Lincoln National Corporation — Q2 2009 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2009. Unaudited consolidated results; dollar amounts are in millions unless stated otherwise. Lincoln operates insurance and investment-management businesses across Retirement Solutions, Insurance Solutions, Investment Management, and Other Operations.
Financial performance and position
| Metric | Q2 2009 | Q2 2008 | Six months 2009 | Six months 2008 |
|---|---|---|---|---|
| Total revenue | $1,952 | $2,493 | $4,152 | $5,001 |
| Continuing-operations income (loss), after tax | $(1) | $112 | $(585) | $394 |
| Net income (loss) | $(161) | $125 | $(740) | $414 |
| Basic and diluted EPS | $(0.62) | $0.48 | $(2.87) basic; $(2.87) diluted | $1.59 basic; $1.58 diluted |
| Net cash from operating activities | Not separately presented | Not separately presented | $447 | $451 |
Q2 revenue fell 22% year over year; six-month revenue fell 17%. Six-month revenue declines included lower insurance fees and investment advisory fees, lower net investment income, and increased realized losses. Consolidated net losses included realized losses of $441 in Q2 and $631 for six months, and six-month intangible impairment charges of $602, principally a $600 goodwill impairment in Annuities. The Q2 discontinued-operations loss of $160 included a $170 after-tax estimated loss on the planned U.K. sale.
Segment income from operations (management’s non-GAAP measure) for Q2 was: Retirement Solutions $93, Insurance Solutions $167, Investment Management $5, and Other Operations $(53). For the six months, the respective results were $196, $334, $6, and $(159). These measures exclude specified items, including realized investment and guarantee-related losses, intangible impairments, and discontinued operations; they are not substitutes for GAAP net income.
- Balance sheet at June 30: assets $167,045; liabilities $157,970; stockholders’ equity $9,075, versus $163,136, $155,159, and $7,977 at December 31, 2008.
- Cash and invested cash: $2,539 at June 30 versus $5,754 at year-end. Six-month investing cash outflow was $5,604, mainly reflecting investment purchases and reduced collateral payables; financing provided $1,919.
- Debt: short-term debt $455 and long-term debt $4,775, totaling $5,230, compared with $5,546 at year-end. The company issued $500 of 8.75% senior notes due 2019 and repaid a $500 note maturity; it also repurchased capital securities and recorded a $64 pretax extinguishment gain.
- Investment portfolio: total investments $70,548. Fixed-maturity AFS securities had $55,050 fair value against $58,567 amortized cost. Gross unrealized losses and OTTI totaled $5,177; the company reported improved market liquidity and a $2.2 billion decrease in gross AFS unrealized losses from year-end.
- Capital and shareholder funding: 46 million common shares were issued at $15 each in June, generating approximately $660 net proceeds. Common equity issuance increased shares outstanding; the common dividend had been reduced to $0.01 per quarter and repurchases were suspended.
Material changes and operating developments
- Retirement Solutions revenue and operating income weakened: six-month operating revenue fell 14% and segment operating income fell 38%, amid reduced variable-account values, lower fee income, and guarantee costs. Annuities segment operating income declined 41%.
- Investment Management six-month operating revenue fell 29% and operating income fell 78%, primarily due to lower assets under management and advisory fees. Total company assets under management were $180.8 billion, down 15% from June 2008.
- Insurance Solutions operating income declined 12% for six months. Life Insurance income fell 14%, while Group Protection income rose 2%; Group Protection cited favorable disability claims experience.
- Company-wide net flows were $2,072 in Q2 and $3,985 for six months, more than double year-ago amounts, despite total deposits declining 10% in Q2 and 3% for six months.
- In March, LNC ceded 55% of a closed block of certain UL/VUL business, releasing about $240 of statutory capital and producing an estimated 20-percentage-point RBC benefit in 2009. Management estimated a continuing consolidated earnings reduction of about $5 per quarter.
- The Swiss Re disability-income reinsurance rescission made LNC responsible for the related claims and reserves. The company reduced reinsurance recoverables by about $900 and funds-withheld liabilities by about $840; a reserve adequacy review remained planned.
Outlook, risks, and unusual items
- Management described improving capital and credit markets in Q2 but expected ongoing challenges from market volatility, illiquid credit markets, recession, low interest rates, potential further investment impairments, and possible goodwill impairment. It expected lower Investment Management earnings in 2009 than in 2008.
- Management planned to reduce excess cash holdings as markets improved, pursue expense reductions and platform consolidation, and further adjust variable-annuity guarantee products to reduce risk. It expected second-half 2009 pension expenses to remain unfavorable year over year.
- The company reported a 12% workforce reduction substantially completed in April and expected approximately $43 of cumulative pretax restructuring charges. It forecast $250 of annual pretax savings from its broader restructuring program.
- On July 10, 2009, after quarter-end, LNC received $950 from the U.S. Treasury under TARP’s Capital Purchase Program in exchange for Series B preferred stock and a warrant for up to 13.05 million common shares. The preferred dividend is 5% for five years, rising to 9% thereafter if still outstanding. Participation brings compensation, dividend, repurchase, regulatory, and oversight restrictions.
- The sale of Lincoln UK was expected to close in Q4 2009, subject to regulatory approvals and other conditions. Estimated proceeds were $280–$300 net of tax; the reported disposal loss may change with currency movements and other adjustments.
- Management expected about $550 of domestic insurance-subsidiary dividends could be paid in 2009 without prior regulatory approval, subject to capital needs and other constraints. The filing noted potential reserve and capital pressure from variable-annuity guarantee requirements, including VACARVM; its preliminary capital-impact estimate was $500.
- The company had triggered net-income tests under certain capital-security terms and a shareholders’ equity test for a future quarter. A further equity decline could require use of an alternative coupon mechanism to fund approximately $33 of interest payments, potentially using shares or warrants and diluting shareholders.
- Other material risks include reinsurance collectibility and Swiss Re exposure, guarantee-hedge ineffectiveness, downgrades to debt or insurer ratings, derivative counterparty exposure, litigation, and assumptions used to value illiquid securities and guarantee liabilities. Management stated that ordinary-course legal matters were not expected to materially affect consolidated financial position, while acknowledging a material adverse outcome could affect a particular period.
Most important facts for investors to verify
- Whether the U.K. sale closed on the anticipated terms and whether the estimated disposal loss changed.
- Actual statutory capital, RBC ratios, dividend capacity, and the effect of VACARVM and guarantee reserves.
- Whether the TARP preferred stock was repaid, and the eventual cost and dilution associated with its dividends and warrant.
- Credit quality, impairment exposure, and recoverability of the investment portfolio, including credit-linked notes and mortgage-backed securities.
- Results of the disability-income reserve review following the Swiss Re rescission, and continuing reinsurance recoverability.
- Progress in stabilizing operating earnings, variable-annuity guarantee exposure, asset-based fees, and the announced expense savings.