Business Context and Reporting Period
Company: Lincoln National Corporation (LNC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2001
Business Overview: LNC operates multiple insurance and investment management businesses under the "Lincoln Financial Group" identity. Operations are divided into five segments: Annuities, Life Insurance, Reinsurance, Investment Management, and Lincoln UK, with other corporate items reported in "Other Operations."
Key Financial Metrics
| Metric | Nine Months Ended Sep 30, 2001 | Nine Months Ended Sep 30, 2000 | Three Months Ended Sep 30, 2001 | Three Months Ended Sep 30, 2000 |
|---|---|---|---|---|
| Total Revenue | $4,907.1 million | $5,078.0 million | $1,609.3 million | $1,716.1 million |
| Net Income | $421.0 million | $472.5 million | $119.1 million | $138.6 million |
| Diluted EPS | $2.18 | $2.42 | $0.61 | $0.71 |
| Net Cash from Operating Activities | $458.7 million | $808.9 million | N/A | N/A |
| Total Assets | $90,206.0 million | $99,844.1 million | N/A | N/A |
| Total Shareholders' Equity | $5,368.6 million | $4,954.1 million | N/A | N/A |
| Short-term Debt | $539.0 million | $312.9 million | N/A | N/A |
| Long-term Debt | $712.4 million | $712.2 million | N/A | N/A |
Material Changes vs. Prior Period
- Revenue Decline: Total revenue decreased 3.4% year-over-year for the nine-month period, driven by lower fee income in the Annuities segment and lower investment advisory fees in the Investment Management segment due to depressed equity markets.
- Net Income Decrease: Net income fell 11% for the nine months and 14% for the quarter. Excluding special items (September 11 losses and reserve re-evaluations), the decline was 7% for the nine months.
- September 11 Impact: The company recorded estimated losses of $33.2 million after-tax ($51.1 million pre-tax) related to the September 11 terrorist attacks. This included $31.3 million in the Reinsurance segment and $1.9 million in the Life Insurance segment.
- Accounting Changes: Adoption of FAS 133 (Derivatives) and EITF 99-20 resulted in a cumulative effect of accounting changes loss of $15.6 million after-tax recorded in the first nine months of 2001.
- Equity Growth: Despite lower net income, Total Shareholders' Equity increased by $414.6 million, primarily due to a $235.9 million increase in net unrealized gains on securities available-for-sale.
Guidance, Outlook, and Risks
Divestiture of Reinsurance Segment
On July 29, 2001, LNC announced the sale of its Reinsurance operation to Swiss Re for $2.0 billion. The transaction is expected to close in the fourth quarter of 2001. LNC expects to record an estimated deferred gain of approximately $800 million after-tax, to be amortized over 7 to 15 years. Proceeds will be used to expand other businesses and repurchase LNC securities.
Outlook and Commentary
- Market Conditions: Management notes that weak equity markets and the September 11 events have created a difficult sales environment, particularly for variable annuities and investment management products.
- Cash Flow: The Annuities segment achieved positive net cash flow for the third quarter of 2001 ($0.3 billion), a significant improvement over prior periods, driven by increased fixed annuity deposits and improved retention.
- Goodwill Accounting: LNC will adopt new standards (FAS 141/142) effective January 1, 2002, which will eliminate goodwill amortization. This is expected to increase 2002 net income by approximately $43.5 million.
Risks and Contingencies
- UK Regulatory Issues: Ongoing investigations by UK regulators regarding mortgage endowment products and pension advice. LNC estimates potential costs of up to $20 million if it does not prevail on warranty arguments regarding BNLA policies.
- Dividend Restrictions: LNC's primary insurance subsidiary, Lincoln National Life Insurance Company (LNL), has negative statutory earned surplus, requiring regulatory approval for dividends. LNL paid $380 million in extraordinary dividends to LNC in the first nine months of 2001.
- Legal Proceedings: Various pending class actions and litigation, including settlements related to universal life insurance sales, though management believes these will not materially affect financial position.
Investor Verification Checklist
- Reinsurance Sale Closing: Verify the final closing date and regulatory approvals for the $2.0 billion sale to Swiss Re.
- September 11 Loss Finalization: Monitor updates on the $33.2 million estimated loss to determine if the liability proves deficient or excessive.
- UK Regulatory Resolution: Track the outcome of the UK regulator's review of mortgage endowment products and potential mis-selling liabilities.
- Dividend Capacity: Assess the timeline for LNL's statutory earned surplus to return to positive levels to ensure continued dividend flow to the parent company.
- Goodwill Impairment Test: Review the results of the first annual goodwill impairment test required under new accounting standards in 2002.