Lincoln National Corp Q4 FY2022 Earnings Call

Good morning, and thank you for joining Lincoln Financial Group's Fourth 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.

Good morning, and welcome to Lincoln Financial's fourth 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, 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 advise 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, including adjusted return on equity and adjusted income from operations or adjusted operating income to their 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. Good morning, everyone, and welcome to Lincoln's fourth quarter 2022 earnings call. Before we begin, I am excited to discuss the news we released last night that Chris Neczypor, currently Lincoln's Chief Strategy Officer, will be appointed Chief Financial Officer effective February 17th. Chris has more than 20 years of experience in the industry. He joined Lincoln in 2018 as Head of Investment Risk and Strategy and was named Chief Strategy Officer and a member of our senior management committee in 2021. In the strategy role, he quarterbacked the organization's shift to our current strategic objectives, working closely with the finance organization and our businesses and built a dedicated team focused on corporate development including evaluating potential transactions. Before joining Lincoln, Chris held a variety of roles in the life insurance industry, including as an analyst and an investor after having started his career as a CPA and auditor of life insurers. Throughout his career, he has cultivated a deep knowledge of the complexities of insurance financials. Chris' leadership will be critical as we continue to fortify our capital position. Chris and I have worked alongside each other for five years, and I know that with his deep financial acumen, analytical expertise, and strategic understanding of our business, he will be focused on our balance sheet resilience and the overall drivers of our valuation. Chris will be succeeding Randy Freitag. Randy will remain CFO through February 16th and continue to work with us through the end of the first quarter to ensure a smooth transition. Randy has made many contributions to Lincoln over the years, and I would like to take a moment to recognize Randy and wish him the absolute best for his next chapter. I know you'll join me in congratulating Chris and also thanking Randy. This morning, I will provide an update on our strategic progress, followed by some key business unit highlights. Since our third quarter earnings call, our new leadership team has been taking the necessary steps to rebuild capital and strengthen our balance sheet, while positioning the overall franchise for profitable, capital-efficient growth. We have a differentiated business model with a powerful distribution franchise, broad product offerings, and a diversified, high-quality investment portfolio. These strengths set the foundation for the successful execution of our enterprise-wide priorities. As we move forward, we will continue to focus on the following strategic objectives: first, maximizing distributable earnings and improving capital generation; second, reducing capital sensitivity to market volatility; and third, further diversifying our earnings mix. To this end, we have taken quick actions and made substantial progress in the last quarter to rebuild capital and our ongoing pace of capital generation, including raising $1 billion of preferred capital, further improving our new business capital efficiency, fully repositioning our VA hedge strategy, putting a partial tactical hedge on our VUL in-force, continuing to implement our Spark enterprise-wide expense initiative, enhancing the profitability of our group business, and seeking to unlock the value of our in-force book. I will further elaborate on each of these at a high level. As a result of the swift and targeted action we took in the fourth quarter, we raised $1 billion of capital through a preferred issuance and expect to end the year with an RBC ratio of approximately 383%, an improvement as we drive towards our target of 400%. Turning to new business capital efficiency. Across Retail Solutions and Workplace Solutions, we are focused on delivering a more capital-efficient product mix, which will continue to produce a robust level of sales, while requiring approximately $300 million less in new business capital this year. We are selling on our terms with new sales in all four businesses meeting or exceeding target returns. This focus on capital efficiency and profitability will also contribute to the higher present value of distributable earnings from new business going forward. We are able to make this pivot by continuing to evolve our products away from long-term guarantees and to provide more options that are attractive for customers involving risk sharing. More tightly, we are focusing this capital on where we have differentiated products and long-standing relationships with key distribution partners, for example, more of a focus on permanent products over individual term life, using flow reinsurance to enhance capital efficiency, and focusing on higher-margin, more capital-efficient products and segments across both our Retail and Workplace Solutions businesses. Next, we fully repositioned the variable annuity hedge program to align with our objectives of maximizing distributable earnings and providing explicit capital protection. As a result, we expect to see less capital volatility in Linbar. In addition, as we focus on improving profitability as well as future capital generation and earnings growth potential, we continue to make substantial progress in the implementation of Spark, our enterprise-wide expense initiative expected to contribute run rate savings of $260 million to $300 million by late 2024. We are also progressing on our group protection margin expansion efforts. We ended full-year 2022 with an underlying margin of 5.3%, within our 5% to 7% target range, with a focus on disciplined pricing and underwriting, providing optimal return to work outcomes for our claimants and implementing segment-level strategies to build a more diversified and balanced book of business. We expect over time to sustain a group after-tax margin in the 7% range, inclusive of pandemic claims. Finally, to maximize the value of our in-force book of business, our fully dedicated team remains engaged in evaluating internal and external opportunities including possible block reinsurance transactions designed to advance our strategic objectives. As we focus on these capital and profitability improvement actions that will positively impact distributable earnings in 2023 and beyond, we are also experiencing headwinds, which we have discussed in the past, such as near-term capital market impacts, pressure on the life business, and higher inflation-driven expenses that Randy will discuss further. Accounting for these pluses and minuses, our 2023 distributable earnings remain in line with our prior expectations. As we look to 2024 and beyond, several of the initiatives that are well underway are expected to drive further improvement in capital generation. We generally expect the 2023 headwinds to begin to dissipate in 2024 or be offset by larger positives, for instance, the growing benefits of our profitability improvement initiatives. Going forward, over the longer term, we expect the distributable earnings and GAAP earnings power of our business to reemerge. Moving to the quarter's results, we demonstrated improving loss ratios in our group business, positive flows in both Retirement and Annuities, and a sequential increase in life insurance sales. Let me now discuss some key business unit highlights. Fourth quarter life insurance sales were up sequentially in all products except for terms where we took pricing actions. Fourth quarter life sales were down from a strong prior year quarter, though sales were up for the full year, particularly in indexed universal life. We have a broad, diverse product portfolio, and as we previously indicated, our distribution leadership is most effective in permanent life products. Annuity sales increased 7% from the prior year quarter with positive flows reflecting continued strength in index variables and fixed index products. We continue to see a mix shift away from products with long-term guarantees in both our sales and our in-force. Our Workplace Solutions business had a strong year and remains key to our long-term strategy. Group Protection had a year of solid top-line and overall earnings results. Premiums grew 7% for the full year, as strong persistency and organic growth continue to generate premium increases. While fourth quarter sales declined 8%, full-year sales rose 15% with increases across all products and case size segments. We continue to see heightened interest in our supplemental health portfolio, and we're pleased with the sales in this category. In Retirement, despite a 7% decline in fourth quarter total deposits from a strong prior year period, full-year total deposits rose 10%. On a full-year basis, net flows were a record $2.9 billion, marking the eighth consecutive year of positive flows for our Retirement business. Finally, Lincoln's investment portfolio continues to be well positioned in the event of a potential credit cycle given its diversification and high quality nature. In closing, we have been fortifying our capital position, increasing our future capital generation, and positioning the franchise for future profitable earnings growth. While there is more to do, we have accomplished a great deal in a short period of time and have built the foundation and put the leadership team in place to execute successfully on our plan. And with that, I will turn the call over to Randy.

Thank you, Ellen, both for those words and our 10 years working side-by-side. Before I get to our results, I'd like to let you know what an honor it has been to serve as Lincoln CFO for the past 12 years. Thank you all for your contributions to this industry that we are so fortunate to work in. While we have had both agreements and disagreements over the years, I'd like to thank that we learn from each other and that we are all better for our interactions. Thank you again, and I wish you all nothing but success as you progress through your careers. With that, let's get started. Before discussing our earnings results today, I will expand on Ellen's comments regarding our capital position. Statutory capital at year-end was $9.6 billion. We down streamed $780 million of the preferred proceeds to our life company and expect to end the year with an RBC ratio of approximately 383%. This compares to the previous guidance of 360% as the contribution of the preferred proceeds was partially offset by $116 million legal expense in other operations. In Linbar, capitalization improved sequentially and is in line with our long-term target. Cash at the holding company stands at $960 million, up $200 million sequentially, the result of retaining a portion of the preferred proceeds to complete the prefunding of our September 2023 debt maturity and book value per share, excluding AOCI, ended the year at $63.73. Now let me turn to our earnings. Last night, we reported fourth quarter adjusted operating income of $170 million or $0.97 per share. As we noted in the earnings release, adjusted operating income included a net unfavorable notable item of $116 million or $0.68 per share from legal expenses, pandemic-related claims of $41 million or $0.24 per share, and below-target alternative investment income of $43 million or $0.25 per share. Net income for the fourth quarter totaled $6 million or $0.01 per share. The difference between net income and adjusted operating income was primarily due to hedge breakage and nonperformance risk. Now turning to segment results, starting with Life Insurance. Operating income for the quarter was $46 million compared to $80 million in the prior-year quarter. The drop was primarily driven by alternative investment results and the quarterly run rate impact of the third quarter unlocking, partially offset by improved pandemic claims. Base spreads were 122 basis points for the quarter, down from 135 basis points in the prior-year quarter. This was due to the impact of certain duration extension programs put in place during the low rate environment. In addition to the life business not yet fully benefiting from higher interest rates due to the long duration and low turnover of its investments. At today's rate environment, we anticipate that 2023 spreads will stabilize about 10 basis points below fourth quarter 2022 levels before beginning to expand in 2024 and beyond. Average account values net of reinsurance fell 6%, reflecting the impact of lower equity markets, while average in-force space amount grew 11%. The Life Insurance business faced many challenges in 2022 and will continue to be pressured in 2023 by pandemic claims, higher reinsurance costs with some additional spread pressure. All that being said, we remain confident in our ability to improve the business over time. Annuities reported operating income of $238 million compared to $332 million in the prior-year quarter, reflecting the decline in the capital markets in 2022. Given the market decline and excluding the benefit of the third quarter unlocking, we are pleased that our Annuities business delivered a 2022 return on assets of 68 basis points and return on equity of 18%. Our net amount of risk for living benefits and death benefits improved to 5% and 4% of account values, respectively, reflecting the sequential rise in equity markets during the quarter. As we continue our progress in diversifying the Annuity business, VAs with living benefit guarantees now represent 45% of total account values, a decrease of five percentage points from the prior-year. Looking ahead, we expect our diverse product portfolio, revised VA hedge program, and the benefit of higher interest rates to help drive future earnings and cash flow generation. Turning to Group Protection, we reported operating income of $47 million, an increase from an operating loss of $115 million in the prior-year quarter, aided by lower pandemic-related claims of $116 million and improved underlying disability results of $35 million. Group's underlying margin was within our target range of 5% to 7% for the quarter and the full year at 5.2% and 5.3%, respectively, when adjusting for the pandemic and unfavorable alternative investment income. The loss ratio adjusted for the impact of the pandemic was 77.1%, a 420 basis point decrease from the prior-year quarter reflecting improved group life and disability loss ratios. Overall, 2022 was a year of progress for the Group Protection business, and we are well positioned to achieve and sustain a 7% margin over time. Retirement Plan Services reported operating income of $49 million compared to $57 million in the prior-year quarter, with the reduction primarily driven by the impact of lower equity markets on fees and alternative investment income, partly offset by higher spreads. Average account values declined by 10%, as lower markets more than offset the benefit of full-year net inflows. Turning to spreads. Base spreads, excluding variable investment income, expanded over the prior-year quarter by 30 basis points. For the full year, base spreads expanded 10 basis points, which is a level of expansion more in line with our view of the go-forward rate of improvement. Reported spreads declined eight basis points over the prior-year quarter. In 2023, we expect reported spreads to be in line with 2022 results as lower variable investment income is offset by base spread expansion. The improved rate environment, coupled with our proven track record of delivering positive flows, positions Retirement to continue to deliver strong results going forward. Moving to investments, where we continue to report excellent credit results and increasing new money yields. The portfolio's credit quality improved throughout 2022, as we benefited from net favorable credit migrations. At 97% investment grade, the portfolio is at its highest quality in the last decade. We continue to leverage our multi-manager platform to perform name-by-name scenario analysis across the entire portfolio under a range of scenarios and are well positioned in the event of a potential recession. Fourth quarter new money yield rose 70 basis points sequentially to 5.7%, 160 basis points above the 4.1% yield on the fixed income portfolio. Lastly, our alternative investment return was a positive 0.4% this quarter. For the year, we achieved a positive 2% return below our long-term target of 10%, but materially outperforming major public equity indices. With LDTI going into effect as of January 1, I will provide a few brief updates. First, as noted on our LDTI initial disclosure call in September, we continue to expect minimal impact to overall operating earnings. Within the business units, we expect Life Insurance to be negatively impacted by approximately $100 million to $120 million, which will be offset by a positive impact in annuities of a similar size. As we also mentioned in September, adjusted operating EPS will exclude market risk benefit fair value changes and will include an estimated $800 million of VA hedge costs. Second, we estimate that the impact of LDTI will increase year-end total book value by about $300 million and reduce year-end book value excluding AOCI by $900 million. These figures represent improvements from the second quarter estimates we disclosed in September, largely driven by the positive impact of higher interest rates on market risk benefits in the second half of 2022, partially offset by the negative impact of the removal of shadow DAC. As a reminder, under LDTI, we will introduce a revised definition for adjusted book value ex-AOCI that will remove variances in MRV fair values and changes in the values of the related hedge instruments. Turning briefly to our 2023 expectations. There are several headwinds that we expect to impact distributable earnings as well as adjusted operating results this year. First, pressures that are capital markets-related, including higher borrowing costs and floating rate debt, certain duration extension programs, as well as lower prepayment income. Second, while reduced from 2022 levels, we would expect some ongoing pandemic claims. Third, outside of the benefits of Spark, we expect some pressure on expenses, including those tied to inflation levels, as well as costs associated with our legacy pension plan. And in the Life business, we also expect a further increase to reinsurance costs. These headwinds notwithstanding, our view of 2023 distributable earnings remains in line with our prior expectations. Against the volatile market backdrop, I'm pleased with what we were able to accomplish in a short time, particularly strengthening our balance sheet and implementing our new hedge program. Although it was a tough year for the Life business, our other businesses performed quite well, and there are many initiatives underway to improve our capital generation and earnings power. And now I will hand it back to Al.

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

Thank you. Our first question is from Tom Gallagher with Evercore ISI. Your line is open.

Good morning. First, Randy, best of luck to you. It's been good working with you over all these years. Ellen, my first question is just on, you mentioned exploring block reinsurance deals. Can you comment on whether this is mainly focused on life insurance and GUL specifically, or you're also exploring VA transactions? And then just second part of that is, are you also open to considering strategic transactions at this point? I'm kind of referring to what AIG did with Blackstone or something along those lines? Thanks.

Sure. So Tom, as it relates to our overall focus, we're really focusing right now on opportunities that will maximize the value of our in-force. And we're doing that with a much wider lens, and we're evaluating both internal and external potential solutions. So what we have said is that we have a fully dedicated team right now that is actively evaluating that the opportunity to do something externally has clearly expanded as we know that there are more buyers out there, first of all, and secondly, there are more buyers out there that would be interested in the potential for complex liabilities. And most importantly, whatever we would do here would be supportive of the enterprise strategic objectives that we've laid out. So we would be looking ideally for some opportunity here that would improve, first of all, our ongoing capital position, but also improve the rebuild of capital as well. So really the ability to be able to do both of those things at the same time. So more to come as we're able to communicate this going forward to you. I'm not going to give you, at this point in time, a specific product orientation because really, the reality is that if there's an opportunity that makes sense for us and it's good for shareholders and at the appropriate price, we would look to transact.

Ellen, are you considering working with a strategic partner, or is your main focus currently on financial transactions?

So at this point in time, we're really focused on financial transactions that at the end of the day would optimize the value of the in-force, if there was an opportunity out there that was along the lines of what you were talking about, again, and it made sense, we would clearly evaluate that as well.

Great. And if I could slip in one numbers question. The $300 million of lower strain from new sales in 2023, was there a consideration of doing a bigger amount of flow reinsurance to provide more cash flow relief or is that sort of the max benefit that you could get from the flow reinsurance?

Yes. So in this number, Tom, there are quite a few management actions. And one of those actions is to be expanding and extending some of our flow agreements to be focused on capital efficiency. And the other thing that I want to mention here is that in addition to the $300 million, and I highlighted this in my upfront comments, but I really want to stress that we've got the expectation of robust levels of sales across all four businesses, with the expectation of freeing up $300 million in terms of capital efficiency. And we also expect to be improving the forward distributable earnings of that block of sales going forward. So we expect ongoing capital generation improvement as well.

Thanks.

The next question is from Erik Bass with Autonomous Research. Your line is open.

Hi, thank you. So you've guided to $600 million to $800 million of distributable earnings for 2023 before interest expense. I was just hoping you could help us think about how that will build over time, maybe expand on some of the levers for improvement, Ellen, that you talked about in your script?

Sure, Erik. So we have guided to a $600 million to $800 million range of distributable earnings coming from the life companies. We back out of that $300 million of annual debt expense, which includes the preferred. So we're really talking about a range of $300 million to $500 million from an overall free cash flow perspective. And that's our range as we move into 2023, assuming a normal capital market environment. So as we move forward and we think about '24 and we talk about the number of ongoing initiatives that we have underway, I'll highlight a few of them for you right now. One of them is Spark. And we talked about the fact that at the end of '24 that we expect $260 million to $300 million in run rate. We talked about GP margin, and we're seeing steady improvement there, and we ended the year with a 5.3% margin. We firmly believe that we're well on our way to a sustained 7% margin. Randy also highlighted the fact that we're seeing improvement in terms of our capital position of Linbar, and so that's clearly something that as we move forward, we'll continue to evaluate as another improvement as well. The other piece that I want to highlight again is that while we're going to see $300 million of capital efficiency improvement in '23, we're also expecting, as we go forward, to be able to see an improving contribution to distributable earnings from that sales mix that will continue to grow over time. Those are some of the things that we're spiking out. Additionally, we're looking at additional levers and potential actions that could even further support this year or 2024 and beyond that.

Thank you. That’s helpful. I think this year's plan includes a reserve release from SGUL, which we should consider a one-time event. Is that correct?

Erik, let me take that question. So when you think about RBC more broadly. As we mentioned, we expect to end the year at approximately 383%. We talked about the couple of big levers: the contribution of the preferreds and the legal settlement going the other way. Additionally, beyond that, we did a step where we're going to establish the AP reserve associated with the third quarter unlocking. We currently expect that will come in a little better than the $550 million we guided to. We're still doing the work. We don't file our statutory blue book for a little bit. Now on the other hand, that a little bit better was offset by some other reserve movements during the quarter that I described as one-time. So you're not seeing a net-net benefit, but we do expect to come in a little better. As we come a little better on the amount we post, we'd have a little less release, but as both Ellen and I said, we're still able to reiterate that same level of expectation for free cash flow. There are some other positives that are driving from our standpoint, a better durable result than before when we had some element of that one-time release in there.

Yes. And an example of that, Erik, is that we had pointed to, last time we spoke, a range of new business capital efficiency in '23 of $200 million to $300 million, so we expect to be on the north end of the range for that. That's an example of some of the pluses and minuses that has us very comfortable in our expectation of that $300 million to $500 million range of free cash flow for '23.

Got it. Thank you very much. Thank you, Randy. Best of luck going forward.

Thank you.

The next question is from Alex Scott with Goldman Sachs. Your line is open.

Hi, good morning. The first question I had is just around the common dividend. And I listened to a lot of the comments you made around the investment portfolio and your confidence. I just wanted to better understand, as you kind of look at different stresses and think about the environment, when you run those scenarios, how would you describe your commitment to the common dividend and how well the balance sheet holds up and your ability to cover the common dividend in those types of scenarios?

So Alex, I will start and then Randy, of course, will continue and fill in. So the first point is that we remain committed to returning capital to shareholders by way of dividend. We've talked about the fact that you all know that we're focused on the rebuild of our RBC and improving our capital generation. We've talked about all the improvements and what our expectation is in terms of our range of free cash flow into 2023. The Board has approved the dividend for first quarter of '23. Just as a reminder, the dividend is under the Board's purview, and we're not going to get ahead of the Board here, but we remain committed to returning capital to shareholders by way of the dividend. As it relates to the overall investment portfolio, and Randy mentioned a couple of things. One is that it is of the highest quality that we believe it's ever been. We've talked to you for some period of time about the significant amount of stress-testing and scenario analysis and name-by-name analysis around credit deterioration. The team does that again on an individual basis. Based on the outlook and based on our expectation of credit deterioration at this point in time, we believe that if we were to hit a credit cycle that it would be quite manageable in the overall realm of our overall current investment portfolio in this scenario. And so that from our perspective is, again, quite manageable.

Yes. I think, Ellen, you hit it perfectly. Alex, I think hypothesizing about what you might do or might not do during a time of stress is premature. The reality is, if you think about Lincoln, our capacity, one, we have a strong balance sheet at 383%. Yes, it's below where we'd like it to be over the long-term, but still a very strong balance sheet. We retain a significant amount of cash to the holding company. We do have access to a $500 million contingent capital facility. So I think there are a lot of capacities, and we would think about all the levers should our industry or the economy enter a period of stress. Presuming which one you would pull, which lever you would play out, I think it's premature and we will act as appropriate if and when that happens.

Understood. Second one I had for you is just thinking about free cash flow over a longer period. Some of the things that are affecting you right now are somewhat temporary. I'm cognizant of the fact that you used to generate a much higher level of free cash flow, and you have talked about making the products more capital light over time as well. I mean, do you expect to be able to get back up to the kind of cash flow that you've earned in the past? How long do you think something like that could take? And are some of the actions that you're targeting and maybe the strategy and direction of the company could it actually cause you to get to even better cash conversion over the long-term? I guess I just want to understand sort of where we're at and how temporary versus long-term the impacts are going to be.

Yes. So Alex, great question. And again, I just want to remind all of us that we have made substantial progress in the last quarter. And exactly as you're pointing out, we feel really good about where we are, what we have done, and also the expected improvement going forward. We completely agree that as we move forward with the lens of a real focus on improving overall capital generation, that over time, everything that is going on to the books, we're really focused on maximizing profitable growth in a capital-efficient way, and that, over time, clearly will have a multiplier effect. We're not at the place right now where we can provide a range or provide a steady state of capital generation or any specific timing around that. Most importantly, a couple of points here. One is we've focused and highlighted today on the fact that we're rebuilding capital, we're improving ongoing capital generation, and to your point, we are making sure that we are also preserving and really investing in the future of the franchise, and that includes allocating a significant portion of our overall organic capital generation into that new business that will provide us with that profitable growth. So we can assure you that we're working swiftly, and I remain very confident that we'll continue to execute, deliver strong results, and we'll be back with you as we continue to deliver.

Great. Thank you.

The next question is from Ryan Krueger with KBW. Your line is open.

Hi, thanks. Good morning. Ellen, I think you had previously mentioned that one thing that has negatively impacted free cash flow is term life statutory reserving strain from PBR. I guess for you or Randy, can you help give us any sense of the magnitude of that item specifically, and if that's something that could potentially be dealt with internal reinsurance? Thanks.

Ryan, I'll not get into the specifics of any particular products. I think inside of the amount of capital we expect to allocate to new business, which, as we mentioned, we expect to be $300 million lower next year, are a lot of actions, as Ellen mentioned, that are more than just a flow reinsurance deal, including the mix of sales. I would expect that you would see next year that in that particular case, term insurance that we would just be selling less than we did in 2022, because it is a very strange product that doesn't fit with the future strategic direction of the organization at the same level it did in the past. So that is an expectation. But in getting to that $300 million, at the north end of where we guided, there are a lot of actions: term is one, flow reinsurance is the other, broader product mixes. Hope that helps, Ryan.

Yes, I was thinking I guess also, but is there a level of existing redundant reserves that have been built up now over the last few years from PBR that could be released if you used reinsurance either externally or internally?

Ryan, yes, I don't think there's much of that. I mean I think we've been pretty proactive over the years in the case of term insurance of really using financing to bring forward distributable earnings in a product like that.

I'll just come back to the fact that, as we had mentioned, we are really focused on levers that can maximize the value of the in-force. So if there was an opportunity like that, we absolutely would be focused on executing on it. And at the same time, we're also focused on our new sales going forward, really maximizing the present value of distributable earnings there as well.

Thank you. Thank you, Randy. Good luck.

Thanks, Ryan.

The next question is from Suneet Kamath with Jefferies. Your line is open.

Yes, thanks. Good morning. And best of luck from us to you, Randy. I wanted to ask a bigger question about the capital structure, because it looks like your debt to capital is still pretty elevated. You issued these preferreds that are callable, I guess, in five years, but they're pretty expensive. You've talked about dividends, but you haven't really mentioned share buybacks. So I guess, maybe can we just talk about your priorities in terms of the capital structure and maybe fixing some of the things that seem a little bit overextended at this point?

If you consider the three main areas we've discussed over the past few quarters, the Life company finished the year at 383%. We aim to strengthen this further with a target of 400% in the long run, so there's some work ahead. Regarding Linbar, we are very pleased that we ended the year aligned with our long-term expectations, especially compared to our position at the end of the third quarter. This improvement positions us better for future capital sources. In Linbar, we remain on track with our long-term goals and have a hedge program that emphasizes capital protection and safeguarding our stream of distributable earnings for the future. Lastly, as you pointed out, leverage is a significant concern. Our leverage ratio is indeed higher than we would like it to be over time. However, we've prefunded a $500 million maturity, which will reduce our leverage as that cash is currently held at the holding company and is due at the end of September 2023. While this is a step forward, I believe there is more to be done. We anticipate numerous actions in the coming years to optimize how we allocate the capital we'll generate, considering the growth Ellen has mentioned and our overall financial structure.

And then any comment on the buyback? I know you ruled it out for this year. I think there's an expectation in the market that there will be something in 2024. I just want to give you the opportunity to comment, if you'd like.

Yes. And so Suneet, as it relates to buybacks, at this moment, we are focused on really continuing to grow our free cash flow and also to really take our risk-based capital, which ended the year at 383%, and we feel really good about the improvement that we made there and really rebuild back up to 400%. As we're getting closer to that point, we'll be able to give you some estimate around how we think about time and expectation there. We have, as I mentioned, a number of initiatives that are well underway. We feel really good about the progress that we've made, and we have a number of additional as we move through 2023, and we start looking forward with a number of additional actions that we're also evaluating, so more to come there.

Got it. And then maybe just one more, if I could. Just are you seeing any commercial impact from a lot of the headlines that we've seen, I guess, since the charge? I mean sales were down in a bunch of areas. You'd mentioned good results for the full-year. But just trying to think through any potential impacts from a ratings downgrade or just from the headlines, if it's having any impact on your ability to generate commercial growth in terms of products? Thanks.

Suneet, I appreciate your question. We have not experienced any disruption in our businesses regarding overall distribution. We are optimistic about the sales volume recorded in the fourth quarter and the anticipated profitability from those sales. I recently attended the annual sales conferences for all four of our businesses, and the sales teams are fully supportive of the changes we are implementing. They are highly motivated and engaged with our partners. We continue to attract and regain producers across all our operations. Therefore, it is business as usual, and we are fully aligned with the efforts to enhance our capital efficiency.

Okay, great and good luck everyone.

The next question is from Elyse Greenspan with Wells Fargo. Your line is open.

Hi, thanks. Good morning. My first question on Individual Life, I think the earnings are around $107 million if you back out COVID in half, can you just help us think about the run rate earnings for that segment? I know you guys spoke about 2023 having some headwinds from higher reinsurance costs. So just trying to get a sense of just the earnings you see in that segment on a go-forward basis.

Elyse, without discussing the run rate, let me highlight a few points: with the third quarter now concluded, we had expected that Life earnings would decrease by $45 million each quarter. Starting from the $150 million, the $107 million you mentioned aligns closely with that $45 million reduction. Additionally, I noted that while we anticipate LDTI to be neutral from an operational perspective, there will be a negative impact of $100 million to $120 million in the life sector, which will be balanced by a similar positive impact in the Annuity sector. This is another consideration to keep in mind. We anticipate some level of ongoing pandemic impact. We're pleased that the pandemic seems to be subsiding, but we expect to see some lingering effects. Also, there are a few specific challenges for the Life business that we've mentioned, including expectations of higher reinsurance costs next year compared to 2022. I indicated that we expect the Life spread to decrease by about 10 basis points or so from current levels before it begins to grow again in 2024 and beyond. So, yes, there are some near-term challenges, and I believe we've effectively addressed them. Regarding the $107 million, it reflects where we were adjusted for the $45 million impact of the unlocking.

Thanks. And then my second question, obviously, a bunch of questions on capital on the call. And I know you guys don't want to comment about buyback specifically beyond this year. But it does seem like you guys could be precluded for a bit longer from buying back your stock based on distributed earnings expectations. So at some point, Ellen, would you guys consider something more transformational, potentially considering selling a business as a way to free up capital and potentially have additional capital flexibility sooner than otherwise?

Yes. Elyse, I'm going to go back to and reiterate the fact that we laid out a quarter ago a number of initiatives that are well underway, and we feel really good about them. We're clearly going to see improvement from '22 to '23, and the number of initiatives are going to continue to accelerate improvement beyond '23 into '24 and beyond. We're continuing to evaluate. So I want to be very clear about the fact that we're continuing to evaluate other actions that can continue to even further really enable us to get our RBC back to the target level as absolutely quickly as possible. So we're going to continue to take swift actions. We'll be back in touch with you. We're not going to give a timeframe today. As we are executing, we'll continue to deliver those results for all of you.

Thank you.

The next question is from Jimmy Bhullar with JPMorgan. Your line is open.

Thanks. Randy, first, good luck in the future. I had a couple of questions on your comments on spreads and then also on reinsurance costs. When you talk about reinsurance costs being up, is it up beyond what you had indicated previously? And if yes, why? Or is it just consistent with what you'd said? And then on spreads, the decline sequentially, is that a function of the crediting rates being up or is there something else that's driving that?

We have discussed reinsurance costs for several years. Over the last five or six years, we've invested significant time with our reinsurance partners focusing on reinsurance rates, particularly for the existing books of business. We have made steady progress with our back book and continued that effort in 2022, reaching some additional agreements. We are nearing completion, approaching about 90% resolution of the issues we faced. However, we have secured some additional settlements that will result in higher reinsurance costs, which we will see reflected in our 2023 figures year-over-year. Regarding spreads, specifically in the Life business, we anticipate a decline of about 10 points. As noted, the Life business hasn't benefited like the retirement and annuities segments have, and the advantages can be seen there. The Life business is a long-duration portfolio with limited rollover each year. In the low interest rate environment, we aimed to maintain our Asset Liability Management discipline by locking in future rates. For the past eight years, we have typically locked in the underlying treasury rates for a couple of years, which is challenging in 2023 as those Treasury Lock agreements will expire. While it has been a net positive overall, it does pose some difficulty this year. Additionally, we engaged in pre-investing by borrowing short-term funds and investing those dollars upfront, planning to repay the borrowings with cash flows from the business; we expect that to decrease throughout 2023. Overall, there are a few temporary challenges, but we anticipate growth in 2024 and beyond. Generally, the Life, Annuity, and Retirement businesses are experiencing expanding spreads, benefiting from the current higher interest rates.

And then on your pivot away from term life, how much of that is a function of just maybe the capital profile of the business versus maybe the margin profile? And the reason I'm asking is I think you've raised prices in term life as well and you're deemphasizing sales. In the past, when companies move away from something like, a few years later, you start seeing reserve issues and stuff. But what's the motivation for you guys on deemphasizing the Term Life business?

So Jimmy, there are a couple of things. First of all, we are deemphasizing parts of the Term Life business. So there's a piece of the Term Life business for us that we see as basically pure price competitive, not utilizing our distribution leadership as part of the overall sales process is the first thing. The second thing is that what we see is that it overall is a pretty significant amount of capital and surplus strain for that portion of the Term Life business that doesn't really have the margins associated with it. That's the part that we're going to shift away from, but not the broader overall term life market. And Randy, is there anything you want to add to that?

Yes, I agree completely. I hope I didn't overemphasize term. We're going to still sell term insurance, but I think we can be much more strategic. We can focus on the areas where we use the strength of our distribution. We can move around inside of the term marketplace into pockets that are, from a distributable earnings pattern standpoint, just better. The reality of a 30-year term product sold on one of the big aggregator platforms is that the breakeven year is very, very far out there. As we think about the future strategy, that just isn't a place that makes sense. But there's still a lot of areas, and I'm sure we'll sell a fair amount of term insurance just not at the same level we were in 2022 and prior.

Exactly. I expect the term that we will put on the books going forward will be more focused in partnership with distribution. It will be higher face amount, higher margin, and will also improve overall distributable earnings profile.

Okay. Lastly, regarding the preferred shares, they are quite costly, and you took the necessary measures. Should we expect that to be a regular aspect of your capital structure moving forward? Or is it reasonable to believe that you will allocate some capital each year to eventually retire them at a feasible time whenever possible?

So Jimmy, we understand that the preferred stock can be called after five years, which is quite some time from now. We've mentioned that we have various initiatives in place that are fostering ongoing capital generation. As we approach that call date, we will reassess our position and determine our actions. We will maintain our current trajectory, and I believe this addresses your question regarding our plans five years from now.

Thank you.

Thanks, Jimmy.

We have no further questions at this time. I'll turn it over to Mr. Copersino for any closing comments.

If any follow-up questions that you have, 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.