Lincoln National Corporation — 2018 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018. Although the request metadata refers to 2018 Q4, this filing reports the full year; quarterly figures are noted separately where available. Amounts are in U.S. dollars unless otherwise stated.
Business context and reporting period
Lincoln National Corporation is an insurance and retirement holding company operating through Annuities, Retirement Plan Services, Life Insurance and Group Protection, plus Other Operations. At year-end it reported $298.1 billion in consolidated assets and $14.4 billion in stockholders’ equity.
On May 1, 2018, Lincoln acquired Liberty Life Assurance Company of Boston, paid $1.5 billion for its group benefits business, and ceded its individual life and annuity businesses to Protective. Liberty’s results are included from the acquisition date, so year-over-year comparisons—particularly for Group Protection—are affected by the transaction.
Financial performance and position
| Metric | 2018 | 2017 |
|---|---|---|
| Total revenue | $16.424 billion | $14.257 billion |
| Net income | $1.641 billion | $2.079 billion |
| Diluted EPS | $7.40 | $9.22 |
| Cash from operating activities | $1.943 billion | $788 million |
| Total assets | $298.147 billion | $281.763 billion |
| Stockholders’ equity | $14.350 billion | $17.322 billion |
| Long-term debt, principal | $5.686 billion | $4.673 billion |
| Total investments | $115.216 billion | $113.089 billion |
Revenue increased about 15%, while net income declined about 21%. The 2017 comparison included a $1.322 billion tax benefit from remeasuring deferred taxes after the Tax Act and a $905 million goodwill impairment. In 2018, reported net income also included $136 million of after-tax unfavorable benefit-ratio unlocking and $67 million of after-tax acquisition and integration costs. Segment operating income is a company-defined, non-GAAP measure: it totaled approximately $1.880 billion in 2018, versus $1.754 billion in 2017.
Comprehensive income was a loss of $1.824 billion, mainly reflecting $3.465 billion of after-tax other comprehensive losses, including declines in unrealized investment values. Cash and invested cash were $2.345 billion. Holding-company available liquidity was $465 million at year-end; the company also had a $2.5 billion revolving credit facility expiring in 2021. It expected domestic insurance subsidiaries could pay about $825 million in dividends to the holding company during 2019 without prior regulatory approval.
Net investment income rose to $5.085 billion from $4.990 billion, but investment yield on invested assets decreased to 4.72% from 4.85%. Reported investment spread measures weakened: Annuities’ spread was 1.71% versus 1.88%; Retirement Plan Services’ was 1.42% versus 1.59%; and Life Insurance’s was 1.47% versus 1.56%.
The fixed-maturity available-for-sale portfolio was $94.0 billion at fair value; 96.5% was investment grade and 3.5% below investment grade. Gross unrealized losses, including the portion recorded in OCI, increased by $2.0 billion during the year. Management said it did not intend, and did not expect to be required, to sell the affected securities before recovery of amortized cost.
Material changes versus the prior comparable period
- Group Protection operating income rose to $187 million from $103 million, with eight months of Liberty Life results included. The segment’s total loss ratio increased to 72.7% from 66.9%; management attributed the change largely to combining blocks with different loss characteristics.
- Annuities’ net outflows improved substantially, to $139 million from $2.707 billion outflows. Management reported positive net flows in Q4 2018 and expected continued improvement in 2019.
- At December 31, account values were $237.9 billion, down from $253.4 billion, reflecting market declines and business flows. Annuities’ account values fell to $121.3 billion from $137.0 billion.
- Reinsurance recoverables rose to $17.7 billion from $4.9 billion, principally from the Liberty transaction. Protective-related recoverables were $12.1 billion and were reported as fully collateralized by trust accounts.
- Stockholders’ equity fell by $3.0 billion, mainly due to the large negative OCI movement. Common shares outstanding declined, with 13.2 million shares repurchased during 2018; cash returned through dividends and repurchases was $1.096 billion.
- Fourth-quarter 2018 revenue was $4.531 billion and net income was $399 million, compared with $3.669 billion and $816 million in fourth-quarter 2017. The prior-year quarter included significant Tax Act and goodwill-impairment effects.
Outlook, management commentary, risks and unusual items
- Outlook: Management did not provide a numerical 2019 earnings forecast in the supplied filing text. It expected its digitization initiative to be approximately net neutral in 2019 and to generate annual pre-tax benefits of about $90 million to $150 million beyond 2020. It also expected annuity net flows to remain positive and improve in 2019.
- Priorities: Management highlighted investment in technology, digitization, product development and distribution; cost discipline; acquisition integration and expense synergies; and close monitoring of capital, liquidity, regulation and reserve financing.
- Market and guarantee risk: Results are sensitive to interest rates, equity markets, credit spreads, policyholder behavior and mortality. At year-end, 27% of variable-annuity contracts with guaranteed living benefits were “in the money,” versus 5% a year earlier; reported exposure after reinsurance was $1.3 billion versus $342 million. These are exposure measures, not estimates of expected claims.
- Interest-rate pressure: Low rates can compress spreads and increase guarantee costs; rapid rate increases can trigger surrenders and asset-sale losses. A 50-basis-point reduction in the long-term new-money yield assumption was estimated to reduce operating income by approximately $160 million, primarily through DAC and VOBA unlocking.
- Capital and reinsurance: Insurance subsidiaries’ RBC ratios exceeded four times the company action level, according to the filing; exact ratios are not provided in the supplied text. Reserve financing relies in part on captive reinsurance and letters of credit. Reinsurance collectability and counterparty concentration remain risks despite collateral arrangements.
- Legal matters: The company disclosed several cost-of-insurance rate litigation matters and said it was vigorously defending them. It estimated aggregate reasonably possible losses of up to approximately $50 million for matters where a range could be estimated, while noting that losses in other matters could not then be estimated. It did not believe known matters were likely to materially adversely affect financial condition.
- Accounting and tax: The 2018 effective federal tax rate was 13%, versus a tax benefit rate in 2017 affected by the Tax Act. The company was still evaluating the potentially significant accounting changes for long-duration insurance contracts scheduled to take effect in 2021.
- Controls and audit: The independent auditor gave an unqualified opinion on the financial statements and internal control over financial reporting. The acquired Liberty Life business was excluded from the internal-control assessment in its acquisition year.
Most important facts an investor should verify
- Reconcile reported net income with segment operating income and the unusually large 2017 Tax Act benefit and goodwill impairment.
- Review whether 2019 annuity net-flow improvement and the expected digitization savings materialized, including implementation and integration costs.
- Assess the sensitivity of guaranteed-benefit liabilities and hedge results to market shocks; distinguish the $1.3 billion “in-the-money” exposure from a projected loss.
- Check the quality, collateral and concentration of the $17.7 billion reinsurance recoverable, particularly Protective and Athene exposures, and the effect of reserve financing on statutory capital and dividend capacity.
- Monitor spread compression, minimum-crediting-rate exposure, investment unrealized losses and any subsequent realized losses or reserve strengthening.
- Track cost-of-insurance litigation, regulatory changes and adoption of long-duration contract accounting; the filing’s stated litigation loss range does not cover matters for which an estimate was unavailable.