Lincoln National Corporation — 2015 Form 10-K
Business and period. Lincoln National Corporation (Lincoln Financial Group) is an insurance and retirement-services holding company with Annuities, Retirement Plan Services, Life Insurance and Group Protection segments, plus Other Operations. This annual filing covers the year ended December 31, 2015; it is not a standalone fourth-quarter filing. Dollar amounts are in U.S. dollars.
Financial performance and position
| Metric | 2015 | 2014 |
|---|---|---|
| Total revenue | $13.572 billion | $13.554 billion |
| Income before tax | $1.430 billion | $1.997 billion |
| Net income | $1.154 billion | $1.515 billion |
| Diluted EPS | $4.51 | $5.67 |
| Operating cash flow | $2.243 billion | $2.526 billion |
| Total assets, year-end | $251.937 billion | $253.377 billion |
| Stockholders’ equity, year-end | $13.617 billion | $15.740 billion |
| Long-term debt, carrying value | $5.582 billion | $5.270 billion |
Revenue was nearly flat, while net income fell 24%. Total expenses rose to $12.142 billion from $11.557 billion. Net investment income was $4.827 billion, down slightly from $4.859 billion. Consolidated comprehensive loss was $1.097 billion, versus comprehensive income of $3.048 billion in 2014, largely reflecting a $2.251 billion after-tax decline in other comprehensive income, primarily unrealized investment losses.
Operating cash flow was $2.243 billion; investing activities used $4.223 billion and financing activities provided $1.207 billion. Cash and invested cash ended the year at $3.146 billion, down $773 million. Holding-company available liquidity was $608 million. No short-term debt was outstanding at year-end; long-term debt principal was $5.323 billion. The company reported that domestic insurance subsidiaries could pay approximately $900 million in dividends in 2016 without prior regulatory approval.
Segment operating income (after tax): Annuities earned $996 million (up 8%); Retirement Plan Services earned $140 million (down 13%); Life Insurance earned $370 million (down 40%); Group Protection earned $43 million (up 87%); and Other Operations had a $154 million loss (versus a $109 million loss). Group Protection’s non-medical loss ratio improved to 75.4% from 78.4%. Interest-rate spreads narrowed: Annuities 1.76% from 1.82%, Retirement Plan Services 1.76% from 1.92%, and Life Insurance interest-sensitive products 1.65% from 1.77%.
Material changes and notable items
- Net income declined despite stable revenue. Management cited unfavorable Life Insurance mortality in the first half, lower investment income from alternative investments and prepayment premiums, spread compression, higher legal expenses, and volatile-market hedge losses.
- 2015 after-tax benefit-ratio and assumption unlocking reduced continuing-operations income by $78 million overall. A lower long-term new-money yield assumption was a principal factor; Life Insurance recorded $118 million of unfavorable after-tax unlocking from that assumption change.
- Excluded realized losses after tax were $214 million, compared with $106 million in 2014; management attributed the increase primarily to variable-annuity hedge performance amid volatile markets and higher investment impairments.
- The 2014 Life Insurance comparison included a reinsurance recapture: Lincoln received $500 million cash consideration and recorded a $57 million after-tax gain. This made 2015 comparisons less favorable.
- Lincoln sold its media business in July 2015 for $75 million cash, net of transaction expenses, plus $28 million face amount of perpetual convertible preferred stock. It recorded an additional $2 million after-tax loss in 2015 related to finalizing the sale.
- Shareholders received $1.102 billion in 2015 through $900 million of repurchases and $202 million of common dividends. Dividends declared per share rose to $0.85 from $0.68.
Outlook, risks and contingencies
Management identified an 8–10% targeted earnings-per-share growth objective and continued improvement in return on equity as priorities, not as a specific 2016 earnings forecast. Its stated priorities included expense discipline, technology and distribution investment, capital and liquidity management, and adapting product mix to regulatory changes. Management said Group Protection expected to approach normal target margins in 2018. Additional 2016 share repurchases were expected to depend on market conditions and alternative uses of capital.
- Rates and markets: Persistently low rates can compress spreads and raise the cost of guarantees; rapidly rising rates may prompt surrenders and asset sales. At year-end, 40% of annuity, 93% of retirement-plan and 96% of life-insurance account values with guaranteed minimum rates were at those minimums.
- Guarantees and hedging: About 67% of individual variable-annuity account values had guaranteed living benefits. The hedge program may not fully offset market movements, policyholder behavior, basis risk or counterparty failures.
- Credit and investments: The company held $7.931 billion of energy-sector bonds at fair value, with $483 million of unrealized losses. It reported that 95.7% of fixed-maturity AFS securities were investment grade. Unrealized losses on AFS securities increased $1.6 billion during 2015; management did not consider the positions other-than-temporarily impaired.
- Capital, regulation and distribution: Statutory reserves, captive reinsurance rules and restrictions on subsidiary dividends may affect capital and holding-company liquidity. The proposed Department of Labor fiduciary rule was expected to affect distribution, compensation and product economics; its final impact was uncertain.
- Reinsurance: Reinsurance recoverables totaled $5.6 billion, including $2.4 billion related to Swiss Re. Non-collection or changes in reinsurance terms could adversely affect results.
- Legal matters: The company estimated aggregate reasonably possible losses, including amounts above accrued liabilities, of up to approximately $175 million for matters for which it could estimate a range. It stated some other matters could not yet be reasonably estimated.
All reported insurer financial-strength and company credit ratings were on stable outlook as of the filing’s stated dates. Management reported that insurance subsidiary RBC ratios exceeded the company-action level. The company reported no off-balance-sheet arrangements reasonably likely to have a material effect on its financial condition, results, liquidity or capital resources.
Investor verification priorities
- Reconcile GAAP net income with segment operating income, realized losses and the $78 million after-tax unlocking impact; distinguish recurring performance from assumption changes and hedge volatility.
- Review Life Insurance mortality, reserve adequacy and the remaining New York secondary-guarantee reserve phase-in, after $270 million of increases through year-end 2015.
- Assess variable-annuity guarantee exposures, hedge effectiveness, reinsurance protection and the sensitivity of statutory capital to stressed equity markets and interest rates.
- Monitor investment credit quality, particularly energy exposure and unrealized losses, alongside liquidity needs and the company’s capacity to sustain subsidiary dividends, debt service and capital returns.
- Track the final fiduciary rule and other regulatory developments for potential effects on annuity sales, fees, compensation, capital requirements and product profitability.