Business Context and Reporting Period
Company: Lincoln National Corporation (LNC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2009
Business Overview: LNC operates multiple insurance and investment management businesses through six segments: Retirement Solutions (Annuities, Defined Contribution), Insurance Solutions (Life Insurance, Group Protection), Investment Management, Lincoln UK, and Other Operations. The company sells wealth protection, accumulation, and retirement income products.
Key Financial Metrics
| Metric | Q1 2009 | Q1 2008 |
|---|---|---|
| Total Revenues | $2,245 million | $2,594 million |
| Net Income (Loss) | $(579) million | $289 million |
| Net Income (Loss) Per Share (Basic) | $(2.27) | $1.11 |
| Total Assets | $157,427 million | $163,136 million (Dec 31, 2008) |
| Total Liabilities | $150,104 million | $155,159 million (Dec 31, 2008) |
| Stockholders' Equity | $7,323 million | $7,977 million (Dec 31, 2008) |
| Short-term Debt | $1,436 million | $815 million (Dec 31, 2008) |
| Long-term Debt | $4,345 million | $4,731 million (Dec 31, 2008) |
| Cash and Invested Cash | $5,613 million | $5,926 million (Dec 31, 2008) |
Material Changes vs. Prior Period
- Net Loss: The company reported a net loss of $579 million compared to net income of $289 million in Q1 2008. This reversal was primarily driven by a $603 million goodwill impairment charge in the Retirement Solutions – Annuities segment and increased investment impairments.
- Goodwill Impairment: A $600 million impairment was recorded for the Retirement Solutions – Annuities reporting unit due to higher discount rates, equity market volatility, and lower annuity sales.
- Investment Impairments: Net other-than-temporary impairment (OTTI) losses recognized in earnings totaled $125 million (up from $57 million in Q1 2008), driven by credit quality deterioration in corporate bonds and mortgage-backed securities.
- Reinsurance Rescission: An arbitration panel rescinded a reinsurance agreement with Swiss Re regarding disability income business. This resulted in a $64 million after-tax unfavorable adjustment to segment income, increasing benefits and interest credited.
- Revenue Decline: Total revenues decreased 13% to $2,245 million, largely due to a $193 million total realized loss (compared to a $35 million loss in 2008) and lower investment advisory fees.
Guidance, Outlook, and Risks
- Outlook: Management expects lower earnings for the remainder of 2009 due to continued equity market volatility, illiquid credit markets, and low interest rates. The company anticipates challenges in accessing capital and potential further intangible asset impairments.
- Liquidity Actions: To preserve capital, LNC reduced its common stock dividend to $0.01 per share and suspended stock repurchases. The company is actively managing liquidity through commercial paper, inter-company cash management, and credit facilities.
- Rating Downgrades: Following the filing, Moody's and Fitch downgraded LNC's long-term credit ratings and financial strength ratings of its insurance subsidiaries. S&P revised its outlook to negative. These downgrades increase the cost of capital and may trigger termination events in derivative agreements.
- Key Risks:
- Market Risk: Continued deterioration in equity markets increases liabilities for guaranteed living and death benefits (GLB/GDB) and reduces asset-based fees.
- Credit Risk: Illiquidity in credit markets may lead to additional OTTI write-downs.
- Regulatory Risk: New statutory reserving standards (VACARVM) effective December 31, 2009, may require significantly higher reserves for variable annuities, constraining dividend capacity.
- Capital Adequacy: The company has triggered tests related to capital securities covenants due to trailing net losses and equity declines, potentially requiring alternative coupon satisfaction mechanisms (issuing stock to pay interest).
Important Facts for Investor Verification
- Goodwill Impairment: Verify the assumptions used in the Step 2 goodwill impairment analysis for the Retirement Solutions – Annuities segment, specifically regarding discount rates and projected cash flows.
- Reinsurance Dispute: Monitor the status of the rescinded Swiss Re reinsurance agreement and the adequacy of reserves established for the disability income business.
- Investment Portfolio Quality: Review the composition of the Available-for-Sale (AFS) portfolio, specifically the exposure to subprime mortgages, CDOs, and credit-linked notes (CLNs), and the methodology for determining OTTI.
- Capital Securities Covenants: Assess the likelihood of triggering the Alternative Coupon Satisfaction Mechanism (ACSM) for capital securities, which would require issuing equity to pay interest.
- Dividend Capacity: Evaluate the impact of new statutory reserve requirements (VACARVM) and current market conditions on the ability of insurance subsidiaries to pay dividends to the holding company.