Lincoln National Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; balance-sheet comparisons are with December 31, 2010. Amounts are in U.S. dollars; financial statement figures are generally in millions unless noted.
Business context
Lincoln National is an insurance and retirement-services holding company operating Retirement Solutions (Annuities and Defined Contribution) and Insurance Solutions (Life Insurance and Group Protection), plus Other Operations. Its products include annuities, life insurance, and group life, disability, and dental coverage.
Financial performance and position
| Metric | Q1 2011 / March 31, 2011 | Comparable period / prior balance |
|---|---|---|
| Total revenue | $2,714 million | $2,527 million; up 7% |
| Income from continuing operations | $339 million | $255 million; up 33% |
| Net income | $339 million | $283 million; up 20% |
| Diluted earnings per share | $1.05 | $0.85 total EPS; Q1 2010 included $0.09 from discontinued operations |
| Operating cash flow | $340 million in the cash-flow statement | $565 million |
| Investing cash flow | $(1,367) million | $(1,489) million |
| Financing cash flow | $502 million | $185 million |
| Cash and invested cash | $2,216 million | $2,741 million at year-end |
| Total assets | $198,317 million | $193,824 million at year-end |
| Total liabilities / stockholders’ equity | $185,227 million / $13,090 million | $181,018 million / $12,806 million at year-end |
| Short-term / long-term debt | $351 million / $5,370 million | $351 million / $5,399 million at year-end |
The MD&A separately states that operating activities provided $382 million, while the consolidated cash-flow statement reports $340 million. The filing text does not reconcile this difference; investors should verify the correct figure and any relevant presentation or classification.
Premiums, insurance fees, and net investment income were $568 million, $818 million, and $1,191 million, respectively. Total deposits were $5,250 million, up 13%; net flows were $1,438 million, up 12%; and reported account values were $162,242 million, up 11% year over year. The filing does not provide a single consolidated operating-margin measure.
Material changes and segment results
- Higher investment income, larger average account values, improved equity markets, lower crediting rates, and lower realized investment losses supported earnings growth. Total realized loss narrowed to $2 million from $26 million; net OTTI losses recognized in earnings were $39 million versus $53 million.
- After-tax segment income from operations rose in Annuities to $147 million from $119 million; Defined Contribution to $49 million from $36 million; Life Insurance to $166 million from $137 million; and Group Protection to $24 million from $21 million. Other Operations reported a $37 million loss in both periods.
- Q1 2010 included $28 million of income from discontinued operations, principally related to the Delaware investment-management and Lincoln UK disposals; Q1 2011 reported none.
- Common shares were repurchased for $75 million during the quarter (about 2.414 million shares at an average $31.09). The quarterly common dividend was $0.05 per share, versus $0.01 a year earlier. Stockholders’ equity increased to $13,090 million.
Outlook, risks, and unusual items
- Management gave no consolidated earnings guidance. It expected strategic-investment expenses to continue through 2011 and planned to repurchase a further $100 million to $150 million of common stock, subject to market conditions and alternative capital uses.
- Management highlighted persistent low interest rates, regulatory and accounting changes, and Group Protection loss ratios likely to remain at the high end of long-term expectations or above. The Q1 non-medical loss ratio was 74.1%, against a stated long-term expectation of 71% to 74%; each one-percentage-point increase above expectation was estimated to reduce annual segment operating income by approximately $10 million to $12 million.
- Statutory reserve financing for secondary-guarantee universal-life and term products is a material capital consideration. Management expected related expenses to approximately double in 2011 versus 2010 and cited about $1.2 billion of letters of credit supporting intercompany reinsurance. It also stated that subsidiaries had capital above current regulatory requirements and were pursuing financing, reinsurance, and more capital-efficient products.
- Variable-annuity guarantees and hedging are exposed to equity markets, interest rates, volatility, policyholder behavior, and hedge effectiveness. The company reported $31.9 billion of account values with guaranteed withdrawal benefits and $12.1 billion with guaranteed income benefits. Management cautioned that hedges may not fully offset liability changes.
- Investment risks include credit deterioration, mortgage-market stress, interest-rate movements, and concentration. Fixed-maturity AFS securities were 95% investment grade by fair value. Gross unrealized losses on AFS securities fell by $186 million during the quarter; management said it did not consider the remaining losses other-than-temporary overall. Q1 included $50 million of gross credit-related OTTI recognized in earnings and $8 million of non-credit OTTI recognized in OCI.
- Legal and regulatory proceedings include matters seeking unspecified or substantial damages; management did not expect them to materially affect consolidated financial position, but noted an adverse outcome could materially affect results in a particular period. The IRS was auditing specified tax years. Management also identified economic, ratings, reinsurance, and regulatory risks.
Investor verification priorities
- Reconcile the MD&A’s $382 million operating-cash-flow figure with the $340 million reported in the cash-flow statement.
- Assess earnings quality and repeatability, including investment income, market-sensitive fees, OTTI, favorable reserve/DAC unlocking, and alternative-investment returns.
- Review statutory capital and reserve-financing capacity, including the availability and cost of letters of credit and other solutions for secondary guarantees.
- Monitor Group Protection claims experience, particularly disability loss ratios, and the expected trajectory of reserve-financing and strategic-investment expenses.
- Evaluate variable-annuity guarantee exposure, hedge effectiveness, interest-rate sensitivity, and the potential effect of rating downgrades on liquidity and distribution.
- Review investment portfolio credit quality and mortgage exposures, and read the full notes for contingencies, commitments, and legal proceedings.