Good morning, and thank you for joining Lincoln Financial Group's First Quarter 2017 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, Amanda. 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 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-Q 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 the most comparable GAAP measures. Presenting on today's call are Dennis Glass, President and Chief Executive Officer; and Randy Freitag, Chief Financial Officer. After the prepared remarks, we will move forward to the question-and-answer portion of the call. I would now like to turn the call over to Dennis.

Thank you, Chris, and good morning, everyone. As I noted in my closing comments on our year end conference call, we entered 2017 with a lot of positive momentum. Looking at first quarter results, this was clearly evident as we reported record operating earnings and EPS, aided by positive onetime tax adjustments; book value per share increased double digits; and our ROE exceeded 12%, excluding the noted tax items. These were high quality results as all four of our businesses delivered significant year over year earnings growth. Looking forward, I'm confident our franchise and actions can drive both near and long term growth. In the near term, we are well positioned to drive organic growth through our multichannel distribution model, where we benefit from industry leading shelf space and our broad set of customer solutions. Notably, first quarter sales growth was strong in most of our businesses, including sequential growth in annuity sales for the first time in nearly two years. Disciplined expense management remains a core strength. And with revenues up 5% over the prior year quarter, we should continue to have positive operating leverage. Account values continued to grow, driving earnings tailwinds to our capital market sensitive businesses. The first quarter is also typically our lowest earnings quarter for the mortality and morbidity businesses. As a result, we are set up well for subsequent quarters. Lastly, our balance sheet remains strong, and statutory capital is at an all time high. This, coupled with consistent capital generation, will enable capital deployment to remain robust. Longer term, I also see significant opportunities. Demographic trends and individuals shouldering more responsibility for their financial security make our financial protection product solutions and retail-centric model more relevant and more valuable than ever. Last quarter, we announced our digital initiative, which is targeted at…

Thank you, Dennis. Last night, we reported income from operations of $442 million or $1.92 per share for the first quarter compared to $1.26 per share in the prior year. As we noted in the earnings release, the current quarter benefited $0.19 from onetime tax adjustments. Excluding notable items, EPS increased 37% year-over-year as all 4 of our businesses delivered double-digit growth. Beyond items that caused typical variability quarter-to-quarter, I would note a couple items that impacted the current quarter. First, within other operations, the adoption of stock compensation accounting guidance will now cause some variability in our taxes, with the biggest impact likely occurring in the first quarter of each year tied to vesting schedules. In the current quarter, this increased earnings by $9 million. Next, within our group business, earnings were reduced by $13 million as DAC amortization was higher than our typical quarterly run rate. Now shifting to key performance metrics. Operating revenue increased 5% in the quarter, driven by a 9% increase in average account values and strong sales results over the past year from our mortality and morbidity businesses. Book value per share, excluding AOCI, grew 10% to $58.37, an all-time high. Reported operating ROE was 13.6%. When adjusting for notable items, ROE was 12.2%, 20 basis points above our annual ROE in 2016. Finally, our balance sheet strength and solid capital generation enabled us to return $266 million to shareholders in the quarter. Net income results for the quarter largely mirrored operating earnings as both credit performance and hedge program results were excellent. Now we will turn to segment results. Starting with annuities. Reported earnings for the quarter were $281 million. Excluding the benefit of onetime tax adjustments, earnings totaled $240 million, up 10% from the prior year quarter. Earnings growth was driven by…

Thank you, Dennis and Randy. We will now begin the Q&A portion of the call. [Operator Instructions] Amanda, can we please begin Q&A.

[Operator Instructions] And our first question comes from the line of Erik Bass of Autonomous Research.

In the life business, you're seeing solid growth in the in-force, and it looks like you're gaining share. And in addition, I think you mentioned that new business returns were at the high end of your range. I was just hoping you could talk more about your competitive position within the market and what's driving the growth?

Let me talk about the market, competitive position in general first. I think it's a fairly solid market. I don't see, we don't see any people reaching for business through pricing actions. And certainly, we're not reaching for business through pricing actions. I mentioned that our sales growth came from, for example, variable universal life, which was up 24% over the first quarter. That has to do with VUL sales being a little depressed in the first quarter of last year because of the volatility in the equity markets and people not wanting to pull the trigger on products that were equity-based. We also mentioned MoneyGuard. We're just a leader in that business. Equity-linked products are growing at 20%. We're a leader, we're growing a little bit faster than that. So it stems from having good growth in a couple products this quarter over prior quarter, but more importantly, on a long-term basis, having a pretty broad portfolio so as consumer preferences change, we can offer another solution. And I would use VUL as an example of that in the first quarter last year. It wasn't a strong preference for the reason I mentioned, but this year, it is. So I come back to distribution strength, shelf space and broad product solutions as the answer to your question.

Okay. And you've talked in the past about potential interests in group benefits M&A, so just hoping you could discuss how you would think about a larger deal that could materially shift your business mix and how much capital capacity you would have for potential M&A, including any potential debt capacity.

Yes. As I mentioned in my remarks, we have a strategy of increasing the percentage of our earnings that come from our mortality and morbidity businesses. This quarter, that percentage was about 25%. Over time, we'd like to see it grow to 30%, 33%. So we've made some progress on that objective organically principally because of the recovery in the group business and, again, this quarter, good results in the life business. So when I think about M&A, broadly speaking, and we've discussed this publicly a number of times, probably our first choice would be the group business, which would help with that target source of earnings from morbidity and mortality. And again, I'm going to turn over the second half of that question to Randy. We are going to be very disciplined about any transaction we do. We're not reaching for any transactions by paying a high price. As we say, I've said and I said again this morning, we're very careful about the return on the capital that we deploy. So if we do go after a transaction, we will be disciplined about it, as we have been in the past. Randy, you want to add?

Yes. Erik, in terms of capacity, as I've mentioned in the past, on the context of an acquisition, I believe, inside of our nearly 9 billion of statutory capital, we have roughly 500 million to 750 million of capacity inside there, once you get in the context of an acquisition. I also think, in the context of an acquisition, on the leverage front, there's some capacity that we would have. Once again, an acquisition that delivers cash flow to the holding company, opens up some capacity, I think probably in the 300 million to 500 million range. Separate from that, we obviously have been and will continue to generate a significant amount of free cash flow, and we've deployed well over $1 billion last couple of years into share buybacks. It represented nearly 900 million for the last couple years. Obviously, we did 200 million this quarter. So I'd point to those items when you think about potential capacity.

Our next question is from the line of Ryan Krueger of KBW. Your line is open.

Dennis, I was just hoping you could provide some additional color on the initial reaction to your -- some of your new VA product rollouts that occurred during the first quarter. As well as I think you mentioned an additional product that was going to come out in the second quarter. I guess more color on what that would be.

Yes. Ryan, the -- we've made a series of product moves that have been well received, some of them this quarter; some of them, over the past couple of quarters. Let me focus on the increase in sales of our non-guaranteed VA business, which is up pretty substantially. What we're seeing on that product -- and again, this comes back to having a lot of products available in the market and changing consumer preferences. We added a death benefit to Investor Advantage, which, again, is a nonliving benefit product, and people just seem to be wanting to lock in some of their equity gains. The benefit -- that benefit provides for sort of a mortality option for them, and so we've seen sales there increase. When I look at our adjustments on the guaranteed business, guaranteed lifetime benefits, we've made some modest increases in the benefits, maybe 25 basis points on the payout of one of our core products. But we have been able to, because of rising interest rates, increase the investment flexibility. Our value proposition for our financial adviser is to let them have as much flexibility as we can provide to choose good outcomes for their customers. And so as we provided more financial flexibility, that has helped with sales. When -- the product for introduction in the second quarter is in the category of guaranteed lifetime income. And we're just offering another solution in the marketplace that has a slightly higher guaranteed payout, but there are slightly lower guarantees in it overall. It's a product that has been successfully sold by our competitors. And again, we think, for a segment of the market, it is potentially going to be popular. So again, I come back to distribution, broad -- product breadth, trying to find additional segments of the market that would add incrementally to our sales, not subtract from sales that we're already making.

Great. And then a related question. Lincoln saw some improvement in the quarter on annuity sales sequentially, but most of your competitors continued to see fairly meaningful declines in VA sales. I guess, do you think we're getting closer to the point where industry VA sales are bottoming?

I think so. If you go back to the fiduciary rule, let me make two comments. One, how can guaranteed lifetime income not be in the best interest of consumers? With the lack of defined benefit plans, more shouldering of financial responsibility on individual consumers, that has got to be a compelling long term value proposition, so I think it will remain a good product in the marketplace. The DOL is creating confusion, more than anything else, and so you're seeing some of our distribution partners not coming forward with their specific plans because they are waiting to see what the final rule is really going to be. So I think the whole market, candidly, both qualified and nonqualified business, is being affected by the uncertainty created by this rule and the distribution partners waiting for certainty so they can formalize what their practices and policies are going to be. So I'm hopeful that we'll get to that certainty sooner rather than later, and I think that will help annuity sales overall.

And our next question is from the line of Tom Gallagher of Evercore ISI.

Dennis, just a follow up on DOL fiduciary rule. From, I guess, what's out there right now, it sounds like, following the delay, it may -- there's speculation it may go into effect without any major modifications, including private right of action. If that, in fact, -- curious on your perspective how you think that's going to play out. And if that does remain, does that become kind of a game changer as you think about the impact of that regulation and legal liability risk, etcetera?

I don't see it as a positive to have to play the part of being the enforcement arm on a product. But as we are doing in our own broker dealer, I think there's enough room inside of that -- inside of the current fiduciary rule to establish practices that meet and exceed the intent of the rule and still provide for the sale of products that are subject to the right of action. So I think that the market will adjust to it. And I come back to, at least in our business, guaranteed lifetime income tromps, whether it's a commission or a fee, and I think it will tromp the BIC, the right of action over time. Personally, and we're public about this, we think that part of the rule should be replaced. I think you've seen less action on this from the DOL, well, I should say I think I know there's less action from the DOL because the Trump administration has not yet gotten their Department of Labor person approved. And I think when that happens, there's a possibility, I'm not saying anything for certain, but there's a possibility that the regulation may have another look by the administration.

Okay. And then just on, I guess a question on individual life mortality. We now had, following, we'll call it, some rocky quarters going back a couple of years ago, you've had a string of maybe 4 or 5 good favorable mortality quarters in a row. That is pretty different than what the industry experience has been. Any thoughts on why your mortality experience has been favorable on a fairly consistent basis here? And anything with your mix, or I know you had that recapture of the reinsurance transactions. I don't know if that's been trending favorable. But any color as to why your experience has been different?

Tom, this is Randy. I can't speak to the industry. I think we've always felt and have proven over time that we are excellent assessors of mortality risk. I think we have one of the finest underwriting departments in the land, and those folks are very good at assessing mortality risk and pricing that risk appropriately, and I think you've seen that in our results over time. As we have retained more business, you're getting a little more variability around our results, and you've seen that. But I think, over time, the quality of our ability to assess mortality risk is coming through our results. In terms of the industry, look, I think that the entire industry is pretty good at understanding mortality. And I think, over time, mortality is going to do what it's always done, which is improve gradually over time. I fully expect that my children will have a longer expectation of life than I have, for instance, and I expect that their children will have a longer expectation of life than they do. So that's mortality over time. That's what we expect, and I think you'll see that in our results and in the industry's results.

Okay. And then just finally, Randy, I just wanted to make sure I had the numbers right. When you were asked about potential funding sources for M&A, you had said excess capital in the regulated entities of $600 million to $800 million. And debt, I missed what you said on debt capacity, and then you have another $800 million to $1 billion of annual cash flow. Those would be the 3 pieces.

To be clear, in the regulated entities, so this is in the context of M&A, I said $500 million to $750 million, so roughly in line with your numbers. In the context of leverage capacity, once again, this is in the context of doing acquisition with the proceeds, I would estimate $300 million to $500 million. And then just factually, we have bought back shares over the last couple years at a rate of about $900 million a year. We did a couple hundred million dollars in the first quarter, so we obviously have been generating and would expect to continue to generate significant free cash flow.

Our next question is from the line of Seth Weiss of Bank of America. Your line is open.

Just a couple modeling housekeeping questions. First, Randy, the $9 million tax benefit in other operations in the quarter, should we expect that to reverse in the subsequent three quarters? And is that seasonality something that we could model out for '18 and beyond?

Sure, Seth. Well, I think it's a difficult item to model. The -- it reflects the difference in performance really in equity from the assumptions that go into the granting of equity compensation to employees. So it is, I think, an inherently difficult item to model. I would say that you should expect some seasonality in the number and that the first quarter should be, I would imagine, the quarter when you would see the most impact. And that's because -- there were two elements of what drives this number. One, you have stock option exercises, which would have a skew into the first quarter because that's when you cross an anniversary, and that is oftentimes a trigger for some sort of event. And separately, the first quarters would be when all of the performance shares that we grant and the restricted stock that we grant vest, and that would be the event that drives part of the results. So I think you should see a seasonality in that -- in it in the first quarter, but you should see some level each and every quarter. I think the $9 million number we experienced this quarter would be at the very high end of what I would expect in a typical quarter.

Okay. And then one more modeling one and just semantics I want to clarify. Your expectations to be at the low end of the range for RPS and Life Insurance and the spread compression, I just want to clarify. That means the beneficial end of the range. Is that correct?

Yes, the beneficial range. On the case of RPS, that would be the low end of 10 to 15, so closer to 10 than 15 and in the case of life, closer to 5 than 10.

Great, just wanted to clarify that you are dealing with negative numbers there. Appreciate it.

No problem.

And our next question is from the line of John Nadel of Crédit Suisse. Your line is open.

Randy, I guess the question is, if I adjust for the onetime tax benefit -- and I get that DRD was a big component of that. If I adjust for that, the quarter's underlying effective tax rate on a consolidated basis was just shy of 20%. And the annuities segment was, I think, under 15%, maybe even closer to 14%. In both of those cases, that's below the levels we've seen in the last several years, if not even a little bit longer than that. How do we think about the sustainability of that underlying sort of sub-20 on a consolidated basis and low to mid-teens for the annuities segment as we look forward?

Sure, John. I think the difference is in the annuities segment itself. So inside of the annuity results, we talked about we had $41 million of what I would call normalizing items, which brought the result down to about $240 million, which is right in line with our expectations for the business. If you were to factor in equity market growth, the negative net flows, the fact that international markets underperformed the S&P, when you factor all those things, $240 million is right in line with our expectations. Inside of that result, you would have had some other pluses and minuses. One of the pluses would have been the fact that every year, in the first quarter, we have a normal truing up of our DRD as we get actual information in from the funds. That had a positive impact on the annuity business of roughly $8 million. Now that positive $8 million was -- that's a recurring item, by the way. That's going to occur on a regular basis. You never know how big it will be, but this year, it happened to be a little bit -- about $8 million. That was offset by the fact that the first quarter of this year had 1 less fee day than last year and also the fact that we had some noise in our commissions this quarter, really a swing between fourth and first quarter, which negatively impacted the quarter probably by $4 million to $5 million. So when you factor that in, that additional just normal DRD true up that we experienced in the first quarter, if you would add that in also, and life had a couple million of this impact also, you would see that the normalized tax rate, if you want to add them back, would be in the 22% range, which I think would be in line with our expectations, all else being equal, for what that number would be as you move forward.

Okay. But you -- but I think you also just mentioned that the DRD -- that $8 million benefit would be ongoing. Is the first quarter reflective of the full year benefit of that? I imagine it's not.

Yes. I didn't mean to say it would be ongoing. What I mean to say by that is this is a normal process . Every year, we get the actual information from funds, and we have to true up our estimates that we put up at the end of the year. This -- in the case of 2017, that happened to be about an $8 million positive for the annuity business.

Got it. That's very helpful. And then just another question on sales, and I'm thinking about the fixed annuity sales. And I know it's not that big of a line, but I'm wondering what the composition looks like in that $560 million or so of sales this year versus the $668 million last year. How much of a contributor is the indexed product?

The indexed product without lifetime guarantees is about $315 million of the total fixed annuity of $516 million -- $562 million. Fixed annuities with lifetime income is about $135 million. So it's all about $100 million of the $562 million.

And how did -- if I think about the sales growth or decline in the indexed portion of the product, it -- what are you seeing there? Is that also being impacted by DOL sort of overhang?

Okay. So let me -- the fixed indexed annuities are up 37% versus the prior quarter, most of that coming out of just normal accumulation fixed indexed annuities. And so the -- and the higher amount is due to the fact that interest rates are a little better in the quarter versus the prior year. And that product competes with CDs, and so we had slightly better advantage. And I'd also say -- and I keep underscoring distribution strength. We've been building our shelf space over the last couple of years in the bank channel for fixed annuities and in the adviser channel for fixed annuities, so we're seeing some effect from just better distribution coverage.

And would you characterize that product line, particularly the indexed annuity product line, as pretty competitive, Dennis? I asked because American Equity said earlier this morning that price competition there is pretty significant. It's not just the Bermuda-backed NIMs. Obviously, now there's some real brands competing in the indexed annuity product area, including your own as well as a few others that, that wasn't, that clearly was not the case just a few years ago and prior?

Yes. First of all, the firm that you've mentioned is not really in the market that we're in. They're a lower investment grade, their products are higher commission, longer surrender periods, less liquidity. So we continue to price rationally. And again, our improvements, I think in large part, are related to a specific attempt to reshape products over the last couple of years for that bank and financial adviser channel. And again, that means shorter surrender charges, more liquidity for the consumer. And that's a good place for us to be, and I just, I don't think it's affected by the company that you mentioned. And let me, I was asked a question earlier about the DOL. Actually, the new head of the DOL has been approved just in the last couple of days. What I meant to say, he hasn't had much time to look at things.

And our next question comes from the line of Humphrey Lee of Dowling & Partners. Your line is open.

Just a question regarding the VA net flows. So for the past year or so, you've been kind of pressured by outflows related to the products that comes with the volatility controlled funds. So if I were to look at the net flows in this quarter, was the voluntary controlled funds VA continued to be a pressure? And if so, how much of those funds account for the net outflows in the quarter?

Yes. I guess, I'm going to jump to a little higher level on that question, and that is that our outflows have ranged from 7% to 10% over the past 3 or 4 years. The 8% or 9% that we saw in the first quarter is a little higher, but sort of within the range of what we see over time. Whenever equity markets rise dramatically, there might be a little bit of a consumer reaction to surrendering. But let me come back to the higher point. There's nothing in this first quarter that is dramatically different. As a matter of fact, it's in the midpoint, mid-range of what we've seen over the last several years.

Got it. And then looking at, maybe a modeling question, but looking at corporate, or sorry, other operations. So if we adjust for the $9 million of tax benefits, the $22 million still looks relatively favorable in the quarter. Was there anything kind of timing related that is kind of taking place in the quarter?

Humphrey, it's Randy. I think it's fairly typical. If you think about other operations, you add back that 9 million, you're right, you get to negative 22 million. If you think about next quarter, we're going to lose a substantial portion, I believe two third, of the amortization of the [indiscernible] and the reinsurance, so that will negatively impact that particular segment. I would say there's a little bit of seasonality in other operation's expenses. Branding is oftentimes a little lower in the first quarter and a little higher in the second quarter. But all in, that segment has been running in that negative 25 to negative 30 range, so I don't think we're really materially different from that this quarter once you adjust for the stock-based compensation.

And our next question is from the line of Suneet Kamath of Citi. Your line is open.

So a question for Dennis. On prior calls, you've kind of given us your sense of sort of bid-ask in terms of M&A opportunities in the market. Obviously, without us commenting on any specific deal, any update there in terms of what you're seeing?

I think there's a couple of rumors about certain companies divesting a noncore businesses. But again, in Randy's and my experience, which goes back decades, it seems to be a pretty low volume of transactions at least that we would have any interested in -- interest in. So I would just say it's at the low end of the range from our experience, the activity. And it doesn't mean that we couldn't pick up or it doesn't mean that we wouldn't do something, just answering your question. There's not much that we're seeing that fits what we're interested in.

Got it. And then, I guess, with tax reform back on the table again, we've been getting some questions about the impact of potential estate tax repeal on the life insurers. Can you help us frame maybe how important that -- or how big a piece of your Life Insurance business that would represent and if the state tax were dramatically reduced or eliminated, what you'd expect in terms of your in-force business?

Yes. The amount of our -- you mean in-force or sales?

It'd be helpful if you give us both actually.

Yes. We'll have to get back to you on in-force. But the amount of new sales that we have is sort of 10% to 12% from what we could observe as being specifically related to estate tax planning. But let me come back to the whole issue. I'm not sure that the change as it's presented, which is the removal of estate taxes but a tax step-up in basis at the transfer of the asset, won't actually give the industry a bigger opportunity for tax. That would be income tax planning. But right now -- I'll just use a simple example. Right now, if you have a $10 million estate and you're husband and wife, you could pass that on estate tax-free, and there's no step-up on basis that you're taxed on. If that estate tax goes away and you have a $9 million step up in your $10 million estate, now all of a sudden, where you didn't have an estate tax, you now have a $9 million -- you have the tax on $9 billion -- $9 million of step up. So I don't -- it's not as simple as the estate tax goes away from an industry perspective.

Got it. And then maybe just one last one, if I could sneak it in. Just on the -- I think somebody asked you about this before, but just a follow up on the ETF based VA. Any comments in terms of the progress there? But then, more importantly, have you seen other competitors launch sort of similar products following the announcement of your BlackRock related product?

As I mentioned in my comments, we've adjusted our products to capture these trends, which we think are going to grow in importance over time, the two trends being a little more fee based compensation than commission based compensation and a little more focus on passively managed funds than actively managed funds. Specifically, with respect to our product that we've talked about, it requires a lot of interfacing technology with the broker dealers that will put it on the shelf. We've had four or five successes so far with getting it on the shelf and having the technology work, but nothing significant in terms of sales. And we wouldn't expect any real significant sales sort of to pop up overnight, but to grow over time. But we do think, over time, it will grow to be a valuable product.

Any competitors following suit?

Not that we're aware of, but it would seem like something that would -- we think it's a good idea.

And this does conclude today's Q&A session. The company will follow up with those with remaining questions later this afternoon. I would like to turn the call back over to Mr. Chris Giovanni for closing remarks.

Thank you all for joining us this morning. As always, we will take your questions on our Investor Relations line at 800-237-2920 or through e-mail at investorrelations@lfg.com. Thank you, and enjoy the rest of your day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect.