Lincoln National Corporation — 2009 Third-Quarter Form 10-Q
Business and period. Lincoln National is an insurance and retirement-products holding company. This filing covers the three and nine months ended September 30, 2009; balance-sheet comparisons are with December 31, 2008. Results include four continuing segments—Annuities, Defined Contribution, Life Insurance and Group Protection. Lincoln UK and investment management operations are reported as discontinued operations.
Financial performance and position
| Metric | Q3 2009 | Nine months 2009 | Comparable 2008 |
|---|---|---|---|
| Total revenue | $2.081 billion | $6.100 billion | $2.270 billion and $7.071 billion |
| Income from continuing operations | $81 million | Loss of $513 million | $129 million and income of $493 million |
| Net income (loss) | $153 million | Loss of $587 million | $148 million and income of $562 million |
| Net income (loss) available to common stockholders | $137 million | Loss of $603 million | $148 million and income of $562 million |
| Diluted EPS | $0.44 | Loss of $2.21 | $0.58 and income of $2.16 |
| Operating cash flow | $552 million for nine months | $811 million |
Amounts are in U.S. dollars. The filing presents quarterly and year-to-date results; “comparable 2008” follows that same order. Management’s segment “income from operations” is a non-GAAP measure that excludes specified items, including realized investment losses, goodwill impairment and discontinued operations.
- Segments: Q3 operating income was $95 million for Annuities, $43 million for Defined Contribution, $137 million for Life Insurance and $35 million for Group Protection. Nine-month figures were $234 million, $100 million, $412 million and $94 million, respectively.
- Margins and spreads: Annuities’ interest-rate spread was 1.73% for Q3 and 1.67% year to date, down 16 and 36 basis points from 2008. Life Insurance’s interest-sensitive-product spread was 1.50% for Q3 and 1.41% year to date, down 40 and 41 basis points. Group Protection’s non-medical loss ratio was 68.1% for Q3 and 69.0% year to date.
- Balance sheet at September 30: Assets were $181.490 billion, liabilities $169.834 billion and stockholders’ equity $11.656 billion. Investments totaled $76.183 billion; cash and invested cash was $3.161 billion. Separate-account assets and liabilities were each $70.111 billion.
- Debt and liquidity: Short- and long-term debt totaled $5.189 billion, versus $5.546 billion at year-end 2008. The company reported $820 million of holding-company cash and cash equivalents and $3.511 billion of revolving-facility capacity; $350 million was borrowed and $2.095 billion of letters of credit were issued. Nine-month cash flow was $552 million from operations, negative $7.300 billion from investing and positive $4.298 billion from financing; cash and invested cash fell $2.450 billion, including discontinued operations.
Material changes versus prior periods
- Q3 revenue fell 8% year over year, while net income rose to $153 million from $148 million. The quarter included $72 million of income from discontinued operations; income from continuing operations declined to $81 million from $129 million.
- Nine-month revenue fell 14%, and results shifted from $562 million net income to a $587 million net loss. The year-to-date loss included a $600 million goodwill impairment in Annuities, $1.003 billion of total realized losses and a $115 million after-tax loss on the Lincoln UK disposal.
- Market recovery improved the fair value of available-for-sale securities: gross unrealized losses declined by $4.3 billion from year-end 2008. The company nevertheless recognized $319 million of net other-than-temporary impairment losses in earnings during the first nine months.
- Equity and capital actions strengthened reported equity: LNC issued 46 million common shares for approximately $690 million gross proceeds and received $950 million from the U.S. Treasury’s TARP Capital Purchase Program. The TARP issuance included preferred stock and a warrant; the preferred stock carries a 5% annual dividend for five years, rising to 9% thereafter if not redeemed.
- Common dividends were reduced to $0.01 per share, and share repurchases were suspended. Stockholders’ equity rose to $11.656 billion from $7.977 billion at year-end, aided in part by improved accumulated other comprehensive loss.
Outlook, commentary, risks and unusual items
- Management said capital and credit markets had improved after first-quarter volatility, but expected prior equity-market declines to continue weighing on earnings. It reported higher Q3 net flows than a year earlier, despite modestly lower deposits.
- For the remainder of 2009, management highlighted credit-market instability and further impairments, equity-market volatility and hedge performance, low interest rates, possible additional intangible impairments, product sales and regulatory or tax changes. It planned to focus on expense control, product development, capital and liquidity management, and reducing risk from variable-annuity guarantees. No consolidated earnings guidance was provided.
- The company estimated a $500 million capital impact from the new VACARVM statutory reserving standard, effective December 31, 2009; the estimate was preliminary and market-dependent. A 15% decline in the S&P 500 from its September 30 level was estimated to reduce year-end statutory surplus by $80–$100 million and consolidated RBC by about five to seven percentage points.
- A 2009 arbitration rescission of disability-income reinsurance with Swiss Re left LNC responsible for the related claims and reserves. The company reported a $64 million after-tax unfavorable adjustment, reduced reinsurance recoverables by about $900 million and funds-withheld liabilities by about $840 million, and expected to complete a reserve adequacy review in Q4; further charges were possible. Swiss Re was LNC’s largest reinsurance exposure.
- The Lincoln UK sale closed October 1, 2009, for approximately $305 million after tax, subject to adjustments; LNC retained the U.K. pension plan assets and liabilities. The Delaware investment-management sale was expected around December 31, 2009; management estimated roughly $430 million of cash consideration, subject to adjustments and regulatory approvals, and expected it to be earnings-per-share neutral if proceeds were reinvested in core insurance businesses.
- Variable-annuity guarantee results remain sensitive to equity markets, interest rates, credit spreads, volatility and policyholder behavior. Management said its hedges may not fully offset guarantee liabilities and reduced interest-rate hedge coverage ahead of VACARVM adoption. The filing also disclosed ongoing litigation, including a claim seeking substantial damages; management expected proceedings generally to resolve without materially affecting consolidated financial position but noted individual adverse outcomes could materially affect a reporting period.
Important facts for investors to verify
- Progress and final capital requirements for VACARVM, including actual statutory reserves, surplus and RBC at year-end.
- Results of the Swiss Re disability-business reserve study and any additional reserve or earnings adjustments.
- Final purchase-price adjustments and completion conditions for the Delaware and Lincoln UK transactions, including retained pension obligations and advisory-agreement terms.
- Credit quality, impairment assumptions and valuation of the investment portfolio, particularly mortgage-backed securities and the $600 million credit-linked-note exposure; one tranche was rated Ba3 at September 30 and B2 by October 31.
- Holding-company liquidity, upcoming debt maturities, access to subsidiary dividends and financing, and the cost and restrictions attached to TARP preferred stock and its warrant.