Lincoln National Corporation — 2011 Form 10-K
Business context and reporting period. Lincoln National Corporation is an insurance and retirement-services holding company operating through Annuities, Retirement Plan Services, Life Insurance and Group Protection, plus Other Operations. The filing covers the fiscal year ended December 31, 2011; quarterly results are also provided. Unless specified otherwise, amounts below are U.S. dollars.
Financial performance and position
- Revenue and earnings: Full-year revenue was $10.636 billion, up 2% from $10.407 billion in 2010. Continuing-operations income fell to $302 million from $951 million; net income was $294 million versus $980 million. Diluted EPS was $0.92 versus $2.54. Full-year results included a $747 million goodwill impairment charge.
- Fourth quarter: Revenue was $2.570 billion; continuing-operations and net loss were each $513 million. Diluted loss per share was $1.73. The filing attributes the major impairment to Life Insurance and media goodwill.
- Segment operating income: Annuities earned $592 million (+22%); Retirement Plan Services $167 million (+8%); Life Insurance $604 million (+18%); Group Protection $101 million (+40%). Other Operations posted a $146 million loss, improved from a $186 million loss. These are management-defined operating measures, not consolidated GAAP net income.
- Cash flow: Operating activities provided $1.277 billion, down from $1.720 billion in 2010. Investing activities used $2.125 billion; financing activities provided $2.617 billion. Cash and invested cash increased to $4.510 billion from $2.741 billion.
- Assets, equity and debt: Total assets were $202.906 billion and stockholders’ equity was $14.164 billion, compared with $193.824 billion and $12.806 billion, respectively, at year-end 2010. Balance-sheet short-term debt was $300 million and long-term debt $5.391 billion. Contractual principal debt was approximately $5.388 billion.
- Investments and credit losses: Investments totaled $93.130 billion, including $76.133 billion of fixed-maturity AFS securities. Net investment income was $4.652 billion, up 2%; net OTTI recognized in earnings was $118 million pre-tax, down from $152 million. AFS securities had $1.109 billion of gross unrealized losses at year-end.
- Liquidity and capital: Holding-company cash and cash equivalents were $622 million. Domestic insurance subsidiaries were expected to be able to pay approximately $675 million of dividends in 2012 without prior regulatory approval. The filing says key subsidiaries’ RBC ratios exceeded the company-action level, but does not provide a clear ratio in this text.
- Margins and spreads: The filing does not present a single consolidated operating-margin measure. Annuities’ interest-rate spread was 1.94%, down 18 basis points; Retirement Plan Services’ was 2.38%, up 7 basis points; Life Insurance’s interest-sensitive product spread was 1.97%, essentially unchanged.
Material changes versus 2010
- Revenue rose 2%, but net income fell 70%, principally because of the $747 million goodwill impairment and higher excluded realized losses. The impairment comprised $650 million for Life Insurance and $97 million for media.
- Consolidated realized losses increased to $299 million pre-tax from $77 million. Variable-annuity net derivatives results were a $113 million after-tax loss, compared with a $28 million loss in 2010.
- Operating cash flow declined by $443 million. Total account values increased 2% to $159.945 billion, supported by positive net flows, despite volatile markets.
- Deposits rose 3% to $21.609 billion; total net flows were $6.378 billion, broadly level with 2010. Life Insurance net flows increased 20%, while Annuities net flows declined 38%.
- Common shares repurchased totaled approximately 24.7 million for $576 million. Common dividends declared were $0.23 per share, up from $0.08 in 2010.
Outlook, management commentary, risks and unusual items
- Management described low interest rates, European debt concerns, equity-market volatility and slow U.S. growth as material headwinds. The Federal Reserve’s then-current outlook anticipated low rates through at least late 2014.
- For 2012, management expected to reprice products, closely monitor capital and liquidity, pursue financing solutions for statutory reserve strain, invest in technology and distribution, and manage expenses. It anticipated lower sales, particularly for universal-life products with secondary guarantees, and higher strategic-investment expenses.
- In a hypothetical low-new-money-rate scenario, management estimated unfavorable earnings effects for Life Insurance of $15–20 million in 2012, $40–45 million in 2013 and $65–70 million in 2014; for Retirement Plan Services and Annuities combined, $10–15 million, $20–25 million and $30–35 million, respectively. These estimates are scenario-based, not formal earnings guidance.
- Low rates are pressuring investment spreads: 85% of Annuities, 93% of Retirement Plan Services and 92% of Life Insurance business with guaranteed minimum rates were at their guarantees at year-end. Rising rates could also increase surrenders and force asset sales.
- Variable-annuity guarantees remain sensitive to equity markets, rates and volatility. About 80% of in-force guaranteed withdrawal benefit contracts were “in the money,” with $2.5 billion of exposure after reinsurance. The hedge program ended 2011 with $2.9 billion of assets against an estimated $2.6 billion liability; hedging may not fully offset changes.
- Statutory reserve requirements for universal life secondary guarantees (AG38/XXX) are uncertain. Captive reinsurance and letters of credit help manage reserve strain, but regulatory, rating-agency or financing constraints could require more capital or increase costs.
- Effective January 1, 2012, the new insurance-acquisition-cost accounting standard was expected to reduce deferrable costs and alter earnings timing. Retrospective adoption was estimated to reduce opening retained earnings by approximately $950 million–$1.15 billion; management estimated 2011 segment results would have been 5%–7% lower under the new method.
- Other exposures include reinsurance collectibility—$6.5 billion recoverable, including $2.8 billion related to Swiss Re—investment and mortgage-credit losses, market-sensitive fair-value estimates, legal proceedings and regulatory changes. The estimated aggregate reasonably possible legal loss range was up to approximately $100 million, including amounts in excess of accruals.
- The financial statements received an unqualified audit opinion, and management and the auditor concluded internal control over financial reporting was effective as of December 31, 2011.
Important facts for investors to verify
- Reconcile the $747 million goodwill impairment, quarterly loss, and the distinction between GAAP earnings and management’s segment operating results.
- Review the 2012 adoption effects of the new DAC methodology, including the estimated $950 million–$1.15 billion retained-earnings adjustment and any subsequent revisions.
- Check statutory capital, RBC ratios, dividend capacity and the availability and cost of reserve-financing arrangements as AG38/XXX guidance develops.
- Monitor variable-annuity guarantee exposure, hedge effectiveness, collateral requirements and sensitivity to equity-market, interest-rate and volatility movements.
- Assess fixed-business spread compression, guarantee exposure, policyholder surrenders and the assumptions underlying management’s scenario estimates.
- Evaluate investment impairment trends, unrealized losses, commercial mortgage delinquencies and concentration, and Swiss Re’s ability to meet reinsurance obligations.
- Confirm the status and potential financial effect of legal and unclaimed-property matters, and assess whether ratings, regulatory actions or subsidiary dividend restrictions have changed.