Business Context and Reporting Period
Company: Lincoln National Corporation (LNC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2007
Business Overview: LNC operates multiple insurance and investment management businesses, as well as a broadcasting and sports programming business (Lincoln Financial Media). The company markets its products under the "Lincoln Financial Group" identity. Following the April 2006 merger with Jefferson-Pilot, LNC offers a broad range of wealth protection, accumulation, and retirement income products including annuities, life insurance, and mutual funds.
Key Financial Metrics
| Metric (in millions) | Three Months Ended June 30, 2007 |
Six Months Ended June 30, 2007 |
Six Months Ended June 30, 2006 |
|---|---|---|---|
| Total Revenue | $2,740 | $5,411 | $3,917 |
| Net Income | $376 | $772 | $570 |
| Diluted EPS | $1.37 | $2.79 | $2.47 |
| Net Investment Income | $1,170 | $2,259 | $1,747 |
| Total Assets (Balance Sheet) | $187,650 | - | - |
| Total Liabilities (Balance Sheet) | $175,814 | - | - |
| Shareholders' Equity (Balance Sheet) | $11,836 | - | - |
| Long-Term Debt | $4,108 | - | - |
| Short-Term Debt | $230 | - | - |
| Cash and Invested Cash | $989 | - | - |
Note: Long-term debt includes Senior notes ($2,382), Junior subordinated debentures ($155), and Capital securities ($1,571).
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 10% for the quarter and 38% year-to-date compared to 2006. This growth was driven by the inclusion of Jefferson-Pilot results (for the six-month comparison), organic growth in business in-force, and favorable equity market performance.
- Profitability: Net income rose 8% for the quarter and 35% year-to-date. The six-month increase was primarily due to the merger and favorable investment results.
- Investment Performance: Net investment income increased 10% for the quarter and 29% year-to-date, aided by higher portfolio yields, increased alternative investment income, and prepayment premiums on commercial mortgage loans.
- Accounting Changes: Adoption of SOP 05-1 (Deferred Acquisition Costs) and FIN 48 (Uncertainty in Income Taxes) on January 1, 2007, resulted in a $41 million reduction to retained earnings and a $15 million increase in unrecognized tax benefits liability.
- Reinsurance Adjustment: A non-cash charge of $13 million (after-tax) was recognized in Q2 2007 related to reserve increases on personal accident business sold to Swiss Re, partially offset by a $5 million catch-up adjustment to deferred gain amortization.
Guidance, Outlook, and Risks
- Strategic Review: On June 7, 2007, LNC announced plans to explore strategic options for Lincoln Financial Media, including potential divestiture. No definitive transaction is expected immediately.
- Leadership Transition: CEO Jon A. Boscia announced his retirement effective September 1, 2007. Dennis R. Glass was appointed CEO, and J. Patrick Barrett was appointed non-executive Chairman.
- Divestiture Activity: An agreement was reached on July 9, 2007, to transfer certain fixed income institutional separate account business (up to $14 billion) to an unaffiliated investment management company. This is not expected to be material to consolidated results.
- Key Risks:
- Interest Rate Risk: Spreads on fixed annuity and interest-sensitive products are at risk if interest rates decline and remain low.
- Equity Market Volatility: Declines in equity markets could reduce sales, asset fees, and increase liabilities related to guaranteed benefit features (GMDB, GMWB, GIB).
- Reinsurance Counterparty Risk: LNC monitors the financial strength of reinsurers, with Swiss Re representing the largest exposure. A dispute exists regarding approximately $80 million of reinsurance recoverables on disability income business.
- Regulatory Changes: Potential adoption of new statutory reserving standards (VACARVM) for variable annuities could require higher reserves and impact capital resources.
Investor Verification Checklist
- Reinsurance Exposure: Verify the status of the $80 million dispute with Swiss Re regarding disability income business and the financial stability of major reinsurers.
- Subprime Exposure: Review the $861 million amortized cost of subprime-backed securities (1.2% of total portfolio) and the $135 million unrealized loss on residential mortgage-backed securities.
- Media Segment Strategy: Monitor the outcome of the strategic review for Lincoln Financial Media and potential divestiture impacts.
- Accounting Adjustments: Assess the ongoing impact of SOP 05-1 adoption on DAC/VOBA amortization and future earnings.
- Capital Management: Track the execution of capital management strategies for AXXX reserves and the impact of the $2 billion stock repurchase authorization.