Lincoln National Corp (LNC) 2015 Q4 法說會逐字稿

Good morning and thank you for joining Lincoln Financial Group's fourth-quarter 2015 earnings conference call. At this time, all lines are in listen-only mode. Later, we will announce the opportunity for questions and instructions will be given at that time. (Operator Instructions).

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

Thank you Michelle. 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 in market conditions, including comments about sales and deposits, expenses, income from operations, share repurchases 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 your participation today and invite you to visit Lincoln Financial'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.

One final item, I want to remind you that Lincoln will hold an investor day in New York City on June 9. We hope many of you will be able to join us there.

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. With that, I'd like to turn things over to Dennis.

Thank you, Chris, and good morning everyone. Fourth-quarter results once again demonstrated the resilience of Lincoln's franchise as we had a solid finish in what proved to be a very volatile year for capital markets. Our EPS, excluding notable items, increased 5% in the fourth quarter. Under the same measure, for the full year, our EPS also increased 5%, which resulted in a ROE of just over 12%.

As we begin 2016, we recognized that there are a number of questions around the impact of weak capital markets on our businesses, and Randy will discuss this later. However, it is important to note we have positive momentum in key business drivers and our strategic initiatives are enabling us to execute on our growth, profitability and capital management initiatives. Some examples of these include consolidated net flows of $1.4 billion in the quarter, nearly double the prior-year quarter, and up 9% for the full year.

Individual life insurance sales increased 11% in the fourth quarter while total life insurance sales were up 8% in 2015.

Our book value per share, excluding AOIC, is now over $52, a record, and up 6% from the prior year. Balance sheet strength combined with solid capital generation enabled us to deploy another $250 million towards buybacks and dividends in the fourth quarter, increasing our total capital return to shareholders in 2015 to $1.1 billion.

Now, turning to our business lines, starting with individual life, as I noted upfront, individual life insurance sales were very strong this quarter, up 11%, while total life insurance sales of $725 million in 2015 were up more than 8%.

It is worth spending a few minutes digging into some product stories as sales for many of our products increased double digits in the fourth quarter. MoneyGuard sales increased 15% as we continue to benefit from market acceptance of our MoneyGuard II product and traction in recently approved states grows. For the full year, MoneyGuard had record sales.

Index universal life sales increased 13% as we were helped by a new product launch and regulation that began in September that required many competitors to make significant reductions in maximum illustration rates. This resulted in an improvement in our competitive position.

Finally, term up 19% and VUL up 12% also benefited from product enhancements.

As a reminder, our focus on sales is not just to grow but to grow profitably with a diversified mix of products and a tilt away from long-term guarantees. In the fourth quarter, we once again achieved these objectives with expected new business returns within our targeted range of 12% to 15%, and no single product represented more than 30% of our total production. Also, 65% of our sales did not have long-term guarantees.

Our outlook for our life insurance business remains positive as our diversified product portfolio combined with the depth and breadth of our distribution distinguishes Lincoln in the marketplace.

Turning to group protection, we are pleased with continued progress we are making with our repricing efforts and the improvement of our claims management effectiveness. Earnings once again increased from depressed results in the prior-year quarter.

Fourth-quarter sales of $223 million were down 11% from the same period last year, and full-year sales were down 16%. With our pricing actions on the poor performing employer paid block largely behind us, our renewal actions have moderated, but we continue to build additional margin into our book of business. As our pricing actions have stabilized, the degree of market disruption has been reduced and we see the pace of sales activity improving. For example, our disability sales decreased just 9% in the quarter after being down 30% through the first nine months of 2015.

We expect continued improvement in sales activity and growth to reemerge during 2016 after two straight years of declining sales. This will be important as we look to drive future margin improvement by growing premiums and sustaining our pricing discipline.

Turning to annuities, our annuity business remains a high quality source of earnings as we posted strong operating results and minimal hedge breakage in the quarter. Total annuity sales were $3 billion and we continue to consistently generate positive organic growth with $435 million of net flows in the quarter and $1.6 billion for the full year.

As I noticed last quarter, noted last quarter, market volatility dampened demand for most equity sensitive products, including variable annuities, and it was hard to tell if the Department of Labor proposal was also having an impact on industry sales. Given continued investor interest on the DoL combined with an obvious overhang on our stock, we wanted to give you more specifics of how we are internally approaching the DoL proposal.

First, it is important to note that there are a number of possible outcomes which we are planning for, including some I have mentioned in the past that would be less onerous on VA's than the original proposal. This morning, I will specifically focus on the scenario where no changes are made to the current proposal, as that is the situation we get asked about most frequently. While this is the most adverse scenario, it is manageable for Lincoln.

So, I would note a few things. One, in the fourth quarter, we had nearly $0.5 billion of positive net flows. Only 30% of our sales came from products that would be impacted by the DoL proposal, namely variable annuities within qualified plans. This compares to nearly 60% for the top 10 VA writers.

Point two, it is also important to note that the DoL proposal does not impact the non-qualified market where our patented i4LIFE has long been known as the income product of choice and has resulted in Lincoln being the market leader in nonqualified VA sales.

Point three, a few years back, we decided to focus on diversifying our mix of annuity sales, tilting away from VAs with living benefits and lowering our risk profile without having a meaningful impact on returns. As part of this pivot, our sales products that are not impacted by the DoL proposal has increased to 70% of total sales, up from 50% pre-pivot. Importantly, given our focus and momentum on diversification, we would expect this percentage to continue to increase, further reducing our dependence on sales impacted by the DoL proposal.

My next point, sales of VA and qualified plans will not entirely go away as the current proposal allows products to be sold on a commissionable basis and many distributors will continue to offer the important guarantees that VAs provide. In addition, we would expect to see accelerated growth in our fee-based VA products as we have been approached by many of our larger distribution partners about the fee-based opportunity. We are also increasing our focus on fixed and indexed annuities, which still have PTE 8424 exemption.

Finally, recall we have said that, if there is a sales disruption, we would be able to reallocate capital to share buybacks to blunt much of the EPS impact over the next several years as we pivot to the extent required, a skill and capability we have successfully demonstrated in the past. So, I believe companies like Lincoln with market leader positions and at scale, that have a broad portfolio of products, along with leading distribution, will continue to succeed.

Let me turn to retirement plan services. Retirement plan services earnings and net flows were consistent with our outlook. Total deposits for the quarter of $2.1 billion were down 10%. However, excluding one large case from the prior year, deposits increased nearly 40%. Full-year results were a very good story with record total deposits of $7.5 billion supported by strength in both small and mid to large markets. Notably, small-market deposits were up 18% to a record $2.1 billion, and mid to large market won two times as many plans as compared to the prior year.

Total outflows for the quarter were negative $220 million and included the large case termination we referenced on our third-quarter call. Full-year net flows increased to $452 million compared to outflows of $881 million in the prior year. The increase was driven by our strong deposits and improvement in our retention rate as we benefit from our strategic investments.

Looking ahead to 2016, we would not be surprised to see lumpiness quarter to quarter in net flows. However, we expect our net flows will exceed 2015 levels. This confidence is driven by our strategy, which aligns the fastest-growing markets with customers that value our high touch service model. This combination enables us to better defend profitability and achieve our targeted returns.

Bottom line, we remain optimistic in the growth outlook for our retirement business.

Lastly, on investment management, we put new money to work in the fourth quarter at an average yield of 4.3%, which was consistent with recent quarters and 210 basis points over the average 10-year treasury. Following strong results in our alternatives portfolio in the third quarter, alternatives did not contribute to earnings this quarter, which makes our EPS growth even more impressive. Over the last four years, our alternatives portfolio has returned more than 10% annually, at a level we target over the long run.

Our investment portfolio is high quality and diversified by industry, geography and issuers. We ended the year with a net unrealized gain of approximately $3 billion and our below investment grade exposure is just 5.1% of invested assets, a slight improvement from the prior year.

With the recent volatility and weakness in the energy markets, I want to update you on our exposure. First, it is worth noting that we stopped investing in the energy sector a year ago. And since the end of 2014, we have reduced our fixed income energy exposure by nearly $1 billion. This included approximately $400 million in maturities and roughly $600 million of asset sales based on an assessment of our exposures with our external asset managers. Importantly, these sales produced fewer losses than what was in our capital plan.

At year-end, the market value of our $8.6 billion energy portfolio was 95% of book value. Our high-yield energy exposure was about $600 million, up modestly from the prior year due to ratings migration and represented just 7.5% of our energy exposure. We continue to proactively monitor and manage our energy exposure.

So, in closing, I am very pleased we were able to grow EPS mid-single digits in 2015 despite equity market declines, persistently low interest rates, and mortality fluctuations. We showed great progress on several strategic initiatives, including restoring profitability in group protection, growth in RPS highlighted by significant improvement in net flows, continued momentum in our annuity pivot, which positions us well for the DoL, and strong life new business returns.

Bottom line, we remain confident in our franchise and our ability to grow earnings.

With that, let me turn the call over to Randy.

Thank you Dennis. Last night, we reported income from operations of $382 million, or $1.54 per share, for the fourth quarter. The current quarter did not include any notable items and as Dennis mentioned, EPS increased 5% year-over-year, excluding $0.20 of favorable items in the prior-year quarter primarily related to our reinsurance recapture. Under the same measure, full-year EPS increased 5% to $6.04.

One other item to point to specific to the fourth quarter, alternative investment income was $18 million below our plan, or $0.07 per share.

Moving to the performance of key financial metrics, all of which normalized for notable items, topline growth remains strong with operating revenue up 6% for the quarter, and for the full year driven by positive net flows in every quarter of the year and product mix shift. Continued focus on managing expenses created further margin expansion as the 4% growth in annual G&A, net of capitalized expenses, trailed revenue growth. Book value per share, excluding AOCI, grew 6% to $52.38. Operating return on equity came in at 12% for the quarter and 12.2% for the full year.

Our balance sheet remains an important source of strength with stronger capital and liquidity metrics which gives us significant financial flexibility.

And finally, our year-end cash flow testing continues to point to significant statutory reserve adequacy and we do not anticipate reserve deficiencies in any of our entities. And we completed our goodwill review and did not have any impairments.

Net income results for the quarter were negatively impacted by a few items, the largest of which was a non-economic charge of $43 million related to nonperformance risk, which is a result of our own credit spread narrowing in the quarter. Hedge breakage was modest at just $13 million.

Before moving to segment results, I wanted to provide some perspective on the current market environment. First, on the recent equity market weakness, this obviously presents a headwind to earnings growth and we have been very clear on the sensitivity, roughly $9 million for every 1% move in equity markets.

Also, it is worth reminding you that we have a reversion to the mean approach within our DAC models, and as of year-end this provided a cushion against weak equity markets.

Next, the interest rate environment. We know interest rates remain topical, but it's important to recognize that we have effectively managed through persistently low rates and will continue to do so. Importantly, our product portfolio has been repriced over the past several years to reflect a low interest rate environment, and last quarter, we lowered our long-term earned rate, which leaves us very well positioned for this particular assumption.

Bottom line, low rates remain just an earnings headwind, and the impact is consistent with the 2% to 3% we have noted in the past. So despite the current Capital Markets environment, we remain confident in our ability to grow EPS.

Now I will turn to segment results, starting with annuities. Reported earnings for the quarter were $243 million, a 3% increase over last year. Operating revenues increased 12% from the fourth quarter of 2014, as premiums benefited from an increase in fixed annuity deposits. Positive net flows in every quarter of 2015 resulted in average account balances reaching $124 billion, up 4%.

Return metrics remain strong and consistent with recent periods. For the full year, ROA increased 3 basis points while ROE came in at 25%. Notably, return on equity has exceeded 20% for the past three years and has averaged 20% for nearly a decade, outstanding results that highlight the returns that a high-quality annuity book can deliver.

In retirement plan services, we reported earnings of $33 million. Fourth-quarter revenue growth was unchanged year-over-year with annual revenue growth up 1%. Average account values ended the year at $54 billion, up 3% compared to 2014, driven by positive net flows.

Normalized spreads compressed 11 basis points for the year. This is at the low end of our guidance and looking forward, we continue to expect spreads to decline by 10 to 15 basis points.

Return on assets was 25 basis points for the fourth quarter and 26 basis points for the full year.

2015 was a good year for the retirement business highlighted by record deposits, nearly $0.5 billion of net flows, and returns that fell within our targeted range. While earnings will fight the headwinds of low interest rates and weak equity markets to start the year, we expect to see continued growth in net flows.

The life insurance segment reported fourth-quarter earnings of $119 million compared to $140 million last year after normalizing items primarily related to the reinsurance recapture. Of the $18 million of below-plan alternative investment income I noted upfront, $12 million of it is the life business.

Mortality results were consistent with the third quarter following elevated experience in the first half of 2015. But I would note the mix of claims was a little different, so the financial impact was slightly worse than we would have hoped. An example of this would be a higher proportion of term plans that have less reserve offsets than a typical interest sensitive claim.

Normalized spreads in the fourth quarter were down 2 basis points quarter-over-quarter and down 6 basis points for the full year. Looking forward, we continue to expect spreads to decline by 5 to 10 basis points on an annual basis.

Earnings drivers remain steady for the quarter and year with average account balances up 3% to 4% and life insurance in force up 3%.

Overall, this year's earnings were dragged down by elevated mortality, which overshadowed strong sales results. While we continue to assume first-quarter results will be negatively impacted by typical seasonality, we do not expect 2015's elevated mortality to persist in the coming year.

Group protection earnings of $13 million compared to a loss of $7 million for the prior-year quarter. Our non-medical loss ratio improved to 75.3% from 81% in the prior-year quarter, driven by our life and disability product lines, which benefited from pricing actions and improvements in disability claims management. For the full year, our loss ratio improved by 300 basis points, and we expect further progress in 2016.

Our renewal pricing actions continue to have a favorable impact on margins, but they have negatively impacted persistency in sales. The result is that nonmedical earn premiums decreased 5% compared to the prior-year quarter.

Our extensive repricing of policy renewals also has an impact on DAC amortization. With the first quarter of our heaviest renewal period, the amortization impact is greatest in this period. In the first quarter, we expect this acceleration of DAC to pressure earnings relative to the most recent run rate. So, overall, another quarter that validates we are on a path an earnings recovery and we expect further improvement in our underwriting profitability in 2016. As the sales momentum Dennis mentioned starts to build and emerges into premiums, we believe margins will continue to improve.

Let me discuss capital management and our capital position before we turn to Q&A. This quarter, we repurchased $200 million of Lincoln shares. For the full year, we repurchased $900 million of stock, which is a 38% increase from the prior year. When combined with a 25% increase in our dividend per share, total deployment to shareholders increased to $1.1 billion.

We have a proven ability to generate free cash flow, and as importantly, we have actually returned that cashed shareholders with share buybacks totaling $3.1 billion over the last five years and dividends more than tripling over the same period.

Historically, I have pointed to 45% to 50% of operating earnings as a good proxy for free cash flow, or what is available for buybacks and dividends. Based on the shift in our product mix, notably successful pivots within our life and annuity businesses, I'm increasing our outlook to 50% to 55%. This positions us well to remain active returning capital to shareholders, and the recent weakness in the share price enables us to acquire stock below book value, an excellent use of capital.

It is also worth noting our revised free cash flow estimate does not include the reallocation of capital under the adverse DoL scenario Dennis spoke to earlier.

Quickly on capital and liquidity, where we are extremely well positioned with statutory surplus at $8.4 billion and an estimated RBC ratio of 490%. Holding company cash at $608 million is well above our target of $500 million and we remain comfortable with our current leverage and capital structure, and would note our next debt maturity is not until 2018.

With that, let me turn the call back over to Chris.

Thank you Dennis and Randy. We will now begin the Q&A portion of the call. As a reminder, we ask that you to please limit yourself to one question and just one follow-up, then re-queue if you have additional questions. So with that, let me turn things over to the operator.

(Operator Instructions). Randy Binner, FBR.

Great, good morning. Thanks. Lots of things to touch on, but I guess I'll start with Randy at the end there. In the buybacks, so you had some positive commentary around free cash flow and generally good comments around the business, the stock is down quite a bit, as you mentioned, below book value. So is there any way that you can kind of gas the buyback here and accelerate what you might do to take advantage of the low share price?

Thanks for the question. When you look at our buyback practices over the last four or five years, we had pointed you to 45% to 50% of free cash flow. In actuality, we exceeded that. We averaged about 51% if you normalized out the extra $200 million we did last year related to the reinsurance recapture. So we have been leveraging our balance sheet to take advantage at times we felt the stock price was depressed and we did that in the third and fourth quarter as we stepped in and elevated our share repurchases to $200 million. So we are deftly cognizant of share price and will definitely step in when we think that the share price is depressed, which it definitely is as we sit here today. All that being said, we're going to be cognizant of the environment that exists today. The environment appears to be a little riskier than it was three to six months ago, so we are going to take that into account. But we are definitely going to be active in the share repurchase market and step in and reflect the fact that we are generating strong free cash flows that have allowed us to increase our guidance, and we will access the strength of our balance sheet when we see it reasonable.

When you see the macro environment as being more risky -- is it from where you sit for Lincoln, is it more of a credit risk issue or is it more of kind of a continued low for long interest rate environment issue?

I think, for us, if you think about the risks, the risks associated with declining equity markets are covered by our hedge program, which continues to perform at a very high level. So, you really don't see a balance sheet issue. From there, you could see it in an earnings headwind, as you talked about, about $9 million per 1% decrease.

You have interest rate risk and I talked about that not really being a balance sheet issue at this point in time. It's still just an earnings headwind issue, so we continue to manage that. So, from a balance sheet standpoint, it becomes credit risk. We have not been through a credit cycle in a while, and we may be entering, or we may not be.

Now, as we enter this future period, I feel very comfortable with our overall position, a very strong balance sheet, a balance sheet that arguably is in a position to handle any stress that comes its way. So I feel very comfortable with where we are, but I would agree with you that, overall, this is primarily a stress that will feature credit.

Thanks a lot.

Nigel Dally, Morgan Stanley.

Thanks. Good morning. So the first question was on the DoL. You mentioned fee-based VA as an alternative to get around the DoL restrictions. Can you comment on the return profile of fee-based versus commission-based VAs? And just on that point, do distributors even have the systems in place to offer variable annuities on their fee-based platforms, or is that more of an intermediate tangible solution?

This is Dennis. I'm sorry, you broke up a little bit there. Could you repeat the question?

Sure. Just on the Department of Labor potentially introducing fee-based VAs as a way to get around some of those restrictions, just hoping to get some differential as to how the returns differ on fee-based versus commission-based. And also whether the distributors have the systems in place to see fee-based VAs.

On the returns, they would be roughly equivalent between a front-end commission and a trailer type fee-based product. I mean that's the way we would price the product.

The second point, again, I'm not quite sure on, but as I said in my remarks, and I think I heard it correctly, there are people who are looking for ways to get valuable living benefits to their customers and looking at our fee-based products which we've already developed. We don't do a lot of that today, but if the DoL pushes some of the distributors in that direction, we have the product portfolio to respond positively.

Okay. And then just second, on energy, just a quick number's question. Do you have the unrealized loss on the high-yield portion of those exposures?

Let me give you the answer to that question. I think at the end -- not I think, but I know, at the end of the fourth quarter, the unrealized loss was about $500 million and with the spreads widening in the energy portfolio grew a couple hundred million.

Okay, thank you.

Suneet Kamath, UBS.

Thanks. I wanted to start with the life business and the outlook for alternative investments. Given that some of this is reported on a lag, Randy, do you have a sense of how 1Q is shaping up and have you changed your view in terms alternatives for full-year 2016?

Thanks for the question. No, really have changed our view, as you noted. As we report alternative returns, you have the private equity piece, which makes up roughly 2/3 of our portfolio, which is recorded on a one quarter -- reported on a one quarter lag. So that will be linked to the third quarter of 2015, which was a pretty good quarter in the equity markets. So I think you'll see that in the results.

Separate from that, you have the hedge funds, which are reported on a one-month lag, so you will see some of the first-quarter impact inside of the hedge fund returns. But overall, it hasn't caused us to change our overall guidance or thoughts on what alternatives will return over a more extended period of time.

I'd also note that when you think about alternatives, especially a portfolio of ours which is not that big at $1.2 billion, you can get that one-off situation where a particular investment gives you an outsized return or an outsized loss in any particular period, so you also have to think about those sorts of things.

Okay. And then just pivoting to the DoL, Dennis, in your opening comments, which were helpful, I think you spent some time talking about qualified versus non-qualified. And I guess the question is, as we talk to some of our industry contacts, there's a view in the industry that whatever happens to the qualified market will ultimately in some way, shape, or form happen to the non-qualified market as the SEC opines on fiduciary standards. That's what we are hearing from industry contacts, so I wanted to get a sense of what your thoughts are on that.

Well, my thoughts -- we don't even know what the DoL rules are going to be yet and there's a lot of speculation about what they might become, some people more positive, some people more negative. So I think it's even harder to speculate about what the SEC might do with respect to any outcome that comes out of the DoL proposal. So, I just think it's very hard to speculate and I would say with some confidence that anything you hear is just pure speculation, could be right, could be wrong.

This is Chris. I just want to clean up one item. Just on the comment around the unrealized losses, the $500 million was of the end of the third quarter. The other additional $200 million was through the fourth quarter.

And operator, if we could move to the next question.

Yaron Kinar, Deutsche Bank.

Good morning everybody. The first question is more strategic I guess for strategic thinking. Given that the market does not seem to be giving Lincoln shares the credit for the diversification of the business and the high returns, and given what we have seen announced from one of your competitors about potential split up, does that kind of thought -- is there room for such thought in Lincoln's board room today, or is it something that you consider?

Consider? That's a pretty open question. The big picture answer to it -- are you asking if we could change the makeup of our company and the way Met is changing the makeup of their company?

Yes.

I'm just going to answer that by saying we believe in the businesses that we are in. Subject to all the comments that we've made about them today, we are making progress overall. We have some things to do better.

But at the end of the day, obviously -- and we've demonstrated this in the past -- whatever is in the best long-term interest of our shareholders, and I say long-term interest of our shareholders, I think reactions to ups and downs from the stock price in a short period of time is not the way we think about things. It's just over the long-term where we're building value for our shareholders.

And with respect to Met, let me just make a couple of comments. One, Steve is a bright guy. He's got a strong management team. I'm sure whatever they end up doing is going to benefit the shareholders.

When I come back to their individual life business and I think about it from a competitive perspective, us competing against them, as I understand what the attempt to achieve by the split up is to get the US life business out from underneath SIFI regulations. And what that would do, importantly for them, from a capital perspective, is put them on the same footing as Lincoln and the rest of the industry. So from that perspective, they are just sort of getting back on a level playing field from a capital perspective. And we don't compete against companies on the basis of uneven capital regimes. So that's a helpful dynamic, doesn't bother us.

And so when I think about Met US versus Lincoln, first of all, we have much more diversification in our business than what I understand they don't end up with. And from -- back to competition, we have such a strong distribution franchise, we have such a strong breadth of product portfolio, just comparatively, we sell twice as much life and annuity as Met does. So I think they will be a good competitor. They have a solid base in the United States but the strength of Lincoln competition capability or from a competitive stance, I think our capabilities are strong and are going to continue to grow.

Thank you for the thoughtful answer. One quick follow-up. Can you tell us how much remains in the reversion corridor today?

We are at about $165 million in total for the annuity and retirement business with the vast majority of that in the annuity business.

And that is as of the end of fourth quarter?

Yes, the end of the fourth quarter.

Okay. Thank you.

Sean Dargan, Macquarie.

Good morning. I have a question about a potential adverse DoL scenario. So, you talked about the pivot to other products if you couldn't sell as much VA in the qualified market. But as I think through that, it might take a while to complete that pivot. Even if your stock was not trading below book value, is it safe to say that you would make up for any potential lost EPS from VA sales by buying back your stock in the meantime?

Yes. I made that comment in my remarks, and I'll just confirm it, yes. Absolutely, we'd do that. We did that, if you recall, a couple of years ago when we were repricing our life insurance portfolio. And we slowed sales down because we were not getting the appropriate returns when interest rates dropped. But I think that created about $200 million of capital that would have otherwise gone into new product sales but instead went into share buybacks. So if that were to happen, it being the DoL more disruptive than we expect, absolutely we would take that capital and buy our shares back. And as we've said, that would mitigate any earnings per share impact from lower VA sales.

Got it, thanks. And when I think about your RBC at almost 500%, I was wondering if you have any -- if you've done any sensitivity analysis, thinking if we are going into a credit cycle, and I'm not saying we are, but that $8.6 billion energy portfolio, if the securities in there were downgraded at an average of one notch, do you have any idea of what that would do to your RBC?

Yes, this is Randy. A one notch downgrade across the entire $8.6 billion portfolio, roughly 15 to 20 points of RBC.

Great. Thank you.

John Nadel, Piper Jaffray.

Hi. Good morning everybody. Randy, maybe just a question, I think this is just more about trying to understand the seasonality pattern for mortality. I'm thinking about the life insurance segment. Obviously, 1Q of 2015 was weaker than you guys would typically expect just the seasonality would produce. Could you walk us through what you expect, in a more normalized environment, seasonality to look like?

Sure. At the highest level, we expect -- this is an individual life mortality -- we expect the first quarter to be elevated, the middle two quarters of the year to be somewhat in line with expectations, and then in the fourth quarter you get back what you are over in the first quarter. That at a high level, as you would expect. Of course, you are going to get some movement around there.

If you remember last year in the first quarter, you can test my memory, but I believe we were $28 million was the number we talked about over our expectations. I think we talked about that maybe being a little high from a seasonality standpoint but not that out of whack with what a typical seasonality would see in the first quarter. So that's what I would say.

Okay, that's helpful. And then I guess my second question is just thinking about the 50% to 55%, and I think, as we moved into 2015 a year ago, you had talked about expecting buybacks to be roughly similar to the level in 2014. Obviously, 2015 benefited from the capital freed up from the reinsurance recapture. Should we expect 2016's level of buyback to look similar to 2015, excluding that $200 million of what I guess we could characterize as more one-time in nature?

What I actually said coming into 2015 was that we would exceed what we did in 2014, and what we did in 2014 was $650 million. So, actually we exceeded that by $250 million. This year, we did $900 million and it did include $200 million associated with the reinsurance or capture.

I would also say that, over the last two quarters of the year, you saw us step in and do an incremental $50 million a quarter, really leveraging the balance sheet. So when I think about the year, the $900 million had the $200 million, and I think about us stepping in and doing about an additional $100 million for the full year over and above what we might have thought otherwise.

Got it. Perfectly helpful. Thank you very much.

Steven Schwartz, Raymond James.

Thank you. Good morning everybody. Just one more, Dennis, if we could, on the DoL, maybe two more on the DoL. The comments that you made about share repurchase mitigating or somewhat mitigating the hit to variable annuities, obviously nobody wants to think about this, but I would imagine that there would be cost savings as well.

I think the way to think about that is that, if sales were reduced, you would have to associate and reduce the variable expenses associated with those sales, but I don't think there's much cost savings on top of the share buybacks that would come out of that kind of a scenario.

Thank you Dennis. And then just switching the emphasis, obviously VA is taking up most of people's attention, but could you talk maybe a little bit about retirement plan? I know a lot of that is teachers, and I don't think they get affected, but I am not sure how much.

By the DoL?

Yes.

Roughly, as it stands today, there's not a best interest contract exemption for plans of less than 100, and that's about 30% of our business. And so it's roughly the same. I'm sorry.

Okay, so that would have to go entirely fee-based and be under fiduciary rules without the pick. I would think that would be negative, but I don't know.

All right. Let's make sure that we are on the same page. For some reason, I'm having a hard time hearing some of these questions. So your question was how much of our current business in retirement is affected by the DoL?

Right. You said 30%.

I misspoke. It's about 10%.

That's much lower. Okay. All right. Thank you Dennis.

I'd like to come back to one question. And I apologize, I'm not sure what the connection problem here is. But I was asked about -- I thought I was asked about the unrealized loss increase in our total energy portfolio, which I answered went from $500 million at the end of the third quarter, up a couple hundred million.

But I think actually the specific question was the unrealized loss in the big portfolio, below investment-grade portfolio, which is only a fraction of that amount. So, for clarification, a fraction of the total amount.

Bob Glasspiegel, Janney.

Good morning Lincoln. I think, Randy, this may be a little bit stale, but a few quarters ago, you said 10% yield on partnership alternatives is normal and $20 million a quarter is the run rate. Is that still sort of your base case assumption A, and was the -- I think you said $7 million low in Q4, was that off of $20 million sort of run rate?

Yes, Bob, thanks for the question. I think, as Dennis mentioned, 10% is still our expectation. Over time, the portfolio as we sit here today is about $1.2 billion, so you can do the math. Pretax it would be $30 million a quarter. As I mentioned this quarter, as Dennis mentioned, we had no alternative investment income and I size that about $18 million after DAC and tax in my sure-up.

That's very helpful. Thank you.

Tom Gallagher, Credit Suisse.

Good morning. I wanted to ask what your thoughts are on anything you are hearing on the regulatory front for VA captives? I think we've had another company out there, Prudential announced they're going to fold in their captives. And I've heard varying stories about companies' views of how this is likely to unfold. But any comments you can give on that? And are you planning on recapturing your captive? I think you've mentioned in the past what the impact would be. If you could update us on that as well in terms of whether it's neutral or positive or negative for RBC.

I don't know what you are hearing from other people, but I personally have been negotiating, at least discussing, this with the executive committee of the NAIC. And so I think I have a pretty good handle on the direction that it's going.

And let me make a couple of comments. The high-level objective of the review is to eliminate the statutory and GAAP reserve issue that has to do simply with market value versus book value accounting. And the regulators understand that there shouldn't be a regulation in place where you can't protect yourself against both potential challenges, but you have to pick one or the other. So what they are trying to do is eliminate this negative arbitrage between sometimes it's called economics, sometimes it's called book value. But the intent is to try to find a way to eliminate that, having to choose one versus the other. The proposal that has come out very definitely goes in that direction. So there is an intent, again, to improve the regulation, both for the benefit of the regulators as well as the benefit of the companies. And so that's the direction it's moving.

Oliver Wyman is about to start a study to try to measure this problem from all the different companies' data. So that's substitutive of what's going on.

Specifically with respect to captives, the need for captives, if this goes in the direction it seems to be going, is lessened. And the current thinking at NAIC is even though it's lessened, whatever captives are in place will be grandfathered. So I generally see this as moving in a very positive direction, the entire VA industry and the regulators. Having said that, there is a long way to go before we get to final regulations.

Tom, let me answer the second part of your question. No, we have no -- I see no need to recapture our captive at this point in time over the long-term. As Dennis mentioned, we are very excited about the way the NAIC is moving, and so we will see what our thoughts are if and when those rules get changed.

But in the interim, no need or reason to that. Let me expand and explain a little bit why I think that is.

Every company has its own facts and circumstances, and I'm not going to speak to why or why not other companies would or would not recapture their captives. But Lincoln's facts and circumstances around this issue are the following. The way we have operated our captive over the years with a hedge program linked to the economics has left us in a very desirable position in that we have a significant amount of hard assets, hard assets that exceed both the economic-based liability, and at the end of the year, they exceeded them by $1.4 billion, and significantly exceed the statutory reserve credit requirement at the end of the year. They exceeded the statutory reserve credit by $900 million.

So, the way we've operated our captive in the past from a reserving standpoint, from a hedging standpoint, has left us in a very favorable position, a position that I don't believe all companies necessarily share.

The second thing I would point out is that the way we have capitalized our VA business also contributes to that very favorable position. The way we capitalize our variable annuities guarantee business is that we have a formula that has a greater-of approach, it's the greater of CT 98, and a floor percentage of -- actually for a while now, that floor has been a controlling item inside of the capital formula.

But the CT 98 is a very high level, high threshold from a capital standpoint. Factually, if we were to take that CT 98 down to CT 95, which is where I hear some of my peer companies talk about the capitalization at, you would actually see $1 billion less of required capital against our VA business.

So we are in a very good position. Recapturing our captive would have very little impact at all on the parent company were we would to do that. And that is directly linked to how we have operated this Company in the past, both from a hedging standpoint and from a capitalization standpoint.

That's really helpful, Randy. And then just one follow-up, and this is more a comment, my opinion, as opposed to the question. But I think given the position you are in, I think it would be a real positive if you all would consider, in the interest of better transparency, recapturing the captive, particularly if it's that strong. I think, right now, I think there's just, generally speaking, those still using captives, there's confusion in terms of how do you compare it versus others, and sort of what it might mean if it does move in the direction of where companies get pushed to move things to an opco. But anyway, that's -- so I think just from a perception, from a transparency standpoint, I think it would be a positive if you moved in that direction. Anyway, I just wanted to make that comment.

We appreciate as always your insight, Tom. As I mentioned, I just don't see that happening. The one benefit you do get really from having a captive is that you are spared from the volatility created by the difference between book value and market value accounting. That $900 million of assets in excess of the statutory reserve requirement, next quarter it may be $1.1 billion, the quarter after that, it may be $700 million. I think that's a real benefit, and we will do everything we can to continue to bring sunshine to the fact that our captive is operated in a very robust way, just exactly consistent with the way we operate our -- the parent. But thank you, and as always, I appreciate your insights.

Thanks guys.

Eric Berg, RBC Capital Markets.

Thanks very much. Good morning Dennis and the rest of your team. Dennis, you indicated at the beginning of the call that your percentage of sales in variable annuities, in qualified plans, I think you said is roughly half that of your peers. My question, my first question, with respect to the qualified business that you do write, can you remind us -- and I apologize if I missed this -- of the split within the qualified between guarantee product and nonguaranteed product? And as part of your response, could you answer the question, do you necessarily think that, when you're selling annuities prospectively into qualified plans with no guarantee, that those sales are necessarily in trouble or not necessarily?

If I understand the question, we sell very little non-guaranteed business into qualified plans. I don't know what the number is, but it's very small. Actually, in some of our broker-dealers, we even restrict that concept. Is that --

Yes. And is it your basic idea that because of the guarantee and the value associated with the guarantee that you may be able to -- that the sales -- is the point plainly and simply that, because of the guarantee and the associated value of that guarantee, that the sales, you may be able to sell these products under the new regime?

Absolutely. And as I said, just to add to that, several distributors have already said that they will continue to sell VAs with living benefits on a commission basis if the rules don't change at all. That's because they're trying to get the value of the guarantee to their customers.

If I could ask one follow-up regarding your investment portfolio. I think I know we've moved -- the numbers have moved around a little bit in the course of this call, but I think that you said that, at the end of the September quarter, the unrealized loss on your energy portfolio was $500 million, give or take, and that the low investment grade loss was much less than that. If I have that right, the basic concept right at what you're saying, that would suggest an outsized loss on your investment grade energy portfolio, something that surprises me since so many of your competitors, for so many of your competitors, the investment grade energy portfolio is basically trading at book. My question, why would you have a large unrealized loss on your investment grade energy portfolio?

That's going to be industry-by-industry and credit-by-credit. And they also -- and I don't know what the other -- the mix of the other competitors is.

Okay. I'll follow up with Chris and we can talk more. Thanks very much.

At this time, I'd like to turn the call back over to Chris Giovanni for any closing remarks.

Thank you and thank you all for joining us this morning. As always, we will take your questions on our Investor Relations line at 800-237-2920, or via email at investorrelations@LFG.com. Thank you all for joining and have a great day.

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