Lincoln National Corporation — Q1 2019 Form 10-Q
Business context and period. The filing covers the three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018. Lincoln National is an insurance and retirement-services holding company with Annuities, Retirement Plan Services, Life Insurance and Group Protection segments. The 2019 results include Liberty Life, acquired May 1, 2018, while Q1 2018 results do not, limiting year-over-year comparability, particularly for Group Protection.
Financial performance and position
Amounts are in millions of dollars except per-share data and percentages.
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| Total revenue | $3,965 | $3,609; up 10% |
| Income before taxes | $268 | $435 |
| Net income | $252 | $367; down 31% |
| Diluted EPS | $1.22 | $1.64 |
| Comprehensive income (loss) | $2,298 | $(1,272) |
| Operating income from segments and Other Operations | $441 | $441; company-defined measure |
| Operating cash flow | $(1,331) | $140 |
| Investing cash flow | $(1,133) | $(595) |
| Financing cash flow | $1,712 | $1,084 |
Reported net income includes $362 million of realized losses, versus $12 million of realized gains a year earlier. The company attributed the larger losses mainly to fair-value movements in embedded derivatives associated with reinsurance and variable-annuity hedging. A $142 million after-tax favorable benefit-ratio unlocking adjustment partly offset excluded realized losses; these items are excluded from the company’s segment operating-income measure. The effective tax rate was 6%, versus 16%.
Segment operating income was Annuities $250 million (down from $267 million), Retirement Plan Services $39 million (from $43 million), Life Insurance $157 million (from $144 million), Group Protection $55 million (from $29 million), and Other Operations loss of $60 million (versus a $42 million loss). Group Protection’s increase reflects the Liberty Life acquisition; its reported premiums rose to $1,023 million from $508 million.
Total deposits were $7,541 million, up from $6,420 million. Net flows were $1,131 million, compared with $933 million: Annuities $492 million (versus $(606) million), Retirement Plan Services $(381) million (versus $463 million), and Life Insurance $1,020 million (versus $1,076 million). Total account values were $253.4 billion, compared with $252.6 billion at March 31, 2018.
At March 31, 2019, total assets were $314.3 billion, up from $298.1 billion at year-end; total liabilities were $297.9 billion and stockholders’ equity was $16.4 billion, up from $14.4 billion. Equity’s increase included $2.046 billion of other comprehensive income, largely reflecting unrealized investment gains. Cash and invested cash was $1.593 billion, down from $2.345 billion. Short- and long-term debt totaled $5.872 billion ($300 million short-term and $5.572 billion long-term), compared with $5.839 billion of long-term debt at year-end. Holding-company available liquidity was $481 million.
Net investment income was $1,251 million, up from $1,233 million. The consolidated filing does not present a single company-wide operating margin; segment operating income and GAAP results use different measures and include significant unusual fair-value effects.
Material changes, outlook and risks
- Drivers and comparability: Revenue growth primarily reflects the inclusion of Liberty Life’s Group Protection business. Lower net income was also attributed to realized losses, weaker alternative-investment results, acquisition/integration costs, the Modco reinsurance transaction and spread compression. Favorable offsets included Group Protection growth and lower tax expense.
- Cash-flow presentation: Management said operating cash outflow primarily reflected purchases of trading securities while repositioning part of the Modco portfolio; these outflows were largely offset by sales of available-for-sale securities in investing activities.
- Reinsurance: The Athene Modco agreement covers approximately $7.7 billion of in-force fixed and fixed-indexed annuities. Management expects an ongoing reduction in Annuities operating income from the transaction. Repositioning the portfolio also caused income-statement volatility because derivative and investment fair-value changes are presented in different lines.
- Margins and guarantees: Management cited spread compression as average new-money rates trailed existing portfolio yields, partly mitigated by lower crediting rates. Variable-annuity guarantees are sensitive to equity markets, interest rates, volatility, policyholder behavior and hedge effectiveness. The share of variable-annuity contracts with guaranteed living benefits that were “in the money” was 14%, versus 6% one year earlier; exposure after reinsurance was $758 million, versus $413 million.
- Capital and shareholder returns: The company declared a $0.37 quarterly dividend per share. It reported $240 million of Q1 share repurchases in its capital-return discussion and 3.9 million shares repurchased; the cash-flow statement reports $150 million of repurchase cash outflow. Remaining authorization at quarter-end was $587 million. Management said further 2019 repurchases depend on market conditions and alternative uses of capital.
- Contingencies: The company estimated aggregate reasonably possible litigation and regulatory losses of up to approximately $50 million, while stating that currently known matters were not likely to have a material adverse effect on financial condition. Multiple cost-of-insurance lawsuits remain; one putative class complaint was dismissed, with the plaintiff seeking leave to amend. Reinsurer rate-increase disputes are being contested.
- Other items and risks: Adoption of lease accounting added $207 million of right-of-use assets and $214 million of lease liabilities at January 1, 2019. Management cited interest-rate and equity-market movements, credit and investment risk, reinsurance collectability, legal and regulatory outcomes, ratings changes, policyholder withdrawals and operational/cyber risks. No formal earnings guidance was provided in the supplied filing text. Disclosure controls were deemed effective, but the controls assessment excluded Liberty Life’s relevant internal controls under the permitted acquisition transition.
Most important facts for investors to verify
- How much of revenue and Group Protection growth reflects Liberty Life, and what the results look like on a comparable basis.
- Whether the large realized losses and benefit-ratio unlocking are mainly market-driven timing effects or indicate persistent earnings volatility; review the hedge and Modco exposures.
- Whether operating cash-flow outflows remain principally portfolio-repositioning related, and how liquidity and collateral needs evolve.
- Trends in new-money yields, credited rates, segment spreads, alternative-investment returns and Retirement Plan Services net outflows.
- Developments in variable-annuity guarantee exposure, hedge effectiveness, reinsurance disputes and cost-of-insurance litigation.
- The reconciliation of reported repurchase cash outflow of $150 million with the $240 million repurchase amount disclosed in the capital-return discussion.