LINCOLN NATIONAL CORP quarterly report, Q1 FY2016

Lincoln National Corporation — Q1 2016 Form 10-Q

Business context and reporting period. Lincoln National is a holding company whose insurance and retirement businesses operate through Annuities, Retirement Plan Services, Life Insurance and Group Protection. This unaudited filing covers the three months ended March 31, 2016; balance-sheet comparisons are with December 31, 2015, and results are compared with Q1 2015. Amounts below are in millions of dollars unless noted.

Financial performance and position

MetricQ1 2016 / March 31, 2016Prior comparable / December 31, 2015
Total revenue$3,243$3,304
Income before tax$235$362
Net income$208; diluted EPS $0.82$300; diluted EPS $1.15
Cash from operating activities$295$296
Cash and invested cash$3,177$3,146
Total assets$255,718$251,908
Total stockholders’ equity$14,658$13,617
Long-term debt$5,650$5,553

Revenue declined 1.8% year over year, while net income fell 30.7%. Calculated from reported GAAP figures, pretax margin was approximately 7.2% versus 11.0%, and net margin approximately 6.4% versus 9.1%. The effective tax rate was 12% versus 17%. The filing does not present a conventional consolidated operating margin.

Net cash provided by operating activities was $295; investing activities used $707, and financing activities provided $443, producing a $31 increase in cash and invested cash. The company reported $539 of available holding-company liquidity at quarter-end. Separate-account assets and liabilities were each $123,506.

Total investments were $106,371, including $88,064 of fixed-maturity securities and $8,916 of mortgage loans. Fixed-maturity AFS securities were 95.6% investment grade by fair value; energy-sector AFS bonds had $7,592 fair value and $401 of unrealized losses. Stockholders’ equity increased in part alongside $1,086 of after-tax other comprehensive income. The quarterly dividend declared was $0.25 per share versus $0.20 a year earlier.

Material changes and segment results

  • Management-defined segment operating income totaled $314 versus $352, a decline of about 11%; this non-GAAP measure excludes specified realized items and other adjustments.
  • Annuities operating income was $218, down 9%; lower variable-account fees and higher benefit reserves were partly offset by lower expenses and higher net investment income.
  • Retirement Plan Services operating income was $31, down 11%, primarily reflecting lower fees and spread pressure.
  • Life Insurance operating income was $75, down 32%. Benefits rose 14% to $740, with management citing unfavorable mortality and growth in business in force. Q1 mortality was elevated due primarily to claim seasonality and higher severity.
  • Group Protection reported $5 of operating income versus a $6 loss, reflecting more favorable non-medical loss experience, particularly disability claim recoveries. Premium revenue fell 13% to $489.
  • Other Operations’ loss narrowed to $15 from $27, mainly because of lower deferred-compensation-related expenses.
  • GAAP realized losses were $114 versus $48. Management cited higher investment-related legal expenses and increased credit impairments, particularly in energy and other commodity sectors. Net OTTI recognized in earnings was $36 versus $13.
  • Total deposits declined 10% to $5,382, and total net flows declined 27% to $873. Annuity net flows turned negative at $35 outflow, versus $196 of inflows; variable annuity deposits declined 43%.

Outlook, risks and unusual items

  • No specific consolidated earnings or revenue forecast is provided in the supplied filing text. Management said it expects to meet holding-company cash needs and manage near-term spreads through portfolio management and, to a lesser extent, crediting-rate actions, subject to assumptions about flows and market conditions.
  • Management reported favorable hypothetical DAC/VOBA/DSI/DFEL reversion-to-the-mean unlockings of approximately $115 for Annuities, $20 for Retirement Plan Services and $15 for Life Insurance, pre-tax, as of March 31, 2016; these were not reported as actual quarter results.
  • Low interest rates may compress investment spreads; rising rates may prompt surrenders and investment losses. Equity-market declines can reduce fee income and increase guaranteed-benefit exposure. At quarter-end, 11% of in-force variable-annuity contracts with GLBs were “in the money,” versus 3% a year earlier; net exposure after reinsurance was $679 versus $254.
  • The company relies on subsidiary dividends and financing arrangements for holding-company liquidity. Subsidiary dividend capacity may be constrained by statutory capital and adverse markets. Debt was $5,650; management reported senior debt ratings of A-/Baa1 (S&P/Moody’s).
  • The final Department of Labor fiduciary rule was issued April 8, 2016, after quarter-end. Phased implementation begins April 10, 2017, with full implementation by January 1, 2018; management warned it could change distribution, compensation and fees and affect sales or margins.
  • Management estimated aggregate reasonably possible litigation and regulatory losses of up to approximately $50, including amounts above accruals; other matters could not be estimated. It did not believe currently known matters were likely to materially adversely affect financial condition. A Lehman-related proceeding had a confidential settlement agreement, with dismissal expected upon filing of a stipulation.
  • The company repurchased $200 of common stock in Q1 and reported $368 remaining under its authorization. Management expected further 2016 repurchases depending on market conditions and alternative uses of capital. Share count declined to 239.0 million from 243.8 million at year-end.

Investor verification priorities

  • Reconcile GAAP net income of $208 with segment operating income of $314, including realized losses, benefit-ratio unlocking and other excluded items.
  • Assess whether elevated Life Insurance mortality was seasonal or signals a sustained change in claims experience.
  • Review the energy and commodity credit exposures, OTTI assumptions, below-investment-grade holdings and potential for additional impairments.
  • Monitor annuity sales and net flows, variable-annuity guarantee exposure, hedge effectiveness, and the sensitivity of earnings and collateral needs to market movements.
  • Verify holding-company liquidity, statutory capital and subsidiary dividend capacity, as well as the effects of the DOL fiduciary rule and litigation developments.