Lincoln National Corp Q2 FY2020 Earnings Call

Good morning and thank you for joining Lincoln Financial Group's Second Quarter 2020 Earnings Conference Call. All lines are currently in a listen-only mode. We will provide details on how to ask questions later. Now, I would like to hand over the call to the Corporate Treasurer, Chris Giovanni. Please proceed.

Thank you, operator. Good morning and welcome to Lincoln Financial's second quarter earnings call. Before we begin, I have an important reminder. Any comments made during the call regarding future expectations, trends and market conditions, including comments about sales and deposits, expenses, income from operations, share repurchases, and liquidity and capital resources are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from current expectations. These risks and uncertainties include those described in the cautionary statement disclosures in our earnings release issued yesterday, as well as those detailed in our 2019 annual report on Form 10-K, most recent quarterly reports on Form 10-Q, and from time-to-time in our other filings with the SEC. These forward-looking statements are made only 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. We appreciate your participation today and invite you to visit Lincoln's website www.lincolnfinancial.com where you can find our press release and statistical supplement which include full reconciliations of the non-GAAP measures used on the call included adjusted return on equity and adjusted income from operations or adjusted operating income to their most comparable GAAP measures. A slide presentation containing supplemental second quarter 2020 earnings and investment portfolio information is also posted on our website in the Investor Relations section. Presenting on today's call are Dennis Glass, President and Chief Executive Officer; and Randy Freitag, Chief Financial Officer and Head of Individual Life. After their prepared remarks, we will move to the question-and-answer portion of the call. I would now like to turn the call over to Dennis.

Thank you, Chris. Good morning everyone. As we all know the pandemic's course and economic consequences, including lower interest rates, are both challenging and difficult to predict. However, Lincoln is effectively dealing with the immediate COVID-19 operating issues, such as working-from-home and virtual selling. We're also aggressively responding to the overall health, economic, and capital market environment. Our near-term focus continues to be on maintaining our already strong balance sheet, actively repricing products to achieve appropriate returns and delivering on expense savings targets. Additionally, over the medium to long-term, our emphasis is on improving the way we operate by capitalizing on the benefits of the accelerated shift in digital and virtual selling to increase wholesaler and employee productivity, adding new well-priced products to complement our refreshed product portfolio, and drive growth and targeting additional expense-saving programs. We expect all these actions will create long-term competitive advantages. I will cover each of these items later, but first I will touch on second quarter results. Second quarter adjusted operating income was affected by elevated claims experienced from COVID-19 and negative returns within our alternative investment portfolio, both consistent with our expectations. Excluding these items, adjusted operating per share would have been more consistent with the very strong prior year quarter. Based on the current level of equity markets, we see a lift in third quarter earnings related to higher fees on assets under management and a recovery in returns on the alternative investment portfolio. We also expect lower COVID-related claims. In aggregate, prior to any impacts from our annual assumption review, we expect adjusted EPS more in line with results from the first quarter of 2020. As I just mentioned, we are responding aggressively to the current environment. In the Individual Life and Annuity businesses this includes active product repricing related to lower interest rates and in some products, higher reserve requirements. Also as we noted on our first quarter earnings call, we are reducing the amount of capital deployed towards new sales by approximately $400 million this year to help maintain our strong capital position. The overall product strategy is to continue to reprice products when necessary to achieve our targeted returns, shift our selling emphasis to products achieving good returns, and provide a powerful consumer value and add new products. In short, our reprice, shift, and add new product strategy. With this backdrop, I will go into more detail on each business focusing a little more on product sales and net flows in the individual lines. Starting with the Life Insurance business. We have one of the broadest portfolios of Life products in the industry and the strongest distribution platform. This has enabled us to target several products that do not require significant repricing, including term and indexed universal life, where sales are up 7% year-to-date and Executive Benefits, which while lumpy quarter-to-quarter, have consistently contributed to annual sales. Life products most affected by price increases include Universal Life, MoneyGuard and variable UL, where we expect sales to be down materially in 2020. With changes to these products and as new product developments kick-in, we are confident we will rebuild sales levels achieving strong returns on capital and contribute to future earnings growth. In the Annuities business, we achieved positive net flows driven by lower surrender rates and strong growth in variable annuity sales without guaranteed living benefits, which represented more than half of our total annuity sales. Indexed variable annuities, a great example of a product achieving good returns and providing a powerful consumer value, were up 68% over the prior year quarter, surpassing $1 billion in sales this quarter. Total annuity sales were down as we reduced benefits on VAs with living benefits and deemedphasized fixed annuity sales due to lower interest rates. However, we are capturing the asset protection value propositions through our indexed variable annuity, which is more capital efficient and provides better new business returns. Though our collective pricing actions are dampening near-term sales, they are protecting the strong returns we have long had in our annuity business. Beyond our repricing, the shift in ad components of our strategy will create additional opportunities as we look to 2021. Shifting to our employer-focused businesses, where repricing isn't as significant. In Retirement Plan Services, strong growth in first-year sales generated a double-digit increase in total deposits. Net flows were affected by two large case terminations. However, we expect to have positive net flows in the second half of the year. At the plan sponsor level, recurring deposits are facing some headwinds from employees reducing or eliminating matching contributions and workforce reductions. At the participant level, we have not seen meaningful outflows related to the CARES Act. Our high-tech, high-touch model coupled with our innovative product customers enable better navigation through these uncertain times and drive our future growth. Lastly on Group Protection, premiums increased mid-single digits as we benefited from improved persistency, renewal rate increases and start sales. We believe the pandemic has only increased national awareness of needs for Life Insurance and disability and leave management products as evidenced by our premium growth. But we may see some disruption in new business sales due to the pandemic. We expect the benefits of our well-diversified customer base will continue to result in strong premium growth while our focus on pricing actions and expense efficiency will improve our margins. Bottom line, across all businesses we are in a good position of having created the broadest product portfolio in the industry, the best distribution and a proven ability to combine these differentiators to shift sales of products with strong value propositions for the customer and good returns for Lincoln. Now shifting to other strategic areas of focus in the current environment. First on the balance sheet, we remain in a very strong position. Our RBC ratio ended the quarter at 444% and positions us well to manage through this period of uncertainty. During the quarter, we also expanded our highly reliable and committed sources of liquidity within our insurance subsidiaries to approximately $9 billion, up from $7 billion in the first quarter. While we certainly do not expect any liquidity issues, these programs can be used to manage any cash flow stress that might develop. At the holding company, we have $774 million of cash and our next maturity is not due for three years. In addition, we have our $2.25 billion credit facility. Within the invested portfolio, we continue to manage credit risk more defensively by adjusting our new money allocation to higher-rated investments as well as proactively derisking. As we've mentioned in the past, we began derisking our investment portfolio a number of years ago, leveraging our multi-manager investment model to analyze a variety of adverse scenarios to identify those securities that have the potential for significant credit deterioration in an economic cycle. We continued with the execution of our program in the quarter, derisking the portfolio by another $1 billion. We remain focused on high-quality new money purchases and when combined with our derisking actions, the overall quality of the portfolio continues to improve. With our exposure to BBB- and below securities decreasing 60 basis points on a sequential basis. Year-to-date, negative RBC impacts from the investment portfolio are running better than our expectations, supported by our derisking program and the benefits of various government support programs including the Fed's action on credit markets. While we remain confident with our balance sheet and capital positions, we expect to stay paused on share buybacks for the third quarter, a prudent approach given that economic outcomes remain unpredictable. Expense management also remains a key focus in the near-term with Liberty synergies of $125 million nearly achieved, digital savings on track for $40 million to $50 million this year, and progressing towards our $90 million to $150 million target. We have also made significant progress on our third savings initiative, an additional $100 million this year to help offset near-term pressures. We expect to maintain this $100 million going forward by leveraging virtual sales capabilities, sustained increased workforce productivity, and capitalizing on the recent acceleration in digital adoptions by both advisers and customers, all of which enable us to conduct business more efficiently. We have a track record of responding with expense programs to help maintain margins and are optimistic about our ability to deliver on these targets. And we'll provide more details as we progress. In closing, second quarter results were impacted by the pandemic and equity markets but as I noted, we expect earnings to recover to more normal levels in the third quarter. Our balance sheet is in a strong position. We are making pricing changes where necessary and still selling a significant amount of new business at good returns and adding new products to drive future growth opportunities and we are executing on existing and new cost saving initiatives to strengthen earnings. All of these position Lincoln for long-term success and deepen our competitive advantages in order to drive long-term shareholder value. I will now turn the call over to Randy.

Thank you, Dennis. Last night we reported second quarter adjusted operating income of $187 million or $0.97 per share, a difficult quarter but consistent with our expectations. There were no notable items within the current or prior year quarters. However, as expected, this quarter was negatively impacted by COVID-19-related claims and performance in the alternative investment portfolio. First on COVID. We estimate that COVID-related claims reduced earnings by approximately $125 million to $145 million or $0.65 to $0.75 per share. We provide an estimated range for COVID impacts because there is undoubtedly a level of imprecision in estimating claims due to timing and recording of deaths. This is slightly above the mortality sensitivity we provided previously. Looking forward, we now estimate every 10,000 COVID-19 deaths in the United States to impact our earnings by approximately $10 million, with $8 million still hitting the Life business and $2 million in Group. In addition, we anticipate morbidity headwinds in Group related to the economic environment. Next on Alternatives. Returns were negative, which reduced earnings by $0.62 per share relative to our targeted annual return of 10%. This represented a negative 7% pre-tax return in the second quarter. We reported a net loss of $94 million. Importantly, the majority of the difference between our adjusted operating income and our net loss was the result of $150 million in items we consider to be non-economic, related to accounting associated with our 2018 sale of Annuity business to Athene and variable annuity GLB non-performance risk. Specific to the Athene transaction, as we have noted in the past, changes in fair value for many of the assets run through the balance sheet while the offsetting change runs through the income statement. This non-economic impact will fluctuate but over time will subside and reverse. Additionally, this year's new accounting standard for expected credit losses or CECL reduced net income by $79 million. Lastly, the variable annuity hedge program performed very well with 99% hedge effectiveness and another volatile quarter for the capital markets. Now turning to segment results. Starting with annuities. Reported operating income of $237 million compared to $266 million in the prior year, with the decrease primarily driven by negative returns within our alternative investment portfolio. Average account values decreased 3% on a sequential basis, but end-of-period account values increased 10% over the same period. Given the increase in end-of-period account values, net amount at risk increased to less than 2% of account values for living benefits and less than 1% for death benefits. This compares favorably to nearly 4% for both as of the end of the first quarter. Base spreads excluding variable investment income increased one basis point on a sequential basis. G&A expenses net of amounts capitalized decreased 12% year-over-year as the entire organization focuses on helping offset pressures from the economic environment. Hurt by negative investment results, ROA came in at 71 basis points and ROE at 19%. Looking ahead, we expect tailwinds from the equity markets and variable investment income to drive a recovery in earnings and returns to more normal levels in the third quarter, excluding any impacts from our annual assumption review. Retirement Plan Services reported operating income of $30 million compared to $42 million in the prior year, with the decrease driven largely by alternative investment performance. Deposits totaled $2.3 billion and included growth in both first-year sales and recurring deposits. Average account values decreased 3% compared to the first quarter though end-of-period values increased 10%. Base spreads excluding variable investment income comprised 24 basis points versus the prior year, which was above normal, primarily due to lower yields on floating rate securities, where the crediting rate on the match to liability adjusts less quickly, combined with the impact of significant deposits towards quarter end. G&A expenses net of amounts capitalized decreased 11% year-over-year, which led to a 110 basis point improvement in the expense ratio. Similar to the Annuities business, we expect tailwinds from equity markets and variable investment income to drive earnings higher in the third quarter. Turning to our Life Insurance segment. We reported an operating loss of $37 million compared to operating income of $168 million in the prior year with the decrease driven by mortality related to COVID-19 and alternative investment performance. COVID-19-related mortality was consistent with our previously stated expectations within the Life business. Underlying earnings drivers continued to show growth with average account values up 2% and average Life Insurance in-force up 10%. G&A expenses net of amounts capitalized decreased 11% year-over-year, which led to a 20 basis point improvement in the expense ratio. Base spreads were consistent with the first quarter. As a reminder, the year-over-year decline is above our five to 10 basis point expectation due to a non-economic change to our crediting rate methodology. Looking forward, based on what we know today, we expect the third quarter to see less of an impact on mortality from COVID-19 and a strong recovery in variable investment income. Group Protection reported operating income of $39 million compared to $68 million in the prior year quarter, with the decrease primarily driven by COVID-related mortality. The loss ratio was 77.8%, a 70 basis point improvement on a sequential basis, but up four percentage points compared to the prior year period. Group Life loss experience was impacted by COVID-19 with the majority of the increase attributable to the pandemic. Our disability loss ratio is consistent with recent quarters, but elevated compared to the prior year quarter. While we saw some improvement in LTV incidence rates on a sequential basis, claims resolution was lower, which we attribute in part to indirect impacts of COVID-19, including the resulting economic conditions. Offsetting disability was favorable dental experience, which we largely attribute to COVID-19. We expect to see this normalize in the third quarter as access to dental care resumes. Results were negatively impacted by alternative performance, with that negative being offset by G&A expenses, net of amounts capitalized that declined 8% over the prior year quarter, driving a 170 basis point improvement in the expense ratio. While disappointed by this quarter's elevated loss ratios, our results were affected by several direct and indirect impacts of the pandemic. However, we are encouraged by our premium growth and expense management. Before shifting to capital let me make a few comments on third quarter expectations. As Dennis noted, based on what we know today, we expect earnings to recover to more normal levels in the third quarter excluding potential impacts from our annual assumption review. This is driven by some of my earlier comments about tailwinds from equity markets, strong expected returns from the alternatives portfolio, and lower expected mortality-related impacts from COVID-19 compared to the second quarter. As you know, we will also complete our annual assumption review in the third quarter. As a reminder, this review included a charge related to interest rates reflecting the impact of the drop in rates on the starting point of a lower long-term ultimate interest rate assumption and extending our grading period. Interest rates are much lower today than they were last year which could impact the interest rate component of our assumptions again this year. That said, I do not want to front-run the process as there are lots of people working on the review and it's ultimately about what all the impacts add up to. Turning to capital, we ended the quarter in a strong capital position with statutory capital of $9.7 billion and an RBC ratio of 444% up five percentage points since our 2019 annual filing. At the holding company, we have $774 million of cash and during the second quarter, we further improved our liquidity position by paying off our 2021 debt and prefunding our $300 million debt maturity due in 2022. The result being our next maturity is not due until September 2023. So to conclude, as expected earnings results were impacted by COVID-19-related claims and performance of the alternative investment portfolio. Excluding the impact of these items, operating ROE would have been approximately 13%. Expense management was excellent as all four businesses reduced G&A expenses resulting in a 7% decrease in consolidated G&A. Lastly, our capital and liquidity positions are strong and have in fact grown stronger during this current period of uncertainty as a result of management actions. With that let me turn the call back over to Chris.

Thank you, Dennis and Randy. We will now start the question-and-answer session of the call. Let me turn the call back to the operator.

And our first question comes from Erik Bass with Autonomous Research. Your line is open.

Good morning. Thank you. First, can you just help us think about the sensitivity to any changes that if you were to make any to your long-term interest rate assumption or the grading period? And should we look at what happened last year and expect that the impact would be similar?

Erik, it's Randy. Thanks for the question. So as I said in my script, if you go back to last year the interest rate component was a negative in the overall unlocking it was in total $291 million and it was impacted by three different areas. First, the starting point and changes to the ultimate rate in the grading period. The starting component of that was $139 million of negative last year. And when you think about our assumption think about the starting point as a mark-to-market, right? So our starting point where are we investing money today? What is the market? Then you have the ultimate rate which is more of a subjective view of where could rates go to over time and then what connects them is the grading period. Last year that $139 million impact from that objective view of our rates was driven by the fact that rates were lower. And again, this year rates are lower. So I wouldn't be surprised if that one component was negative again this year. In terms of the more subjective view of where rates could go over time, I think that's part of the process for reaching out for the managers collectively coming up with a reasonably reasonable view of what that future could be. And that will be part of what we're doing right now and what we'll do over the remainder of the quarter. So I think that and hopefully that gives you some insight. I also said in my script and I just want to remind everybody, at the end of the day interest rates are one piece of what is a broad set of assumptions and so we'll review all of those assumptions. And while the interest rate piece of that may have a negative bend to it right now, at the end of the day it's going to be about what all the assumption impacts add up to.

Okay. Got it. That's helpful. And then a bigger picture question for the Life business. Does the pandemic experience change your view at all on risk retention limits and the amount of reinsurance you may look to utilize especially since you don't have any material exposure to longevity businesses that act as an offset to mortality?

Erik. No, I don't think so. The pandemic itself, I think, the use of reinsurance and the amount of reinsurance we use is more aligned with things like is the cost of reinsurance at that moment in time attractive? What is our risk appetite as a company? And as we talked about mortality and morbidity-based earnings are something we're very comfortable with. We are very comfortable with our ability to underwrite Life Insurance. And so our current retention program and just as a reminder we keep up to the first $2.5 million. After that we reinsure the majority of the risk we keep a small percentage of it. So we're very comfortable with that. And I don't think the pandemic changes our view of appropriate risk retention.

Got it. Thank you.

Thank you. Our next question comes from Ryan Krueger with KBW. Your line is open.

Hi. Thanks. Good morning. On the capital position in the $400 million of expected free cash flow benefits this year from lower sales activity, I guess, has that come through in the first half of the year at around half of that pace? I guess, the reason I'm asking is RBC ratio is kind of just steady in the quarter I thought it may have increased some more given the lower sales actually to be strategic review some of the moving parts of the RBC ratio in the quarter, and if you'd expect to build in the second half of the year?

Thanks, Ryan, for the question. Yes, more than half of the sales came through in the first quarter, primarily influenced by our expectations for fixed annuity sales. These sales experience a significant first-year drag, and for several valid reasons, we have reduced our sales of pure fixed annuities. Regarding the second quarter and the RBC ratio not increasing, I want to remind you that the key issues we mentioned in GAAP, including COVID-19 claims and alternative performance, also impact statutory results. In fact, they have a slightly greater effect in statutory since there isn't a DAC offset. These two factors created approximately $300 million of headwinds to statutory results this quarter. Additionally, there were some minor negative factors as well, leading to overall headwinds of about $350 million to $400 million on a statutory basis. I'm pleased that our overall capital stayed level for the quarter, which indicates that despite these challenges, there were strong underlying statutory results. I am happy with the quarter's results and have seen significant benefits from lower fixed annuity sales affecting the denominator.

Thanks. Regarding buybacks, I understand they are still paused for the third quarter. However, considering the improved credit experience we've seen so far, is there a possibility of resuming buybacks before the year ends?

Ryan, its Dennis. And I think we'll just stay with a couple of comments. One it's very unpredictable these days. I mean as we all know there's so many drivers of what might happen over the next several quarters, which could affect earnings, which could affect our investments. So I think right now the focus is on maintaining our high-quality strength in the balance sheet. And at this point, we'll just comment that we are pausing for the third quarter.

Got it. Understood. Thank you.

Thank you. Our next question comes from Elyse Greenspan with Wells Fargo. Your line is open.

Hi. Thanks. Good morning. I guess, my question follows up on the capital question to a certain degree. You guys obviously know a little while ago did that philosophy insurance deal with the fee and that was not helpful to free up capital for buybacks. Obviously, given where interest rates are from what we're hearing right there is a greater bigger spread on some deals in the market right now. But do you guys have a view on whether you'd be more or less willing to transact in other deals? And then would you consider transactions similar to that to not free up capital potentially return to buying back your shares sooner than you might otherwise?

Elyse, it's Dennis. I think your first point about low interest rates affecting the sales of blocks of business is valid. Currently, while some deals might be made, it is challenging to reach an agreement that satisfies both buyers and sellers. We have witnessed some strategic moves in the market that extend beyond just the financial return from selling a block. However, aside from those strategic transactions, it has been relatively quiet. We remain open to opportunities and will evaluate any that make sense for both parties involved. Nevertheless, the unpredictable circumstances we face currently impact the market dynamics.

Okay. That's helpful. And then you guys provided an updated sensitivity on COVID, right? That's a little bit higher within Group than what you guys expected before. I guess when thinking about the mortality impact in the third quarter, is it just as simple as we should just kind of like pay attention to the death rate number of lives and kind of use a sensitivity there? Or what would – given the mix of your book in the third quarter, what could cause that to vary within Group where things could potentially trend in a little bit better than expected?

Elyse, it's Randy. Thanks for the question. We think about COVID-19. We spent a fair amount of time last quarter coming up with our estimates. We included our doctors, we included our data experts in terms of analyzing the different studies that were out there. We included our actuaries in terms of understanding our own mix of business. So we spend a lot of time. I think that shows in the overall fact that our estimate came very close to our actual experience. I've actually been a little surprised by some of the companies I've seen out there who missed by upwards of 75%. I'm not really sure why we've seen those sorts of gaps. But we spend a lot of time and so we're very – nobody's happy with claims but we think we did a really good job of estimating the potential impact. As we mentioned, in the Life business we had $8 million. When the final number came in we're right in line with that. So that number sticks. But in the Group business we did see a little pick up from $1 million, which was the estimate we provided last quarter to what we're now updating the $2 million. I don't think there's anything truly impactful in there. I think it just reflects a growing understanding of exactly how the pandemic is going to hit different areas of the economy. So we felt good about the nine. It came in pretty close. We'll update it to 10 and we feel that provides a good estimate as we move into the third quarter.

Okay. Thanks for the color.

Our next question comes from John Barnidge with Piper Sandler. Your line is open.

Thank you. As we look forward in the Group Protection segment, can you talk about how you square favorable claim trends in dental in the likelihood that a segment of the population is just not going to use their benefits this year and square that with renewal pricing and the prospect of catch-up claims or emergence of more severe claims in 2021?

Thank you for the question, John. This is a broad inquiry regarding Group results. Dental is a relatively small part of our Group business, with premiums this quarter nearing $1.1 billion. Group premiums account for only about 6% to 7% of that, translating to roughly $65 million. Therefore, we are less affected by developments in the dental sector compared to some of our peers. Looking ahead to the third quarter, we anticipate that more people will return to the dentist, which should bring the group loss ratio back in line with its long-term trend of around 70%. This quarter, it was approximately 40%. Regarding other sectors, for Disability and Life, we observed an 11-point year-over-year increase in our Life loss ratio, primarily driven by COVID. If we exclude this 11% rise, it corresponds to about $35 million in after-tax claims. Currently, two-thirds of those claims are reported as related to COVID on death certificates, but we lack complete data on all certifications, so that figure may increase. Our analysis suggests a significant amount of underreporting, particularly in April, regarding COVID-related causes of death. Therefore, we attribute most of the quarter's increase to COVID. As we approach the third quarter, we've revised our sensitivity on claims from $1 million to $2 million but expect the overall effect of COVID-related claims to decrease, as we anticipate the number of deaths will be under the 125,000 experienced in the second quarter. Regarding disability, predicting its COVID-related impact is more complex due to broader economic factors. While incidents improved slightly from the first quarter, they still show a year-over-year increase. These incidents largely relate to developments from the fourth quarter. We are encouraged that the incidence began to trend downward but remains elevated compared to last year. On termination experience, we noted a slight decrease, likely an indirect consequence of the pandemic, as accessing healthcare has become more challenging. Thus, projecting future disability experiences remains tricky. However, as stated earlier, we wouldn't be surprised if the Disability sector faces some headwinds tied to the pandemic and its economic repercussions. I hope this information is helpful.

Thank you very much.

Our next question comes from Tom Gallagher with Evercore. Your line is open.

Good morning. As you look to shift to a derisking approach in 2021, it seems likely that this will release more capital and enhance cash flow. However, it may also increase pressure on GAAP earnings growth, whether that's due to yield considerations or the impact of weaker sales this year leading to lower revenue growth next year. Would you agree with that perspective, Randy? If so, how much pressure on GAAP EPS do you anticipate this strategy will exert, assuming it continues over the next few quarters?

Let me take the first response to that. We're not shifting to a less risky approach in 2021; rather, we are monitoring the developments. Currently, we are being more cautious about deploying capital. If conditions improve, which I sincerely hope they do for America, it could alter our strategy regarding capital deployment. Additionally, we have been emphasizing that our expense management efforts can enhance earnings and partly compensate for the decline in earnings growth in 2021 due to lower sales experienced in 2020. We are actively focusing on earnings growth while also safeguarding our capital. It is crucial to be prudent with capital deployment during these unpredictable times. However, we are also taking additional measures, like managing expenses, to mitigate some of the GAAP earnings challenges that arise from this cautious approach.

Got you, and would you guys be able to offer up any way you could think about the impact, if we isolate put the expense initiatives on the side is this maybe a couple of points of growth being sacrificed, or is it potentially more meaningful than that?

Tom, it's kind of difficult to answer that question. I mean, if you look at some of the components of our 8% to 10% growth targets over time, I think you get about 4% from new business. That will come down a little bit I don't know how much. We get 1% from expense efficiencies that will come up a little bit. Whether or not they completely offset each other would be hard to predict right now. Then you got the impact of capital markets and spread compression then you have share buybacks. So all of those things contribute to, the long-term outcome and a little bit unpredictable in the short-term.

Got you. My follow-up is regarding the 55% free cash flow conversion ratio you've mentioned. How should we approach that now? I assume it might improve because of the capital being released due to lower sales. Is that a reasonable perspective? Can you provide any insights on the 55% ratio? Do you think there are enough potential challenges from credit and low rates to prevent it from exceeding 55%, or could it possibly rise above that?

Hey, Tom, it's Randy. Thanks for the question. I think you highlighted most of the relevant points. So I'll add one to what you mentioned. On its own, lower sales is supportive of statutory earnings. So that's a positive in that regard. What's the other side of statutory earnings is what is your required capital right? So what at the end of the day are your distributable earnings? That's statutory earnings less your change in required capital. And that's driven by a lot of factors, including the level of sales and the sales come down that's supportive. But addition to that is really the big driver of the change in required credit capital will be what goes on in the credit markets? And that's really where a lot of the uncertainty in the current environment lies. And that's as Dennis mentioned, if we look into the third quarter we still think it's uncertain enough where the best action is to not do buybacks. We'll reassess that in the fourth quarter. And as we get around the planning for next year and looking at the results we'll make our best estimates what we think as we look into 2021 and beyond. But ultimately, what happens to free cash flow I think is going to be determined to buy what we believe will be the impact on the credit markets of everything that's going on whether that's the pandemic or the resulting impact on the overall economy.

That makes sense. Thanks, Randy.

Thank you. Our next question comes from Humphrey Lee with Dowling & Partners. Your line is open.

Good morning, and thank you for taking my question. Just a couple of clarification questions. So, you mentioned about full alternative returns you expect better results in the third quarter. Do you anticipate the return to be better than kind of your normal run rate so providing a decent tailwind in the third quarter?

Humphrey, it's Dennis. The – again, I don't think we're going to predict exactly what's going to happen in the alternative portfolio in the third quarter. Let me just say this: as we see the effects of capital markets and energy prices on our returns in the second quarter both of those are trending up. And so we therefore think that our alternative returns will be trending up. We – for the last six or seven years, we have about a 10% return on our alts portfolio. Our alts portfolio today consists about 88% private equity and the balance in hedge funds. Private equity returns generally have a higher long-term outcome and return. So we're comfortable in the long-term with our 10% and our experience supports that. And again, quarter-to-quarter it's sort of difficult to predict. But I will say that, what we saw in the second quarter had to do with equity markets in large part and a little bit energy prices. And again, those indicators have trended up in the third quarter, or in the second quarter affecting the third quarter alts business returns.

That's helpful. And then Dennis in your prepared remarks you talked about the sales outlook for different channels and for Life Insurance you expect to be declining – to be down substantially for 2020 but what about for annuities? Do you expect some of the pressure to continue in the balance of the year? And if so, do you still anticipate the segments to see net inflows for a full year basis?

Yeah. We'll have to see how net flows develop. Humphrey, though I would come back to the aggregate sales as we look forward are shifting more toward our index variable annuities and our – which is getting a good return. We continue to get additional shelf space. We continue to provide additional sort of value propositions within that product. So we see that continuing to grow. As Randy and I both pointed out fixed annuities are just simply not an emphasis of ours today in our business model. We would be investing at sort of in the new money range of 2% there's just not enough juice in a 2% investment return to provide both a good value proposition for the consumer and a good return on capital for Lincoln. So in aggregate we would expect total annuity sales to be down driven mostly by a pretty significant decline in fixed annuities.

That's helpful. Thank you.

Our next question comes from Suneet Kamath with Citi. Your line is open.

Thanks. I have another question regarding capital. Recently, during our second quarter calls, we've discussed the NAIC's assessment of the reversion to the mean assumption for interest rates concerning VA capital. Some companies have stated that if the NAIC were to make changes, it wouldn't greatly affect their positions. One company even expressed strong support for it. I'm curious about your perspective. Would such a change significantly impact your hedging strategy or your VA capital position?

Hey, Suneet, it's Randy. Yes, we're very supportive of the NAIC's efforts. If you think about the NAIC and the work they did with the Oliver Wyman, they were careful in hiring an outside expert and collaborating with the industry. They arrived at a very good outcome that benefits both regulators and the industry. I believe it will be the same with this initiative. We are backing the effort and will continue to do so. I don't expect it to take effect until probably 2022, but we don't anticipate it having a significant impact. Just as a reminder, our hedge program is refocused on the economics, and they are discussing making the interest rate generator more reflective of the economics, which I think is a positive move.

Got it. And then my follow-up is just on the Life sales again. So MoneyGuard has historically been a really big differentiator for you guys. And I know that you talked about repricing your Life products. But in this interest rate environment with credit spreads as tight as they are, can you make that product work in terms of repricing, or is it just sort of a difficult one for you guys to sell to achieve your returns, but also provide value to the customer?

Suneet, it's Randy. You can just look at the results, right? Sales are down 36% over the prior year. I think they'll fall even further as we look into the back half of the year. I mean, the short answer to your question is MoneyGuard really any general account type product is a tough sell. It's tough to create a compelling value proposition for the consumer and a return for the company when you're investing money in the low 2s. So I think that we would expect that in the current environment that MoneyGuard sales will continue to fall. I think there is a significant opportunity because MoneyGuard is an example of a product that speaks directly to a huge need for the American consumer. And I think there's an opportunity to create a compelling value proposition in MoneyGuard something we're working on right now. You know we created that's Lincoln's innovation MoneyGuard. And we're actively working on creating what we believe is the next version of MoneyGuard, which thematically is going to be very similar to things we've talked about for instance with IVA right, lower guarantees, a different way to generate investment returns, shifting risk to the consumers probably moving to more of a variable-type chassis. So I think there's a huge opportunity for a product like MoneyGuard, but yes when you're investing at rates we're investing at today the existing version of that product is a tough sell and I'd expect sales to be down in the remainder of the year.

Yes. Suneet, if I could jump in, in a period where we're preserving capital, our focus is on any capital that we're deploying to be absolutely certain we're getting appropriate returns. So yes, in aggregate sales will be down in the last half of the year, we think from the first half of the year in the individual lines. But those products by line of business are getting in aggregate appropriate returns. So even though we're husbanding capital a little bit the capital that we're deploying is getting good returns on it. And then as I mentioned and Randy just discussed, lots of activity in product development, so that we can begin to rebuild sales and continue to grow earnings from new business over time. And I'd also come back to most of the pressure from interest rates and the repricing activity is going on in the individual lines and we're seeing good returns and higher levels of sales in both RPS and Group.

Okay. Thanks.

Our next question comes from Janice R. with Credit Suisse. Your line is open.

Thank you, guys. Just wanted to get your feedback on a higher-than-expected claims environment and associated reserves as well as your overall outlook across the segments and related to the economic recovery. How do you see the trajectory of operating income over the next few quarters, and how do you view your reserve position in light of the impacts from COVID-19?

Hey, Janice. It's Randy. Thanks for the question. I think when you think about how we view reserve positioning, I think we said in our prepared remarks we still believe that the reserve position is healthy. I think we have developed reasonable assumptions through COVID based on all the factors we talked about. And our intent is to use all the data we have at the moment and all the analysis that we have about our trends and claims to inform how we think about our assumptions going forward. I think I commented earlier about the overall sensitivity we provided, has shifted up a little bit as we've seen a bit more claims increase than our expectations going forward. So the trajectory of operating income, there probably will see continued pressure in the short term in light of continued impacts from COVID. Over the longer term, I think we expect to see improvement. We still feel good about the long-term outlook specifically within Life, Annuities, RPS, as you've heard from both Dennis and I, we still believe in a lot of the underlying performance trends that we have ongoing in our businesses.

Okay. Thank you. I will pass it on.

At this time, I'm showing no other questions in the queue. I'd like to turn the call back to Mr. Chris Giovanni for any closing remarks.

Thank you, everyone. We appreciate your participation today and look forward to speaking with you again in the future. Thank you and have a great day.

Thank you, and thank you all for joining us this morning. As always, we are happy to take your questions on the Investor Relations line or you can e-mail us at investorrelations@lfg.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. Everyone have a great day. Speakers please stand by.