Lincoln National Corporation (LNC) — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. Amounts are in millions unless stated otherwise. LNC operates insurance and retirement businesses through Annuities, Retirement Plan Services, Life Insurance and Group Protection, with additional results in Other Operations.
Financial results and position
| Metric | Q1 2018 | Q1 2017 / prior year-end |
|---|---|---|
| Total revenue | $3,609 | $3,500 |
| Net income | $367 | $435 |
| Diluted EPS | $1.64 | $1.89 |
| Operating cash flow | $140 | $109 |
| Total assets | $279,237 | $281,763 at Dec. 31, 2017 |
| Stockholders’ equity | $15,985 | $17,322 at Dec. 31, 2017 |
| Cash and invested cash | $2,257 | $1,628 at Dec. 31, 2017 |
| Short- and long-term debt | $5,898 | $5,344 at Dec. 31, 2017 |
| Dividend declared per common share | $0.33 | $0.29 |
Revenue increased, while net income and diluted EPS declined. Net income included $19 after-tax loss on early debt extinguishment, $13 unfavorable net Tax Act impact, $4 acquisition and integration costs, and $10 unfavorable benefit-ratio unlocking. Net income also benefited from lower realized losses than in Q1 2017. The reported effective tax rate was 16%, versus 8%.
Other comprehensive loss was $1,639, compared with $281 of comprehensive income in Q1 2017. The filing attributes the substantial current-period AOCI movement principally to unrealized investment losses; gross unrealized losses on fixed-maturity AFS securities increased $627 from year-end, primarily reflecting wider credit spreads and rising interest rates. Management stated it did not intend, and was not more likely than not required, to sell the affected securities before recovery, and expected cash flows to support recovery of amortized cost.
Cash from operations was $140; investing activities used $595 and financing activities provided $1,084. LNC reported $1.1 billion of available holding-company liquidity at quarter-end. Insurance subsidiaries had investments with carrying value of $3.6 billion on loan or subject to repurchase agreements; LNL’s estimated maximum FHLBI borrowing capacity was $5.0 billion, subject to qualifying collateral and lender discretion.
Segment performance and material changes
| Segment | Operating revenue | Operating income | Change and reported drivers |
|---|---|---|---|
| Annuities | $1,073 | $267 | Income down from $281; lower tax benefit, spread compression and alternative-investment returns offset higher fee income. Interest-rate spread was 1.63%, down from 1.74%. |
| Retirement Plan Services | $292 | $43 | Income up from $37, primarily from lower tax expense and higher fee income. Interest-rate spread was 1.47%, down from 1.52%; net flows were $463 versus $141. |
| Life Insurance | $1,660 | $144 | Income up from $130, supported by business-in-force growth and lower tax expense, partly offset by higher benefits. Interest-rate spread was 1.42%, down from 1.60%. |
| Group Protection | $553 | $29 | Income up from $7, mainly due to lower benefits and higher premiums; total loss ratio improved to 64.3% from 71.0%. |
| Other Operations | $67 | $(42) | Loss widened from $13, reflecting no 2018 amortization of a reinsurance gain fully amortized in 2017, less favorable tax benefits and higher digitization expense. |
Total deposits were $6,420, up from $5,682; total net flows were $933, versus $308. Annuities had net outflows of $606, while Retirement Plan Services and Life Insurance had net inflows of $463 and $1,076, respectively. Total account values were $252,620, compared with $236,168 a year earlier.
Outlook, commentary, risks and unusual items
- Management said it expects to manage near-term spread effects through portfolio management and, to a lesser extent, crediting-rate actions. These expectations assume no significant changes in fixed-account flows or other factors affecting spreads; the filing provides no company-wide numerical earnings guidance.
- Management stated it expects to meet ongoing holding-company cash needs and maintain capital to provide downside protection, while noting that weaker markets could reduce subsidiary statutory surplus and dividend capacity. It also expected additional 2018 share repurchases depending on market conditions and alternative uses of capital; none were made in Q1.
- In February, LNC issued $1.1 billion of senior notes, including $150 million at 4.00% due 2023, $500 million at 3.80% due 2028 and $450 million at 4.35% due 2048. Proceeds supported debt refinancing and the announced acquisition. LNC repurchased $287 million of 8.75% notes due 2019, recording a $23 pre-tax extinguishment loss, and repaid $200 million of 7.00% notes due 2018.
- After quarter-end, on May 1, 2018, LNC and its insurance subsidiary completed the acquisition of Liberty Life Assurance Company of Boston. Certain policies were ceded to Protective Life affiliates under reinsurance agreements, supported by trust accounts. The supplied filing text does not provide a clear purchase price or full acquisition financial impact.
- Key exposures include interest-rate and equity-market movements, spread compression, policy surrenders, variable-annuity guarantees and hedge performance, investment credit losses, reinsurance availability and counterparty risk, regulatory and tax changes, and litigation. LNC estimated aggregate reasonably possible litigation losses of up to approximately $50 million; other matters could not be reasonably estimated. It also disputed reinsurers’ requested rate increases on certain yearly renewable term treaties.
- The filing describes putative class actions alleging improper increases or deductions in universal-life cost-of-insurance charges. LNC disputed the allegations and said it would defend the cases. It stated that adverse litigation charges could be material in particular periods, but management did not believe currently known matters were likely to materially adversely affect financial condition.
- The Fifth Circuit vacated the DOL Fiduciary Rule in March 2018; the SEC proposed Regulation Best Interest in April. The ultimate regulatory requirements and their effects on product sales, compensation and margins remained uncertain.
Most important facts for investors to verify
- Whether lower reported net income reflects continuing operating trends: compare segment operating income with GAAP net income and assess the tax, debt-extinguishment, unlocking and acquisition items.
- How rising rates, credit spreads and market movements affect AFS fair values, AOCI, investment income, policyholder behavior and variable-annuity hedge results.
- Whether interest spreads stabilize, given declines across Annuities, Retirement Plan Services and Life Insurance, and whether crediting-rate actions affect retention and flows.
- The completed Liberty Life acquisition’s purchase accounting, reinsurance structure, integration costs and contribution to future results, which are not quantified here.
- Holding-company liquidity and access to subsidiary dividends, financing facilities and collateral, alongside higher debt and the substantial reserve-financing arrangements.
- Developments in cost-of-insurance litigation, reinsurance-rate disputes, and federal or state conduct-of-business regulation.