Lincoln National Corporation — Q2 2020 Form 10-Q
Business context and period. LNC is an insurance and retirement-services holding company with Annuities, Retirement Plan Services, Life Insurance and Group Protection segments. This unaudited filing covers the quarter and six months ended June 30, 2020; comparisons are with the corresponding 2019 periods unless stated otherwise.
Financial results and position
| Metric | Q2 2020 | Six months 2020 | Comparison |
|---|---|---|---|
| Total revenue | $3.517 billion | $7.942 billion | Down 18% and 4%, respectively |
| Net income (loss) | $(94) million | $(42) million | 2019: $363 million and $616 million |
| Diluted EPS | $(0.49) | $(0.27) | 2019: $1.79 and $3.01 |
| Net cash from operating activities | $971 million for six months | 2019: $(2.562) billion |
GAAP results included realized losses of $647 million in Q2 and $671 million for the first half, largely reflecting variable-annuity hedge and other market-related effects. Other comprehensive income was $4.319 billion in Q2 and $1.650 billion for the first half, primarily reflecting investment valuation changes. Comprehensive income was therefore $4.225 billion and $1.608 billion, respectively.
Management’s segment operating income measure totaled $187 million in Q2 and $652 million for the first half, versus $478 million and $919 million in 2019. This measure excludes specified items, including excluded realized gains and losses; it is not GAAP net income. Q2 segment results were Annuities $237 million, Retirement Plan Services $30 million, Life Insurance $(37) million, Group Protection $39 million and Other Operations $(82) million.
- Balance sheet, June 30: assets $339.7 billion; liabilities $318.9 billion; stockholders’ equity $20.7 billion. At December 31, 2019, equity was $19.7 billion.
- Investments and liquidity: total investments were $144.9 billion; cash and invested cash were $4.2 billion, up from $2.6 billion at year-end. The holding company reported available liquidity of $774 million.
- Debt: long-term debt was $6.736 billion, with no short-term debt outstanding. LNC issued $800 million of senior notes and repaid or redeemed debt during the first half; management said its next debt maturity was not until 2023.
- Credit and investment measures: the fixed-maturity AFS portfolio had a fair value of $113.5 billion, with 96.5% investment grade. Mortgage-loan allowances for credit losses were $273 million at June 30, versus $2 million at year-end; the first-half provision was $183 million.
- Capital returns: dividends declared were $0.40 per share in Q2 and $0.80 for the first half. Share repurchases were suspended beginning in Q2, with the suspension announced to continue into Q3.
Material changes and segment trends
- Revenue and GAAP earnings fell, while operating cash flow improved substantially versus the prior-year first half.
- Life Insurance operating income fell to a Q2 loss, mainly because of higher mortality benefits and lower investment income. Group Protection income also declined as life and disability claims worsened. Management attributed unfavorable mortality and disability experience partly to COVID-19.
- Annuities operating income declined, reflecting lower fee income, alternative-investment losses and higher benefit reserves and hedging costs. Retirement Plan Services income declined amid lower fee and investment income and spread compression.
- Net investment income was $1.172 billion in Q2 and $2.547 billion for the first half, down 14% and 2%, respectively. Alternative-investment losses were $126 million in Q2 and $78 million for the first half, compared with gains of $70 million and $73 million in 2019.
- Retirement Plan Services had net outflows of $1.207 billion in Q2, including two large mid-to-large-market plan terminations. Total company net flows were $(126) million in Q2 and positive $2.035 billion for the first half.
Outlook, risks and unusual items
- Management said the pandemic’s duration and financial effects remained uncertain. It expected higher Life Insurance and Group Protection mortality for the remainder of 2020, as well as disability-claim and claim-resolution pressure.
- Near-zero interest rates were expected to continue weighing on interest margins. Management described repricing, a shift toward shorter-duration products, expense reductions and expense discipline as responses; it also expected lower Life Insurance sales to continue for the remainder of 2020 and lower Annuities deposits into Q3.
- Management warned that renewed equity-market declines or volatility could reduce asset-based fees and pressure net flows; weak economic conditions could increase credit defaults, allowances and investment impairments. Hedge strategies may not fully offset changes in guaranteed-benefit liabilities.
- COVID-19-related economic forecasts contributed to higher mortgage credit-loss provisions. LNC also adopted the expected-credit-loss standard, recording a $218 million after-tax decrease to retained earnings, partly offset by a $15 million increase from a fair-value election for certain loans.
- The company estimated reasonably possible litigation and regulatory losses of up to approximately $90 million, including amounts above accruals; this is not an estimate of expected loss or maximum exposure. It also disclosed disputes with reinsurers over requested rate increases.
- No specific quantitative earnings guidance was provided in the filing. Management cautioned that first-half results were not necessarily indicative of full-year results.
Most important facts for investors to verify
- How much of the reported loss reflects hedge and other mark-to-market volatility versus changes in underlying insurance and retirement operations.
- Whether COVID-19 mortality, disability claims and claim-resolution delays develop in line with management’s expectations.
- Whether low rates, equity-market volatility, plan terminations and product-mix changes further pressure spreads, fees, sales or net flows.
- How mortgage and other credit-loss allowances evolve, particularly given the economic outlook and the increase in residential mortgage delinquencies and impaired loans.
- Whether holding-company liquidity, subsidiary dividend capacity, ratings and collateral needs remain adequate; and whether repurchases resume after the announced suspension.
- How the disclosed litigation, reinsurance-rate disputes and future implementation of long-duration insurance accounting affect results, capital or reserves.