Business Context and Reporting Period
Company: Lincoln National Corporation (LNC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2003
Business Overview: LNC operates through four primary segments: Lincoln Retirement, Life Insurance, Investment Management, and Lincoln UK. The company provides insurance, annuity, and investment management products. As of August 1, 2003, there were 177,728,818 shares of Common Stock outstanding.
Key Financial Metrics
| Metric (in millions, except per share) | Six Months Ended June 30, 2003 |
Six Months Ended June 30, 2002* |
Three Months Ended June 30, 2003 |
Three Months Ended June 30, 2002* |
|---|---|---|---|---|
| Total Revenue | $2,312.5 | $2,283.4 | $1,213.2 | $1,157.5 |
| Net Income | $184.3 | $134.2 | $142.7 | $48.5 |
| Diluted EPS | $1.03 | $0.71 | $0.80 | $0.26 |
| Net Investment Income | $1,314.9 | $1,312.2 | $660.2 | $657.4 |
| Realized Loss on Investments | $(94.1) | $(184.4) | $(2.7) | $(81.1) |
| Total Assets | $99,532.8 | $93,184.6 | -- | -- |
| Total Shareholders' Equity | $5,815.9 | $5,347.5 | -- | -- |
| Short-term Debt | $83.4 | $153.0 | -- | -- |
| Long-term Debt | $1,121.4 | $1,119.2 | -- | -- |
| Cash and Invested Cash | $1,945.8 | $1,690.5 | -- | -- |
*2002 figures have been restated for the retroactive adoption of FAS 123 (Stock-Based Compensation).
Material Changes vs. Prior Period
- Net Income Growth: Net income increased 37% ($50.1 million) for the six months ended June 30, 2003, compared to the same period in 2002. The three-month increase was $94.2 million.
- Realized Losses: Net realized losses on investments and derivatives decreased significantly. The six-month loss was $94.1 million in 2003 versus $184.4 million in 2002. The 2002 losses were largely driven by WorldCom and telecommunications write-downs, while 2003 losses were primarily in airlines, electric utilities, and asset-backed securities (ABS).
- Equity Market Impact: The recovery in equity markets (S&P 500 up 11% from Dec 31, 2002) positively impacted earnings by $3.5 million in the first six months of 2003, primarily through fee income and DAC unlocking in the Lincoln Retirement segment.
- Segment Performance:
- Lincoln Retirement: Net income rose to $88.6 million (6 months) from $55.7 million, driven by lower realized losses and equity market recovery.
- Life Insurance: Net income increased to $114.1 million (6 months) from $100.2 million, aided by improved mortality margins and lower realized losses.
- Investment Management: Net income improved to $5.6 million (6 months) from $1.3 million, supported by positive net flows and market appreciation.
- Restructuring: Restructuring charges increased to $19.0 million (pre-tax) for the six months ended June 30, 2003, compared to $1.6 million in 2002, due to realignment of Life Insurance and Retirement operations.
Guidance, Outlook, Risks, and Unusual Items
- Accounting Changes (VIEs): LNC anticipates adopting FASB Interpretation No. 46 (Variable Interest Entities) in Q3 2003. This may require consolidating managed Collateralized Debt Obligation (CDO) pools. LNC estimates CDO assets at $1.2 billion against $1.5 billion in nonrecourse debt. While LNC does not bear the economic risk of the $300 million difference, the accounting treatment could result in a charge to net income for "other than temporary" declines in asset value.
- Accounting Changes (Modco): Implementation of FASB DIG B36 regarding modified coinsurance (Modco) is expected in Q4 2003. Depending on characterization, this could result in a one-time pre-tax loss of approximately $481 million upon adoption, offset by a $450 million increase in equity, with no impact on ultimate economic profit.
- Restructuring Outlook: In August 2003, LNC announced further restructuring actions expected to impact all domestic operations. Total pre-tax charges are estimated at $135 million over three years ($95 million in 2003), with expected savings of $25 million in 2003. Job eliminations are expected to range between 800 and 1,000.
- Equity Market Volatility Guidance: LNC provided illustrative scenarios for Q3 2003. A 2.5% market decline could reduce earnings by $9.6 million, while a 2.5% increase could boost earnings by $3.6 million, largely driven by GMDB reserves and DAC unlocking in the Retirement segment.
- Regulatory Contingencies: LNC faces ongoing scrutiny regarding UK selling practices (pension mis-selling, mortgage endowments). A liability of $40.6 million was recorded as of June 30, 2003. Additionally, The Lincoln National Life Insurance Company (LNL) has negative statutory earned surplus, requiring regulatory approval for dividends in 2003.
Investor Verification Checklist
- Accounting Impact of FASB Interpretation 46: Verify the final determination on CDO pool consolidation in Q3 2003 and the resulting charge to net income versus equity.
- Modco Reinsurance Accounting: Monitor the Q4 2003 adoption of DIG B36 rules and the specific characterization of embedded derivatives, which could cause significant earnings volatility.
- Restructuring Execution: Track the actual costs and savings associated with the announced $135 million restructuring plan and the integration of Life and Retirement segments.
- Investment Portfolio Quality: Review the status of unrealized losses in the airline, electric utility, and ABS sectors, particularly regarding the "other than temporary" impairment assessments.
- Dividend Restrictions: Confirm the status of LNL's statutory earned surplus and any regulatory approvals required for future dividend payments to the holding company.