Business Context and Reporting Period
Company: Lincoln National Corporation (LNC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 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 insurance and investment products under the "Lincoln Financial Group" brand. Key segments include Individual Markets (Annuities and Life Insurance), Employer Markets (Retirement Products and Group Protection), Investment Management, Lincoln UK, and Lincoln Financial Media.
Key Financial Metrics
| Metric (in millions) | Three Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2007 | Nine Months Ended Sep 30, 2006 |
|---|---|---|---|
| Total Revenue | $2,681 | $8,092 | $6,405 |
| Net Income | $330 | $1,102 | $934 |
| Diluted EPS | $1.21 | $4.00 | $3.76 |
| Net Investment Income | $1,067 | $3,326 | $2,854 |
| Total Assets (Sep 30, 2007) | $192,217 | ||
| Total Liabilities (Sep 30, 2007) | $180,254 | ||
| Shareholders' Equity (Sep 30, 2007) | $11,963 | ||
| Long-Term Debt (Sep 30, 2007) | $4,408 | ||
| Short-Term Debt (Sep 30, 2007) | $326 | ||
| Cash and Invested Cash (Sep 30, 2007) | $1,326 |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 8% for the quarter and 26% for the nine-month period compared to 2006. This growth was driven by the April 2006 merger with Jefferson-Pilot, organic growth in Employer Markets, and favorable equity market performance increasing insurance fees.
- Net Income: Net income decreased 9% ($34 million) for the quarter ended September 30, 2007, primarily due to favorable items in the prior year quarter (UK sales practice recovery and tax adjustments) and hedge effectiveness issues. However, net income increased 18% ($168 million) for the nine-month period, reflecting the merger impact, stronger alternative investment results, and positive net flows.
- Investment Performance: Net investment income decreased 4% for the quarter due to lower commercial mortgage prepayments and a decrease in the market value of S&P 500 call options used for hedging. For the nine months, it increased 17% due to the addition of Jefferson-Pilot assets and higher alternative investment income.
- Realized Losses: The company reported net realized losses of $37 million for the quarter and $15 million for the nine months, compared to $11 million and $17 million in the prior year periods, respectively. Write-downs for other-than-temporary impairments totaled $34 million for the quarter and $68 million for the nine months.
Guidance, Outlook, and Risks
- Strategic Review: On June 7, 2007, the company announced plans to explore strategic options for Lincoln Financial Media, including potential divestiture. No definitive course of action had been reached as of the filing date.
- Leadership Transition: Jon A. Boscia retired as CEO effective September 1, 2007. Dennis R. Glass was appointed CEO, and J. Patrick Barrett was appointed non-executive Chairman.
- Capital Management: In October 2007 (subsequent to the period end), LNC issued $375 million of senior notes to release approximately $300 million of capital previously supporting universal life products with secondary guarantees. The company intends to use this capital for general corporate purposes, including share repurchases.
- Accounting Changes: The company adopted SOP 05-1 and FIN 48 effective January 1, 2007. SOP 05-1 resulted in a $41 million reduction to retained earnings and increased expenses. FIN 48 resulted in a $15 million increase in liability for unrecognized tax benefits.
- 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 Risk: Declines in equity markets could reduce sales, asset-based fees, and increase liabilities related to guaranteed benefit features (GMDB, GMWB, GIB).
- Reinsurance Risk: Significant exposure to Swiss Re ($4.3 billion receivable). A dispute exists regarding approximately $80 million of reinsurance recoverables on disability income business, currently in arbitration.
- Regulatory Risk: Potential changes in tax laws (e.g., estate tax repeal) and new statutory reserving standards (VACARVM) could impact product attractiveness and capital requirements.
Investor Verification Checklist
- Reinsurance Dispute: Verify the status and potential financial impact of the arbitration with Swiss Re regarding the $80 million disability income business recoverable.
- Subprime Exposure: Review the detailed breakdown of residential mortgage-backed securities (RMBS) and asset-backed securities (ABS) exposure, noting $797 million in subprime investments (1.1% of total portfolio) and the associated unrealized losses.
- Lincoln Financial Media: Monitor developments regarding the strategic review and potential divestiture of the media segment.
- Guaranteed Benefit Liabilities: Assess the adequacy of reserves for Guaranteed Minimum Death Benefit (GMDB), Withdrawal Benefit (GMWB), and Income Benefit (GIB) features, particularly given the volatility in equity markets and the effectiveness of hedging strategies.
- Capital Release: Confirm the deployment of the ~$300 million capital released via the October 2007 senior note issuance and its impact on future dividend capacity and share repurchases.