Lincoln National Corporation — Q1 2022 Form 10-Q
Business context and reporting period. Lincoln National Corporation (Lincoln Financial Group) is an insurance and retirement-services holding company with Annuities, Retirement Plan Services, Life Insurance and Group Protection segments. This unaudited report covers the three months ended March 31, 2022, compared with Q1 2021; balance-sheet comparisons are with December 31, 2021.
Financial performance and position
| Metric | Q1 2022 | Q1 2021 or prior date |
|---|---|---|
| Total revenue | $4.687 billion | $4.534 billion |
| Net income | $104 million; diluted EPS $0.58 | $225 million; diluted EPS $1.16 |
| Net investment income | $1.412 billion | $1.510 billion |
| Operating cash flow | $753 million | $(642) million |
| Cash and invested cash | $1.960 billion | $2.612 billion at Dec. 31, 2021 |
| Total assets | $365.929 billion | $387.301 billion at Dec. 31, 2021 |
| Total stockholders’ equity | $14.712 billion | $20.272 billion at Dec. 31, 2021 |
| Long-term debt | $6.561 billion | $6.325 billion at Dec. 31, 2021 |
Total expenses were $4.595 billion, up from $4.272 billion. Pre-tax income was $92 million, down from $262 million; the effective tax rate was negative 13%, reflecting tax benefits. Cash flow from investing activities was a use of $2.141 billion and financing activities provided $736 million. Cash, invested cash and restricted cash decreased by $652 million during the quarter.
Management’s segment operating income was $294 million, compared with $350 million in Q1 2021: Annuities $302 million (up from $290 million), Retirement Plan Services $55 million (down from $57 million), Life Insurance $58 million (down from $107 million), Group Protection loss of $41 million (versus a $26 million loss), and Other Operations loss of $80 million (versus $78 million). These are management-defined measures, not GAAP net income.
Deposits increased to $7.406 billion from $6.673 billion; net flows were $1.276 billion versus $364 million. Common dividends declared were $0.45 per share, versus $0.42. The company repurchased $400 million of shares during the quarter.
Material changes and drivers
- GAAP net income fell by $121 million. Management cited lower alternative-investment income, unfavorable variable-annuity hedge results, adverse disability experience, higher Spark Initiative expense, the prior-year comparison for Life Insurance reinsurance, and spread compression. Lower mortality claims, higher prepayment and bond make-whole premiums, and a tax benefit partly offset these factors.
- Fixed-maturity available-for-sale securities had a fair value of $110.695 billion, down from $118.746 billion at year-end. Gross unrealized losses increased by $2.5 billion, principally due to rising interest rates and wider credit spreads. Management said it did not intend, and was not likely required, to sell the securities before recovery of amortized cost; it did not record an earnings impairment for this market-value decline.
- Accumulated other comprehensive income fell to $1.250 billion from $6.441 billion, largely reflecting unrealized investment losses. Separate-account assets and liabilities each declined to $168.879 billion from $182.583 billion.
- Life Insurance income from operations declined, with the company citing lower investment income and the impact of a reinsurance agreement effective October 1, 2021; management expects that agreement to reduce future segment operating income.
Outlook, risks and unusual items
- Interest rates and markets: Management expected spread compression from low interest rates to continue in the near term, though to moderate as rates rise. It cited portfolio management, product design, crediting-rate actions and asset-liability practices as mitigants. Rapid rate increases could also increase policy surrenders and affect hedging.
- COVID-19 and claims: The filing said pandemic effects remained uncertain and expected to continue affecting the business in Q2 2022. Management anticipated disability morbidity headwinds and elevated mortality in Life Insurance, alongside improving pandemic mortality conditions.
- Variable-annuity guarantees: After-reinsurance exposure on in-the-money guaranteed living-benefit contracts was $1.1 billion, versus $541 million a year earlier; 19% of in-force contracts with such features were in the money, versus 9%. Hedge performance may be imperfect and sensitive to market moves and policyholder behavior.
- Expense initiative and accounting: Spark Initiative expense was $31 million, versus $13 million, and management expected further investments. The company plans to adopt long-duration insurance accounting changes on January 1, 2023; the effect was still under evaluation and could be material.
- Liquidity and capital: Management said it expected to meet holding-company cash needs and retain sufficient capital for downside protection. The insurer subsidiaries’ dividends, statutory capital and market access remain important dependencies. LNL had $3.9 billion of FHLB borrowings and $3.9 billion of maximum available borrowing based on qualifying assets; the filing also describes collateral and rating-related liquidity risks.
- Litigation: A cost-of-insurance class-action settlement involving LLANY and Voya was preliminarily approved, subject to final court approval, for $92.5 million pre-tax cash plus a five-year rate freeze and other terms. Separately, the company estimated aggregate reasonably possible litigation and regulatory losses of up to approximately $120 million after tax; this is not an expected-loss estimate or maximum exposure. Other cost-of-insurance litigation remains pending, including a class-certification order in Vida Longevity Fund.
Most important facts for investors to verify
- How much of the decline in earnings and equity reflects temporary market-driven effects versus changes in underlying operating performance, and how investment losses evolve as rates and credit spreads change.
- The adequacy and performance of variable-annuity hedges, guarantee reserves, and the exposure of statutory capital and dividend capacity to market movements.
- The future earnings and capital effects of the 2021 Life Insurance reinsurance agreement, and whether the stated cost-of-insurance settlement receives final court approval.
- Whether disability claims, pandemic-related mortality, interest-rate spreads, and policyholder withdrawals develop in line with management’s expectations.
- The company’s liquidity headroom, including collateral calls, FHLB borrowing availability, ratings triggers, and the ability of insurance subsidiaries to upstream dividends.
- The eventual transition impact of the 2023 long-duration contract accounting standard and the costs and savings achieved under the Spark Initiative.