LINCOLN NATIONAL LIFE INSURANCE CO /IN/ – 10-Q – Management's Narrative Analysis of the Results of Operations
Index to Management's Narrative Analysis of the Results of Operations
Page
Forward-Looking Statements - Cautionary Language 55
Introduction 56
Critical Accounting Policies and Estimates 57
Results of Consolidated Operations 59
Results of Annuities 60
Results of Retirement Plan Services 61
Results of Life Insurance 62
Results of Group Protection 64
Results of Other Operations 65
Realized Gain (Loss) 66
Liquidity and Capital Resources 68
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Management's Narrative Analysis ("MNA") of the results of operations for the
three and nine months ended
periods in 2021 of
consolidated subsidiaries 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
reports filed with the
otherwise stated or the context otherwise requires, "LNL," "Company," "we,"
"our" or "us" refers to
consolidated subsidiaries. LNL is a wholly-owned subsidiary of Lincoln National
Corporation ("LNC").
See "Part I - Item 1. Business" and Note 1 in our 2021 Form 10-K for a
description of the business.
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 14. 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
readers with a more valuable measure of our performance because it better
reveals trends in our business.
Management's Narrative Analysis is presented pursuant to General Instructions
H(2)(a) of Form 10-Q in lieu of Management's Discussion and Analysis of
Financial Condition and Results of Operations.
FORWARD-LOOKING STATEMENTS - CAUTIONARY LANGUAGE
This Quarterly Report on Form 10-Q, including "Risk Factors" and "Management's
Narrative Analysis of the Results of Operations," contains "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 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;
?Legislative, regulatory or tax changes that affect the cost of, or demand for,
our products or our ability to conduct business;
?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 products; a reduction of asset-based fees that we charge on
various investment and insurance products; and an increase in liabilities
related to guaranteed benefit features of our variable annuity products;
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?Changes in our assumptions related to deferred acquisition costs ("DAC"), value
of business acquired ("VOBA"), deferred sales inducements ("DSI") or deferred
front-end loads ("DFEL");
?Ineffectiveness of our risk management policies and procedures;
?A deviation in actual experience regarding future persistency, mortality,
morbidity, interest rates or equity market returns from the assumptions used in
pricing our products;
?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 financial strength ratings;
?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 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 we can charge for our products;
?The unknown effect on our 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.
We do not intend, and are under no obligation, to update any particular
forward-looking statement included in this document. See "Risk Factors" included
in "Part I - Item 1A. Risk Factors" in our 2021 Form 10-K for a discussion of
certain risks relating to our business.
INTRODUCTION
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 Narrative Analysis of the
Results of Operations - Critical Accounting Policies and Estimates - Annual
Assumption
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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 MNA 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.
Investments
Investment Valuation
For more information about the valuation of our financial instruments carried at
fair value, see "Part II - Item 7. Management's Narrative Analysis of the
Results of Operations - Critical Accounting Policies and Estimates - Investments
- Investment Valuation" in our 2021 Form 10-K and Note 13 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.
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 $ 35 $ 18
Retirement Plan Services 6 -
Life Insurance (1,971 ) (51)
Group Protection 1 16
Excluded realized gain (loss) (102 ) (11)
Net income (loss) $ (2,031 ) $ (28)
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.
?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.
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?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 capital market assumptions.
2021
?For Annuities, favorable unlocking was driven by updates to expense and
policyholder behavior assumptions, partially offset by unfavorable updates to
interest rate 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), unfavorable unlocking was driven by updates
to policyholder behavior assumptions, partially offset by favorable updates to
other items.
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
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 Narrative Analysis of the Results of Operations
- Introduction - Critical Accounting Policies and Estimates -
Intangible Assets" and Notes 1 and 9 in our 2021 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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