Q4 2022 Lincoln National Corp Earnings Call
Bruce.
Which will be offset by a positive impact in annuities are of similar size.
As we also mentioned in September adjusted operating EPS will exclude market risk benefit fair value changes.
And will include an estimated $800 million.
VA hedge costs.
Second we estimate that the impact of L. DTI will increase year and total book value.
By about $300 million.
And reduce year end book value, excluding OCI by $900 million.
These figures represent improvements from the second quarter estimates we disclosed in September .
Largely driven by the positive impact of higher interest rates on market risk benefits in the second half of 2022.
Partially offset by the negative impact.
The removal of shadow deck.
As a reminder, under <unk>, we will introduce a revised definition for adjusted book value per Se OCI that will remove variances in MRV fair values and changes in the values of the related hedge instruments.
Turning briefly to our 2023 expectations.
There are several headwinds that we expect to impact distributable earnings as well as adjusted operating results. This year.
First <unk>.
Pressures at our capital markets related including higher borrowing costs on floating rate debt.
And certain duration extension programs as well as lower prepayment income.
Second while reduced from 2022 levels, we would expect some ongoing pandemic claims.
Third.
Outside of the benefits of spark.
We expect some pressure on expenses, including those tied to inflation levels.
As well as costs associated with our legacy pension plan.
And then the life business. We also expect a further increase to reinsurance costs.
These headwinds notwithstanding.
Our view of 2023 distributable earnings remained in line with our prior expectations.
Against the volatile market backdrop.
I'm pleased with what we were able to accomplish in a short time.
Particularly strengthening our balance sheet and implementing our new hedge program.
Although it was a tough year for the life business or other businesses performed quite well.
There are many initiatives underway to improve our capital generation and earnings power.
And now I will hand, it back to al.
Thank you Ellen and Randy.
We will now begin the question and answer portion of the call.
As a reminder, we ask that you. Please limit yourself to one question and one follow up and then re queue. If you have additional questions.
With that let me turn the call over to the operator to begin the Q&A.
Yeah.
Thank you if you would like to ask a question. Please press Star then one on your telephone keypad and for optimal sound quality. Please do not use the speakerphone. Please speak directly into your receiver or user wired headset with a microphone.
Our first question is from Tom Gallagher with Evercore ISI. Your line is open.
Good morning, first Randy best of luck to you.
It's been good working with you over all these years.
Allen My that's my first question is just on you.
You mentioned exploring block reinsurance deals.
Can you comment on whether this is mainly focused on life insurance and <unk>, specifically or are you also exploring.
<unk> transactions and then just second part of that is.
Are you also open to considering strategic transactions at this point.
I'm kind of referring to what AIG did with Blackstone or something along those lines. Thanks.
Sure so.
Tom as it relates to our overall focus we're really focusing right now on opportunities that will maximize the value of our in force.
We're doing that right now with a much wider lands and we're evaluating both internal and external potential submissions.
So what we have said is that we have a fully dedicated team right now.
Actively evaluating that opportunity to do something externally has clearly expand it as we know that there are more buyers out there first of all in.
And secondly, there are more buyers out there that would be interested in the potential for complex liabilities.
And most importantly, what ever we would do here would be supportive of the enterprise strategic objectives that we've laid out so we would be looking ideally for.
Some opportunity here that would improve first of all our ongoing capital position, but also.
Improve the rebuild of capital as well, so really the ability to be able to do both of those things at the same time, so more to come.
As as we're able to communicate this going forward to you.
I am not going to give you at this point in time, a specific product orientation, because really the reality is is that if there is an opportunity that makes sense for us and it's good for shareholders and is that the appropriate price.
We would look to transact.
And then and then Alan on the strategic side are you is that something you are considering.
With with a strategic partner or are you really focused on financial transactions at this point.
At this point in time, we're really focused on financial transactions that would that then at the end of the day, we would optimize the value of the in force. If there was an opportunity out there.
That was along the lines of what you were talking about again and it made sense, we would clearly evaluate that as well.
Great and if I could slip in one one numbers question to <unk>.
$300 million of lower strain from new sales in 2023.
Was there a consideration of doing a bigger amount of flow reinsurance to provide more cash flow relief or was that sort of the Max benefit that you could get from from the flow reinsurance.
Yes, so so in this number.
Are quite a few management actions.
And one of those actions is to be expanding and extending some of our flow agreements.
To be focused on capital efficiency and the other thing that I want to mention here is that in addition to the $300 million and I highlighted in my upfront comments, but I really want to stress that we've got the expectation of robust level of sales across all four businesses.
With the expectation of freeing up $300 million in terms of capital efficiency and we also expect to be improving the forward distributable earnings go forward of that block of sales going forward.
So we expect an ongoing capital generation improvement as well.
Okay. Thanks.
Okay.
The next question is from Erik bass with Autonomous Research Your line is open.
Hi, Thank you so you've guided to the $600 million to $800 million of distributable earnings for 2023 before interest expense I was just hoping you could help us think about how that will build over time, maybe expand on some of the levers for improvement that you talked about in your script.
Sure Eric So we.
We haven't guided to 600 to 800 range of distributable earnings coming from the life companies.
We back out of that $300 million.
And annual debt expense that interest, which includes the preferred so we're really talking about a range of $3 million to $500 million from an overall free cash flow perspective, and that's our range as we as we move into 2023, assuming normal capital market environment.
As we move forward and we think about 'twenty four and we talk about the number of ongoing initiatives that we have underway and so I'll highlight a few of them for you right now one of them is spark and we talked about the fact that at the end of 'twenty four that we expect $260 million to $300 million in terms of run rate.
We talked about GP margin and we're seeing steady improvement there and we ended the year with a five 3% margin and we firmly believe that we're well on our way to a sustained 7% margin.
Randy you also highlighted the fact that we're seeing improvement in terms of our capital position of Lindbergh and.
And so that's clearly something that as we move forward, we will continue to evaluate as another improvement as well and then the other piece that I want to highlight again is that while we're going to see $300 million of capital efficiency improvement in 'twenty. Three we're also expecting as we go forward to be able to.
See an improving contribution to distributable earnings of that sales mix that will continue to grow over time. So those are some of the things that were spiking out and then in addition, there were a number of other actions again, we've been at this for about a quarter now we feel really good about the action plan, we've got a lot of initiatives in place and additional.
We're looking at additional levers additional potential actions that could even further support.
This year 2024 and beyond that.
Thank you that's helpful and just to be sure I have it too I think this year's plan includes a reserve release from SQL, which we should probably think of this one time is that correct.
Yes.
Eric Let me take that question. So when you think about.
RBC more broadly as we mentioned we expect to end the year at approximately 383% we talked about a couple of big levers or the contribution of the preferreds the legal settlement going the other way.
Additionally, beyond that.
We did a stat, where we're going to establish.
The reserve associated with the <unk>.
Third quarter unlocking we currently expect that will come in a little better than the $550 million. We guided to were still doing the work we don't file our statutory blue book for a little bit now on the other hand.
Got a little bit better was offset by some other reserve movements during the quarter that I would describe as one time, so youre not seeing a net benefit but we do expect to comment a little better as we come in a little better on the amount we post we'd have a little less release, but as both Alan and I said, we're still able to reiterate.
That same level of expectation for free cash flow. So I think there are some other positives.
That that are driving.
From our standpoint, a better durable result.
Than before when we had did have some element of that onetime releasing or an example of that Eric is that we had pointed to last time, we spoke a range of new business capital efficiency and 23, 2% to 300. So we expect to be on the north end of the range for that so that's an example of some of the pluses and minuses.
That has us very comfortable in our expectation of $3 to $500 million range of free cash flow for 'twenty three.
Got it. Thank you very much and thank you Andy and best of luck going forward.
Thank you.
Okay.
The next question is from Alex Scott with Goldman Sachs. Your line is open.
Hi, Good morning, the first question I had is.
Just around the common dividend.
I listened to a lot of the comments you made around the investment portfolio and your confidence in it.
And I just wanted to better understand as you kind of look at different stresses and think about the environment.
When you run those scenarios.
How would you describe your commitment to the common dividend and.
Well the balance sheet holds up and your ability to cover the common dividend and those type of scenarios.
So Alex I'll start and then Randy of course, we'll continue in fill in so.
First point is that we remain committed to returning capital to shareholders by way of dividend.
We've talked about the fact that you all know that we're focused on the rebuild of our RBC and improving our capital generation and we've talked about all the improvements and what our expectation is in terms of our range of free cash flow.
Into 2023, the board has approved the dividend for first quarter of 'twenty three.
As a reminder, the dividend is under the birds at the boards per view and we're not going to get ahead of the board here, but we remain committed to returning capital to shareholders by way of the dividend.
As it relates to the overall investment portfolio and Randy mentioned, a couple of things. One is that it is of the highest quality that we believe it's ever been we've talked to you for for some period of time about a significant amount of stress testing and scenario analysis and name by name.
Analysis around credit deterioration.
The team does that again on an individual basis and based on the outlook and based on our expectation of credit deterioration at this point in time, we believe that if we were to hit a credit cycle that it would be quite manageable and the overall random of of our overall current investment portfolio in this scenario.
And so that that from our perspective is is again quite manageable.
Yes, I think Ellen you hit it perfectly.
Alex I think hypothesizing about what you might do or might not do during a time of stress as is.
It's premature I think the reality is if you think about Lincoln our capacity when we have a strong balance sheet of 383%, yes below where we'd like it to be over the long term, but it's still a very strong balance sheet. We retained a significant amount of cash at the holding company. We do have access to a $500 million contingent capital facility.
So I think there is a lot of capacity.
And we would think about all the levers should.
Our industry or the economy enter a period of stress you, presumably and which one you would pull which lever you would play out.
Premature and will act as appropriate if and when that happens.
Understood.
Secondly, I had for you is just thinking about free cash flow over a longer period.
Some of the things that are affecting your right now are somewhat temporary.
Cognizant of the fact that you used to generate a much higher level of free cash flow and you have talked about making the products and so forth more capital light overtime as well.
Do you expect to be able to get back up to the kind of cash flow that you've earned in the past.
How long do you think something like that could take and are some of the actions that you are targeting and maybe the strategy and direction of the company because it actually.
Cause you to get to even better cash conversion.
The long term.
So I just wanted to understand sort of where we're at.
How temporary versus long term the impacts are going to be yes.
Yes, so so Alex.
Great Great question.
And I again, just want to remind all of us that we have made substantial progress in the last quarter.
And exactly as you're pointing out we feel really good about where we are what we have done and also the expected improvement going forward and we completely agree that as we move forward with the lens of a real focus on improving overall capital generation that over time.
Everything that is going onto the books is really focused on maximizing profitable growth in a capital efficient way and that over time that clearly will have a multiplier effect.
We're not at the place right now, where we can provide a range and provide a steady state of capital generation.
Or any specific timing around that.
Most importantly.
A couple of points here, one is we focused and highlighted today on the fact that we're rebuilding capital we're improving ongoing capital generation and to your point, we are making sure that we are also preserving and really investing in the future of the franchise and that includes allocating a significant.
<unk> portion of our overall organic capital generation into that new business that will provide us with that with that profitable growth.
We can assure you that we're working swiftly and I remain very confident that we will continue to execute deliver strong results and we'll be back with you as we can as we continue to deliver.
Great. Thank you.
The next question is from Ryan Krueger with <unk>. Your line is open.
Hi, Thanks, good morning.
Alan I think you had you had previously mentioned that one thing that has negatively impacted free cash flow as term life statutory reserving strain from PBR I guess for you or Randy can you help.
Give us any sense of the magnitude of that of that item, specifically and if that's something that could potentially be dealt with with internal reinsurance.
Yes.
Okay.
Brian will get into the specifics of any particular products I think inside of there.
The amount of capital, we expect to allocate to new business, which as we mentioned, we expect to be $300 lower than last next year.
A lot of actions as Ellen mentioned, it's more than just a flow reinsurance deal, including the mix of sales and I would expect that you would see.
Next year that in that particular case term insurance that we would just be selling less than we did in 2022, because it is a very strange product.
That doesn't fit with what the future strategic direction of the organization at the same level as in the past so that is an expectation, but in getting to that $300 million at the north end of where we guided there are a lot of actions term is one flow reinsurance broader product mixes.
Our actions are inside of there.
Hope that helps right.
Yes, I was thinking.
I guess also.
There are level of existing redundant reserves that have been built up now over the last few years from PBR that that could be released.
Used reinsurance either externally or internally.
Brian Yes, I don't think there's much of that I mean, I think we've been pretty proactive over the years in the case of term insurance of really using financing et cetera to really bring forward distributable.
Distributable earnings.
And a product like that.
I'll just come back to the fact that.
Then as as we had mentioned we are really focused on levers that can maximize the value of the <unk>. So if there was an opportunity like that we absolutely would be focused on executing on it.
And at the same time, we're also focused on our new sales going forward really maximizing the present value of distributable earnings there as well going forward.
Thank you and thank you Randy good luck.
Thanks, Brian .
The next question is from <unk>, who need to come up with Jefferies. Your line is open.
Yes, Thanks, good morning, and best of luck from Us to you Randy.
I wanted to ask a bigger question about the capital structure, because it looks like your debt to capital is still pretty elevated.
You issued these preferreds that are callable I guess in five years, but they are pretty expensive you've talked about dividends, but you haven't really mentioned share buybacks.
I guess, maybe can we just talk about <unk>.
Priorities in terms of the capital structure, and maybe fixing some of the things that seem a little bit over an extended at this point.
Okay.
So.
If you think about.
Three big buckets, which we've talked about over the last couple of quarters.
Life Company Alright, we ended the year at three to 383, we expect to continue to strengthen that with a longer term target of 400% So little work to do there.
Limbaugh.
I think we are.
Super Happy and excited that you are relative to where we were at the end of the third quarter. We entered your beer in line with our long term expectations and I think that puts us in a better position in that particular case, when we think about.
Future sources of capital.
So inland bar.
In line with our long term expectations and with our hedge program.
Much more aligned with our focus on capital protection.
The protection of that stream of distributable earnings looking forward and then the last Big thing I think you mentioned it is leverage yes, absolutely we do see our leverage ratio is elevated.
Beyond where we want it over time and I would point out we've pre funded a $500 million maturity that cash sits at the holding company that's coming towards the end of September 2023, So we'll take down $500 million of leverage there, but I think there's more work to do there.
I think there is a.
A lot of actions that are going to occur over the next few years.
As we think about how best to allocate the capital that we're going to generate.
With all the actions that Alan's talked about the growth we expect from a capital depend how we allocated as we think about broadly both financial structure of the organization.
And then any comment on the buyback I know you've rolled it out for this year I think there is an expectation in the market that there will be something in two.
<unk> 2024, just wanted to give you the opportunity to comment if you'd like.
Okay.
Yes.
As it relates to buybacks.
At this moment, we are focused on.
Really continuing to grow our free cash flow.
And also to really take our risk based capital which ended the year at 383, we feel really good about the improvement that we made there and and really rebuild back up to 400 as we're getting closer to that point, we'll be able to give you. Some estimate around how we think about timing and expectation.
There.
We have as I mentioned, a number of initiatives that are well underway, we feel really good about the progress that we've made and we have a number of additional as we move through 2023, and we start looking forward. We have a number of act of additional actions that we're also evaluating some more to come there.
Got it and then maybe just one more if I could.
Are you seeing any commercial impact from a lot of the headlines that we've seen I guess since that since the charge I mean sales were down in a bunch of areas. You had mentioned good results for the full year, but just trying to think through any potential impacts from a ratings downgrade or just from the headlines if it's having any impact on your ability.
To.
Generate commercial growth in terms of products.
Thank you I am very grateful that you asked this question.
We have seen no disruption across any of our businesses as it relates to overall distribution.
We feel very good about the overall volume both volume of sales that went on to the books in the fourth quarter and also the expectation here as it relates to the profitability of those sales on the books as well.
What I can tell you is that I recently attended the annual sales conferences across all four of our businesses.
Our sales teams are.
<unk> fully behind the shift that we're making.
They are highly energized in terms of our overall partners, we continue to add and actually win back producers across all of our businesses. So it is business as usual.
And completely aligned and onboard with the ship that we're making as it relates to improving our capital efficiency.
Okay, Thanks, and good luck everyone.
Yes.
The next question is from Elyse Greenspan with Wells Fargo. Your line is open.
Hi, Thanks, good morning.
My first question.
On individual life I think the earnings are around $107 million. If you back out Covid Ards can you just help us think about the run rate of earnings for that segment. I know you guys spoke about 2020 is coming I think some headwinds from higher reinsurance costs. So just trying to get a sense of just the earnings you see in that segment on a go forward.
Basis.
At least without getting.
Getting to the run rate, let me point out a few facts right with the third quarter and lock in and we mentioned.
This we did have an expectation of life's earnings will be reduced by $45 million a quarter.
No.
If you just started out at the 100 papers that we used to have 107, you've got two is sort of right in line with $45 million lower than we were at additionally.
Additionally, I did mentioned while in total we expect <unk> API to be neutral on an operating earnings standpoint that is a negative $100 million to $120 million in our life business.
Offset by a similar sized positive in the annuity business. So that was another factor.
I would take into account, we do expect some level.
All of ongoing pandemic, we're really happy about the pandemic is seems to be fading in the background, we're going to see some ongoing level and then there were a couple of headwinds individually for the life business that we mentioned for instance, we do have some expectation of higher reinsurance cost next year than we experienced in 2022 I mentioned that we expect.
Life's spread to sell down about 10 basis points or so from where it is today.
<unk> starts to grow in 2020 form beyond so I think there are some near term headwinds I think we did a good job of covering them, but in terms of 107 itself. It sort of is in line with where we were less.
The $45 million impact of the unlocking.
Thanks, and then my second question, obviously, a bunch of questions on capital on the call.
And I know you guys don't want to comment about buyback specifically beyond this year, but it does seem like you guys could be precluded for a bit longer if I'm buying back your stock based on distributable earnings expectation. So at some point Alan like would you guys consider something more transformational potentially considering selling a business as a way to free.
Capital and potentially have additional capital flexibility sooner.
Sooner than otherwise.
Yes.
I'm going to go back to and reiterate the fact that.
We laid out a quarter ago, a number of initiatives that are well underway and we feel really good about them and we're clearly going to see improvement from 22 to 23 and a number of initiatives are going to continue to accelerate improvement beyond 'twenty three 'twenty four and beyond.
And we are continuing to evaluate so I'm going to be very clear about the fact that we're continuing to evaluate other actions that can continue to even further.
Really enable us to get our RBC back to the target level as absolutely quickly as possible. So we're going to continue to take Swift actions, we'll be back in touch with you.
We're not going to give a timeframe today and as we are executing well, we'll continue to deliver those results for all of you.
Thank you.
Okay.
The next question is from Jimmy Mueller with Jpmorgan. Your line is open.
Thanks.
Randy first and good luck in the future.
I had a couple of questions on your comments on spreads and then also.
On reinsurance thoughts when you talk about the reinsurance costs being up is it up beyond what you had indicated previously and if yes, why or is it just consistent with.
What you said and then on spreads.
The decline sequentially is that a function of the crediting rates being up or is there something else that's driving that.
So on the reinsurance costs, we've talked about this over the years.
We have over the last five years six years spent a lot of time working with our reinsurance partners.
On the topic of reinsurance rates, especially on the in force books of business and we have steadily worked through our back book. We've continued that process in 2022. So we've reached some additional agreements I think we're getting very close and I think we're up into the 90% range or so in terms of.
What we've put in the rearview mirror, but we have reached some additional settlements which involve us paying some higher reinsurance costs. So just on a year over year basis.
Going to see some of that in 2023.
In the context of spreads I think youre talking specifically about the life business.
As I mentioned, we expect that spread to settle down about 10 points in my script I mentioned that.
Our life business is not seeing the same benefits that we've seen in retirement and annuities and you can definitely see those benefits inside of our.
So let me take the life look it's a very long duration portfolio. It doesn't have a huge amount of rollover in any given year and then additionally.
During the low rate environment, as we sought to maintain our discipline around Haile and matching we were doing some things to lock in rates into the future. We had a couple of programs in place to add duration to the life business. So we could stay in line with our with our targets a couple of things I'd mention is that we would temper.
Generally we've.
Been doing this for like eight years go on a couple of years and lock in the underlying treasury rates now that is painful in 2023, because those T locks will burn off over 2023, but over the last eight years I would tell you in total it's been a net positive but it is painful a little bit in 2023 and the other thing.
We did that we would do some pre investing we would borrow short and we would pre invest those dollars may pay off those those borrowings with cash flows off the business and we would also expect that to trend down over 2023. So there's just a couple of temporary headwinds that we've described.
Before we start to expand in 2024 and beyond.
Broadly speaking, though Jimmy once again, you see the life business or the annuity business you see the retirement business those spreads ever expanding nicely.
As they are experienced.
Immediate benefit of higher interest rates.
And then on your pivot away from term life, how much of that is a function of just maybe the capital profile of the business versus maybe the margin profile and the reason I'm asking is.
I think you've raised prices in term life, as well and Youre deemphasizing sale.
And the vast run companies move away from something like viewers. Later you started a few years later, you start seeing reserve issues and stuff, but what's the motivation for you guys.
Emphasizing that our mice business.
So Jamie there are a couple of things first of all.
Our deemphasizing parts of the term life business. So there there is a piece of the term life business for us that we see is basically a pure price competitive.
Utilizing our distribution leadership.
As part of the overall sales process is the first and the second thing is that what we see is that it overall.
Is a pretty significant amount of.
Capital and surplus strain for that portion of the term life business that doesn't really have the margins associated with it. That's the part that we're going to shift away from but not of the broader overall term life market. Randy is there anything you want to add to that yes, I agree completely and I hope I didn't.
Overemphasized term are you still sell term insurance, but I think we can be much more strategic we can focus on the areas where we are.
Use the strength of our distribution.
We can move around inside of the term marketplace into pockets that are from a distributable earnings pattern standpoint, just better I mean, the reality, our 30 year term product sold.
One of the big aggregator platforms is that the breakeven year is very very far out there and as we think about the future strategy that just isn't a place that makes sense, but there's still a lot of areas and I'm sure we'll sell.
Fair amount of term insurance just not at the same level we were.
In 2022 and prior exactly so I expect the term that we will put them on the books going forward will be more focused in partnership with distribution it'll be higher face amount and it will and it will be higher margin and also <unk>.
Improved overall distributable earnings profile.
And then just lastly on the preferreds.
Obviously, a fairly expensive and you did what you had to do but do you should we assume that that's a normal part of your capital structure going forward or is it reasonable to think that youre going to be putting away some capital to be every year to be able to retire that.
At some reasonable point in time or as soon as you were able to do it.
So Jimmy we know that the preferred is callable at the five year Mark.
Obviously, a long way away we've talked about the fact that we have many initiatives.
Right now that are supporting the ongoing capital generation.
To continue to evaluate as we get closer to that call date.
And see where we are we continue on the track that we are I think that that will answer. The question for you about what we will do five years from now.
Thank you.
Thanks, Jeremy.
We have no further questions at this time I'll turn it over to Mr. Carpino for any closing comments.
You can take any follow up questions that you have you can email us at Investor Relations at <unk> Dot com. Thank you and have a good day.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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