Lincoln National Corporation — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Lincoln National operates Annuities, Retirement Plan Services, Life Insurance and Group Protection businesses. Results include Liberty Group Business, acquired May 1, 2018; comparisons are therefore not fully like-for-like.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $4.310B | $4.020B | $8.275B | $7.629B |
| Income before tax | $421M | $451M | $689M | $886M |
| Net income | $363M | $385M | $616M | $752M |
| Diluted EPS | $1.79 | $1.70 | $3.01 | $3.34 |
| Net cash from operating activities | Not separately reported for quarter | $(2.562)B | $632M |
Q2 revenue rose about 7%, while net income fell about 6%. For the first half, revenue increased about 8% but net income declined about 18%. The six-month effective tax rate was 11%, versus 15% in 2018; the filing attributes the lower rate partly to tax benefits associated with realized losses.
Segment operating income for Q2 was Annuities $266M (down from $275M), Retirement Plan Services $42M (down from $43M), Life Insurance $168M (up from $150M), Group Protection $68M (up from $45M), and Other Operations loss $(66)M (versus $(59)M). These are non-GAAP segment measures; consolidated GAAP net income also reflects realized losses and other excluded items.
Financial position, liquidity and capital
- At June 30, total assets were $322.3B, up from $298.1B at year-end 2018. Investments were $126.4B; separate-account assets and liabilities were each $146.3B.
- Cash and invested cash was $3.3B. Total debt was $5.9B, comprising $300M short-term and $5.6B long-term debt. Stockholders’ equity was $18.5B, versus $14.4B at year-end, with accumulated other comprehensive income rising to $4.3B from $407M.
- Six-month operating cash outflow of $2.6B was primarily driven by purchases of trading securities in repositioning part of a modified coinsurance portfolio; the filing says this was largely offset by sales of available-for-sale securities in investing activities. Investing cash outflow was $59M and financing cash inflow was $3.6B.
- Parent-company available liquidity was $474M. Insurance subsidiaries paid $485M in dividends to the holding company during the first half. The company reported a $2.25B unsecured credit facility entered into July 31, 2019, subsequent to quarter-end.
- First-half common dividends declared were $0.74 per share. The company repurchased $390M of stock during the first half and said further 2019 repurchases were expected depending on market conditions and alternative capital needs.
Material changes and management commentary
- First-half realized losses were $480M, compared with a $5M gain in 2018, mainly reflecting mark-to-market effects, Modco-related embedded derivatives, indexed annuity options and variable-annuity hedge results. These losses materially affected reported net income.
- Management cited spread compression as average new-money rates trailed existing portfolio yields, partly offset by lower crediting rates. Life Insurance income benefited from business-in-force growth and investment income, but Q2 mortality was unfavorable relative to expectations.
- Group Protection results benefited from Liberty Group Business and business growth; the acquisition also affects period comparability and segment loss ratios.
- Management expects ongoing lower Annuities operating income from the Athene Modco reinsurance transaction. It also described portfolio management and, to a lesser extent, crediting-rate actions as tools to manage near-term spread effects, assuming no significant changes in fixed-account flows or other conditions.
- The annual review of key assumptions for deferred acquisition costs and insurance reserves is conducted in Q3. Management said a hypothetical June 30 reversion-to-the-mean update would have produced about $215M of favorable pretax unlocking across Annuities, Life Insurance and Retirement Plan Services; this was not reported as an actual adjustment.
Risks, contingencies and unusual items
- Market, credit, interest-rate, equity, policyholder behavior and hedging risks could affect investment returns, guaranteed benefits, spreads, surrenders and liquidity. The company said its economic exposure to market risks had not changed materially since year-end.
- Variable-annuity guaranteed living benefits were “in the money” for 12% of contracts with such features, versus 7% a year earlier; related exposure after reinsurance was $701M, versus $475M.
- Legal and regulatory matters include multiple cost-of-insurance disputes and putative class actions. The company estimated aggregate reasonably possible litigation and regulatory losses of up to approximately $50M; it said some matters’ potential losses could not yet be estimated. It is disputing requested reinsurance rate increases.
- Fixed maturity securities were 96.5% investment grade by fair value. Management considered unrealized losses generally temporary and reported that gross unrealized losses declined $2.0B during the first half. Credit impairments recognized in earnings were $12M net for the six months.
- The company cited dependence on subsidiary dividends, statutory capital and reserve-financing arrangements, potential rating downgrades, persistently low or rapidly changing interest rates, litigation, reinsurance collectability and operational/cyber risks. It reported no material change in internal control over financial reporting.
Most important facts for investors to verify
- How much of the reported earnings decline reflects recurring operating trends versus realized and Modco-related valuation losses.
- Whether spread compression, Life Insurance mortality and Group Protection claims experience persist in subsequent quarters.
- The future earnings and capital effects of the Athene Modco transaction, including portfolio repositioning and embedded-derivative volatility.
- Whether liquidity, subsidiary dividend capacity and reserve-financing arrangements remain adequate under adverse market or rating scenarios.
- Developments in cost-of-insurance litigation, reinsurance rate disputes and the estimated reasonably possible loss exposure.