Lincoln National Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods unless noted. Amounts are in millions of dollars except per-share data. Lincoln National sells annuities, life insurance, retirement plan services, and group protection products.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $3,716 | $3,411 | $10,400 | $9,869 |
| Net income | $227 | $439 | $871 | $1,166 |
| Diluted EPS | $0.87 | $1.65 | $3.37 | $4.34 |
| Operating cash flow | Not separately stated for quarter | Not separately stated for quarter | $1,487 | $1,095 |
- Q3 revenue rose 9%, while net income fell 48%; nine-month revenue rose 5%, while net income fell 25%. The filing attributes weaker earnings mainly to annual assumption unlocking, higher life claims and legal costs, and less favorable realized investment results.
- Q3 operating income by segment: Annuities $259 (up 6%); Retirement Plan Services $42 (up 5%); Life Insurance $36 (down 76%); Group Protection $17 (up from $8). Nine-month segment operating income was $753, $107, $251, and $29, respectively. Other Operations reported losses of $65 for Q3 and $127 year to date.
- Q3 net income was approximately 6.1% of revenue versus 12.9% a year earlier; nine-month net income was approximately 8.4% of revenue versus 11.8%. These are calculated ratios, not reported company measures.
- At September 30, total assets were $249.5 billion, total liabilities $235.1 billion, and stockholders’ equity $14.4 billion, down from $15.7 billion at year-end 2014. AOCI declined to $1.7 billion from $3.1 billion, primarily reflecting investment and derivative valuation changes.
- Cash and invested cash was $3.8 billion, compared with $3.9 billion at year-end. Long-term debt was $5.6 billion; short-term debt was zero. The company reported $505 million of holding-company available liquidity and a senior debt rating of A-/Baa1.
- Nine-month net cash provided by operating activities was $1.5 billion; investing activities used $2.1 billion and financing activities provided $513 million. Cash and invested cash decreased $147 million over the period.
- Net investment income was $1.254 billion for Q3, up 3%, and $3.627 billion year to date, unchanged. The nine-month investment yield on invested assets declined to 5.07% from 5.26%.
Material changes and notable items
- Annual actuarial assumption review lowered the long-term new-money investment yield assumption, resetting projected rates to recover gradually over five years to an ultimate rate 50 basis points below the prior assumption. Management reported an unfavorable after-tax effect of $118 million in Life Insurance, $2 million in Annuities, and $1 million in Retirement Plan Services. Life Insurance operating income also reflected substantial DAC/VOBA unlocking effects.
- Q3 realized gain was $27 million versus $89 million; the nine-month result was a loss of $11 million versus a gain of $106 million. Management cited volatile markets, unfavorable variable-annuity hedge performance, and increased corporate-bond impairment losses.
- Gross unrealized losses and related OTTI on available-for-sale securities rose by $941 million during the first nine months. The company stated it did not expect to need to sell temporarily impaired securities before recovery and considered its cash flows adequate; fixed maturity securities were 95.6% investment grade by fair value.
- Life Insurance segment nine-month operating income fell 40% to $251 million. Net death benefits rose 34% to $1.29 billion, reflecting higher claims severity and business growth; management said Q3 mortality was in line with expectations after elevated first-half experience.
- Group Protection premiums fell 6% in Q3 and 2% year to date. Management cited repricing-related sales declines, while shifting toward employee-paid business to improve profitability.
- Lincoln sold Lincoln Financial Media in July. The filing reports $105 million of consideration, subject to adjustments, including cash and Entercom preferred stock; the cash-flow statement separately reports $75 million of proceeds from sale of a subsidiary/business.
Outlook, risks, and contingencies
- The filing provides no consolidated earnings guidance. Management expected to manage near-term spread pressure through portfolio management and, to a lesser extent, crediting-rate actions; it cautioned that low rates can compress spreads and higher rates can increase surrenders.
- Management expected continued Retirement Plan Services investments in technology and distribution during the remainder of 2015, increasing expenses. Group Protection expected higher DAC amortization due to increased lapses and repricing.
- In October 2015, the company’s primary insurance subsidiary amended its variable-annuity GLB reinsurance treaty, adding $2 billion of capacity through December 31, 2016. Also after quarter-end, the board raised the quarterly dividend from $0.20 to $0.25 per share; management expected further 2015 repurchases subject to market conditions and capital alternatives.
- Lincoln planned a $90 million fourth-quarter 2015 statutory reserve increase at its New York-domiciled insurance subsidiary related to universal-life secondary guarantees. It said subsidiaries had statutory surplus and risk-based capital above current regulatory requirements, while noting reliance on letters of credit and other reserve-financing arrangements.
- Variable-annuity guarantees are exposed to equity-market declines and volatility. The share of in-force GLB contracts that were “in the money” rose to 11% from 4% a year earlier; exposure after reinsurance was $639 million versus $291 million.
- Management estimated aggregate reasonably possible litigation losses of up to approximately $175 million, including amounts above accruals. It stated that some matters could not yet be estimated and that potential charges could be material in individual periods, but did not expect known matters to materially adversely affect overall financial condition. A class settlement in the Bezich matter was awaiting court approval.
- Other key risks include investment credit and valuation losses, interest-rate and equity-market movements, reinsurance collectability, regulatory or tax changes, ratings downgrades, policyholder behavior, and operational or cybersecurity disruption. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- How much of the earnings decline reflects recurring operating performance versus actuarial unlocking, market-sensitive derivatives, and realized losses.
- The assumptions and sensitivity behind the lower long-term investment-yield projection, life-insurance reserves, and variable-annuity guarantee exposure.
- Whether investment impairments, particularly in corporate bonds and energy-related holdings, increase, and whether the company can continue to hold securities through recovery.
- The sustainability of subsidiary dividends and the $505 million holding-company liquidity position amid collateral, debt-service, repurchase, and reserve-financing needs.
- The final consideration and cash proceeds from the media sale, the $90 million New York reserve increase, and developments in litigation and the Bezich settlement.