Business context and reporting period
Lincoln National Corporation (LNC) is an insurance and retirement-services holding company. This Form 10-K covers the fiscal year ended December 31, 2013, with comparisons primarily to 2012. Its four segments are Annuities, Retirement Plan Services, Life Insurance and Group Protection; Other Operations includes corporate activities, debt and run-off businesses.
Key financial metrics
| Metric | 2013 | 2012 |
|---|---|---|
| Total revenue | $11.969 billion | $11.535 billion |
| Net income | $1.244 billion | $1.313 billion |
| Diluted EPS | $4.52 | $4.56 |
| Operating cash flow | $799 million | $1.269 billion |
| Total assets | $236.945 billion | $218.869 billion |
| Stockholders’ equity | $13.452 billion | $14.973 billion |
- Net income from continuing operations was $1.244 billion, down 3% from $1.286 billion. Revenue increased about 4%; net income declined about 5%.
- Comprehensive loss was $1.001 billion, versus comprehensive income of $2.441 billion in 2012. The main driver was a $2.457 billion after-tax unrealized loss on available-for-sale securities recorded in OCI.
- Investing cash flow was negative $4.710 billion; financing cash flow was positive $2.045 billion. Cash and invested cash ended the year at $2.364 billion, down from $4.230 billion.
- Balance-sheet debt was $501 million of short-term debt and $5.320 billion of long-term debt. Holding-company available liquidity was $1.2 billion. LNC also reported a $2.5 billion unsecured revolving facility, expiring in May 2018.
- Net investment income was $4.754 billion, up 1%; the consolidated yield on invested assets declined to 5.33% from 5.51%. Net realized investment results were a $135 million loss, compared with a $74 million gain in 2012.
- Fixed-annuity spread was 1.97% versus 2.01%; Retirement Plan Services spread was 2.03% versus 2.06%. Life Insurance interest-sensitive spread declined to 1.84% from 1.99%.
- Segment income from operations: Annuities $750 million, up 26%; Retirement Plan Services $141 million, up 8%; Life Insurance $544 million, down 5%; Group Protection $71 million, down 1%; Other Operations loss $122 million, compared with an $87 million loss.
- Group Protection’s 2013 total non-medical loss ratio was 74.0%, versus 74.5%; management expected it to remain at the high end of its 71%–74% long-term expectation in 2014.
- Total deposits rose 17% to $26.726 billion; net flows rose 41% to $9.514 billion; reported account values increased 16% to $206.821 billion.
Material changes versus the prior comparable period
- Net income fell 5%, reflecting more favorable prior-year tax benefits and unlocking in 2012, higher Life Insurance death claims, unfavorable variable-annuity net derivatives results in 2013, and continued spread compression. Growth in account values and insurance in force partly offset these effects.
- Annuities income improved with higher variable-account fee income and stronger deposits and net flows. Variable-annuity deposits rose 48% to $10.060 billion; annuity net flows increased to $5.012 billion.
- Life Insurance income declined as benefits increased 15%, including higher death claims and less favorable unlocking effects. Life Insurance sales rose 15% to $677 million, with growth in VUL, indexed UL and term products.
- Group Protection premiums increased 9% to $2.084 billion, while income was roughly flat; higher expenses and commissions partly offset premium growth and favorable long-term disability reserve adjustments.
- Stockholders’ equity declined about 10%, primarily reflecting the swing in unrealized investment gains and losses in OCI. Assets increased about 8%, driven in part by growth in separate-account assets.
- Net OTTI recognized in earnings fell to $70 million pre-tax from $153 million. Gross unrealized losses on AFS securities rose to $1.4 billion at year-end; management stated it did not consider the losses other-than-temporary.
Outlook, commentary, risks and unusual items
- Management’s 2014 priorities included shifting new business toward shorter-duration liabilities, more limited guarantees and mortality or morbidity earnings; managing capital and liquidity; pursuing reserve-financing options; investing in technology and distribution; and controlling expenses. No numerical company-wide earnings guidance was provided.
- Management cited persistently low interest rates, market volatility and regulatory change as key issues. Low rates can pressure investment spreads and reserves; rapid rate increases can prompt surrenders, asset sales and realized losses. Equity declines may reduce fee income and increase guaranteed-benefit liabilities.
- NYDFS reserve treatment for secondary-guarantee UL/VUL business required a $90 million reserve increase in 2013. LNC expected to phase in further increases over four years, with each year not expected to exceed $90 million, subject to ongoing discussions. Management did not expect the total increase to materially harm financial condition.
- Captive reinsurance and LOC arrangements support statutory reserves for term and secondary-guarantee UL business. Changes in regulation, reduced reinsurance credit or difficulty obtaining financing could increase capital needs and constrain subsidiary dividends.
- Reinsurance recoverables were $6.0 billion, including $2.6 billion related to Swiss Re; $4.1 billion of total recoverables was collateralized. A Swiss Re trust supporting the ceded business held $2.2 billion. Reinsurer nonpayment remains a material exposure.
- Management estimated reasonably possible losses above accrued amounts for certain litigation and regulatory matters of up to approximately $220 million. The filing also describes unclaimed-benefit audits and a multistate settlement requiring $12.6 million reimbursement and additional claims-identification procedures.
- Variable-annuity guarantee hedging and fair-value accounting produced volatility: excluded realized losses were $178 million after tax in 2013, compared with $25 million in 2012. Hedging may not fully offset market, behavior or basis risks.
- Management reported no material goodwill impairment in 2013; goodwill was $2.273 billion. It also reported a $2.0 billion deferred tax asset and stated it believed realization was more likely than not.
Important facts for investors to verify
- Reconcile GAAP net income with segment operating results and excluded realized losses, benefit-ratio unlocking and prior-year tax benefits.
- Review the drivers of the $2.457 billion OCI loss, the decline in equity, and the sensitivity of AFS valuations to interest rates and credit spreads.
- Assess reserve adequacy and statutory capital implications of the NYDFS reserve phase-in, AG38/XXX requirements and captive reinsurance arrangements.
- Check holding-company liquidity, debt maturities, subsidiary dividend capacity and compliance with credit-facility and capital-security covenants.
- Evaluate variable-annuity guarantee exposure, hedging effectiveness, policyholder behavior assumptions and the concentration in the American Legacy product and AFIS funds.
- Monitor Swiss Re and other reinsurer credit quality, collateral sufficiency, and the status and potential costs of legal, regulatory and unclaimed-property matters.
Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting as of December 31, 2013.