Lincoln National Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; financial statements are unaudited. Lincoln National is an insurance and retirement-services holding company operating Annuities, Retirement Plan Services, Life Insurance and Group Protection, plus Other Operations.
Financial results and position
| Metric | Q1 2014 | Q1 2013 / prior date |
|---|---|---|
| Total revenue | $3.176 billion | $2.839 billion |
| Income before taxes | $427 million | $305 million |
| Net income | $329 million | $239 million |
| Diluted EPS | $1.21 | $0.86 |
| Operating cash flow | $263 million provided | $251 million used |
| Cash and invested cash | $1.849 billion at March 31 | $2.364 billion at December 31 |
| Total assets | $241.949 billion at March 31 | $236.945 billion at December 31 |
| Stockholders’ equity | $14.486 billion at March 31 | $13.452 billion at December 31 |
| Long-term debt | $5.380 billion at March 31 | $5.320 billion at December 31 |
Revenue rose 12% and net income 38% year over year. Other comprehensive income was $890 million, versus a $227 million loss in Q1 2013; comprehensive income was $1.219 billion. The filing attributes much of the equity and comprehensive-income movement to investment-related unrealized gains. Total realized loss was $18 million, improved from $59 million a year earlier.
Cash from operations improved primarily due to timing of receipts and payments. Investing activities used $377 million. Financing activities used $401 million, including repayment of $500 million of maturing debt, $150 million of common-stock repurchases and $42 million of dividends. Holding-company available liquidity was $562 million at quarter-end. The company declared a $0.16 quarterly dividend per common share; it expected further 2014 repurchases subject to market conditions and competing capital needs.
Management reported $6.403 billion of deposits, up 5%, but total net flows fell 44% to $1.163 billion. Account values across the reported segments were $209.187 billion, up 13% from March 2013.
Segments and material changes
| Segment | Q1 2014 operating income | Q1 2013 | Reported change |
|---|---|---|---|
| Annuities | $216 million | $159 million | Up 36% |
| Retirement Plan Services | $39 million | $35 million | Up 11% |
| Life Insurance | $120 million | $112 million | Up 7% |
| Group Protection | $20 million | $14 million | Up 43% |
| Other Operations | $(30) million | $(35) million | Loss narrowed |
Management cited higher account values, insurance in force and group premiums, lower variable-annuity derivative losses, and stronger alternative-investment income as contributors to higher net income. Offsets included higher Life Insurance death claims, unfavorable disability experience, and spread compression as new-money yields remained below portfolio yields.
- Annuities: Higher average variable account values drove fee-income growth. The reported fixed-business interest-rate spread was 1.82%, down from 2.10%; lapse rate improved to 7% from 8%. Net flows were $695 million, down 21%.
- Retirement Plan Services: Income benefited from higher account-value fees and alternative-investment income, partly offset by spread compression. Net flows were negative $361 million versus positive $344 million; management noted flows vary with large plans entering and leaving the platform and that older, higher-margin blocks continue to run off.
- Life Insurance: Higher fees and investment income supported results, partly offset by higher death claims and expenses. Sales were down 4% to $145 million; in-force face amount increased 5% to $622.614 billion. Secondary-guarantee UL products accounted for 12% of sales, down from 18%.
- Group Protection: Premium growth supported higher operating income, but long-term disability incidence was elevated. The Q1 non-medical loss ratio was 74.8%, above management’s long-term expectation of 71%–74%; management expected it to remain near the high end of that range during 2014.
Outlook, risks and unusual items
- The filing provides no consolidated earnings or revenue guidance. Management said it expects to manage near-term spread effects through portfolio management and, to a lesser extent, crediting-rate actions; these expectations assume no significant adverse changes in fixed-account flows or other spread drivers.
- Management stated that insurance subsidiaries had statutory surplus and risk-based capital above current regulatory requirements. Additional New York reserve increases for secondary-guarantee universal-life business totaled $180 million through March 31, 2014; remaining annual increases were not expected to exceed $90 million, subject to discussions with regulators. Management did not expect the total increase to materially harm financial condition.
- Captive reinsurance and other financing structures help manage statutory reserve strain. Regulatory changes could restrict these structures, reduce returns or subsidiary dividend capacity, or require product repricing or lower sales.
- Variable-annuity guarantees expose results to equity markets, interest rates, volatility, lapse behavior and hedge effectiveness. Management’s sensitivity analysis estimated a $181 million reduction in net income for a combined scenario of a 20% equity-market decline, a 50-basis-point rate decline and a 4% rise in implied volatility; management cautioned that estimates are instantaneous, assumption-dependent and not forecasts.
- Investment risks include credit deterioration, interest-rate changes, real-estate and mortgage exposures, and unrealized losses. Fixed-maturity AFS securities were 95.6% investment grade by fair value. Unrealized losses on AFS securities declined by $607 million during the quarter; management said it did not expect to be forced to sell temporarily impaired securities before recovery.
- Legal and regulatory matters include a pending putative class action alleging excessive cost-of-insurance charges; a class-certification ruling was expected in summer 2014. A settlement concerning unclaimed benefits required additional procedures and reimbursement of $12.6 million for participating jurisdictions’ examination costs. Management said no known contingency was likely to materially adversely affect financial condition, while acknowledging some losses could not yet be estimated.
- The company was disputing reinsurers’ requested rate increases on certain yearly renewable term treaties and could pursue arbitration; it did not expect the disputes to materially adversely affect financial condition.
Most important facts for investors to verify
- Whether operating earnings growth persists after separating recurring segment performance from realized investment and derivative results, and how variable-annuity hedge performance develops.
- Whether spreads continue to compress, particularly in fixed annuity and retirement products, and whether crediting-rate actions affect retention and net flows.
- Disability claims and Group Protection loss ratios relative to the stated 71%–74% long-term expectation.
- Progress and final cost of New York reserve requirements, and any changes to captive-reinsurance rules or availability of reserve-financing capacity.
- Holding-company liquidity, subsidiary dividend capacity, debt maturities and capital returned through repurchases and dividends.
- Developments in the cost-of-insurance class action, unclaimed-benefit compliance and reinsurance rate disputes.