Feb 9, 2010
Executives
Dennis Glass - President & Chief Executive Officer Fred Crawford - Chief Financial Officer Jim Sjoreen - Vice President of Investor relations
Analysts
Andrew Kligerman - UBS Randy Binner - FBR Capital Markets Jimmy Bhullar - JP Morgan Bob Glasspiegel - Langen McAlenney Mark Finkelstein - Macquarie Colin Devine - Citi Tom Gallagher - Credit Suisse Eric Berg - Barclays Capital John Nadel - Sterne Agee
Operator
Good morning and thank you for joining Lincoln Financial Group’s fourth quarter 2009 earnings conference call. At this all lines are in a listen-only mode.
Later we will announce the opportunity for questions and instructions will be given at that time. (Operator Instructions) At this time I would like to turn the conference over to Vice President of Investor Relations, Mr.
Jim Sjoreen; please go ahead sir.
Jim Sjoreen
Thank you, operator and good morning and welcome to Lincoln Financials 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 liquidity and capital resources, premiums, deposits, expenses, and income from operations 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, 10-Q 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.
A general account supplement is again available on the website as well. Presenting on today’s call are Dennis Glass, President and Chief Executive Officer, and Fred Crawford, Chief Financial Officer.
After their prepared remarks we will move to the question-and-answer portion of the call. So, with that, I would now like to turn the call over to Dennis.
Dennis Glass
Thanks Jim and good morning to all of you on the call. 2009 was an eventful and challenging year for our country and for our industry.
For Lincoln, in terms of strategic focus and execution, it was certainly one of the most active years in our history. In the face of challenging market we completed a series of actions designed to place the company firmly on the path performance and growth, while preserving our financial flexibility and our franchise value.
I never doubted the strength and resilience of our business model, but today looking back on 2009 with a little perspective it is worth noting just how well our operating businesses performed. Given the severity of the downturn we had expected somewhat reduced production, but we found that the quality of our business model protected our market share in key lines and generated increasing levels of activity throughout the year.
For the full year 2009 we reported total positive net flows of $7 billion and total gross deposits of nearly $20 billion, only modestly off 2008 levels. Our retirement asset balances reached $110 billion, up 27% from last year due to net flows and market lift close to the record levels of 2007.
Through the third quarter we steadily increased market share for variable and fixed annuities, and maintained our share of life industry sales. In spite of the noise and headwinds, and due to the fact that we remained active in our markets with all of our products and services, and proactively engaged in dialogue with our partners, we in fact grew our franchise in 2009.
At Lincoln Financial Distributors we added or expanded relationships with 26 firms. We increased the number of active advisors recommending Lincoln solutions by 11% to more than 55,000, and we significantly increased the number of new producers recommending Lincoln solutions for the first time.
At Lincoln Financial Network we increased net new advisors by more than 300 to approximately 7,700 at year end and an industry magazine recently ranked LFN as one of the largest independent broker dealers in the country. Turning to our employee base, we added to the experience of our workforce by attracting talented individuals from inside and outside of the industry.
We also benefited in 2009 from our commitment to a broad product portfolio designed to support different financial planning needs and our distribution organizations proved to be nimble, keeping pace as consumers adjusted their preferences over the course of the year. For example, in our annuity business we are able to take advantage of the shift from variable annuities to fixed solutions during the year, and then pivoted back to variable solutions with our clients as the markets improved.
Similarly our individual life business benefited from the breadth of our solutions set, and again, nimble distribution. Throughout 2009 we saw steady, quarter-over-quarter increases in policies sold for both UL and term and total policies sold in 2009 were 28% and 98% higher respectively over 2008.
In our Defined Contribution business we saw an increase of more than 20% in both total net flows and ending balances. Group Protection had another very strong year across all measures and a strong fourth quarter.
Total sales were up 14% over 2008, and fourth quarter sales were up 29% over the year ago period. We are successfully taking advantage of the growing importance of voluntary sales in these relationships.
38% of sales came from voluntary business, an increase of 7 percentage points over the year-ago period. The financial services landscape will continue to shift as our competitors change and our distribution partners settle into new structures and regulations.
Our approach to distribution and reputation for distribution excellence at Lincoln Financial Distributors, Lincoln Financial Network, and our worksite sales and service organizations will continue to be a catalyst for market share gains, as consultants, advisors, employers and consumers seek out providers they trust. Given this backdrop, we continue to evolve our distribution strategies to maintain our competitive advantage.
At LFD, one of the largest wholesale distribution organizations in the industry, our focus today is on driving productivity, which has already resulted in a 22% increase during the year. Lincoln Financial Network is leveraging its model to attract seasoned advisors, who want to affiliate with a company with national presence, a recognized brand, and a commitment to support their independence, while helping them grow deeper relationships with their clients.
We also continue to build our worksite based sales platform, primarily found in our Group Protection and Defined Contribution businesses, with the goal of expanding opportunities to help employers and employees understand how to make the most of company sponsored retirement benefits and additional voluntary benefits. Now let me turn to financial strength.
As you know, we achieved positive net income from operations in every line of business in every quarter of 2009. We ended the year with an estimated risk based capital ratio of approximately 450% and we have roughly $1 billion in cash at the Holding company, net of cash set aside to repay a $250 million maturity in March.
Product updates completed last year are adding to our long term financial strength and profitability. We improved the risk return profile for our income guaranteed variable annuity products, and also redesigned our secondary guaranteed life product, which allows us to meet our ROE expectations on new business without a capital solution.
Our need for additional capital over the past 18 months has been mostly related to asset impairments and downgrades and some maturing debt. We expect some level of investment losses in 2010, but absent any new market disruption, we expect those losses will be significantly lower than in 2009, benefiting from a well diversified portfolio spread across a broad spectrum of issuers and asset types.
In summary, we are on a strong financial footing. I expect a slow economic recovery in 2010 and as we have seen lately, it is likely that the capital markets will remain volatile for sometime.
Given these expectations, we will continue to manage expenses carefully and maintain a conservative approach to overall capitalization. We are balancing prudence, however, with targeted strategic investments to grow top line sales and further spur productivity, particularly in Defined Contribution and Group Protection with technology upgrades, and in new products for the voluntary market, and an expanded distribution focus for Group Protection.
We are also increasing the visibility of our brand in the market, for example, by returning to network TV with the CBS Sports Desk. With respect to CPP, as I discussed at our annual investor conference in November, we expect to repay the funds in the second half of 2010 or first half of 2011, as market conditions dictate, again, without diluting earnings per share and importantly, we have not to date seen any evidence that our participation in the program has adversely impacted our businesses in any meaningful way.
As we move into 2010, everyone at Lincoln is focused on capitalizing on the tailwinds provided by today’s landscape, including consumer demographics, the need for Americans to rebuild their portfolios, and the expected higher tax environment, and on executing our plans to grow our revenues and earnings. Now let me turn the call over to Fred to discuss our fourth quarter and full year results in more detail.
Fred Crawford
Thank you, Dennis. We reported income from operations of $297 million or $0.90 per share for the fourth quarter.
Our release points out notable earnings items impacting the business segments, but a few of the more meaningful items worth noting include the following. CPP preferred stock dividends and related accretion of the discount totaled $18 million in the quarter.
This cost to our shareholders does not run through income from operations, but does impact the calculation of earnings per share. We completed our review of the individual disability income business taking back from Swiss Re earlier this year.
The review resulted in a charge to operating earnings of about $33 million in the quarter. The loss was somewhat offset by the combination of favorable unlocking in our Annuity segment of $12 million, and a favorable state income tax liability release of $13 million taken through other operations.
We experienced a strong recovery in our alternative investment portfolio, contributing about $22 million to earnings. While returns can be volatile at times, we would expect normalized returns in the 5% to 10% range pretax on this $700 million portfolio as we move through 2010.
We recorded net income of $102 million or $0.27 per share, impacted by net realized investment losses and an impairment taken on our media holdings. Continued weakness in our radio broadcasting properties resulted in impairments to goodwill and intangibles totaling $109 million in the quarter.Net losses on invested assets were $91 million after-tax.
Gross realized losses and impairments on general account invested assets were $212 million pretax. Concentrations include RMBS totaling $52 million, impairment taken on the Royal Bank of Scotland and Lloyds Hybrid Securities totaling $60 million, and commercial real estate equity of $49 million.
While elevated from recent quarters, we view the banking impairment as isolated, and took a prudent approach to marking down the value of our real estate equity exposures. As we focus on our overall mortgage lending business, core metrics remain strong with only eight delinquencies on a very granular portfolio of 1,300 loans, this equating to a delinquency rate of roughly 0.5%.
As a matter of practice we have not been active in restructuring loans, which artificially lowers delinquency rates. Finally, our variable annuity hedge program performance had very little net impact on the quarter’s results.
Our strategic position on interest rate coverage as we prepared for the adoption of VACARVM contributed to positive results in the period. This offset by refinements to our existing hybrid approach to estimating the liabilities on our income and lifetime benefits to a mix of FAS 133 and traditional SOP insurance reserving, which increased GAAP reserves.
Our VA hedge program finished the quarter with assets comfortably in excess of the actuarial liability. Annuity results benefited from unlocking, which contributed about $12 million to the quarter’s results.
Our DAC model uses a corridor process in estimating account values. Having reset our assumptions when the S&P was at roughly 900, the market recovery in the quarter produced a significant cushion against the negative DAC unlocking under stressed markets.
Results in this segment also benefited from positive tax items contributing $7 million to earnings and favorable alternative investment results. Annuity earnings continued to benefit from increased average account values and improved trends in DAC amortization.
Average account values in our variable annuity business increased approximately $5 billion in the quarter, driving expense assessment revenue up 10% sequentially. We ended the fourth quarter with total average annuity account values of $73 billion, an increase of roughly $16 billion over a year ago, and amazingly, only $3 billion short of our all time highs reported in 2007.
Turning to our Defined Contribution business, ending average account values were up about $1.8 billion sequentially, driving a 5% increase in overall expense assessment revenue. We ended the fourth quarter with total DC account values of $35 billion, up $1 billion over the third quarter’s ending values.
Net asset flows were negative in the quarter, but can be seasonal and lumpy when focused on a quarter. For the year we recorded positive flows of $1 billion, up roughly 27% over the previous year.
We experienced margin compression on the fixed portion of our DC business, weighed down in part by a few unusual items impacting yields. While under pressure we would expect some recovery heading into 2010.
The changing mix of business also impacts earnings, with lower ROA and higher long term ROE business becoming more prevalent in our sales mix. These items, together with current and planned infrastructure and product investments, will holdback on earnings growth rates throughout 2010.
In our Life business fundamentals remain stable. Average account values and in force were up 2% and 1%, respectively, from the third quarter, returning to more normalized growth rates annualized in the mid single-digit area.
Our Life segment absorbs most of the results of our alternative investment portfolio, contributing about $7 million to the period’s results. A few comments on this segment with respect to 2010, it’s important to factor into your forecast the impact of our $550 million term life financing, and the cost of the long term letter of credit.
The cost of the LOC, together with investment shifting from reserves to surplus, will result in lowering our quarterly Life segment earnings by about $7 million, $4 million of which will simply shift to other operations where we house our unallocated capital. The transaction served to contribute roughly $400 million to our statutory capital position.
We are also working through converting our Life and Annuity evaluation systems to a single platform. As part of this process we review methodologies across various blocks of business.
This is more important in our Life segment, given we run on two different systems dating back to the merger. Not unlike our annual prospective unlocking exercise, this may result in onetime gains or losses, adjustments we would expect to have little impact on net earnings trends in this segment.
We should complete this work in the first half of the year. Turning to our Group business another strong earnings performance with favorable loss ratios coming in at roughly 69%, we experienced strong loss ratios in both our Life and long term disability lines, with favorable mortality and solid overall fundamentals.
Net earned premium increased 5% sequentially, and up about 4% over last year’s quarter. As we move into 2010, we would expect loss ratios at the low end of our range, closer to 70%, and a modest recovery in premium growth rates to the high single-digit area, recognizing we ended the year with strong production results.
Turning to capital, there were a number of moving parts as we closed out the year, including our year end reserve financing, the NAIC’s new approach to rating RMBS, impairments and statutory earnings. As Dennis highlighted, we estimate our year end RBC ratio will approach 450%.
We successfully installed AG 43, or the new variable annuity reserving guidelines. The adoption resulted in very little impact to our life subsidiary capital ratios; however, we did make a capital contribution into our reinsurance captive of $250 million at year end.
The contribution consisted of approximately $100 million in support of reserve credit taken by Lincoln Life, and an additional $150 million in support of the captive’s future capital needs. Overall we believe the capital position of our insurance subsidiaries is very strong.
Our insurance subsidiaries are positioned to absorb stressed economic conditions, fund core insurance new business growth. We are afforded both flexibility and patience as we work on efficient life capital solutions, which include refinancing letters of credit over the next few years.
Turning then to the holding company capital and liquidity position, we currently have approximately $1.3 billion in short term investments, after giving effect for the closing of Delaware Investments, a $300 million debt offering during the quarter, and the $250 million capital contribution to our reinsurance captive. We ended the year with roughly $100 million of commercial paper outstanding.
Looking forward we have a debt maturity in March of $250 million pre-funded by the debt offering in the fourth quarter, and set to be paid off with cash on hand. All told, we would expect to settle into roughly $1 billion in holding company capital liquidity as we proceed through the first quarter.
Before closing, a few additional comments on expense trends as we enter 2010. When looking at our enterprise wide expenses we accomplished our savings goals for the year with only modest spring back to support better than expected strength in our core business model.
We were as much playing good defense as offense, meaning we have seen some expenses naturally elevate during a year of financial market stress. The sale of the U.K.
and Delaware results in a level of unabsorbed overhead. While we have worked to reduce the strain, we expected an EPS impact of roughly $0.05 for the year.
Dennis highlighted various investments back into our business model. We expect these investments to impact earnings per share by roughly $0.10 for the year.
We fully expect returns on these investments in the form of increased production, improved market share, and efficiencies in time. So in closing, we end the year on a solid financial footing, having taken significant actions in the face of economic and market challenges, and are now turning our attention to earnings growth and building risk adjusted returns.
We have seen most of our core earnings drivers return back to normal patterns, not fully recovered, but healthy when considering the significance of last year’s events. We have important capital strategies yet to execute on namely our approach to exiting CPP and structuring cost effective Life insurance capital solutions.
Now let me turn it back to Dennis for closing comments.
Dennis Glass
Thank you, Fred. In conclusion, Lincoln today is a stronger company, a tougher competitor and a smarter organization.
We have the financial strength to support our growth. Our model is intact and stronger than ever.
We are market leaders in products and services that consumers want and need, especially today. We are making targeted investments and critical growth businesses and as our solid progress in the fourth quarter demonstrates given decent external factors, we have the ability to continue to deliver strong results in 2010 and beyond.
Now let me turn the call over to the operator for questions.
Operator
(Operator Instructions) Your first question comes from Andrew Kligerman - UBS.
Andrew Kligerman - UBS
Just regarding your capital position, so a 450% RBC ratio, and yet you down streamed some money to the insurance course of the quarter. Is there a chance that you can upstream any capital and if so, how much?
Then also with regard to capital, the media companies, where you took a write-down this quarter of $109 million, how much goodwill remains associated with those operations, and what is the likelihood of a sale of that business?
Fred Crawford
In terms of the 450% RBC to give some boundaries around that, that’s rough justice around $6.7 billion to $6.8 billion of capital above $1.5 billion of RBC, and that’s how you get to that number, just to provide that information. In terms of the up streaming of capital, we are just now settling into this RBC, having a number of moving parts at year end, and assessing overall capital conditions as we speak.
A couple of things I would point out, and that is while we do have a significant capital margin, roughly $1.5 billion above a 350% RBC, for example. We do think it’s important to maintain a level of margin related to turbulence or economic conditions in the marketplace, if they were to become choppy again.
It’s also important to maintain a level of excess capital to support the business growth that we’ve been experiencing across the company, and that we expect to continue and then obviously, we want to be cautious about our ability to execute on, and our ability to be patient in putting in place longer term solutions for capital solutions on our life business. All of those reasons suggest to me, and suggest to us as a company, that we need to retain a level of excess capital down in the Life Company as a precautionary measure.
Now as these things start to unfold and become more surefooted, this can truly turn into a level of excess capital that could be better utilized for greater returns and investment back into our business, but at the moment we’re going to be cautious as we move through the early part of this year. On the media, a couple of dynamics with the media, as you recall, we had contributed the media asset down into the Life Company back a few quarters ago.
The impairment itself resulted in about a six or so point impact to RBC, and is fully reflected in the 450% estimate. In looking at that business we have a carrying value of roughly $180 million and I believe that is split in general between goodwill and intangibles, rough justice, but both intangibles and goodwill will tend to be reviewed for markdown when you’re looking at the value of those properties, and so the write-down we took this quarter, for example, was a mix of write-down on both goodwill as well as the intangible aspect of the business.
That marketplace has gone through substantial turmoil. Literally a handful of the largest players in the industry have in one case, a player has actually announced bankruptcy.
A couple of the players are in the midst of having to renegotiate bank covenants, having been over levered and seeing a tremendous falloff in cash flow. So you really have an upside down industry right now among most of the players, and that’s weighing down on valuations and for us, it suggests being patient and continuing to monitor and manage the properties.
These are good properties that perform well in their given markets. We like how they’re positioned, but we think it’s an awfully difficult time to be considering monetizing those investments, and instead we intend to continue to support them for the time being.
Andrew Kligerman - UBS
Then just any chance you could give a little color on the DC market with the net outflows of $62 million? I know you mentioned that there can be some lumpiness in those numbers, but I mean what’s going on there?
Is the economy really hurting it? What are you looking at into ‘10?
I mean could that negative flow continue?
Dennis Glass
It is Dennis. Was that the DC business?
Andrew Kligerman - UBS
The DC business, yes.
Dennis Glass
Well again, the deposits in the fourth quarter were up 5% sequentially from the third quarter, so we did see some improvement.
Andrew Kligerman - UBS
Down 7% year-over-year though?
Dennis Glass
Yes, I understand that, but showing some improvement. The small case market was up 20% over the prior year.
The larger case market, as I’ve seen in some of our competitors releases, is showing more of the impact from the economy. There’s not much movement around.
Employment is being reduced. So I think it was a tough year just because of external factors as well as internal factors.
Now having said that, we do need to make significant investment in this business this year, and probably next year, to bring our capabilities up to the scale that will make us more competitive than we are right now. Last year, just because of all the stress that was going on in the economy, of course at Lincoln, we stopped that investment.
So I would say that we are a little bit behind where we had hoped to be at this time because of slower investment. I think particularly the 403(b) market is a strong market.
We have a very good position in it. We have very good products and with continued thoughtful and rifled investment, we will begin to show some more progress in the DC business.
Operator
Your next question comes from Randy Binner - FBR Capital Markets.
Randy Binner - FBR Capital Markets
Just a quick question, so there’s $1 billion of holding company liquidity net of all the moving pieces here. Is there any update on the amount that you would be required to hold?
I think $400 million to $450 million was a number that was referenced earlier. I am not sure if there’s any change in the thought on that?
Fred Crawford
This is Fred. No change in that.
As a matter of policy, really liquidity policy internally to Lincoln going forward, we would expect to hold, rough justice, a year to 18 months worth of liquidity at the holding company, just as emergency cash on hand. It’s one of the things we experienced through the depths of the crisis is that you can have the credit markets seize up on you for a period time.
If that were to be the case, we don’t want to be caught in a situation where we are either forced into the market to raise capital in an expensive way, or run into any questions surrounding liquidity or availability of liquidity. So, really as a matter of policy, we would expect to retain upwards of $300 million to $500 million of liquidity at all times at the holding company.
Randy Binner - FBR Capital Markets
So $300 million to $500 million and I guess that would that indemnify you if the commercial paper market seized again?
Fred Crawford
Yes, I mean that comfortably, keeping in mind that together with internal lines that are available and untapped, you’re able to comfortably make your way through any maturities of commercial paper.
Randy Binner - FBR Capital Markets
Was there any statutory impact from the media goodwill impairment this quarter?
Fred Crawford
Yes, about six points. We had contributing the media company down to the Life Company, when we take the impairment; it had about six points of impact on RBC.
Randy Binner - FBR Capital Markets
Then just one other kind of housekeeping one, I guess there’s been some talk about investments in the Defined Contribution segment. Just from a modeling perspective, how should we comp that?
I guess there were expenses last year, but maybe they got put on hold. You had mentioned kind of $0.10 of expense investments, if I heard that right.
How should we think about that kind of a comp basis to last year, so we’re sure we are capturing that correctly?
Fred Crawford
Rough justice, the way to think about it is of the investments we’re making across the company and what Dennis had mentioned is investments in DC, investments in our group business, some of the branding work we’re doing and there’s an assortment of other enterprise initiatives, but rough justice, I would characterize the investment in the DC business as being about one third of what we plans to invest in as a company and that maybe a decent way of thinking about rolling it forward.
Randy Binner - FBR Capital Markets
So $0.10 for the whole company, one third at DC and that’s incrementally up from a level you ran at in ‘09?
Fred Crawford
Right.
Operator
Your next question comes from Jimmy Bhullar - JP Morgan.
Jimmy Bhullar - JP Morgan
I had a question, first on the variable annuity DAC. I think you took a charge when the market was around 900.
You had a modest release in the fourth quarter, but just wanted to get an idea on where the market would have to go for you to take a negative unlocking. Then secondly, just on your group insurance sales, they seem pretty strong.
Other companies have reported weakness, partly because the macro environment, but if you could just discuss what’s causing that, and whether you have taken any pricing actions that are helping your group sales?
Fred Crawford
It is Fred. On the DAC corridor, obviously we have built up a level of cushion, having reset the prospective assumption when the S&P was at 900.
It would take rough justice about a 15% or better move in the market for us to be contemplating a positive unlocking off fourth quarter levels and then it would take a pretty severe drop in the markets for us to unlock negatively, upwards of 30%, 35% drop in the market from year end levels to be contemplating a negative unlocking. So that’s what I mean when I suggest that we’ve created some cushion.
For example, if today we were to unlock, unravel the corridor and unlock to the mean, we would be looking at a positive DAC unlocking of roughly $200 million to $250 million pre-tax. That gives you a little bit of an idea of the kind of cushion we have built up.
You do see some retrospective DAC unlocking coming through and helping earnings out and that’s nothing more than the underlying account values performing better than the DAC model assumption upon reset and so the combination of a rising market driving account values, positive underlying fund performance, and slightly better than expected lapse rates are all driving account values up relative to our model, and resulting in some level of retrospective unlocking and that’s what you saw come through the quarter.
Dennis Glass
On the Group Protection, a couple of comments, first, the fourth quarter are always larger by far than the other quarters during the year. So that explains in part the fourth quarter up tick.
Second point and substantive to the increasing results at the company, sales results, is that we’re in the second full year of change to the distribution model. So the model is beginning to settle in and the sales rep development and tenure is paying off.
Average rep productivity increased 10% versus 2008 to up to the highest productivity ever of about $3 million per rep. We’ve done our annual pricing review in mid 2009, just like every other year, some prices increased, some prices decreases, but we’re certain that pricing is not driving the results.
Furthermore, continued refinement in the service model, underwriting and implementation is paying dividends with improved broker and customer experience. I guess in short, the model is working.
We continue to focus on the 50 to 500 market. We’ve got increased penetration in the voluntary market, and we have some what I would refer to as opportunistic sales in the 1,000 employee market, where it sets fits our model, both from a service, the simplicity of product and distribution.
Yes, we are doing very well.
Operator
Your next question comes from Bob Glasspiegel - Langen McAlenney.
Bob Glasspiegel - Langen McAlenney
One LFD and one disability question. What’s your headcount in LFD, and how is that trending, and what is the outlook for 2010 producers?
Dennis Glass
The current headcount or at least the headcount at the end of 2009, now this removes the investment people, but the total wholesaler headcount is 498, managers is 52, and that adds up to 550. That compares to year end actual ‘08 of about 760, down 210.
In terms of trending, as I mentioned, we’re going to continue to focus on productivity. We’re going to add, particularly where we get shelf space that we don’t now have that needs to be serviced.
We are adding wholesalers in our MoneyGuard product, because we are having such tremendous success in that product. So there will be additions.
We will continue to focus on productivity and the additions will be focused on the addition of shelf space and/or where there is a product that is really outperforming.
Bob Glasspiegel - Langen McAlenney
My follow-up is on LFD and then my follow-up is on disability, the business that you got back from Swiss Re. Can you remind me the mechanics of that business, whether it is a closed block or an operating company?
If it is operating, are we going to move it back into an operating unit or is it going to stay in your corporate other line?
Fred Crawford
No, these represent essentially reinsured blocks that are effectively closed blocks and are effectively in runoff. They are not a business unit.
They don’t represent a business that we’re taking back and they will be running through our corporate and other segment of the business as a result. It is all told about $1 billion or so of reserves on three different blocks of DI business that are quite old and we believe now, after having reviewed the numbers, we’ve setup certainly adequate reserves to support that business rolling forward.
There’s really a de minimum impact the go forward earnings of the company, and so not really an impact item there, but yes, runoff blocks that we simply have to administer and sort through what we want to do it them in time.
Bob Glasspiegel - Langen McAlenney
What age roughly is the in force average age?
Fred Crawford
I don’t know that I can answer that Bob. We would have to maybe get back to you with some more.
Operator
Your next question comes from Mark Finkelstein - Macquarie.
Mark Finkelstein - Macquarie
Fred, you kind of alluded to AXXX solution. You got the AXXX $400 million kind of capital relief done this quarter or last quarter.
Can you just talk about the status of AXXX solutions, kind of what you’re seeing in terms of availability? Is it not available now, at what prices and then or do you see the solution being more kind of regulatory based as opposed to financing based?
Fred Crawford
The transaction we did at year end, the $550 million LOC for $400 million of relief was related to term life block. The degree to which we continue to sell term life, which has been growing and building any reserves on that front, we feel comfortable that we can find attractively or at least reasonably attractively, priced long term solutions.
On the universal life side it is arguably more difficult to structure transactions because of the dynamics of that product. Our approach to it is really the following and that is, we would expect to use a combination of long term solutions, structured solutions, which they are out there, but they are more complex to execute on and that’s why we want to be patient when pulling the trigger on them.
A combination of that, letters of credit, shorter term in nature or intermediate term letters of credit, but downsized from our current usage and then just capital on a temporary basis, so the degree to which we have to absorb and take the after tax impact of capital related to the runoff of any letters of credit, we will do that within our RBC, just to be patient. It is a timing issue.
We do believe these are markets that will offer up opportunities for term solutions. We also think the bank market is notorious for running hot and cold on letters of credit over the years.
So what we’re most pleased with in terms of our capital position is that we can be patient, and work to execute a long term solution that makes sense for the returns in the business. That’s what we will attempt to do.
On the regulatory front there continues to be dialogue, as you know on this topic, but the progress is slow and we continue to try to push it forward. We think that’s very necessary for the industry and good for the industry, but the progress is slow, and I don’t think we could build our plans around that kind of a solution, albeit we continue to work hard on it.
Dennis Glass
If I might just add something, I think everybody understands the fact that we’ve redesigned our secondary guaranteed product. That what we have is what we’ve got in terms of the need to release some of these reserves as LOCs mature and as Fred has been pointing out, this really is a longer term issue, and it’s mitigated quite substantially even under the most difficult environment by the fact that we have a 450% RBC as we sit here today.
So it’s not a growing problem. It’s one that we could handle with smaller market availability, if that were to happen.
Then I want to make the important point as well that we’re the number one player in the universal life business. We have been for many years and that gives us an advantage over others, because we just have such a large number of policies, such varied number of different type of underwriting sales and so if anyone is going to be able to do this, Lincoln is going to be able to do this.
Again, I think overtime, as Fred said, the banks will be back in this market, but I would just summarize by saying the size of our block, the skill of our finance team, the different avenues that we have at this point to handle the situation, it is something that we’re resolving, but again to use Fred’s terms, we have enough capital to be patient as we work through these things.
Mark Finkelstein - Macquarie
I guess my follow-up is just, Fred, I think you mentioned you put capital in the captive. I guess how much did you put into the captive?
Can you give an overview of the capitalization of the captive at year end?
Fred Crawford
We put $250 million into the captive at year end. About $100 million of that was more specifically the result of adopting VACARVM or AG 43 and needing to increase the reserve credit, if you will, that Lincoln National Life Insurance Company needs from the captive.
So that was just to marry up assets with the reserve credit. The additional $150 million was there to bolster capitalization of the captive, recognizing the business that runs through it, and the need to hold higher capital levels to absorb market volatility, etc.
I don’t have at my fingertips the balance sheet if you will, of the Barbados subsidiary, other than to say we think the injunction of capital went a long way to building out its balance sheet to absorb some of these movements going forward. What we’re going to have to do Mark, as we watch our overall insurance capitalization, is balance the level of capital margin we have in our core life insurance subsidiaries with what the captives need to support these reinsurance credits that we take.
We also need to be mindful of the fact that these captives need to some degree stand on their own relative to their capitalization. So part of what we did when we injected the capital into Barbados was not simply a VACARVM issue, but also to start moving in the direction of capitalizing these captives at higher ratings levels or the equivalent of higher ratings levels.
Operator
Your next question comes from Colin Devine - Citi.
Colin Devine - Citi
A couple of questions, Fred, you mentioned you had to increased, or you elected to the increase reserves on the VA block, and that was related to some assumption changes. Could you clarify how much you had to increase the reserves, and specifically what assumption changes you made?
Then also with respect to the RBC level, is part of the reason why you’re maintaining such a abnormally high number right now is that also captures that the rating agencies are looking at LOCs differently right now, that they are factoring it into their models, and that they’re putting in a charge for that sort of thing, which we may not be seeing under the NAIC?
Fred Crawford
Sure. First, on the reserve issue, I think what you’re referring to is what we took through the hedge program in a negative related to a refinement of our estimate of 133 versus SOP reserve.
What we’re doing there, and this is somewhat commonly done in the industry, is when you are offering a variable annuity that has a mortality element to it, such as an income benefit or a lifetime withdrawal benefit, you have to and are really required to take a level of insurance reserving and not just a pure FAS 133 derivative. When you take that insurance component of the reserving, that’ done under an SOP approach.
In our particular case, it ended up actually increasing the reserves backing these guarantees. The reason being that on a pure derivatives basis interest rate movements and equity market recovery had driven down the derivative nature of the liability pretty significantly, while the SOP or insurance liability is more specifically sensitive to equity markets and not interest rates.
So as interest rates rise, you don’t have quite the dynamic of driving down your reserve need as you would in a derivative structure, so that’s result. So it’s a blended or so-called hybrid approach, 133 SOP, and served to increase the reserve in the period, offsetting what otherwise would have been a gain in the actual hedge program itself.
On the RBC, you’re absolutely correct. There is a growing level of discussion and work being done at the rating agencies on how best to treat shorter term securitization or life solutions in the overall capital structure of insurance companies and most notably, the agencies have been looking at for a while now the notion of shorter term letters of credit, or long term solutions that are reaching closer to maturity, and factoring in, or feathering in, some element of that to your overall leverage.
So when we look at the total company capitalization, the combination of RBC and holding company leverage, we have to factor in the notion of to the degree we can’t find long term solutions, we have to be delevering the company to absorb this. Now obviously, we continued to look for long term solutions and most of the rating agencies have pointed to the longer term solutions, out beyond five years, for example, as retaining their capital credit and not being necessarily infused into your leverage.
So, yes, it does play into our overall view.
Colin Devine - Citi
Now with that, when we think about the profitability of the big secondary guarantee you all blocked that Lincoln has, and as Dennis pointed out, I guess in the industry. What sort of long term return are you going to make off the in-force?
I appreciate, you changed the pricing and adjusted it for the go forward business, but it’s the in-force, how much capital does that tie up, and how much is it going to weigh you down?
Fred Crawford
Here’s kind of a way to think about it. If you exclude goodwill, we reported an ROE in the Life business of around 9.6%, Shy at 10%, on an unlevered basis.
If you normalize for normal limited partnership income that runs through there, you would kick that up closer to 11%. The reserve financing equation, that is the ability to finance reserves, has in and around a couple of hundreds basis point, or so benefit to returns upwards of 200 to 300 basis point benefits to returns.
So the degree to which you’re unable to do any, versus able to do all of it, has a relatively big swing factor in the returns. The actual cost of the securitization is less an impact on the returns.
For example, the recent transaction we did on the term life business over the course of the entire block of the business would have as much as maybe 50 basis point or so negative impact on returns. So finding these long term solutions is important to supporting the returns of the in-force block.
As Dennis mentioned, we’ve restructured the product and done some level of repricing to alleviate that need on the go forward basis, but we have to continue to address the returns on the in-force. As a result, we’ll keep looking for these long term solutions, but what we want to be as patient.
We don’t want to have a gun to our head to have to put them in place, if pricing is not cooperating, or if market dynamics don’t dictate. So we’re hopeful that being patient we can securitize a lot of this product and do it at rates that defend the returns in the business.
Colin Devine - Citi
You’re thinking over the next two years then, before those LOCs mature?
Fred Crawford
Yes, in fact, we’ve been working on it really ever since putting the LOCs in place. It was really never our intention to rely solely on letters of credit.
They’re available; they’re obviously economic, but that’s not really the way in which you would normally manage these reserves. We had to take a timeout during the crisis, obviously, because the markets were shut down, but it’s always been our intention to term it out and that’s what we’ll do over the next few years.
To the degree that we have to absorb some level of letter of credit runoff, we’ve got the capital to absorb that.
Dennis Glass
I would just add that, although it blends in overtime, that these repriced secondary guaranteed products with reasonably conservative assumptions are the new business is projected to get 12% to 15% unlevered returns. So adding to working hard to get the capital teed up at the right level and at the lowest cost in the business to improve the in-force, we’ll be adding new business at much higher ROEs.
Colin Devine - Citi
Dennis does the timing of this then potentially impacts your ability to repay the TARP? Do we really have to get this thing fixed that’s the last question or addressed before you can really button down the TARP repayment?
Dennis Glass
Of course, a lot depends on what’s going on in the markets. As I said, we expect to repay TARP at the end of 2010, the beginning of 2011.
I guess, you might think of it in two buckets. One is, the capital that we have at the holding company, and we have substantial excess capital there as well as available to prepay CPP, and then you can think about the insurance subsidiaries, with this high level of RBC, is probably the dominant bucket, if you will, to worry about these other things.
So in short, I think the CPP can be handled in our timeframe, given where we are today.
Fred Crawford
One other thing I would add, because it’s a worthwhile, it all has to be factored into itself, but one other thing I would add is that, the CPP is treated as 100% leveraged by the rating agencies, because the notion is that it will be repaid. So despite its preferred stock nature, it serves to pump up your leverage.
So repayment of CPP, whether with cash on hand or other forms of financing, will naturally be a delevering event, and you want that delevering event to take place as you then go out to credit markets for long term solutions on Life Insurance. So there are some sequencing issues that really work in your favor as a company.
You want to do favorable credit spread actions as a company, when you’re looking to then go out and find these solutions on the Life side.
Operator
Your next question comes from Tom Gallagher - Credit Suisse.
Tom Gallagher - Credit Suisse
I just wanted to follow up on the AXXX question. Not to beat a dead horse here, but I think there’s been a lot of attention on the $1.5 billion of LOC refinancings that lie ahead of us, but I guess what surprised me was when you announced AXXX deal, that there was a source of capital relief, not capital pressure.
So I guess my question is; are there other pockets of the in-force XXX or AXXX that you currently don’t have a solution for that are creating similar strain? If so, might we hear about more XXX or AXXX deals ahead, which are not to alleviate pressure, but rather to lift RBC?
Fred Crawford
A couple of things one is, we really always had a level of additional reserves held on our balance sheet related to term life NUL. In other words, we’ve always been absorbing some level of XXX and AXXX onto our actual balance sheet.
So at year end you simply saw us take a block of that business that was otherwise held to capital weighing down on our RBC, and finding a better financing solution for it out in the marketplace. As a matter of routine, you should know each year, year in and year out, there’s a natural build in some of these reserves, and we carry that build through our statutory income, and we remain profitable in our Life business despite carrying those levels of excess reserves.
So by nature, the answer to your question is, yes, there will always be a level of reserves that could be subject to financing solutions, but would probably be the case that we’re not going to simply securitize or find solutions for every last dollar. It’s always going to be the case that we retain a level of this in our balance sheet, in our RBC, and we would expect to do that going forward.
I think most of our activities, particularly because of the new product we launched that starts to stop the issue going forward. Most of our activities would be addressing in-force and addressing more refinancing activities related to our current use of letters of credit.
Tom Gallagher - Credit Suisse
So, Fred, all else equal, that’s probably the last big in-force deal and then what we need to focus on would be the LOC refinancings from $1.5 billion or so?
Fred Crawford
That would be what we’re focused on. Overtime, as we continue to sell term life and other business, there will be opportunity likely to bring more of, particularly the term life out into the marketplace, but that will take sometime.
So our focus now is going to be on the refinancing of existing solutions to really term them out into longer term structures.
Tom Gallagher - Credit Suisse
Just one follow-up, the re-rating benefit, PIMCO, and did you also get a CMBS re-rating benefit from Realpoint? If so, could you quantify each one of those?
Fred Crawford
No CMBS impact in the quarter, but we did have the RMBS impact. It had about a 20 point positive impact to our RBC.
Operator
Your next question comes from Eric Berg - Barclays Capital.
Eric Berg - Barclays Capital
Fred, you and Dennis have talked repeatedly in this call about plans to find permanent solutions, term out some of the shorter term solutions that you have had for XXX and AXXX, but after all securitization in general was at the center of the financial crisis, and my sense of things tell me, whether it’s your sense is that the securitization market in general was basically dead. There may be some securitizations, but it’s a very, very small market.
I’m not aware of any, if there have been, I’m not aware of them, major securitizations of Life Insurance reserves. Why are you hopeful that this market will come back?
Do you perceive it, for example, as being materially different from say the traditional securitization markets of car loans and auto loans? Or isn’t there a risk that investors will just use securitization as one sort of nasty thing that they don’t want to ever hear about again?
Fred Crawford
I think first, it’s absolutely important to be planning your capital structure to not rely on any piece of the capital markets necessarily being there and being attractive at a moment in time. So most importantly, while we do have confidence that we can structure solutions in time, we need to ready our capital structure to be patient, because it takes time to structure these.
They’re not always available, just as you have noted. So that is A number one, is we’re not relying upon having to have a solution to manage at a competitive and strong risk-based capital for our ratings.
Having said that, these markets, the engineers that surround these markets are quite creative and quite active and as you can imagine, we’re in a level of dialogue, and have been for quite sometime, looking at a number of structures, many of which have pros and cons that you have to weigh before you would look to execute. One of the things that we want to be very careful about and set ourselves up for does not have to have a rush into a marketplace that’s disruptive and costly, and that’s what we mean by being patient.
Letter of credit markets are notorious for falling out of bed and then coming back. Reserve securitization structures can fall out of favor and back in favor.
So you’re right to say it’s more complicated. You’re right to say that the financial crisis has hurt the securitization market, but we do think the dynamics around this are such that we can find some longer term solutions in time and if we can’t, we need to retain the excess capital to absorb any temporary shortfall.
Dennis Glass
The strong message that we’re sending is that, given the capital conditions in the Life Company we add no pressure from RBC strength, even if we don’t do the LOCs. So from my perspective this is and Colin was driving at it.
This is all about how do we maximize the ROE on the book of business. I think that is the key issue, not this impending LOC issue.
Eric Berg - Barclays Capital
My second relates to sort of a follow-up to an early discussion on CPP. I certainly heard your message is coming through loudly and clearly, Dennis; that you’re going to do this when it is appropriate, but do you have excess cash at the holding company, given your desire to have more liquidity than in the past?
Similarly, given that you’ve acknowledged that the rating agencies are going to sort of haircut your capital at the Insurance Company for LOCs, do you originally have excess capital that in theory could be a source of funding to repay CPP from the Life companies? Do you really have money right now to repay the CPPs is really the question?
Dennis Glass
The question as to how we’re going to repay CPP has to take into consideration the different sources. I don’t want to get into, because we don’t know exactly what mix of cash/debt and some small possibly some smaller amount of equity in terms of the reduction of the whole amount, but as Fred said, we do have a policy not a requirement so much as a policy of keeping about $300 million to $500 million at the holding company.
So if we’ve got $1 billion, because we’ve already netted out to $250 million we need next year, we really only need $300 million to $500 million at the holding company. So in theory at the low end of that, we would have $700 million of cash available to repay CPP, at the high end $500 million.
So, but yes, there is capital and let me see say it differently, there is significant cash available to pay a portion of the CPP, as we sit here today.
Operator
Your final question comes from John Nadel - Sterne Agee.
John Nadel - Sterne Agee
Under the wire, just a couple of quick follow-ups; Fred, did you mention what 2009 statutory earnings were?
Fred Crawford
No, I did not. Pretax earnings, the statutory earnings, I think ran around $900 million, give or take.
Dennis Glass
The operating earnings, Fred, ran about a little over $1 billion on an after-tax basis and of course we had to realize losses that went against that, giving us net income in the $200 million range.
Fred Crawford
So do you follow that?
John Nadel - Sterne Agee
No, I just missed it. So pretax or after-tax, I’m not sure?
Fred Crawford
Operating earnings after-tax about $1 billion, then you had realized losses and impairments that brought the net income down to about $200 million.
John Nadel - Sterne Agee
How do we think about 2010, relative to 2009?
Fred Crawford
A couple of comments I’d make on those results. Those are very strong stat earnings results for our company relative to a normalized basis.
Meaning, it would typically be the case that you ‘d generate statutory income of rough justice between 60% and 70% of your GAAP earnings, year in and year out, that’s assuming you have a growing business platform, which we do. So what you saw come through this year was adjustments related to the market increase and CARVM adjustments running through, some favorable tax items that were running through the year.
So we were afforded a particularly strong stat earnings, now don’t lose sight of the fact that we also got damaged on the stat income side as we rolled through 2008.
John Nadel - Sterne Agee
Well, I was just going to mention that’s probably just a lot of recovery. Yes.
Fred Crawford
Right, some of its recovery, but just be careful about running forward with a normalized stat income assumption that we experienced here in 2009. We would expect it to normalize down a bit.
John Nadel - Sterne Agee
Then you made a comment early on, Fred, I think I missed it, just on, and I think you made a comment on your outlook for alternatives yield in 2010. I just missed it.
Fred Crawford
Yes, our outlook would be that the portfolio would start the process of recovering, and would generate between 5% and 10% returns pretax. That’s a $700 million portfolio.
John Nadel - Sterne Agee
Then the last quick one then, so putting that together, I think you mentioned what it was at nickel of pressure relative to the securitization, $0.10 from investment spending. Was there any other sort of incremental items, one way or the other, just to summarize them?
Fred Crawford
The nickel was related to unabsorbed overhead from the sale of Delaware.
John Nadel - Sterne Agee
That it, sorry I missed that.
Fred Crawford
Then the $0.10 is on strategic investments. The only item we noted was the impact of the securitization, or the LOC really.
I use the term securitization, but really these are financings that we’re doing on the Life side and the structure of that financing together with the movement of reserves, and that is the assets out of reserves and into unallocated capital, brings down the Life segment earnings by about $7 million a quarter, but don’t lose sight of the fact that that’s going to be picked up about $4 million of that will be picked up in other operations, where we hold unallocated capital.
John Nadel - Sterne Agee
Those are both after-tax numbers?
Fred Crawford
That’s right.
Operator
That does conclude our question-and-answer session. I would like to turn the call back over to Mr.
Sjoreen, for any additional or closing remarks.
Jim Sjoreen
We want to thank all of you for participating this morning and if you do have any follow-up questions, as always, we will take your questions on our Investor Relations line at 1-800-237-2920 or via e-mail at [email protected]. So again, thank you for participating, and have a good day.
Operator
Once again, that does conclude today’s call. Thank you for your participation.