Q1 2020 Earnings Call
Good morning, and thank you for joining Lincoln financial group's first quarter 2020 earnings conference call.
This time all lines are in listen only mode. Later, we'll we'll now see opportunity for questions and instructions will be given at that time, if you need assistance at anytime during the call. Please press the star key followed by zero and someone will assist you.
Now I'd like to turn the conference over to the corporate Treasurer, Chris Giovanni. Please go ahead Sir.
Thank you operator, good morning, and welcome to Lincoln financials first quarter earnings call before we begin I'd been important reminder, any comments made during the call regarding future expectations trends and market conditions, including comments about sales deposits expenses income from operations share repurchases and liquidity in capital raise.
Sources are forward looking statements under the private Securities Litigation Reform Act was 1995.
These forward looking statements involve risks and uncertainties that could cause actual results could 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 in 10-Q filed with the FCC before.
These statements are only made as of today and we undertake no obligation to update or revise any of them to reflect events or circumstances that occur. After this date.
I appreciate your participation today and invite you to visit Lincoln's website, Www Dot Lincoln financial Dot Com, where you can find our press release and statistical supplement which include a full reconciliation to the non-GAAP measures used in the call, including adjusted return on equity and adjusted income from operations or adjusted operating income to their most.
Comparable GAAP measures a slide presentation, which provides additional information or on our investment portfolio is also included on our website presenting on todays call are done its glass, President and Chief Executive Officer, and Randy Free Tag Chief Financial Officer, and head of individual life. After their prepared remarks, we will move.
The question and answer questions, Nicole I would now like to turn the call over to Dennis.
Thank you Chris good morning.
Health crisis has been difficult on everyone.
Hope you are staying safe and our thoughts are with you.
I also want to recognize our Lincoln employees for their extra ordinary efforts and unwavering commitment over the past few months.
Lincoln has been navigating the current prices like focusing on three priorities.
First and foremost.
Doing what we can help protect the health and safety of our employees.
Second.
It's operating the business and the best interest of our customers partners policyholders and shareholders.
And third is doing our park to help America overcome the challenges of cobot 19th.
Early on Lincoln began monitoring the emerging pandemic and started taking actions to reduce this helped threats, including restricting travel.
Emanating non critical face to face meetings and studying social distancing guidelines.
In March we moved to a work from home model for 99% of our employees.
Help limit.
Rather the virus within the Lincoln family and our communities.
Because of our business continuity planning and significant digital investments.
Which we have discussed with you.
Connectivity and productivity of our employees working from home has been excellent.
We have maintained our commitments to our customers and partners. During this difficult time, which service at the same high standards, we have always delivered.
Finally, we remain committed to honoring our namesake through our actions as they responsible company.
Our foundation has made significant financial commitments to help distribute food through out the communities, where we operate.
And as a founding sponsor people plus work come back.
We are bringing companies together.
To help get people back to work faster.
This morning, we're going to handle our prepared remarks, a little differently.
I will briefly touch on the first quarter results before detailing the current environment and the potential impacts to link.
Along with the strategies and actions we had in place to successfully manage through this period of uncertainty.
Randy will then cover results in greater detail and speak to our strong financial position.
So.
Our first quarter results were solid.
And largely unaffected by the virus.
While we are now in a different barb.
It is important to highlight that we continued to execute on our long term strategic plan and this quarter's results once again demonstrates that.
Adjusted operating earnings per share were up 5% compared to the prior year quarter.
Adjusted operating revenues increased 3%.
Net flows nearly doubled.
We generated a return on equity excluding AOCI I.
Over 13%.
The annuity business.
Strong quarter as both the top and bottom line grew in the mid single digits over the prior year quarter add we produce positive net flows in both variable and fixed annuities.
Notably sales would be age outs guarantees exceeded the age with guarantees the first time in recent history.
As sales of our index variable annuity.
Which is much less sensitive to interest rates gain further momentum.
We expect this shift to continue as we expand shelf space and add new producers.
In retirement plan services. We also grew both the top and bottom line versus the prior year period.
Net flows were once again positive in the quarter.
With strong growth and recurring deposits and low withdrawal rates being the biggest drivers.
Our high touch Hi Tech focused service model distinguishes us from the competitors and is a differentiator in our target markets.
We are leveraging these capabilities, which are more important now and these uncertain times to drive positive outcomes for planned sponsors and participants.
Turning to life insurance operating revenues and operating income each grew in the high single digits compared to the first quarter of 2019.
As expected sales decreased compared the prior year as increases and I, you L and term, which our strategic focuses and less sensitive interest rates.
Were offset by declines in other products.
In part driven by pricing actions.
We remain focused.
On leveraging our broad product portfolio made pain product diversification.
Lastly on group protection.
Operating income decreased year over year, driven primarily by higher than expected mortality.
This offset strong premium growth and expense efficiencies.
Premiums are benefiting from improvement in persistency.
Fine with renewal rate increases over the prior year.
Our expense ratio improved 120 basis points as we continue to achieve synergies from the Liberty acquisition.
In short positive results, we saw in first quarter again demonstrated the strength of our long term strategic initiatives, which will be critical to our success when the health crises subsides.
Now shifting to the current environment.
It is important to recognize that we came into this crisis in a position of strength.
In our businesses and balance sheet.
And is a markedly more favorable situation than we had heading into the global financial crisis.
First on the businesses, we have a diverse mix of businesses that are all at scale.
Our predictable in force blogs combined with the long term nature of liabilities results at an attractive and highly recurring revenue stream.
Over 90% of revenues persisting each year.
We have also benefited from strategic actions taken over the past several years.
Reduce our sensitivity to the capital markets and diversify our sales mix.
This includes shifting to non guaranteed products.
Which now represent over 80% of total sales no single product being more than 16% of total sales and achieving our target for 30% of earnings coming from mortality and morbidity sources.
On balance sheet Sprague, let me address four topics.
Liquidity in our life insurance subsidiaries is very strong with a vast majority of our investment portfolio and publicly traded investment grade securities and we have strict asset liability management requirements.
We also have additional flexibility with $7 billion committed borrowing facilities, which can be used to manage any cash flow stress that might develop.
At the holding company, we have $760 million of cash and have pre funded our 2021 debt maturity.
Which makes our next maturity not do for almost two years.
Dividends from the life subsidiaries are more than sufficient to meet our current corporate interest expense and maintain the level of our shareholder dividend.
In addition to the $7 billion committed borrowing facilities I. Just noted we also have a 2.25 billion dollar lineup credit, which is undrawn that can be used for general corporate purposes.
Our investment portfolio has been materially de risks over the past five years as we have been selling securities have greater risk credit deterioration under stress scenarios. This has reduced the potential impacts for both credit losses and rating downgrades.
The actions have improved results of our rigorous stress testing, which factor in low interest rates and equity market shocks.
Our stress planting focuses on maintaining our financial strength ratings and business franchise, preserving our shareholder dividends and not having to issue equity.
Based on our most current stress tests, we're confident we can meet these goals.
Despite our comfort and given the wide array of potential outcomes from the virus and its economic consequences, we're taking additional steps to protect and further improve our capital position.
Including.
Slowing sales to reduce capital consumption.
Suspending share buybacks for the second quarter, and possibly longer and selectively trimming more positions in the investment portfolio.
There are other areas, where were seeing or expect to see direct impacts from cobot 90.
First.
Claims experienced some of the virus, including mortality and morbidity impacts.
We expect our virus related claims experience to be in earnings impact for Lincoln and not a balance sheet event.
We did not see many cobot 19 mortality claims in the first quarter, but we expect an increase beginning in the second quarter.
In terms of morbidity impacts.
We're seeing an increase in short term disability claims.
And long term disability claim recoveries have slowed.
As a result, we believe.
Ability trends and experience from Cobot 19, and the economic fallout, we'll have a larger impact life mortality claims within our group business.
The secondary is consumer changes due to financial stress such as missed premium payments or for one k. hardship withdrawals.
We're extending premium payment grace periods on a case by case basis for those with cold 19 related hardships and falling state issued mandates as appropriate.
As part of the cares Act, we are waiting eligible withdrawal and loan initiation fees for retirement savers.
We believe these are the right things to do and while early we have not seen meaningful activity in these programs and did not expect them to have a large impact on earnings.
The third area is distribution disruption, we entered this crisis with industry, leading distribution and customer solutions.
Shelf space and distribution breadth led to over 100000 individual producers selling the Lincoln products over the past 24 months.
We have efficiently moved to a virtual sales environment across all our distribution channels, we have launched training and armed or 1500 customer facing sales professionals with digital tools and appropriate insightful marketing materials.
Interaction with our customers remains at a very high level.
Paul virtually.
The digital investments, we have made are enabling us to conduct business effectively as our ability to receive applications and issue policies digitally is very good also.
Customers are adopting these tools with pickup rates increasing by 50%.
Or more in most cases.
And for.
Resulting downdraft in economy will result in some incremental credit downgrades and asset impairments.
Which I have said is anticipated in our stress testing.
Let me turn to sales as you had seen our first quarter sales, which reflect our solid product and distribution positions were good.
And highlight our potential long term sales growth.
However, sales and subsequent quarters will likely be at lower levels, what we saw in first quarter for several reasons.
We are seeing consumers and companies being more cautious as they try to better understand their own situations and not make immediate purchase decisions.
Also at Lincoln, we have raised prices on several products and in a few cases suspended products, where the return on capital.
Customer value proposition could not be supported in this low interest rate environment.
These factors will decrease the amount of capital we invest in growth.
But meeting Lee increase our free cash flow.
Well the expanded this by touching on our strategic approach to proactively respond to lower interest rates and increased economic uncertainty.
Since the beginning of last year, we had been actively repricing products, where returns are more affected by interest rates.
This has been primarily concentrated in our life and annuity businesses as new business returns and Rps and group are less affected by low rates.
Products that have been particularly affected include fixed annuities.
Variable annuities with guarantees universal life and Moneyguard.
We're also shifting to emphasize existing products that meet or exceed return requirements.
As I noted earlier, our index variable annuity continues to gain momentum, enabling sales a b a's without guarantees to overtake sales would be a's with guarantees.
Which is a great.
This capital and return trade off.
Bottom line, we're going to continue to sell products itself consumer needs, while maintaining our focus on achieving appropriate returns on capital.
We are in a fortunate position of having the broadest product portfolio in the industry.
A proven ability to shift sales and a demonstrated capability to add new well priced products.
All of which should support long term growth initiatives as the economy stabilizes.
Lastly on the investment portfolio.
I noted earlier, we had been managing credit risk for defensively.
Adjusting our new money allocation to higher rated investments as well as pro actively de risking.
In preparation for a potential credit cycle.
For example, within our commercial mortgage loan portfolio more than 99% a rated the equivalent of investment grade.
The average loan to value of 48% and debt service coverage ratio of 2.4 times.
Within the structured portfolio, 97% of Seo lows are rated double a. and above.
We have also shifted our investment portfolio through de risking actions selling more than $5 billion since 2015.
With 70% and Securities rated Triple B minus four below.
These measures have contributed to below investment grade assets, representing just 4% of rated assets and our energy allocation declining approximately 50%.
And importantly, shifting the mix subsectors generated less impacted by the price of oil.
As I mentioned upfront our rigorous stress testing of the investment portfolio involves a wide array of scenarios to assess significant credit to period option and this has informed many of the actions I just discussed.
Power of our multi manager invest model also becomes more evident in the current environment.
We have leveraged our entire suite of managers since the onset of cobot 19 to analyze a variety of extremely adverse scenarios on a name by name basis across all asset classes in the portfolio.
While we do expect to see an increase in ratings migration and credit losses. We currently believe the impact will be significantly below our financial plan stress test results and be manageable.
So in closing the impact from quoted 19, and the economic fallout remains unknown.
However throughout Lincoln's 150 year existence, we have overcome similar economic challenges and our management team has a history of leading through difficult environments, including the financial crisis.
Importantly, we learned valuable lessons and as I have noted.
Taken several actions since 2008 to prepare us well for this crisis.
Well, we expect sales and earnings to decline.
Our liquidity and capital positions, our strong our financial planning and stress testing are robust and I'm confident that strategies, we havent pace combined with actions, we're taking will drive long term shareholder value.
I will now turn the call over to Randy.
Thank you Dan.
Last night, we reported first quarter, adjusted operating income of $465 million or $2.24 per share.
A strong start to the year.
5% over the prior year period.
There were no notable items within the current or prior year quarter. However.
There were few items driving some variability both up and down and I will detail them in the business segments.
Touching on the performance of key financial metrics compared to the prior year.
Adjusted operating ROE.
90 basis point.
13.5%.
Book value per share, excluding AOCI <unk> increased 2% to $70.24.
With the current quarter negatively impacted by $1.40 cents per share related to the new accounting standard for expected credit losses.
For Cecil.
On an after tax basis, our Cecil reserve increased $51 million and stands at $270 million.
Adjusted operating revenues decreased 3% to four and a half billion dollars.
And expense management was excellent as DNA net of amounts capitalized decreased nearly 3%.
After adjusting for a 30 million dollar non economic decline associated with accounting for Lincoln equity and employees and directors deferred comp accounts.
Net income per share for the quarter was 15 so.
With the primary driver being unprecedented volatility and the capital markets, which resulted in a 349 billion dollar loss.
Variable annuity net derivative results.
With approximately one third driven by fun basis risk.
Which we expect to reverse overtime.
Overall, the hedging program with highly effective.
Hovering well over 95% of the changes in the hedge target during what was the most volatile quarter, we have ever seen.
Let me provide a couple of measures to size the volatility.
First hedge target increased $5.2 billion.
However, the total distance travel was $20 billion more than two times any preceding quarter.
Yep.
The amount of trading that occurred during these volatile four week period was equivalent.
We typical nine month period.
Now turning to segment results starting with annuities.
Operating income of $261 million increased 4% from the prior year.
Increasing earnings was primarily driven by higher average account those which have benefited from nearly $1.9 billion in positive net flows over the past 12 months.
Including $520 million in the first quarter.
They spread excluding variable investment income increased five basis points on a sequential basis.
However, fixed annuity earnings declined over the same period due to lower variable investment income.
Procured metrics remain solid with our away at 76 basis points and a 21% ROI.
End of period account values decreased 3% compared to the prior year and totaled $126 billion.
As a result net amount at risk increased to 3.6% of account value for both living and death benefits.
We expect this percentage will remain at the very low end of peers.
Highlighting the lower risk nature of our in force business.
Looking ahead, we expect some headwinds from first quarter's end of period account values, the 9% below average confidence.
Though we are well positioned to continue delivering strong financial performance.
In retirement plan services operating income of $40 million was up 3% from the prior year.
With the increase earnings primarily driven by strong expense management.
Deposits totaled $2.8 billion and included growth in both first your sales and recurring deposits.
Net flows totaled $671 million and $1.7 billion over the trailing 12 months.
Average account values increased 8%.
So end of period values were 8% below the quarterly average.
Based spreads excluding variable investment income compressed 18 basis points versus prior year.
Elevated somewhat by a higher than normal cash position.
We continue to expect a 10 to 15 basis point decline for the full year.
Genie expenses net almost capitalize decreased 4% year over year.
When combined with an increase in operating revenues the expense ratio improved 110 basis points compared to the prior.
Retirement business had a strong quarter highlighted by growth in deposits net flows operating revenues and earnings.
However, we do expect some headwinds for lower account values in the near term.
Turning to our life insurance segment.
Operating income of $171 million increased 9% from the prior year driven by new business growth.
As you know.
And our annual mortality expectation, we typically see elevated experienced in the first quarter.
However results came in $19 million better than expected.
Similar to last year's first quarter.
Underlying earnings drivers were solid with average account values up 5% over the prior year.
Average life insurance in force up 11%.
Operating revenues increased 7%, while GNS expenses were flat.
Which resulted in a 40 basis point improvement in the expense ratio.
Spreads increased six basis points year over year as variable investment income returned to more normal levels.
It's more than offset the impact from a non economic change to our crediting rate methodology.
Which caused based spreads to declined 19 basis points.
Consistent with what we expect for the full year.
So a solid start to the here for the life business with operating revenues and operating income each growing high single digits.
As Denis noted we are keeping a close eye and cobot 19 related mortality claims.
We expect this to negatively impact near term earnings results. So the business remains well positioned.
Okay.
Group Protection reported operating income of $40 million compared to $55 million in the prior year.
With the decrease primarily driven by higher than expected mortality.
Premiums increased 7% benefiting from improvement in persistency and renewal rate increases.
The loss ratio in the first quarter was 78.5%.
Up nearly five percentage points compared to the favorable loss ratio, we reported in the prior year period.
And the life business, we saw elevated large claim experience in some larger accounts.
Which added a couple of points to the total loss ratio.
We would expect these larger cases based on credible experience to ultimately return to historical levels.
Disability experience was slightly elevated primarily by higher incidence.
It's impacted the total loss ratio by roughly one point.
Genie expenses declined over the prior year as we continue to achieve synergies from the Liberty acquisition.
Also benefiting from favorable expense variances.
This resulted in a 120 basis point improvement in the expense ratio.
While disappointed by this quarter's elevated loss ratios, we are encouraged by premium trends and expense management.
Additionally, we do expect some negative near term impacts from cobot 19, and the slowdown in economy on a mortality and morbidity claims.
Before shifting to capital.
Let me make a few comments on second quarter expectations.
Well, we do not provide guidance there were three items, we expect to APAC results.
One.
The impact from lower end of period account values I noted in annuities and Rpfs.
I would remind you that every 1% change in equity markets impacts earnings by approximately $10 million.
Second.
As you know we report private equity returns on any one quarter like.
Given the significant decline in equity markets in the first quarter, we expect a negative return on the alternative portfolio.
Third.
We expect mortality and morbidity claims related to covert 19 will increase.
We currently estimate every 10000 deaths in the United States will impact our earnings by approximately $9 million.
With $8 million have usable life business.
$1 million in group.
And minimal impacts the annuities.
Rps businesses.
Additionally, and as noted before we would expect elevated loss ratios in group disability.
Turning to capital we ended the quarter in a very strong position with our RBC ratio increasing seven point.
To 446%.
Additionally, we further improved our liquidity position as we paid off our only debt maturity due this year in February.
And increased our holding company cash to $760 million by Prefunding, Our June 2021 debt maturity of $296 million.
Now, let me discuss how Lincoln thinks about financial strength and how we expect to manage through the current environment.
Oh, absolutely none of us enjoy beat and a stressed financial world.
In many respects, what we have been doing for over a decade is preparing and practicing for scenario like this.
We started by building a strong balance sheet.
When comparing the end of the first quarter to the end of 2008, you would know.
Cash at the holding company net a pre funded debt maturities is up over $1 billion.
Since we prefunded or 2021 debt maturity. Our next maturity is nearly two years away.
A very different picture in 2008.
Statutory capital stands at $9.7 billion nearly double the level.
In 2008.
And our RBC ratio of 446% is up approximately 50 percentage points.
Which equates to $1.1 billion of capital.
Not only is our balance sheet strong, but we have been stress testing at non stop over the past decade.
It is worth repeating that we have three goals in the stress test.
Maintain our financial strength ratings and business franchise.
Preserve our shareholder dividends.
And not have to issue equity.
Our stress testing has both driven strategic actions and informed our confidence in the financial strength of Lincoln.
Let me provide some color on what we think about when we stress test.
We assume the equity markets will experience a significant drop.
Next up to 40% and not snap back over the three years that we model.
We drop interest rates to very low levels.
Coming into this year, we took the 10 year treasury down to 50 basis points compared to 1% in prior years.
And given year to date declines we have subsequently looked at impacts of rates go into zero.
We also play a very deep in the tail credit shop.
Officially we think of it as they see T 99 credit stress.
As you might expect that level of stress drive significant credit losses and downgrades.
That's a real stress it drives a long list of negative impacts to read to capital.
Well the stress test does not just identify the negatives that is just the beginning.
It also informed actions that we have taken our will take to offset those negative impacts for example.
The investment portfolio de risking that Denis noted earlier.
On the business mix front products with long term guarantees that have fallen to approximately 20% of total sales.
And we have also successfully managed expenses to offset headwinds with the most recent example, being our employees deliberative plan a few weeks back to reduce expenses by $100 million in 2020.
As part of our stress testing, we have also had her I and possible impacts to statutory capital from reserve strengthening.
Primarily related to SQL sub test if interest rates stayed low.
Over the years, we have talked about the potential to see an approximate 350 million dollar impact if rates stayed at 1%.
For $700 million at 50 basis points.
Based on an updated analysis, we see significant reduction.
For example, at 50 basis points, we now expect the potential impact a peak in 2021 and be in the range of 100 million to $200 million.
This significant improvement is driven by positive experience relative to the conservatism in statutory reserves and an increase in base reserves over the years at the block ages.
The loan for the range reflects the wider spreads where she today.
Well the upper end assume spreads return to more normal levels.
Now let me discuss our two primary uses of capital.
New business in capital returned to shareholders.
We recognize that many of you define capital returned to shareholders as free cash flow.
But this fail to capture all the capital we generate any given year.
For instance, in 2019, we returned $938 million of capital to shareholders, including.
$640 million and buybacks.
However, we allocated an additional $1.7 billion of capital to the production of new business.
As Denis noted, we expect sales decrease as we repriced business for the current environment combined with disruption from cobot 19 in the weaker counted.
As a result, I expect the amount of capital that we allocate to do business will be lower by approximately $400 million in 2012.
Turning to our expectations for buybacks.
We have made the decision to temporarily halt buybacks considering the events over the past few months.
Well that is not an announcement about anything beyond the second quarter, we will assess and reassess as time goes on and resumed buybacks when it is prudent to do so.
In the meantime, we're focused on achieving the three primary goals, we defined in our stress test.
And for all the reasons I have described based on what we know today Im very confident in our ability to achieve those goals.
So to conclude.
We had a solid first quarter with mid single digit revenue and EPS growth.
And a 13.5% ROI.
The impact that opened 19 are primarily a near term earnings headwind.
And with a strong RBC ratio.
Significantly lower expectations for reserve strengthening in a low rate environment.
And the actions, we have taken and we'll take the balance sheet isn't a good position to manage the stressful environment. We're currently in.
With that let me turn the call back over to Chris.
Thank you Dennis and Randy we will now begin the question and answer cushion recall as a reminder, we ask that you. Please limit yourself to one question and only one follow up and then re queue. If additional questions are necessary.
With that let me turn the call back to the operator.
Thank you to ask a question you'll need to press star one on your telephone to withdraw your question press the pound key.
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And our first question comes from Ryan Krueger with KBW. Your line is open.
Hey, Thanks, good morning.
I guess, the starting with the SQL.
Potential that reserve impact, that's a pretty sizable difference.
The 200 from 750.
I guess can you go into some more granular detail on why that why that improve so much at this point.
Right Yeah. Thanks for the question it's Randy.
We came out with that guidance a number of years ago and at the time, we talked about the fact that it was going to peak.
Then it would go down overtime.
You know that peak.
When we first came out with this guidance was about 2018.
So the actual numbers than an coming down for a little bit.
Ill take the hit for not getting this updated guidance out there a little earlier.
But also then when you factor in that 2020 is pretty much locked in because of what the index that really drives the thing has been has done over the past.
910 months, you really now three three full years of the into 2021 passed the peak on this.
As I mentioned in my script, you also have a natural unwinding of some of the conservatism that's embedded in statutory reserves, it's really those.
Two big items, which really drive this big decrease.
In in our expectation, we see it all in a very low rate environment.
If that helps.
Got it and then.
When you run the stress test scenarios that you provided.
Can you give that I guess, a sense of what type of RBC ratio. You. You think you you would maintain and that scenario and I guess, what RBC are you protecting two in an actual tailor that.
[music].
So I guess, you're you're asking.
What is our downside.
When we run our full stress test run.
That's right and I think what do you need to kind of maintain for capital target in that downside.
It was we we mentioned both Dennis and I mentioned.
Our stress testing has three goals one of which is to preserve our financial strength.
Radiance and our business franchise, the other two which are maintaining the dividend not have to issue equity, but we gear that whole stress test run and I ran through the different stresses that we use.
Has the one of the main goals is maintaining a ratings so with the stresses me Ron offset by the actions.
We talk about we believe that the capital we started more we started today as I mentioned this 446% that the number we will ultimately go down to.
Consistent with the doubly ratings, we operate operate at today historically.
That number's bend in the range of 350, 325% to 250%.
Got it thank you.
You bet.
Thank you and our next question comes from Jimmy Bhullar with JP Morgan Your line is open.
Hi, Good morning. So first just a question on the hedge loss that you had can you discuss what sort of drill and.
The other you're sort of making any changes to hedge program as a result to that but just a little bit more detail on the drivers of the loss.
Sure Jimmy this is Randy.
First no changes to great program, no need to make any changes.
First let me make up.
A comparative comments, so I think to me that we're the only company.
Whose hedging target equals a number.
That we that appears in our balance sheet I think that's really a best in class approach with an economic view of the risk that we are both hedging too.
And that appears is the liability inner financial state.
Well that liability itself that hits target.
With five and a half billion dollars at the end of the Concorde corridor and that compares to a net amount at risk on our living benefit of two and half billion net amount at risk on or death benefits of about 4 billion.
So with that as the predicate some comments on Gi net derivative results or whatever the coke breakage in general first it's real number it's relevant letter.
Represents the amount that are derivative assets.
Creased relative to the 5.2 billion dollar increase you saw in our liability, but there are things that we know about breakage, one it's lumpy.
And it will run at very low levels for extended periods of time, that's what we seen for for a number of years now.
Over an extended period of time.
Average out to a relatively small number.
And this isn't the port one it's also a number that we Chrysler.
So we have breakage.
There's a couple of things that we analyze very closely with the team first capital because breakage ultimately comes out of capital comes out to cap little anymore.
And this is a really good example of one of the very positive financial and Russ cages that we made coming out in the financial crisis, not that we switched from a straight ctdna indeed approach to capitalization can approach that.
Takes a greater role of Cpnine D and a percent of account.
What that does is during the good times when markets are rising.
It doesn't allow you to pull capital out of the business, which is really what a street CTG 19 approach those.
And that's what we've seen that percent of account value.
Floor has been controlling for awhile and its forces to hold an extra $4 million to $500 million in the business. So why well it gets temporarily used up.
By this lumpy breakage, we're still left with a very strong capitalization so great.
Policy change that we made that's worked just like we would have wanted.
The second thing we think about is really the economics of the annuity business. So specifically does the breakage change our view the economics of the business. The answer that's now let me dig into that.
A little bit.
Economics really start with our approach to reporting the V. results, which as I mentioned earlier I think of it.
As best in industry.
The other two big components Jimmy to.
The cost of running the hedge program.
The first is the day to day cost of buying hedges. So for every policy we issue.
We calculate across the hedging that cost represents a significant portion of what we actually charge the customer.
Cost, which will be about $500 million are so this year gets pulled straight out of operating revenue straight out of income.
That's what we're left with is an operating.
Income and operating return on equity that's averaged about 21% over the years averaged in every level, it's actually what we reported in the first quarter.
But the other thing we know that it's possible to.
On the hedge program that's perfect.
Which leads for the second big cost of running hedge program and that's what we're talking about that's called breakage.
Yes, you price for that so when we price. These products we've seen the program will be 80% affected that means we price in.
20% breakage.
So coming into this quarter.
Let's break it represented about an additional 2% cost against operating our early.
When you combine in this quarter's breakage that cost goes to about 3%.
21% or so operating our early gets reduced to about an 18% economic our OE, which compares very favorably.
To the 60% target we've priced for over the years. So from my standpoint, the economics of that business are still very strong.
And stand strong even after a quarter like like this I.
I hope that helps Jimmy a long answer, but I think it's an important topic.
Sure and then just another one on your share buybacks what are the thing that you're going to be looking at sort of decide when to get back into the market.
I think Jimmy ultimately, it's a decision about whether or not.
You are in a stress scenario, sorry, we're going to operate in the second quarter.
Like we're in a stress scenario and we've got a playbook for that situation will get till the next quarter and we'll look at the environment will ultimately will make the determination are we still under stress scenario is that how we should be operating I guess, that's how I think a body Jimmy.
Thank you.
Thank you and our next question comes from Tom Gallagher with Evercore. Your line is open.
Good morning.
Randy just a follow up on the the commentary about when bar and about the way you're managing capital D. should I think about.
Where you're at now or at least at the end of March would that would you be holding to CTV 98, now or is it 4%.
That's the greater out at this point and.
When you think about.
That business and you think about what might be required if you had another sort a repeat.
Of one Q.
Performance.
What are your how how much of a buffer I guess do you have when you think about managing capital there he.
Doesn't sound like you're Theres any risk of near term additions to that to that entity, but can you talk a little bit about how its capitalize now and then you know thinking about further stresses and positioning.
Thanks, Tom.
I guess I would think about it it is.
So the seeking 98 calculation when the markets go down.
Jumps up.
But we've had this account value floor, that's been holding us above that.
So we've got that buffer.
So I think about where we are today.
Consistent with that CP, Maggie and approach everything had mentioned to you is that the difference between TT 98.
And CTG 95, which is sort of another level you hear people talk about me industry in our case for book of business.
Is somewhere between a billion in the field in a billion between one and one and half billion dollar use me so.
Lin bar the entity remains very well capitalized.
We'll continue to grow capital over there, we we hadnt take root taken dividends other Lindbergh for a long time, we're just sort of left the earnings accrue over there.
Last year were really took her first dividend out of there in an extended period of time. So we can easily go back to letting that entity accrue the Ernie naturally makes than in any given year, we feel very good about where we are today Tom.
Okay. Thanks, and then.
Let's see the other one I just had was on Dennis you mentioned, you're seeing increased short term in long term disability claims.
Can you provide a little bit of color on what you think's going on here is it just didn't correlate the historic correlation unemployment, where you see it kind of a surgeon borderline claims what do you think's going on sort of behind the scenes with with disability.
Yes, so far there has not been much colder related.
Claim experience.
When we think about the effect on morbidity, particularly in the group business.
We lump together a couple of the concepts that you've just ask about one is the direct coated effect.
On claims.
And we expect that to increase.
And the second one sort of relates to your question about.
The experience at all providers have that in a recessionary period.
Long term claim incidence increases.
So when we look forward, it's some combination those two things direct.
Claims and.
Potential.
And again historical increase LPD experience associated with recession.
So well, we'll be watching those things closely.
Uh huh.
As we go through the quarters.
Thanks, Thanks, Dennis in just one last if I could sneak it and just give us an estimate for stressed credit losses.
That you would expect annually here and how would that compare Randy to that 400 million that you said should be freed up.
At least in 2020 from from the lower sales levels.
Tom We don't like a talk specifically about the number.
The amount of of stress credit losses, I mentioned at the BT 99.
Area, what drives a significant amount of.
Credit losses as you.
I can imagine a comment I'd make is that the environment, we see today I'll call. The coal bid environment. If you will we don't see this deemed to stressful as the stress we run.
Every single year, so it hasn't risen to that level, yet and it's really.
Primarily as we see right now as we as Ellen and her team worked very closely with our asset managers and still appears to be primarily a downgrade event.
Supported somewhat by what the the fed them and the government is doing but still appears to be primarily downgrades in.
The first quarter, we actually had 655 million of downgrades.
That hurt our RBC.
Five point.
But that we were still able to grow overall RBC myself and points.
So that's what we've seen so far.
As downgrades and that's kind of our expectation for what we were going to see unless the environment changes significantly from.
When it has been for the last few months.
So I might add to what Randy I'd add what Randy said and just repeat what both and both he and I did say.
In our scripts is that were coming in to.
This stress period with a substantially stronger investment portfolio because all the actions we've taken since 2008.
So that's a that's a really good starting point.
In addition to what brand is talked about.
Thanks.
Thank you. Our next question comes from Humphrey Lee with Dowling and partners. Your line is open.
Humphrey Please check your mute button.
Good morning, and thank you for taking my questions.
Thank you for providing the color in terms of what's your thinking in terms of mortality and morbidity impacts from coal to 19, but we would think about from I guess from a top line perspective, and especially given some of the unemployment and furloughed.
Employees deal what are you seeing in terms of in Rps any group protection relative to your premium base and.
Account value.
Okay.
Thanks, Operator, when you think about those two businesses specifically, we haven't seen much in the way of impact so far either from a top line or from a bottom line or at least through the first quarter. It gives you think forward.
Third in the group business.
There really three things that that can impact the top line or that we would think might impact the topline.
The first is that even in this environment just disruption that's going on we'd expect some.
Some slowdown in sales no Dennis mentioned that.
Offsetting that there's an expectation that you'll have better than expected persistency I think but those two items sort of offsetting each other.
Which leaves me with the third impact, which is what you see in a group business in every recession, which you higher unemployment lower covered lives and that provides a bit of a drag on top line growth. So we grew 7% and the first quarter wouldn't be surprised at all if that comes down.
As you move over the course of the year, because really because of that third item you into retirement business, we haven't really seen much again in terms of people.
Taking additional hardship girls, we saw very modest amount 30 million over the past few weeks, 0.03% Silva of account values. So you could that kick up and have a modest impact it could but.
That hasn't been our experience so far.
Got it.
And then looking at you all kind of funding shows this quarter. It looks like you've done a small life insurance reinsurance transaction I was wondering if you can provide some color in terms so that particular transaction in homes currently freedom.
Oh, Yeah, Humphrey, we did sort of I think about an ordinary course transaction with with one of our existing partners was on a very old.
Book of term insurance term insurance that was actually passed it's.
Guarantee period.
Yes.
Generated about my recollection here $50 million to $60 million of capital.
For a very modest give up in earnings. So it was a good transaction.
Partner, we've got a long history workforce.
Got it thank you.
Thank you we have a question from Sunni come off with Citi. Your line is open.
Thanks, Good morning hubs I appreciate the update on the SQL set test.
In the past you've also provided reserve redundancy guidance for the non as to you help book.
Because the question is should we assume that those numbers similar to the S.G. You also test of also increased pretty dramatically since that last guidance.
Hi.
Yes, Sidney I think historically.
Sort of in the base case cash flow to thing they had been growing roughly 1 billion year and there hasn't really been a change and that Weve continued over the past three four years to.
So a lot of profitable business.
And that's been more than enough to overcome the natural runoff that occurs in the business. So yes, I think there hasn't there hasn't been really any change in the patterns over.
Over the years.
So then related Lee and we spent a lot of time on this on the last call. So I figured I'd just ask again this call in terms of enforce transactions, obviously the rate environments change.
Spreads have widened.
Is doing something with the in force block.
Part of that playbook that you talked about in terms of managing for capital flexibility and is doing a transaction in this environment.
Double.
[noise] Suneet I think the current environment is really showing the overall M&A.
Landscape.
People are trying to understand their own situations.
Much less.
Pick on somebody else's situation, so big picture M&A, I think as chilled for the moment.
Bought transactions sort of 12 and for that same general category.
And it's possible that something like that could develop as we've had said in the past as you pointed out that way.
All of US have discussed this that's that's a balance between what return requirements and interest rate return levels.
Can you get that right.
Clearly the table, where both the buyer and seller.
I haven't vantage.
Just a state and the flow of transactions.
But I think there's sort of but show right now because of the uncertainty.
Okay. Thanks.
Thank you and that's all the time, we have for questions.
Going to turn the call back over to Chris Giovanni for any closing remarks.
Thank you all for joining us this morning as always we are happy to take your follow up questions. Please email us at Investor Relations at LSG Dot com.
Thank you and have a great day.
Ladies and gentlemen. This concludes today's conference call. Thank you for participating you may now disconnect everyone have a great day.
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