Lincoln National Corporation — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; balance sheet compared with December 31, 2019. Lincoln National operates Annuities, Retirement Plan Services, Life Insurance and Group Protection businesses, plus Other Operations.
Financial results and position
| Metric | Q1 2020 | Prior period / comparison |
|---|---|---|
| Total revenue | $4.425 billion | $3.965 billion in Q1 2019 |
| Net income | $52 million | $252 million in Q1 2019 |
| Diluted earnings per share | $0.15 | $1.22 in Q1 2019 |
| Cash dividends declared per share | $0.40 | $0.37 in Q1 2019 |
| Operating cash flow | $455 million provided | $1.331 billion used in Q1 2019 |
| Net investment income | $1.375 billion | $1.251 billion in Q1 2019 |
| Total assets | $318.649 billion | $334.761 billion at year-end 2019 |
| Total stockholders’ equity | $16.575 billion | $19.689 billion at year-end 2019 |
| Long-term debt | $6.748 billion | $6.067 billion at year-end 2019 |
| Cash and invested cash | $6.202 billion | $2.563 billion at year-end 2019 |
Q1 net income included a $349 million after-tax unfavorable benefit-ratio unlocking adjustment and $60 million of after-tax excluded realized losses. Management’s segment operating income measure totaled $465 million, compared with $441 million in Q1 2019; this non-GAAP measure excludes specified items and should not be equated with GAAP net income.
Holding-company available liquidity was $760 million at March 31, 2020. The company also reported a $500 million floating-rate loan due in 2022 and repaid $300 million of 2020 senior notes during the quarter. Cash returned to shareholders was $304 million, including $225 million of share repurchases and $79 million of dividends paid.
Material changes and business performance
- Revenue increased 12%, while net income fell substantially, reflecting higher benefits and market-related effects. The company cited lower realized losses, higher alternative-investment income, business growth and a tax benefit as partial offsets.
- Net income was affected by severe capital-market volatility and variable-annuity hedging results. Variable-annuity net derivatives results were a $349 million loss, after associated items, compared with a $42 million loss in Q1 2019.
- Group Protection operating income declined to $40 million from $55 million; its total loss ratio rose to 78.5% from 73.7%, reflecting unfavorable life mortality and waiver experience and higher disability claim incidence and severity.
- Annuities operating income rose to $261 million from $250 million. Its interest-rate spread narrowed to 1.45% from 1.61%.
- Retirement Plan Services operating income was $40 million versus $39 million; its interest-rate spread narrowed to 1.13% from 1.31%.
- Life Insurance operating income increased to $171 million from $157 million, supported by higher fee income and investment income, partly offset by higher benefits and expenses.
- Net flows across Annuities, Retirement Plan Services and Life Insurance were $2.162 billion, versus $1.131 billion in Q1 2019. The increase was led by Retirement Plan Services, whose net flows improved to $671 million from $381 million of outflows.
Liquidity, investments and unusual items
- Cash from operations improved to $455 million from cash used of $1.331 billion. Investing activities provided $742 million and financing activities provided $2.442 billion.
- Separate-account assets and liabilities each fell to $130.617 billion from $153.566 billion at year-end 2019. Total assets declined by $16.112 billion.
- Accumulated other comprehensive income fell by $2.669 billion during the quarter, primarily amid market-driven investment valuation changes. Gross unrealized losses on available-for-sale fixed-maturity securities increased by $2.1 billion; management said it did not intend, and was not more likely than not required, to sell the affected securities before recovery.
- At March 31, 96% of the fair value of the corporate bond portfolio was investment grade. Fixed-maturity AFS securities were 96.4% investment grade by fair value; below-investment-grade securities represented 3.6% of that portfolio’s fair value.
- The company adopted the expected-credit-loss accounting standard on January 1, 2020. Adoption reduced opening retained earnings by $218 million after tax, net of related adjustments; a separate fair-value-option election for certain mortgage loans increased retained earnings by $15 million after tax. The quarter included a $71 million mortgage-loan credit-loss provision attributed to pandemic-related economic assumptions. The reinsurance-related credit-loss allowance was $192 million at adoption.
- Collateral payables on investments increased to $8.434 billion from $5.082 billion, including higher derivative collateral associated with market movements.
Outlook, risks and contingencies
Management said the effects of COVID-19 and the resulting economic and market disruption remained uncertain, and that first-quarter results were not necessarily indicative of full-year results. It expected higher mortality in Life Insurance and Group Protection, increased disability claims and delays in resolving claims, lower alternative-investment income, pressure on asset-based earnings and net flows, and continued spread pressure from near-zero interest rates. The company also anticipated possible sales and distribution disruption beginning in Q2 2020. No quantitative earnings or revenue guidance was provided.
Key risks include market and credit losses, low interest rates and spread compression, equity-market declines and variable-annuity guarantee exposure, higher mortality and morbidity, policy surrenders or missed premiums, reinsurer rate disputes and collectability, ratings downgrades, litigation, and operational or cybersecurity disruption. Management noted that adverse market conditions could reduce insurance-subsidiary statutory capital and dividends available to the holding company. The company reported an estimated aggregate range of reasonably possible litigation losses of up to approximately $90 million; this is not stated to be an expected loss or maximum exposure. The filing also describes multiple cost-of-insurance disputes and arbitration over certain reinsurer rate increases.
Important facts for investors to verify
- How COVID-19 affected claims, sales, persistency, investment income and statutory capital after March 31, 2020.
- Whether the large market-related unrealized losses and credit-loss allowances changed, and whether any securities or loans required further impairment.
- The durability of variable-annuity hedge performance and the sensitivity of guarantee liabilities to equity markets, interest rates, volatility and policyholder behavior.
- Holding-company liquidity, subsidiary dividend capacity, collateral needs and debt obligations under prolonged market stress.
- Developments in cost-of-insurance litigation and reinsurer rate disputes, including any change in reasonably possible loss estimates.