LNC

Business Context and Reporting Period

Company: Lincoln National Corporation (LNC)
Reporting Period: Fiscal year ended December 31, 2002
Business Overview: LNC is a holding company operating through four primary segments: Lincoln Retirement (annuities), Life Insurance, Investment Management, and Lincoln UK. The company markets its products under the "Lincoln Financial Group" brand. In 2002, LNC completed the sale of its reinsurance operations to Swiss Re (closed December 2001), with ongoing accounting impacts related to indemnity reinsurance agreements.

Key Financial Metrics

Material Changes vs. Prior Period

• Significant Earnings Decline: Net income dropped 84% primarily due to a $199.1 million after-tax charge related to increased reserves for personal accident and disability income business sold to Swiss Re, and an increase in realized investment losses of $102.8 million.
• Revenue Reduction: Total revenue fell 27%, driven by the absence of the former Reinsurance segment's revenue (which was sold in late 2001) and lower fee income across segments due to declining equity markets.
• Investment Losses: Realized losses on investments and derivatives totaled $271.5 million (pre-tax), compared to $114.5 million in 2001. Losses were attributed to write-downs of fixed maturity securities, particularly in the telecommunications and airline sectors, and collateralized debt obligations (CDOs).
• Segment Performance:
  • Lincoln Retirement: Net income fell 79% to $57.8 million due to equity market declines impacting fee income, DAC unlocking, and increased GMDB reserves.
  • Life Insurance: Net income decreased 10% to $209.0 million, impacted by less favorable mortality experience and investment losses, though sales of universal life products grew significantly.
  • Investment Management: Net income increased 117% to $25.6 million, largely due to the cessation of goodwill amortization under new accounting standards (FAS 142) and expense reductions.
  • Other Operations: Reported a net loss of $240.8 million, heavily influenced by the $199.1 million reserve charge related to the Swiss Re transaction.

Guidance, Outlook, and Risks

• Equity Market Sensitivity: Management provided guidance indicating that a 2.5% decline in equity markets in Q1 2003 could reduce earnings by approximately $17.7 million due to impacts on fee income, DAC unlocking, and GMDB reserves.
• Deferred Dealer Commission Asset: A decline of approximately 3% in equity markets from March 2003 levels could trigger an impairment loss of $7.4 million to $11.4 million on the deferred dealer commission asset in the Investment Management segment.
• Restructuring: New restructuring plans announced in early 2003 for the Life Insurance and Lincoln Retirement segments are expected to incur costs of $15-$17 million and $3-$5 million, respectively, in 2003.
• Regulatory and Legal: LNC faces ongoing uncertainty regarding UK selling practices (pension misselling and mortgage endowments) with a reserve of $82.2 million. Management believes future developments will not materially affect financial position. LNC also faces potential impacts from proposed U.S. tax legislation regarding the double taxation of dividends.
• Liquidity: LNC maintains $580 million in revolving credit facilities. Statutory earned surplus for its primary subsidiary, LNL, was negative at year-end, requiring regulatory approval for future dividends.

Key Facts for Investor Verification

• Swiss Re Reserve Adequacy: Verify the adequacy of the $199.1 million reserve increase for personal accident and disability income business sold to Swiss Re, as future developments could require further adjustments.
• Investment Portfolio Quality: Review the composition of fixed maturity securities in unrealized loss positions ($735.4 million gross unrealized losses) and the potential for further "other-than-temporary" impairment write-downs, particularly in CDOs and telecom sectors.
• Equity Market Exposure: Assess the sensitivity of fee income and GMDB reserves to further equity market volatility, as outlined in the Q1 2003 guidance.
• Dividend Restrictions: Confirm the status of LNL's statutory earned surplus and the regulatory approval process required for future dividend payments to the holding company.
• Deferred Dealer Commission Asset: Monitor the Investment Management segment's deferred dealer commission asset ($50 million estimated balance in March 2003) for potential impairment triggers if equity markets decline further.