Good morning and thank you for joining Lincoln Financial Group’s First Quarter 2020 Earnings Conference Call. [Operator Instructions] Now I’d like to turn the conference over to the Corporate Treasurer, Chris Giovanni. Please go ahead, sir.

Thank you, operator. Good morning, and welcome to Lincoln Financial’s first 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, 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-Q filed with the SEC. These forward-looking statements are only made as of today, and we undertake no obligation to update or revise any of them to reflect events or circumstances that occur after this date. We appreciate your participation today and invite you to visit Lincoln’s website, www.lincolnfinancial.com, where you can find our press release and statistical supplement, which include a full reconciliation to the non-GAAP measures used in the call, including adjusted return on equity and adjusted income from operations or adjusted operating income to their most comparable GAAP measures. A slide presentation, which provides additional information on our investment portfolio, is also included on our website. Presenting on today’s call are Dennis Glass, President and Chief Executive Officer; and Randy Freitag, Chief Financial Officer and Head of Individual Life. After their prepared remarks, we will move to the question-and-answer portion of the call. I would now like to turn the call over to Dennis.

Thank you, Chris. Good morning. The health crisis has been difficult on everyone. We hope you are staying safe, and our thoughts are with you. I also want to recognize our Lincoln employees for their extraordinary efforts and unwavering commitment over the past few months. Lincoln has been navigating the current crisis by focusing on 3 priorities. First and foremost, doing what we can to help protect the health and safety of our employees. Second is operating the business in the best interest of our customers, partners, policyholders and shareholders. And third is doing our part to help America overcome the challenges of COVID-19. Early on, Lincoln began monitoring the emerging pandemic and started taking actions to reduce this health threat, including restricting travel, eliminating noncritical face-to-face meetings and setting social distancing guidelines. In March, we moved to a work-from-home model for 99% of our employees to help limit the spread of the virus within the Lincoln family and our communities. Because of our business continuity planning and significant digital investments, which we have discussed with you, the connectivity and productivity of our employees working from home has been excellent. We have maintained our commitments to our customers and partners during this difficult time with service at the same high standards we have always delivered. Finally, we remain committed to honoring our namesake through our actions as a responsible company. Our foundation has made significant financial commitments to help distribute food throughout the communities where we operate and as a founding sponsor of People + Work Connect we are bringing companies together to help get people back to work faster. This morning, we are going to handle our prepared remarks a little differently. I will briefly touch on the first quarter results before detailing the current environment and the potential…

Thank you, Dennis. Last night, we reported first quarter adjusted operating income of $465 million or $2.24 per share, a strong start to the year and up 5% over the prior year period. There were no notable items within the current or prior year quarter. However, there were a few items driving some variability, both up and down, and I will detail them in the business segments. Touching on the performance of key financial metrics compared to the prior year. Adjusted operating ROE increased 90 basis points to 13.5%. Book value per share, excluding AOCI, increased 2% to $70.24, with the current quarter negatively impacted by $1.40 per share related to the new accounting standard for expected credit losses or CECL. On an after-tax basis, our CECL reserve increased $51 million and stands at $270 million. Adjusted operating revenue increased 3% to $4.5 billion, and expense management was excellent as G&A net of amounts capitalized decreased nearly 3% after adjusting for a $30 million non-economic decline associated with accounting for Lincoln Equity and employees’ and directors’ deferred comp accounts. Net income per share for the quarter was $0.15, with the primary driver being unprecedented volatility in the capital markets, which resulted in a $349 million loss from variable annuity net derivative results with approximately 1/3 driven by fund basis risk, which we expect to reverse over time. Overall, the hedging program was highly effective, covering well over 95% of the changes in the hedge target during what was the most volatile quarter we have ever seen. Let me provide a couple of measures to size the volatility. First, the hedge target increased $5.2 billion. However, the total distance traveled was $20 billion, more than 2x any preceding quarter. Next, the amount of trading that occurred during a volatile 4-week period…

Thank you, Dennis and Randy. We will now begin the question-and-answer portion of the call. [Operator Instructions] With that, let me turn the call back to the operator.

[Operator Instructions] Our first question comes from Ryan Krueger with KBW. Your line is open

Hey, thanks. Good morning. I guess starting with the SGUL potential stat reserve impact, that’s a pretty sizable difference the $100 million to $200 million from $750 million. I guess can you go into some more granular detail on why that improved so much at this point?

Ryan, yes, thanks for the question. It’s Randy. We came out with that guidance a number of years ago. And at the time, we talked about the fact that it was going to peak and then it would go down over time. That peak when we first came out with this guidance was about 2018. So the actual number has been coming down for a little bit. I’ll take the hit for not getting this updated guidance out there a little earlier. But also when you factor in that 2020 is pretty much locked in because of what the index that really drives this thing has done over the past 9, 10 months, you’re really now 3 full years of the end of 2020, when we pass the peak on this. And as I mentioned in my script, you also have the natural unwinding of some of the conservatism that’s embedded in statutory reserves. And it’s really those 2 big items, what’s really drive this big decrease in the – in our expectation for what we see it in a very low rate environment. I hope that helps.

Got it. And then when you run the stress test scenarios that you provided, can you give us, I guess, a sense of what type of RBC ratio you think you would maintain in that scenario? And I guess what RBC are you protecting to in an actual tail event?

So I guess you’re asking what is our downside when we run our full stress test, Ryan?

That’s right. And what do you need to kind of maintain for capital targets in that downside?

We mentioned, both Dennis and I mentioned, our stress testing has 3 goals, 1 of which is to preserve our financial strength, ratings and our business franchise, the 2 of which are maintain the dividend and not have to issue equity. But we gear that whole stress test and run it. I ran it through the different stresses that we use. It has – one of its main goals is maintaining our ratings. So with the stresses we run, offset by the actions that we talked about, we believe that the capital we started and where we started today, as I mentioned, is 446%, that the number we will ultimately go down to is consistent with the AA ratings we operate at today. Historically, that number has been in the range of 350%, 325% to 350%.

Got it. Thank you.

You bet.

Thank you. And our next question comes from Jimmy Bhullar with JPMorgan. Your line is open.

Hi, good morning. So first, just a question on the hedge loss that you had can you discuss what sort of drove that and whether you are sort of making any changes to the hedge program as a result of that, just a little bit more detail on the drivers of the loss?

Sure, Jimmy. This is Randy. First, no changes, it’s a great program. No need to make any changes. First, let me make a comparative comment. So I think, Jimmy, that we’re the only company whose hedging target equals a number that we – that appears in our balance sheet. And I think that’s really a best-in-class approach. It’s an economic view of the risk that we are both hedging to, and that appears as the liability in our financial statement. That liability itself, that hedge target was $5.5 billion at the end of the quarter, and that compares to a net amount at risk on our living benefits of $2.5 billion and net amount at risk on our death benefits of about $4 billion. So with that as a predicate, some comments on VA net derivative results or what I’m going to call breakage in general. First, it’s a real number. It’s a real number that represents the amount at our derivative assets, increased relative to the $5.2 billion increase which you saw in our liability. But there are a few other things that we know about breakage. One, it’s lumpy and it will run at very low levels for extended periods of time and that’s what we see in – for a number of years now. And over an extended period of time, it’s going to average out to a relatively small number. And this is the fourth one. It’s also a number that we price for. So we have breakage. There’s a couple of things that we analyze very closely with the team versus capital because breakage ultimately comes out of capital, comes out of capital and labor. And this thing is a really good example of one of a very positive financial and risk changes that we…

Sure. And then just another one on your share buybacks, what are the things that you’re going to be looking at to sort of decide when to get back into the market?

I think, Jimmy, ultimately, it’s a decision about whether or not you’re in a stress scenario. So we’re going to operate in the second quarter, like we’re in a stress scenario, and we’ve got a playbook for that situation. We’ll get to the next quarter, and we’ll look at the environment. Well, ultimately, we’ll make the determination. Are we still in a stress scenario? Is that how we should be operating? I guess, that’s how I think about it, Jimmy.

Thank you.

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

Randy, just a follow-up on the commentary about LNBar and about the way you’re managing capital. Should I think about where you’re at now or at least at the end of March, would that – would you be holding to CTE-98 now or is it 4% that’s the greater of at this point? And when you think about that business and you think about what might be required if you had another sort of repeat of 1Q performance, what are your – how much of a buffer, I guess, do you have when you think about managing capital there? Do you – it doesn’t sound like there’s any risk of near-term additions to that entity. But can you talk a little bit about how it’s capitalized now and then thinking about further stresses and positioning?

Thanks, Tom. I guess I would think about it is so the CTE-98 calculation when the markets go down, jumps up. But we’ve had this account value floor that’s been holding us above that. So we’ve got that buffer so I think about where we are today, sort of consistent with that CTE-98 approach. The other thing I’d mention to you is that the difference between CTE-98 and in CTE-95, which is sort of another level you hear people talk about in the industry. In our case, for our book of business, it’s somewhere between $1 billion and $1 billion – between $1 billion and $1.5 billion, excuse me. So LNBar, the entity remains very well capitalized. We’ll continue to grow capital over there. We haven’t taken dividends out of LNBar for a long time. We just sort of let the earnings accrue over there. Last year, we really took our first dividend out of there over an extended period of time. So we can easily go back to letting that entity accrue with the earnings that naturally makes in any given year. But we feel very good about where we are today, Tom.

Okay, thanks. And then let’s see, the other one I just had was on Dennis. You had mentioned you’re seeing increased short-term and long-term disability claims. Can you provide a little bit of color on what you think is going on here? Is it just the historic correlation on unemployment, or you see it kind of a surge in borderline claims or what do you think is going on sort of behind the scenes with disability?

Yes. Tom, so far, there has not been much COVID-related claim experience. When we think about the effect on morbidity, particularly in the group business, we lump together a couple of the concepts that you just asked about. One is the direct COVID effect on claims, and we expect that to increase. And the second one sort of relates to your question about the experience that all providers have that in a recessionary period of long-term claim incidence increases. So when we look forward, it’s some combination of those two things, direct claims and potential. So again, historical increase in LTD experience associated with recession. So we’ll be watching those things closely as we go through the quarters.

Great. Thanks Dennis. And just one last, if I could sneak it in, just do you have an estimate for stressed credit losses that you would expect annually here? And how would that compare, Randy, to the $400 million that you said should be freed up at least in 2020 from the lower sales levels?

Tom, we don’t – we’re not going to talk specifically about the number the amount of stressed credit losses. I mentioned the CTE-99 scenario, drives a significant amount of credit losses as you can imagine. A comment I’d make is that the environment we see today, I’ll call it the COVID environment, if you will. We don’t see this as being as stressful as the stress we run every single year. So it hasn’t risen to that level yet, and it’s really primarily as we see right now as we – as Ellen and her team work very closely with our asset managers, this still appears to be primarily a downgrade event, probably supported somewhat by what the Fed and the government is doing, but it still appears to be primarily a downgrade event. In the first quarter, we actually had $655 million of downgrades. That hurt our RBC by about 5 points. Despite that, we were still able to grow overall RBC by 7 points. So that’s what we’ve seen so far. It’s downgrades and that’s kind of our expectation for what we’re going to see unless the environment changes significantly from what it has been for the last few months.

Tom, I might add to what I’d add to what Randy said and just repeat what both he and I did say in our scripts is that we’re coming into this stress period with a substantially stronger investment portfolio because all the actions that we’ve taken since 2008. So that’s a really good starting point in addition to what Randy has talked about.

Thanks.

Thank you. Our next question comes from Humphrey Lee with Dowling & Partners. Your line is open. Humphrey, please check your mute button.

Good morning. And thank you for taking my questions thank you for providing the color in terms of what you’re thinking in terms of mortality and mobility impacts from COVID-19. But when we think about from, I guess, from a top line perspective, and especially given some of the unemployment and furloughed employees, what are you seeing in terms of RPS and in Group Protection relative to your premium base and account value?

Thanks, Humphrey. When you think about those 2 businesses specifically, we haven’t seen much in the way of impact so far, either from a top line or from a bottom line, at least through the first quarter. I guess as you think forward in the group business, there are really 3 things that can impact the top line or that we would think might impact the top line. The first is that in this environment, disruption that’s going on, we’d expect some slowdown in sales. Dennis mentioned that. Offsetting that, there’s an expectation that you’ll have better-than-expected persistency. I think about those two items sort of offsetting each other, which leaves you with the third impact which is what you see in the group business in every recession, which you have higher unemployment, lower covered lives, and that provides a bit of a drag on top line growth. So we grew 7% in the first quarter. I wouldn’t be surprised at all if that comes down as we move over the course of the year because really, because of that third item. In the retirement business, we haven’t really seen much again in terms of people taking additional hardship grows. We saw a very modest amount, $30 million over the past few weeks or 0.03% of account value. So could that kick off and have a modest impact? It could, but that has been our experience so far.

Got it. And then looking at the all kind of financials this quarter, it looks like you’ve done a small life insurance – reinsurance transaction. I was wondering if you can provide some color in terms of the particular transaction and how much capital had freed up?

Yes, Humphrey. We did sort of I think about an ordinary course transaction with one of our existing partners. It was on a very old book of term insurance, term insurance that was actually past its guarantee period. It generated about my recollection here, $50 million to $60 million of capital for a very modest give up in earnings. So it was a good transaction with a partner we’ve got a long history of working with.

Got it. Thank you.

We have a question from Suneet Kamath with Citi. Your line is open.

Thanks. Good morning. So, I appreciate the update on the SGUL subtest, in the past, you’ve also provided reserve redundancy guidance for the non-SGUL book. I guess the question is, should we assume that those numbers, similar to the SGUL subtest, have also increased pretty dramatically since that last guidance?

Yes, Suneet, I think historically, sort of in the base case cash flow testing, they have been growing roughly $1 billion a year, and there hasn’t really been a change and that we’ve continued over the past 3, 4 years to sell a lot of profitable business, and that’s been more than enough to overcome the natural runoff that occurs in the business. So yes, I think there hasn’t been really any change in the pattern we see over the years.

So then relatedly, we spent a lot of time on this on the last call, so I figured I’d just ask again this call in terms of in-force transactions. Obviously, the rate environment has changed, but spreads have widened. Is doing something with the in-force block part of that playbook that you talked about in terms of managing for capital flexibility and is doing a transaction in this environment possible?

Suneet, I think the current environment is really chilling the overall M&A landscape. People are trying to understand their own situations, much less take on somebody else’s situation. So big picture, M&A, I think, is chilled for the moment. Bought transactions sort of falls into that same general category. And it’s possible that something like that could develop. As we have said in the past, and you’ve pointed out that we’ve – all of us have discussed this, it’s a balance between what are the return requirements and interest rate at the current at levels and you get the right – can you clear the table where both the buyer and the seller have an advantage and we’ll just stay in the flow of transactions, but I think there’s sort of a chill right now because of the uncertainty.

Okay, thanks.

And that’s all the time we have for questions. I’m going to turn the call back over to Chris Giovanni for any closing remarks.

Thank you all for joining us this morning. As always, we are happy to take your follow-up questions. Please e-mail us at investorrelations@lfg.com. Thank you, and have a great day.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.