The operator welcomes everyone to the Lincoln Financial Group Second Quarter 2023 Earnings Webcast Conference Call and introduces Al Copersino. Al Copersino then reminds participants of the risks and uncertainties associated with forward-looking statements and invites them to visit Lincoln's website to view the press release and statistical supplement which offer full reconciliations of the non-GAAP measures used on the call.

Ellen Cooper and Chris Neczypor are presenting on the call, and Cooper is discussing the company's progress in executing their strategy to rebuild capital and improve their long-term free cash flow profile. She is focusing on their four businesses - annuities, retirement, group, and alternative investments - and how they are working to lower their capital sensitivity to market volatility and diversify their earnings mix.

The Group business had a strong quarter due to margin expansion and a favorable industry environment. The Fortitude Re block reinsurance transaction is expected to close soon and will improve the RBC ratio by 15 points and increase free cash flow by $100 million annually. The Spark Initiative is on track to reduce expenses in 2024 and the new business approach is shifting to a product mix with more capital efficiency. The VA hedge program is reducing capital sensitivity to market volatility and additional actions are being taken to improve capital generation of the in-force book.

The company is executing swiftly on capital rebuild and generation efforts while aiming to reduce financial leverage and build capital for long-term value for shareholders. Sales in retail solutions, annuities, and Index Variable Annuities (IVA) were down year-over-year, but are expected to increase in the back half of the year due to product enhancements and distribution partner actions. Fixed annuity sales were up over 100% year-to-date, but competitive pressure still remains in the market.

Traditional variable annuity sales were up 19% sequentially, while life insurance sales were down as the company shifts towards a more capital-efficient product mix. Indexed universal life and variable MoneyGuard hybrid product sales were slightly up. Executive benefits sales were down in the quarter due to variable placement timing. The company is investing in technology, customer experience, distribution franchise, and claims organization to increase customer satisfaction and retention. These investments are expected to drive profitable growth in the future.

The Workplace Solutions businesses are expected to be major cash flow and earnings growth drivers for the company. In group protection, premiums grew 6% due to strong customer relationships and pricing actions. Sales were down 24%, but on a year-to-date basis were only down 3%. Employee-paid sales were up 6%, largely driven by a 52% increase in supplemental health products. Retirement Plan Services had positive net flows and retention, with first year sales down but recurring deposits up 4%. These businesses are meeting or exceeding capital efficiency and new business return targets, and the company is enhancing customer-focused strategies for long-term growth.

In the second quarter, the company reported adjusted operating income available to common stockholders of $343 million and net income available to common stockholders of $502 million. The company's high-quality investment portfolio with 97% investment-grade holdings experienced net positive credit migrations and its commercial mortgage loan portfolio is performing well. Chris will provide details on the mark-to-market accounting loss related to the Fortitude Re transaction. The company is making progress executing against its priorities and is generating capital-efficient sales with returns at or above targeted levels.

The difference between net and adjusted operating income for the quarter is largely due to three factors: higher equity markets and interest rates resulting in a non-operating increase to net income, hedge instruments declining in value, and an after-tax realized loss of $493 million due to an impairment of securities in the reinsurance transaction with Fortitude Re. Additionally, the preferred stock dividend will increase to roughly $34 million in the third quarter.

In the fourth quarter, the estimated Risk Based Capital ratio was approximately 380%, with the Fortitude transaction expected to increase it by 15 points. Group Protection was the highlight of the quarter, with a profit margin of 8.6%, 450 basis points higher year-over-year. Lincoln is continuing to hold capital above its target level at LNBAR, and is pleased with the performance of its repositioned hedge program. However, it is still waiting for more time to pass before resuming regular LNBAR dividends to the holding company.

The Group business is becoming a larger part of the company's story, contributing to almost a third of operating earnings this quarter. This was due to strong execution of the company's group strategy, investments to support claimants, and a favorable economic environment. Group reported operating income of $109 million compared to $49 million in the prior year quarter, with both life and disability results showing improvement. The expense ratio increased from 12.5% to 13.6%, reflecting investments in talent and strengthening the operational organization. These investments are providing optimal outcomes for customers.

The group business has been making significant progress, contributing to both GAAP earnings and free cash flow. Annuities experienced a decrease in operating income year-over-year due to higher expenses and lower prepayment income, but earnings improved sequentially due to higher fee income. Spread income increased year-over-year but experienced temporary headwinds sequentially due to fluctuation in option costs. Spreads are expected to decline for one more quarter before leveling in the fourth quarter and rebounding in 2024. Surrender rates for fixed annuities have increased due to the higher interest rate environment, but are generally in line with expectations. Reinsurance is in place for new business and in-force block, and reported numbers are on a gross basis with an offset as it relates to seeded surrenders.

The Annuities business delivered a solid result and significant free cash flow for the company in the quarter, while Retirement Plan Services reported operating income of $47 million, a decrease due to lower prepayment income and higher expenses. These headwinds were partly offset by higher base spreads and positive net flows, leading to a 4% growth in average account values. Life Insurance reported operating income of $33 million, a decrease driven by the run rate impact from last year's assumption reset, partially offset by higher alternative investment income. Mortality was mostly in line with expectations this quarter.

The term Block experienced lower frequency of claims and higher severity of claims for universal life-type products, due to the lack of offsetting change in DAC amortization. Base spreads were 113 basis points in the quarter, down 12 basis points from the prior year quarter, and are expected to bottom slightly lower before expanding in 2024. Company-wide expenses have increased due to investment in business projects and strategic initiatives. Management is focused on improving the earnings power and free cash flow profile over time.

The company's expenses have increased due to the challenges of the past year, but these costs are expected to decline in the future. The company is also committed to the Spark initiative, which will help increase earnings and capital generation. The credit performance of the company's portfolio has been solid for the quarter, and the commercial mortgage loan portfolio is performing well with a weighted average loan-to-value and debt service coverage ratio of 46% and 2.4 times, respectively. The company is confident in its ability to navigate various economic environments.

In this paragraph, the speaker talks about the disciplined underwriting and monitoring processes of the company, the shift away from Office loans, and the performance of the alternative investment portfolio. They also emphasize that the investment portfolio includes assets from reinsurance agreements and that they have no direct real estate equity or transitional loan exposure.

Chris Neczypor discussed the progress made in terms of free cash flow and capital, noting that RBC has been flat year-to-date and that $150 million has been returned to shareholders in the first half of the year. The company's top priority is closing the Fortitude transaction, but they are looking at other projects to improve free cash flow and capital structure.

The company has taken losses on some regional banks, but is still on track with what was communicated last year. Going forward, there will be gradual improvement in reserves and capital needs, as well as increased free cash flow from the growth of young blocks. Management actions, such as running the business more efficiently and deploying capital more effectively, will also help to maximize long-term distributable earnings. The company is also aiming to return to a more regular LNBAR dividend.

Chris Neczypor discussed the impact of the Fortitude transaction on the company's capital goals and the effect of mortality on GAAP LDTI. He explained that while mortality was in line on an underlying basis, it had a negative GAAP impact due to the dynamics between term and UL. Alex Scott then asked for further information on the RBC movement this quarter, which Neczypor attributed to lower new business production and Life and Annuities. He also provided insight into how the situation would be once Fortitude is closed.

Chris Neczypor answers Alex's question about the RBC this quarter, noting that the same dynamics that affect GAAP will affect RBC as well. He goes on to say that the pluses and minuses of the quarter are indicative of some of the highlights this quarter, and that the closing of Fortitude will result in an annualized improvement to free cash flow of $100 million. He also addresses Alex's question about mortality, noting that there is still a degree of volatility in the industry, but does not provide an answer as to whether the heightened old-age mortality is a pull forward or an adjustment to long-term assumptions.

Ellen Cooper and Alex Scott are discussing the mortality rate of older individuals in the industry, which has been exacerbated by the pandemic. Cooper states that it would not be appropriate to speculate or comment on the mortality rate at this time, but that the company will discuss the results of the assumption process on the third quarter call. Cooper also confirms that the company is exploring additional strategic levers, such as internal reinsurance, as part of their balance sheet optimization efforts.

In the Fortitude RE transaction, the goal is to increase free cash flow, raise RBC, and reduce risk on the balance sheet, particularly in the GUL block. When asked if the MoneyGuard part of the transaction was a full risk transfer, Chris Neczypor replied that in any reinsurance deal, some risk is retained, and the goal is to craft a transaction that achieves the desired goals.

In the recent deal with Fortitude, the majority of the GUL business rates were renegotiated, and the lapse risk was transferred to Fortitude. The MoneyGuard block was included in the transaction due to its strong cash flow, and mortality and morbidity risk was retained via YRT reinsurance. All other risks, including lapse and default risk, were ceded to Fortitude. Lastly, there is always the tail risk of insolvency of the reinsurer, which would cause the assets and liabilities to come back to the company.

Chris Neczypor explains that when dealing with a long tail block such as GUL, it is important to be aware of the counterparty's creditworthiness and investment strategy. Counterparties with higher ratings and more aggressive investment strategies can result in higher ceding commissions. To mitigate risk, there are counterparty protections such as assets held in trust and over collateralization. Chris states that there is more information than most companies disclose in these deals, and then Tom Gallagher asks if there is a sharing of the long-term rider explicitly. Chris answers that depending on how the mortality and morbidity evolve, there is risk that transfers back to them.

Ellen Cooper and Chris Neczypor discussed the Fortitude deal, which requires regulatory approvals, and expressed their confidence that it will close in due course. They were unable to provide specifics on the timing of the close, but Cooper mentioned that they will be back with more information when they have it. Neczypor also declined to provide free cash flow expectations from the Life Insurance business following the Fortitude deal, but mentioned that they are looking into providing that information in the future.

Ellen Cooper and Chris mentioned that they are continuing to work on improving the in-force business, which is under pressure. They are focusing on capital efficiency and shifting away from commoditized term products to more of the accumulation-type products. This shift is being supported by their distribution, new products, new channels, and new segments. They also provided an update on the cadence of Spark expenses and savings, noting that there are differences between the GAAP and cash basis.

Erik Bass asked if the changes that have been made in the Group business have gotten it to a point where it can run at a 7% margin level going forward, even when macro factors normalize. The response was that they are still expecting to achieve net run rate savings of $260-$300 million by the end of 2024, with a total direct investment of $400 million. They are currently 63% into that investment, and expect the total direct investment in 2023 to be around the $150 million range.

Ellen Cooper explains that the company is seeing a favorable macroeconomic environment with low unemployment, rising wages, and rising interest rates. The company is remaining disciplined in its approach to renewals, striving to achieve rate increases and maintain relationships with customers while also offering supplemental health services. Cooper believes that the company's management actions will sustain margins in the 7% range, even if the market or macro environment changes. Erik Bass appreciates the additional information.

John Barnidge asked Ellen Cooper about Group's earnings perspective going forward and she responded that the long-term sustainable margin is in the 7% range and they are focused on growing the overall business across all segments. Additionally, they are investing in employee benefits and expect the Group representation of long-term earnings to be bigger. Annuities and Individual Life were down a lot in both product lines.

Ellen Cooper explains that there is no pushback from distributors regarding their product mix shift and they are seeing an increase in sales per dollar of capital and their new business present on distributable earnings. Annuities sales have declined by 4% in the second quarter, but are up 6% year-to-date. They are expecting full year sales growth for 2023 and launching a range of product enhancements to elevate sales in the back half of the year. Life sales were down 36%, but they expect executive benefit to be higher in the second half of the year.

The company has stepped away from commoditized portions of term, and is seeing the beginnings of a shift into more accumulation product. They are continuing to invest in their distribution franchise and building relationships with financial advisers. They are also continuing to receive significant brand and recognition, and focusing on capital-efficient sales in the Retail and Workplace businesses.

Al Copersino thanked participants for joining the conference call and invited them to email any follow-up questions to investorrelations@lfg.com. The conference call was then concluded and participants were invited to disconnect.

This summary was generated with AI and may contain some inaccuracies.