Lincoln National Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; balance-sheet comparisons are with December 31, 2011. Amounts are in U.S. dollars. LNC is an insurance and retirement-services holding company with Annuities, Retirement Plan Services, Life Insurance, and Group Protection segments.
Financial performance and position
| Metric | Q1 2012 | Comparable / prior period |
|---|---|---|
| Total revenue | $2.714 billion | $2.718 billion, Q1 2011 |
| Income from continuing operations | $246 million | $314 million, Q1 2011 |
| Net income | $245 million | $314 million, Q1 2011 |
| Diluted EPS | $0.83 | $0.97, Q1 2011 |
| Operating cash flow | $282 million | $340 million, Q1 2011 |
| Total assets | $208.018 billion | $201.491 billion at Dec. 31, 2011 |
| Stockholders’ equity | $13.261 billion | $13.238 billion at Dec. 31, 2011 |
Revenue was essentially flat year over year. Insurance fees rose to $907 million from $818 million, while net investment income declined to $1.166 billion from $1.191 billion. Benefits and expenses increased to $2.407 billion from $2.289 billion; pre-tax continuing income fell to $307 million from $429 million. No consolidated profit-margin measure is stated.
Segment operating income was $137 million for Annuities (down 5%), $35 million for Retirement Plan Services (down 27%), $142 million for Life Insurance (flat), $16 million for Group Protection (down 33%), and a $34 million loss for Other Operations. These are management-defined non-GAAP measures, not consolidated net income.
Net investment income yield on invested assets was 5.56%, down 40 basis points year over year. Fixed-account interest spreads narrowed: Annuities to 1.82% from 2.23%, and Retirement Plan Services to 2.17% from 2.63%. Group Protection’s non-medical loss ratio was 74.9%, versus 74.1%.
Total investments were $92.912 billion and cash and invested cash was $3.516 billion at quarter-end. Short-term debt was $300 million and long-term debt $5.606 billion. LNC issued $300 million of 4.20% senior notes due 2022 and expected to use the proceeds to repay a $300 million 5.65% note maturing in August 2012. The holding company reported approximately $800 million of cash and cash equivalents and $25 million invested in fixed-maturity corporate bonds.
Cash declined by $994 million during the quarter: operating activities provided $282 million, investing activities used $1.913 billion, and financing activities provided $637 million. The reduction in investment collateral payables was a substantial cash-flow factor; collateral payables decreased $858 million in investing cash flows, including an $848 million decrease related to derivatives.
Material changes versus the prior comparable period
- Net income declined 22%, primarily reflecting unfavorable realized results, lower investment income, and investment in technology and distribution initiatives.
- Realized losses were $85 million, compared with a $2 million gain in Q1 2011. Variable-annuity derivative results were pressured by narrowing credit spreads and the resulting unfavorable guaranteed-living-benefit nonperformance-risk component; less volatile markets improved hedge-program performance.
- Net investment income declined 2% to $1.166 billion, reflecting lower new-money yields, reduced prepayment and bond make-whole premiums, and weaker alternative-investment income.
- Deposits decreased 2% to $5.150 billion and net flows decreased 13% to $1.256 billion. Retirement Plan Services net flows increased, while Annuities and Life Insurance net flows declined.
- Share repurchases totaled $150 million, versus $75 million, and common dividends were $23 million, versus $16 million. The quarterly common dividend was $0.08 per share.
Outlook, commentary, risks, and unusual items
- No formal consolidated earnings guidance is provided in the supplied filing text. Management said Group Protection non-medical loss ratios were expected to remain within a 71%–74% long-term range during 2012; each one-percentage-point increase above expectation could reduce annual segment operating income by approximately $10 million–$12 million.
- Management cited sustained low interest rates as a pressure on investment spreads and product pricing. Life Insurance pricing changes could reduce sales and potentially market share; Retirement Plan Services noted that a shift toward lower-return products would require stronger new-deposit production to maintain earnings.
- Market, equity, interest-rate, credit, and counterparty risks affect investment values and guaranteed-benefit liabilities. About 48% of variable-annuity account values had a guaranteed withdrawal benefit rider; 39% of those in-force contracts were “in the money,” versus 29% a year earlier. The filing estimates equity-market sensitivity for fee-related operating income, but excludes sales, customer behavior, and hedge performance.
- Investment risks include mortgage-backed securities, commercial real estate, credit exposures, and valuation uncertainty. About 95.3% of fixed-maturity AFS securities were investment grade. Gross unrealized losses on AFS securities fell $208 million during the quarter; management stated it did not expect to be required to sell temporarily impaired securities before recovery. Net OTTI recognized in earnings was $47 million, versus $41 million.
- The company adopted new insurance acquisition-cost guidance retrospectively on January 1, 2012. It reduced deferred acquisition costs and restated prior-period amounts; Q1 2011 continuing income was reduced by $25 million and diluted EPS by $0.08. Management said the adoption lowered deferrable acquisition costs, partly offset by lower amortization.
- Insurance subsidiaries used letters of credit and structured financing to mitigate statutory reserve strain associated with secondary-guarantee life products. LNC reported approximately $1.9 billion of long-dated letters of credit supporting intercompany reinsurance arrangements. Management said subsidiaries had capital above current regulatory requirements, but limited availability of these financing structures could affect returns.
- LNC disclosed pending or threatened legal and regulatory matters, including class actions. Loss amounts could not always be estimated; management did not believe currently known matters were likely to have a material adverse effect on financial position, while acknowledging that charges in a particular period could be material.
Important facts for investors to verify
- Reconcile the decline in GAAP earnings with management’s segment operating results, realized losses, and benefit-ratio unlocking adjustments.
- Track fixed-account spreads, new-money yields, crediting-rate actions, and the effect of continued low rates on profitability and policyholder behavior.
- Review variable-annuity guarantee exposure, hedge effectiveness, and sensitivity to equity markets and credit spreads.
- Assess investment-credit quality, mortgage and other unrealized losses, OTTI assumptions, and liquidity needs relative to policy obligations.
- Monitor statutory capital and reserve financing, holding-company liquidity, upcoming debt maturities, and the effect of subsidiary dividend capacity.
- Confirm trends in segment deposits, net flows, policy persistency, claims experience, and Group Protection loss ratios; also review the progress and costs of strategic investments.