Lincoln National Corp (LNC) 2016 Q3 法說會逐字稿

Good morning and thank you for joining Lincoln Financial Group third-quarter 2016 earnings conference call. (Operator Instructions)

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

Thank you, Charlotte. 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, 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.

Presenting on today's call are Dennis Glass, President and Chief Executive Officer, and Randy Freitag, Chief Financial Officer. After their prepared remarks, we will move to the question-and-answer portion of the call.

I would now like to turn things over to Dennis.

Thank you, Chris. Good morning, everyone. Third-quarter earnings were particularly strong as we reported record operating earnings and earnings per share. Excluding notable items, EPS increased 10% compared to the prior year. These were high-quality results as all four of our businesses produced solid earnings and our sources of earnings were well-balanced.

Our balance sheet and capital position continue to be very strong, evidenced by nearly $9 billion of statutory capital and a 10% increase in our book value per share, excluding AOCI, to almost $57. During the quarter we also completed our comprehensive annual consumption review, which had a modest impact on our financials.

Given the strength of our balance sheet and our consistent capital generation, we returned more than $250 million to shareholders in the third quarter. In addition, we also announced last night that the Board of Directors approved a 16% increase in our quarterly dividend.

As we are all aware, macro headwinds are dampening growth for the life insurance industry and we are certainly not immune to that. However, I am pleased that across the enterprise we are successfully responding to these challenges with short-term actions, including disciplined expense management and incremental capital management to sustain our EPS growth.

We also have additional actions underway to position us for the longer term, including pricing changes on both in-force and, where needed, new business, an enterprise-wide digitization initiative that will significantly enhance our customer experience and provide efficiencies over time, and an intense focus on product innovation, particularly in our annuity business, to meet evolving consumer preferences and marketplace shifts. The strategy will once again rely on our core strengths: distribution and product development.

We will update you on these initiatives as they evolve, but I am excited that each will provide us an opportunity to sustain our strong track record of financial success.

Now turning to our business segments starting with annuities. It was another solid earnings quarter for the annuity business, which highlights the ongoing underlying earnings power of our in-force business, including another year of modest unlocking impacts. Our hedge program also had strong performance.

Consistent with the past several quarters, new business continues to be affected by various market factors. As a result, industry sales are down roughly 30% and our sales are down as well. We continue to believe uncertainty in the capital markets is a primary driver, but we see some additional factors, including shifting consumer preferences towards passive investments and choice between fee and commission-based compensation -- notably, sales of passive investments and fee-based advice are not currently prevalent in the VA space -- short-term performance of risk managed funds in V-shaped markets, and some impact from the DOL, which is difficult to quantify given similar declines in both qualified and nonqualified markets.

We have an active plan to boost sales, grounded in our successful long-term strategy of both expanding and developing distribution, coupled with product evolution. Let me highlight some aspects of this.

First, beginning in the fourth quarter we are improving our comp value growth first value proposition by providing more choice and investment flexibility, which should offer better upside potential. Also, we are leveraging our unique i4LIFE solution, which is positioned very well in the nonqualified market to provide better income outcomes. We expect these refinements to draw new advisors and improve distribution effectiveness.

Next, we see the movement towards fee-based products as a significant long-term growth opportunity as it expands our distribution reach into fee-based and registered investment advisors. There is a growing interest in fee-based annuity products and we will be refreshing our full suite of products to meet this demand and they will be ready in early 2017.

We recently filed a VA product that creates a new product category, which is a no load and lower fee passive investment-based VA with a simplified guaranteed income story. We are partnering with one of the leading passive investment managers to capitalize on the movement towards passive investments. We expect a gradual rollout starting in the first quarter and see a long runway for growth.

Finally, as it relates to the DOL, we have seen a major distributor narrow its shelf space, leaving up in place. We expect to benefit from this trend if it continues.

As a result of these actions, we expect to see momentum in the fourth quarter and further sales gains throughout next year, recognizing there could be some disruption in the qualified market around DOL implementation. Ultimately, we expect to return to full-year positive net flows in 2018.

Of note, as we are building sales, we intend to buyback more stock to blunt the EPS impact of lower sales.

So as we talked about at investor day, our annuity book has a solid earnings foundations and strong returns because we started this business prudently and smartly from the get-go. The actions I just described will allow us to navigate the changing dynamics in the marketplace and build on our successful track record.

Turning to life insurance, our earnings were robust and included mortality results that were in line with our third-quarter expectations. Total life insurance sales in the quarter were $193 million, a 12% increase from the prior-year quarter, as nearly all of our product lines generated solid growth.

Included in our sales results are several noteworthy stories. Term sales of $31 million were a post-merger record and increased 55% as we continued to benefit from several product and process enhancements over the past year. VUL sales increased 11% as our strong pipeline began to convert to sales following a slow start to the year.

Indexed universal life sales increased 10% as regulations that began last September required many competitors to make significant reductions in maximum illustration rates, resulting in an improvement in our competitive position. Lastly, MoneyGuard sales increased 8% as we are benefiting from continued market demand for linked-benefit products.

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. This quarter we once again achieved these objectives with expected new business returns within our targeted range, 12% to 15%, and all individual life products representing between 10% and 30% of total life insurance sales. Also, 65% of our sales did not have long-term guarantees.

Overall, our life insurance franchise continues to be strong as growth in key business drivers, combined with pricing actions, leave us optimistic about our ability to grow our life business.

Turning to group protection, this quarter reflects our continuing progress in improving profitability and the long-term growth potential of our group business. Consistent with recent quarters, we continue to benefit from a favorable nonmedical loss ratio, primarily attributable to our repricing efforts and enhancements to our claims management function. Although loss ratio results can fluctuate from one quarter to the next, we believe that our underlying experience trends are solid.

As we have noted recently, top-line will be critically important to drive the next leg of our margin improvement story and we are clearly seeing signs of success as our premiums grew sequentially for the first time since 2014. We will build on this growth moving forward and expect year-over-year premium growth to reemerge in 2017.

Driving our encouraging top-line momentum are improvements in sales and persistency. For the full year, our sales growth is solid, up 16%, off a low sales result in 2015, while our pricing remains sound. Just as important, renewal persistency has been improving as needed price increases have moderated throughout 2016.

Bottom line, I am pleased to see signs of growth reemerge while we continue to sustain our pricing and risk management discipline.

In retirement plan services, earnings were consistent with recent quarters. Third-quarter deposits of $1.8 billion were down 5% from a year ago, due to timing of first-year sales in the mid-large market. That said, we have pointed to a strong sales pipeline which we are seeing convert to new sales.

As a result, first-year sales increased 41% sequentially. With several recent wins scheduled for fourth-quarter implementation, we expect 2016 net flows to exceed 2015 levels. This quarter generated nearly $100 million of positive flows and have had positive flows in six of the past seven quarters.

Our strong results and optimistic growth outlook are being driven by several positive factors, including distribution expansion and increased wholesaler productivity in the small market; the launch of our enhanced small-market director product, which is level fee and DOL-ready; and lastly, investments in our digital and mobile customer experience that is resonating in the marketplace. To this point, since launching our new Click to Contribute functionality in June, we have seen 12,000 participants take action to increase their contribution rates.

These tangible outcomes, combined with our alignment to the fastest-growing markets and an ability to distinguish ourselves in these markets through our high-touch service model, give us a lot of positive momentum.

Shifting to investment results, our alternative investments had a solid quarter with a 12% annualized return, above our long-term average and targeted return of 10%. Better results from both our private equity investments and hedge funds helped drive the increase over the prior quarter. We expect to further increase our alternative earnings over time as we continue to grow the portfolio to our long-term target of 1.5% of invested assets and further shift the mix towards private equity.

In the third quarter, we put new money to work at an average yield of 3.6%, down 20 basis points from the second quarter. The decrease in new money rates was consistent with the drop in treasury rates as we invested approximately 200 basis points over the average 10-year treasury. Lastly, the investment portfolio remains high quality with below-investment-grade assets representing just 5.4% of our fixed income portfolio.

Before wrapping up, let me provide a few comments on the DOL, as there has been a fair number of developments over the past few months. First, as we have noted, most of our distribution partners are continuing to work towards using the best interest contract exemption to serve retirement savers and will offer the choice of commissions or fees, whichever is in the client's best interest. This is the decision we made with LFN and shared with our advisors early on.

While some distributors have publicly announced their intentions, many have been slower to formally communicate their decisions. That said, if you listen to recent earnings calls, you would have heard a number of the large wirehouses imply that choice has always been fundamental to their firm's practice and they do not expect that to change. Let me provide some specifics on what we expect.

Of our 10 largest VA partners, we believe nine will use the best interest contract exemption for commissions. Also of note, 85% to 90% of the sales from our top VA partners will -- our top 25 VA partners will also allow commissions.

As I mentioned earlier, we are also seeing significant interest in fee-based annuity product offerings. With fee-based annuity currently representing a small portion of industry sales, we see this as a big distribution growth opportunity.

As I already mentioned, we are seeing some distribution partners narrow manufacturers and product offerings. We expect to benefit from this, given our leading wholesaler force, the breadth of our customer solutions, and our consistent market precedence. In fact, we are already seeing early signs of this as a leading distributor announced that effective January 1 they will be paring down the number of products and manufacturers they offer.

Proudly, we have more products retained on their shelf than any other manufacturer. Once again proof that we will be well-positioned in a post-DOL world.

So in closing, I am pleased with our record results, which include underlying EPS growth of 10%, consistent with the EPS growth targets we have provided. While clearly there are economic and regulatory issues, we are taking both short- and long-term actions to manage them.

Also, when I look around the industry, I continue to believe we have a clear and straightforward story. We are not in the crosshairs of dual regulation. We are not undertaking uncertain transformational changes. We are not distracted by precarious runoff businesses, while our 100% domestic footprint better protects us from global macro uncertainty.

Our business model is simple: manufacture only retail products, lead with distribution and product prep, target the fastest-growing segments of the broader US market, maintain industry-leading risk management, and actively direct capital to the highest and best uses. Most importantly, our business model has a track record of financial success and stability and we see opportunities to respond to market headwinds to drive further shareholder value.

I will now turn the call over to Randy.

Thank you, Dennis. Last night we reported income from operations of $441 million, or $1.89 per share, for the third quarter. Excluding notable items, EPS increased 10% year over year.

First, let me touch on this year's annual review of DAC and reserve assumptions. Following last year's lowering of our long-term earned rate assumption by 50 basis points, this year's annual review had a series of pluses and minuses that netted to a modest positive impact to operating earnings of $5 million, or $0.02 per share.

A few comments on this year's review process. Favorable items this year included variable annuity policyholder behavior and expenses. These items more than offset the impact of lower interest rates and a 30 basis point decrease in our separate account return assumption, which now stands at 7.3%.

It is also worth noting that we did not unlock our reversion to the mean quarter, which still provides a cushion against weak equity markets. So the bottom line related to our annual review is that when viewed in total, the assumptions underlined in our balance sheet continue to be solid.

Outside of the annual assumption review, other notable items included a $0.02 benefit in group protection from a balance sheet review that I will discuss later and another $0.02 in other operations, largely from tax adjustments. One other item of note before shifting to key performance metrics and that is variable investment income was strong this quarter. Results ran $18 million after tax impact, or $0.08 per share, ahead of our five-year average for prepayment-related income and our 10% return assumption on alternatives.

Moving to the performance of key financial metrics, book value per share, excluding AOCI, now stands at $56.65, up 10%, as we continue to consistently compound book value. Operating ROE was outstanding at 13.7%, while our ROE for the first nine months ends just shy of 12%.

Expense discipline contributed to G&A expenses net of amounts capitalized, declining by more than 2%, in line with our full-year results. I continue to be pleased with our ability to effectively manage G&A in a period of slower growth for the life insurance industry.

Consolidated net flows were positive and with end-of-period account values exceeding the quarterly average, we enter the fourth quarter with a slight tailwind. Our balance sheet and capital generation remain important sources of strength and it enabled us to repurchase $200 million of stock this quarter.

Lastly, net income for the quarter was $2 per share, exceeding operating EPS, driven by very strong performance from our variable annuity hedge program, which reported $82 million of realized gains. Net income results also included $28 million of realized losses related to investments.

Now to business results and starting with annuities. Reported earnings for the quarter were $240 million, down 2% from last year when excluding notable items in both periods.

Net unfavorable items this quarter totaled $10 million, primarily related to lowering our separate account return assumptions as policyholder behavior assumptions, which have resulted in significant charges for many of our competitors, were once again favorable.

Equity markets strength over the past year has more than offset the negative net flows that Dennis mentioned. As a result, end-of-period account balances increased 6%, which further improved our risk profile as our guaranteed living benefit net amount at risk, as a percentage of account value, is less than 1%.

Return metrics remain strong. Our ROI of 77 basis points is consistent with recent periods, while ROE came in at 21%. Again, an outstanding result.

So the financial impact of changes to assumptions was minimal, another testament to our established and strong foundation in the annuity business. Earnings continue to be high quality, the business is well managed, and we expect to build on our success in the future.

Turning to our life insurance segment, earnings of $167 million included net favorable items of $17 million related to our annual review. Excluding notable items, earnings were consistent with the prior-year period. Also included in the current quarter's results was $9 million of the favorable variable investment income I noted upfront and strong mortality experience, which largely reflected typical third-quarter seasonality.

Spreads, excluding variable investment income, came in at 131 basis points. Year to date, spreads have compressed 7 basis points compared to last year, the midpoint of our 5 to 10 basis point expectation.

Lastly, total in-force face amount increased 5% with average account values up 4%. Both these measures are in line with recent performance and support our mid single-digit organic growth expectations.

Group protection earnings of $28 million marked the highest quarterly earnings since 2009. Included in this quarter's results were net favorable items of $5 million from a review of disability reserves and DAC assumptions. Excluding this adjustment, our earnings increased 35% and our operating margin was 4.7%.

Our nonmedical loss ratio, excluding the disability reserve refinements, improved to 70.2% from 74.5% in the prior-year quarter. This 400 basis point improvement was driven by better loss experienced in all product lines: life, disability, and dental.

As Dennis noted, top-line growth is expected to drive the next leg of our margin improvement story and we are encouraged that nonmedical premiums grew compared to the second quarter. This marked the first sequential increase in premiums in two years. Given these successes, we expect our positive momentum to continue.

In retirement plan services, we reported earnings of $32 million compared to $42 million in the prior-year quarter. This quarter's earnings were negatively impacted by $2 million from our annual assumption review, while the prior-year period benefited by $2 million.

Spreads, excluding variable investment income, were 148 basis points. Year to date, spreads have compressed 12 basis points compared to last year, the midpoint of our 10 to 15 basis point expectation. For the quarter, our ROA was 23 basis points, consistent with our year-to-date results.

Account values have benefited from several quarters of positive net flows. When combined with positive changes in the equity markets over the past year, end-of-period account values increased 8% to $57 billion. Our outlook for net flows remains positive. We are positioned well to further increase account values and earnings in the retirement business.

Before moving to Q&A, let me comment on a few other items of note. As I noted upfront, our capital position remains very strong and our business model continues to generate capital, allowing us to remain one of the best capital return stories in the life insurance space. This quarter we repurchased $200 million of Lincoln shares and year to date we have deployed 76% of our operating earnings towards buy backs and dividends, above our annual target of 50% to 55%.

We expect to remain active allocators of capital. An example of this can be seen by our announced 16% increase in our shareholder dividend. As we have noted in the past, we anticipate growing and maintaining a competitive dividend.

Our statutory surplus stands at $8.8 billion, up over $500 million from the prior-year period, even after sending a little over $1 billion to the holding company. We also estimate our RBC ratio will end the quarter at approximately 500%. Lastly, our holding company cash ended the quarter at $546 million.

So to conclude, we reported record operating earnings and EPS. Net income was also a record and exceeded operating income as the hedge program had an excellent quarter. We grew book value per share by 10% and our ROE approached 14%. This year's annual review had a modest positive impact on our operating earnings and enterprise discipline -- enterprise expense discipline continues.

At the business level, annuities continue to report strong returns, earnings in our life business reflect a strong mortality experience, RPS results were consistent with recent quarters and group protection posted its best earnings quarter in seven years. These solid results have drove consistently strong capital generation and when you combine that with the strength of our balance sheet, it allows me to conclude my comments by stating that we expect to continue actively returning capital to shareholders.

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

Thank you, Dennis and Randy. We will now begin the Q&A session; we have about 30 minutes. And as a reminder, we ask that you please limit yourself to one question and only one follow-up. Then re-queue if you have additional questions.

With that, let me turn it over to Charlotte to begin.

(Operator Instructions) John Nadel, Credit Suisse.

Good morning, everybody. The first question I have is around risk-based capital and just capital supporting the variable annuity business.

We have I guess heard on the first two calls this morning, both Met and Pru, that they're maybe taking or at least articulating a slightly different approach to the way they think about risk-based capital and capital supporting the VA blocks. And really thinking about a targeted risk-based capital ratio of 400% for everything, ex variable annuities, and then thinking about variable annuity capital relative to a CTE(97) or (98) kind of level.

If we thought the same way or in a similar fashion for Lincoln, what kind of impact does that have? I think, given the captive, your risk-based capital at about 500% is still something we can think about relative to that 400% longer term. Is that reasonable?

John, thanks for the question. That's a very broad question so let me come at it this way.

I think about how we develop capital that's appropriate for all of our businesses, I don't think about it as any different business to business. Ultimately, we are looking at the stresses that can impact each and every business and that should ultimately drive the amount of capital that we put behind each of those businesses.

In the case of the variable annuity business, we expressed that with a CTE measure and we talk about capitalizing that business to a CTE(98) measure. The stresses are going to be different in a life business, for instance, where you are primarily talking about credit stress or an annuity business where once again you are talking about credit stress.

So while these stresses or the potential impacts may be different, the fundamental underlying approach for how we develop our capital is consistent across all of the businesses. We then convey those approaches, typically through an expression of an RBC percentage. As I mentioned, we were at 500% at the end of the quarter.

As I have said in the past, we have a very strong balance sheet, but I wouldn't anticipate taking some piece of that balance sheet and doing an outsized share buyback, for instance, in a particular quarter. I think we do have excess capital on our balance sheet if we wanted to do something like some M&A, probably in the range of $500 million or $750 million. But I don't think that when you take everything like ratings into account, that we would take a similar amount of capital and suddenly put that into buybacks.

That being said, we continue to do a strong amount of buybacks each and every year and I would point out that our shares went down nearly 8% year over year, indicating the strong capital return story that we have been. So, John, that's how I would think about capital that we use to support the business and how we ultimately express that as an RBC percentage.

I appreciate that, Randy. That's very helpful.

My second question, unrelated to the first, is if we think about mortality results in the life insurance segments, seasonally 3Q tends to be more favorable than the other three quarters of the year. Just reflecting upon that relative to a typical seasonal strong 3Q, how would you characterize this quarter's results? Could you remind us how to think about the contribution in 3Q relative to the other -- to the rest of the year?

Sure. I think the third Q was the better twin of the first quarter only with a little different numbers in terms of the mix. If you remember, in the first quarter I talked about $30 million of negative mortality experience with roughly two-thirds of that being expected seasonality and then the other one-third being over and above that.

This quarter we had roughly, in total, what I would say is about $50 million of favorable mortality over a full year's average quarter, with about two-thirds of that being normal seasonality and the other third being experienced better than.

When you look -- you try to break that down into percentages, the actual expected for the quarter, John, came in about 95%, 96% I believe it was. So a good quarter all around. A quarter that wasn't unexpected as we do talk about favorable seasonality in the quarter, but nonetheless a very good quarter.

Perfect. Thank you, Randy.

Jimmy Bhullar, JPMorgan.

Just had a question first on alternative investment income. It was pretty strong this quarter, so -- I don't think you highlighted the number that you see as maybe above your expected long-term run rate, but if you could do that. And then also just talk a little bit about which asset classes did well, which ones -- and contributed the most to that. Then I have a couple other questions.

Jimmy, in terms of the impact, I mentioned $0.08 between prepayment income and alternatives. About one-quarter, or $0.02, of that was from the alternative portfolio. You know we have a long-term expectation of a 10% return in the portfolio. I think we actually came in at 12.4% for the quarter.

So it was a good, strong quarter, but I think it was consistent with movements in the equity markets that we had seen in prior quarters.

Jimmy, just a follow up, about 90% set of that overall number came from private equities, balanced hedge funds. But both categories performed nicely.

Okay. And then you reported pretty strong margins, both in group insurance where you've been repricing and individual life. Individual life especially has been weak the last few quarters, so does this represent more of a run rate that you can improve off of or you considered the margins in both of those businesses [abnormal] when you go to this quarter?

Well, you asked about two businesses and I just addressed the life question. We had a good mortality quarter, which benefited us by roughly $15 million. I also mentioned that additionally we had about half of that $18 million of variable investment income, or $9 million, was located in the life line.

So overall it was a strong quarter that featured good mortality. I would also note that when we think about seasonality, we think about it being negative in the first quarter and then getting it back in the third and fourth quarter. So our base expectation as we go to the fourth quarter is that mortality, in terms of once again an average quarter, would be a little better than that full year's average quarter.

In terms of the group business, $28 million of earnings. I noted that $5 million of earnings came from the review of reserves in back, so if you took that out you'd get $23 million or a 4.7% margin.

At the end of the day, Jimmy, it was a good quarter. If you go business by business and look at the loss ratios that we reported and if you adjusted those loss ratios for the reserve review, you would see that every line -- life, disability, and dental -- improved from the prior year and improved from the preceding quarter. So it was undoubtedly a quarter consistent with what we have talked about, which is the repricing of this business has been done and is largely behind us and you are starting to see that feed through into the results.

When you look business by business, I would say it was -- strongest quarter would've been in the life business. And when you look forward I would -- I think if you look in the stats up, Jimmy, the loss ratio in the life business was 66%. I would expect that I would expect that to trend up a little over time and the adjusted loss ratio for the disability business would've been 74%. I would expect that to trend down a little bit over time.

When you wrap it all together, we had an adjusted loss ratio of 70.2%. I would put that on the good side of an expected quarter for this business. And I think if you went back to the first quarter, I talked about a 1% to 2% margin around an expected mean and I think that this quarter was on the good side of that expected mean.

Then you mentioned you are done with your repricing initiatives. As you are looking at year-end renewal season, how is the pricing in the market? Because we have heard from some other companies that it's starting to get a little bit more competitive now. But how is the pricing in the group benefits market?

Jimmy, it's Dennis. We're not seeing across any of our businesses any outliers and all of our businesses have good, strong tough competition. Interestingly, in some of the business lines -- take for example RPS -- it's a little bit less price and a little bit more technology and how that technology can help both the provider and the participant.

But, in general, we don't see any extreme pricing, either people coming in and underpricing or anything in that arena.

Okay, thank you.

Tom Gallagher, Evercore ISI.

Dennis, I wanted to follow up on some of your DOL comments as it relates to the variable annuity business. You had talked about by 2018 you expect net flows to become positive. Can you provide a little color on how you see this playing out for yourself, for the industry a little more broadly in this context?

Is your expectation that you're going to see a pretty meaningful product pivot and commission structure pivot here, as it relates to a move into passives on the product side and a move to level fee sales versus the frontload commission structure that has existed historically? Or do you not see something that dramatic happening here?

That's a good question and I think a lot of that answer remains to be seen. What we know now and what I said during my remarks, which I know you've heard but I will repeat them, is that there is a big group of advisers that haven't been doing the VA business because the VA business didn't have -- it had more commission-based financial advisors and fee-based advisers.

We think that is an opportunity for growth. We think there's a very significant population of financial advisors, if the industry and Lincoln provides better fee-based product structures, that they will participate. So that's one direction.

Is there going to be a significant shift from commissions in the traditional marketplace where it has been commissioned? Is there going to be a significant shift from commission -- compensation to fee-based compensation? Again, I think we have to wait and see if that's going to take place.

We are focused on -- I think all of our distribution partners are focused on what is in the best interest of their clients in terms of the type of fees or the type of compensation that they charge. And as we have talked about on numerous occasions, for insurance contracts where the advice cycle is mostly upfront, it seems like commissions make the most sense, both for the advisor who is providing the advice upfront and it is less expensive oftentimes for the client because there's not this ongoing management fee that is really, in long-dated insurance contracts, not as necessary as say, for example, with an advisor who is helping with asset mix on a daily or quarterly basis.

So there are in fee-based -- excuse me, in the industry in general, the movement to passive investments has been pretty significant. Whether or not that continues we will have to see, but we want to be in a position to meet that need as well. So we'll have to see, but we think we are well-positioned no matter what direction the overall marketplace takes.

Thanks for that, Dennis. And then if I could shift to question on the NAIC proposal to change variable annuity capital and reserving framework.

Randy, any initial thoughts on this as it relates to your views on ultimately how much capital is going to be needed for this business? Do you feel well-positioned based on the way this is trending? Would you expect that maybe this could consume more capital? Any initial thoughts?

Tom, there hasn't been a lot of change since the last time we talked about this. Yes, we do feel well-positioned. In general, I think we are typically going to be supportive of changes that we see as improvements to how we account for our products and, undoubtedly, what the NAIC in conjunction with Oliver Wyman is working on is an improvement in how variable annuities are accounted for, both from a reserve and a capital standpoint.

It's an improvement because it's moving from what I would describe as more of a book value approach to what I would describe as more of an economic value approach. And that is a good change because that is how we hedge the products when we think about that risk. So we are supportive of what Oliver Wyman is doing. We believe we are well-positioned.

If you go piece by piece through the proposal, you are going to find some that are positives and some that are negatives relative to the current approach to reserving that the NAIC has. For instance, I think linking the return to the risk re-rates would probably be a negative, but on the other hand, hedge accounting for derivative assets is a definitive positive. (technical difficulty)

I'd like to follow up on Tom's question around DOL and annuity sales in another way. Dennis and Randy, for the last couple of years you have been saying that if annuity sales fell because of changes in how the product sold due to DOL you would use the capital that was backing those annuities and buy back more stock.

We are kind of essentially there now, at least in order of magnitude, versus what I was thinking; it came a little earlier. I was thinking the fall would come in 2017. So I'm just wondering, Randy, if the stat surplus in RBC that you referenced earlier, if that has benefited at all from the lower capital strain from lower annuity sales.

Sean, I think we've pretty much done what we said we would do. If you look at what we've done year-to-date, we have returned 76% set of operating earnings to shareholders through buybacks and dividends. That compares to a guidance of 50% to 55%.

If you use the central point of that guidance, you are talking -- and you develop how much additional buybacks of our guidance that would be, what you will see is that there's probably or about $75 million in there related to lower variable annuity sales. And I would expect that to continue should annuity sales remain below our longer-term expectations.

As Dennis mentioned, we will be working aggressively to get back to a positive flow situation. But we have been and we will continue to do what we've said, which is put that capital to work through share buybacks.

Okay, thanks. Can you help us think -- if you do get to positive flows and the vehicle that gets you there is a fee-based annuity chassis, is the capital strain lower on selling new products with that type of product versus the commission-based chassis that you have used in the past?

Yes, absolutely. You have less investment upfront so what you will typically see is that, from a return standpoint, your ROEs are a little higher and your ROAs are a little lower, because of the fact that you don't have as much investment and you have less capital strain.

All right, thank you.

Ryan Krueger, KBW.

Thanks, good morning. I wanted to follow up on the no-load passive VA that you're going to rollout. I guess, one, is that an investment-only product or does it have an income guarantee?

Then secondly, are there many other passive-only VAs in the market or is yours the first or one of the first to rollout?

I refer to this, Ryan, as a new product category; not that elements of it aren't in the market. We're not going to go into too much detail because it is a competitive opportunity I think, but it's the combination of passive investment income, a simplified guaranteed living benefit, and a no-load product. Again, I'm not aware of any competitive products that include all of those features.

And, importantly, sort of back to the question that I was asked about -- what's the direction of commissions versus fees -- I think the most important answer is what's in the best interest of customer? What is the customer's investment ideas coming back to -- or preferences I should say, coming back to passive? At the moment a lot of active investment moving to passive.

We're just trying all the time to be responsive to major trends in the industry. I think this particular product citing has a lot of technology associated with it that makes it easier for the customer to understand the product and where it might fit into the customer's overall portfolio of investments.

So we are very excited about it; we've got a great partner. And again, because it is so technology-heavy, it will take a few months to get it into the market and then connect with our different distribution partners' systems.

Thanks. And then for Randy, since a lot of your peers have disclosed their long-term interest rate assumptions on a risk-free basis, I think your [5.25] is in earned rate assumption. I was just hoping you could tell us what that translates into for risk-free rate for comparison purposes.

I think most people generally have talked about the 10-year risk-free rate and how that translates into a longer-term earned rate.

For us, the underlying 10-year treasury assumption is 3.75%. When I look around -- and I do have access to some surveys and other information around the industry -- I would say that that number is, in general, at the lower end of industry assumptions. I would say that the industry average is probably about 50 basis points higher than that.

On the other hand, our grading period at five years is probably a little shorter than the average industry grading period. I think those two items, from an economic standpoint, probably offset each other.

I would prefer, or we would prefer, right now to be in a situation with the lower ultimate rate assumption because I think most evidence indicates that over the longer term we should expect rates to be a little lower than they have historically. And we also happen to think that whatever the ultimate resolution on rates is going to be, it's going to be known inside of five years. We will understand that rates are going to move higher or in the next five years we will understand that we should lower the assumption again.

All right, great. Thank you.

Michael Kovac, Goldman Sachs.

Great, thanks. For Randy here, I was wondering if you could share any initial thoughts, as we are in the fourth quarter, about statutory testing and lower rate utilization. Anything you learned this quarter that you could share with us.

Michael, thanks for the question. I think, as we have done in the past, our overall cash flow (inaudible) has yielded a growing efficiency over time as we add more new business and more profitable new business than runs off our books.

In terms of the things that can be variable from year to year, you are generally talking about these subtests, what are called 8C and 8D, the highly-descriptive test 8C and 8D. The rates for those -- for the 8D test was locked in back at June 30. It's well-known and we don't anticipate any stress from either of those tests this year.

So we feel very good about how we are positioned for cash flow testing and would not expect any additional reserves this year-end.

Michael, I will just, for everybody's benefit, just add a comment that if you go to our investor presentations there is a lot of sensitivity around this question and the consequences of interest rates at different levels. If you go into the policyholder assumption sensitivity, you can see very little. You can see what the impacts are on us in all cases I think; we feel like we're in a good shape.

Thanks, that's helpful. And then one for Dennis here. Appreciate all the additional color on the Department of Labor and the uncertainty that maybe still exists to some degree. Was wondering if you could give us an update in terms of any either upfront expenses or ongoing expenses that you believe you will incur as we head into April and then sort of on the go forward.

Michael, let me bucket that for you. The most significant investment is on the distributor's part, not on the manufacturers' part.

And so, yes, in our RPS business and in our annuity business there's some incremental investment but it's not significant. In our own broker-dealer, which is not a large contributor to earnings, there's probably a little bit more in terms of its expenses, a little bit higher for the implementation. But I'm not aware of any significant expense item with Lincoln, primarily because of the manufacturer-related DOL.

Nothing outside of what I would describe as manageable expenses, the sort of expenses that come up all the time.

That's helpful.

Humphrey Lee, Dowling & Partners.

Good morning and thank you for my questions. I have a question regarding the new products that you are launching, not the passive one but the other one that you are enhancing the investment flexibility.

For those enhanced flexibility, will you still have the volatility control features in those fund options? Or if not, would that still have any kind of living benefits associated with that product?

Humphrey, that's a good question and let me talk about the design of products generally and let me put it into three categories.

One, if you will, you have the investment engine and that means do you have asset allocation funds or do you have risk management -- risk managed funds are individual securities or individual mutual funds? So we make adjustments in all of the engine, if you will, that drives outcomes.

The next block that you have is how does the rollup feature work for guaranteed living benefits? As you know, most everyone on the phone knows, oftentimes in the market it's a 5% roll up for income purposes. And then on the backend, you have the third important piece, which is what's the identified payout? How can that identified payout be adjusted?

So when looking at your questions, I can tell you that in terms of the risk-managed fund, we did develop a product that doesn't rely on them. But we have also had to look carefully at those other two buckets so that when you step back and ask is it a good consumer value and does it fit into our risk tolerances, the answer is yes on both.

So basically it will be you kind of broadened the investment choices without building the volatility control in those options, but then you kind of managed it from the roll up perspective and the payout perspective?

I think, if I heard you correctly, that's correct.

Okay. And then maybe just shifting gears a little bit. In terms of the life insurance sales running being pretty decent, how should we think about when would you get into the capacity that you can do some reserve financing again? On top of it, with the upcoming principal base reserving, how will that change your need for reserve financing going forward?

I think with the level of term sales we've had this year -- as Dennis noted, term sales were up quite nicely year over year -- I would expect that we would likely have the amount of term business where we would look to do one next year. Don't know the exact timing on when it would be next year, but it is likely that we would have the capacity to do one next year.

I would just add in that principal-based reserving has had a very positive effect on the reduction of the required reserves on that product. And so it longer term will have less need for reserve financing on term business.

Dennis is absolutely right. As we look at PBR rolling out, principal's-based reserves, excuse me, rolling out next year, you would see much less strain on term insurance sales so much less need to do reserve financing.

Okay, thank you for the color.

Thank you. I'm not showing any further questions and would like to turn the call back over to Chris Giovanni for closing remarks.

Thank you, Charlotte, and thank you all for joining us this morning. As always, we are available to take your questions on our investor relations line at 800-237-2920 or via email at investorrelations@lfg.com. Thank you all and have a good 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.

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