Lincoln National Corporation — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; balance-sheet comparisons are with December 31, 2009. Amounts are in millions of dollars unless noted. Interim results are unaudited and management cautions they are not necessarily indicative of full-year results.
Business context and results
Lincoln National, marketed as Lincoln Financial Group, provides annuity, life insurance, retirement and group protection products through four segments: Annuities, Defined Contribution, Life Insurance and Group Protection. Former Investment Management and U.K. businesses are reported as discontinued operations.
Total revenue increased 19% to $2,527. Net income was $283, compared with a $579 net loss in Q1 2009; income from continuing operations was $255 versus a $587 loss. Diluted EPS was $0.85 versus a $2.27 loss. The turnaround is not a like-for-like measure of underlying improvement: Q1 2009 included a $604 intangible impairment expense and materially higher investment and hedge losses.
Key financial metrics
| Metric | Q1 2010 | Q1 2009 / comparison |
|---|---|---|
| Revenue | $2,527 | $2,132; up 19% |
| Net investment income | $1,106 | $1,013; up 9% |
| Net realized loss | $(26) | $(196); improved |
| Net OTTI recognized in earnings, pre-tax | $53 | $122 |
| Cash from operating activities | $565 | $(344) |
| Cash used in investing activities | $(1,489) | $(870) |
| Cash from financing activities | $185 | $901 |
| Cash and invested cash, at quarter-end | $3,445 | $4,025 at year-end 2009 |
| Total assets / stockholders’ equity, at quarter-end | $181,621 / $12,368 | $177,433 / $11,700 at year-end 2009 |
| Short-term / long-term debt, at quarter-end | $101 / $5,060 | $350 / $5,050 at year-end 2009 |
Segment operating income, a non-GAAP measure, was $155 for Retirement Solutions (up from $104), $158 for Insurance Solutions (down from $168), and a $37 loss for Other Operations (versus a $109 loss). Segment results exclude specified items; they should not be substituted for GAAP net income.
Selected spread and claims indicators: Annuities’ interest-rate spread was 2.13%, up from 1.42%; Defined Contribution’s was 2.16%, up from 1.91%; Life Insurance’s interest-sensitive spread was 1.87%, up from 1.52%. Group Protection’s non-medical loss ratio rose to 74.8% from 70.8%.
Material changes and notable items
- Revenue growth reflected higher insurance fees and investment income. Improved equity markets lifted account values; company-wide account values were up $4.3 billion from year-end 2009.
- Net flows were $1,286, down 22% year over year; deposits were $4,660, down 3%. Defined Contribution net flows fell to $109 from $657, while Annuities net flows rose to $575 from $430.
- Q1 2010 included $28 of income from discontinued operations, including gains on disposal of the Delaware investment-management and U.K. businesses. Delaware’s sale closed January 4 for $452 cash proceeds; the company reported approximately $405 after tax.
- Effective January 1, new VIE accounting led to consolidation of two credit-linked-note structures. The company recorded a $169 after-tax reduction to opening retained earnings; consolidated CLN assets and liabilities were $579 and $142 at March 31. The structures had underlying defaults but no default on the notes; maximum principal loss was stated as limited to the original $600 investment.
- Q1 operating cash flow improved substantially, while investing outflows and a $250 debt maturity contributed to lower cash. The holding company reported $1.2 billion in cash and cash equivalents at March 31.
- Series B preferred stock issued under the U.S. Treasury’s Capital Purchase Program totaled $950. Common dividends were $0.01 per share for the quarter; CPP terms restrict increases without Treasury consent.
Outlook, risks and contingencies
- Management said it was likely to accelerate repayment of the $950 CPP investment to before the second half of 2010, subject to negotiations, government conditions that may include raising equity, and no significant adverse market developments. This is an intention, not a committed repayment date.
- Management expected Group Protection non-medical loss ratios for the rest of 2010 at the low end of its historical 71%–74% range. It expected a lower 2010 Other Operations loss than in 2009, while noting possible earnings volatility from run-off disability business.
- Management cited continuing risks from unstable credit markets and further impairments, volatile equity markets and hedge performance, low interest rates and spread pressure, policyholder behavior, rating changes, regulation and statutory reserve requirements. Annuity and life guarantees expose results to equity, interest-rate, volatility and behavioral assumptions; hedges may not fully offset liability changes.
- Approximately $1.7 billion of letters of credit supporting secondary-guarantee life reinsurance relied on facilities maturing in Q1 2011; the company planned to replace them with longer-term financing and/or new shorter-term letters of credit. Failure to obtain capacity could affect returns, though management said insurers had capital to support reserves if structures were unavailable.
- Standby real-estate equity commitments were $136 at March 31. The company funded $59 during Q1 and recorded an additional $8 loss, following a $69 estimated loss in 2009; management warned economic conditions could increase funding obligations and said it had stopped entering new commitments.
- Management expected to substantially complete critical phases of an actuarial-system conversion by Q3 2010; it warned harmonized assumptions or methods could produce one-time earnings adjustments but did not provide an estimate. A Delaware-related lawsuit seeks substantial damages; management expects proceedings, after reserves and indemnification, to conclude without materially affecting consolidated financial position, while acknowledging a particular-period operating-results impact is possible.
Most important facts for investors to verify
- How much of the earnings rebound reflects recurring segment performance versus the prior-year impairment, lower realized losses, market gains, unlocking and discontinued-operation disposal gains.
- The timetable, funding source and any equity or regulatory conditions for repayment of the $950 CPP preferred investment.
- Insurer statutory capital and rating-agency requirements, especially the refinancing of secondary-guarantee life letters of credit and reserve financing.
- Credit quality, impairment trends and liquidity exposure in mortgage-backed, commercial mortgage-backed and other structured securities, including the consolidated CLNs.
- Whether annuity net flows, Group Protection claims experience, investment spreads and hedging outcomes support management’s 2010 expectations.
- Potential earnings effects from actuarial-system conversion, real-estate commitments, litigation and other contingencies.