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Lincoln National Q4 2022 Earnings Call Transcript

Participants

Corporate Executives

  • Al Copersino
    Vice President & Head of Investor Relations
  • Ellen Gail Cooper
    President, Chief Executive Officer & Director
  • Randal Jay Freitag
    Executive Vice President, Chief Financial Officer & Head of Individual Life

Analysts

Presentation

Operator

Good morning, and thank you for joining Lincoln Financial Group's Fourth Quarter 2022 Earnings Conference Call. [Operator Instructions] Now I would like to turn the conference over to the Vice President of Investor Relations, Al Copersino. Please go ahead, sir.

Al Copersino
Vice President & Head of Investor Relations at Lincoln National

Thank you. Good morning, and welcome to Lincoln Financial's fourth quarter earnings call. Before we begin, I have an important reminder. Any comments made during the call regarding future expectations, including those regarding deposits, expenses, income from operations, share repurchases and 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 and that could cause actual results to differ materially from current expectations. These risks and uncertainties include those described in the cautionary statement disclosures in our earnings release issued yesterday as well as those detailed in our 2021 annual report on Form 10-K, most recent quarterly reports on Form 10-Q and from time to time in our other filings with the SEC.

These forward-looking statements are made only as of today and we undertake no obligation to update or revise any of them to reflect events or circumstances that occur after this date.

We appreciate your participation today and advice you to visit Lincoln's website, www.lincolnfinancial.com, where you can find our press release and statistical supplement, which include full reconciliations of the non-GAAP measures used on the call, including adjusted return on equity and adjusted income from operations or adjusted operating income to their most comparable GAAP measures.

Presenting on today's call are Ellen Cooper, President and CEO; and Randy Freitag, Chief Financial Officer. After their prepared remarks, we will move to the question-and-answer portion of the call. I would now like to turn the call over to Ellen.

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Thank you, Al. Good morning, everyone, and welcome to Lincoln's Fourth Quarter 2022 Earnings Call. Before we begin, I am excited to discuss the news we released last night that Chris Neczypor, currently Lincoln's Chief Strategy Officer, will be appointed Chief Financial Officer effective February 17. Chris has more than 20 years of experience in the industry. He joined Lincoln in 2018 as Head of Investment Risk and Strategy and was named Chief Strategy Officer and a member of our senior management committee in 2021. In the strategy role, he quarter backed the organization's shift to our current strategic objectives, working closely with the finance organization and our businesses and built dedicated teams focused on corporate development including evaluating potential transactions.

Before joining Lincoln, Chris held a variety of roles in the life insurance industry, including as an analyst and an investor after having started his career as a CPA and auditor of life insurers. Throughout his career, he has cultivated a deep knowledge of the complexities of insurance financials. Chris' leadership will be critical as we continue to fortify our capital position. Chris and I have worked alongside each other for five years, and I know that with his deep financial acumen, analytical expertise and strategic understanding of our business, he will be focused on our balance sheet resilience and the overall drivers of our valuation.

Chris will be succeeding Randy Freitag. Randy will remain CFO through February 16, and continue to work with us through the end of the first quarter to ensure a smooth transition. Randy has made many contributions to Lincoln over the years, and I would like to take a moment to recognize Randy and wish him the absolute best for his next chapter. I know you'll join me in congratulating Chris and also thanking Randy.

This morning, I will provide an update on our strategic progress, followed by some key business unit highlights. Since our third quarter earnings call, our new leadership team has been taking the necessary steps to rebuild capital and strengthen our balance sheet while positioning the overall franchise for profitable, capital-efficient growth.

We have a differentiated business model with a powerful distribution franchise, broad product offerings and a diversified, high-quality investment portfolio. These strengths set the foundation for successful execution of our enterprise-wide priorities. And as we move forward, we will continue to focus on the following strategic objectives.

First, maximizing distributable earnings and improving capital generation; second, reducing capital sensitivity to market volatility; and third, further diversifying our earnings mix. To this end, we have taken quick actions and made substantial progress in the last quarter to rebuild capital and our ongoing pace of capital generation, including raising $1 billion of preferred capital, further improving our new business capital efficiency, fully repositioning our VA hedge strategy, putting a partial tactical hedge on our VUL in-force, continuing to implement our Spark enterprise-wide expense initiative, enhancing the profitability of our group business and seeking to unlock the value of our in-force book.

I will further elaborate on each of these at a high level. As a result of the swift and targeted action we took in the fourth quarter, we raised $1 billion of capital through a preferred issuance and expect to end the year with an RBC ratio of approximately 383%, an improvement as we drive towards our target of 400%.

Turning to new business capital efficiency. Across Retail Solutions and Workplace Solutions, we are focused on delivering a more capital-efficient product mix, which will continue to produce a robust level of sales while requiring approximately $300 million less in new business capital this year.

We are selling on our terms with new sales in all four businesses meeting or exceeding target returns. This focus on capital efficiency and profitability will also contribute to higher present value of distributable earnings from new business going forward. We are able to make this pivot continuing to evolve our products away from long-term guarantees and to provide more options that are attractive for customers involving risk share.

More tightly focusing this capital where we have differentiated products and long-standing relationships with key distribution partners, with, for example, more of a focus on permanent products over individual term life, using flow reinsurance to enhance capital efficiency and focusing on higher margin, more capital-efficient products and segments across both our Retail and Workplace Solutions businesses.

Next, we fully repositioned the variable annuity hedge program to align with our objectives of maximizing distributable earnings and providing explicit capital protection. As a result, we expect to see less capital volatility in [Indecipherable]

In addition, as we focus on improving profitability as well as future capital generation and earnings growth potential, we continue to make substantial progress in the implementation of Spark, our enterprise-wide expense initiative expected to contribute run rate savings of $260 million to $300 million by late 2024. We are also progressing on our group protection margin expansion efforts.

We ended full year 2022 with an underlying margin of 5.3%, within our 5% to 7% target range, with a focus on disciplined pricing and underwriting, providing optimal return to work outcomes for our claimants and implementing segment-level strategies to build a more diversified and balanced book of business. We expect over time to sustain a group after-tax margin in the 7% range, inclusive of pandemic claims.

Finally, to maximize the value of our in-force book of business, our fully dedicated team remains engaged in evaluating internal and external opportunities including possible block reinsurance transactions designed to advance our strategic objectives.

As we focus on these capital and profitability improvement actions that will positively impact distributable earnings in 2023 and beyond, we are also experiencing headwinds, which we have discussed in the past, such as near-term capital market impacts, pressure on the life business and higher inflation-driven expenses that Randy will discuss further.

Accounting for these pluses and minuses, our 2023 distributable earnings remain in line with our prior expectations. And as we look to 2024 and beyond, several of the initiatives that are well underway are expected to drive further improvement in capital generation. We generally expect the 2023 headwinds to begin to dissipate in 2024 or be offset by larger positives. For instance, the growing benefits of our profitability improvement initiatives.

Going forward, over the longer term, we expect the distributable earnings and GAAP earnings power of our business to reemerge.

Moving to the quarter's results. We demonstrated improving loss ratios in our group business, positive flows in both Retirement and Annuities and a sequential increase in life insurance sales.

Let me now discuss some key business unit highlights. Fourth quarter life insurance sales were up sequentially in all products except for terms where we took pricing actions. Fourth quarter life sales were down from a strong prior year quarter, though sales were up for the full year, particularly in indexed universal life.

We have a broad, diverse product portfolio, and as we previously indicated, our distribution leadership is most effective in permanent life products. Annuity sales increased 7% from the prior year quarter with positive flows reflecting continued strength in index variables and fixed index products.

We continue to see a mix shift away from products with long-term guarantees in both our sales and our in-force. Our Workplace Solutions business included a strong year and remain key to our long-term strategy.

Group Protection had a year of solid top line and overall earnings results. Premiums grew 7% for the full year, as strong persistency and organic growth continue to generate premium increases, while fourth quarter sales declined 8%, full year sales rose 15% with increases across all products and case size segments. We continue to see heightened interest in our supplemental health portfolio, and we're pleased with the sales in this category.

In Retirement, despite a 7% decline in fourth quarter total deposits from a strong prior year period, full year total deposits rose 10%. On a full year basis, net flows were a record $2.9 billion, marking the eighth consecutive year of positive flows for our Retirement business. Finally, Lincoln's investment portfolio continues to be well positioned in the event of a potential credit cycle given its diversification and high-quality nature.

In closing, we have been fortifying our capital position, increasing our future capital generation and positioning the franchise for future profitable earnings growth. While there is more to do, we have accomplished a great deal in a short period of time and have built the foundation and put the leadership team in place to execute successfully on our plans.

And with that, I will turn the call over to Randy.

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Thank you, Ellen. both for those words and our 10 years working side-by-side. Before I get to our results, I'd like to let you know what an honor it has been to serve as Lincoln CFO for the past 12 years. And thank you all for your contributions to this industry that we are so fortunate to work in. While we have had both agreements and disagreements over the years, I'd like to thank that we learn from each other unless are all better for our interactions. Thank you again, and I wish you all nothing but success as you progress through your careers.

With that, let's get started. Before discussing our earnings results today, I will expand on Ellen's comments regarding our capital position. Statutory capital at year-end was $9.6 billion. We down-streamed $780 million of the preferred proceeds to our life company and expect to end the year with an RBC ratio of approximately 383%.

This compares to the previous guidance of 360% as the contribution of the preferred proceeds was partially offset by $116 million legal expense in other operations. In [Indecipherable] capitalization improved sequentially and is in line with our long-term target. Cash at the holding company stands at $960 million, up $200 million sequentially, the result of retaining a portion of the preferred proceeds to complete the prefunding of our September 2023 debt maturity and book value per share, excluding AOCI, ended the year at $63.73.

Now let me turn to our earnings. Last night, we reported fourth quarter adjusted operating income of $170 million or $0.97 per share. As we noted in the earnings release, adjusted operating income included a net unfavorable notable item of $116 million or $0.68 per share from legal expenses, pandemic-related claims of $41 million or $0.24 per share and below-target alternative investment income of $43 million or $0.25 per share.

Net income for the fourth quarter totaled $6 million or $0.01 per share. The difference between net income and adjusted operating income was primarily due to hedge breakage and nonperformance risk.

Now turning to segment results, starting with Life Insurance. Operating income for the quarter was $46 million compared to $80 million in the prior year quarter. The drop was primarily driven by alternative investment results and the quarterly run rate impact of the third quarter unlocking, partially offset by improved pandemic claims.

Base spreads were 122 basis points for the quarter, down from 135 basis points in the prior year quarter. This was due to the impact of certain duration extension programs put in place during the low rate environment. In addition to the life business, not yet fully benefiting from higher interest rates due to the long duration and low turnover of its investments.

At today's rate environment, we anticipate that 2023 spreads will stabilize about 10 basis points below fourth quarter 2022 levels before beginning to expand in 2024 and beyond. Average account values net of reinsurance fell 6%, reflecting the impact of lower equity markets, while average in-force space amount grew 11%. The Life Insurance business faced many challenges in 2022 and will continue to be pressured in 2023 by pandemic claims, higher reinsurance costs with some additional spread pressure.

All that being said, we remain confident in our ability to improve the business over time. Annuities reported operating income of $238 million compared to $332 million in the prior year quarter, reflecting the decline in the capital markets in 2022.

Given the market decline and excluding the benefit of the third quarter unlocking, we are pleased that our Annuities business delivered a 2022 return on assets of 68 basis points and return on equity of 18%.

Our net amount of risk for living benefits and death benefits improved to 5% and 4% of account values, respectively, reflecting the sequential rise in equity markets during the quarter. As we continue our progress in diversifying the annuity business, VAs with living benefit guarantees now represent 45% of total account values, a decrease of five percentage points from the prior year.

Looking ahead, we expect our diverse product portfolio, revised VA hedge program and the benefit of higher interest rates to help drive future earnings and cash flow generation.

Turning to Group Protection. We reported operating income of $47 million, an increase from an operating loss of $115 million in the prior year quarter, aided by lower pandemic-related claims of $116 million and improved underlying disability results of $35 million.

Group's underlying margin was within our target range of 5% to 7% for the quarter and the full year at 5.2% and 5.3%, respectively, when adjusting for the pandemic and unfavorable alternative investment income.

The loss ratio adjusted for the impact of the pandemic was 77.1%, a 420 basis point decrease from the prior year quarter reflecting improved group life and disability loss ratios. Overall, 2022 was a year of progress for the group protection business, and we are well positioned to achieve and sustain a 7% margin over time.

Retirement Plan Services reported operating income of $49 million compared to $57 million in the prior year quarter. with the reduction primarily driven by the impact of lower equity markets on fees and alternative investment income, partly offset by higher spreads. Average account values declined by 10%, as lower markets more than offset the benefit of full year net inflows.

Turning to spreads. Base spreads, excluding variable investment income expanded over the prior year quarter by 30 basis points. For the full year, base spreads expanded 10 basis points, which is a level of expansion more in line with our view of the go-forward rate of improvement. Reported spreads declined eight basis points over the prior year quarter. In 2023, we expect reported spreads to be in line with 2022 results as lower variable investment income is offset by base spread expansion. The improved rate environment, coupled with our proven track record of delivering positive flows, positions Retirement to continue to deliver strong results going forward.

Moving to investments, where we continue to report excellent credit results and increasing new money yields. The portfolio's credit quality improved throughout 2022, as we benefited from net favorable credit migrations. At 97% investment grade, the portfolio is at its highest quality in the last decade. We continue to leverage our multi-manager platform to perform name-by-name scenario analysis across the entire portfolio under a range of scenarios and are well positioned in the event of a potential recession.

Fourth quarter new money yield rose 70 basis points sequentially to 5.7%, 160 basis points above the 4.1% yield on the fixed income portfolio. Lastly, our alternative investment return was a positive 0.4% this quarter. For the year, we achieved a positive 2% return below our long-term target of 10%, but materially outperforming major public equity indices.

With LDTI going into effect as of January 1, I will provide a few brief updates. First, as noted on our LDTI initial disclosure call in September, we continue to expect a minimal impact to overall operating earnings. Within the business units, we expect Life Insurance to be negatively impacted by approximately $100 million to $120 million, which will be offset by a positive impact in annuities of a similar size.

As we also mentioned in September, adjusted operating EPS will exclude market risk benefit fair value changes and will include an estimated $800 million of VA hedge costs. Second, we estimate that the impact of LDTI will increase year-end total book value by about $300 million and reduce year-end book value excluding AOCI by $900 million. These figures represent improvements from the second quarter estimates we disclosed in September, largely driven by the positive impact of higher interest rates on market risk benefits in the second half of 2022, partially offset by the negative impact of the removal of shadow DAC. As a reminder, under LDTI, we will introduce a revised definition for adjusted book value ex AOCI that will remove variances in MRV fair values and changes in the values of the related hedge instruments.

Turning briefly to our 2023 expectations. There are several headwinds that we expect to impact distributable earnings as well as adjusted operating results this year. First, pressures that are capital markets related, including higher borrowing costs and floating rate debt, and certain duration extension programs as well as lower prepayment income. Second, while reduced from 2022 levels, we would expect some ongoing pandemic claims. Third, outside of the benefits of Spark, we expect some pressure on expenses, including those tied to inflation levels as well as costs associated with our legacy pension plan. And in the Life business, we also expect a further increase to reinsurance costs.

These headwinds notwithstanding, our view of 2023 distributable earnings remains in line with our prior expectations. Against the volatile market backdrop, I am pleased with what we were able to accomplish in a short time, particularly strengthening our balance sheet and implementing our new hedge program.

Although it was a tough year for the Life business, our other businesses performed quite well, and there are many initiatives underway to improve our capital generation and earnings power.

And now I will hand it back to Al.

Al Copersino
Vice President & Head of Investor Relations at Lincoln National

Thank you, Ellen and Randy. We will now begin the question-and-answer portion of the call. As a reminder, we ask that you please limit yourself to one question and one follow-up and then re-queue if you have additional questions. With that, let me turn the call over to the operator to begin the Q&A.


Questions and Answers

Operator

Thank you. [Operator Instructions] Our first question is from Tom Gallagher with Evercore ISI, your line is open.

Thomas Gallagher
Analyst at Evercore ISI Institutional Equities

Good morning, First, Randy, best of luck to you. It's been good working with you over all these years. Ellen, my first question is just on, you mentioned exploring block reinsurance deals. Can you comment on whether this is mainly focused on life insurance and GUL specifically or are you also exploring VA transactions?

And then just second part of that is, are you also open to considering strategic transactions at this point? I'm kind of referring to what AIG did with Blackstone or something along those lines? Thanks.

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Sure. So Tom, as it relates to our overall focus, we're really focusing right now on opportunities that will maximize the value of our in-force. And we're doing that right now with a much wider lens, and we're evaluating both internal and external potential solutions. So what we have said is that we have a fully dedicated team right now that is actively evaluating that the opportunity to do something externally has clearly expanded as we know that there are more buyers out there, first of all, and secondly, there are more buyers out there that would be interested in the potential for complex liabilities.

And most importantly, whatever we would do here would be supportive of the enterprise strategic objectives that we've laid out. So we would be looking ideally for some opportunity here that would improve, first of all, our ongoing capital position, but also improve the rebuild of capital as well.

So really the ability to be able to, to do both of those things at the same time. So more to come as we're able to communicate this going forward to you. I'm not going to give you at this point in time, a specific product orientation because really, the reality is, is that if there's an opportunity that makes sense for us and it's good for shareholders and is at the appropriate price, we would look to transact.

Thomas Gallagher
Analyst at Evercore ISI Institutional Equities

And then, Ellen, on the strategic side, are you -- is that something you're considering with a strategic partner or are you really focused on financial transactions at this point?

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

So at this point in time, we're really focused on financial transactions that at the end of the day would optimize the value of the in-force, if there was an opportunity out there that was along the lines of what you were talking about, again, and it made sense, we would clearly evaluate that as well.

Thomas Gallagher
Analyst at Evercore ISI Institutional Equities

Great. And if I could slip in one numbers question. The $300 million of lower strain from new sales in 2023, was there a consideration of doing a bigger amount of flow reinsurance to provide more cash flow relief or is that sort of the max benefit that you could get from the flow reinsurance?

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Yes. So in this number are quite a few management actions. And one of those actions is to be expanding and extending some of our flow agreements to be focused on capital efficiency. And the other thing that I want to mention here is that in addition to the $300 million, and I highlighted this in my upfront comments, but I really want to stress that we've got the expectation of robust level of sales across all four businesses with the expectation of freeing up $300 million in terms of capital efficiency..

And we also expect to be improving the forward distributable earnings, go forward, of that block of sales going forward. So we expect an ongoing capital generation improvement as well.

Thomas Gallagher
Analyst at Evercore ISI Institutional Equities

Great, thanks.

Operator

The next question is from Erik Bass with Autonomous Research, your line is open.

Erik Bass
Analsyt at Lincoln National

Hi, thank you, so you've guided to $600 million to $800 million of distributable earnings for 2023 before interest expense. I was just hoping you could help us think about how that over time, maybe expand on some of the levers for improvement, Ellen, that you talked about in your script?

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Sure, Erik. So we have guided to $600 million [Phonetic] to $800 million range of distributable earnings coming from the life companies. We back out of that $300 million of an annual debt expense, debt interest, which includes the preferred.

So we're really talking about a range of $300 million to $500 million from an overall free cash flow perspective. And that's our range as we move into 2023, assuming normal capital market environment. So as we move forward and we think about '24 and we talk about the number of ongoing initiatives that we have underway. And so I'll highlight a few of them for you right now.

One of them is Spark. And we talked about the fact that at the end of '24 that we expect $260 million to $300 million in terms of run rate. We talked about GP margin, and we're seeing steady improvement there, and we ended the year with a 5.3% margin. And we firmly believe that we're well on our way to a sustained 7% margin.

Randy also highlighted the fact that we're seeing improvement in terms of our capital position of [Indecipherable] and so that's clearly something that as we move forward, we'll continue to evaluate as another improvement as well.

And then the other piece that I want to highlight, again, is that while we're going to see $300 million of capital efficiency improvement in '23, we're also expecting, as we go forward, to be able to see an improving contribution to distributable earnings of that sales mix that will continue to grow over time.

So those are some of the things that we're spiking out. And then in addition, there were a number of other actions. Again, we've been at this for about a quarter now. We feel really good about the action plan. We've got a lot of initiatives in place. And additionally, we're looking at additional levers, additional potential actions that could even further support this year 2024 and beyond that.

Erik Bass
Analsyt at Lincoln National

Thank you, that's helpful. And just -- sure, I have it, too. I think this year's plan includes a reserve release from SGUL, which we should probably think of as onetime. Is that correct?

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Erik, let me take that question. So when you think about RBC more broadly. As we mentioned, we expect to end the year at approximately 383%. We talked about the couple of big levers, right, the contribution of the preferred, the legal settlement going the other way. Additionally, beyond that, we did a step where we're going to establish the AP reserve associated with the third quarter unlocking. We currently expect that will come in a little better than the $550 million we guided to.

We're still doing the work. We don't file our statutory blue book for a little bit. Now on the other hand, that a little bit better was offset by some other reserve movements during the quarter that I described as onetime. So you're not seeing a net-net benefit, but we do expect to come in a little better.

As we come a little better on the amount we post, we'd have a little less release, but as both Ellen and I said, we're still able to reiterate that same level of expectation for free cash flow. So I think there are some other positives that are driving, from our standpoint, a better durable result than before when we had -- did have some element of that onetime release in there.

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Yes. And an example of that, Erik, is that we had pointed to, last time we spoke, a range of new business capital efficiency in '23 of $200 million to $300 million, so we expect to be on the north end of the range for that. So that's an example of some of the pluses and minuses that have us very comfortable in our expectation of $300 million to $500 million range of free cash flow for '23.

Erik Bass
Analsyt at Lincoln National

Got it, thank you very much. And thank you Randy, best of luck going forward.

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Thank you.

Operator

The next question is from Alex Scott with Goldman Sachs, your line is open.

Alexander Scott
Analsyt at Lincoln National

Hi, good morning. The first question I had is just around the common dividend. And I listened to a lot of the comments you made around the investment portfolio and your confidence I just wanted to better understand, as you kind of look at different stresses and think about the environment, when you run those scenarios, I mean, how would you describe your commitment to the common dividend and how well the balance sheet holds up and your ability to cover the common dividend in those types of scenarios?

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

So Alex, I will start and then Randy, of course, will continue and fill in. So first point is that we remain committed to returning capital to shareholders by way of dividend. We've talked about the fact that you all know that we're focused on the rebuild of our RBC and improving our capital generation. We've talked about all the improvements and what our expectation is in terms of our range of free cash flow into 2023.

The Board has approved the dividend for first quarter of '23. Just as a reminder, the dividend is under the Board's purview, and we're not going to get ahead of the Board here, but we remain committed to returning capital to shareholders by way of the dividend.

As it relates to the overall investment portfolio, and Randy mentioned a couple of things. One is that it is of the highest quality that we believe it's ever been. We've talked to you for some period of time about the significant amount of stress-testing and scenario analysis and name-by-name analysis around credit deterioration. The team does that again on an individual basis. And based on the outlook and based on our expectation of credit deterioration at this point in time, we believe that if we were to hit a credit cycle that it would be quite manageable in the overall realm of our overall current investment portfolio in this scenario. And so that from our perspective is, again, quite manageable.

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Yes. I think, Ellen, you hit it perfectly. Alex, I think hypothesizing about what you might do or might not do during a time of stress is premature. I think the reality is, if you think about Lincoln, our capacity, one, we have a strong balance sheet at 383%. Yes, it's below where we'd like it to be over the long term, but still a very strong balance sheet..

We retain a significant amount of cash to the holding company. We do have access to a $500 million contingent capital facility. So I think there is a lot of capacity, and we would think about all the levers should our industry or the economy enter a period of stress. And presuming which one you would pull, which lever you would play out, I think it's premature and will act when that happens.

Alexander Scott
Analsyt at Lincoln National

Understood. Second one I had for you is just thinking about free cash flow over a longer period. Some of the things that are affecting you right now are somewhat temporary. I'm cognizant of the fact that you used to generate a much higher level of free cash flow, and you have talked about making the products and so forth more capital-light over time as well.

I mean do you expect to be able to get back up to the kind of cash flow that you've earned in the past? How long do you think something like that could take? And are some of the actions that you're targeting and maybe the strategy and direction of the company could it actually cause you to get to even better cash conversion over the long term? I guess I just want to understand sort of where we're at and how temporary versus long term the impacts are going to be?

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Yes. So Alex, great, great question. And again, I just want to remind all of us that we have made substantial progress in the last quarter. And exactly as you're pointing out, we feel really good about where we are, what we have done and also the expected improvement going forward.

And we completely agree that as we move forward with the lens of a real focus on improving overall capital generation that over time, everything that is going on to the books is we're really focused on maximizing profitable growth in a capital-efficient way and that, over time, that clearly will have a multiplier effect.

We're not at the place right now where we can provide a range or provide a steady state of capital generation or any specific timing around that. Most importantly, a couple of points here. One is we focused and highlighted today on the fact that we're rebuilding capital, we're improving ongoing capital generation, and to your point, we are making sure that we are also preserving and really investing in the future of the franchise, and that includes allocating a significant portion of our overall organic capital generation into that new business that will provide us with that profitable growth.

So we can assure you that we're working swiftly, and I remain very confident that we'll continue to execute, deliver strong results, and we'll be back with you as we continue to deliver.

Alexander Scott
Analsyt at Lincoln National

Great, thank you.

Operator

The next question is from Ryan Krueger with KBW, your line is open.

Ryan Krueger
Analsyt at Lincoln National

Hi, thanks, good morning. Ellen, I think you had previously mentioned that one thing that has negatively impacted free cash flow is term life statutory reserving strain from PBR. I guess for you or Randy, can you help give us any sense of the magnitude of that item specifically, and if that's something that could potentially be dealt with, with internal reinsurance? Thanks.

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Ryan, I'll not get into the specifics of any particular product. I think inside of the amount of capital we expect to allocate to new business, which, as we mentioned, we expect to be $300 million lower next year, are a lot of actions, as Ellen mentioned, is more than just a flow reinsurance deal, including the mix of sales.

And I would expect that you would see next year that in that particular case, term insurance that we would just be selling less than we did in 2022 because it is a very strange product. that doesn't fit with the future strategic direction of the organization at the same level it did in the past.

So that is an expectation. But in getting to that $300 million, right, at the north end of where we guided, there are a lot of actions: term is one, flow reinsurance is the other, broader product mixes, actions are inside of there. Hope that helps, Ryan.

Ryan Krueger
Analsyt at Lincoln National

Yes, I was thinking I guess also, but is there a level of existing redundant reserves that have been built up now over the last few years from PBR that could be released if you used reinsurance either externally or internally?

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Ryan, yes, I don't think there's much of that. I mean I think we've been pretty proactive over the years in the case of term insurance of really using financing, et cetera, to really bring forward distributable earns in a product like that.

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

I'll just come back to the fact that as we had mentioned, we are really focused on levers that can maximize the value of the in-force. So if there was an opportunity like that, we absolutely would be focused on executing on it. And at the same time, we're also focused on our new sales going forward really maximizing the present value of distributable earnings there as well going forward.

Ryan Krueger
Analsyt at Lincoln National

Thank you and thank you Randy. Good luck.

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Thanks, Ryan.

Operator

The next question is from Suneet Kamath with Jefferies, your line is open.

Suneet Kamath
Analsyt at Lincoln National

Yes, thanks, good morning and best of luck from us to you, Randy. I wanted to ask a bigger question about the capital structure because it looks like your debt to capital is still pretty elevated. You issued these preferreds that are callable, I guess, in five years, but they're pretty expensive. You've talked about dividends, but you haven't really mentioned share buybacks. So I guess, maybe can we just talk about your priorities in terms of the capital structure and maybe fixing some of the things that seem a little bit overextended at this point?

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

If you think about three big buckets, which we've talked about over the last couple of quarters, the life company, right? We ended the year at 383%. We expect to continue to strengthen that with a longer-term target of 400%. So a little work to do there.

[Indecipherable] I think we are super happy and excited that relative to where we were at the end of the third quarter, we ended a year in line with our long-term expectations. And I think that puts us in a better position in that particular case, when we think about future sources of capital. So in [Indecipherable] in line with our long-term expectations and with a hedge program much more aligned with a focus on capital protection and the protection of that stream of distributable earnings looking forward.

And then the last big thing I think, and you mentioned it, is leverage. Yes, absolutely. We do see our leverage ratio is elevated beyond where we want it over time. Now I'd point out, we've prefunded a $500 million maturity that cash sits at the holding company that's coming towards the end of September 2023.

So we'll take down $500 million of leverage there. [Indecipherable] a lot of actions that are going to occur over the next few years, as we think about how best to allocate the capital that we're going to generate -- with all the actions that Ellen has talked about, the growth we expect from the capital, but then how we allocate it as we think about broadly about the financial structure of the organization.

Suneet Kamath
Analsyt at Lincoln National

And then any comment on the buyback? I know you ruled it out for this year. I think there's an expectation in the market something in 2024. I just want to give you the opportunity to comment, if you'd like.

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Yes. And so Suneet, as it relates to buybacks, at this moment, we are focused on really continuing to grow our free cash flow and also to really take our risk-based capital, which ended the year at 383%, and we feel really good about the improvement that we made there and really rebuild back up to 400%. As we're getting closer to that point, we'll be able to give you some estimate around how we think about time and expectation there.

We have, as I mentioned, a number of initiatives that are well underway. We feel really good about the progress that we've made, and we have a number of additional as we move through 2023, and we start looking forward with a number of additional actions that we're also evaluating, so more to come there.

Suneet Kamath
Analsyt at Lincoln National

Got it. And then maybe just one more, if I could. Just are you seeing any commercial impact from a lot of the headlines that we've seen, I guess, since the charge? I mean sales were down in a bunch of areas. You'd mentioned good results for the full year. But just trying to think through any potential impacts from a ratings downgrade or just from the headlines, if it's having any impact on your ability to generate commercial growth in terms of products?

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Suneet, thank you -- I'm very grateful that you asked this question. We have seen no disruption across any of our businesses as it relates to overall distribution. We feel very good about the overall volume, both volume of sales that went on to the books in the fourth quarter and also the expectation as it relates to the profitability of those sales on the books as well.

What I can tell you is that I recently attended the annual sales conferences across all four of our businesses. The sales teams are fully behind the shift that we're making. They're highly energized in terms of our overall partners. We continue to add and actually win back producers across all of our businesses. So it is business as usual and completely aligned and on board with the shift that we're making as it relates to improving our capital efficiency.

Suneet Kamath
Analsyt at Lincoln National

Alright, thanks Ellen, good luck everyone.

Operator

The next question is from Elyse Greenspan with Wells Fargo, your line is open.

Elyse Greenspan
Analsyt at Lincoln National

Hi, thanks, good morning. My first question on Individual Life, I think the earnings are around $107 million if you back out COVID [Indecipherable] Can you just help us think about the run rate earnings for that segment. I know you guys spoke about 2023 having some headwinds from higher reinsurance costs. So just trying to get a sense of just the earnings you see in that segment on a go-forward basis.

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Elyse, without getting into the run rate, let me point out a few facts, right? With the third quarter [Indecipherable] we mentioned this -- we did have an expectation that Life earnings will be reduced by $45 million a quarter.

So if you just started out at the 150 we used to remit the 107 you've got to is sort of right in line with $45 million lower than we were at. Additionally, I did mention, while in total, we expect LDTI to be neutral from an operator standpoint -- that is a negative $100 million to $120 million in life business, offset by a similar size positive in the annuity business.

So there's another factor that I would take into account. We do expect some level of ongoing pandemic. We're really happy that the pandemic is -- seems to be fading the back room, but we're going to see some ongoing level. and then there were a couple of headwinds individually for the life business that we mentioned. For instance, we do have some expectation of higher reinsurance costs next year than we experienced in 2022. I mentioned that we expect life spread to sell down about 10 basis points or so from where it is today before it starts to grow in 2024 and beyond. So yes, I think there are some near-term headwinds, I think we did a good job of covering them. But in terms of 107 itself, it sort of is in line with where we were less the $45 million impact of the unlocking.

Elyse Greenspan
Analsyt at Lincoln National

Thanks, and then my second question, obviously, a bunch of questions on capital on the call. And I know you guys don't want to comment about buyback specifically beyond this year. But it does seem like you guys could be precluded for a bit longer from buying back your stock based on distributed earnings expectations.

So at some point, Ellen, like would you guys consider something more transformational, potentially considering selling a business as a way to free up capital and potentially have additional capital flexibility sooner than otherwise?

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Yes. Elyse, I'm going to go back to and reiterate the fact that we laid out a quarter ago a number of initiatives and that are well underway, and we feel really good about them. And we're clearly going to see improvement from '22 to '23, and the number of initiatives are going to continue to accelerate improvement beyond '23 into '24 and beyond..

And we are continuing to evaluate. So I want to be very clear about the fact that we're continuing to evaluate other actions that can continue to even further really enable us to get our RBC back to the target level as absolutely quickly as possible.

So we're going to continue to take swift actions. We'll be back in touch with you. We're not going to give a timeframe today. And as we are executing, we'll continue to deliver those results for all of you.

Elyse Greenspan
Analsyt at Lincoln National

Thank you.

Operator

The next question is from Jimmy Bhullar with JPMorgan, your line is open.

Jamminder Bhullar
Analsyt at Lincoln National

Thanks. Randy, first, good luck in the future. I had a couple of questions on your comments on spreads and then also on reinsurance costs. When you talk about reinsurance costs being up, is it up beyond what you had indicated previously? And if yes, why? Or is it just consistent with what you'd said.

And then on spreads, the decline sequentially, is that a function of the crediting rates being up or is there something else that's driving that?

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

So on the reinsurance costs, we've talked about this over the years. We have, over the last five, six years, spent a lot of time working with our reinsurance partners on the topic of reinsurance rates, especially on the in-force book of business.

And we have steadily worked through our back book. We've continued that process in 2022. So we've reached some additional agreements. I think we're getting very close. I think we're up into the 90% range-or-so in terms of what we've put in the rearview mirror. But we have reached some additional settlements, which involve us paying some higher reinsurance costs.

So just on a year-over-year basis, we're going to see some of that in 2023. In the context of spreads, I think you're talking specifically about the Life business. And as I mentioned, we expect that spread to settle down about 10 points.

In my script, I mentioned that the Life business is not seeing the same benefits that we've seen in retirement and annuities. And you can definitely see those benefits inside of our [Indecipherable] But then in case of Life, look, it's a very long-duration portfolio. It doesn't have a huge amount of rollover in any given year.

And then additionally, during the low rate environment, as we sought to maintain our discipline around ALM matching, we were doing some things to lock in rates into the future. We had a couple of programs in place to add duration to the Life business so we could stay in line with our targets. A couple of things I'd mention is that we would typically -- we've been doing this for like eight years, go on a couple of years and lock in the underlying treasury rates.

Now that is painful in 2023 as those [Indecipherable] locks will burn off over 2023, but over the last eight years, I would tell you, in total, it's been a net positive, but it is painful a little bit in 2023.

And the other thing we did is that we would do some pre-investing. We would borrow short and then we would reinvest those dollars and then pay off those borrowings with cash flows of the business, and we'd also expect that to trend down over 2023.

So there's just a couple of temporary headwinds I would describe before we start to expand in 2024 and beyond. Broadly speaking though, Jimmy, once again, you see a Life business or the Annuity business, you see the Retirement business, those spreads have expanding nicely as they experience a more immediate benefit of higher interest rates.

Jamminder Bhullar
Analsyt at Lincoln National

And then on your pivot away from term life, how much of that is a function of just maybe the capital profile of the business versus maybe the margin profile? And the reason I'm asking is I think you've raised prices in term life as well and you're deemphasizing sales. In the past, when companies move away from something like a few years later, you start seeing reserve issues and stuff. But what's the motivation for you guys on deemphasizing the term life business?

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

So Jimmy there are couple of things, we first of all, deemphasizing parts of the term life business, there is a piece of the term life business for us that we see as basically pure price competitive, not utilizing our distribution leadership as part of the overall sales process is the first thing. And the second thing is that what we see is that it overall is a pretty significant amount of capital and surplus strain for that portion of the term life business that doesn't really have the margins associated with it. That's the part that we're going to shift away from, but not the broader overall term life market. And Randy, is there anything you want to add to that?

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Yes, I agree completely. And I hope I didn't overemphasize term. We're going to still sell term insurance, but I think we can be much more strategic. We can focus on the areas where we use the strength of our distribution. We can move around inside of the term marketplace into pockets that are, from a distributable earnings pattern standpoint, just better.

I mean the reality of a 30-year term product sold on one of the big aggregator platforms is that the breakeven year is very, very far out there. And as we think about the future strategy, that just isn't a place that makes sense. But there's still a little a lot of areas, and I'm sure we'll sell a fair amount of term insurance just not at the same level we were in 2022 and prior.

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

Exactly. So I expect the term that we will put on the books going forward will be more focused in partnership with distribution. It will be higher face amount and it will be higher margin and also improved overall distributable earnings profile.

Jamminder Bhullar
Analsyt at Lincoln National

Okay. And then just lastly, on the preferreds, they are obviously fairly expensive and you did what you had to do. But do you -- should we assume that that's a normal part of your capital structure going forward? Or is it reasonable to think that you're going to be putting away some capital to be -- every year to be able to retire at some reasonable point in time or as soon as you're able to do it?

Ellen Gail Cooper
President, Chief Executive Officer & Director at Lincoln National

So Jimmy, we know that the preferred is callable at the five-year mark. That's obviously a long way away. We've talked about the fact that we have many initiatives right now that are supporting the ongoing capital generation. We're going to continue to -- we'll evaluate as closer to that call date and see where we are. We continue on the track that we are. I think that, that will answer the question for you about what we'll do five years from now.

Jamminder Bhullar
Analsyt at Lincoln National

Thank you.

Randal Jay Freitag
Executive Vice President, Chief Financial Officer & Head of Individual Life at Lincoln National

Thanks Jamminder.

Operator

We have no further questions at this time. I'll turn it over to Mr. Copersino for any closing comments.

Al Copersino
Vice President & Head of Investor Relations at Lincoln National

If any follow-up questions that you have, you can e-mail us at investorrelations@lfg.com. Thank you, and have a good day.

Operator

[Operator Closing Remarks]

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