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Lincoln National (NYSE:LNC)
Q3 2019 Earnings Call
Oct 31, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good morning, and thank you for joining Lincoln Financial Group's third-quarter 2019 earnings conference call. [Operator instructions] Now I'd like to turn the conference over to the corporate treasurer, Chris Giovanni. Please go ahead, sir.

Chris Giovanni -- Corporate Treasurer

Thank you, Catherine. Good morning, and welcome to Lincoln Financial's third-quarter earnings call. Before we begin, I have an important reminder. Any comments made during the call regarding future expectations, trends and market conditions, including comments about sales and deposits, expenses, income from operations, share repurchases and liquidity and capital resources are forward-looking statements under the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from current expectations. These risks and uncertainties include those described in the cautionary statement disclosures in our earnings release issued yesterday, as well as those detailed in our 2018 annual report on Form 10-K, most recently quarterly report 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 invite you to visit Lincoln's website, www.lincolnfinancial.com, where you can find our press release and statistical supplement, which include a full reconciliation to the non-GAAP measures used in the call, including adjusted return on equity and adjusted income from operations or adjusted operating income to their most comparable GAAP measures.

Presenting on today's call are Dennis Glass, president and chief executive officer; and Randy Freitag, chief financial officer and head of individual life. After their prepared remarks, we will move to the question-and-answer portion of the call. I would now like to turn the call over to Dennis.

Dennis Glass -- President and Chief Executive Officer

Thank you, Chris. Good morning, everyone. Third-quarter earnings were disappointing, but I am confident that our strategies and management actions are driving and are going to continue to drive earnings growth. I also want to emphasize that our franchise and business model have the strength to deal with low interest rates, a headwind facing us and the industry.

First, on the quarter's negative operating earnings results, there were three primary impacts. Number one, our annual review included a significant charge with a component related to interest rates. While our interest rate assumptions were already more conservative than most competitors, we still followed a rigorous process and made appropriate changes. Number two, alternatives meaningfully underperformed as we wrote down a large private equity holding.

This is an investment we've owned for many years. The third impact was quarterly fluctuations we see from time to time. Randy will cover each of these in more detail shortly. Turning to the ongoing strength of the franchise.

We continue to benefit from actions taken by management to accelerate growth, diversify sales, achieve appropriate returns and tactically tilt our sales mix toward shorter-duration products, which are less sensitive to interest rates. These actions help drive double-digit sales growth in annuities, Life Insurance and Group Protection and, along with the Liberty acquisition, resulted in 84% of our total sales coming from products without long-term guarantees, up 20 percentage points compared to five years ago. We're also successfully executing on our digital program and diligently managing expenses, which were down 3% compared to the prior-year quarter. Net savings from our digital program should begin to ramp up next year and, along with further Liberty integration savings, provide a tailwind to earnings in the medium term.

Lastly, our diversified and attractive business mix enables us to consistently generate a significant amount of cash flow, which we are both investing in growth and returning to shareholders. Our active share buyback program led to an 8% decrease in shares outstanding compared to the prior year. And last night, we announced an 8% increase in the quarterly common stock dividend. Now turning to the business segments starting with annuities.

Our decision to broaden the product portfolio and participate in more segments of the market enabled us to meet different customer needs, sustain our growth and maintain a diversified sales mix even while we are adjusting pricing and product features in response to lower interest rates. Total sales increased 12% compared to the prior-year quarter, and net flows were positive for the fourth consecutive quarter. Consistent with our strategy, we have shifted our sales mix as five years ago, over 70% of our sales were variable annuities with living benefit guarantees compared to this quarter where sales were evenly balanced among VAs with living benefit guarantees, VAs without living benefit guarantees and fixed annuities. Expanding shelf space and adding new producers resulted in significant momentum in index variable annuity sales.

This led to a 54% increase in sales of VAs without living benefit guarantees, which improves our long-term risk profile. We're also expanding shelf space and increasing wholesalers with fixed annuities, which resulted in 15% sales growth, including significant gains in independent marketing organizations where we launched customized products for two large distribution partners last year. So another quarter of strong momentum with annuities business as growth metrics are clearly benefiting from our broad set of consumer solutions and our multichannel distribution model where both client-facing headcount and total producers are up 12% over the prior-year quarter. When combined with disciplined pricing, appropriate assumptions and an industry-leading hedge program, we are well positioned to deliver strong results even if consumer preferences and capital markets shift.

In retirement plan services, our high-touch, high-tech, digitally focused model creates a competitive advantage in our target markets. This differentiated service model continues to improve the experience in both plan sponsors and employees, driving higher participation and contribution rates and benefiting retention. As a result, recurring deposits increased 12% over the prior-year quarter with double-digit growth in both the small and mid- to large markets and net flows remain positive. Total deposits decreased as prior-year quarter benefited from a previously disclosed sale of $1 billion healthcare plan.

The sales pipeline is strong as we enter the fourth quarter with Your Path, our proprietary alternative to target date funds and another great example of product innovation at Lincoln, which is a true differentiator in the marketplace. Additionally, we see an opportunity to expand Your Path adoption across our in-force block, providing incremental growth. Overall, it was a solid quarter for the retirement business highlighted by another quarter of positive flows and healthy bottom-line growth. Turning to life insurance.

Strategically, we had in our repositioning the life portfolio toward products that both meet consumer needs and drive profitable growth. In the quarter, individual life sales increased 26%, demonstrating the life business franchise strength by shifting and growing at the same time. Total sales grew 40% as we had a large executive benefits case in the quarter. Our sales are benefiting from further penetrating the IUL market, which is the large and fast-growing industry segment where we are taking market share.

Term sales are growing as we make significant process improvements and adjust prices more agiley. We're also maintaining our leadership position in the VUL and hybrid markets. The ability to grow end-to-end product sales is in part accomplished through our industry-leading distribution platform. Our client-facing headcount is nearly 300 employees and up 8% over the prior-year quarter.

We are in every major life distribution channel, and over the past two years, over 66,000 independent producers have sold a Lincoln National life insurance product. This vast network of distribution partners has helped us position our sales mix where now two-thirds of our sales are not meaningfully effected by the level of interest rates. Our manufacturing capabilities have created diversified product portfolio where no product represents more than 30% of total life sales. And this broad-based strength has enabled us to maintain aggregate returns above targets.

Nonetheless, we're making additional pricing changes where needed to reflect low interest rates. While life insurance earnings were most affected by our annual assumption review, the business remains well positioned, moving forward with a proven record of disciplined growth and financial management, which has enabled us to overcome headwinds facing the industry. Turning to group protection. Benefits from the Liberty acquisition and successful integration were once again demonstrated this quarter as sales were robust, premiums grew and after-tax margins remain strong.

A national competitive environment has enabled us to effectively execute on strategic objectives and maximize the competitive advantages created by the acquisition. This includes leveraging our larger book of business and expanding capabilities to cross-sell additional lines of coverage and further penetrate the employee-paid market. These strategies contribute to 53% growth in sales compared to the prior quarter with employee-paid sales increasing at a faster rate than employer-paid. That 5,000-plus market, a historical strength of Liberty, is seeing growth reemerge as distribution partners gain confidence in our post integration service and execution, while the 1,000 to 5,000 mid-mark segment is benefiting from the best of both companies.

The group business had another strong quarter, and we're optimistic that we'll continue to achieve attractive margins.Shifting to investment results. We invested new money at a pre-tax yield of 3.7%, 190 basis points over the average 10-year treasury. Additionally, as the credit cycle extends, we have continued to focus on managing credit risk more defensively by derisking in sectors and securities that have greater risk of credit deterioration under a stress scenario and further diversifying the portfolio. We have decreased our overall exposure to corporate credit, particularly in the energy and consumer cyclical sectors while increasing our exposure to infrastructure, consumer noncycle -- excuse me, consumer noncyclical and high-quality loan-to-value commercial mortgage loans.

The portfolio of credit quality is in great shape with below investment-grade assets representing less than 4% of total assets and BBB- rated securities decreasing by more than 100 basis points from prior-year quarter.As I noted upfront, we had a writedown of a large private equity holding. Our commitment to this single investment was $11 million, and over the following five years, the value increased to $138 million before getting markdown this quarter to $24 million. Over this period, the alternatives portfolio achieved a 9% pre-tax return, including this writedown. I would note this particular investment was a uniquely concentrated position within an otherwise highly diversified private equity portfolio, which includes 255 limited partnerships with an average size of less than $7 million and no other single investment with a carrying value greater than $36 million.

Overall, we continue to like the construction and diversification of the alternatives portfolio and believe our long-term annual return target of 10% remains achievable. Before closing, let me briefly comment on the current interest rate environment. As we have noted in the past, there are three areas of potential impacts from low rates: one, new business returns; two, spread compression; and three, the balance sheet. First, on new business returns.

We have benefited from the actions mentioned earlier by selling more products without long-term guarantees and that are less impacted by low interest rates. Nevertheless, we have been taking a proactive approach of reviewing all our product features and pricing to make sure we maintain a disciplined balance between customer value, growth, risk and returns. We're comfortable selling where we are today given our product mix combined with pricing actions we have taken or expect to take. We'll continue to reprice when necessary to achieve appropriate returns on the capital we invest in growth.

Next on spread compression. Previously, we anticipated a 2% to 3% headwind to EPS growth from interest rates and to see that abate over time. Given the current interest rate environment, we expect to be at the upper end of that range as spread compression is persisting longer than we originally anticipated. However, it is important to recognize that this level of spread compression is consistent with recent years and the benefit from our diversified business model has enabled us to grow EPS and generate a steady percentage of earnings from capital-market-sensitive businesses.

Third, on the balance sheet, while the impact from unlocking was larger than usual this year, I would note that book value per share, excluding AOCI, still increased 5% compared to the prior-year quarter and the charge was noncash. We continue to expect minimal impacts on statutory capital from asset advocacy testing unless the 10-year Treasury rate is persistently in the 1% range, and even then, we expect manageable impacts. So while this quarter's results included significant negative impacts, we continue to successfully execute on key strategic initiatives that position Lincoln to sustain our track record of excellent financial performance and create long-term value for shareholders. I will now turn the call over to Randy.

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Thank you, Dennis. Last night, we reported a third-quarter adjusted operating loss of $46 million or $0.25 per share. As we noted in the earnings release, this year's annual review of DAC and reserve assumptions resulted in a charge of $403 million or $2 per share. Included in this was $291 million from interest rates, of which $139 million came from the impact of the significant drop in rates on the starting point.

Additionally, we lowered our long-term ultimate interest rate assumption to 3.5% and extended our grading period to seven years, which resulted in a $152 million negative impact. Based on our review of industry surveys, we remain on the conservative side with respect to interest rate assumptions and continue to follow our normal process of prudently responding to changes in the capital markets and appropriately reflecting our experience across our assumptions. Outside of interest rates, there was a $112 million net unfavorable impact with mortality updates and higher reinsurance cost coming in negative, partially offset by several adjustments, including modifications to policyholder behavior assumptions and other items. As part of this year's review, we did not unlock the reversion to the main quarter, which still provides an approximate $135 million after-tax cushion against declines in the equity markets.

In addition to the significant impacts from the annual assumption review, there were a few other items that resulted in some large variability this quarter, including negative returns in the alternatives portfolio, primarily from the writedown Dennis mentioned, reduced adjusted operating earnings by $94 million or $0.47 per share relative to our expectations. And quarterly fluctuations in individual life mortality relative to our annual expectations, along with a higher group loss ratio, reduced adjusted operating earnings by $42 million or $0.21 per share. When normalizing for unlocking alternatives and quarterly fluctuations it implies an EPS of approximately $2.40 and gives you a much better indication of our earnings power. Moving to the performance of key financial metrics.

When normalizing for notable items and alternatives under performance, strong sales, net flows and equity market strength resulted in all four businesses showing operating revenue growth over the prior-year quarter, G&A expenses net of amounts capitalized decreased 3% year over year, and when combined with revenue growth, the expense ratio improved 60 basis points. Moving to the balance sheet. Capital ratios are solid. We have significant cash to holding company, and strong capital generation is enabling us to both invest in growth and return capital to shareholders.

Before shifting to segment results, our net loss in the quarter was $161 million. This included a $33 million charge from an early tender for a debt and acquisition and integration cost of $31 million. The hedge program performed well during a period of heightened market volatility with $22 million of net losses, and the general account performed well as credit losses were negligible. Now turning to segment results, starting with annuities.

Reported operating income for the quarter was $169 million, which included a $93 million unfavorable impact from our annual review primarily related to interest rates. Adjusting for notable items in both periods, this quarter's alternatives underperformance of $10 million and our Modco reinsurance transaction, earnings decreased slightly. Return metrics, excluding notable items and alternatives under performance, remain strong with ROA at 81 basis points and a ROE of 22%. Average account values of $134 billion increased 2%, excluding the reinsurance transaction, driven by positive net flows and equity market gains.

Risk metrics remain solid as net amount of risks is just above 1% of account value for living benefits and 0.5% for death benefits. So annuities results were a bit noisier than usual this quarter, but the underlying trends were solid as net flows remain positive, and year-over-year earnings growth should reemerge following a year of theme-related impacts. In retirement plan services, we reported operating income of $44 million, up from $40 million in the prior-year quarter driven by great expense management. Net flows totaled $272 million in the quarter, which when combined with favorable equity markets and further organic growth drove average account values to $74 billion, up 4%.

A 3% decrease in G&A net of amounts capitalized combined with revenue growth resulted in a 100-basis-point year-over-year improvement in the expense ratio. Base spreads, excluding variable investment income, compressed 6 basis points versus the prior-year quarter, and ROA came in at 24 basis points. Retirement business had a strong quarter with organic growth and expense discipline remaining key drivers going forward. Turning to life insurance.

The annual assumption view in this year's -- in this quarter's alternative underperformance have the greatest impact on the life business as we reported an operating loss of $245 million. In total, the net assumption changes reduced operating earnings by $320 million, including $225 million from interest rates. As noted earlier, there were several other unlocking adjustments that had a net unfavorable impact of $95 million in the life segment. Additionally, $69 million of alternative investment under performance impacted the life business.

Adjusting for notable items in this quarter's alternatives under performance, operating earnings were $144 million, compared to $196 million in the prior-year quarter. The decline was related to $29 million in unfavorable mortality relative to our annual expectations in the current quarter, compared to $22 million of favorable mortality in the prior-year quarter. Underlying drivers were solid with average life insurance in-force up 8% over the prior-year quarter and average account values increasing 4%, both of which help drive a 3% increase in operating revenues, excluding impacts from unlocking and the underperformance in alternatives. Base spreads, excluding variable investment income, compressed 6 basis points when adjusting for an unfavorable impact in the prior-year quarter.

So a challenging earnings quarter for the life business, however, key growth drivers remain solid, position us nicely moving forward. Group protection reported operating income of $61 million, compared to $63 million in the prior-year quarter with this quarter's alternatives under performance reducing earnings by $7 million. The loss ratio in the quarter was 74.1%, up 50 basis points year over year and sequentially, as a higher underlying loss ratio was partially offset by favorable reserve review impacts. G&A expenses decreased 7% as we continue to benefit from integration synergies, which resulted in a 120-basis-point improvement in the expense ratio compared to the prior year quarter.

Overall, business trends remain positive, which resulted in an after-tax margin of 6%. Favorable impacts from expense savings and pricing discipline should enable us to sustain attractive margins. Turning to capital and capital management. Statutory surplus stands at $9.4 billion and our RBC ratio ended the quarter at approximately 425%.

Holding company cash came in at $765 million, ahead of our $450 million target as we prefunded a $300 million debt maturity due in February 2020 to take advantage of attractive rates. During the quarter, we returned $224 million of capital to shareholders, including $150 million of share buybacks. To conclude, third-quarter earnings were definitely noisier than usual with significant impacts from our annual assumption review, underperformance of alternatives and other quarterly fluctuations. Looking through those items, we continue to see strong underlying earnings.

While the impact from this year's annual review was larger than previous years driven by a prudent change to our long-term interest rate assumption, this is a noncash charge, does not impact our RBC ratio and leaves our balance sheet well positioned for low interest rates. I would also note that over the past five years, we have grown book value per share, excluding AOCI, by nearly 40%, including a 5% increase this year to $69.33. Importantly, this quarter's results had several positives, including double-digit sales growth in three of our four businesses; revenue growth in all four businesses when adjusting for unlocking the underperformance of alternatives; continued discipline around managing costs; SG&A expenses declined compared to the prior year; and all of our businesses continued to demonstrate strong core earnings power after adjusting for the items previously mentioned. With that, let me turn the call back over to Chris.

Chris Giovanni -- Corporate Treasurer

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

Questions & Answers:


Operator

Thank you. [Operator instructions] And our first question comes from Ryan Krueger with KBW. Your line is open.

Ryan Krueger -- KBW -- Analyst

Hi. Thanks. Good morning. Randy, do you expect much ongoing impact from the actuarial assumption review to future earning?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Hey, Ryan. As I've said in prior unlockings, I'd expect a bit of a headwind from these changes. But when I sit down and take a look at analyst expectations for the next quarter, I don't see much of an overall impact. I think there are couple of items that I'd point out as we move into 2020 outside of debt impact.

First, as we mentioned, the decline in rates has moved spread compression up a little bit, so we have been traveling in the 2% range, and I think were up toward 3%. So if you do the math, that's approximately $20 million. And the other thing I'd point out is that resolutions that we've had with some major reinsurance partners this year, I think would imply a headwind of a similar magnitude, but I also point out that we've been having these exact sorts of impacts over the past five, six years, and we're going to work hard to overcome them with things like the digital program. So don't see much other than the items I mentioned, Ryan.

Ryan Krueger -- KBW -- Analyst

Got it. And then just higher level, clearly, you had number of things go against you this quarter, sounded like -- I think in your prepared remarks you sounded like you're pointing to $2.40 that's still a pretty good run rate going forward. I just wanted to just confirm that that's kind of your intention to suggest that that's a better run rate going forward past this quarter.

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Ryan, yes, absolutely. So I said approximately $2.40 in my script. We noted that the earnings themselves reported were $0.25 negative. But the three specific items we mentioned, which were the unlocking, which was $2 per share, which was the alternatives under performance, primarily in that one security, was $0.47.

So if you add those two items to what we reported, you get to $2.22. The other items we mentioned were the individual life mortality that was $29 million. And also mentioned that the group business itself had a bit of a tick up, a little bit of a tick up in their loss ratios, and that was in the range of $13 million or so. I also noted that that was offset by favorable reserve review impact.

But so if you take the $29 million and $13 million, that would be another $0.21 or so. So if you add those items together, you get up to the approximate $2.40 that I mentioned and exactly consistent with sort of what we expect coming out of the quarter.

Ryan Krueger -- KBW -- Analyst

Great. Thanks, Randy.

Randy Freitag -- Chief Financial Officer and Head of Individual Life

You bet.

Operator

Thank you. And our next question comes from Alex Scott with Goldman Sachs. Your line is open.

Alex Scott -- Goldman Sachs -- Analyst

Hey, good morning. I guess my first question is just on corporate expenses. I mean it looks like its right at a higher level. I know part of that is just prefunding maturity next year.

But I'd just be interested to hear where you expect that to run? I mean how much will that benefit from some of the things you're doing on the efficiency side as we think about next year?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Hey, Alex. Thanks for the question. Let me just speak to corporate or other operations in total. I'd say that this quarter had a few negatives that primarily were on the benefits line.

I think if you look in there, we've seen some seasonality in benefits and other operations segment typically in the third quarter. So I think there were some negatives maybe in the mid-single-digit range. But I'd point out that if you look across, for instance, in retirement, I think they had some small positives that probably from a total standpoint sort of offset each other. So Other Operations segment did have a little bit of a negative tinge this quarter, but I think that was offset by some other items across other businesses.

Alex Scott -- Goldman Sachs -- Analyst

Got it. And then the follow-up I had was just with the stock trading where it is. Is there anything strategically you guys can do to take advantage of the situation, the valuation environment? Or is the macro where it is and rates as low as they are, I mean, does that kind of prevent you from acting?

Dennis Glass -- President and Chief Executive Officer

It's Dennis. Our intention is to continue to review all options that would result in increasing the growth rate of earnings per share. I think the lower interest rates make that a little bit more difficult today. But there's a flow of ideas that are coming through, but nothing that is imminent.

So the answer is, interest rates make it tougher, but we continue to review all opportunities to -- both from a normal growth perspective and then the occasional unique item to grow EPS.

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Alex, I'd also point out that if you look at this year, we've been able to fund a substantial growth in sales in life and annuities, while at the same time continuing to return capital to shareholders. I think year to date, we're at about $765 million of capital return, $540 million of that in buyback. So not only have we've been able to fund the strong sales growth we've seen, but we've been able to continue to return capital to shareholders. And obviously, that's our goal, to continue to fund organic growth while at the same time, in a disciplined manner, returning capital to shareholders.

Alex Scott -- Goldman Sachs -- Analyst

Thank you.

Operator

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

Tom Gallagher -- Evercore ISI -- Analyst

Good morning. Can you discuss -- Randy, can you talk a little bit about what the underlying drivers were on the mortality and reinsurance pricing side? The reason I ask is I'm just wondering, have you reflected the rate that's been pushed through by the reinsurers currently? Or are you assuming further rate increases or put through? And I'm saying that just because you've obviously had adverse mortality in three of the last four quarters now, so I just want to know whether, I don't know, there's some level of assumed, we'll call it, adversity that's embedded in this review, whether it's reinsurance cost or your own mortality or whether you're assuming that normalizes or reverts back to like normal trend?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Tom, I think there are a couple of questions inside there. So let me, hopefully, tackle all of them. On the other impacts, and as we mentioned, the other impacts outside of interest rates, totaled $112 million and $95 million of that was in the life business. Let me make a few comments on some of the components.

So as we do every year, we absolutely analyze mortality. That's one of the big components. And what we found ourselves a small slice of business where mortality rates at the oldest ages, we're a little out of whack, so we brought them in line with the rest of the book and that drove one of the negative impacts I referenced. On the reinsurance side, really look at this as the completion of what has been a six-year process, which saw us back in 2014, put estimates in our models that reinsurance rates would go up.

In 2019, we completed negotiations with most of our major reinsurance partners and really have good clarity on the few remaining pieces. So I believe that this puts that issue largely behind us. On the favorable side, modifications to policyholder, behavior assumptions, investment allocations, and some of the other items, I think this is just the nature of the assumptions, as things emerge, you see more experience, it's going to lead to some pluses. It's going to lead to some minuses.

And hopefully, over time, they equal out. This year, unfortunately, they were on the negative side. But once again, over time, and we've actually seen this, they have tended to even out. I think I looked at this recently, over the last decade and looked at the unlockings with all the pieces and outside of interest rates, what you see is that over the last decade all of the other items have really summed to a very small positive number actually, which speaks to our goal.

We know when we price a product we're not going to get every single assumption right. We try to make sure that we do a prudent job of coming up with some best estimates and then hope over time that the totality of those assumptions will equal, at least from a financial standpoint the impacts -- the numbers your pricing. And that's what we've seen over a longer period of time, not to diminish the $112 million negative impact that we had this quarter. I think you also inside your question had a comment or a question about the last few quarters.

It's a fact that in three of the last four quarters we've had negative or unfavorable mortality. But I think inside of there, Tom, I think that's a bit of cherry-picking because it's also a fact that if you look at the last eight quarters that I could say that five of the last eight quarters have unfavorable mortality. And that's what we expect, right? So we retain more insurance these days. Over the last five, six years, we have done some recaptures.

So we expect that we're going to have more quarterly volatility. But once again, over time, we expect that mortality will come in line with our expectations. That's what we've seen over the last couple of years. That's what we've seen over the last decade.

And that's what we would expect going forward.

Tom Gallagher -- Evercore ISI -- Analyst

That was helpful, Randy. And from what Dennis mentioned on impacts, and I think you reiterated that point, it sounds like there's not much of a statutory impact expected based on low rates, but what about the consequence of this charge? Is there any -- should we think about any reduction in stat earnings? Because I think -- at least the comments I heard seemed more be directed at the balance sheet. I'm just curious whether you would expect there to be any impact to statutory earnings or cash flow.

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Not going forward, Tom. I think for this quarter, obviously, the alternatives that flow through statutory earnings, and this quarter's unfavorable mortality would flow to this quarter's earnings. But not going forward, don't see an impact. And as a reminder, on our statutory asset adequacy testing, Dennis mentioned this, we really don't see negative impacts until that 10-year Treasury, using that as a proxy, gets down to the 1% range where we see roughly $350 million of asset adequacy reserves, required 50 basis points on the 10-year, goes to about $700 million.

Those aren't small numbers, but those are manageable numbers in the context of a company with $9.4 billion of statutory reserves or statutory surplus, excuse me.

Tom Gallagher -- Evercore ISI -- Analyst

Got it. All right. Thank you.

Operator

Thank you. And our next question comes from Erik Bass with Autonomous Research. Your line is open.

Erik Bass -- Autonomous Research -- Analyst

Hi. Thank you. Starting with the group business. You mentioned a little bit of softness in terms of the claims experience this quarter.

I was just hoping you can give a little bit more color there on what drove that.

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Yes. So inside the group, which had $61 million of reported earnings, you had a favorable impact from the reserve review this year of about $10 million. And then offsetting that, you had slightly elevated loss ratios in the quarter, and that was pretty much evenly split between life and disability. And in both cases, it was driven by severity.

So life claims came in a little higher than our average expectation and the average reserve we put up on new LTD claims came in a little higher than our expectations.

Erik Bass -- Autonomous Research -- Analyst

Got it. And then on the interest rate assumption change, I realized you moved more than just the kind of long-term rate assumption, but can you kind of put in context the change this quarter versus the guidance you'd given I think at investor day of $160 million impact for a 50-basis-point change?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Yes. Erik, I'll take that. So the guidance we've given, which is really been focused on a change in that ultimate rate assumption, has been $160 million per 50 basis points. This quarter, we reduced that assumption by 25 basis points, and we saw pretty much exactly half of that $160 million.

I think it came in actually at $74 million. Additionally, you've heard us reference in the past, I forgot, maybe it was a couple of years ago, referenced the fact that at least from a financial impact standpoint, we saw that five years of grade was roughly the equivalent of a 50-basis-point cut. And that -- once again, that's what we saw. We extended our grade from five to seven, and we saw roughly that impact, that impact came in at $78 million.

So you sum those up, $152 million. I think of what we bid this year has been pretty much economically or financially equivalent to a 50-basis-point-reduction in the ultimate rate. So when you sum up the 25-basis-point reduction and the extension of the grade, I think about it as being pretty much equivalent from a financial standpoint to a 50-basis-point reduction.

Erik Bass -- Autonomous Research -- Analyst

Got it. And then the remainder is just truing up for actual versus expected rates over the past year?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Yes. And this isn't a number which has been in our results every year, just at a much lower level. But we've never seen year over year the kind of underperformance we had this year. To help you understand this, this quarter, third quarter, we invested new money at 370, but there was deceleration as we were moving throughout the quarter.

And so the rate we embedded at the starting point was actually lower than the 370. I think it came in over all the books of business on average at about 350. As a reminder, last year, in the third quarter, we were investing money at 430 at that time. And of course, that number in our model would have been great enough over time.

So that can give you a sense of the magnitude of the drop in the starting point that drove that $139 million impact.

Erik Bass -- Autonomous Research -- Analyst

Got it. Thank you. That's helpful.

Operator

Thank you. And our next question comes from Suneet Kamath with Citi. Your line is open.

Suneet Kamath -- Citi -- Analyst

Thanks. Good morning. I wanted to start with RPS. Earlier this week, there was some chatter in the media about some reviews of the 403(b) business, in particular the K through 12 business.

So just curious, how big of a business is that for you guys within the RPS segment?

Dennis Glass -- President and Chief Executive Officer

Yes. This is Dennis. It's about 10% of assets, 4% of annual deposits. So it's not very big for us.

Suneet Kamath -- Citi -- Analyst

Got it. And then I guess maybe high level for Dennis. As you think about the current interest rate environment and assuming that we don't really see any material changes from here, how are you balancing this trade-off between kind of growth at the product level and then using some of the free capital for, if you don't grow, for share repurchase?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

That's a big question and a good question. As I said in my script, we have to balance maintaining the strength of the franchise, getting the appropriate returns on capital, repricing where necessary, and using capital both to grow the business, protect the franchise, and then use what's left over to buy back shares, increase the dividend. So it's always a balancing act. I can tell you without question that if we aren't getting the returns on products that are appropriate for our model, we'll slow those product sales down and use the freed up capital to buy our shares back.

And we've been doing that on and off over the years successfully. So very much a daily decision about where we can get the best return on capital, not a daily decision, but an ongoing decision.

Operator

Thank you. And our next question comes from John Barnidge with Sandler O'Neill. Your line is open.

John Barnidge -- Sandler O'Neill + Partners, L.P.-- Analyst

Thanks. Can you talk about the strong growth in group sales and maybe how much of this was new distribution partners versus maybe brokers taking you out of the penalty box and your expectations going forward?

Dennis Glass -- President and Chief Executive Officer

Sort of all of the above. We saw a good growth in our life business, good growth in disability, little bit less growth in or actually negative at dental. And so it's across the spectrum. As I mentioned in my remarks, we're seeing a little success in the large case market, is getting us out of the penalty box, as I mentioned.

The employee-paid market were up quite a bit, 45%. That's cross-selling more into the Liberty block where they have not had much emphasis on employee-paid sales. Within the book, we are seeing a lot of upselling with existing customers, so I think that was up pretty significantly. The upselling with significant customers is if a client has just used us for LTD and they shift over to, say, adding the lifeline, so there's all these specific issues, but it's the overall strength of the portfolio and bringing the overall strength of the two companies and using that to increase the sales.

John Barnidge -- Sandler O'Neill + Partners, L.P.

Great. Thanks for the answer.

Operator

Thank you. And our next question comes from Elyse Greenspan with Wells Fargo. Your line is open.

Elyse Greenspan -- Wells Fargo -- Analyst

Hi. Thanks. Good morning. My first question is on the group business.

So the loss ratio was a little bit higher this quarter, which you guys pointed to in the prepared remarks. In terms of seasonality, how should we think about just thinking about the loss ratio for the fourth quarter? Any trend that you kind of want to highlight to us?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Elyse, I'd make a general comment that historically, and that doesn't obviously guarantee it's going to happen, but historically, we've tended to see a little bit of a tick up in our loss ratio in the fourth quarter. I can't tell you exactly what drives that seasonality. But if you look back at our results, I think you saw it a little bit last year in the fourth quarter, for instance. So that 74.1% we reported, which, as I mentioned, had two offsetting items inside of it, I think is right in line, maybe a little better than our long-term expectations.

But to your direct question, historically, we would expect to see a little bit of a tick up in the fourth quarter, we have seen historically a little bit of a tick up in the fourth quarter.

Elyse Greenspan -- Wells Fargo -- Analyst

OK. And then my second question, so with your annual review, you guys kick up the grading period associated with your rates to seven years from five, you said. Just as you were doing the review, I guess, can you just provide us why you -- kind of you guys settled on seven years as opposed to something else, just kind of background there that you can, any additional color?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Elyse, I don't think there's anything specific we can speak to, other than it just felt like we're in an environment where getting to a final answer, if you will, or getting to that ultimate rate just felt like it was going to take longer than it did coming in. We came into this year at five years. We felt good about that. But as we looked around and thought about all the things that can and are impacting interest rates, just felt appropriate to us to think about a little longer period of time before all those various items unwound.

Dennis Glass -- President and Chief Executive Officer

Yes, there's a lot of forward-looking and backward looking analysis that we do. But on the specific issue, one of the examples of what we would be thinking about is a historical look-back at how quickly in other historical periods have interest rates moved up from one level to the other ones. So that would be an example of what we looked at, along with other issues to form the judgment around seven versus five.

Elyse Greenspan -- Wells Fargo Securities -- Analyst

OK. Thank you very much.

Operator

Thank you. Our next question comes from John Nadel with UBS. Your line is open.

John Nadel -- UBS -- Analyst

Hey, good morning. I realize that this is a challenging environment and I also realize that the question I'm going to ask may seem a little bit extreme. But it sounds like you probably given us the task to do this math in any case. If Randy -- if someone said to the entire life insurance industry, Lincoln included, no more of this assumption of rising rates over time and your balance sheet needs to reflect the current rate environment as it is today period, so let's just put it in round numbers and say instead of a 3.5% 10-year in seven years, let's just assume it is fixed at 175 basis points or 2% for the foreseeable future.

How big of an impact would that be on whether it's book value per share or just common equity? And similarly, would there be any related impact on a statutory basis from that kind of an extreme?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

So let me take a crack at your question and I doubt that I am going to be able to answer exactly, but we have an assumption of the 10-year Treasury reverting to 3.5%, which seems quite reasonable given all the expectations for growth and everything. But today, the 10-year Treasury is about 175 basis points lower than that. So we have an estimate that each 50-basis-points reduction is approximately $160 million. We haven't tested it.

We don't have guidance out there at 175 basis points, but typically, we've seen that size adjustment has been fairly static for each 50 basis points. So, you can do --

John Nadel -- UBS -- Analyst

That's ratable?

Randy Freitag -- Chief Financial Officer and Head of Individual Life

And I also talk about -- talked about grades at this level on the statutory balance sheet. Once again, we don't see at this level of interest rates any need for additional, any material need for additional asset advocacy reserves, so really not much impact on the statutory balance sheet. The other thing I'd point out to you is that we carry in our overall book value $30 -- $32 per share of unrealized gains. So if you were to mark your liabilities to market, you would logically think about that rather healthy unrealized gain, which from a dollar standpoint is over $6 billion after tax, I believe, going against any sort of impact like that.

John Nadel -- UBS -- Analyst

Yes. No, that's what I'm trying to get at. It's -- I know stock is down like it is today, and on the surface this is a pretty significant charge relative to the impact of the last several years. But even still, if we went to that extreme, it feels to me like it's somewhere in the $3 to $4 per share impact noncash, and I guess that's what I was trying to get at, so thank you.

Randy Freitag -- Chief Financial Officer and Head of Individual Life

You bet.

Operator

Thank you. And our next question comes from Josh Shanker with Deutsche Bank. Your line is open.

Josh Shanker -- Deutsche Bank -- Analyst

Yes. Thanks for picking up at the end of the call. I mean Suneet now has kind of asked my questions, but I was wondering if we could dig a little deeper. In this SEC investigation into the K through 12, can you appraise on what they're looking for and in the past has these kind of regulatory issues kept you from growing organically or inorganically in that segment of the market?

Dennis Glass -- President and Chief Executive Officer

Yes. I'm not giving -- we can't get any depth on that. In that market, we have salaried employees. And so I think our practices are pretty good.

But I really don't know what is driving those inquiries.

Josh Shanker -- Deutsche Bank -- Analyst

OK. And then if we go back to last year, I'm just wondering about timing the process, what was sort of the gap in time between your recognition that there was something wrong between the stock price and the fundamental value of your business and you signing a deal with Athene to bring some earnings into the future to accelerate shareholder return, I guess? If that's true today, I'm wondering how long the process between wanting to do something and being able to do something has there been?

Dennis Glass -- President and Chief Executive Officer

Well, that's a pretty tough question because we're always talking to people. And we've been talking for a long time, but not in sort of a negotiation, it will happen quicker and vice versa. So it's very hard to pinpoint any kind of a nonorganic transaction in terms of what's the likelihood. So I'll just say that each one is different and we continue to look at opportunities.

Operator

Thank you. And that's all the time we have for questions right now. We will be able to follow up with those in the queue later this afternoon. I'd like to turn the call back over to Chris Giovanni.

Chris Giovanni -- Corporate Treasurer

Thank you all for joining us this morning. We'll follow up with those that are still in the queue. And as always, we will take your questions on the investor relations line at 1 (800) 237-2920 or via email at investorrelations@lfg.com. Thank you all.

Have a great day and a great Halloween.

Operator

[Operator signoff]

Duration: 62 minutes

Call participants:

Chris Giovanni -- Corporate Treasurer

Dennis Glass -- President and Chief Executive Officer

Randy Freitag -- Chief Financial Officer and Head of Individual Life

Ryan Krueger -- KBW -- Analyst

Alex Scott -- Goldman Sachs -- Analyst

Tom Gallagher -- Evercore ISI -- Analyst

Erik Bass -- Autonomous Research -- Analyst

Suneet Kamath -- Citi -- Analyst

John Barnidge -- Sandler O'Neill + Partners, L.P.-- Analyst

Elyse Greenspan -- Wells Fargo -- Analyst

John Nadel -- UBS -- Analyst

Josh Shanker -- Deutsche Bank -- Analyst

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