Lincoln National Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Amounts are in millions of dollars, except per-share data. Lincoln National operates annuity, retirement plan services, life insurance and group protection businesses.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $4,264 | $3,511 | $11,893 | $10,588 |
| Net income | $490 | $418 | $1,242 | $1,264 |
| Diluted EPS | $2.24 | $1.87 | $5.59 | $5.58 |
| Comprehensive income (loss) | $125 | $566 | $(1,794) | $2,557 |
| Cash dividends declared per share | $0.33 | $0.29 | $0.99 | $0.87 |
Q3 revenue and earnings benefited from business growth, lower tax expense, alternative investment income and the Liberty Life acquisition. For the nine-month period, lower earnings reflected variable-annuity derivative losses, acquisition and digitization costs, weaker alternative investment income and lower prepayment and make-whole premiums. Net income includes $32 million of Q3 tax-related benefit and $47 million of nine-month after-tax acquisition and integration costs.
Other comprehensive loss was $3,036 for the first nine months, substantially reducing equity. The company reported $5,520 of unrealized holding losses on AFS securities before related adjustments, citing higher interest rates and wider credit spreads. Management considered the declines temporary and said it did not expect to need to sell the securities before recovery.
| Balance sheet / cash flow | September 30, 2018 | December 31, 2017 or comparable period |
|---|---|---|
| Total assets | $303,850 | $281,763 |
| Total stockholders’ equity | $15,070 | $17,322 |
| Long-term debt | $5,804 | $4,894 |
| Short-term debt | — | $450 |
| Cash and invested cash | $1,460 | $1,628 |
| Operating cash flow, nine months | $1,034 | $609 |
| Investing cash flow, nine months | $(4,240) | $(2,784) |
| Financing cash flow, nine months | $3,038 | $1,418 |
Holding-company available liquidity was $465 million at September 30. The company reported $114.1 billion of investments and cash against $105.6 billion of insurance-policy and contract obligations, net of reinsurance recoverables. Debt issuance and acquisition financing increased long-term debt; the company issued $1.1 billion of senior notes and repaid $537 million of debt during the first nine months.
Segments and material changes
- Annuities: Operating income was $302 in Q3 and $844 year to date, versus $277 and $809. Higher average variable account values supported fee income; spread compression and lower prepayment premiums weighed on investment results.
- Retirement Plan Services: Operating income was $40 in Q3 and $125 year to date, versus $35 and $109. Nine-month net flows rose to $2,373 from $1,003, driven particularly by mid-to-large-market plans; older-block outflows continued.
- Life Insurance: Operating income was $176 in Q3 and $470 year to date, versus $121 and $384. Growth in business in force and fee income helped, while higher expenses included unfavorable unlocking effects. Nine-month sales declined to $502 from $556.
- Group Protection: Operating income was $63 in Q3 and $137 year to date, versus $41 and $83. Comparisons include Liberty Life results from May 1, 2018; the acquired business contributed $929 of revenue and $26 of net income since acquisition. Group revenue growth is therefore not purely organic.
- Other Operations: Operating loss widened to $71 in Q3 and $171 year to date, versus $20 and $71. Drivers included increased debt expense, digitization costs and lower investment income.
Acquisition, outlook, risks and contingencies
On May 1, 2018, Lincoln acquired Liberty Life. It paid $1.5 billion for the group benefits business; Liberty Life’s $1.8 billion excess capital was paid to Liberty Mutual. The individual life and annuity business was reinsured to Protective for a $423 million ceding commission. Acquisition fair values remain provisional, and recorded goodwill was $390 million, allocated to Group Protection. Reinsurance recoverables rose to $18.3 billion from $4.9 billion, primarily because of the transaction. Protective is now the company’s largest reinsurance exposure; related recoverables are fully collateralized in trust, but Lincoln remains liable on the reinsured policies.
No quantitative earnings guidance is provided in the supplied filing text. Management said it expects to manage near-term spread effects through portfolio management and, to a lesser extent, crediting-rate actions, subject to net-flow and market conditions. It expected further share repurchases during the remainder of 2018 depending on market conditions and alternative uses of capital. On October 31, the board raised the quarterly dividend from $0.33 to $0.37 per share.
Key risks include interest-rate and equity-market movements, spread compression, variable-annuity guarantee exposure and hedge effectiveness, credit and investment valuation, reinsurance collectability, ratings and subsidiary dividend capacity, and acquisition integration. Management reported that 96.3% of fixed-maturity AFS securities were investment grade; unrealized losses on those securities had increased by $1.5 billion since year-end. The company estimated aggregate reasonably possible litigation losses of up to approximately $50 million; some matters could not be estimated. It is disputing reinsurer requests for rate increases on certain yearly renewable term treaties and said it did not expect a material adverse financial effect.
Annual assumption reviews produced a net $1 million reduction in Q3 net income from unlocking. Separately, management estimated that applying its reversion-to-the-mean process as of September 30 would have produced favorable pretax unlocking of approximately $215 million for Annuities, $50 million for Life Insurance and $30 million for Retirement Plan Services; this was not reported as an actual recognized result.
Important facts for investors to verify
- How much of Group Protection’s reported growth and future earnings reflects Liberty Life, and whether integration and synergies meet expectations.
- Protective’s ongoing collateralization and credit quality, and Lincoln’s retained liability and concentration exposure under the reinsurance arrangements.
- Whether unrealized AFS losses remain temporary and whether the substantial decline in AOCI affects statutory capital, ratings or liquidity.
- Variable-annuity hedge performance, guarantee exposure and sensitivity to equity markets, interest rates and volatility.
- Trends in segment spreads, Retirement Plan Services’ older-block outflows, Life Insurance sales and Group Protection loss ratios.
- Holding-company liquidity, subsidiary dividend capacity, debt service, planned repurchases and the outcome of legal and reinsurance disputes.