Lincoln National Corporation — FY2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010; comparisons are primarily with FY2009. This is an annual filing, not a standalone fourth-quarter report. Amounts are U.S. dollars unless stated otherwise.
Business context
Lincoln National is an insurance and retirement-services holding company operating four segments: Annuities, Defined Contribution, Life Insurance, and Group Protection. Other Operations includes corporate activities, debt, media and run-off businesses. Delaware investment management was sold on January 4, 2010; Lincoln UK was sold in October 2009. Both are reported as discontinued operations.
Financial performance and position
| Metric | FY2010 / Dec. 31, 2010 | Prior comparable period |
|---|---|---|
| Total revenue | $10.407 billion | $8.499 billion in 2009 |
| Income from continuing operations | $951 million; diluted EPS $2.45 | Loss of $415 million; diluted loss per share $1.60 in 2009 |
| Net income (loss) | $980 million; diluted EPS $2.54 | Loss of $485 million; diluted loss per share $1.85 in 2009 |
| Operating cash flow | $1.720 billion | $937 million in 2009 |
| Total assets / stockholders’ equity | $193.824 billion / $12.806 billion | $177.433 billion / $11.700 billion in 2009 |
| Debt | $5.399 billion long-term; $351 million short-term | $5.050 billion long-term; $350 million short-term in 2009 |
| Cash and invested cash | $2.741 billion | $4.025 billion in 2009 |
FY2010 net margin was approximately 9.4% of total revenue; continuing-operations income was approximately 9.1%. These are simple calculations from reported GAAP amounts, not company-defined operating margins. Operating cash flow improved, while cash and invested cash declined. Investing activities used $5.630 billion and financing activities provided $2.467 billion.
Segment operating results (management’s non-GAAP measure) were: Annuities $484 million, up 37%; Defined Contribution $154 million, up 16%; Life Insurance $513 million, down 10%; Group Protection $72 million, down 42%; and Other Operations loss of $186 million, improved from a $237 million loss. Segment operating revenues rose 13% for Retirement Solutions to $3.642 billion and 7% for Insurance Solutions to $6.421 billion.
Total deposits increased 6% to $20.902 billion; total net flows declined 14% to $6.321 billion. Year-end account values across Annuities, Defined Contribution and Life Insurance rose 11% to $157.257 billion. The Defined Contribution segment recorded negative net flows of $291 million, including the lapse of several large cases.
Material changes versus FY2009
- The return to GAAP profitability chiefly reflected the absence of FY2009’s $730 million impairment of intangibles, higher investment income and improved market-related results. Total realized loss narrowed to $77 million from $1.146 billion; net OTTI recognized in earnings fell to $152 million from $392 million.
- Benefits rose 17% to $3.330 billion, while underwriting, acquisition, insurance and other expenses increased 10% to $3.067 billion. Interest and debt expense increased 48% to $291 million, in part reflecting higher average debt.
- Net investment income increased 9% to $4.541 billion. The investment portfolio grew to $83.340 billion; 94.8% of fixed-maturity AFS securities were investment grade at fair value, compared with 93.1% in 2009.
- Group Protection’s non-medical loss ratio increased to 76.2% from 69.1%, above the company’s 71%–74% long-term expectation. Life Insurance income declined amid higher benefits and unfavorable prospective unlocking.
Liquidity, capital and unusual items
- Operating cash flow was $1.720 billion. At year-end, the holding company reported $582 million in cash and cash equivalents; it also had a $174 million receivable under the intercompany cash-management program and $100 million of commercial paper outstanding.
- Available credit facilities totaled $3.180 billion, including $2.048 billion of issued letters of credit. The company reported compliance with facility covenants. It expected domestic insurance subsidiaries could pay approximately $630 million in 2011 without prior regulatory approval; actual capacity depends on statutory limits and capital needs.
- Lincoln redeemed the $950 million U.S. Treasury Series B preferred stock in June 2010, funded with common-stock and debt offerings and holding-company cash. Redemption accelerated $131 million of remaining discount accretion, charged against retained earnings and income available to common stockholders. The company issued $250 million of 4.30% senior notes due 2015 and $500 million of 7.00% notes due 2040.
- Adoption of revised VIE consolidation guidance brought two credit-linked-note entities onto the balance sheet and reduced opening retained earnings by $169 million after tax. The company reported $169 million of goodwill impairment in 2009 relating to Annuities and media; no goodwill impairment was recorded in 2010. Goodwill totaled $3.019 billion at year-end.
- FY2010 included $35 million of unfavorable after-tax prospective unlocking, partly offset by $65 million of favorable retrospective unlocking. A lower new-money yield assumption produced a $114 million after-tax unfavorable prospective unlocking in Life Insurance. The actuarial-system conversion for certain Retirement Solutions blocks had a $16 million after-tax unfavorable effect; additional conversions were planned.
- A $40 million after-tax charge was recorded for the Transamerica litigation settlement; a dismissal was entered in January 2011. Management said pending legal and regulatory matters were not expected to materially affect consolidated financial position, while acknowledging individual outcomes could affect a reporting period.
- Insurance subsidiaries’ RBC ratios exceeded the regulatory “company action level,” but the filing does not provide clear actual ratios. LNC’s statutory capital and dividend capacity remain sensitive to equity markets, reserves, reinsurance financing and regulation.
Outlook, management commentary and key risks
Management described the recovery as fragile, with persistent unemployment and a weak housing market. For 2011 it planned to manage crediting rates and claims, pursue financing for statutory reserve strain, reduce risk in variable-annuity guarantees, invest in Defined Contribution and Group Protection, control expenses, and monitor capital and liquidity. The filing does not provide full-year earnings or revenue guidance.
- Assuming rates remained constant through 2012 and other stated assumptions held, management estimated minimal earnings impact from spread compression in 2011 and approximately $20 million of unfavorable impact in 2012, primarily in Life Insurance. Reserve-financing expenses were expected to roughly double in 2011 versus 2010.
- Group Protection loss ratios were expected to remain above the long-term range well into 2011. Management estimated that each one-percentage-point excess over expectation could reduce annual operating income by approximately $10 million–$12 million.
- Equity-market declines could reduce asset-based fees, increase guarantee liabilities and affect statutory capital. Hedging may not fully offset liability changes because of market volatility, basis risk, timing and policyholder behavior. Guaranteed-living-benefit hedge assets exceeded estimated liabilities by $544 million at year-end, but this relationship can change.
- Low interest rates could compress spreads, increase reserves or trigger further unlocking; rising rates could increase withdrawals and force asset sales. Credit losses, illiquid investments, mortgage exposure and the collectibility of reinsurance—particularly the large Swiss Re exposure—are additional risks.
- Dodd-Frank implementation, fiduciary and Department of Labor rulemaking, statutory reserve requirements, and ASU 2010-26 (effective in 2012) could affect costs, products, capital or the timing of reported earnings. Management had not determined the ultimate impact of the accounting change.
Most important facts for investors to verify
- Reconcile GAAP earnings to management’s operating results and identify the effects of realized losses, reserve changes, unlocking and discontinued operations.
- Review statutory capital and RBC ratios, dividend capacity, reserve-financing arrangements, letters of credit and upcoming debt maturities; actual RBC ratios are not clearly stated in the provided filing text.
- Track Group Protection claims and loss ratios against the 71%–74% long-term expectation, and assess whether pricing and claims-management actions improve results.
- Assess variable-annuity guarantee exposure, hedge effectiveness, counterparty collateral and the sensitivity of statutory capital to equity-market and interest-rate changes.
- Monitor investment impairments, commercial mortgage performance, Level 3 valuations and reinsurance recoverables, including Swiss Re collateral and collectibility.
- Evaluate the prospective effect of the 2012 acquisition-cost accounting standard and remaining actuarial-system conversions on earnings and balance-sheet measures.