Good morning and thank you for joining Lincoln Financial Group's Fourth Quarter 2016 Earnings Conference Call. [Operator Instructions]. Now I would like to turn the conference over to the Senior Vice President of Investor Relations, Chris Giovanni. Please go ahead, sir.

Thank you, Kailey. 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, trends and market conditions including comments about sales and deposits, expenses, income from operations, share repurchases and liquidity and capital resources are forward-looking statements under the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from current expectations. These risks and uncertainties are described in the cautionary statement disclosures in our earnings release issued yesterday and our reports on Forms 8-K and 10-K filed with the SEC. We appreciate your participation today and invite you to visit Lincoln's website, www.lincolnfinancial.com, where you can find our press release and statistical supplement which include a full reconciliation of the non-GAAP measures used in the call, including income from operations and return on equity, to their most comparable GAAP measures. Presenting on today's call are Dennis Glass, President and Chief Executive Officer; 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 things over to Dennis.

Thank you, Chris. Good morning, everyone. Fourth quarter results were strong, with operating earnings per share up 15% compared to last year. This capped a solid year which included record EPS, a 9% increase in book value per share and a 12% ROE. Notably, we have a multi-year track record of similarly strong financial results; and, more importantly, we continue to believe these results are sustainable over time. Our financial success and stability are the result of our clear and straightforward business model. As you know, we lead with distribution and product breadth. Nearly 90,000 independent brokers, agents and financial advisors have sold a Lincoln product in the past two years and we consistently focus on expanding our distribution reach. Our 1,300 highly sophisticated wholesalers and reps provide our independent producers with customer solutions and product education. We match this distribution with one of the broadest product portfolios in the industry and are at the forefront of product innovation. This strategy works throughout cycles and was successful once again in 2016. This year, individual life insurance sales increased 7%; group protection sales were up 17%; and RPS deposits reached a record $7.7 billion. 2016 was a challenging year for sales growth in the annuity business which reflects somewhat of an adjusting market. But I am confident in our distribution and the product initiatives we're putting into place to respond. We expect these actions will rebuild sales momentum and enable us to return to full-year positive net flows in 2018. In response to our lower annuity sales, we increased our share repurchases as we said we would; executing on another one of our core strategies which is to actively direct capital to the highest and best use. When combined with our solid capital generation, we returned $1.1 billion to shareholders this…

Thank you, Dennis. Last night we reported income from operations of $409 million or $1.77 per share for the fourth quarter, a 15% increase from the prior year. I would note a few items that drove some variability within the segments this quarter. On the positive side were $8 million of benefit on the tax line and other operations and $13 million of favorable variable investment income spread across the businesses. These two items were completely offset by some expense items, including an increase in deferred comp-related expenses associated with the $19 increase in our share price during the quarter and higher variable expenses from strong sales growth in most of our businesses. Additionally, we had favorable mortality which I will speak to later. Now let me touch on the performance of key financial metrics. For the full year, reported operating EPS of $6.50 was a record and up 19%. Our EPS, excluding notable items, was also a record, up 7%. Book value per share, excluding AOCI, grew 9% to $57.05. Operating return on equity was strong at 12.7% in the quarter and 12% for the full year. Positive consolidated net flows have contributed to account values that continue to grow from depressed levels earlier in the year, providing a nice earnings tailwind. Our balance sheet remains an important source of strength, supported by solid liquidity metrics and strong capital generation. This enabled us to return $261 million of capital to shareholders in the quarter and $1.1 billion for the full year. Further highlighting the strength of our balance sheet, our year-end cash flow testing continues to point to significant statutory reserve adequacy and we do not anticipate any reserve deficiencies. And we completed our goodwill review which did not have any impairment. Net income results for the quarter were…

Thank you, Dennis and Randy. We will now begin the question-and-answer portion of the call. As a reminder, please limit yourself to one question and just one follow up; then re-queue for additional questions. And now I will turn things over to the operator.

[Operator Instructions]. Our first question comes from the line of Suneet Kamath with Citi. Your line is open.

I just wanted to start with the variable annuity flow picture. Can you talk about the timing of the rollout or the pace of rollout for that new product, the BlackRock ETF-based product? And do you see this in any way cannibalizing some percentage of your existing VA production?

No. The core income, the BlackRock product I think -- not I think, but I've said -- is a new product category. It's been approved in a lot of states. We're signing up with broker-dealers. There is technology involved in executing with the broker-dealers. And so I think we expect this to grow over time. The more significant sales results will probably be later part of this year and into the next year.

And then your comment on the positive flows in 2018. My assumption is that means you might still be negative this year. Does that assume no change to Department of Labor as it currently stands?

Correct.

Okay. And then the last one for Randy, just as we think about that new BlackRock product, is there any material change in the capital strain guidance that you've given us for VA? I think it's been like $0.05 for every $1 of VA capital strain on the old product. What is that for the new product?

I don't think of it as materially changing the guidance we've given. As I've talked about in the past, the profile for a product that is more of a fee-based product as opposed to a commission-based product is that you have less investment up front which drives two things. That drives typically a little lower ROA, but a little higher ROE. This product is going to be a percentage of our overall sales. And so I don't see it making a significant change in either of those two return metrics which I'd remind -- our ROA is in the high 70s and an ROE which has been running in excess of 20%.

Our next question comes from the line of Nigel Dally with Morgan Stanley. Your line is open.

With capital management being 10 points above the longer term average of 50% to 55% in 2017, what's driving that? Is that a reflection of the somewhat weaker annuity sales that we've been seeing this year? Or are there some reserve refinancings on the horizon? Just wanted to get some additional color there.

Nigel, I'll talk about it in comparison to what we did this year. So this year we ended up at 72% of operating earnings which is roughly 20 points above the midpoint of our long term range. 20 points translates into about $300 million of additional share repurchases. If you broke that down, I would say about $200 million of that came from the reinsurance transaction we did earlier in the year which generated a significant amount of capital; and about $100 million of it came from the fact that variable annuity sales were below where they had been in the past. As you look forward and as Dennis talked about, I would continue to expect the VA sales to be below our long term expectations. So I think that will drive some of the continued increase that I talked about. And then just the strength of our balance sheet will drive the other piece.

Then just a follow-up on the passive variable annuities. I know it's early on in the rollout process, but just would be interested as to the kind of reception that you got from the first distributors that you've introduced it to.

It's probably one of the most exciting product concepts that we've ever delivered into the marketplace. So, distribution partners, advisors are quite excited about it. But, Nigel, I'd like to repeat that it's technology-based; and so the rollout is going to be effective and efficient. But just like any new product, it's going to take time to build sales.

Our next question comes from the line of Thomas Gallagher with Evercore. Your line is open.

Good morning. Just wanted to discuss what's going on behind the scenes with what's been driving the variable annuity sales weakness. Is it -- do you think it's that you've seen a big shift, move away from frontload commission type products broadly? And that's predominantly how VAs have been sold and the move to level fee commissions is kind of a tricky transition because that's not historically a lot of the way those products have been sold. Can you talk a bit about is that really what's driving it? And do you think that despite what happens with DOL, that you think a lot of distributors have moved in that direction and they are going to stay there, so we're going to see a depressing impact for a while here?

Yes, that's a multi-faceted question. Let me talk about a couple of responses to the general trends that we have. And let me talk first about our core value proposition that has led to what we all know as the strongest in-force block of business from a quality, risk and earnings perspective in the industry. And that quality was built off of a base that value proposition to the consumer of upside potential and lower initial guarantees. So, that value proposition remains in the marketplace. It's been hurt a little bit by lower returns inside the sub-accounts, some of that related to risk managed funds. So our response to that -- and we're able to be responsive inside of that category because interest rates have moved up a little bit, giving us a little bit more flexibility. So what we're doing in that product category is providing more investment flexibility. So, for example, in the past we may have had a requirement of 70% equity, 30% debt and we're modifying that a little bit. Again because of the interest rate environment we're able to, a little bit, up the initial payout rates or the initial income payout rates. So we've got that block of business. And again, it's been affected a little bit by fund performance, but we're responding to that. Then there is a second value proposition which is even more investment flexibility but with a lower initial income payout. And that's very exciting, again taking our initial equity debt relationship with 70/30 -- or, excuse me, 60/40 to 70/30. So there is an ability to get more equity into the account, giving more upside potential; and also, the removal of the risk managed funds in that particular product category. So, lower income initially with more investment restrictions; just…

Then just a follow-up. Do you have broad level statistics in terms of what percent of your VA sales are frontload commission? I know there's different structures; but just broadly, frontload versus level fee. My understanding, from an industry standpoint, the vast preponderance of sales have been frontload. Just curious if that's the case for you. And do you think that will be an evolution for the industry, to make a big move in that direction? And do you see there being kind of a longer transition period if it does move in that direction?

To your point, the entire industry has been built on commissions and active fund management in the subaccounts. And so that's going to move -- those two pieces are going to move a little bit. Instead of just commissions, you are going to have fee-based products; and as I mentioned, more passive opportunities for investments inside. And let me differentiate that for a second. When I talk about commission and active, that's a set of financial advisors that exist and are selling annuities. And some of the refreshment activities we've had in our product set address that particular advisor cohort, such as reducing the fees within -- on the fee-based part of it, reducing the fees; paying for that with lower payments out to the broker-dealers. That will move, I think, gradually over time, as between the amount of people that use commissions and the amount of people that prefer fees. And that's going to be, in part, based on what their customers' preference is. So that's going to move forward. The second issue is a little different. And that is the RIA market which is pretty significant market in the United States where the annuities haven't been a big piece of what they've provided. There is one firm that has been reasonably successful. I think that's the area for additional cohort of financial advisors, expanding the distribution opportunity beyond what exists today.

Our next question comes from the line of Erik Bass with Autonomous Research. Your line is open.

Can you talk about how much margins on new business have improved in both life and annuities, as a result of higher interest rates and lower hedge costs?

Eric, let me sort of break it up by the products. I think the products most impacted would be in the annuity and the life business. In the annuity businesses, as Dennis has talked about, the increase in interest rates has allowed us to make some changes on the products which we believe will make them more attractive to consumers. So I don't think that the increase in interest rates has had a huge impact on the returns that we expect on those products. I think maybe on fixed annuities, you get a little bit of a boost. Because if you get a little higher return on your surplus, they get a little better metric there. But I wouldn't say it's a material impact. On the life side, we have been running strong returns, 12% to 15%, for some time now. And I don't expect that to change materially. I think the market will respond to rates with either benefit changes or premium decreases. So I wouldn't expect a material change in the returns we're getting on the life business which have been strong for a number of years now.

I would add a little bit -- not change -- but just add to what Randy said. And that is, day in and day out, we try to get our required returns in capital on products. There's a lot of input to pricing, interest rates being one of them as interest rates change. In terms of pricing, that gives us more flexibility. But we're driven by our return on capital requirements, no matter what the environment is.

And I guess just then thinking about the interest rate benefit, is it really that you get a recovery in spreads back to normal levels, so you would lose that I guess now 2% drag on earnings that way? But in terms of the returns, it sounds like a lot of the benefit of higher rates stops dropping to the bottom line, once kind of you've recovered that spread. Is that the right way of thinking about it?

Eric, it's a big deal that spread compression goes away. I'd remind you if you just took one of our businesses, the life business, it's a sum total over the last four or five years of nearly $100 million of impact from spread compressions from its in-force. So you take that away and that's a big deal both for that business and the company in total. So the biggest financial impact and the impact you are going to see immediately, is because that spread compression number goes down. As you mentioned, we were at between 2% to 3%. We're now down at about 2%. So you've got a little bit less spread compression and that's a benefit across the Company -- and from that standpoint. On new business -- and Dennis mentioned this in his comments - it allows products to become -- to get adjusted in a way that makes them more attractive to consumers. You are able to offer more benefit or lower premiums which makes these products not only more attractive to consumers, but more competitive with other options they may have. So I think that's a big deal from a new business standpoint, if you can see those new sales levels move up. Factually, new business has never had a huge impact on the earnings we expect in the next year or two. That's more about the growth of the business. So anything, I think, that drives sales higher is -- it's a positive for the long term outlook for the organization.

Okay. So at a minimum, you get 2% kind of improvement back to your normalized growth rate. And then additional sales volumes would be a long term plus to that, as well.

Absolutely. As Dennis mentioned, we're invested at about 4.1% right now. So, that's about 70 basis points below our portfolio. So that would be the number that would eliminate that; but at the level we're at right now, we're at about a 2% headwind.

Our next question comes from the line of John Nadel with Credit Suisse. Your line is open.

The first question is, for 2016, any reason to believe that the dividend received, the DRD benefit in your tax rate was significantly different from the roughly $190 million benefit it provided in 2015?

No. It was actually almost perfectly level at about $180 million, actually. So it did not change materially, John. And, John, it's good to know that you guys are working hard on a Thursday here in February.

Yes, definitely working hard, Randy; maybe not as hard as you guys are. So then, the question is -- the next question, just thinking about the drop in annuities sales; and I know you guys have done a great job of sort of redeploying the capital not used to fund annuities sales into primarily buybacks. Am I doing the math right? If I think about annuities sales in 2016 were down $4.4 billion, $4.5 billion year-over-year. Using the roughly 5% capital requirement or strain, I would've thought we would see something more along the lines of $200 million to $250 million of incremental capital deployment. It sounds, from your earlier comments, like about $100 million of your buybacks in 2016 was related to redeployment of capital, not used to fund sales.

John, I think one of the things in your math which is largely correct as math goes, is when we gave that guidance, I think the run rate of sales was a little lower. So the amount of sales drop isn't -- that went into that math -- isn't quite at that $4.5 billion level. So that would be one aspect. You also saw a shift in some products to fixed annuity sales, a little bit which are a little more capital-intensive than variable annuities. So that was a little bit of a drag on the math. But roughly speaking, what we said came true, in that we were able to overcome the drag on earnings caused by the lower annuities sales through share repurchases in 2016. Now I would note when you look forward, that math changes a little bit because of the increase in share price. We can't buy quite back the same number of shares per $1 that we use. So there is a little bit of drag just using that math. But in 2016, factually, we were able to overcome the drag from lower sales through share repurchases.

High-quality problem; I don't think your shareholders will give you a hard time over that. Thank you.

Our next question comes from the line of Jimmy Bhullar with JPMorgan. Your line is open.

I had a couple of questions. The first one is just on the individual life business. You spoke about the seasonality in the business. But obviously earnings have moved even more so than the seasonality might imply. So do you view the 2016 earnings number for the business as more of a normal annual level going forward? Or did results benefit from variable investment income or other items that might not repeat to the same extent?

Yes, Jimmy, I think of the year as almost perfectly in line with what I've said in the past which is that this business is about $125 million a year business or $500 million for a full year --

$125 million a quarter. Yes, yes.

Yes, excuse me. And if you think about the year, we made $550 million and that included $17 million positive unlocking. So right at that $125 million guidance. In terms of the quarter, the $154 million, we had strong variable investment income. That was largely offset, as I mentioned, by expenses. So at the end of the day, what you just had was mortality, really good mortality driving the $154 million of earnings; which, just coincidentally, was almost an exact mirror of the first quarter of the year. As I said in the first quarter of the year, about $20 million of expected seasonality. We had about $10 million of additional; total of $30 million this quarter. About $29 million of benefit overall, compared to an average quarter, from good, strong mortality which we expect to happen in that quarter of the year.

Okay. And then on the variable investment income being strong, can you just give a little bit of color on what the drivers were and also discuss where you are on your plan to reduce your hedge fund exposure?

It was strong across all areas. So the PE and hedge funds, I think as Dennis might have mentioned in his script, the return was about 12% for the quarter. And we expect 10%, long term. So we had good, strong performance from the alts portfolio. And then, prepayment income was above what we've experienced over the last 4 to 5 years and was over what I would expect over a much longer cycle. In total, it came up to about $13 million after tax, as I mentioned in my script. I would say that was fairly evenly split, maybe a little skewed towards prepayment income. If you broaden this out and you think about alternatives and prepayment income over a longer cycle and you look at the last couple of years, what you've seen is that alternatives in both of those years were a little below our long term expectations. So for the full year, we were about $40 million lower than we would expect on the alternative side, whereas prepayment income was a little stronger. When you add them together, I don't think we're materially different from what a longer term expectation might be for the sum of those two items.

Our next question comes from the line of Yaron Kinar with Deutsche Bank. Your line is open.

I had a question regarding capital deployment. You mentioned buybacks as probably being still quite elevated or strong in 2017. One part that I was surprised I didn't hear you talk about was the potential for M&A. I think in the past, you talked about being interested in morbidity business. I think interest rates are higher. The group business has turned around. You may see less of a regulatory risk here. Is that still something that you are considering or maybe looking at more carefully today?

M&A is always a tool. And over the last 22, 20 years or so, we've used it pretty effectively to really achieve what would otherwise would be our plan anyway. And so whenever we do M&A, it's because we're trying to accelerate a strategy; not to do it for the sake of doing it. You are correct; we have said that we have a longer term strategy of increasing the percentage of our income that comes from mortality and morbidity; and that sort of in terms of our businesses, we would probably think the group business as the top priority. So, that's the strategy. Deals coming into market come episodically. We'll continue to look at things. We've looked at some properties in the last 24 months and back to our allocating capital to the best use, it was way more expensive. Properties sold for way more than what we think would make sense for our use of capital. But it made a lot of good sense for the people who bought it. I don't know what their strategies were. So, prices would probably have to come down a little bit before we got real interested in a deal. But we'll keep looking. We're good at assessing M&A. We're good at integrating M&A. And if something comes along that fits with our long term strategy, all of which points we have articulated, we would take a look. I will say that we wouldn't do anything that would materially affect our share buyback program over time.

Okay. And then switching gears a little bit to the digitalization initiative. Just want to get a little more understanding of the numbers. So as -- I'm assuming that 2019 that -- the breakeven year, you expect to see some cost saves flowing in and then those really ramping up in beyond that. So, can you give us a little bit of color as to where you see those cost saves coming in? Which segments would be more impacted? I'm assuming that the expenses -- that the related expenses will remain in the corporate segment or corporate and other. But where could we see the benefits?

Maybe let's back up a little bit as I answer that question. We have, over the past four months, have had an internal team at Lincoln; the core team, eight or 10 people. We have had another 25 or 30 people from our outside consultant and then we've involved overall probably another 100 people from Lincoln. And what we've spent our time doing is really trying to understand where the best opportunities are to both improve the customer experience -- I don't want to lose that concept -- improve the customer experience; and then as we're doing that, make sure that we find ways to finance that investment. And so the numbers that we're talking about are not just pulled out of the pocket. But they are the consequences of four months of pretty hard work and detail and math. Now, having said that, as we move into the execution and repeating what Randy said, we're going to have to pay attention to short term earnings as well as long term opportunity. And the execution phase is very important. And I think it would be pretty premature to try to identify exactly what line of business is going to get the most benefit.

Thank you. Ladies and gentlemen, this does conclude the question-and-answer session. We will be able to follow up with those in the queue later this afternoon. I would now like to turn the call back over to Mr. Chris Giovanni.

Thank you all for joining us this morning. As always, we will take your questions at our investor relations line. And we'll follow up with those that were remaining in the queue. You can reach us at 800-237-2920 or via email at investorrelations@lfg.com. Thank you again for your participation and have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a wonderful day.