Lincoln National Corporation — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011; balance-sheet comparisons are to December 31, 2010. Amounts are in millions unless stated otherwise. Lincoln operates retirement and insurance businesses through Annuities, Defined Contribution, Life Insurance and Group Protection, plus Other Operations.
Financial performance and condition
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenues | $2,804 | $2,605 | $5,518 | $5,132 |
| Income from continuing operations | $325 | $252 | $665 | $508 |
| Net income | $325 | $255 | $665 | $539 |
| Diluted EPS | $1.01 | $0.33 | $2.07 | $1.18 |
| Operating cash flow | Not presented quarterly in the supplied filing text | $878 | $873 |
Revenue rose 8% in both comparisons; net income rose 27% for Q2 and 23% year to date. Prior-year net income included discontinued-operations income of $3 million for Q2 and $31 million for the first six months. Prior-year common earnings also reflected preferred dividends and discount accretion, so net income and earnings available to common stockholders are not directly interchangeable.
At June 30, total assets were $201,554, total liabilities $187,968 and stockholders’ equity $13,586. Cash and invested cash was $2,912. Investments totaled $86,278, including $71,513 of fixed-maturity securities at fair value. Short-term debt was $251 and long-term debt $5,729. These consolidated figures include substantial insurance and separate-account balances; the filing does not provide a conventional current ratio as a useful liquidity measure.
Six-month net cash from investing activities was negative $2,072 and net cash from financing activities was positive $1,365. Total cash and invested cash increased $171 from year-end. Net flows across reported retirement and life businesses were $2,828, down 14% from the prior-year period; total account values were $163,694, up 17% from June 30, 2010.
Material changes and operating drivers
- Retirement Solutions reported after-tax operating income of $192 in Q2, up from $152; Insurance Solutions reported $178, up from $174. These are management-defined, non-GAAP segment measures, not consolidated GAAP net income.
- For the first six months, segment operating income was $388 for Retirement Solutions versus $307, and $370 for Insurance Solutions versus $332. Growth was led by Annuities and Defined Contribution; Life Insurance was broadly steady in Q2.
- Management attributed stronger results mainly to higher average account values and equity markets, increased insurance fees, favorable reserve/DAC unlocking, lower crediting rates and higher investment income. Benefits rose 23% in Q2 and 15% year to date, including higher death claims and growth in secondary-guarantee life reserves.
- Q2 consolidated realized loss was $13, versus a gain of $5 a year earlier; first-half realized loss was $15, versus $21. Q2 losses included higher impairment charges on selected residential and commercial mortgage-backed securities. Net OTTI recognized in earnings was $30 in Q2 and $69 for the half, versus $11 and $64 in 2010.
- Common-stock repurchases were $226 for the first half, covering 7.563 million shares; common dividends paid were $31. Shares outstanding fell from 315.7 million at year-end to 308.3 million at June 30.
Outlook, risks and unusual items
- The filing gives no consolidated full-year earnings or revenue guidance. Management said the economic recovery remained uncertain and cited low interest rates, regulatory and accounting changes, weak housing conditions and market volatility. It expected higher expenses in the remainder of 2011 in Annuities, Life Insurance, Group Protection and Other Operations, primarily from strategic initiatives and marketing.
- Management expected Group Protection non-medical loss ratios to remain near the high end of its long-term 71%–74% range in 2011, though it expected recovery over time. The Q2 and first-half ratios were 73.4% and 73.7%. The company estimated each one-percentage-point increase above expectation would reduce annual operating income by about $10–$12.
- Management said expenses for reserve financing supporting secondary-guarantee UL and term business were expected to approximately double in 2011 versus 2010. It cited statutory reserve strain under AG38/XXX and continued use of reinsurance, letters of credit and other financing alternatives; availability and cost remain relevant risks.
- Low rates could compress spreads and raise guarantee-related costs. A hypothetical stress scenario assuming current new-money rates persist through 2013 estimated Life Insurance earnings impacts of $0–$5 in 2011, $10–$15 in 2012 and $20–$25 in 2013; Retirement Solutions impacts of $0–$5 for the remainder of 2011, $5–$10 in 2012 and $10–$15 in 2013. These are scenario estimates, not guidance, and exclude other effects.
- Variable-annuity living-benefit results depend on equity markets, interest rates, volatility, customer behavior and hedge effectiveness. The company reported $32.6 billion of account values with guaranteed-withdrawal features and $12.6 billion with guaranteed-income features. Management warned hedges may not fully offset liability changes.
- Fixed-maturity AFS securities were 95.4% investment grade by fair value. Gross unrealized losses on AFS securities declined $334 during the half, which management attributed mainly to lower market yields. Management considered the temporary losses recoverable, but reported continued real-estate weakness and impairment risk. Mortgage loans totaled $6,871; $67, or 1.0%, were delinquent and in foreclosure.
- On June 24, the company issued $300 of 4.85% senior notes due 2021. It used proceeds to redeem $275 of 6.75% capital securities on July 7, 2011. A $250 senior note was due December 15, 2011. At June 30, the holding company had $1.0 billion of cash and cash equivalents before the July redemption; this is distinct from consolidated cash and invested cash.
- Management said pending litigation was not expected to materially affect consolidated financial position after reserves and indemnification, while acknowledging an adverse outcome in some matters could materially affect results for a particular period. Moody’s raised its outlook on the company to positive from stable in June 2011.
Important facts for investors to verify
- How much of earnings growth reflects recurring business performance versus favorable equity markets, reserve/DAC unlocking, prepayment premiums and other investment effects.
- Whether statutory capital and reserve-financing arrangements for secondary-guarantee products remain adequate and available at acceptable cost.
- Credit quality, valuation assumptions and subsequent performance of mortgage-backed securities, commercial mortgage loans and other impaired or below-investment-grade holdings.
- Liquidity and debt service after the July 2011 redemption, including the December 2011 maturity, available credit facilities and dependence on subsidiary dividends.
- Whether Group Protection claims experience, low interest rates and variable-annuity guarantee exposure develop consistently with management’s assumptions and outlook.