LINCOLN NATIONAL CORP – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
Index to Management's Discussion and Analysis of Financial Condition and Results
of Operations
Page
Forward-Looking Statements - Cautionary Language 54
Introduction 55
Executive Summary 55
Critical Accounting Policies and Estimates 56
Results of Consolidated Operations 60
Results of Annuities 62
Results of Retirement Plan Services 66
Results of Life Insurance 70
Results of Group Protection 76
Results of Other Operations 80
Realized Gain (Loss) 82
Consolidated Investments 84
Liquidity and Capital Resources 96
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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,
the 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 2021 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;
?Weak general economic and business conditions that may affect demand for our
products, 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;
?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, including the adoption effective
2023
Update ("ASU") 2018-12, Targeted Improvements to the Accounting for
Long-Duration Contracts;
?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 inability to realize or sustain the benefits we expect from, greater than
expected investments in, and the potential impact of efforts related to, our
strategic initiatives, including the Spark Initiative;
?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 2021 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)
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from operations will provide investors with a more valuable measure of our
performance because it better reveals trends in our businesses.
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 2021 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 2021 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 us and are
expected to continue to adversely affect our business, results of operations and
financial condition in the fourth quarter of 2022. We continue to monitor
CDC reports related to COVID-19 and the potential impacts of the COVID-19
pandemic on our Life Insurance and Group Protection segments. See "Additional
Information" within Results of Life Insurance and Results of Group Protection
below for expected impacts of the COVID-19 pandemic in the fourth quarter of
2022.
The ultimate impact on our business, results of operations and financial
condition depends on the severity and duration of the COVID-19 pandemic and
related health, economic and business impacts and actions taken by governmental
authorities and other third parties in response, each of which is uncertain,
rapidly changing and difficult to predict. 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
2021 Form 10-K.
Interest Rate Environment
In light of substantial progress since 2020 in the labor markets, elevated
inflation and geopolitical events, the
the first increase to the federal funds rate target range since
Subsequently, the
funds rate target range through
Reserve
at 3.75% to 4.00% and reiterated that it will implement policy as needed to
combat inflation. Additionally, the
continue the reduction it started in
securities, agency debt and agency mortgage-backed securities. As interest rates
are rising, which impacts our portfolio yields, 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 interest rate environment.
We have provided disclosures around interest rate risk in "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," "Part II - Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations - Critical Accounting Policies
and Estimates - Annual Assumption Review - Long-Term New Money Investment Yield
Sensitivity" and "Part II - Item 7A. Quantitative and Qualitative Disclosures
About Market Risk - Interest Rate Risk" in our 2021 Form 10-K.
Critical Accounting Policies and Estimates
The MD&A included in our 2021 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 2021 Form 10-K,
and therefore, should be read in conjunction with that disclosure.
DAC, VOBA, DSI and DFEL
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 2021 Form 10-K.
If we had unlocked our RTM assumption as of
recorded unfavorable unlocking of approximately
within our Annuities segment.
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Table of Contents 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, 2022 : 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$ 421 $ 84,591 $ 164 $ 85,176 Priced by independent broker quotations - - 4,388 4,388 Priced by matrices - 13,168 - 13,168 Priced by other methods (1) - - 2,925 2,925 Total$ 421 $ 97,759 $ 7,477 $ 105,657 Percent of total 0% 93% 7% 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
2021 Form 10-K and Note 14 herein.
Derivatives
For information on our accounting policies for derivatives, see Note 5 herein.
For information on market exposures associated with our derivatives, including
sensitivities, see "Part II - Item 7A. Quantitative and Qualitative Disclosures
About Market Risk" in our 2021 Form 10-K.
Future Contract Benefits
Guaranteed Living Benefits
Within our annuity business, we have certain products that contain guaranteed
living benefit ("GLB") features. The proportion of our variable annuity account
values that contained GLB features to our total annuity account values, net of
reinsurance, was 46% and 51% as of
Underperforming equity markets 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
2021, 72% and 9%, respectively, of all in-force contracts with a GLB feature
were "in the money," and our exposure, after reinsurance, as of
2022
only way the contract holder can 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 - Future Contract Benefits - GLB" in our 2021 Form 10-K.
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Table of Contents Annual Assumption Review
During the third quarter of each year, we conduct our comprehensive review of
the assumptions and projection models used for our EGPs underlying the
amortization of DAC, VOBA, DSI and DFEL as well as our reserves and embedded
derivatives. For more information on our comprehensive review, see Note 1 in our
2021 Form 10-K. Details underlying the effect to net income (loss) from our
annual assumption review (in millions) were as follows:
For the Three
Months Ended
September 30,
2022 2021
Income (loss) from operations:
Annuities $ 217 $ (5 )
Retirement Plan Services 6 -
Life Insurance (2,197 ) (26 )
Group Protection 1 16
Excluded realized gain (loss) (86 ) 6
Net income (loss) $ (2,059 ) $ (9 )
The impacts of our annual assumption review were driven primarily by the
following:
2022
?For Annuities, favorable unlocking was driven by increases to interest rate
assumptions, partially offset by unfavorable updates to other items.
?For Retirement Plan Services, favorable unlocking was driven by increases to
interest rate assumptions and other items.
?
behavior assumptions related to universal life insurance ("UL") products with
secondary guarantees in the amount of
updates to mortality, morbidity and reinsurance assumptions and other items.
?For Group Protection, the favorable impact was driven by updates to life waiver
assumptions and increases to interest rate assumptions, partially offset by
unfavorable updates to long-term disability incidence and severity assumptions.
?For excluded realized gain (loss), unfavorable unlocking was driven by updates
to policyholder behavior assumptions that impacted ceded reserves, partially
offset by favorable updates to expense and capital market assumptions.
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 Group Protection, the favorable impact was driven by updates to long-term
disability termination rate assumptions, partially offset by unfavorable updates
to interest rate 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.
1
likely than not reduce the fair value of a reporting unit below its carrying
value.
The fair values of our reporting units are comprised of the value of in-force
(i.e., existing) business and the value of new business. Specifically, new
business is representative of cash flows and profitability associated with
policies or contracts we expect to issue in the future, reflecting our forecasts
of future sales volume and product mix over a 10-year period. To determine the
values of in-force and new business, we use a discounted cash flows technique
that applies a discount rate reflecting the market expected, weighted-average
rate of return adjusted for the risk factors associated with operations to the
projected future cash flows for each reporting unit.
We apply significant judgment when determining the estimated fair value of our
reporting units. Factors that can influence the value of goodwill include the
capital markets, competitive landscape, regulatory environment, consumer
confidence and any items that can directly or indirectly affect new business
future cash flows. Factors that could affect production levels and profitability
of new business include mix of new business, pricing changes, customer
acceptance of our products and distribution strength. Spread compression and
related effects to profitability caused by lower interest rates affect the
valuation of in-force business more significantly than the valuation of new
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business, as new business pricing assumptions reflect the current and
anticipated future interest rate environment. Estimates of fair value are
inherently uncertain and represent only management's reasonable expectation
regarding future developments.
As a result of the current capital market environment, including (i) declining
equity markets and (ii) the impact of rising interest rates on our discount rate
assumption, we accelerated our quantitative goodwill impairment test for our
Life Insurance reporting unit as we concluded that there were indicators of
impairment. Based on this quantitative test, which included updating our best
estimate assumptions therein, we incurred an impairment during the third quarter
of 2022 of the Life Insurance reporting unit goodwill of
represents a write-off of the entire balance of goodwill for the reporting unit.
We concluded that, for the third quarter, there were not indicators of
impairment for our remaining reporting units (Annuities, Retirement Plan
Services and Group Protection). During the fourth quarter, we will perform our
annual quantitative goodwill impairment test as of
other reporting units. For more information on goodwill, see Note 7 herein and
"Part II - Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations - Introduction - Critical Accounting Policies and
Estimates -
Form 10-K.
Income Taxes
In
corporate alternative minimum tax ("CAMT"), effective for tax years beginning
after
business, results of operations and financial condition.
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