Business Context and Reporting Period
Company: Lincoln National Corporation (LNC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2002
Business Overview: LNC operates through four primary segments: Lincoln Retirement, Life Insurance, Investment Management, and Lincoln UK. In December 2001, LNC divested its reinsurance operations to Swiss Re via indemnity reinsurance agreements. Consequently, the former Reinsurance segment results are now reported within "Other Operations."
Key Financial Metrics
| Metric (in millions, except per share) | Q1 2002 | Q1 2001 |
|---|---|---|
| Total Revenue | $1,126.4 | $1,698.8 |
| Net Income | $94.5 | $160.2 |
| Diluted EPS | $0.49 | $0.83 |
| Net Investment Income | $648.1 | $673.7 |
| Realized Loss on Investments | $(103.3) | $(20.7) |
| Total Assets | $97,846.4 | $98,001.3 |
| Total Shareholders' Equity | $5,131.1 | $5,263.5 |
| Cash and Invested Cash | $1,699.5 | $3,095.5 |
| Short-term Debt | $510.2 | $350.2 |
| Long-term Debt | $861.8 | $861.8 |
Operating Cash Flow: Net cash used in operating activities was $248.3 million in Q1 2002, compared to $355.3 million provided in Q1 2001. The 2002 usage was significantly impacted by $516.2 million in federal income taxes paid from the proceeds of the Swiss Re divestiture.
Material Changes vs. Prior Period
- Revenue Decline: Total revenue decreased 34% year-over-year. This is primarily attributable to the sale of the reinsurance business in late 2001, which removed approximately $515 million of pre-tax operating revenue present in the prior year quarter.
- Net Income Decrease: Net income fell 41% to $94.5 million. The decline was driven by a $54.3 million increase in realized investment losses (largely due to write-downs of Collateralized Debt Obligations and high-yield telecommunication bonds) and the absence of reinsurance segment earnings.
- Accounting Change (FAS 142): LNC adopted FAS 142 on January 1, 2002, eliminating goodwill amortization. This change increased Q1 2002 net income by $10.4 million ($0.05 per share) compared to what it would have been under prior rules.
- Investment Portfolio: The investment yield decreased from 7.24% in Q1 2001 to 6.81% in Q1 2002 due to lower interest rates on new purchases and the reinvestment of Swiss Re proceeds into lower-yielding liquid assets.
Guidance, Outlook, Risks, and Contingencies
Management Commentary and Outlook
- Segment Performance: Lincoln Retirement and Life Insurance segments saw income declines due to investment losses and, in the case of Life Insurance, poor mortality experience. Investment Management income improved due to cost containment. Lincoln UK results were relatively flat.
- Capital Allocation: LNC utilized proceeds from the Swiss Re transaction ($1.4 billion after-tax) to repurchase $165 million of common stock and reduce $175 million of short-term debt. Remaining proceeds are held in liquid instruments for potential acquisitions or further debt/equity buybacks.
- Goodwill Impairment: Preliminary results of the transitional goodwill impairment test (required by FAS 142) indicate no impairment, as the fair value of reporting units exceeds their carrying values.
Risks and Contingencies
- Swiss Re Dispute: LNC and Swiss Re have not finalized closing statements for the reinsurance sale. There are disputed matters totaling approximately $770 million, primarily regarding personal accident business reserves ($500 million) and other asset/liability transfers ($270 million). LNC's indemnification exposure is capped at $100 million ($65 million after-tax) for personal accident payments exceeding $148 million. Swiss Re filed legal action in April 2002 to compel dispute resolution.
- UK Regulatory Issues: Lincoln UK faces scrutiny from UK regulators regarding selling practices for pension products and mortgage endowments. A liability of $134.1 million was accrued as of March 31, 2002. Management believes these matters will not materially affect consolidated financial position.
- Investment Risk: Significant realized losses were incurred on CDOs and high-yield telecom bonds. While the portfolio has been written down, remaining exposure to non-investment grade CDOs is approximately $100 million.
Key Facts for Investor Verification
- Swiss Re Settlement Status: Verify the resolution timeline and potential financial impact of the $770 million in disputed matters with Swiss Re, specifically the $500 million related to personal accident reserves.
- Investment Write-downs: Confirm the extent of remaining exposure to Collateralized Debt Obligations (CDOs) and high-yield telecommunication securities, which drove the $103.3 million realized loss.
- UK Regulatory Liability: Monitor developments in the UK regarding mortgage endowment mis-selling and pension product advice, as the $134.1 million reserve may prove deficient or excessive.
- Dividend Restrictions: Note that while the primary subsidiary (LNL) now has positive statutory earned surplus, future dividends to the holding company are still subject to standard regulatory limitations (greater of 10% of surplus or prior year statutory earnings).
- Goodwill Impairment Test: Await the completion of the second step of the FAS 142 transitional goodwill impairment test, due by June 30, 2002, to confirm no impairment charges are required.