Lincoln National Corporation — Q2 2010 Form 10-Q
Business context and reporting period. Lincoln National is an insurance and retirement-products holding company, operating through Retirement Solutions (Annuities and Defined Contribution) and Insurance Solutions (Life Insurance and Group Protection). This unaudited filing covers the quarter and six months ended June 30, 2010; comparisons are with the corresponding 2009 periods unless otherwise noted. Amounts below are in millions except per-share data.
Key financial results
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenue | $2,605 | $1,883 | $5,132 | $4,015 |
| Income (loss) from continuing operations | $252 | $(7) | $508 | $(594) |
| Net income (loss) | $255 | $(161) | $539 | $(740) |
| Net income (loss) available to common | $106 | $(161) | $371 | $(740) |
| Diluted EPS | $0.33 | $(0.62) | $1.18 | $(2.87) |
| Operating cash flow | Not presented quarterly | $873 | $447 |
Revenue rose 38% in Q2 and 28% for the first half. Higher insurance fees and net investment income contributed; Q2 also benefited from much smaller realized losses and the absence of the prior-year Lincoln UK disposal loss. Net income available to common was reduced by $149 million of preferred dividends and discount accretion in Q2; the six-month amount was $168 million.
For the first half, investing activities used $2,533 million and financing activities provided $1,176 million. Cash and invested cash declined $484 million from the beginning of the year to $3,700 million. At June 30, total assets were $180,129 million, total liabilities $167,491 million and stockholders’ equity $12,638 million, versus $177,433 million, $165,733 million and $11,700 million at December 31, 2009. Short-term debt was $99 million and long-term debt $5,865 million, compared with $350 million and $5,050 million, respectively, at year-end.
Segment operating income for the first half was $307 million in Retirement Solutions, $288 million in Life Insurance and $44 million in Group Protection; Other Operations reported a $73 million loss. Annuities’ interest-rate spread was 2.09% for the first half versus 1.53% in 2009; Life Insurance’s interest-sensitive spread was 1.93% versus 1.36%. Group Protection’s Q2 non-medical loss ratio was 75.5%, compared with 68.2% a year earlier.
Material changes and notable items
- Results improved substantially from 2009, which included a $603 million intangible impairment in the first half, significant securities impairment losses and a $170 million after-tax loss on the Lincoln UK disposal.
- Lincoln sold Delaware Management Holdings on January 4, 2010, receiving approximately $405 million after tax. Delaware’s results are reported as discontinued operations. Lincoln UK was sold in 2009; a $18 million after-tax post-closing adjustment was received in Q2 2010.
- The company issued 14.1 million common shares at $27.25 per share and issued $250 million of 4.30% senior notes due 2015 and $500 million of 7.00% notes due 2040. It used $950 million to redeem its Series B preferred stock held by the U.S. Treasury under the Capital Purchase Program. The Treasury retained a warrant for 13.05 million common shares at $10.92 per share.
- Adoption of revised VIE consolidation guidance led to consolidation of credit-linked-note structures and a $169 million after-tax reduction to opening retained earnings. Related derivative losses were recorded in 2010 results.
- Gross unrealized losses on available-for-sale securities fell about $1.0 billion from year-end, which management attributed to lower market yields and improved credit fundamentals. First-half net OTTI losses recognized in earnings were $64 million pre-tax, versus $239 million in 2009.
Outlook, commentary and risks
- Management described the recovery as fragile, citing volatile credit and equity markets, low interest rates, weak housing and economic uncertainty. No consolidated earnings-per-share or revenue guidance was provided.
- Management expected Other Operations’ 2010 loss to be lower than in 2009. It anticipated approximately $5 million per quarter of fees beginning in Q3 for the long-term financing solution and LOCs supporting secondary-guarantee life reserves.
- Group Protection results were pressured by higher long-term disability claims and termination experience. Management expected loss ratios to remain elevated for the rest of 2010, though it expected recovery over time.
- The actuarial-system conversion and harmonization of assumptions, expected to be substantially completed by year-end, could produce material one-time gains or losses; the company said it could not estimate the impact. The annual review of assumptions was scheduled for Q3.
- Key risks include sustained low rates compressing investment spreads, equity declines increasing variable-annuity guarantee exposure, credit losses and OTTI, hedge underperformance, reserve adequacy, statutory reserve financing, rating downgrades, regulatory changes and litigation. Management reported $3.1 billion of net GWB exposure after reinsurance and said hedge assets exceeded guarantee liabilities at June 30, while cautioning that hedge offsets may be imperfect.
- Legal proceedings include a substantial-damages dispute connected with Delaware’s hiring of a portfolio-management team; LNC retained responsibility for the matter. The IRS proposed an assessment for 2005–2006 that the company is contesting; management did not expect resulting adjustments to be material.
Most important facts for investors to verify
- Whether reported earnings improvement persists after separating discontinued operations, 2009 impairment and disposal comparisons, market-sensitive gains and losses, and preferred-stock accretion.
- Quarterly and subsequent-period performance of Group Protection disability claims, annuity and life spreads, and variable-annuity guarantee hedges.
- Availability, cost and covenant headroom of LOCs and other financing for secondary-guarantee reserves; the filing reports $2,038 million of LOCs issued and $3,180 million of listed credit-facility capacity.
- Investment credit quality, mortgage exposures, OTTI assumptions and the performance of consolidated credit-linked-note structures.
- Results of the Q3 actuarial assumption review and valuation-system conversion, including any reserve, DAC or earnings adjustments.