Lincoln National Corporation — FY 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012; comparisons are primarily with FY 2011. This is an annual filing, not a standalone fourth-quarter report. Lincoln National is an insurance and retirement-services holding company with Annuities, Retirement Plan Services, Life Insurance, and Group Protection segments, plus Other Operations.
Financial performance and position
| Metric | FY 2012 / Dec. 31, 2012 | Prior comparable period |
|---|---|---|
| Total revenue | $11.532 billion | $10.641 billion in 2011 |
| Income from continuing operations | $1.286 billion; $4.47 diluted EPS | $229 million; $0.72 diluted EPS in 2011 |
| Net income | $1.313 billion; $4.56 diluted EPS | $221 million; $0.69 diluted EPS in 2011 |
| Operating cash flow | $1.269 billion | $1.276 billion in 2011 |
| Total assets / stockholders’ equity | $218.869 billion / $14.973 billion | $201.491 billion / $13.101 billion |
| Investments / cash and invested cash | $99.065 billion / $4.230 billion | $93.130 billion / $4.510 billion |
| Debt | $200 million short-term debt and $5.439 billion long-term debt on the balance sheet | $300 million and $5.391 billion, respectively |
Revenue rose about 8%; net income increased substantially, mainly reflecting the absence of 2011 goodwill impairments, improved realized results, favorable tax adjustments, favorable unlocking, and growth in account values and insurance in force. These gains were partly offset by spread compression and higher business investment. FY 2012 net income also included $27 million from discontinued operations.
Operating income by segment was: Annuities $595 million (+4%); Retirement Plan Services $130 million (-20%); Life Insurance $574 million (+3%); Group Protection $72 million (-26%); and Other Operations loss of $87 million, improved from a $146 million loss.
Other key measures: total deposits increased 6% to $22.894 billion; net flows increased 6% to $6.727 billion; and account values rose 11% to $177.770 billion, supported by market gains and positive flows. Annuities’ interest-rate spread narrowed to 1.91% from 1.94%; Retirement Plan Services’ spread fell to 2.06% from 2.38%. Group Protection’s non-medical loss ratio rose to 74.5% from 72.9%, above the company’s 71%–74% long-term expectation.
Material changes versus FY 2011
- Net income rebounded from $221 million to $1.313 billion; 2011 included $747 million of goodwill impairment expense, while no goodwill impairment was recorded in 2012.
- Total realized gain was $74 million in 2012, compared with a $294 million realized loss in 2011. Net other-than-temporary impairment losses recognized in earnings were $153 million pre-tax, versus $124 million in 2011.
- Segment performance diverged: Annuities and Life Insurance increased operating income, while Retirement Plan Services and Group Protection declined.
- The company retrospectively adopted new insurance acquisition-cost accounting in 2012, reducing deferred acquisition costs and restating comparative periods. It also restated prior-period tax balances and results after identifying deferred-tax and uncertain-tax-position errors. The filing says those errors were not material to previously filed statements, but the correction would have been material if recorded in 2012.
- Stockholders’ equity increased to $14.973 billion, including a rise in accumulated other comprehensive income to $3.808 billion from $2.680 billion. Common shares outstanding declined, with 20.467 million shares repurchased during 2012.
Liquidity, capital, and outlook
Consolidated operating activities generated $1.269 billion of cash. The holding company reported $706 million of available liquidity at year-end and received $635 million of dividends from LNL in 2012. Management estimated domestic insurance subsidiaries could pay approximately $730 million in dividends in 2013 without prior regulatory approval, subject to statutory and capital constraints. The company returned $582 million to common stockholders in 2012 through dividends and share repurchases; the quarterly dividend increased from $0.08 to $0.12 per share in November 2012.
Management reported that insurance-subsidiary risk-based capital ratios exceeded the regulatory company-action level. The company had approximately $1.2 billion of capital securities outstanding and a $2 billion unsecured revolving credit facility expiring in June 2015. Principal debt maturities included $200 million in 2013 and $500 million in 2014. Moody’s outlook was positive; other cited ratings outlooks were stable. Insurer financial-strength ratings for the principal subsidiaries included A+ from A.M. Best, A+ from Fitch, A2 from Moody’s, and AA- from S&P for LNL and LLANY.
Management’s 2013 commentary was qualitative, not formal earnings guidance. Priorities included monitoring capital and liquidity, pursuing reserve-financing solutions, repricing products for low rates, investing in technology and distribution, controlling expenses, and shifting Life Insurance sales toward VUL, indexed UL, and term products that rely less on secondary guarantees. These “pivot” products were 46% of Life sales in 2012, up from 31% in 2011. Management cautioned that product repricing could reduce sales and market share in the near term.
Risks, contingencies, and unusual items
- Low interest rates and spread pressure: New-money yields remained below portfolio yields; management warned that sustained low rates could compress spreads, require reserve strengthening, and cause adverse unlocking. A hypothetical 10-year Treasury rate of 1.50% through end-2014 was estimated to reduce earnings by about $35 million in 2013 and $100 million in 2014 versus 2012.
- Variable-annuity guarantees and hedging: About 70% of individual annuity variable-account values had guaranteed living-benefit features. The hedge program ended 2012 with $1.9 billion of assets versus an estimated $1.2 billion liability, but hedges may not fully offset market, behavior, or basis risks.
- Statutory reserves and capital: Revised AG38 requirements applied to certain in-force policies at year-end 2012; the company did not expect a material effect on total in-force reserves, but said the revised approach for new business would generally require higher reserves. Reserve financing depends partly on letters of credit and capital-market alternatives.
- Reinsurance exposure: Reinsurance recoverables were $6.4 billion, including $2.8 billion related to Swiss Re; a $2.0 billion trust supported the Swiss Re business. The company remains liable to policyholders if reinsurers fail to pay.
- Investment and credit risks: Approximately 95.4% of fixed-maturity AFS securities were investment grade by reported fair value. Gross unrealized losses on AFS securities were $515 million. Management identified illiquid investments, mortgage-credit exposure, and valuation judgments as risks.
- Legal and regulatory matters: The company estimated reasonably possible losses, including amounts above accruals, of up to approximately $200 million as of year-end; other matters could not be reasonably estimated. State audits and inquiries concerning unclaimed benefits and abandoned funds were ongoing.
- Tax and reporting matters: The tax restatement did not change total cash flows in the periods presented. FY 2012 federal tax expense was $282 million, an 18% effective rate; the separate-account dividends-received deduction benefit was $128 million. Management reported no deferred-tax valuation allowance.
- Other: FY 2012 included $20 million of restructuring charges in Other Operations. Management and Ernst & Young concluded internal control over financial reporting was effective; the auditor issued an unqualified opinion on the financial statements.
Most important facts for investors to verify
- Review the restated 2011 and 2010 comparisons and the effects of both the tax corrections and the new acquisition-cost accounting.
- Track spread trends, minimum-rate exposure, and the actual earnings effects of continued low rates and product repricing.
- Assess variable-annuity guarantee liabilities, hedge effectiveness, policyholder behavior, and statutory capital under stressed markets.
- Confirm subsidiary dividend capacity, holding-company liquidity, debt maturities, credit-facility covenant compliance, and capital-security triggers.
- Monitor Group Protection claims experience against its long-term loss-ratio range and the status and potential cost of legal, unclaimed-property, and reinsurance matters.