Business Context and Reporting Period
Company: Lincoln National Corporation (LNC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2008
Business Overview: LNC operates multiple insurance and investment management businesses through six segments: Individual Markets (Annuities, Life Insurance), Employer Markets (Retirement Products, Group Protection), Investment Management, Lincoln UK, and Other Operations. The company markets products under the "Lincoln Financial Group" identity.
Key Financial Metrics
| Metric (in millions, except per share) | Q1 2008 | Q1 2007 |
|---|---|---|
| Total Revenues | $2,524 | $2,628 |
| Net Income | $289 | $396 |
| Income from Continuing Operations | $293 | $388 |
| Net Investment Income | $968 | $1,090 |
| Realized Gain (Loss) | $(38) | $26 |
| Operating Cash Flow | $98 | $469 |
| Total Assets | $185,349 | $191,435 |
| Total Liabilities | $174,263 | $179,717 |
| Stockholders' Equity | $11,086 | $11,718 |
| Short-term Debt | $411 | $550 |
| Long-term Debt | $4,627 | $4,618 |
| Earnings Per Share (Diluted) | $1.10 | $1.42 |
Material Changes vs. Prior Period
- Net Income Decline: Net income decreased 27% to $289 million, driven by lower earnings from variable annuity and mutual fund products due to equity market declines, higher write-downs for other-than-temporary impairments ($92 million), and the initial impact of adopting SFAS 157 ($16 million loss).
- Investment Performance: Net investment income fell 11% to $968 million. This was caused by unfavorable results from alternative investments, prepayment and bond makewhole premiums, and a $97 million negative change in call option market value.
- Realized Losses: The company reported a realized loss of $38 million compared to a gain of $26 million in the prior year, primarily due to $92 million in write-downs for other-than-temporary impairments on corporate bonds and asset-backed securities.
- Discontinued Operations: The company recorded a $4 million loss from discontinued operations (media business divestitures), compared to an $8 million gain in Q1 2007.
- Accounting Changes: Adoption of SFAS 157 (Fair Value Measurements) on January 1, 2008, resulted in a $16 million decrease to income from continuing operations and a $0.06 decrease to EPS.
Guidance, Outlook, and Risks
Management Commentary: Management expects continued challenges in 2008, including volatility in equity and credit markets, a low interest rate environment, and potential economic recession. The company is focusing on expanding distribution, product development, and cost discipline. Assets under management decreased $12.2 billion from year-end 2007 due to equity market declines, reducing fee-based income by approximately $9 million.
Key Risks and Contingencies:
- Market Risk: Significant exposure to equity market declines affecting fee revenues and variable annuity liabilities. Credit spreads have widened, causing $1.2 billion in increased gross unrealized losses on available-for-sale fixed maturity securities.
- Credit-Linked Notes: LNC holds $850 million in credit-linked notes with $420 million in unrealized losses. Management believes these are not other-than-temporarily impaired but notes the risk of principal loss if defaults exceed subordination levels.
- Regulatory: Potential impact of new statutory reserve requirements (VACARVM) for variable annuities and AG38 for universal life products, which could reduce dividend capacity from subsidiaries.
- Legal: Ongoing litigation regarding sales practices and a dispute with Swiss Re regarding approximately $50 million in reinsurance recoverables on disability income business.
Investor Verification Checklist
- Impairment Analysis: Verify the rationale for the $92 million other-than-temporary impairment write-downs and the status of the $420 million unrealized loss on credit-linked notes.
- Equity Market Sensitivity: Assess the impact of continued equity market volatility on fee revenues and the adequacy of hedging strategies for guaranteed living benefits.
- Regulatory Capital: Monitor the impact of pending VACARVM and AG38 reserve requirements on subsidiary dividend capacity and liquidity.
- Discontinued Operations: Confirm the final settlement of the media business divestitures and any remaining liabilities.
- Reinsurance Concentration: Review the financial strength of key reinsurers, particularly Swiss Re and Scottish Re, given the $8.4 billion in reinsurance recoverables.