LINCOLN NATIONAL CORP – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
The following Management's Discussion and Analysis ("MD&A") is intended to help
the reader understand the financial condition as of
with
months ended
of
otherwise stated or the context otherwise requires, "LNC," "Company," "we,"
"our" or "us" refers to
subsidiaries.
The MD&A is provided as a supplement to, and should be read in conjunction with,
our consolidated financial statements and the accompanying notes to the
consolidated financial statements ("Notes") presented in "Part I - Item 1.
Financial Statements"; our Form 10-K for the year ended
Form 10-K"); and other reports filed with the
("SEC"). For more detailed information on the risks and uncertainties associated
with the Company's business activities, see the risks described in "Part I -
Item 1A. Risk Factors" in our 2020 Form 10-K.
FORWARD-LOOKING STATEMENTS - CAUTIONARY LANGUAGE
Certain statements made in this report and in other written or oral statements
made by us or on our behalf are "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995 ("PSLRA"). A
forward-looking statement is a statement that is not a historical fact and,
without limitation, includes any statement that may predict, forecast, indicate
or imply future results, performance or achievements. Forward-looking statements
may contain words like: "anticipate," "believe," "estimate," "expect,"
"project," "shall," "will" and other words or phrases with similar meaning in
connection with a discussion of future operating or financial performance. In
particular, these include statements relating to future actions, trends in our
businesses, prospective services or products, future performance or financial
results and the outcome of contingencies, such as legal proceedings. We claim
the protection afforded by the safe harbor for forward-looking statements
provided by the PSLRA.
Forward-looking statements are subject to risks and uncertainties. Actual
results could differ materially from those expressed in or implied by such
forward-looking statements due to a variety of factors, including:
?The continuation of the COVID-19 pandemic, or future outbreaks of COVID-19, and
uncertainty surrounding the length and severity of future impacts on the global
economy and on our business, results of operations and financial condition;
?Further deterioration in general economic and business conditions that may
affect account values, investment results, guaranteed benefit liabilities,
premium levels and claims experience;
?Adverse global capital and credit market conditions that may affect our ability
to raise capital, if necessary, and may cause us to realize impairments on
investments and certain intangible assets, including goodwill and the valuation
allowance against deferred tax assets, which may reduce future earnings and/or
affect our financial condition and ability to raise additional capital or
refinance existing debt as it matures;
?The inability of our subsidiaries to pay dividends to the holding company in
sufficient amounts, which could harm the holding company's ability to meet its
obligations;
?Legislative, regulatory or tax changes, both domestic and foreign, that affect:
the cost of, or demand for, our subsidiaries' products; the required amount of
reserves and/or surplus; our ability to conduct business and our captive
reinsurance arrangements as well as restrictions on the payment of revenue
sharing and 12b-1 distribution fees;
?The impact of
capital;
?The impact of Regulation Best Interest or other regulations adopted by the
the
organizations relating to the standard of care owed by investment advisers
and/or broker-dealers that could affect our distribution model;
?Actions taken by reinsurers to raise rates on in-force business;
?Further declines in or sustained low interest rates causing a reduction in
investment income, the interest margins of our businesses, estimated gross
profits ("EGPs") and demand for our products;
?Rapidly increasing interest rates causing contract holders to surrender life
insurance and annuity policies, thereby causing realized investment losses, and
reduced hedge performance related to variable annuities;
?The impact of the implementation of the provisions of the Dodd-Frank Wall
Street Reform and Consumer Protection Act relating to the regulation of
derivatives transactions;
?The initiation of legal or regulatory proceedings against us, and the outcome
of any legal or regulatory proceedings, such as: adverse actions related to
present or past business practices common in businesses in which we compete;
adverse decisions in significant actions including, but not limited to, actions
brought by federal and state authorities and class action cases; new decisions
that result in changes in law; and unexpected trial court rulings;
?A decline or continued volatility in the equity markets causing a reduction in
the sales of our subsidiaries' products; a reduction of asset-based fees that
our subsidiaries charge on various investment and insurance products; an
acceleration of the net amortization of deferred acquisition costs ("DAC"),
value of business acquired ("VOBA"), deferred sales inducements ("DSI") and
deferred front-end loads ("DFEL"); and an increase in liabilities related to
guaranteed benefit features of our subsidiaries' variable annuity products;
?Ineffectiveness of our risk management policies and procedures, including
various hedging strategies used to offset the effect of changes in the value of
liabilities due to changes in the level and volatility of the equity markets and
interest rates;
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?A deviation in actual experience regarding future persistency, mortality,
morbidity, interest rates or equity market returns from the assumptions used in
pricing our subsidiaries' products, in establishing related insurance reserves
and in the net amortization of DAC, VOBA, DSI and DFEL, which may reduce future
earnings;
?Changes in accounting principles that may affect our business, results of
operations and financial condition;
?Lowering of one or more of our debt ratings issued by nationally recognized
statistical rating organizations and the adverse effect such action may have on
our ability to raise capital and on our liquidity and financial condition;
?Lowering of one or more of the insurer financial strength ratings of our
insurance subsidiaries and the adverse effect such action may have on the
premium writings, policy retention, profitability of our insurance subsidiaries
and liquidity;
?Significant credit, accounting, fraud, corporate governance or other issues
that may adversely affect the value of certain financial assets, as well as
counterparties to which we are exposed to credit risk, requiring that we realize
losses on financial assets;
?Interruption in telecommunication, information technology or other operational
systems or failure to safeguard the confidentiality or privacy of sensitive data
on such systems, including from cyberattacks or other breaches of our data
security systems;
?The effect of acquisitions and divestitures, restructurings, product
withdrawals and other unusual items;
?The adequacy and collectability of reinsurance that we have obtained;
?Future pandemics, acts of terrorism, war or other man-made and natural
catastrophes that may adversely affect our businesses and the cost and
availability of reinsurance;
?Competitive conditions, including pricing pressures, new product offerings and
the emergence of new competitors, that may affect the level of premiums and fees
that our subsidiaries can charge for their products;
?The unknown effect on our subsidiaries' businesses resulting from evolving
market preferences and the changing demographics of our client base; and
?The unanticipated loss of key management, financial planners or wholesalers.
The risks and uncertainties included here are not exhaustive. Our most recent
Form 10-K as well as other reports that we file with the
factors that could affect our businesses and financial performance. Moreover, we
operate in a rapidly changing and competitive environment. New risk factors
emerge from time to time, and it is not possible for management to predict all
such risk factors.
Further, it is not possible to assess the effect of all risk factors on our
businesses or the extent to which any factor, or combination of factors, may
cause actual results to differ materially from those contained in any
forward-looking statements. Given these risks and uncertainties, investors
should not place undue reliance on forward-looking statements as a prediction of
actual results. In addition, we disclaim any obligation to update any
forward-looking statements to reflect events or circumstances that occur after
the date of this report.
INTRODUCTION
Executive Summary
We are a holding company that operates multiple insurance and retirement
businesses through subsidiary companies. We sell a wide range of wealth
protection, accumulation, retirement income and group protection products and
solutions through our four business segments:
?Annuities; ?Retirement Plan Services; ?Life Insurance; and ?Group Protection
We also have Other Operations, which includes the financial data for operations
that are not directly related to the business segments. See "Part I - Item 1.
Business" in our 2020 Form 10-K for a discussion of our business segments and
products.
In this report, in addition to providing consolidated revenues and net income
(loss), we also provide segment operating revenues and income (loss) from
operations because we believe they are meaningful measures of revenues and the
profitability of our operating segments. Operating revenues and income (loss)
from operations are the financial performance measures we use to evaluate and
assess the results of our segments. Accordingly, we define and report operating
revenues and income (loss) from operations by segment in Note 15. Our management
believes that operating revenues and income (loss) from operations explain the
results of our ongoing businesses in a manner that allows for a better
understanding of the underlying trends in our current businesses. Certain items
are excluded from operating revenue and income (loss) from operations because
they are unpredictable and not necessarily indicative of current operating
fundamentals or future performance of the business segments, and, in many
instances, decisions regarding these items do not necessarily relate to the
operations of the individual segments. In addition, we believe that our
definitions of operating revenues and income (loss) from operations will provide
investors with a more valuable measure of our performance because it better
reveals trends in our businesses.
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We provide information about our segments' and Other Operations' operating
revenue and expense line items and realized gain (loss), key drivers of changes
and historical details underlying the line items below. For factors that could
cause actual results to differ materially from those set forth, see
"Forward-Looking Statements - Cautionary Language" above and "Part I - Item 1A.
Risk Factors" in our 2020 Form 10-K.
Industry trends, significant operational matters and outlook are described in
"Part II - Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations - Introduction - Executive Summary" of our 2020 Form
10-K, which is further updated by the discussion that follows.
COVID-19 Pandemic
The health, economic and business conditions precipitated by the worldwide
COVID-19 pandemic that emerged in 2020 continue to adversely affect our
business, results of operations and financial condition. The COVID-19 pandemic
led to an extreme downturn in and volatility of the capital markets in the early
part of 2020, record-low interest rates and wide-ranging changes in consumer
behavior, including as a result of quarantines, shelter-in-place orders and
limitations on business activity. Although vaccinations are under way,
hospitalization rates remain elevated in populations with lower vaccination
rates due to COVID-19 variants. While states have eased restrictions and the
capital markets have recovered, it is unclear when the economy will operate
under normal conditions. Because the economic and regulatory environment
continues to react and evolve, we cannot predict the full impact of the pandemic
and ensuing conditions on our business and financial condition.
We continue to monitor vaccination rates and
COVID-19 and the potential impacts of the COVID-19 pandemic in our Life
Insurance and Group Protection segments. We expect elevated mortality in the
fourth quarter of 2021 in our Life Insurance and Group Protection segments as a
result of the impacts of the COVID-19 pandemic.
Because the profitability of some of our business depends in part on interest
rates, changes in interest rates may impact both our margins and our return on
invested capital. In response to the economic impact of the COVID-19 pandemic,
the
announced its intention to keep interest rates near zero in the near term. We
expect the continuation of the low interest rate environment to continue to
adversely affect the interest margins of our businesses. We continue to be
proactive in our investment strategies, product designs, crediting rate
strategies, expense management actions and overall asset-liability practices to
mitigate the risk of unfavorable consequences in this low interest rate
environment. For risks related to sustained low interest rates, see "Part I -
Item 1A. Risk Factors - Market Conditions - Changes in interest rates and
sustained low interest rates may cause interest rate spreads to decrease,
impacting our profitability, and make it more challenging to meet certain
statutory requirements, and changes in interest rates may also result in
increased contract withdrawals" and "Part II - Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations - Introduction -
Executive Summary - Significant Operational Matters - Sustained Low Interest
Rate Environment" in our 2020 Form 10-K.
The economic environment has continued to improve from the early part of 2020
and economic restrictions have eased, but there could be ongoing weakness if
there is a resurgence of COVID-19 cases that could cause renewed restrictions on
economic activity. This could impact select corporate industries and parts of
the commercial mortgage loan market, which could lead to increased credit
defaults and/or negative ratings migrations within our broader investment
portfolio. We continue to closely monitor developments relating to the COVID-19
pandemic.
For more information on the risks related to the COVID-19 pandemic, see "Part I
- Item 1A. Risk Factors - Market Conditions - The impacts of the COVID-19
pandemic have adversely affected and are expected to continue to adversely
affect our business and results of operations, and the future impacts of the
COVID-19 pandemic on the company's business, results of operations and financial
condition remain uncertain" in our 2020 Form 10-K.
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Spark and Strategic Digitization Initiatives
In the fourth quarter of 2021, we formally communicated our new expense savings
initiative, the Spark Initiative, focused on driving efficiencies throughout all
aspects of our business from leveraging automation to simplifying and improving
process efficiency. In addition, this program will target benefits beyond cost
savings including improving the way we work by focusing on reskilling and
upskilling our valuable employee base.
Because we have almost completed the investments related to our strategic
digitization initiative first announced in 2016, we integrated the remainder of
those projected program amounts into the following table, which sets forth the
projected net recurring benefits, one-time investments and net impact (in
millions, pre-DAC and pre-tax) associated with the Spark Initiative and the
balance of the strategic digitization initiative:
2025+
2021 (1) 2022 (2) 2023 (3) 2024 Run Rate
Net recurring benefits $ 50 $ 100 - 120 $ 170 - 190 $ 260 - 280
One-time investments (75 ) (145 - 165 ) (90 - 110 ) (40 - 60 )
Net impact $ (25 ) $ (25 - 65 ) $ 60 - 100 $ 200 - 240 $ 260 - 300
(1)2021 includes approximately
approximately
digitization initiative.
(2)2022 includes approximately
approximately
initiative.
(3)2023 and beyond includes approximately
from the strategic digitization initiative.
Critical Accounting Policies and Estimates
The MD&A included in our 2020 Form 10-K contains a detailed discussion of our
critical accounting policies and estimates. The following information updates
the "Critical Accounting Policies and Estimates" provided in our 2020 Form 10-K,
and therefore, should be read in conjunction with that disclosure.
DAC, VOBA, DSI and DFEL
Unlocking
As stated in "Part II - Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Critical Accounting Policies and
Estimates - Unlocking" in our 2020 Form 10-K, we conduct our annual
comprehensive review of the assumptions and projection models underlying the
amortization of DAC, VOBA, DSI, DFEL, embedded derivatives and reserves for life
insurance and annuity products in the third quarter of each year. As a result of
this review, we recorded unlocking that resulted in increases and decreases to
the carrying values of these items. See "DAC, VOBA, DSI and DFEL" in Note 1 of
our 2020 Form 10-K for a detailed discussion of our unlocking process.
Details underlying the effect to net income (loss) from our unlocking as a
result of our annual comprehensive review (in millions) were as follows:
For the Three
Months Ended
September 30,
2021 2020
Income (loss) from operations:
Annuities $ (5 ) $ (101 )
Retirement Plan Services - (3 )
Life Insurance (26 ) (440 )
Excluded realized gain (loss) 6 58
Net income (loss) $ (25 ) $ (486 )
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Unlocking was driven primarily by the following:
2021
?For Annuities, unfavorable unlocking was driven by updates to policyholder
behavior and interest rate assumptions, partially offset by favorable updates to
expense assumptions.
?
behavior and interest rate assumptions, partially offset by favorable updates to
investment allocation assumptions.
?For excluded realized gain (loss), favorable unlocking was driven by updates to
expense assumptions and other items, partially offset by unfavorable updates to
policyholder behavior assumptions.
2020
As part of our annual comprehensive review in the third quarter of 2020, we
updated our interest rate assumptions. These updates included lowering starting
new money rates to reflect the current interest rate environment and reducing
our long-term new money investment yield assumption by 50 basis points,
resulting in an ultimate long-term assumption of 3.0% for a 10-year
unlocking of
million
?For Annuities, unfavorable unlocking was driven by updates to interest rate
assumptions, partially offset by favorable updates to policyholder behavior
assumptions and other items.
?For Retirement Plan Services, unfavorable unlocking was driven by updates to
interest rate assumptions, partially offset by favorable updates to expense
assumptions and other items.
?
rate and policyholder behavior assumptions.
?For excluded realized gain (loss), favorable unlocking was driven by updates to
policyholder behavior and expense assumptions, partially offset by unfavorable
updates to other items.
Reversion to the Mean
As variable fund returns do not move in a systematic manner, we reset the
baseline of account values from which EGPs are projected, which we refer to as
our reversion to the mean ("RTM") process, as discussed in our 2020 Form 10-K.
If we had unlocked our RTM assumption as of
recorded favorable unlocking of approximately
within our Annuities segment.
Investments Investment Valuation The following summarizes investments on our Consolidated Balance Sheets carried at fair value by pricing source and fair value hierarchy level (in millions) as ofSeptember 30, 2021 : Quoted Prices in Active Markets for Significant Significant Identical Observable Unobservable Assets Inputs Inputs Total (Level 1) (Level 2) (Level 3) Fair Value Priced by third-party pricing services$ 537 $ 108,564 $ 224 $ 109,325 Priced by independent broker quotations - - 3,804 3,804 Priced by matrices - 14,778 - 14,778 Priced by other methods (1) - - 3,747 3,747 Total$ 537 $ 123,342 $ 7,775 $ 131,654 Percent of total 0% 94% 6% 100%
(1)Represents primarily securities for which pricing models were used to compute
fair value.
For more information about the valuation of our financial instruments carried at
fair value, see "Part II - Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations - Introduction - Critical
Accounting Policies and Estimates - Investments - Investment Valuation" in our
2020 Form 10-K and Note 14 herein.
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Table of Contents Derivatives
Our accounting policies for derivatives and the potential effect on interest
spreads in a falling rate environment are discussed in Note 5 of this report and
"Part II - Item 7A. Quantitative and Qualitative Disclosures About Market Risk"
in our 2020 Form 10-K.
Guaranteed Living Benefits
Within our individual annuity business, 57% and 60% of our variable annuity
account values contained guaranteed living benefit ("GLB") features as of
increase our exposure to potential benefits with the GLB features. A contract
with a GLB feature is "in the money" if the contract holder's account balance
falls below the present value of guaranteed withdrawal or income benefits,
assuming no lapses. As of
of all in-force contracts with a GLB feature were "in the money," and our
exposure, after reinsurance, as of
and
realize the excess of the present value of benefits over the account value of
the contract is through a series of withdrawals or income payments that do not
exceed a maximum amount. If, after the series of withdrawals or income payments,
the account value is exhausted, the contract holder will continue to receive a
series of annuity payments. The account value can also fluctuate with equity
market returns on a daily basis resulting in increases or decreases in the
excess of the present value of benefits over account value.
For information on our variable annuity hedge program performance, see our
discussion in "Realized Gain (Loss) - Variable Annuity Net Derivative Results"
below.
For information on our estimates of the potential instantaneous effect to net
income (loss) that could result from sudden changes that may occur in equity
markets, interest rates and implied market volatilities, see our discussion in
"Part II - Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations - Introduction - Critical Accounting Policies and
Estimates - Derivatives - GLB" in our 2020 Form 10-K.
Acquisitions and Dispositions
For information about acquisitions and dispositions, see Note 3 in our 2020 Form
10-K.
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