Lincoln National Corporation — Q2 2017 Form 10-Q
Business context and period. Unaudited results for the quarter and six months ended June 30, 2017, compared with the corresponding 2016 periods. Lincoln National operates annuity, retirement-plan, life-insurance and group-protection businesses. Amounts are in millions except per-share data.
Financial performance
- Second quarter: Revenue was $3,577, up 8% year over year; pretax income was $533; net income was $411, up 26%; diluted EPS was $1.81 versus $1.35. Declared dividends were $0.29 per share versus $0.25.
- First half: Revenue was $7,077, up 8%; pretax income was $1,008; net income was $846, up 58%; diluted EPS was $3.70 versus $2.18. Net income included $71 after tax from benefit-ratio unlocking, compared with $4 in 2016.
- Revenue and expenses: Q2 insurance premiums were $801, fee income $1,393 and net investment income $1,262. Total expenses were $3,044, including $14 of strategic digitization expense; that expense was $23 for the first half.
- Cash flow: First-half operating cash flow was $202, compared with $536 in 2016. Investing activities used $2,004 and financing activities provided $1,058. Consolidated cash and invested cash declined to $1,978 from $2,722 at year-end.
- Financial position at June 30: Total assets were $271,651 and stockholders’ equity $15,996, compared with $261,627 and $14,478 at December 31, 2016. Total debt was $5,351 ($450 short-term and $4,901 long-term), versus $5,345 at year-end. Available holding-company liquidity was $523.
- Margins: Derived GAAP net margin was approximately 11.5% in Q2 versus 9.8% in Q2 2016, and 12.0% for the first half versus 8.2%. These are calculated as net income divided by reported revenue.
Segments and changes versus prior periods
- Annuities: Operating income was $251 in Q2, up 7%, and $532 for the first half, up 17%. Higher variable-account fees and investment income helped; annuity deposits fell 6% in Q2 and 10% in the first half, and net flows were negative.
- Retirement Plan Services: Operating income rose 19% to $37 in Q2 and 21% to $74 for the first half. First-half deposits increased 23% to $4,229; net flows were $511 versus $82.
- Life Insurance: Operating income rose 11% to $133 in Q2 and 35% to $263 for the first half. Growth in fees and investment income was partly offset by higher benefits. First-half sales increased 21% to $378.
- Group Protection: Operating income increased to $35 in Q2 from $15 and to $42 for the first half from $20, reflecting lower benefits and improved loss experience. The first-half total loss ratio improved to 68.5% from 71.0%.
- Other Operations: Operating loss widened to $37 in Q2 from $28 and to $51 for the first half from $39, including digitization costs and lower amortization of deferred reinsurance gains.
- Consolidated drivers: Management cited business-in-force and account-value growth, stronger alternative-investment income and prepayment/make-whole premiums, more favorable Group Protection claims, and lower realized losses than in 2016. Offsets included spread compression, higher incentive compensation and digitization costs. First-half tax benefits also contributed to the earnings increase.
Outlook, risks and unusual items
- The filing provides no specific consolidated earnings or revenue guidance. Management said it expected to meet ongoing holding-company cash needs and maintain capital to provide downside protection, while noting that weaker markets could reduce subsidiary dividends and statutory capital.
- Management said that, if it had performed its annual assumption “unlocking” as of June 30, estimated favorable pretax effects would have been approximately $180 for Annuities, $35 for Life Insurance and $25 for Retirement Plan Services. These are hypothetical estimates, not reported results; the annual comprehensive review was scheduled for the third quarter.
- Key exposures include persistently low or rapidly rising interest rates, equity-market declines and variable-annuity guarantees, investment credit losses, policy surrenders, reinsurance collectability, ratings downgrades, regulatory and tax changes, cyber and operational disruption, and litigation. Management identified spread compression because new-money yields trailed portfolio yields.
- The DOL fiduciary rule’s phased implementation began June 9, 2017, with full implementation then scheduled for January 1, 2018; further changes or delays remained possible. The company warned of potential effects on distribution, sales, compensation and legal exposure.
- Unrealized losses on available-for-sale securities, including the OCI portion of impairment, were $618 at June 30, down $548 from year-end. Management considered these losses temporary and stated it did not expect to be forced to sell securities before recovery. Corporate bonds were 96% investment grade by fair value; the broader fixed-maturity portfolio was 95.9% investment grade.
- The company estimated aggregate reasonably possible litigation and regulatory losses of up to approximately $50; some matters could not be estimated. It stated that currently known matters were not expected to materially adversely affect financial condition.
- Share repurchases were $400 and common dividends declared were $131 for the first half. The remaining repurchase authorization was $614 at June 30. Statutory capital and risk-based capital at insurance subsidiaries were reported above current regulatory requirements, without amounts stated here.
Important facts for investors to verify
- How much of the reported earnings growth is attributable to sustainable segment performance versus tax benefits, benefit-ratio unlocking and market-sensitive investment or derivative results.
- Whether negative Annuities net flows persist, and how deposit trends and variable-annuity guarantee exposure affect future fees, reserves and hedging results.
- How interest-rate spread compression, new-money yields and crediting-rate actions affect earnings across fixed annuity, retirement and life products.
- The quality and liquidity of the investment portfolio, including below-investment-grade exposures, unrealized losses, investment commitments and collateral requirements.
- Whether subsidiary dividends, statutory capital, available holding-company liquidity and debt maturities support planned dividends and repurchases under adverse conditions.
- Developments in DOL fiduciary-rule implementation and the estimated litigation-loss range, including matters for which a loss range cannot yet be determined.