and good morning, everyone.

In a quarter marked by significant capital markets volatility, Lincoln's growth, profitability and capital management initiatives produced solid results. Top line metrics were very strong as we benefited from a number of new product introductions. As a result, we generated positive net flows in all our segments, which led to a 17% increase in consolidated net flows, while life insurance sales also grew 8%.

EPS, excluding notable items in both periods, increased 10%. As we noted in the press release, our annual assumption review reduced reported EPS. Nevertheless, this was a non-cash item and our balance sheet continues to be a source of strength.

To this point, our book value per share excluding AOCI, increased 7% and buybacks accelerated to $200 million as capital generation remains solid. Bottom line, our franchise, earnings growth potential and balance sheet are all very strong.

Equally important, our quarterly results should mitigate several recent areas of investor uncertainty. Notably, Individual Life Mortality returned to normal levels following elevated experience in the first half of 2015. Annuity earnings proved to be resilient despite market volatility and Group Protection produced stable results as we continue our path to a full recovery in earnings.

Now turning to our business lines, starting with Annuities. Total annuity sales of $3.3 billion were steady with our quarterly average over the past year which is a testament to our consistent approach to the market. We are focused on delivering -- on diversifying the mix of our annuity sales and there are a couple examples in this quarter.

First, 27% of our VA sales did not have living benefits as we are well within reach of our strategic goal of 30%. Investor Advantage, our investment focused VA product, remains an important contributor to this risk diversification strategy. Also in October, we amended our variable annuity reinsurance treaty. We now have an additional $2 billion of capacity through year-end 2016, which provides another lever for diversification.

Next, fixed annuity sales approach $600 million, more than double the prior year and up 55% sequentially as we broaden our indexed annuity portfolio and expanded relationships. Market volatility in August also likely contributed to this solid growth, although it dampened VA sales. This shift is just another example of the benefit of a diverse set of product offerings that meet different consumer needs.

Subsequent to the end of the quarter, we introduced a new benefit again with the goal of diversifying our annuity portfolio and meeting different consumer preferences. Our recently launched Market Select Advantage is a variable annuity rider designed to offer greater investment flexibility in a living benefit without the guaranteed roll-up traditionally offered with GMWBs. Market Select Advantage is positioned to fill the gap between investment focused VAs and VAs with roll-up living benefits.

Net flows in the quarter totaled $536 million, as we continued to consistently generate positive organic growth. And this marks the second straight quarter of sequential improvement. Positive net flows has more than offset unfavorable equity fund performance as average account balances increased versus the prior period to $123 billion.

Our Annuity business remains a high-quality source of earnings. This is attributable to decisions we made over a decade ago when we entered the living benefit marketplace. Namely, fully hedging capital market risks and not participating in competitor feature wars. As a result, we have produced a long track record of success.

I would encourage you to all look at our presentation from Barclays Financial Conference last month. In it, we review our extended record of positive net flows and fee growth that compares favorably to asset managers. When combined with effective risk management and a movement to a lower risk profile, I continue to believe this business is very under-appreciated.

Turning to Individual Life. Total life insurance sales in the quarter were $173 million, an 8% increase from the prior year quarter, while Individual Life insurance sales increased 5%. Overall, sales once again achieved our expected hurdle rate for returns of 12% to 15%.

Digging into a few noteworthy product stories. MoneyGuard sales increased 21% as we are benefiting from continued market acceptance of our MoneyGuard II product and traction in recently approved states.

Indexed Universal Life sales increased 17% due to the success of new product launches. Momentum should continue as new regulation that began in September required many competitors to make significant reductions in maximum illustration rates. As a result, our market position should improve.

Product portfolio diversification continues to be a strategic focus within our Life business as well. This quarter, no single product represented more than 30% of our total production and 67% of our sales did not have long-term guarantees, up from 63% in the prior year quarter. Overall, key business drivers indicate mid-single digit earnings growth potential for our Life Insurance business, consistent with our expectations.

Turning to Group Protection. We are pleased with the continued progress we are making with our repricing efforts and the improvement of our claims management effectiveness. Overall, earnings increased from depressed results in the prior year quarter and were consistent with the second quarter as we work toward achieving our targeted margins.

Third quarter sales of $61 million were down as our pricing actions continue to put pressure on new business opportunities. Despite this pressure, we are pleased with our continued progress to improve the contribution of the more profitable employee paid voluntary market. In the quarter, 49% of our sales were employee paid, up from 45% in the prior year quarter. It is worth noting, we do see momentum building in our sales pipeline going into the fourth quarter which is important, as this quarter typically contributes about 50% of full-year sales.

In Retirement Plan Services, third quarter deposits of $1.9 billion were up 17% from a year ago. And it included growth in both the small and mid-large markets. First year sales increased 65%, as our investments in our sales force and technology continue to gain momentum. Net flows of $251 million marked the third consecutive quarter of positive net flows and increased our year-to-date totals to $673 million compared to just $55 million in the prior year.

As you know, the fourth quarter is when we typically see large case movement. To this point, we were recently notified of a case termination. As a result, we expect to have negative flows in the fourth quarter. However, our annual net flows will be positive and mark a significant improvement from last year.

Bottom line, our pipeline remains robust and we are confident our growth can outpace the market as our strategic investments improve our infrastructure and deepen our relationships and value proposition with consultants, plan sponsors and participants.

In Distribution, we differentiate ourselves in the marketplace through our retail, wholesale and work site teams that once again delivered exceptional results. Strong sales growth noted in many products within the business sections has been on our terms and importantly, aligns with our business mix shift. Our 1,400 client facing professionals and our base of 91,000 producers that sold Lincoln products over the past two years, continued to be a strategic advantage. We remain focused on increasing productivity of this sales force and to this point, sales driven by distributors where we have multiple products on their platforms increased sequentially in key cross-sell areas such as RPS, MoneyGuard and fixed annuities.

In the quarter, Lincoln Financial Network produced year-over-year sales growth across Life, Annuities and RPS as the retail advisor network of 8,300 delivered our valuable customer solutions. We'll continue to invest in already deep and powerful distribution to drive future growth and pivot to products that clients need and that Lincoln is uniquely positioned to offer.

Lastly, on Investment Management, we put new money to work in the third quarter, have an average yield of 4.4%, about 10 basis points above the prior quarter. We benefited from higher average Treasury rates and wider spreads. The Investment portfolio quality remains strong with investment grade assets representing just 5% of our fixed maturity portfolio, down slightly from the prior year.

Our Alternatives portfolio was a strong contributor to Investment income in the quarter. Alternatives now represent 1.3% of our total invested assets and has steadily grown towards our long-term target of 1.5%. As we expand this portfolio, we expect to drive further growth in Alternative Investment income.

In closing, underlying EPS growth of 10% is consistent with the target we provided at our investment -- Investor Day last year, driven by organic earnings, modest capital tailwinds and effective capital management. We remain confident in our ability to drive earnings growth as we leverage attractive growth opportunities, enforce margin improvement and our strong balance sheet which supports our active capital allocation.

I will now turn the call over to Randy.

Thank you, Dennis. Last night, we reported income from operations of $289 million or $1.11 per share for the third quarter. As Dennis noted, excluding notable items, EPS increased 10% year-over-year as this quarter was negatively impacted by $0.55, primarily from our annual review of DAC assumptions. While last year's third quarter benefited $0.05 largely from the annual review. This year's DAC assumption review results were driven by a $121 million negative impact from lowering our long-term earned rate assumption by 50 basis points.

A couple important items to note. This is a non-cash charge and the impact was consistent with the sensitivity we previously provided. Recall, we last lowered this assumption three years ago, also by 50 basis points. Outside of changing our long-term earned rate assumption, there were a series of pluses and minuses that netted to a modest positive impact to operating earnings of $7 million.

A few comments on this year's review process. With the 50 basis point reduction on our long-term earned rate, we are very well-positioned with this particular assumption. Our ultimate earned rate now assumes only modest annual increases from today's level, increases that are largely in line with the forward curve and significantly below the rate implied by the Federal Reserve's own expectations.

In conjunction with the 50 basis point reduction in our long-term earned rate, we lowered our separate account return assumption by a similar amount. I will discuss this in more detail in the Annuity section of my remarks.

Every year we go through this extensive review of all of the assumptions underlying our DAC balances and we consistently have come back with the same result. That is, that when viewed in total, the assumptions underlying our balance sheet are sound. In fact, over the past five years, the cumulative impact has been just 0.3% of our equity. During this same period of time, our book value per share excluding AOCI, has grown by approximately 40% including 7% this year to $51.47, an all-time high.

Moving to the performance of key financial metrics all of which normalized for notable items. The top line continues to show growth with operating revenues up 2%, driven by another quarter of positive net flows.

All four of our segments showed year-over-year growth in earnings. Operating return on equity came in at 13.5%. And finally, our balance sheet remains an important source of strength providing significant financial flexibility and an ability to opportunistically respond to marketplace dislocations.

One other item of note before shifting to segment results and that is Investment income this quarter was strong with Alternatives running $11 million after tax and DAC ahead of our targeted returns. Prepayment related Investment income remains elevated but was right in line with our quarterly average of the past three years.

Now to business results and starting with Annuities. Reported earnings for the quarter were $259 million, a 6% increase over last year. Net favorable items this quarter totaled $5 million, primarily related to taxes, with $1 million of the total coming from the net impact of our DAC assumption review.

As I noted earlier, we did lower our separate account return assumptions which is an important input inside Annuity's DAC models. This reduction brought our return assumption down to 7.6%, compared to 8.2% last year. We did not unlock our reversion to the mean corridor. This currently still provides a cushion against weak equity markets.

Return metrics remain strong and consistent with recent periods. ROA increased 3 basis points versus the prior year while ROE came in at 24%, again, an outstanding result.

Overall, our Annuity business continues to generate organic growth and excellent returns. The financial impact of changes to assumptions that underlie the earnings and valuation of the business was minimal and are a testament to this being a well-managed and strong, high quality source of earnings.

Turning to our Life Insurance segment. Our annual assumption review had the greatest impact on Life operation as reported earnings were $36 million. $118 million of the $121 million earnings impact I noted up front from lowering our long-term earned rate assumption, fell within the Life business. We now assume an ultimate rate of 5.25%, down from 5.75%. All the other items that went into the unlocking process resulted in a benefit to earnings of $1 million.

Excluding notable items, earnings increased 2% over the prior year quarter and notably, Mortality returned to normal levels following elevated experience in the first half of 2015. We continue to expect Mortality to perform in line with pricing as we look forward. Normalized spreads came in at 165 basis points, down 1 basis point from the prior year.

Quickly, on Life earnings drivers. Average account values increased 4% with total in force face amount up 3%, consistent with recent performance, and our mid-single digit organic growth expectations.

In the Group Protection segment, earnings of $17 million more than doubled the prior year quarter and were consistent with the second quarter. Our non-medical loss ratio improved to 74.5% from 77.6% in the prior year quarter, driven by improvement in all product lines, life, disability, and dental. Our disability loss ratio did increase sequentially which I would attribute to normal quarter-to-quarter volatility.

Our pricing actions continued to have a favorable impact on margins but they have negatively impacted persistency and sales. The result is non-medical earned premiums decreased 1% compared to the prior year quarter. Overall, I believe we have another quarter that validates that we are on a path to an earnings recovery in Group Protection.

In Retirement Plan Services, we reported earnings of $42 million, compared to $40 million in the prior year quarter. This quarter's earnings benefited by $2 million from the annual review of model assumptions. Earnings benefited this quarter from strong investment results, including alternatives in prepayment income, while normalized spreads compressed 10 basis points versus the prior year quarter, at the low end of our expectation.

Account values have benefited from several quarters of positive net flows. When combined with modest negative changes in equity markets over the past year, average account values increased 1% to $54 billion. Year-to-date our ROA is 26 basis points, a level I expect to be a good proxy in the intermediate term as we continue to make investments in the business to position us well for future growth.

Before moving to Q&A, let me comment on capital. We have a proven ability to generate free cash flow and a track record of returning cash to shareholders. This quarter we repurchased $200 million of Lincoln shares as we reacted to some weakness in the share price, resulting in incremental buybacks below book value.

Year-to-date, we have repurchased $700 million of stock which is consistent with our full-year guidance. That said, we expect to remain active in the fourth quarter.

We also announced a 25% increase in our shareholder dividend. As we have noted in the past, we anticipate growing and maintaining a competitive dividend. As you can see by this quarter's results, and more importantly over an extended period of time, capital allocation remains a key priority for Lincoln. Holding Company cash ended the quarter at $505 million and statutory surplus stands at $8.3 billion, while we estimate our RBC ratio will end the quarter at approximately 495%.

So to conclude, statutory and GAAP balance sheets are both in very solid position as evidenced by strong RBC and holding Company cash positions and our annual assumption review did not compromise steady growth in book value per share ex AOCI. Organic growth drivers are firmly intact with another quarter of positive net flows across the enterprise.

Mortality returned to normal levels following the elevated experience earlier in the year. Annuity earnings remain a high quality source of income and prove to be resilient despite market volatility. And we took advantage of weakness in the share price with incremental buybacks below book value.

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

(Operator Instructions)

Our first question comes from Suneet Kamath from UBS.

Your line is open.

Great. Thanks.

Good morning. I wanted to start with the Department of Labor issue. I realize that they're still in deliberations in terms of the final proposal.

But I was wondering if, Dennis, you can give us a sense of how conversations are going with some of your distribution partners related to scenarios for potential outcomes. I guess there's been some talk in the press about annuity sales maybe being cut in half for some period of time, if the proposal passes as originally proposed. So I just wanted to get a sense of how you're thinking about the relationship with your distribution partners and the outlook for VAs. Thanks.

Let me speak to the DOL and the specific issue of having a reasonable regulation to permit the sales of variable annuities on a commission basis into IRAs. That's the biggest area that. It's an area of focus for Lincoln, and the area that we've tried and have successfully gotten a coalition of annuity manufacturers to focus on.

On that issue -- I'm not updating anything from what I've said in the past -- but we continue to feel optimistic based on direct discussions with the DOL staff that they're giving consideration to permit this to occur. So on that specific issue, we remain pretty optimistic. And if that were to happen, I think the idea of VA sales being cut by 50% for IRAs or the qualified market would be way overshot. So that's that.

With respect to our other distributors, as you know and we keep repeating, we have a large number of distributors. Every one of those distributors is looking at the DOL, if it impacts them, and trying to anticipate what the rules were or might be and what reaction they might have to take. So we're in discussions with them.

We are aware of the issues. We are developing backup plans if some of our distributors modestly change their business models. And that's as much as we know today.

Thanks.

And I guess one for Randy. On the alternative investment income, I was a little surprised that it was so strong in the quarter, just given the choppy capital market. Can you give us a sense of, one, where the strength came from? And then, two, is there any kind of lag that we need to think about in terms of how this alternative investment income actually flows through?

Well, thanks, thanks for the question. It was a strong quarter for Alternatives. As I mentioned, it was $11 million after tax and DAC, above our expectations. When you view it over a longer term -- if you look at, for instance, the full year this year -- we're actually right on top of our expectations of a 10% yield in that portfolio. And that's by and large the case over the last couple of years also. So I don't think of the performance of the Alternatives over a more extended period of time being out of bounds with our expectations.

In terms of where the performance came this year, I think consistent with what you have in Alternatives, it oftentimes depends on where you're positioned. Are you in the hedge funds that didn't do bad or didn't do good? Are you in a PE that has a particularly good quarter?

I think we experienced that this quarter. We had some PEs that just had good quarters. They had valuation events which led to strong valuations, which led to the strong results.

In terms of predicting the future, I'm going to stay out of that game. We'll stick to what I say when I say that over an extended period of time, we'll expect to see and I think we'll see, a 10% return come out of this book of business. Predicting what you're going to have in any particular quarter is a difficult game that I will choose not to endeavor in.

Understood.

I was more asking about if third quarter results are a true reflection of the capital markets environment in the third quarter. Or was there a little bit of a spillover from the second quarter because of some sort of a lag in terms of how Alternatives are reported to you?

I think third quarter was reflective of what you see in this business. It's a small piece of the portfolio. It's a limited number of holdings. This quarter, we had some of those that really performed strongly. And that's what you're going to have.

You had some pieces that didn't perform so well, but we had a certain number of pieces that's really performed strongly. And that's what you're going to see in this sort of business. But that over time, you will continue to see the results in this business perform in line with our expectations.

Okay. Thanks, Randy.

You bet.

Our next question comes from the John Nadel from Piper Jaffray.

Your line is open.

Good morning, everybody. Really a question about the mix of Annuity sales.

And I'm sorry if, Dennis, you addressed it in your prepared remarks because I hopped on just a little bit late. I was curious about the year-over-year and the quarter-over-quarter decline in variable Annuity sales. But the obviously very significant pickup in the pace of what you characterized as fixed annuities. I'm sure it was more driven by -- or I'm suspecting it's more driven by index.

Whether you believe that that's an indication of distributors shifting in response to DOL or whether you think that was really much more about just shifting preferences during a period of heightened market volatility?

We think it's more the latter. We think in general, whether it's VA or it's a mutual fund, spikes in volatility chill the sales of those products; consumers get more conservative.

We think that's why VA sales were dampened a little bit, again, volatility. It's also why we think in part indexed annuities picked up a little share. I guess what we continue to point to is that we have the shelf space and the products to be able to sell as consumer preferences shift. And this is a good example of that.

We're continuing the focus throughout the businesses on improving products, having better distribution, not only improving products from a return standpoint but having greater diversification and breadth of products so we can be successful as consumer preferences/market conditions change. So that's the answer to the first part.

Is there a hint of the DOL in these sales? It's hard to say.

Okay.

It's hard to say.

And then along those same lines, if you could choose to -- the next $1 billion of annuity sales manufactured by Lincoln, and I gave you the choice between it's 100% variable annuities or 100% indexed annuities. What's your choice?

Well, it's really what the consumers' choice is more than my choice.

I get that. It's a hypothetical. But I'm more interested around capital allocation, return potential, mix of business, that sort of thing.

And I'll just fall back on our guidance on strategy in terms of mix. We are very comfortable with 70% of our sales going into VA products that have one or the other degree of living benefits.

I mentioned we offered a product, or just started offering a product, that has a little bit more investment flexibility but a little bit less income because we don't have a roll-up in it. I think that's a pretty good addition to the VA portfolio that we have inside that 70% guaranteed. It diversifies risk just a little bit, and it also helps in the marketplace. The financial advisors be a little bit more crisp for their clients in discussing investment only; no-guarantee products; products with a stronger guarantee; and now, a middle-of-the-road product. We think that's a pretty good addition.

I still think the two ends of that spectrum are going to see the most traction. But we do expect that middle segment to get good sales.

And then --

Let me just finish up. So that's VA.

On the fixed annuity side, it's part of the 30%; and we're comfortable with that. I think the returns are a little bit less than what you see on the variable annuities. So we want to manage that mix a little bit. Okay.

Got it.

And then just one quick follow-up also related to the VA block. And that is, obviously we saw a period of very heightened market volatility. I'm just curious how you feel about how the self-hedging or the internal hedging -- I forget the exact term -- funds performed this quarter and how you can relate that to -- I know your overall hedge program had a little bit more breakage than I think is typical.

Let me speak to the --

The Volatility Managed Fund. Thank you.

The risk managed funds in general across the industry, whether it's in the mutual fund business or in the VA business, didn't perform as well in this period of heightened volatility. So I think there was a couple of questions about risk management funds performance across all industries, not just the VA industry.

Over time, these are designed over the long term to provide a smoother path of return for consumers. And we think that's a good thing. So I wouldn't react too much to the fact that in a 60-day period, they didn't perform as well.

And Randy, do you want to speak to --

Sure, John.

On the hedge program performance, there was more breakage this quarter than we have been experiencing or that we typically experience in a quarter. A couple comments. It was a quarter with a significant amount of volatility in the capital markets, just to scale that. I think over half the days you saw intraday movements of greater than 1%. And when you have that, you are going to have some level of breakage.

Also, what you see when you have those sorts of days is you also actually have your trading costs go up, which manifests itself as breakage also. You're just trading a lot as you're chasing the liability around. So I'm not surprised in a quarter with that sort of volatility to have some level of breakage. I think what exacerbated it a little bit this quarter is the fact that we had our funds underperform in their indexes also.

I'll just remind you, the fund basis risk is what you call it. Over time, if you look at the last decade, that's a number that's summed up essentially to zero for us. That's a number that can come and go. So I wouldn't be surprised to see that come back at some point in time. But it's when you get both those sort of items, a very volatile quarter in the capital markets, you combine it with that fund basis risk, and you have a quarter like we did this quarter with a little more breakage.

I'd point out when viewed over a more extended period of time -- I think the last time I looked at this, I looked at it over the last six years. Breakage in the hedge program was a 1% to 2% impact on the overall ROE. I think the overall ROE over that period was 22%. And if you included the below-the-line items, it was just a 1% to 2% reduction from that. So still very, very confident in performance in the hedge program over a more extended period of time. But understand that this quarter did have a little more breakage than usual.

Okay, understand. Thank you so much for the color and the answers.

You bet.

Our next question comes from Tom Gallagher from Credit Suisse.

Your line is open.

Good morning.

Randy, wanted to start with the lowering of the long-term separate account return assumptions, down to 7.6%. Can you take us underneath the covers a little bit? Explain how that affected the balance sheet review. You didn't have any charge associated with that. What would have been some of the offsetting adjustments?

Sure. Well, it's primarily an item -- essentially all the impact shows up in the annuity business. You get a little bit in the Life business and a real little bit in the RPS business. It's primarily an item that impacts the Annuity business.

Really the driver of the reduction, Tom, I would really point to what drove us to lower our ultimate earned rate assumption. It's essentially a reflection that risk rerates are going to be a little lower when you look forward. And that fed through to our thoughts on what overall capital markets returns would be. So as I mentioned, we ended up lowering the separate account return assumption by a similar amount to what we lowered that J-curve assumption.

In terms of the impact, it was as I mentioned. It's primarily in the Annuity business. It was definitely a negative item. I'm not going to get into sizing of the dollar amounts, but it was a definite negative.

It was offset inside of the annuities by all the other assumptions that go into the process: lapses, fee income. All those other items that go into the process added up to be a positive number that offset the negative number that was caused by lowering the separate account return assumption.

Okay. And then what's the size of the reversion to mean equity cushion as of the end of this quarter?

In total, it's in the range of $165 million. $130 million of that is in the Annuity businesses, with small pieces in Life and RPS.

Got you.

And then, Randy, after making that change, any impact on earnings? I presume there's going to be some change in DAC amortization after you change the separate account return assumptions. But should we think about any go-forward operating earnings impact that's meaningful at all?

Tom, both the J-curve and the separate account return assumption have modest negative impacts on run rate earnings. It's not a number I'm going to spike out and say that I would see significant changes to your models. Both of them have modest negative impacts on run rate.

Okay.

And then last question. Just in lieu of what's happened in the Life business, including the adjustment this quarter, any impact on goodwill testing that we should think about for next quarter? Or is there still a long enough margin there?

Once again, you know we do this analysis in the fourth quarter. So I'm not going to get ahead of all of that analysis. And I'm going to look to the items I've talked about in the past when it comes to goodwill testing.

The big drivers -- first off, we have two businesses that have typically gone to step 2 of the goodwill analysis, Life Insurance and Group Protection. The big drivers of goodwill for those businesses are the level of sales, the profitability on those sales and the discount rate that you apply to those sales. When you look at those three metrics, I think they continue to run strong.

Life sales continue to grow. Group sales, while down, are still very strong relative to the size of that book of business. Profitability on Life sales remain strong. Profitability on Group business, we've talked about, remains strong. And discount rates have gone nowhere but down compared to where they were in past years.

So the big three items that I think about when I'm looking to think about what might be coming in goodwill, seem to be pointing in a favorable direction. But we'll go ahead and do the analysis in the fourth quarter.

And if I could just sneak in one last one. I saw the RBC, $495 million, still pretty strong despite the pickup in buybacks. How about if you looked at consolidated capitalization of the Company? Any meaningful changes to holdco cash during the quarter?

Holdco cash came down a little bit. I think it came down from maybe in the $540 million to the $505 million range; so it came down a little bit. But it's still in excess of our targeted amount of $500 million, so very comfortable there. Overall, RBC at $495 million, as you mentioned, remains very strong and very supportive of continued capital deployment as you've seen in the past.

Okay. Thanks, Randy.

You bet.

Our next question comes from Seth Weiss from Bank of America. Your line is open.

Hello, thank you.

Randy, last quarter I think you commented on expectations to perhaps do a reserve financing transaction in the back half of the year. Could you just provide an update on that, please?

Yes, Seth. Thanks for the question.

We do expect to do a reserve financing transaction in the fourth quarter. It's around term business that we've written over the last couple years. So I'd expect to see that come through as a positive item on capital in the fourth quarter.

Okay. And are you able to size that for us, or too early to say?

In the range, we've typically talked about $200 million being fairly typical. It would be in that area -- maybe a little better, but in that area.

Great. Thanks.

And, Dennis, if I could just return to the DOL topic for a moment. The comments today, I think, are pretty consistent with what you said at the Industry Conference last month in terms of DOL staff giving consideration to permit commission sales to occur. From what we're hearing here, our impression was that avenue was through the best interest contract, which has obviously gotten pushback from the VA manufacturer community.

So I'm just curious. When you say that your discussions have yielded this cautious optimism, are you hearing anything different when it comes to maybe a separate VA carve-out or inclusion in the 8424 exemption?

You've touched on the two big paths to the right answer. And if you look at the letter that was signed by eight or nine of the annuity companies, our first choice would be to put VAs back in 8424 the way 8424 exists. It was that way for 30 years. It was that way in the 2010 initial proposal. And it's only in this later proposal -- I think it was 2010 -- it's only in this later proposal where it was moved into best interest contract exemption.

I think it's more uphill on 8424. But if it's in the best interest contract exemption, as we've provided a framework for in our letters, I think they'll still give consideration to separating out annuities from mutual funds because it's just different. So that's more detail. I suggest you go take a look at our letter, but it's pretty consistent with what I've just said.

Great. That's very helpful. Thanks a lot.

Our next question comes from Michael Kovac from Goldman Sachs.

Your line is open.

Great. Thanks.

This is maybe for Dennis. We talked about the risked managed funds. And I guess I was a little surprised that they underperformed in this period, given I imagine that a consumer is really buying them to outperform exactly in the kind of market that we saw in the third quarter. As you spoke to, this is not really a Lincoln-specific but more of an industry issue.

I guess I'm wondering. What are your thoughts going forward on the consumer appetite for this kind of product, particularly in VA, if it is underperforming in a volatile and sort of a rising market as well?

I'm going to speak very generally here. These overlays are intended to operate over a long period of time. And they should perform well over a long period of time. All the back testing that's done in the development of the product suggests that.

I would characterize the last 90 days as unusual in the sense that you had so many V-shaped patterns to the S&P market in such a short period of time. Randy addressed that in the discussion of the hedging program, why that volatility led to some more breakage. Similarly, I discussed volatility just as a chilling effect upon equity-based products in general, mutual funds and VAs.

And the other point I would say is that even though the risk management overlay -- and the performance has improved a little bit by the way in the last 30 days. Again, this is industry wide. Remember that this is at the end of the spectrum of product design, where people pay a lot of attention to the guarantee. And the guarantee is working for them just as it should. The roll-up is working; the payout down the road is still what the expectations are.

So I think it would be hard to say, based on 90 days, that consumers are cooling over the long term or not. Again, I think you have to take all of the expectations by the consumer, both in terms of fund performance as well as the guarantee on these products. Remember, the only way you can get the high income guarantee in the industry, with maybe one exception, is through the use of risked managed funds. Does that help?

Yes, that's helpful.

And then if I could, one more on VA here. It sounded like you added an additional $2 billion to your reinsurance capacity for this product. What do you see as the appetite from reinsurers to this type of risk? Do you see more participants in the market, or any changing terms that you got on this transaction versus prior?

Randy, could you take that, please?

Yes.

Michael, the extension was with the same company that we had the reinsurance treaty with previously. I would describe the overall environment as still relatively modest from the number of people who are participating. I think you see a little more interest. I think the very fact that the company we did our deal with did the deal, raised some interest and has caused some people to look at it.

But I don't think you see a huge number of participants yet out there in the marketplace. We'll continue to work. I think we obviously have a lot of connections.

Anybody who would be interested in doing reinsurance is naturally going to be in discussions with us. And we will continue those sorts of discussions. But I wouldn't describe the marketplace as robust.

Thanks.

Our next question comes from Jimmy Bhullar from JPMorgan.

Your line is open.

Hello.

Randy, I had a question on just your repricing of the disability book. If you could describe how much you're done or will be done by the end of this year. And what's the environment like in terms of clients absorbing price hikes? Your sales, I think, this quarter were down 35%. As we look at year-end renewing cycles, should we expect a similar decline in sales and then obviously weak revenues next year?

I think I'll take that. To start at a high-level answer to that question, the business that was poorly priced a couple of years ago, we're about 70% of the way through. And so we have a little bit more to do. But a good example, by the way, on that business, is year to date on the premium that we retained, we've gotten really high, middle-single-digit improvements in margins. So our pricing activities are proving out to be successful in that earnings will flow into the income statement over time.

As I mentioned in my remarks, the pipeline for sales is up. And that's a good indicator of premium growth or sales momentum. With respect to the retention rate of business as we go through the next 60 to 90 days of repricing, based on what we're doing, we would think the retention might be a little bit better than 60%. But we'll have to see.

And then on the legal loss, you've had higher legal expenses for the past couple of quarters. I think partly this is related to your Life Insurance business. But to what extent do you expect them to sustain, or are the issues behind you now?

We have a pretty good review of aggregate litigation issues in our SEC filings. And so I'm not going to get into a very specific answer to this question. I've watched this over the last decade. Litigation ebbs and flows for all companies -- insurance companies, financial services companies, as well. And I think there's no exception to that. But the aggregate amount of cases that you have and the severity of those cases at any one point in time ebb and flow. We'll continue to see that. I do not expect that, particularly this quarter, would be any indication of a normal level of legal expense.

Okay. Thank you.

Our next question comes from Ryan Krueger from KBW.

Your line is open.

Hey, thanks. Good morning. I had a follow-up for Randy.

I know you mentioned that Mortality was in line. But can you give us any more detail on either actual-to-expected Mortality or another metric that you look at, and maybe how it compared to the year-ago quarter?

Yes, I think compared to the year-ago quarter, I'd describe both quarters as in line with our expectations. So our expectations are for a number that typically travels in the 80%. So we're right in that range. I don't think there was anything abnormal about either quarter.

Of course the first half of the year, we had elevated experience. I would have loved to see it come in below expectations, but it didn't. It came in right in line with our expectations, very similar to where we were last year in the third quarter.

Okay. Thanks.

And then in the Annuity business, the normalized ROA was 83 basis points, which was up a bit from the second quarter despite the weaker market. Do you think that the 83 basis points is a good run rate going forward? Or should we be thinking about anything else there?

As we mentioned, I think both Dennis and I mentioned that we're very happy with the resilience of the Annuity results despite the drag of the markets. In terms of what we would expect, I mentioned that the business had $5 million of items, primarily a favorable tax item -- along with a little bit, $1 million or so, from the unlocking process. We also mentioned that Alternative Investment income added $11 million across the enterprise. Most of that was in Life, but Annuity got a little bit of it, a couple million.

And then the prepayment income. If you look at last quarter, prepayment income was actually very low; whereas this quarter it was strong. Which is sort of reflective of the nature of prepayment income. Quarter to quarter, it's going to hop around. But over the last three years, if you look over a calendar year period, it's been very steady in the amounts that we've received. In fact, it was very similar to the amount we received this quarter.

So I think the fact that it hopped up had to do with, one, first and foremost, the resilience of the business. And secondly, strong performance in the Investment portfolio.

Got it.

Last one real quick. Do you have an update on the assets and liabilities in the VA assets?

They continue to run very strong. So assets exceed the hedge target by $1.4 billion, I believe, at the end of the quarter. So it's still a very comfortable margin. And they also exceed the statutory reserve credit by a significant amount -- $800 million, $900 million -- in excess statutory reserve credit needed. So in a very good position on assets.

Of course, the hedge performance in the quarter hurt that a little bit. But once again, when you look at hedge performance over an extended period of time, I wouldn't expect to see this sort of quarter repeated.

Okay. Great. Thank you very much.

You bet.

Our next question comes from Yaron Kinar from Deutsche Bank.

Your line is open.

Hello, good morning. Actually, all my questions have been answered. Thank you.

Our next question comes from Humphrey Lee from Dowling & Partners.

Your line is open.

Good morning.

Just have a question about the latest NAIC proposal about potentially eliminating the use of VA captives. Any color or comments from the proposal?

Yes. Let me explain what the problem is to begin with. And that is that statutory accounting is on a book value basis. And hedging, typically, is on an economic basis. And in tail situations, those two things can differ. And so it could create some temporary capital calls in severe capital market conditions.

I think the regulators understand the idea that a regulated company having to protect against one risk and, because it's the exact opposite of the other risk, not being able to protect that other risk is not a good regulatory situation. So the industry and the regulators are striving to achieve a regulatory framework that permits all of us to profitably hedge the risks that we undertake.

The NAIC has hired Oliver Wyman as a consultant. Oliver Wyman has put out its first report. And although there's a lot of detail that went into it, the initial report seems to get at solving this problem. So at this point, we're encouraged. There's a long way to go.

And Lincoln is active, as we typically are, in working with the regulators on this issue. But I've met regularly with the regulators. I think there's a pretty good sense of let's get to a good answer for the regulators, and let's get a good answer for the industry.

I think, at least from my understanding, there will be obviously some positives and negatives. To the extent that the capital requirement may turn out to be lower, or maybe more on an economic basis as opposed to a prescribed model, and at the same time you may get some benefits from better admission of the hedged assets. Those would potentially provide some offsets if there's some challenges to the use of captives. Would that be a fair statement?

You raised a lot of issues in there. And I'll just fall back to the issue is to get a regulation that makes sense for the industry and for the regulators. Again, the situation now with book value versus economic creating a problem, we are making progress on that issue.

Some of the things that you mentioned are helpful on that specific issue. Some of them I wasn't quite sure of where they are in discussions right now. But again, overall it's positive. And we're all, regulators and industry, hopeful that we can get to a solution that makes sense for everyone.

Thanks.

And then just one last question for Randy. So you talked about fourth quarter in terms of buybacks will remain active. And then you also mentioned about the potential reserve financing in the fourth quarter. Should we think about the buyback was largely driven by reserve financing? Or do you still have some kind of free cash flow generation capacity that would add onto the reserve financing?

When I think about overall buybacks, we're $700 million year to date. So that's over, actually, the full-year guidance we came into the year with. And it's reflective of a number of things, including strong capital generation, continued strong performance from the Company.

When you look to the fourth quarter specifically, I think I would describe my expectations coming into the quarter as a normal quarter. We've been running in that $150 million range -- $125 million, $150 million range. So I don't go into the quarter with any expectations for anything outsized.

But we continue to have a very strong balance sheet. And we continue to have a capability to step in when we see dislocations in the marketplace. As we did in the third quarter when we stepped in and upped the buyback amount when we saw the share price dip below book value.

Okay. Thanks.

You bet.

Our next question comes from Steven Schwartz from Raymond James.

Your line is open.

Thank you.

Good morning, everybody. A couple of quickies.

Dennis, you mentioned the loss of a large case retirement plan in the fourth quarter. I was hoping that maybe you could size it for us and give us a little background?

And then for Randy, I would follow up Tom's question and ask about the actuarial assumption review and what kind of effect that might have on a go-forward basis for the Life business?

The case was about $600 million to $675 million, in that range.

Randy, you want to take the rest of that?

Sure.

Steven, I'm not going to go beyond what I said earlier, which is both assumption changes -- and the primary one that impacts the Life business happens to be the change in the J-curve ultimate earned rate -- have modest negative impacts on run rate earnings. So there will be a modest negative impact on Life earnings. I don't think of it as a number that would significantly change your models or your expectations.

The business continues to grow also, as I mentioned. Drivers in that business continue to grow 3%, 4%. So while there will be a modest negative impact for a period of time, it's not a number that I can consider to be of such that I'm going to spike anything out. Okay. Thanks, Randy. I thought you were just referring to Annuities at the time.

No.

Steven, just back to the question on the outflow. I do want to reinforce and repeat what I said earlier, which is we expect flows to be positive in RPS for the year, which is quite an improvement over where we were last year.

Dennis, what's the background of that loss? Is it a merger? Is it pricing? Can you fill that out?

Pricing -- and again, losing business isn't a good thing. But the minimum guarantee in that contract was pretty high. And so we weren't making a lot of money on it, and so we weren't as competitive as some others were to get the business.

All right. Thanks.

Okay.

At this time, I'm showing no further questions. I would like to turn the call back over to Mr. Chris Giovanni for closing remarks.

Thank you all for joining us this morning. Apologies on running a few minutes over. But as always, we're around to take your questions at the Investor Relations line, at 800-237-2920, or through e-mail at InvestorRelations@LFG.com. Thank you and have a good day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.