Business Context and Reporting Period
Company: Lincoln National Corporation (LNC)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and Six Months ended June 30, 2002
Business Overview: LNC operates through four primary segments: Lincoln Retirement, Life Insurance, Investment Management, and Lincoln UK. The company markets its products under the "Lincoln Financial Group" identity. A significant event impacting the period was the December 2001 divestiture of its reinsurance operations to Swiss Re, with results now reported in "Other Operations."
Key Financial Metrics
| Metric (in millions, except per share) | Six Months Ended June 30, 2002 |
Six Months Ended June 30, 2001 |
Three Months Ended June 30, 2002 |
Three Months Ended June 30, 2001 |
|---|---|---|---|---|
| Total Revenue | $2,271.4 | $3,297.8 | $1,145.0 | $1,599.0 |
| Net Income | $153.9 | $301.9 | $59.4 | $141.7 |
| Earnings Per Share (Diluted) | $0.81 | $1.57 | $0.31 | $0.74 |
| Net Investment Income | $1,299.1 | $1,346.8 | $651.0 | $673.1 |
| Realized Loss on Investments | $(184.4) | $(38.2) | $(81.1) | $(17.5) |
| Total Assets | $95,069.2 | $98,001.3 | — | — |
| Total Shareholders' Equity | $5,307.9 | $5,263.5 | — | — |
| Cash and Invested Cash | $2,265.4 | $3,095.5 | — | — |
| Long-term Debt | $1,112.3 | $861.8 | — | — |
Material Changes vs. Prior Period
- Revenue Decline: Total revenue decreased 31% year-over-year for the six-month period. This was primarily driven by the absence of the former Reinsurance segment (sold to Swiss Re in late 2001), which contributed $966.5 million in revenue in the prior year. Remaining segments also saw declines due to poor equity market performance reducing fee income.
- Net Income Drop: Net income fell 49% to $153.9 million. The decline is attributed to a $95.2 million increase in realized investment losses (largely from WorldCom and CDO write-downs) and a $14.4 million charge related to reserve increases on business sold to Swiss Re.
- Investment Losses: Realized losses on investments and derivatives surged to $184.4 million (pre-tax) for the six months ended June 30, 2002, compared to $38.2 million in the prior year. Approximately 80% of these losses stemmed from telecommunications issuers and collateralized debt obligations.
- Accounting Changes: LNC adopted FAS 142 (Goodwill and Other Intangible Assets) on January 1, 2002. Consequently, goodwill is no longer amortized, resulting in a $20.9 million increase in net income for the six-month period compared to what it would have been under prior rules.
Guidance, Outlook, and Risks
- Outlook: Management expects the non-amortization of goodwill to increase net income by approximately $41.7 million for the full year 2002. The company anticipates continued volatility in equity markets impacting fee income and DAC amortization.
- Swiss Re Contingency: Significant disputes remain regarding the final closing statements of the reinsurance sale to Swiss Re. Approximately $770 million in matters are disputed, including $500 million related to personal accident reserves. LNC's indemnification exposure is capped at $100 million for net future payments in excess of specific thresholds, but litigation or dispute resolution could impact future earnings.
- UK Regulatory Issues: Lincoln UK faces ongoing scrutiny from UK regulators regarding mortgage endowment mis-selling and pension product advice. A liability of $114.7 million has been accrued, though management believes future developments will not materially affect the consolidated financial position.
- Liquidity and Capital: LNC maintains strong liquidity with $2.3 billion in cash and invested cash. The company has a $500 million revolving credit facility and recently issued $250 million in senior notes. Share repurchases of $226.7 million were executed in the first half of 2002, with an additional $600 million authorization approved in August 2002.
Investor Verification Checklist
- Investment Portfolio Quality: Verify the extent of exposure to below-investment-grade securities and the specific impact of WorldCom and CDO write-downs on future earnings.
- Swiss Re Dispute Resolution: Monitor the status of the $770 million dispute with Swiss Re, as resolution could trigger adjustments to deferred gain or realized gains/losses.
- UK Regulatory Liability: Track developments in the UK mortgage endowment and pension mis-selling investigations to assess if the $114.7 million reserve is sufficient.
- Equity Market Sensitivity: Assess the impact of continued equity market declines on Deferred Acquisition Cost (DAC) unlocking and Guaranteed Minimum Death Benefit (GMDB) reserves in the Lincoln Retirement segment.
- Dividend Restrictions: Confirm the status of statutory earned surplus for The Lincoln National Life Insurance Company (LNL) to ensure continued ability to pay dividends to the holding company without regulatory approval hurdles.