Lincoln National Corporation — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Lincoln National operates annuity, retirement-plan, life-insurance and group-protection businesses. The 2018 comparison includes Liberty Life only from its May 1, 2018 acquisition date, affecting year-over-year comparisons, especially in Group Protection.
Financial performance and condition
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $4.638 billion | $4.264 billion | $12.913 billion | $11.893 billion |
| GAAP net income (loss) | $(161) million | $490 million | $454 million | $1.242 billion |
| Diluted EPS | $(0.83) | $2.24 | $2.24 | $5.59 |
| Net investment income | $1.235 billion | $1.271 billion | $3.842 billion | $3.736 billion |
| Operating cash flow | Not provided here by quarter | $(2.857) billion | $1.034 billion |
Segment operating income (loss), Q3 / nine months: Annuities $169 million / $686 million; Retirement Plan Services $44 million / $125 million; Life Insurance $(245) million / $79 million; Group Protection $61 million / $184 million; Other Operations $(75) million / $(201) million. These are management-defined segment measures, not GAAP net income.
- Q3 GAAP loss reflected the annual assumption review, unfavorable Life Insurance mortality, weak alternative-investment returns, a $42 million pretax debt-extinguishment loss and acquisition/integration costs. The Q3 after-tax unlocking impact was $(410) million, primarily Life Insurance $(320) million and Annuities $(93) million.
- Nine-month GAAP earnings declined despite higher revenue. Items included $(492) million of excluded realized losses after tax and $80 million of after-tax acquisition and integration costs; favorable benefit-ratio unlocking contributed $186 million after tax.
- Alternative investments generated an $81 million loss in Q3, versus $54 million income in Q3 2018, largely reflecting a write-down of a large private-equity investment. For nine months, the loss was $9 million versus $114 million income.
- Group Protection’s total loss ratio was 74.1% in Q3 and 73.8% for nine months, compared with 73.6% and 71.4%, respectively, in 2018. The nine-month comparison includes additional Liberty business.
Balance sheet, liquidity and capital
- At September 30, total assets were $325.3 billion, up from $298.1 billion at year-end 2018; stockholders’ equity was $20.0 billion, up from $14.4 billion. AOCI rose to $6.248 billion from $407 million, largely reflecting unrealized investment gains.
- Cash and invested cash was $2.939 billion. Short-term debt was $300 million and long-term debt was $6.070 billion. The company issued $500 million of 3.05% senior notes due 2030 and repurchased $109 million of older notes.
- Holding-company available liquidity was $765 million. A refinanced, unsecured credit facility permits up to $2.25 billion of borrowing and letters of credit through July 2024; the company reported compliance with its covenants.
- Nine-month operating cash use of $2.9 billion was primarily associated with repositioning assets in the Athene modified-coinsurance portfolio. The company said these outflows were largely offset by AFS-security sales in investing activities. Investing cash use was $2.3 billion; financing cash provided was $5.7 billion.
- Insurance subsidiaries paid $685 million in dividends to the holding company during the first nine months. The company repurchased $540 million of common stock and paid $225 million in dividends during that period. After quarter-end, the board raised the quarterly dividend from $0.37 to $0.40 per share.
Material changes, outlook and risks
- The annual review lowered starting and long-term new-money-rate assumptions and extended the transition to long-term assumptions from five to seven years. Management cited a 3.5% ultimate long-term yield assumption for a 10-year U.S. Treasury. These changes drove substantial unfavorable unlocking, particularly in Life Insurance.
- Management expects the Athene reinsurance transaction to reduce Annuities operating income in future periods. It also cited spread compression as new-money yields lagged portfolio yields, partly offset by reductions in credited rates. No specific earnings or revenue guidance was provided.
- Variable-annuity guarantees remain sensitive to equity markets, interest rates, volatility, policyholder behavior and hedge performance. The share of in-force GLB contracts described as “in the money” was 16%, versus 7% a year earlier; the stated exposure after reinsurance was $853 million, versus $451 million.
- Other key risks include sustained low or rapidly rising interest rates, investment credit losses, mortality and claims experience, reinsurance availability and pricing, rating downgrades, regulatory changes, and operational or cybersecurity events. Management reported no material change in economic exposure to market risks since year-end 2018.
- Legal and regulatory proceedings include cost-of-insurance disputes and class actions. The company estimated aggregate reasonably possible losses of up to approximately $50 million as of September 30, 2019, while noting some matters could not yet be estimated. It is disputing requested rate increases by certain reinsurers.
- SEC Regulation Best Interest and Form CRS became effective September 10, 2019, with compliance required by June 30, 2020. The filing says the effect of evolving federal and state standards on the business remained uncertain.
Important facts for investors to verify
- How much of the earnings decline reflects recurring business performance versus annual assumption unlocking, realized losses, alternative-investment marks and debt retirement?
- Whether interest-rate spreads, new-money yields and credited-rate actions stabilize, and how the Athene reinsurance arrangement affects future Annuities earnings.
- Whether Life Insurance mortality, reserve assumptions and guarantee exposure develop as expected after the unfavorable Q3 review.
- How the company funds holding-company needs and maintains subsidiary dividend capacity, ratings and statutory capital amid market or regulatory stress.
- Developments in cost-of-insurance litigation, reinsurer rate disputes, Regulation Best Interest compliance and adoption of new accounting standards.