Business context and reporting period
Lincoln National Corporation (NYSE: LNC) filed its Form 10-K for the fiscal year ended December 31, 2019. This is an annual report, not a standalone quarterly filing; the filing also reports unaudited fourth-quarter results. LNC is an insurance and retirement-services holding company with Annuities, Retirement Plan Services, Life Insurance and Group Protection segments. The 2018 acquisition of Liberty Life expanded Group Protection; the acquired individual life and annuity business was reinsured to Protective.
Financial results and key metrics
| Metric | 2019 | 2018 |
|---|---|---|
| Total revenue | $17.258 billion | $16.424 billion |
| GAAP net income | $886 million | $1.641 billion |
| Diluted EPS | $4.38 | $7.40 |
| Operating cash flow | $(2.686) billion | $1.943 billion |
| Net investment income | $5.223 billion | $5.085 billion |
| Assets at year-end | $334.761 billion | $298.147 billion |
| Stockholders’ equity at year-end | $19.689 billion | $14.350 billion |
Revenue increased about 5%, while GAAP net income declined about 46%. Net income included $627 million of after-tax excluded realized losses, $103 million of after-tax acquisition and integration costs, and a $33 million after-tax loss on early debt extinguishment. The filing separately reports a $277 million after-tax favorable benefit-ratio unlocking adjustment. The annual assumption review generated $410 million of unfavorable after-tax unlocking, primarily from updated interest-rate assumptions; these are distinct reported items.
Segment income from operations (after tax) was: Annuities $954 million (down from $1.102 billion); Retirement Plan Services $172 million (roughly flat); Life Insurance $259 million (down from $645 million); and Group Protection $238 million (up from $187 million). Other Operations recorded a $268 million loss. Fourth-quarter 2019 revenue was $4.344 billion and net income was $431 million, or $2.15 diluted EPS; third-quarter net income was a loss of $161 million.
Operating cash flow was negative largely because the company repositioned part of a modified-coinsurance investment portfolio: purchases of trading securities were substantially offset by sales of available-for-sale securities reported in investing cash flows. Investing cash flow was $(5.499) billion and financing cash flow was $8.403 billion.
At year-end, total investments were $133.697 billion, including $105.200 billion of fixed-maturity available-for-sale securities; 96.7% of that portfolio was investment grade. The company reported $136.3 billion of investments and cash against $117.3 billion of future policy obligations, net of reinsurance. Total debt carrying value was $6.367 billion, including $300 million short-term debt and $6.067 billion long-term debt. Holding-company available liquidity was $702 million; the revolving credit facility was $2.25 billion. LNC expected domestic insurance subsidiaries to be able to pay approximately $845 million in dividends to the parent in 2020 without prior regulatory approval. Insurance subsidiaries’ statutory capital and surplus was $8.564 billion, and their consolidated RBC ratio exceeded four times the company-action-level threshold.
Material changes versus the prior comparable period
- Group Protection results benefited from a full year of Liberty Group Business in 2019 versus eight months in 2018. 2019 segment operating income rose, although claims severity was unfavorable in life and long-term disability businesses.
- Life Insurance operating income fell substantially, reflecting unfavorable unlocking, higher benefits and expenses, weaker alternative-investment income and spread compression.
- Annuities returned to positive net flows: $1.851 billion in 2019 versus net outflows of $139 million in 2018. Total company deposits rose to $31.310 billion from $28.869 billion.
- Investment income from alternative investments fell to $22 million from $222 million, including a write-down of a large private-equity investment. Net investment income yield on invested assets declined to 4.47% from 4.72%.
- Unrealized investment gains drove other comprehensive income of $5.266 billion, compared with a $3.465 billion loss in 2018, contributing to higher reported equity. This is distinct from net income.
- The common dividend declared per share increased to $1.51 from $1.36. LNC repurchased $640 million of common stock in 2019, compared with $810 million in 2018.
Outlook, commentary, risks and contingencies
Management did not provide quantified 2020 earnings guidance in the supplied filing text. Its priorities included investing in technology, digitization, product innovation and distribution; managing expenses and capital; repricing products and shifting sales toward shorter-duration products; and evaluating reserve-financing strategies. Management expected annual pre-tax benefits of approximately $90 million to $150 million from the digitization initiative beyond 2020.
- Persistently low interest rates may compress spreads, increase the cost of guarantees and create further unfavorable unlocking or reserve strengthening. In 2019, management lowered starting and long-term new-money yield assumptions and extended the grade-in period; it estimated a further 50-basis-point reduction in its long-term new-money yield assumption could reduce operating income by about $180 million, primarily through unlocking.
- Equity-market, interest-rate and volatility changes can affect variable-annuity guarantees, hedging results, account-based fees and statutory capital. Hedging may not fully offset guarantee movements or basis, behavior and counterparty risks.
- Reinsurance recoverables were $17.1 billion; Protective was the largest exposure, with $11.8 billion recoverable, supported by trust collateral. Reinsurer default, disputes over rate increases and concentration remain risks.
- Pending litigation includes class and other actions alleging improper cost-of-insurance rate increases. Management estimated aggregate reasonably possible losses, including amounts above accruals, of up to approximately $90 million; this is not an expected-loss estimate or maximum exposure.
- Insurance dividend capacity, statutory reserves and RBC can be affected by markets, regulation and reserve-financing availability. New variable-annuity statutory rules took effect January 1, 2020; management did not expect a material adoption impact. The long-duration insurance accounting standard was deferred to January 1, 2022, and its impact was still under evaluation.
- Other notable exposures include investment valuation and credit risk, cybersecurity and privacy, regulatory change, policyholder behavior, catastrophe claims and goodwill or deferred-tax-asset valuation. Goodwill was $1.778 billion; the 2019 annual impairment test found reporting-unit fair values above carrying values.
Most important facts for investors to verify
- Reconcile the $886 million GAAP net income to excluded realized losses, unlocking, acquisition costs, tax effects and other adjustments; distinguish reported operating measures from GAAP results.
- Review why 2019 operating cash flow was negative and confirm the corresponding investing cash flows and Modco portfolio repositioning.
- Assess the assumptions behind life-insurance and annuity reserves, DAC and guarantee liabilities, including sensitivity to rates, equity markets, lapse rates and rider utilization.
- Check the quality, collateralization and concentration of reinsurance recoverables, especially Protective, Athene and Swiss Re, and monitor cost-of-insurance litigation and the disclosed loss range.
- Evaluate holding-company liquidity, debt maturities, dividend capacity, statutory capital and RBC under stressed market conditions.
- Track the results of the 2020 priorities, including digitization benefits, product-mix changes, integration savings and the adoption effects of new accounting and statutory rules.