Lincoln National Corp Q2 FY2022 Earnings Call

Good morning, and thank you for joining Lincoln Financial Group's Second Quarter 2022 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we will announce the opportunity for questions and instructions will be given at that time. Now, I will turn the conference over to Vice President of Investor Relations, Al Copersino. Please go ahead, sir.

Thank you. 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, including those regarding 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 2021 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 about 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 physical supplement, which include full reconciliations of the non-GAAP measures used on this call, including adjusted return on equity and adjusted income from operations or adjusted operating income to the most comparable GAAP measures. Presenting on today's call are Ellen Cooper, President and CEO; and Randy Freitag, Chief Financial Officer. After their prepared remarks, we will move to the question-and-answer portion of the call. I would now like to turn the call over to Ellen.

Thank you, Al, and good morning, everyone, and welcome. As you all know, Lincoln has been providing financial protection and security to millions of Americans and their families for 117 years through two pandemics and numerous recessions. Over those years, we have built a powerful franchise with a reputation and brand grounded in integrity and trust, and we are a destination employer known for our great culture, talent development and commitment to diversity, equity and inclusion. We pride ourselves on our many strengths, including innovative and agile product manufacturing, world-class distribution and industry-leading risk management capabilities. We have consistently delivered on our financial performance objectives and we are committed to continuing to enhance shareholder, customer and employee value as we move into our next chapter, and we will do this as we always have, with the right strategy and consistent execution. Effective execution starts with leadership, ensuring we have the right people in place to drive the organization forward. I am pleased to share that we have assembled an incredibly experienced and talented senior leadership team, including the recent appointment of Matt Grove as Head of Individual Life, Annuity and Lincoln Financial Network. Matt joined us with deep experience running retail businesses, including all aspects of individual life, annuity and wealth management. Bringing these businesses together enables us to leverage opportunities for synergies across product manufacturing best practices, in-force management optimization and enhancing the customer experience. Additionally, we recently announced the addition of James Reid as Head of Workplace Solutions which includes group protection and retirement plan services. James joins Lincoln as an established group protection leader with deep group experience, which is critical as we continue to deliver strong results and grow this integral part of our business. Chris Neczypor is our newly appointed Chief Strategy Officer and his organization is quarterbacking all aspects of the build-out of our longer-term strategic framework. Jayson Bronchetti, as our new Chief Investment Officer; and of course, our long-standing CFO, Randy Freitag is a key partner to me in this next chapter. I am confident in our senior team and excited about Lincoln's future. Regarding strategy, we are on the right path to continue to deliver shareholder value in the near term, and we are also focused on developing a longer-term strategy to accelerate the pace of value creation for all stakeholders. In addition to having the right people in the right roles, we also optimize our deployment of capital balancing capital allocated to build long-term value to support new business, investing in our future, for example, direct investments in our Spark program and, of course, returning capital to shareholders. And we also acknowledge the critical importance our investors place on cash flow generation and capital return as we evaluate deepening our strategic focus on distributable cash flow generation alongside our long-standing goal of generating strong ROE and growing operating earnings and sales. To that end, we have an excellent track record of setting strategy and executing against it as demonstrated in part by having delivered compounded underlying EPS of 11% over the past decade. Despite the recent market headwinds, as we look forward over the next few years, we continue to expect to grow underlying EPS in the 8% to 10% range. I will touch on the key strategic initiatives that have and will continue to drive results. First, product strategy. Sales remain robust as we continue to benefit from our reprice, shift and add new product strategy. New sales are generating returns at or above targeted levels while contributing to an ongoing strategic shift to a broader diversified mix of products that provide a range of customer value propositions and away from traditional long-term guarantees. This shift has also contributed to a more capital-efficient new business mix as the capital per dollar of sales and overall capital to support new business have continued to decline. Second, Spark. We are on track and making substantial progress in the implementation of this enterprise-wide effort. In addition to the expense run rate savings of $260 million to $300 million we expect to achieve, Spark is designed to accelerate delivery of results with increased agility and innovation. We have made about one-third of our planned direct investments and will continue to deliver, to accelerate our execution capabilities, modernize our technology, improve operational processes and create expanded opportunities for our employees as well as further enhance our customer experience. Third, Group protection margins. We are making excellent progress, and in the quarter, achieved an underlying 6.8% margin and remain confident in sustaining the top end of our targeted 5% to 7% margin range through continued pricing actions, improved claims effectiveness and Spark expense savings. Fourth, balance sheet resilience. As Randy will mention in his remarks, we did see a decline in our risk-based capital ratio in the quarter of about 15 points to approximately 400%, which was expected given the equity market downturn. We maintain a solid balance sheet, including our high-quality investment portfolio and remain comfortable with our RBC level. Turning to the quarter's results. Despite market headwinds, second quarter underlying earnings were solid, and we are seeing positive developments, improving group protection results, a significant sequential decline in pandemic claims and a meaningful rise in interest rates year-to-date, supporting future earnings growth and new business returns. In Annuities, we saw flat sequential sales that included growth of indexed variable annuities and fixed annuities of 16% and 40%, respectively, offset by a drop in traditional VAs, not surprisingly during a stock market downturn. The combination of this downturn and higher interest rates are shifting customer preferences towards IVA and fixed products. This marks the third consecutive quarter of sequential IBA sales growth. This change in consumer preferences has been boosting a strategic mix shift that has been underway at Lincoln for several years. For the eighth consecutive quarter, more than 70% of total annuity sales were of products other than variable annuities with guaranteed living benefits. This sales mix shift is in turn contributing to a shift in our account value mix as products other than BAs with GLBs represented 53% of our total annuity account value, up 5 percentage points compared to the prior year period. Retirement Plan Services continues to deliver as our proven strategy, competitive product offerings and differentiated high-touch, high-tech customer experience model drove another quarter of excellent results. Compared to the prior year period, total deposits grew 6% and withdrawals improved 11%, demonstrating our focus not only on sales, but also persistency. Net flows were again favorable this quarter at over $900 million. In the Life Insurance business, second quarter life insurance sales grew 53% from the prior year period and 25% sequentially. Sales of all product categories and sales across all major distribution channels were up compared to both the second quarter of 2021 and the first quarter of this year. All products are priced to generate new business returns in line with or above target levels. Following the introduction of seven new products and features in 2021, we continue to innovate and expand our offerings as part of our reprice, shift and add new product strategy. Lastly, on group protection, as I mentioned, our margin expansion efforts are gaining traction, and I am pleased to report that group achieved strong earnings this quarter. Premiums were up 7%, driven by solid persistency, organic growth and price increases. Most importantly, we remain disciplined in our pricing approach and are meeting or exceeding our targets for both new sales and renewals. In what is typically not a big seasonal quarter for sales, sales were up 61% over the prior year period with increases across all products and case sizes. We are also achieving a healthy mix of both employee-paid sales and sales to existing customers. By continuing to focus on pricing discipline, claims management effectiveness and expense efficiency supported by our Spark program, I am confident that our margin expansion plan is on a solid path to achieve and sustain our margin expectations. Across these four businesses, our broad and diversified set of products to meet a range of customer value propositions, expanded digital capabilities to enhance the customer experience and industry-leading distribution strength position us to continue to generate profitable growth in the quarters and years to come. Moving to investment results. Our credit performance and the quality of our investment portfolio remain excellent. You may recall that we began derisking our portfolio well before the onset of the pandemic. And today, fixed income assets are comprised of 97% investment grade holdings. Our credit outlook remains solid as net positive ratings migration continued for a fourth consecutive quarter and credit losses remain benign. We recognize that the risk of recession has been increasing with the Federal Reserve tightening financial conditions. One of the many benefits of our multi-manager investment model is that we leverage our entire suite of managers to perform scenario analysis on a name-by-name basis across all asset classes in our portfolio. Based on our current views, we would expect any potential credit impacts from a near-term recession to have a modest impact on our balance sheet. New money yields have risen sharply as we invested new money at a rate of 4.2% in the second quarter, up 90 basis points sequentially and 20 basis points above our fixed income portfolio yield. In fact, our total fixed income portfolio yield rose 5 basis points sequentially. At these levels, we expect to see spread compression shift to spread expansion and support EPS growth over the coming years. Briefly on our alternatives portfolio, despite declines in the public equity markets during the prior quarter, our highly diversified alternative investment portfolio delivered a positive 1.5% quarterly return. In closing, we are a financially strong organization that provides our customers' financial security and peace of mind. We have a long-standing, proven track record of discipline and consistent execution and are committed to continuing to achieve strong financial performance. Our leadership team is excited and energized to continue to deliver on our strategy with actions to continue to produce strong results while we also develop our vision for the longer-term business of tomorrow with the objective of accelerating growth and value creation for our shareholders, customers and employees. I will now turn the call over to Randy.

Thank you, Ellen. Last night, we reported second quarter adjusted operating income of $391 million or $2.23 per share. There were no notable items in the current or prior year quarter. However, this quarter's results included pandemic-related claims, which reduced earnings by $39 million or $0.23 per share. Alternative investment income that was $19 million or $0.11 per share below our target return levels and unfavorable one-time items of $14 million or $0.08 per share in the Annuity segment. Net income for the second quarter totaled $238 million or $1.34 per share. With the difference between net income and adjusted operating income, primarily the result of hedge breakage. The hedge program was 98% effective in what was a volatile quarter for the market. With the increase we have seen in new money rates, we have reached the point where interest spreads have become a positive contributor to earnings growth. As these earnings accumulate over time, they will work to offset and eventually overcome the negative impacts we have seen from equity markets in the first two quarters of 2022. Nine months into the implementation of the Spark initiative, we have already made about one-third of the investments and generated about 40% of the expected savings. As previously disclosed, Spark is expected to achieve $260 million to $300 million in run rate savings by the end of 2024 and is expected to begin boosting EPS growth next year. Touching on the performance of key financial metrics relative to the prior year on a consolidated basis, adjusted operating ROE came in at 11.6%, adjusted operating revenues, not including resolution and alternatives were down 2%, negatively affected by the stock market decline. G&A net of amounts capitalized declined 4% as Spark savings, lower incentive and deferred comp expenses and ongoing expense management more than offset an increase in Spark investments. Shares outstanding declined 10% and book value per share, excluding AOCI, stands at $79.49 up 5% and an all-time high. Now turning to segment results, starting with Annuities. Operating income for the quarter was $256 million compared to $323 million in the prior year quarter. The decline was driven by a drop in average account values, lower variable investment income and the $14 million of unfavorable one-time items I noted upfront. The decline in the equity markets during the quarter increased our net amount of risk for living benefits and death benefits to 5% and 4% of account values, respectively. We expect these figures to remain at the low end of peers. G&A expenses net of amounts capitalized declined 11% from the prior year quarter, leading to a 30 basis point improvement in the expense ratio. Looking at return metrics, Annuities return on assets was 67 basis points compared to 78 basis points in the prior year period, and return on equity was 18% compared to 25% in the prior year period. During what was a tough quarter for the markets, the annuity business delivered over $250 million of earnings, the result that we would expect to improve as the market stabilize and return to growth. Retirement Plan Services reported operating income of $54 million compared to $62 million in the prior year quarter, with the reduction driven by lower variable investment income. Average account values declined 4% compared to the year-ago quarter to $91 billion, is $1.5 billion of positive flows more than offset by market headwinds. G&A expenses that month capitalized were down $4 million or 6% versus the prior year period. Interest spreads, excluding variable investment income, expanded 3 basis points versus the prior year quarter as our ongoing crediting reductions continue to take hold and the benefits of higher new money investment yields emerge. Looking forward, we expect expansion to continue. The retirement business continues to produce profitable new business growth and to manage expenses effectively, while also benefiting from an improved interest rate environment. This combination positions the retirement business to deliver long-term growth. Turning to Life Insurance. We reported operating income of $114 million compared to $255 million in the prior year quarter. The drop was primarily due to lower alternative investment income when compared to the year-ago quarter's record results and $10 million of reduced earnings associated with the resolution block deal. Pandemic-related claims impacted results by $18 million. Outside of the pandemic, mortality was in line with expectations. Average account values, excluding the impact of last year's block reinsurance deal fell 1%. Reflecting the impact of lower equity markets, while total in-force face amount grew 11%, driven by strong term sales. G&A expenses net of amounts capitalized decreased 9% from the prior year quarter. To contribute to an understanding of the long-term benefit of alternative investments, we have added a new item in our staff, which shows that when using our 10% annual target at returns, life spreads have stabilized on a year-over-year basis. Strong sales growth, good underlying mortality experience and stabilize the spreads position the life business for future growth. Group Protection reported operating income of $59 million up from $46 million in the prior year quarter, driven by strong top line growth, improved underlying profitability and lower pandemic-related claims. Pandemic-related claims were $21 million, substantially improved from the first quarter and representing the smallest impact on the group business since the pandemic. This includes $13 million in our group life business and $8 million in group disability. Excluding pandemic claims, and adjusting for below-target alternative investment income, the group margin was 6.8%. On the same basis and further excluding unfavorable items in the prior quarter, our total loss ratio of 75.9% improved 130 basis points sequentially as an improvement in disability results more than offset a tick up in life loss ratio. Moving to the product lines and excluding pandemic impact. The life loss ratio of 77% rose 370 basis points from the prior year period and 400 basis points sequentially and driven by an increase in the number of larger claims. Looking at results over an extended period of time, we are confident this past quarter's experience was an outlier and not likely to repeat in the third quarter. Group's disability loss ratio of 75.2% improved 230 basis points from the prior year quarter and 520 basis points sequentially, as we benefited from what is typically our seasonally strongest disability quarter and new disability claims that return to within a range of historical levels. Driven by our strong top line growth, the expense ratio of 12.5% was down 50 basis points compared to the prior year quarter. While we are excited about the progress we have made in improving group's profitability, we are well aware that there's still more to do, continued pricing actions, improvements in claims management, and executing on Spark are all components of what will allow us to deliver on our long-term goals for this business. Turning to capital and capital management. We ended the quarter with $9.6 billion of statutory surplus and estimate our RBC ratio at approximately 400%, while cash at the holding company stands at $756 million. The approximate 15-point sequential decrease in the RBC ratio was in line with our expectations and driven by weaker equity markets and non-economic limitations on the deferred tax assets. Taking into account the strength of our capital position, our high-quality investment portfolio and an improved view on potential credit losses, we intend to continue to repurchase our stock in the third quarter. We look forward to getting together with you next month for a holistic discussion about the impacts of LDTI, not to front-run that discussion as we continue to assess the impact, I will note that as of 6/30, we would currently expect to see only a modest impact from LDTI under total book value. In closing, in the face of a challenging equity market environment, our second quarter earnings performance remained solid. We are confident in our balance sheet and pleased to be continuing buybacks in the current market environment. Finally, we see continued opportunity for earnings growth through our group protection margin expansion efforts and the Spark initiatives. With that, let me turn the call back over to Al.

Thank you, Ellen and Randy. We will now begin the question-and-answer portion of the call. With that, let me turn the call over to the operator to begin Q&A.

Your first question is from Elyse Greenspan of Wells Fargo.

My first question is on share repurchase. Randy, you said that you guys will continue to buy back stock in the third quarter, typically, you pointed to $150 million. I know that Q2, you had said, would be a little bit light of that and came in at $100 million. So how should we think about the third quarter level of buybacks that you guys are targeting?

Elyse, thank you for your question. Al informed me that this topic was discussed last night, so I've spent some time considering it. To answer your question briefly, we are looking at up to $100 million. However, it may be beneficial to provide some context regarding our capital allocation philosophy. Like any company, we have a structured approach to how we allocate capital, and we believe that buybacks should mainly reflect our capital generation circumstances during any particular period. For instance, last year, we experienced some unusual influences. We paid out around $642 million in pandemic claims, which is a significant capital outflow. At the same time, we had record performance and a 25% increase in the equity markets, which led us to execute approximately $605 million in buybacks over the past few years. This year, the factors we're seeing differ. The pandemic is subsiding, and we anticipate this trend will continue. However, in the first quarter, we utilized $150 million in pandemic-related expenses, with another $39 million this quarter. If we project that out, it roughly amounts to about $250 million in pandemic claims for this year. Currently, the equity markets are down significantly. While we expect fluctuations in our models, there have been some unexpected reserve movements, particularly in our Life Business due to market sensitivities. Additionally, as Ellen pointed out, this is a pivotal year for our Spark Investments. The long-term gains from Spark are projected to be between $260 million to $300 million, offering substantial returns on those investments. On a positive note, our credit performance has exceeded expectations, which supports our capital generation. Furthermore, the benefits from rising interest rates accumulate over time, unlike the immediate impacts from equity market movements. Taking all of this into account, the $100 million buyback last quarter and the same figure we discussed for the third quarter accurately represent our current situation. I want to also remind you that this year we will be distributing over $300 million in shareholder dividends and allocating about $1.5 billion to new business. We expect strong returns from these investments, which are crucial for future cash flows. This year's figures don't necessarily reflect what we might see in a typical year, but they do illustrate our current conditions. Our commitment to returning capital to shareholders remains strong, as we've consistently done over the years, with over 50% of our shares repurchased. We intend to maintain this approach moving forward. I hope this clarifies things.

It does. And then my follow-up, can you share your expectations for dividends over the remainder of the year? Will that come from L&L or from the captive?

We took a dividend from LNBar back in the first quarter, I believe it was roughly $125 million. In the second quarter, we took a dividend out of LNL of roughly $280 million. So I think that we have plenty of dividend capacity. We're very comfortable with where RBC is today. So I'd expect that the majority of dividends would come out of LNL over the remainder of the year. We have had a couple of breakage in LNBar and I think about that in the context of how we manage that entity, and we've managed that entity to maintain very robust capital also. So I think a lot of capacity will come out of LNL and will be supportive of the buybacks we've talked about, the shareholder dividends we've talked about and other corporate needs like debt interest expense, et cetera.

Your next question is from Erik Bass of Autonomous Research.

In your script, you mentioned wanting to deepen the focus on cash flow generation. Can you expand on what you're thinking about here and is increasing the free cash flow conversion ratio over time a strategic priority?

Absolutely. Erik, it's clearly a priority. I want to take a moment to provide some comments to address your question. First, I've discussed our near-term strategy, and as part of the senior management team for a decade, I feel very confident about our focus and progress in delivering results. With the new team in place, we are also looking at our long-term strategy, which will take time and is a new endeavor. We are focusing on how to accelerate growth and enhance shareholder value, emphasizing distributable cash flow generation and capital returns to shareholders, in conjunction with our longstanding focuses on return on equity and earnings per share growth. To make it more tangible, one aspect of our product strategy involves making our products more capital efficient, which has been a significant area of focus. For instance, we allocated $1.5 billion of capital to new sales that are generating returns at or above our targets, and we aim to further accelerate capital efficiency across our product suite. Additionally, we are looking to maximize the value of our existing operations and the present value of our distributable earnings under various economic scenarios. Historically, we've engaged in transactions to achieve this, and while there are no current commitments or timelines, we would evaluate any suitable opportunities that arise. We also seek to optimize our long-term business mix. A few years back, we aimed to increase our earnings mix from mortality and morbidity sources to 30%, which we achieved by acquiring the Liberty business. As we continue to look long-term, with James Reid joining us as a deep group expert, our goal is to grow our Workplace Solutions business. Moreover, we believe there are additional sources of earnings and revenue we can cultivate, as evidenced by our managed account business, which has grown to $30 billion in assets under management. We are strategically evaluating its long-term potential. Lastly, I want to highlight emerging trends and our commitment to accelerating innovation and agility, exemplified by our Spark program, and we will explore more opportunities for long-term value enhancement. In summary, we will emphasize distributable cash flow generation, focus on capital efficiency, and maintain our strategic approach. This will take time, and we will keep you updated as we work through this with our new team, currently evaluating our businesses and looking for growth opportunities by leveraging our existing capabilities. I hope this answers your question.

Yes. And then my second question is just around your SGUL exposure. And I was hoping you could talk a little bit about your current lapse assumptions for the block and maybe provide any color on how the compared to the industry or maybe how they've changed over time?

Thank you for your question, Erik. I believe you're looking for insights on our assumption reviews for the third quarter. Let me expand on that. Generally speaking, our process for reviewing assumptions is very thorough, with numerous controls in place and dedicated personnel involved. I won't preempt that work, as we'll discuss it in more detail during next quarter's call. At a high level, the establishment of assumptions improves with more data and skilled individuals, and as a leading player in the life insurance sector, we possess a wealth of data. We continuously adjust our assumptions based on this data every year. We also participated in a specific study this year focused on guaranteed universal life (GUL), among other ongoing studies about our assumptions. The findings from that study will be incorporated by our team. Regarding lapses, while I won’t delve into geographic specifics, there have been industry-wide trends over the past few years that are worth mentioning. The pandemic led consumers to recognize the importance of life insurance, resulting in a drop in lapse rates across all products initially. However, after three to four quarters, those rates began to rise again. Though they haven't fully returned to pre-pandemic levels, they have increased. Overall, I hope this provides some context around the interesting changes in lapse experience over the past couple of years and how we might expect future trends to evolve. For example, will the rates return to pre-pandemic levels, or will they stabilize at some point? All of these considerations play a role in our analysis. Overall, we have extensive data that we continuously seek out and integrate into our assumptions annually.

Your next question is from Jimmy Bhullar of JP Morgan.

I just had a question on your RBC ratio decline in 1Q and in 2Q as well. How much of this is purely because of higher required reserves with the market going down, which might potentially reverse as the market recovers versus other factors such as hedge breakage that might or might not necessarily come back.

Jimmy, we started the year at about 427, as I mentioned, we're at roughly 400. About two-thirds of that is really associated with capital markets-driven reserves that pop up. About 25% is associated with a little bit of limitations we experienced in our DTA. So our non-admitted DTA went up a little bit. That was at least 6 or 7 points. So those are the drivers of the decline this year, Jimmy.

As you consider buybacks, you mentioned up to 100 million. Was that comment more relevant to the third quarter, or was it intended for the rest of the year, or just generally applicable for the next several quarters?

The comment was specifically about the third quarter, and then we'll talk about the fourth quarter when we get to that call.

Okay. Is it fair to say that unless the RBC recovers, your outlook on potential buybacks wouldn't change much on the upside?

Yes. I'll just go back to my answer with the lease. It will really be controlled by the facts and circumstances that we see over the back half of 2022.

Okay. And then just lastly on RBC. Is there a level that you want to let it not go below? Like is 400 the base you'd want to keep it at? Or how do you think about how far down would you be comfortable having a drop?

I believe, as Ellen and I stated, we are both quite comfortable at 400 where we currently stand. If you consider last year, 400 would have equated to 420, as the C1 factors decreased by about 20 points, but this did not alter our view on the appropriate amount of capital. Thus, 400 this year is stronger in a relative sense than it would have been last year. Additionally, our philosophy regarding capital is that the right amount of capital evolves over time, and we avoid discussing a fixed target. We think the right RBC ratio changes over time. At a broad level, immediately after a significant stress event, we expect to see our metrics drop below our typical travel rate, perhaps by 50 to 70 points. Conversely, if you time it perfectly the day before a major stress event, you might find yourself about 50 points above your average travel rate. Over time, our view of what the right number is has shifted. However, at our current position of 400, we feel very comfortable there.

Your next question is from John Barnidge of Piper Sandler.

The NAIC is considering increased RBC charges on investments in CLOs to address what it argues as a capital arbitrage benefit? What are your views on the proposal and discuss the potential impact of the proposal or maybe required capital in the RBC ratio? And maybe if it's in what that would do to appetite for CLO assets?

We're actively engaged as we are with the NAIC on all their topics. I think it really is a good partnership and relationship that Lincoln and the industry has with the NAIC as they work through these projects. Just as with any project, it's big, I feel very good about how we're positioned. I think you're well aware, our CLO Holdings skew very high from a rating standpoint. So it's a high-quality portfolio and I don't see a material impact in terms of anything they might do with CLOs.

Yes, I would like to add that we have always been actively involved in all of the AOCI efforts, particularly regarding capital and C1. We were also very much engaged in the first round. Our Chief Risk Officer is currently chairing this second round. Regarding CLOs, most of our CLOs are single A and above, with a strong presence of AAA ratings. Ultimately, we are collaborating across the industry to ensure there is a robust model that appropriately correlates losses with capital. Given the growth of CLOs on insurance company balance sheets, it is wise to reassess and confirm that the capital levels are suitable.

Okay. Great. And then my second question, you talked about a recent new hire, James Reid. Can help notice he was previously working in a place that had a sizable dental and vision exposure. As you talk about increasing some of that group business, should we be thinking about dental over time and even vision to becoming a larger portion of Lincoln's group story?

That's a great question. As James joins us and we assess the group as a whole, we believe that this is a crucial strategic area for Lincoln. Merging the old Lincoln and Liberty businesses has significantly expanded our market presence, allowing us to operate in both smaller and larger markets. Additionally, we've launched a variety of new products. Historically, our focus has been on life and disability insurance, but we've been placing greater emphasis on supplemental health for various reasons. Last year, we introduced a new hospital indemnity product and currently have a small dental business relative to our overall group operations. As James familiarizes himself with our current business and capabilities, we'll evaluate the long-term potential of these areas in our strategic review. We will follow up with more information regarding whether we can expand in these segments or if we will pursue different directions. Importantly, we recognize the strategic value of this segment and are committed to improving our margins and growing this part of our business.

Your next question is from Josh Shanker of Bank of America.

Thank you, Randy, for your comment about the limited impact of the change in LDTI numbers. Clearly, your team manages your own accounts and has several internal objectives. However, LDTI is expected to introduce greater volatility in GAAP results. Are you considering spending more on derivatives to align with GAAP expectations after LDTI, or would you consider it merely a cosmetic adjustment to your risk management strategies?

Josh, when I was in my script, I used the word holistic. So I think when we get together later in September, I think we'll discuss a lot of topics, including the hedge program. Look, at a high level, we have a super robust and expansive hedge program today. it has a significant amount of expense, and I wouldn't expect those costs to change, right? But that's all about what we do today, which we spend a lot of money to create this world-class hedge program. And I don't expect material change. But it's going to be a great discussion. I look forward, as I mentioned, to get in together with you at least virtually around the end of September.

Your next question is from Tom Gallagher of Evercore ISI.

Returning to the SGUL question and your current perspective, Randy, I'm not asking you to provide details about the balance sheet review. I'm just considering the implications for capital due to Peru's mention of their GAAP charge leading to a statutory charge. In the past, you've expressed confidence in the statutory reserves for SGUL, which I've interpreted primarily in terms of interest rates rather than mortality and lapse rates. What is your overall view on capital adequacy and its potential impacts? If there's a GAAP balance sheet review charge that also affects statutory reserves, I assume it could influence your capacity for stock buybacks. I apologize for the lengthy question, but any insights you can share would be appreciated.

Tom, I have a few comments on the topic. Statutory reserving is mainly formula-based and establishes reserves conservatively, aimed at ensuring solvency. I'm confident in the adequacy of the reserves. SGUL also has its own specific tests, referred to as HC and HB, which we have discussed previously. If there were to be any effect on statutory capital, it would show in these subtests. Historically, we've mentioned the risk associated with falling rates, which has decreased over time as our base reserves have grown. Each test within HC and HB is somewhat unique, and significant changes in assumptions can affect them. However, we haven't discussed potential impacts from HC and HB in quite some time, possibly over a year now. Overall, we feel positive about the situation, but any adjustments in future assumptions would need to be reflected in those tests as well.

That does. Okay. And then my follow-up is just on VA hedging and LNBar. Just based on the performance you saw in 2Q and overall capital levels, any chance you either have to make contributions in the LNBar. Or do you feel good about those capital levels? Or alternatively, any chance you might take dividends out?

Yes. Look, we took a dividend out in year. Historically, we’ve been sort of one time a year. So I don’t think – I wouldn’t expect any dividends over the remainder of the year. Yes, Tom, you’re right. We’ve had elevated breakage for a couple of quarters in a row. A couple of other comments are on LNBar itself. It does have earnings, right? So we tend to talk about the breakage, but it does have a level of earnings that is meant to cover sort of a normal level of breakage and build capital over time. So that’s the entity structure. Just like any ongoing enterprise. I’d also point out that if you look back at last year, we came into the year in a pretty good place because we really didn’t have elevated breakage last year. I think I’m remembering like the middle two quarters of last year added up to actually to a small positive. There was no breakage. So we came into the year in a pretty good spot. That being said, two quarters in a row of elevated breakage. I would we have to think about that. That’s real capital. That’s a real use of capital, and we’ll have to manage around the reality of that outcome. But once again, I think we came into the year in a pretty good place. The entity has ongoing earnings. We’ve taken our dividend up for the year, the earliest we would contemplate doing another dividend would be next year, and then we’ll have to see what the reality of these first two quarters and the reality of the back half of the year brings to us.

Your next question is from Mike Ward of Citi.

Just had one question. I was wondering if you could comment on what you're seeing in terms of wage inflation. This has been a topic, but I think the growth for higher wage earners has been a little bit more recent. I think this is of course, a product of inflation in general. But just wondering if you're seeing that in the higher wage earner demographic and how that might be impacting how you're thinking about the kind of near-term outlook?

So Mike, I'll start and comment and then I'll hand it over to Randy. So I suspect that when you talk about wage inflation that you're really thinking in terms of how that might impact in terms of our overall employees. And we have been seeing in this war for talent and in attrition and in general, just a lot of movement that we've seen here at Lincoln and attracting a lot of new people. We have overall continued to really keep pace with what we're seeing as it relates to wage inflation. And so when you see our overall numbers, and Randy talks to you about our overall expenses for the last, I would say, probably 12 to 18 months. We have been, in terms of our hiring, we've been increasing wages in terms of our higher performers inside and we have been increasing wages. And also we have been looking at appropriate market adjustments to be able to keep pace. And then the other comment that I'll make is that we also see a benefit as it relates to overall wage inflation in our workplace businesses as well. So we know and I talked about in my remarks earlier, that we've seen overall broad-based increase in terms of deposits on the RPS side. We've seen broad-based increases as it relates to employee-paid the group protection business. And we believe that one of the contributors there is more dollars in the employees' pocket and they're able, therefore, to allocate more to savings and also to protection. And Randy, why don't I hand it over to you?

Ellen, I think you did a great job. Mike, we've been adjusting to higher wages for over a year now, which is reflected in the numbers. I always remind people that we operate like any other company; you don’t consider things in isolation. When wages increase slightly, the management team works a bit harder to enhance productivity. I view wages as just one component of our overall expenses. As I mentioned, we had strong expense performance, which does factor in inflation. Regarding the Highway juniors, one positive aspect of the inflation we've encountered is that it has been widespread. The increases are not solely due to higher wages; they have been seen across various sectors. In fact, one could argue that lower wage earners have experienced more significant growth. I hope that clarifies things, Mike.

Lincoln Financial Group will follow up later this afternoon for those remaining in the queue. I will now the call over to Al Copersino for closing remarks. Thank you all for joining us this morning. As always, we are happy to take any follow-up questions that you have. You can e-mail us at investorrelations@lfg.com. Thank you all, and have a great day.

This concludes today's conference call. Thank you for your participation. You may now disconnect.