Business Context and Reporting Period
Company: Lincoln National Corporation (LNC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2008
Business Overview: LNC operates multiple insurance and investment management businesses through six segments: Annuities, Defined Contribution, Life Insurance, Group Protection, Investment Management, and Lincoln UK. The company markets products under the "Lincoln Financial Group" identity, including fixed and indexed annuities, variable annuities, universal life insurance, and mutual funds.
Key Financial Metrics
| Metric (in millions) | Three Months Ended Sept 30, 2008 | Nine Months Ended Sept 30, 2008 | Three Months Ended Sept 30, 2007 | Nine Months Ended Sept 30, 2007 |
|---|---|---|---|---|
| Total Revenues | $2,436 | $7,610 | $2,601 | $7,893 |
| Net Income | $148 | $562 | $330 | $1,102 |
| Net Investment Income | $1,089 | $3,231 | $1,062 | $3,285 |
| Realized Loss | $(204) | $(347) | $(65) | $(24) |
| Total Assets | $173,271 | N/A | N/A | $191,435 (Dec 31, 2007) |
| Total Liabilities | $163,771 | N/A | N/A | $179,717 (Dec 31, 2007) |
| Stockholders' Equity | $9,500 | N/A | N/A | $11,718 (Dec 31, 2007) |
| Short-term Debt | $635 | N/A | N/A | $550 (Dec 31, 2007) |
| Long-term Debt | $4,569 | N/A | N/A | $4,618 (Dec 31, 2007) |
| Cash and Invested Cash | $2,160 | N/A | N/A | $1,665 (Dec 31, 2007) |
Material Changes vs. Prior Period
- Net Income Decline: Net income decreased 55% for the quarter and 49% for the nine-month period compared to 2007. This was primarily driven by higher write-downs for other-than-temporary impairments (OTTI) on available-for-sale securities ($312 million in Q3; $523 million YTD) and unfavorable retrospective unlocking of deferred acquisition costs (DAC) and reserves.
- Realized Losses: Realized losses increased significantly to $204 million in Q3 and $347 million YTD, compared to $65 million and $24 million in the prior year periods. This includes gross write-downs of $312 million (Q3) and $523 million (YTD) on securities.
- Investment Portfolio: Total investments decreased from $71.97 billion (Dec 31, 2007) to $67.96 billion (Sept 30, 2008). Gross unrealized losses on available-for-sale securities increased by $3.8 billion YTD due to reduced liquidity and credit deterioration.
- Intangible Impairments: The company recorded a non-cash impairment of $83 million in goodwill and $90 million in FCC licenses (specifically identifiable intangibles) in the second quarter of 2008 due to declines in advertising revenue for radio properties.
- Discontinued Operations: The company completed the sale of its media businesses (television, Charlotte radio, sports programming) in 2008. Results are reported as discontinued operations, showing a loss of $1 million for Q3 2008 and $5 million YTD 2008.
Guidance, Outlook, and Risks
- Capital Preservation Actions: On October 10, 2008, the Board of Directors approved a reduction in the quarterly dividend from $0.415 to $0.21 per share, effective in 2009, and suspended further stock repurchase activity to preserve capital.
- Market Outlook: Management expects continued challenges from equity market volatility, illiquid credit markets, and a low interest rate environment. A further 20% decline in equity markets from September 30 levels could reduce net income by approximately $250 million (after-tax) in the fourth quarter due to prospective unlocking of DAC/VOBA assumptions.
- Statutory Capital: Unfavorable equity market impacts in Q3 reduced the statutory surplus of the primary insurance subsidiary (LNL) by approximately $110 million. A further 30% drop in equity markets could reduce LNL's statutory surplus by an additional $275-$300 million and lower its Risk-Based Capital (RBC) ratio by approximately 25 percentage points.
- Reinsurance Disputes: LNC is in arbitration with Swiss Re regarding approximately $47 million in reinsurance recoverables on disability income business. Management believes it is probable they will collect the full amount.
- Accounting Changes: The adoption of SFAS 157 (Fair Value Measurements) in Q1 2008 decreased income from continuing operations by $16 million and increased earnings volatility related to non-performance risk factors in variable annuity guarantees.
Key Facts for Investor Verification
- Investment Impairments: Verify the classification of $523 million in YTD other-than-temporary impairments (OTTI) and the company's intent to hold remaining securities with unrealized losses ($4.96 billion total) until recovery.
- Variable Annuity Guarantees: Assess the exposure to Guaranteed Living Benefits (GLB) and Guaranteed Death Benefits (GDB). The company reported a $252 million "breakage" (ineffectiveness) in its hedge program for GLB in Q3 2008.
- Dividend Capacity: Monitor the impact of the dividend cut and the suspension of share buybacks on the holding company's liquidity and ability to meet debt obligations.
- Statutory Surplus: Track the RBC ratios of insurance subsidiaries, particularly LNL, given the sensitivity of statutory reserves to equity market declines and the potential need for additional capital.
- Credit-Linked Notes: Review the status of $600 million in credit-linked notes, which had unrealized losses of $421 million as of September 30, 2008, and the adequacy of subordination to absorb potential defaults.