Lincoln National Corporation — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The filing also reports fourth-quarter results; it is an annual report, not a standalone quarterly filing. Amounts are in U.S. dollars.
Business context
Lincoln National is an insurance and retirement-services holding company operating through Annuities, Retirement Plan Services, Life Insurance and Group Protection. Other Operations includes corporate activities, debt and certain run-off businesses.
Financial performance and position
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $14.257 billion | $13.330 billion |
| Income before taxes | $1.130 billion | $1.458 billion |
| Net income | $2.079 billion | $1.192 billion |
| Diluted EPS | $9.22 | $5.03 |
| Operating cash flow | $788 million | $1.272 billion |
| Total assets, year-end | $281.763 billion | $261.627 billion |
| Stockholders’ equity, year-end | $17.322 billion | $14.478 billion |
| Debt principal | $5.123 billion | $5.123 billion |
Reported net income includes a $1.322 billion tax benefit from remeasuring deferred tax balances after enactment of the Tax Cuts and Jobs Act and a $905 million goodwill impairment charge in Life Insurance. Excluding items is necessary to assess underlying earnings; management’s segment operating results totaled $1.754 billion in 2017 versus $1.540 billion in 2016, but this measure is not GAAP net income.
Operating cash flow declined despite higher net income, partly reflecting changes in contractholder balances and tax accruals. Cash and invested cash at year-end was $1.628 billion. Holding-company available liquidity was $605 million. Insurance subsidiaries paid $1.069 billion in dividends to the parent during 2017; the company estimated they could pay approximately $1.3 billion in 2018 without prior regulatory approval.
Net investment income was $4.990 billion, up from $4.874 billion. The investment portfolio was $113.089 billion, including $94.840 billion of fixed-maturity available-for-sale securities; 96% of those securities were investment grade. Mortgage loans on real estate totaled $10.762 billion, with three impaired loans and a $3 million valuation allowance.
Business indicators included total deposits of $23.590 billion, up from $21.639 billion, and total net flows of $2.412 billion. Annuities continued to have negative net flows of $3.458 billion, while Retirement Plan Services and Life Insurance reported positive net flows of $1.338 billion and $4.532 billion, respectively.
Changes versus prior year and fourth quarter
- Revenue increased 7.0%, while income before taxes declined; the rise in net income primarily reflects the one-time tax benefit rather than pre-tax earnings growth.
- Fourth-quarter 2017 revenue was $3.669 billion and net income was $816 million, compared with $3.255 billion and $189 million in fourth-quarter 2016. Fourth-quarter 2017 included the tax remeasurement benefit and goodwill impairment.
- Segment operating income improved in Annuities ($1.074 billion versus $935 million), Retirement Plan Services ($149 million versus $127 million), Life Insurance ($536 million versus $515 million) and Group Protection ($103 million versus $65 million). Other Operations’ loss widened to $108 million from $102 million.
- Interest-rate spreads remained pressured: Retirement Plan Services’ spread fell to 1.59% from 1.66%; Life Insurance was 1.56% in both years. Annuities’ spread was 1.88% in both years. The Group Protection total non-medical loss ratio improved to 66.9% from 68.3%.
- Stockholders’ equity increased, partly reflecting $1.664 billion of other comprehensive income. The company returned $984 million to common shareholders through dividends and repurchases, versus $1.115 billion in 2016.
Outlook, risks and unusual items
- Management expects approximately $40 million of pre-tax net costs from its digitization initiative in 2018, a net-neutral impact in 2019 and annual benefits of approximately $90 million to $150 million beyond 2019.
- Management identified market volatility, interest rates, evolving regulation and product trends, capital and liquidity, reserve financing, and integration of acquired businesses as key issues. Low rates can compress investment spreads; rising rates may increase surrenders and force asset sales. Variable-annuity guarantees expose results to equity markets, interest rates, volatility and hedging effectiveness.
- The Tax Act reduced the federal corporate tax rate to 21%. Lincoln recorded the deferred-tax remeasurement benefit in 2017 and estimated near-term effective tax rates of 15%–17% for consolidated operations, subject to interpretation and further guidance. The filing says the separate-account dividends-received deduction benefit is expected to decrease significantly in 2018.
- Lincoln announced an agreement to acquire Liberty Life Assurance Company of Boston for approximately $3.3 billion, subject to approvals and other closing conditions; closing was expected in the second quarter of 2018. The transaction was subsequent to year-end and was not included in 2017 results.
- After year-end, Lincoln issued $150 million of additional 2023 notes, $500 million of 2028 notes and $450 million of 2048 notes. The filing reports no off-balance-sheet arrangements reasonably likely to have a material effect. It estimates reasonably possible litigation losses of up to approximately $50 million for matters where a range could be estimated; other matters could not be reliably estimated.
- Reported insurer RBC ratios exceeded the company-action level; management said the combined ratio for principal insurers was nearly five times that threshold. Ratings, capital requirements and dividend capacity remain sensitive to markets, regulation and reserve needs.
Key facts for investors to verify
- How much of 2017’s reported earnings came from the $1.322 billion tax benefit, and what sustainable earnings measure best reflects ongoing operations?
- What assumptions and business outlook drove the $905 million Life Insurance goodwill impairment, and could further impairment occur?
- How are annuity outflows, guarantee exposures and hedge performance evolving, particularly under adverse equity-market and interest-rate scenarios?
- What are the funding, capital and integration implications of the Liberty transaction, including the planned reinsurance of approximately $13 billion of statutory reserves?
- Can subsidiary dividend capacity and holding-company liquidity support debt service, shareholder returns and business investment under stress?
Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting as of December 31, 2017.