Lincoln National Corporation (LNC) — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods unless noted. Amounts are in millions except per-share data. LNC is an insurance and retirement-services holding company with Annuities, Retirement Plan Services, Life Insurance and Group Protection segments.
Financial results and condition
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $2,999 | $2,898 | $5,838 | $5,608 |
| Income from continuing operations | $317 | $321 | $556 | $565 |
| Diluted EPS | $1.15 | $1.09 | $2.01 | $1.93 |
| Net cash from operating activities | — | $55 | $614 |
- Q2 revenue increased 3.5%, while net income declined 1.2%; six-month revenue grew 4.1% and net income declined 1.4%. Q2 net margin was approximately 10.6%, versus 11.1% a year earlier.
- Q2 revenue growth included higher insurance fees and premiums; expenses rose faster, up $125 to $2,581. Six-month expenses increased to $5,115 from $4,858.
- Net investment income was $1,213 in Q2, up 1%; six-month net investment income was $2,363, essentially flat. The six-month investment yield declined to 5.35% from 5.60%; prepayment and make-whole premiums partially offset lower underlying yields.
- At June 30, total assets were $223,321, liabilities $210,004 and stockholders’ equity $13,317, compared with $218,869, $203,896 and $14,973, respectively, at year-end 2012. AOCI fell to $1,893 from $3,808, primarily reflecting a large after-tax other comprehensive loss of $1,915 for the first half amid market movements.
- Cash and invested cash fell to $2,574 from $4,230 at year-end. Short- and long-term debt totaled $5,556, versus $5,639. Operating cash flow was substantially lower than in 2012; investing activities used $2,803, while financing activities provided $1,092.
- Holding-company available liquidity was $693 at June 30. LNC reported compliance with its credit-facility covenants. $506 of short-term debt included $500 of 2014 senior-note maturities; management expected to pre-fund up to $350 before year-end 2013.
- Six-month deposits rose 26% to $13,178 and net flows rose 75% to $5,005; total account values were $188,636, up 12% year over year.
Segments and material changes
- Annuities: Q2 operating income was $195, up 23%; first-half income was $353, up 20%. Growth reflected higher fee income and account values. Six-month deposits rose 38% and net flows rose 160%.
- Retirement Plan Services: Q2 operating income was $39, up 3%; first-half income was $75, up 3%. Higher fees and investment income were partly offset by spread compression and expenses. Management cited continued outflows from mature, higher-margin blocks and anticipated further strategic investment spending in 2013.
- Life Insurance: Q2 operating income was $135, flat; first-half income declined 10% to $247, mainly from higher death claims and the prior-year benefit of favorable unlocking. First-half sales rose 34% to $333, while premiums and fees also increased.
- Group Protection: Q2 operating income declined 19% to $22; first-half income declined 14% to $37. Higher premiums were outweighed by unfavorable group-life mortality and higher expenses, including investment in sales, distribution and technology.
- Other Operations: Q2 loss was $40, compared with $39; first-half loss was $77, compared with $73. Higher expenses, including deferred-compensation costs linked to LNC’s share price, were partly offset by lower debt expense.
Outlook, risks and unusual items
- No formal consolidated earnings guidance was provided. Management said it expected to meet the holding company’s ongoing cash needs and maintain capital for downside protection, while noting that subsidiary dividends could be pressured if market conditions weakened statutory capital.
- Management’s annual review of assumptions and models was scheduled for Q3. A hypothetical RTM assumption reset at June 30 would have produced an estimated favorable pretax unlocking of about $235 for Annuities and $20 each for Retirement Plan Services and Life Insurance; this was an illustrative estimate, not reported earnings.
- LNC identified low interest rates and spread compression, rising-rate-driven surrenders and investment losses, equity-market declines, variable-annuity guarantees, hedging effectiveness, investment credit risk, ratings changes, regulatory and tax changes, reinsurance collectibility, and litigation as risks. A hypothetical 10-year Treasury rate held at 2.50% through 2014 was estimated to cause an approximately $35 adverse 2014 earnings effect versus 2013, all else equal.
- About 72% of individual variable-annuity account values had guaranteed living-benefit features. At June 30, 6% of contracts with such features were “in the money”; estimated exposure after reinsurance was $480. Market movements drove significant derivative and guarantee valuation volatility. Excluded realized losses after tax were $33 in Q2 and $92 for the first half, versus gains of $12 and losses of $61, respectively, in 2012.
- Unrealized losses on available-for-sale securities increased $680 during the first half. Management considered the positions temporary and said it did not expect to need to sell securities before recovery; this assessment depends on market conditions, cash flows and the ability to hold the investments.
- Statutory reserve requirements for term and secondary-guarantee life products create capital strain. LNC uses letters of credit and structured financing and said it believed subsidiaries had sufficient capital under current projections if these arrangements were unavailable.
- Various legal and regulatory matters were pending. Management said potential charges could be material in individual periods but did not believe, based on currently known information, that they were likely to materially adversely affect financial position.
- Moody’s upgraded the financial-strength ratings of principal insurance subsidiaries from A2 to A1 during Q2. LNC repurchased $250 of common stock and paid $65 in dividends in the first half; the quarterly common dividend had been increased to $0.12 per share.
Most important facts for investors to verify
- Whether the $55 first-half operating cash flow, lower cash balance and holding-company liquidity adequately cover upcoming maturities, dividends and other obligations.
- How much of earnings and cash generation depends on favorable investment prepayment premiums, market-sensitive derivative marks and the scheduled Q3 assumption review.
- Whether sustained low rates, spread compression, surrender behavior and statutory reserve financing affect segment profitability and subsidiary dividend capacity.
- Changes in unrealized investment losses, credit quality, ratings, and management’s ability and intent to hold impaired securities through recovery.
- Claims experience in Life Insurance and Group Protection, persistence and net flows in mature retirement blocks, and variable-annuity guarantee exposure and hedge performance.
- Developments in litigation, regulation, reserve requirements, and the availability and cost of letters of credit or other reinsurance-financing arrangements.