Lincoln National Corporation (NYSE:LNC) Q1 2020 Earnings Conference Call - Final Transcript

May 07, 2020 • 10:00 am ET

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Lincoln National Corporation (NYSE:LNC) Q1 2020 Earnings Conference Call - Final Transcript

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Q & A
Analyst
Jimmy Bhullar

had. Can you discuss what sort of drove that. And whether you're 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.

Executive
Randy Freitag

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 who's 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 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 made coming out of the financial crisis.

Note that we switched from a straight CTE-98 approach to capitalization from an approach that takes a greater of CTE-98 and a percent of account value. And what that does is during the good times when markets are rising, it doesn't allow you to pull capital out of the VA business, which is really what a straight CTE-98 approach does. And that's what we see, that percent of account value floor has been controlling for a while and it's forced us to hold an extra $400 million to $500 million in the business. So while it gets temporarily used up by this lumpy breakage we're still left with a very strong capitalization. So great policy change that we made that's worked just like we would have wanted.

The second thing we think about is really the economics of the annuity business itself, specifically, does the breakage change our view of the economics of the business. The answer