Lincoln National Corp Q4 FY2023 Earnings Call

Good morning and thank you for joining Lincoln Financial Group's Fourth Quarter 2023 Earnings Conference Call. At this time, all lines are on listen-only mode. We will later provide the opportunity for questions and give instructions at that time. Now, I would like to turn the conference over to the Senior Vice President, Head of Investor Relations, Tina Madon. Please go ahead.

Thank you. Good morning and welcome to Lincoln Financial's fourth quarter and full year 2023 earnings conference call. We appreciate your participation today and invite you to visit Lincoln's website, www.lincolnfinancial.com, where you can find our press release, statistical supplement, and supplemental investor outlook presentation. These documents include reconciliations of the non-GAAP measures used on our call, including adjusted income from operations or adjusted operating income and adjusted income from operations available to common stockholders to their most comparable GAAP measures. Before we begin, I have an important reminder. Any comments made during the call regarding future expectations, actions or trends in our businesses, prospective services or products, and future performance or financial results, including those regarding expenses, income from operations, share repurchases, and liquidity and capital resources, as well as any statements relating to our 2024, 2026, and longer-term outlook, and the expected timing and impact of our strategic initiatives 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 this morning as well as those detailed in our 2022 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 correct, update, or revise any of them to reflect events or circumstances that could occur after this date. Presenting on today's call are Ellen Cooper, Chairman, President, and CEO; and Chris Neczypor, Chief Financial Officer. After their prepared remarks, we will move to the question-and-answer portion of the call. Let me now turn the call over to Ellen.

Thank you, Tina and good morning everyone. I want to start my remarks today by looking back on 2023 and reflecting on the significant progress we've made in repositioning Lincoln for long-term value creation. We're entering 2024 in a much stronger position compared to 12 months ago as we advanced on our key initiatives, which were to: one, repair and rebuild our balance sheet; two, deliver organic growth while shifting new business to more capital-efficient and higher risk-adjusted return products; three, position our group business to become a larger part of our overall business mix; and four, continue to build our leadership team, putting the right people in the right roles to produce results-driven outcomes and lead the organization forward. We have a powerful franchise, a trusted brand, distribution prowess and a broad product portfolio that meets customer needs across our four businesses. These attributes will continue to serve as a solid foundation for our future growth. Our primary focus last year was to strengthen our balance sheet. And as you'll hear from Chris in more detail, this will remain a top priority. We closed a major reinsurance transaction with Fortitude Re, which marked a big step forward in our efforts to derisk our balance sheet and improve our capital position and ongoing free cash flow. We also announced an agreement to sell our wealth management business to Osac. This transaction is expected to provide a capital benefit of at least $700 million upon closing, which we anticipate in the first half of this year with no expected material impact on ongoing free cash flow or earnings. We ended 2023 with an estimated RBC ratio above our target of 400%, which includes the impact of the Fortitude Re transaction and represents a substantial increase from the 375% to 385% range at the end of the third quarter. And when the sale of our wealth management business is finalized, we expect this will further improve our RBC ratio and provide us with additional financial flexibility. We also made good progress last year in shifting our new business to a more capital-efficient mix with higher risk-adjusted returns and we are doing this across all of our businesses. While a shift like this takes time, both our product and distribution teams are executing on this transformation. Our group protection business delivered substantial year-over-year margin expansion, while also generating solid premium growth. A larger and more profitable group business is a core tenet of our long-term strategy to achieve a balanced mix of earnings from businesses and products with higher stable cash flows. Lastly, I'd like to acknowledge our leadership team. Not only did the team execute at a high level to achieve our 2023 results, they are also refining our strategy and processes, creating the framework for further transformation. We are continuing to invest in our technology and infrastructure to support future profitable growth, including digital platforms to enhance the customer experience and innovative tools to drive more production for our distribution force. Next, I'll briefly touch on our results for the fourth quarter and full year. I am pleased with our overall performance and the progress we are making to transform our company. In the quarter, we delivered improved operating performance led by our Group Protection business, record sales and annuities, and more stable life earnings. In Retirement Plan Services, we delivered our ninth consecutive year of positive flows. Elevated expenses remained a company-wide headwind and as I mentioned last quarter, we are actively addressing this along with exploring a range of additional strategic initiatives to continue growing the franchise, which you'll hear more about later on. Turning to our Retail Solutions businesses, Annuities and Life Insurance. In Annuities, we had a record sales quarter, driven by strength in fixed annuities, which surpassed the $2 billion mark in the quarter for the first time. While variable sales, including our RILA product, were flat sequentially, we have several product enhancements launching in 2024, focused on increasing our addressable market and expected to grow sales. Total annuity sales for the year increased by 8% with a well-balanced mix across product categories and strong growth driven by our strategic positioning across fixed product categories and with select distribution partners. We also continue to achieve our objectives for capital efficiency and product returns while providing customers with a broad range of product solutions to meet their evolving needs. We expect further momentum in our annuity business as we head into 2024. In Life Insurance, sales declined in the fourth quarter and full year, driven by our intentional strategic realignment to products with more stable cash flow profile and risk-adjusted returns, such as accumulation life products. We anticipate that this sales shift will continue to take time and entails optimizing the product portfolio by deemphasizing long-term guarantees such as Guaranteed Variable Universal Life or GBUL, and commoditized lower-margin products such as term. We expect to further support this shift with go-to-market strategies, including product actions and expanded distribution channels. Next, turning to Workplace Solutions, which comprises our group protection and retirement plan services businesses. In Group, we had a compelling 2023 as we delivered record full-year earnings and strong top-line growth. This reflects our progress executing on our new segment strategies and our actions to drive margin expansion. Premiums grew more than 5% for the full year and 3% versus the prior year quarter. Our deep relationships and positive customer experience enabled us to achieve strong persistency while executing on the pricing actions that are core to our margin expansion. In what is typically our highest sales volume quarter of the year, sales were up 12% versus the prior year quarter and up 3% for the full year as we achieved significant momentum across all market segments and products. We saw continued strength in supplemental health, where sales more than doubled in 2023, helping to build a more balanced and diversified book of business. Strong claims execution and a favorable external environment helped improve risk results in 2023 and when combined with pricing actions were drivers of the substantial progress we made toward our goal of sustainable 7% margins. We are also taking the necessary strategic actions to position this business for future growth with investments to build out our infrastructure, including technology and digital platforms, enhancements to our customer experience delivery, and segment-specific offerings that we believe will provide differentiation. We're confident that our strategy will deliver further profitable growth and margin expansion. Lastly, in retirement plan services. While 2023 results were below our expectations, we are taking actions to regain momentum and drive long-term sustainable growth. First-year sales were down for the quarter and full year, driven in part by a lower volume of stable value sales as higher interest rates drove lower demand for this product category and also contributed to participant-driven stable value outflows. Our employer retention remained excellent, which we attribute to our differentiated service model. Total deposits in the quarter were in line with the prior year quarter and recurring deposits were up year-over-year, driven in part by higher participant contribution rates. We are focused on the actions and initiatives necessary to move this business forward. We are already seeing some positive results as we have a larger pipeline of known sales wins than we had a year ago, although this growth will take time to emerge in our financial results. Looking ahead, we're optimistic about our strategy to grow and improve the profitability of the retirement business. Before I turn the call over to Chris, I want to set the stage for our outlook discussion. As we progress on our multi-year journey to reposition Lincoln and restore value, we remain focused on three strategic priorities: one, to further strengthen our balance sheet; two, to improve free cash flow; and three, to grow our franchise profitably, which includes advancing the optimization of our business model. As a market leader in our at-scale businesses, we have the opportunity to expand our footprint by utilizing three key foundational competitive advantages, which include leveraging our distribution strength to grow our addressable market, target specific segments and deepen existing partnerships; emphasizing products in our core markets that have higher risk-adjusted returns and more stable cash flows, while expanding into adjacent product categories; and offering a differentiated customer-centric service model with enhanced digital delivery. Over time, we expect to grow and diversify our group business across products and size segments, our annuity business to evolve with a well-balanced product mix that includes expansion of spread-based product lines, our life business to emphasize more accumulation products and deemphasize products away from long-term guarantees, and our retirement business to grow its core recordkeeping segment. This longer-term mix is expected to provide more balanced, stable cash flows and higher risk-adjusted returns that over time will support our financial objectives that Chris will cover during his remarks. Our businesses are in different stages of their strategic realignments and as I mentioned previously, it will take some time for these changes to manifest in our financial results. While we are taking the necessary steps within each business, we are also continuing to actively evaluate a series of strategic initiatives expected to further contribute to building a stronger capital foundation and optimizing our operating model. Chris will provide further details on these initiatives in his remarks. To sum up, I believe we're at an important inflection point for our company. Today's outlook provides the first lens into our future as we proceed on our journey to create increasing shareholder value. I am confident in the path ahead and look forward to updating you on our progress. With that, I'll turn it over to Chris.

Thank you, Ellen, and good morning everyone. Overall, we reported solid results for the fourth quarter, marking a year of consistent progress across our business. We are executing well against our strategic priorities, strengthening our balance sheet, improving free cash flow, and focusing on profitable growth. I will highlight three areas this morning. First, I'll recap our full year and fourth quarter results, including a review of our segment-level financials. Second, I'll briefly discuss our investment portfolio. Lastly, I will address our financial outlook, focusing on capital, free cash flow conversion, and expected growth. We've also posted an investor outlook presentation on our website that provides these details. So, let's begin with a recap of the quarter and the full year. This morning, we reported fourth quarter adjusted operating income available to common stockholders of $246 million, or $1.45 per share. There are two key items to mention regarding our results. First, while alternative investments delivered a 7% annualized return in the quarter amounting to $58 million, after tax, this was $20 million short of our target or $0.12 per share. Second, our Annuities business had a one-time favorable item of $14 million or $0.08 per share related to a model refinement. Excluding the impacts of our annual assumption review, full year 2023 adjusted income from operations was $1.1 billion, showing a slight improvement compared to 2022 due to growth in our group business offsetting expense pressures across the enterprise. Now, regarding net income for the quarter, we reported a net loss available to common stockholders of $1.2 billion or $7.35 per diluted share. The variance between net and adjusted operating income for the quarter was mainly driven by two factors. First, there was an unfavorable non-economic impact within non-operating income, driven by negative movements in market risk benefits as lower interest rates countered the advantages from higher equity markets. We remain satisfied with the performance of our VA hedge program, which has positioned the block well for the upcoming year. Second, there was a change in the fair value of the GAAP embedded derivative related to the Fortitude Re reinsurance transaction, with the corresponding adjustment reflected in AOCI. Now let’s move on to segment results, starting with Group Protection. The Group reported operating income of $52 million, up from $26 million in the same quarter last year. This progress was broad-based, with improvements in both disability and life loss ratios compared to the prior year quarter. Although fourth quarter earnings typically dip due to seasonality, excluding the effects of the assumption review, results increased by $8 million sequentially as improved life mortality more than offset seasonal challenges. In the fourth quarter, the Group life loss ratio was 67%, down over 7 percentage points from the prior year quarter and about 10 percentage points sequentially. This enhancement stemmed from reduced severity compared to the elevated levels seen in the third quarter. For disability, the loss ratio was 83%, dropping by 260 basis points over the same period due to fewer long-term disability claims incurred. Sequentially, excluding the assumption review impacts, the disability loss ratio increased over 7 percentage points, reflecting higher claim severity and seasonal trends. Now, briefly reviewing full year results, excluding assumption reviews, Group reported full year operating income of $275 million and a margin of 5.5%, compared to $53 million and a margin of around 1% in 2022. The improvement stemmed from continued advancements in our margin expansion strategy, including diversifying our business across market segments and products, maintaining pricing discipline, and operational investments aiding claimants' return to work. Looking ahead to 2024, the group business will continue to contribute to growth in both our operating earnings and free cash flow. As I mentioned last quarter, we aim for a sustainable margin of 7%, and as we pursue this goal, we anticipate ongoing execution of our strategy to contribute another 50 to 100 basis points of margin expansion in 2024. Turning to Annuities, operating income was $279 million, which includes the one-time favorable impact of $14 million from model refinement, compared to $275 million in the prior year quarter. Excluding this one-time impact, the decrease was primarily due to increased expenses. Sequentially, excluding the assumption review impacts and the one-time item, results improved by about $5 million, mainly due to better spread income, though partially offset by lower average account balances. Nevertheless, ending account balances increased by 4% over the same period, which will positively impact first quarter results. For 2024, we expect the spread improvement seen in the fourth quarter to persist throughout the year, with the Annuities business continuing to be a significant driver of earnings and free cash flow. Now, shifting to Retirement Plan Services, the segment reported operating income of $38 million, down from $52 million in the previous year quarter. For the full year, earnings reached $171 million, compared to $211 million last year. The declines were chiefly due to higher expenses and outflows driven by participants in stable value funds as a result of rising interest rates throughout 2023. Average account balances for the quarter grew by 9% compared to the prior year quarter, and end-of-period account balances surpassed $100 billion for the first time, buoyed by strong performance in equity markets and a ninth consecutive year of positive net flows. Lastly, regarding Life Insurance, this segment reported an operating loss of $6 million compared to a loss of $9 million in the prior year quarter, with run rate impacts from both the Fortitude transaction and our annual assumption review offset by improved alternative investment income. The recorded impact from the Fortitude transaction this quarter was around $15 million, slightly below the anticipated quarterly run rate of $25 million due to the timing of the transaction's closure. Concurrently, we faced slightly elevated mortality severity during the quarter, which largely neutralized the favorable impact from the transaction's closing timing. Sequentially, excluding the assumption review impacts and one-time items, earnings declined by $29 million, primarily due to higher expenses and ongoing impacts from the Fortitude transaction. Overall, as previously mentioned, numerous headwinds exist for the life business, but we expect many of these to lessen in the upcoming years. In 2024, we project modestly positive earnings for the life business, driven partly by reduced expenses, improving spreads, and increased alternative investment income. We believe the actions taken in 2023 laid a strong foundation for delivering earnings growth in this segment over time, with continued progress expected in 2024. Moving on to investments, following the completion of the reinsurance transaction, total invested assets decreased by $28 billion. This portfolio adjustment aligns with our investment strategy of maintaining a high-quality, well-diversified portfolio, which remains 97% investment grade, with an average credit rating of A. Credit performance was solid during the quarter, with negligible credit-related losses. More information on our investment portfolio is available in the outlook presentations. Now, a brief update on our commercial mortgage loan portfolio: it remains conservatively positioned and has performed exceptionally well. In 2023, we experienced no significant loan modifications or losses, delinquencies, or forced extensions. Regarding our office portfolio, we have future maturities of $133 million and $178 million due in 2024 and 2025, respectively, which is less than 2% of our commercial mortgage loan portfolio. The short-term maturing office loans are performing well and are conservatively positioned, with an average debt-to-service coverage ratio of 3.5 times. Lastly, regarding alternative investment performance, alternative investments yielded an annualized return of 7% in this quarter and an 8% return for the entire year. Our alternatives portfolio benefits from a diversified investment approach, yielding strong risk-adjusted long-term returns. I will discuss our outlook shortly, but first, I want to highlight the information we've shared today. The outlook presentation available on our website focuses on three key areas. First, as Ellen mentioned, it provides more detail on our strategic priority for the company. Second, we’ve outlined several guideposts around key financial metrics for the company and our businesses. We acknowledge the importance of increasing disclosures and metrics and see today as a solid move in that direction, while recognizing that this is just a starting point as we continue to reposition our business. Third, in the appendix, we provide an outlook for adjusted operating earnings for 2024, necessary to ground the full-year ranges of outcomes for our businesses and the seasonal nature post-Fortitude transaction's impact on our financial statements. Given our time constraints today, we won’t cover every slide, but I will highlight the major points. In terms of our outlook, there are three key takeaways. First, we see significant opportunities to continue transforming Lincoln. Our foundation comprises large retail and workplace businesses with leading distribution and considerable balance sheet strength. However, we aim to leverage these competitive advantages to evolve our business toward more stable cash flows, substantial capital strength, and focusing on maximizing risk-adjusted returns. Achieving this goal requires us to first hold more capital than before; second, further optimize our operating model; and third, pursue profitable growth, which entails expanding our group business and enhancing our retail spread and spread-like products while reducing our sensitivity to equity markets. Our ability to execute will depend on strategic financial and operational initiatives, many of which we began last year. The outlook presentation illustrates examples of these initiatives and an indicative timeline, which can be seen on Page 8. This timeline is crucial to help you understand our journey and provides context for expected free cash flow growth in the coming years, rather than focusing solely on 2024, since many initiatives may entail one-time costs or timing uncertainties. For instance, last quarter, I discussed the expense challenges we are addressing and the ongoing opportunity to rightsizing our expense base. Earlier this week, we took steps to reduce organizational complexity, and through this headcount reduction, we aim to optimize our organizational structure and set Lincoln on a more efficient and agile course. While these actions will contribute positively to the company's run rate value, there will be a cost associated with this reduction that will affect us in the first half of the year. Moreover, as we continue diversifying our product strategy, we see opportunities to optimize our general account. Our multi-manager sourcing model provides the necessary flexibility, and we are exploring optimal ways to strategically achieve our goal of adding incremental risk-adjusted yields. This initiative is expected to start delivering value in the upcoming quarters, but it will require time to reposition the portfolio and fully capture the run rate value. Another strategic initiative under consideration to enhance our operating model is an increased use of affiliated reinsurance. We have effectively utilized LNBAR for years to manage our VA guarantees. However, we are exploring opportunities to establish additional domiciles, such as Bermuda, as a means to deliver profitable growth across a variety of other products. This remains an active focus, and we anticipate it will significantly benefit free cash flow over the next few years as we emphasize our capital framework. Ultimately, we expect these initiatives to yield substantial progress in the coming years and drive improvement in our free cash flow conversion. On Page 9, we project that by 2026, free cash flow conversion will improve from approximately 35% in 2023 to a range of 45% to 55%. Simultaneously, we anticipate continued operating income growth. The overall growth in both operating income and free cash flow conversion will be supported by enhancements across all our business segments. Page 10 details examples of drivers within each segment, highlighting a few main dynamics. First, we expect Annuities and Retirement Plan Services to grow in the low single digits, consistent with recent historical growth rates, as account balances rise and spread expansion continues. Notably, we are only factoring in 6% market appreciation in our estimates. More significantly, earnings growth will primarily stem from our less market-sensitive businesses, with the group business progressing toward its 7% margin, while retail life should see headwinds shift to tailwinds, with improving mortality and spreads, alongside more normalized alternative returns and a focus on expense rationalization. The second message is our commitment to sustain RBC above 420% moving forward. We ended the year with an estimated RBC of over 400%, a rise of more than 20 percentage points from the third quarter. Importantly, this does not account for the significant benefit expected from the closing of the Fortitude transaction in the first half of this year. A 420% RBC level is deemed sufficient to maintain a minimum of 400% RBC in a typical recession, and we are dedicated to further minimizing our capital volatility. The combination of increased free cash flow generation and rebuilding capital above targeted levels will afford us greater capital flexibility in the years to come. Lastly, the metrics for 2026 should not be interpreted as long-term targets. Over time, we expect free cash flow conversion to rise, driven by two main dynamics: the natural timing of reserve building for the legacy Life portfolio, which should become less of a drag, and the mix shift as we allocate capital to higher risk-adjusted businesses, leading overall free cash flow conversion to trend higher, with expectations to reach closer to 65% to 75% long-term. As Ellen noted, this is a multi-year journey, but the actions taken in 2023 to solidify the company's foundation, combined with our confidence in executing on today's outlined initiatives, should position Lincoln for sustainable growth in the years to come. I will now turn the call back over to Tina.

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

Thank you. We'll go first to Alex Scott at Goldman Sachs.

Hi, good morning. First one I had for you is on the free cash flow and I know you're not giving a 2024 specific guide, but I wanted to see if you can expand on the severance costs and how we should consider that in the context of 2024 cash flow, as well as helping us think through some of the year-over-year puts and takes?

Hey Alex, good morning. Sure. So, look, I think the you step back, right, the goal of the outlook is really to think about over the next couple of years, the growth in income and then what we see is ultimately two to three years from now what the free cash flow conversion will look like. And then longer term, what do we think the mix of business should support. So, what I would say about 2024, is that it will improve relative to 2023 and 2025 will improve relative to 2024. I think when you look at the slides we've put out as an example on Page 8, what you see is that there's a number of initiatives that are embedded in the way that we're thinking about the next couple of years. And so there's some uncertainty around timing, right? Affiliated reinsurance is a good example where it's something we're working on that could land in 2024, could land in 2025. The expense initiative that I mentioned in your question is another great example where the run rate impact from that will be a meaningful lift to free cash flow. But the one-time cost this year will be a negative to free cash flow in 2024. So, we think focusing on 2026 gets you to the point where you can understand the steady state. I think if you look at 2023, where we landed somewhere close to $400 million in terms of free cash flow, and we would expect that continue to improve. But there's just some uncertainty around timing for some of the initiatives and then for some of the other initiatives, there was just a degree of one-time cost that will be required.

And Alex, just to one additional point, just as it related to expenses in particular and your question about severance. So as we think about expenses going forward, it is really critical to us that once we get through the initial upfront costs here that ultimately G&A expenses will show a downward trend. The action that we took and the severance that we noted in our outlook is about a 5% reduction in our overall workforce. And as Chris commented in his script, this is really intended to remove the organizational complexity and just put us on a more efficient and agile path as we go forward.

Got it.

And to your specific question, it will be about a $40 million after-tax one-time item in the first quarter.

Okay. All right. And when you guys are defining free cash flow, is that before or after interest expense at the Holdco?

So, that is after interest expense at the Holdco.

Got it, okay. And if I could sneak one more in. I noticed affiliate reinsurance was mentioned, I think, five times in your outlook slides. So, it seems like that's something you're pretty focused on. Can you help us think through like what are the inefficiencies on the balance sheet today that you're looking at?

So, look, I think if you step back, we've utilized Barbados, as I mentioned, and as you know, effectively to manage some of our guarantees in the annuity block. I think that if you look across the industry, we're one of the few that haven't utilized other domiciles and so we mentioned Bermuda as an example. Ultimately, as we continue to move towards optimizing the capital framework and really thinking about economic capital, Bermuda makes a lot of sense and there’s a lot to like about the regulatory regime. There's a lot to like about the US, obviously, as well. But it's prudent to have multiple tools in the toolkit as we look out the next couple of years.

Thank you.

We'll move next to Tom Gallagher at Evercore ISI.

Hi, thank you. I have a question about the capital plan and a follow-up regarding free cash flow. Regarding the capital, I want to clarify a few details. I understand your point about the 420 RBC, which suggests an additional 10 or 20 points of RBC. How much debt reduction is included in your 2026 plan? When I see the deleveraging, I assume part of that is related to equity growth and debt reduction. So, what is the expected incremental debt reduction? Also, are you planning to change the holding company cash from the current $458 million? Are you looking to increase that, and if so, by how much? Sorry for the lengthy first question. I'll stop there.

That's correct. Those were great initial questions, Tom, and we're glad to address them. As you mentioned, we expect to finish the year with a capital ratio between 400% and 410%. We started the year at 377%, so our primary focus has been rebuilding capital to reach that 400% target, and we feel positive about it. Additionally, this projection does not include the capital we will obtain when the relevant deal closes, which should provide a helpful boost and bring us closer to the buffer we aim to maintain. As noted in our press release regarding that deal, we plan to use some proceeds for deleveraging and potentially repurchasing some debt. Regarding 2026, you are correct that some leverage will naturally decrease as equity increases. We are currently exploring options for opportunistically reducing debt. Given current market conditions, it is sensible to thoroughly assess our liability management. Overall, it is important to highlight that the preferred equity matures in a couple of years, representing a significant cost of capital. Taking everything into consideration, if you evaluate the projected free cash flow for 2026 along with our $300 million dividend, we believe there is considerable financial flexibility. Consequently, we anticipate being able to pursue various strategies depending on market conditions and debt trading dynamics.

Got you. Thanks. And then just on one question on Life Insurance free cash flow by the 2026 free cash flow guide by segment. I noticed Life still doesn't have any. I think the one concern that's still out there on your stock is that you had obviously a reserve strengthening for SGUL. And when I look at 2026 free cash flow, there's none coming from Life Insurance. Is that signaling that the reserves still need to be strengthened there since there's effectively no free cash flow? Or do you think you're out of the woods as it comes to balance sheet risk and Life Insurance reserves?

Thank you for the question, Tom. When considering free cash flow at the business segment level, it can be defined in various ways. Essentially, it reflects the capital generated by the business minus the investments being made for new initiatives. I want to assure you that we will continue to invest in the Life business over the next few years. Sales in that segment typically require significant capital in any given year. By 2026, we expect to be more at ease with the capital generated from that block. The Fortitude deal we completed last year made considerable progress in reducing risk for the GUL block. However, we continue to invest a substantial amount into new business capital within the Life segment. It's important to note, as Ellen has discussed, our shift towards a more capital-efficient product portfolio, which should also support new business capital. Overall, we feel increasingly optimistic following the deal, but it's essential to remember that when evaluating free cash flow, you must consider both the reserve build and the capital being generated, as well as any new business investments. Does that clarify things?

Yes, fair point. Thanks.

We'll go next to Ryan Krueger at KBW.

Hey thanks. Good morning. My first question was on the affiliated reinsurance. Is this something that you're thinking about primarily as using for new business to improve free cash flow and improve capital efficiency? Are you also of the view that that could also release capital from the in-force upfront?

So, Ryan, it's a good question. What I would say is we're looking at everything, right? I think to go back to the earlier point, we are one of the few that haven't worked to build out multiple tools in the toolkit. I think it would be fair to say that at the end of the day, if you're going to stand up an affiliated reinsurance subsidiary that you would see that initially with some liabilities. So, I would imagine that there would be an element of current in-force would go to start the reinsurance affiliate. And then more importantly, over time, it would absolutely be a tool in the toolkit and a thoughtful way of us deploying for new business.

Got it. Thanks. And then I don't think you talked too much yet about the optimization of legacy life liabilities that you listed, which I think policy buyouts could maybe be one option, but also probably require capital to do so. So, I was just hoping you could expand a little bit on what you're looking to do there and how we should think about the potential, I guess, cost of doing something like that?

We included this on the agenda to emphasize that this remains a major focus for us, as you would anticipate. When considering a legacy Life block, it involves a wide range of elements. For instance, the transaction we completed last year with Fortitude clearly helped improve the results for the block we ceded. On the other end, you might consider options related to affiliated reinsurance. Additionally, there are various other factors to consider such as hedging strategies and different asset allocations within that block. The key point is that we are evaluating all of these aspects as expected. We made significant progress last year and believe there is substantial potential for growth over the next two years.

Okay guys. Thank you.

We'll take our next question from Mike Ward at Citi.

Thanks guys. Good morning. I was just wondering, is there any kind of metric that we or you are tracking? It's probably early for this, but in terms of like a buyback resumption, should we think about that as maybe a 2026 target or longer-term target than that?

So, Mike, I think importantly, first of all, just to reiterate the fact that every action that we took last year and everything that we have, as we contemplate our path to go forward are all focused on the strategic objectives around strengthening the balance sheet, improving free cash flow, and profitable growth. And so importantly, that as we are growing our earnings, as we are improving our free cash flow over time that those things obviously are going to support increasing in terms of overall shareholder returns. So, we're not today going to provide any specific timing as it relates to buybacks. But it goes without saying that as we are improving and growing our free cash flow as we're growing our earnings, as we're shifting the overall earnings mix and everything that you've heard about today that will also just increase our overall financial flexibility.

Got it. Totally. It makes sense. Thanks. And then just on the wealth management sales. It seems like a pretty solid deal for you guys. Just kind of wondering if you could sort of elaborate kind of on what exactly you're giving up in that transaction?

Sure, Mike. So, if I take a step back, and there is one transaction that we closed last year, the Fortitude Re transaction, I want to spend a moment talking about that. So, as you all know, a complicated transaction, $28 billion of liabilities, 40% of our GUL. And as part of that transaction, we were able to really stick to our overall strategic objectives. So, we reduced our balance sheet risk, we improved our capital, and we also improved, and increased our ongoing free cash flow. So, in the announcement of the Wealth Management transaction and as we thought about that broadly, and we really looked at the overall opportunity for wealth management, and we evaluated the fact that, A, we did not believe that we had scale in that business, but it was a very good business. We made the decision to divest of it and recognize that in the comments of a net capital benefit of $700 million, we are improving our capital position, and we have also communicated that there are no material earnings or free cash flow impacts as well. So, again, really sticking as we think about these overall transactions importantly to maximizing relative to the strategic objectives that we've laid out for you.

Thanks. It seems like the proceeds for wealth management are very solid. Is it due to other competitors being on the same distribution platform for wealth? It really looks like a great deal. I'm curious about the factors involved.

The Wealth Management business is very appealing, particularly when it demonstrates profitable growth at scale. In evaluating our Wealth Management division, which is strong, we've realized that unlike our other businesses where we have significant scale and maturity, we need to do quite a bit to elevate this segment to the same level. To maximize its potential, it would be best for us and for the business to hand it over to an organization that focuses on this area every day and has the scale to drive the profitable growth we believe is possible.

Okay. Thanks.

We'll go next to Wilma Burdis at Raymond James.

Good morning. Can you provide some insights into the earnings outlook for the Life segment? We were anticipating a loss in that segment, but the 2024 guidance exceeded our expectations. Has anything changed, or is this simply the result of the recent deal?

So, Wilma, if you step back, the Life business for Lincoln, you earned about $600 million a year if you go back a couple of years. And over the course of the year in 2023, we tried to lay out the drivers of the degradation over time and how we went from $600 million to basically flat for 2023. And embedded in that were a number of things that we've highlighted that actually turned from headwinds to tailwinds over the next couple of years. So, if you step back, right, part of the lost earnings power for the Life business was obviously tied to the assumption reset in 2022. Part of it was due to significant prepay income that we used to earn when interest rates were lower, and part of it was reinsurance-related. And so there's a number of those dynamics that we're not when you look out the next couple of years, obviously, don’t recover prepay income, maybe a question mark depending on what happens with rates. But generally speaking, these are not what we would expect. However, there's a number of dynamics that ultimately do reverse. And so one example that we've highlighted just at a high level is our alternatives income. We had a great year for ops from a relative perspective and relative to markets. But at the end of the day, it was still below our long-term target. When we look out to 2024, we see that recovering. We also see the opportunity to be more efficient as it relates to expenses. I think the Life business is one of the examples when you think about some of the longer term expense ratio dynamics that we've highlighted that we see opportunity there. And then the last thing I would say is we've spent some time over the past couple of quarters, making this point. We really haven't seen spread expansion in the Life business despite higher rates from the past couple of years. And the point that we've made is that we had a duration extension program in place, which as short rates went up became a headwind. And so as that program has run down, you would now expect to see spread expansion move through that portfolio. And obviously, it's a big portfolio even after the transaction with Fortitude. So you put all that together on Page 10 of the outlook, we have a relatively high earnings CAGR expected over the next three years, but it's obviously off of a very low base. So, if you think about what the math is implied when you look at the starting point and then the growth numbers, it gets you back to a number that is not where we used to be, but certainly accounts for a number of the headwinds turning to tailwinds over the next two or three years.

Thank you. Second question on Group. 13% to 16% annual CAGR is a pretty strong target. I know that this is a business that you guys have been trying to improve for a while now, from even before you had some issues in Life. So, can you just talk about that and the confidence in that outlook there? Thank you.

Sure, Wilma. And really, this ties into the conversation we've been having all year around the change in strategy, the investments that we're making in the business, and the recovery in the margins. So, if you go back a couple of years, really even a year or two, I mean, this was a business that for Lincoln generated a 1% margin, right? And so we're going to end the year over 5%. So significant work being done over the past five, six quarters to begin to turn the business around, that's a 400 basis point increase in margins year-over-year. And our peers are north of 10%. So part of that is mix. Part of that is operational improvement. We have a lot of work to do to get back to a margin level that would be on par with some of our peers, but the improvement is already there. You're seeing it year-over-year. And there's a lot of investment that's gone into the business. There's been significant action from a strategy perspective. And so if you step back, the growth rates for Group over the next two or three years basically get you to the target level that we've been saying that we're targeting and have already shown substantial progress. So, I feel pretty good about the growth rates there. There are certainly more wood to chop, so we're not done. But the investment that's being made in the business and the success we've seen so far gives us some confidence there.

I'll add a bit more regarding our strategy and the reasons for our confidence. We are observing improvements in margin expansion and strong topline growth. Year-over-year premiums increased by 5%. As we move forward, we have tailored our profitable growth strategy into three distinct segments: small business, regional, and national. We are confident because sales grew in all business segments last year, especially in the small market and supplemental health. Small market sales rose by 15%, and in our regional and national segments, we’ve been focusing on driving sales through existing customers, which accounted for 42% of our sales. Our supplemental health strategy has also seen significant progress, with sales increasing by over 100% in 2023. As Chris mentioned, we are continuing to invest in creating a differentiated customer experience and tailoring our overall strategy across different employer levels.

Thank you.

We'll take our next question from Joel Hurwitz at Dowling Partners.

Hey good morning. So, you guys mentioned that the 2023 free capital generation was close to $400 million. So, it looks like the pace accelerated in the fourth quarter. Can you just talk about what drove the stronger Q4 capital generation?

Sure, Joe. I would say it was tracking relatively close to what we've been seeing all year, maybe a little bit of an improvement as you had some tailwinds in the fourth quarter, markets were a little bit higher. And so I don't think there was anything game-changing as it relates to Q4 relative to the first two or three quarters. We did have a couple of credit losses in the first quarter, which would have dragged it down if you're looking at it quarter-over-quarter. But generally speaking, I don't think there was anything materially different in fourth quarter other than what you had seen sort of your normal operating income, so the market is a little bit higher and so forth.

Was there any dividend taken from LNBAR again in the fourth quarter?

There was not. We don't take dividends from LNBAR every quarter, and we took one in the third quarter. That being said, we obviously now have a year of the new VA hedge program, and we feel really good about where we landed at the end of the year.

Okay. And then just maybe expectations for LNBAR dividends in 2024 now that you're more comfortable with the hedge program?

Yes. So, what I would say is that we are increasingly comfortable, but it's only been a year. And so we felt good at the third quarter of 2023, and we're able to take a dividend out. But if you think about overall in 2023, there was some volatility in markets, but it was relatively supportive overall. Rates were probably the bigger driver overall of reserves and the hedge program. But generally speaking, it was a very supportive backdrop. So, I don't want to get in front of how we're thinking about LNBAR for 2024 and 2025. But I would say it should continue to improve, assuming that markets are supportive, and we just want to watch and see it's only been a year with the new hedge program, and so we're just trying to be prudent.

We'll move next to John Barnidge at Piper Sandler.

Great. Thank you very much. Appreciate the opportunity. Lots of weighting of Group protection distribution to fourth quarter and good sales growth there. Can you maybe talk about the opportunities set for the products and product development pipeline for that business? Thank you.

Sure. So, in the Group Protection business, and again, we are a $5-plus billion premium protection business. And we really have historically been in the group life and in the group disability areas. And as we are looking to overall grow, and I mentioned earlier the business segment specific strategy, we are also looking further increase our overall voluntary business. And you actually can see that year-over-year that our employee contributions continue to increase year-over-year from 2022 to 2023. And additionally, the supplemental health overall benefits as well. And we've got three different products there that are very important to our customers and ultimately to their employees. And as I mentioned earlier, we saw a doubling there of the overall sales year-over-year, and we expect that to continue. The other thing that I will add is that I referenced earlier the small market segment. And what's important and different about the small market segment is that there were really tailoring holistic offerings there. Smaller employers, as you can imagine, are looking for one-stop shop with overall bundled offerings. So, part of what we're uniquely able to offer there is yes, differentiated customer service and all the technology and the infrastructure that they need, but also bundling the various different products together. And we believe that that's part of our value proposition as well.

Thank you very much. And a follow-up question. With the call out of use of Affiliate reinsurance in a number of times, how should we think also about third-party opportunities within that?

Yes, John, I think what I would say is, as you would expect, we're looking at all options. Obviously, the Affiliated reinsurance is distinct from, I think, the opportunity that you're describing. But rest assured, when we think about the next two or three years, we would have all the different strategic opportunities on the table.

And that concludes the question-and-answer session. For those left in the queue, we will follow up with you later this afternoon. I would like to turn the conference over to Tina Madon for closing remarks.

Thanks Sandra and thanks again to everyone on the call for joining us this morning. We're happy to take any follow-up questions you have. Please e-mail us at investorrelations@lfg.com. Thank you.

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