Lincoln National Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are with December 31, 2016. Lincoln National is an insurance and retirement-services holding company operating Annuities, Retirement Plan Services, Life Insurance and Group Protection segments. Unless noted, financial amounts below are in millions.
Financial results and position
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Total revenue | $3,500 | $3,243 |
| Income before taxes | $475 | $235 |
| Federal income tax expense | $40 | $24 |
| Net income | $435 | $211 |
| Diluted EPS | $1.89 | $0.83 |
| Comprehensive income | $716 | $1,297 |
| Operating cash flow | $109 | $298 |
| Cash and invested cash, March 31 | $1,923 | $2,722 at Dec. 31, 2016 |
| Total assets, March 31 | $267,468 | $261,627 at Dec. 31, 2016 |
| Total stockholders’ equity, March 31 | $14,973 | $14,478 at Dec. 31, 2016 |
| Debt, March 31 | $5,333, including $200 short-term and $5,133 long-term | $5,345 long-term at Dec. 31, 2016 |
Net income margin was approximately 12.4%, compared with 6.5% in Q1 2016. The effective tax rate was 8% versus 10%, well below the 35% statutory rate, primarily because of the separate-account dividends-received deduction and other tax preference items. The company declared common dividends of $0.29 per share, up from $0.25.
Cash flow from investing activities was negative $1,499, reflecting investment purchases and lending activity; financing activities provided $591. These cash flows and the decline in cash should be read in the context of the company’s insurance investment and policyholder funding operations, not as a conventional operating-company liquidity measure. Holding-company available liquidity was $551 at quarter-end.
Material changes versus Q1 2016
- Revenue rose 8% and net income more than doubled. Management cited growth in business in force and average account values, higher tax benefits, favorable alternative-investment income, and better variable-annuity derivative results; lower realized losses also helped the comparison.
- Segment operating income increased to $442 from $317: Annuities $281 (up 29%), Retirement Plan Services $37 (up 19%), Life Insurance $130 (up 73%), Group Protection $7 (up 40%), and Other Operations loss of $13 (versus a $12 loss). This is a non-GAAP management measure, not consolidated GAAP net income.
- Total deposits increased 6% to $5,682, while total net flows fell to $96 from $873. Annuities had negative net flows of $944, compared with negative $35 a year earlier; Retirement Plan Services and Life Insurance reported positive net flows of $116 and $924.
- Net investment income rose 6% to $1,238, including a $63 improvement in alternative-investment results (income of $49 versus a loss of $14). Net realized loss narrowed to $39 from $114; credit-related other-than-temporary impairment losses were $4 versus $36.
- Other comprehensive income fell to $281 from $1,086, largely reflecting a smaller increase in unrealized investment gains. Total assets rose about 2% from year-end, with separate-account assets increasing to $132,958.
Management commentary, outlook and risks
- Spread pressure: Management reported spread compression as average new-money rates trailed portfolio yields, partly offset by lower crediting rates. Annuities’ interest-rate spread narrowed to 1.74% from 1.96%; Retirement Plan Services’ narrowed to 1.52% from 1.65%. Life Insurance’s spread increased to 1.60% from 1.32%, helped by stronger alternative-investment returns. Management expects to manage near-term spread effects through portfolio management and, to a lesser extent, crediting-rate actions.
- Annuity flows and regulation: Management attributed weak variable-annuity sales and negative flows partly to regulatory uncertainty and market trends. The Department of Labor fiduciary rule’s initial applicability date was delayed from April 10 to June 9, 2017, with possible further changes or delays; the rule could affect product distribution, compensation, sales and margins.
- Variable-annuity guarantees and markets: Equity-market declines, interest-rate changes, volatility, policyholder behavior and hedge performance can affect guarantee liabilities and earnings. At March 31, 8% of in-force contracts with guaranteed living benefits were “in the money,” versus 11% a year earlier; after-reinsurance exposure was $538 versus $679.
- Capital and liquidity: The holding company depends on subsidiary dividends and intercompany funding. The company estimated domestic insurance subsidiaries could pay approximately $900 in dividends during 2017 without prior regulatory approval, subject to capital, ratings and other constraints. Statutory reserve financing needs include Regulation XXX and AG38 exposures; the final planned $90 annual reserve increase for New York policies was expected in Q4 2017.
- Debt and ratings: Long-term senior debt ratings were A-/Baa1 (S&P/Moody’s). A downgrade could trigger derivative termination provisions, affect liquidity, increase surrenders or impair product sales.
- Legal contingencies: The company estimated aggregate reasonably possible losses of up to approximately $50; some matters could not be estimated. A consolidated putative class action alleges that cost-of-insurance rate increases beginning in 2016 breached universal-life policy terms; the company is defending the case.
- Unusual items: Q1 included $9 of strategic digitization expense. GAAP net income also reflected a $45 after-tax favorable benefit-ratio unlocking adjustment and $52 of after-tax excluded realized losses. Results included favorable mortality relative to expected seasonality in Life Insurance; management cautioned that Q1 results are not necessarily indicative of full-year results.
- Outlook: The filing provides no specific full-year earnings or revenue guidance. Management said it expected to meet ongoing holding-company cash needs and indicated it expected further share repurchases in 2017, subject to market conditions and alternative uses of capital.
Most important facts for investors to verify
- Whether reported earnings growth persists after separating core segment operating results from tax benefits, benefit-ratio unlocking and market-sensitive realized/derivative results.
- Whether negative Annuities net flows continue, and how deposits, surrenders and product mix affect account values and future fee income.
- Whether portfolio yields and credited rates continue to compress spreads, particularly in Annuities and Retirement Plan Services.
- Whether investment credit quality, unrealized losses and alternative-investment returns change materially; management concluded current unrealized losses were not other-than-temporary.
- Whether subsidiary capital, statutory reserve financing, dividend capacity and holding-company liquidity remain adequate, including the impact of ratings or regulatory changes.
- Developments in the DOL fiduciary rule, the cost-of-insurance litigation and other legal or regulatory contingencies.