Lincoln National Corporation — 2014 Form 10-K
Business context and reporting period. This filing covers the fiscal year ended December 31, 2014; quarterly figures below include the fourth quarter. Lincoln National is an insurance and retirement-services holding company operating through Annuities, Retirement Plan Services, Life Insurance and Group Protection, with additional corporate and other activities.
Financial results and position
- Full-year results: Revenue was $13.554 billion, up 13% from $11.969 billion in 2013. Net income was $1.515 billion, up 22%; diluted EPS was $5.67 versus $4.52. Income from continuing operations was $1.514 billion.
- Fourth quarter: Revenue was $3.685 billion and net income was $349 million; diluted EPS was $1.32. For Q4 2013, revenue was $3.122 billion, net income $351 million and diluted EPS $1.29.
- Segment operating income, after tax: Annuities $925 million (+23%); Retirement Plan Services $160 million (+13%); Life Insurance $612 million (+13%); Group Protection $23 million (-68%); Other Operations loss $109 million, compared with a $122 million loss in 2013. Segment operating income is a company-defined measure, not GAAP net income.
- Cash flow: Operating activities provided $2.526 billion, compared with $799 million in 2013. Cash and invested cash was $3.919 billion at year-end, up from $2.364 billion.
- Assets, equity and investments: Total assets were $253.377 billion versus $236.945 billion; stockholders’ equity was $15.740 billion versus $13.452 billion. Total investments were $102.967 billion. Available-for-sale fixed-maturity securities were 95.6% investment grade by fair value.
- Debt and liquidity: Debt carrying value was $5.520 billion, comprising $250 million short-term and $5.270 billion long-term debt. Holding-company available liquidity was $554 million. The company reported a $2.5 billion unsecured revolving facility, subject to its terms and covenants.
- Capital returns: LNC returned $818 million to common shareholders in 2014: $650 million of share repurchases and $168 million of dividends. The annual dividend declared was $0.68 per share. Remaining repurchase authorization at year-end was $615 million.
- Investment and balance-sheet items: Net investment income was $4.859 billion, up 2%. Net OTTI recognized in earnings was $16 million, down from $70 million. Other comprehensive income was $1.533 billion, versus a $2.245 billion loss in 2013, driven chiefly by the change in unrealized AFS-security values.
Material changes versus 2013
- Net income growth reflected higher account values and insurance in force, lower variable-annuity derivative losses, stronger alternative-investment income and a reinsurance recapture. Partly offsetting these gains were spread compression, higher Life Insurance death claims and weaker Group Protection disability experience.
- Annuities’ operating income rose with higher variable-account fee income. Its interest-rate spread declined to 1.82% from 1.97%; average variable-annuity account values increased 16%.
- Retirement Plan Services’ operating income improved, but net flows turned negative at $881 million outflow, versus $792 million of inflows in 2013. Management attributed the 2014 lapse-rate increase to a large mid-to-large-market plan termination.
- Life Insurance operating income increased, but benefits rose 23%, including a $226 million reserve increase associated with recaptured business. Interest-sensitive product spread declined to 1.77% from 1.84%.
- Group Protection operating income fell to $23 million from $71 million. Its total non-medical loss ratio rose to 78.4% from 74.0%, principally due to higher long-term disability incidence and lower recoveries.
Outlook, management commentary and risks
- Outlook: The filing gives no numerical company-wide earnings guidance. Management cited low interest rates, market volatility and regulatory uncertainty, and said it would emphasize products with shorter-duration liabilities and fewer guarantees, disciplined expenses, distribution and technology investment, and capital and liquidity management.
- Group Protection: Management expected loss ratios to remain above the high end of its 71%–74% long-term target range during 2015, with normal target margins approached toward the end of 2016 to 2017. The company linked deterioration partly to implementation of a new claims-management system and reported pricing actions underway.
- Reinsurance recapture: In Q4, LNC recaptured certain traditional and interest-sensitive business, receiving $500 million, including $78 million reimbursing prepaid premiums. The company reported a $57 million after-tax one-time gain; the transaction also increased reserves by $226 million and reduced DAC by $123 million. The cash-flow statement reports $422 million of proceeds from the recapture.
- Media sale: LNC agreed to sell Lincoln Financial Media for $105 million in cash and Entercom Parent preferred stock. The transaction was subject to regulatory approvals and other closing conditions; a request for additional information under the Hart-Scott-Rodino Act could delay closing beyond Q2 2015. LNC recorded a $28 million after-tax loss in 2014.
- Interest rates and guarantees: Persistent low rates may further compress spreads and require reserve or DAC/VOBA changes; rising rates could prompt policy surrenders and asset sales. As of year-end, 43% of Annuities, 94% of Retirement Plan Services and 97% of Life Insurance account values with guaranteed minimum rates were at those minimums. Hedging may not fully offset movements in guaranteed-benefit liabilities.
- Reserves and regulation: New York reserve requirements for certain UL/VUL secondary guarantees had increased reserves by $180 million through 2014; further increases were under discussion and were not expected to exceed $90 million per year for each of the next three years. New captive-reinsurance rules (AG48) and other regulatory changes could affect reserve financing and capital.
- Capital, credit and legal risks: Insurance-subsidiary dividends are regulated and depend on statutory capital and earnings. Swiss Re was LNC’s largest reinsurance exposure, with a $2.5 billion recoverable and a $2.6 billion supporting trust balance. Management estimated reasonably possible aggregate litigation losses of up to approximately $200 million, including amounts above accruals; other matters could not be estimated.
- Controls and audit: Management and Ernst & Young reported effective internal control over financial reporting; the auditor issued an unqualified opinion on the consolidated financial statements.
Important facts for investors to verify
- Whether the improvement in earnings and operating cash flow is sustainable after separating one-time reinsurance-recapture effects, market-related items and changes in investment income.
- Whether Group Protection disability claims and recoveries improve, and whether loss ratios return toward management’s 71%–74% target on the stated timeline.
- How low rates, guaranteed minimums, policyholder behavior and hedge performance affect spreads, reserves, liquidity and earnings.
- Progress on New York secondary-guarantee reserve increases and the availability and cost of captive or other reserve-financing arrangements under AG48.
- Collectability and collateral support for reinsurance recoverables, particularly the Swiss Re exposure, and any effects from the media-sale closing, regulatory approvals or litigation developments.
- Holding-company liquidity, regulated subsidiary dividend capacity, debt maturities and the capital available for the announced dividend and repurchase plans.