Lincoln National Corporation — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020; balance-sheet comparisons are against December 31, 2019. LNC operates Annuities, Retirement Plan Services, Life Insurance and Group Protection, plus Other Operations.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenue | $5.361 billion | $4.638 billion | $13.303 billion | $12.913 billion |
| Net income (loss) | $398 million | $(161) million | $356 million | $454 million |
| Diluted EPS | $2.01 | $(0.83) | $1.74 | $2.24 |
| Net investment income | $1.458 billion | $1.235 billion | $4.005 billion | $3.842 billion |
| Declared dividends per share | $0.40 | $0.37 | $1.20 | $1.11 |
- Profit drivers and quality: Q3 realized gains were $629 million, versus an $11 million loss in Q3 2019. Nine-month realized losses were $43 million, versus $491 million in 2019. These results included significant variable-annuity hedge and embedded-derivative fair-value effects; they make GAAP earnings volatile and are excluded in part from segment operating results.
- Segment income from operations, after tax: Q3 / nine months were Annuities $196 million / $694 million; Retirement Plan Services $50 million / $119 million; Life Insurance losses of $311 million / $177 million; and Group Protection $6 million / $85 million. Other Operations losses were $74 million / $202 million.
- Balance sheet at September 30: Total assets were $347.8 billion, including $149.5 billion of investments and $2.6 billion of cash and invested cash. Total liabilities were $326.3 billion and stockholders’ equity was $21.5 billion. Long-term debt was $6.714 billion; short-term debt was zero. AOCI was $7.809 billion, up from $5.673 billion at year-end 2019.
- Cash flows, nine months: Operating activities provided $341 million, compared with $2.857 billion used in 2019. Investing activities used $6.445 billion, compared with $2.285 billion used; financing activities provided $6.136 billion, compared with $5.736 billion provided. Cash and invested cash ended at $2.595 billion.
- Liquidity and capital: Holding-company available liquidity was $756 million. LNC reported $641 million of subsidiary dividends received in the first nine months. It also had access to additional sources including borrowing facilities, subject to availability, collateral and contractual terms.
Changes versus comparable periods
- Q3 net income improved from a loss to profit, principally reflecting the swing from realized losses to realized gains, alternative-investment income versus losses, expense management and lower acquisition costs. These benefits were partly offset by unfavorable Life Insurance mortality, Group Protection experience, annual assumption unlocking and spread compression.
- Nine-month net income declined from $454 million to $356 million. Higher benefits, unfavorable unlocking and spread compression outweighed lower realized losses, expense actions, lower acquisition costs and improved alternative-investment results.
- Deposits fell to $6.450 billion in Q3 from $7.380 billion and to $20.624 billion year to date from $22.333 billion. Total net flows were $1.235 billion in Q3 and $3.270 billion year to date, down from $1.752 billion and $4.785 billion, respectively.
- At September 30, the fixed-maturity AFS portfolio was $118.3 billion at fair value, versus $105.2 billion at year-end 2019. Unrealized gains contributed to higher AOCI; the company said it did not intend, and did not expect to be required, to sell securities before recovery of amortized cost.
- Residential mortgage credit quality weakened: $82 million was nonperforming at September 30, versus $17 million at year-end 2019; 74 specifically identified impaired residential loans had a $35 million carrying value, versus four loans totaling $1 million. The total mortgage-loan allowance was $202 million.
Outlook, risks and unusual items
- COVID-19 and economy: Management said the full effects remained uncertain and expected higher Life Insurance and Group Protection mortality for the remainder of 2020, along with disability-claim headwinds related to economic conditions. It also warned of possible investment credit deterioration and further allowance increases or impairments.
- Interest rates: Management expected near-zero rates to persist and adversely affect business interest margins. In its annual third-quarter assumption review, LNC lowered starting new-money assumptions and reduced its long-term new-money yield assumption by 50 basis points, to 3.0% for a 10-year U.S. Treasury. The review reduced net income by $486 million in Q3, primarily through Life Insurance and Annuities. This was an assumption-driven, non-cash-sensitive accounting item, not a stated cash outflow.
- Management actions: LNC repriced products, shifted sales toward shorter-duration and more capital-efficient products, moved distribution to virtual channels, and pursued expense reductions. It suspended repurchases in Q2 and Q3 after $225 million of first-quarter repurchases and planned to resume them in Q4. The board approved a quarterly dividend increase from $0.40 to $0.42 per share on November 3, 2020.
- Debt transactions: LNC issued $500 million of 3.40% senior notes due 2031 and $300 million of 4.375% notes due 2050, redeemed $296 million of 4.85% notes due 2021 and repaid a $500 million 2022 term loan. A separate trust facility provides a conditional right to issue up to $500 million of 2.330% notes; specified triggers include consolidated stockholders’ equity, excluding AOCI, falling below $2.75 billion.
- Accounting adoption: Adoption of the expected-credit-loss standard reduced retained earnings by $218 million, net of related effects; election of the fair-value option for certain mortgage loans increased retained earnings by $15 million after tax. The filing said adoption of long-duration contract accounting was still under evaluation; its effective date was subject to a proposed deferral.
- Legal contingencies: LNC estimated aggregate reasonably possible losses of up to approximately $90 million, including amounts above accruals; it cautioned this is not expected loss or maximum exposure. The company described multiple cost-of-insurance disputes and other cases and said it was vigorously defending them. Certain reinsurers also sought rate increases that LNC disputed.
- No specific consolidated earnings guidance is provided in the filing. Management’s outlook is expressed as operating expectations and risks, rather than a numerical earnings forecast.
Most important facts for investors to verify
- How much future earnings depend on recurring segment operations versus volatile realized gains, derivative marks, non-performance-risk assumptions and annual actuarial unlocking.
- Whether mortality and disability claims, particularly COVID-19-related experience, remain elevated and how that affects Life Insurance and Group Protection results.
- Whether persistently low rates further compress spreads, reduce product sales or increase withdrawals, and whether repricing and expense actions offset those pressures.
- Trends in mortgage delinquencies, impairments and credit-loss allowances, as well as broader portfolio downgrades or defaults.
- Holding-company liquidity, subsidiary dividend capacity, collateral demands and compliance with the conditional debt-facility terms as capital markets and statutory capital evolve.
- Developments in cost-of-insurance litigation, reinsurance rate disputes and other contingencies, including any change to the disclosed reasonably possible loss estimate.