Lincoln National Corporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Lincoln National Corporation is an insurance and retirement solutions provider. Their business centers around annuities, life insurance, group protection, and retirement plan services, and while they have some competitive advantages, the market can be challenging and they have some financial risks to consider.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Lincoln National Corporation (LNC) operates across the United States, offering a wide range of financial products and services. The company reports its results through four major segments.

1. Annuities:

LNC offers fixed, variable, and indexed annuities, aiming to grow assets and provide guaranteed retirement income, offering both accumulation and payout options to clients.

  • Products include single premium, deferred, variable and indexed annuities.
  • These products appeal to individuals seeking tax-advantaged or guaranteed retirement solutions.
  • The annuities segment is sensitive to interest rate fluctuations and equity markets. Changes in these can impact the value of products and affect profitability.

2. Life Insurance:

LNC offers a variety of life insurance policies designed to provide financial protection, including term life, variable universal life, universal life, and indexed universal life, for both individual and group markets.

  • Products cater to various needs, such as income protection and estate planning.
  • The life insurance segment’s performance is significantly impacted by mortality rates and persistency levels (policy retention).
  • Product design and pricing must carefully balance profitability and attractiveness to consumers.

3. Group Protection:

LNC provides employers with products that offer financial protection to employees, including term life, disability, accidental death & dismemberment, and other benefits.

  • These plans help employers attract and retain employees.
  • The group protection segment is significantly impacted by medical cost inflation.
  • The segment also faces challenges due to the overall level of employment (and thus the number of insured employees) in the economy.

4. Retirement Plan Services:

LNC works with small, mid-sized and large plan sponsors to provide recordkeeping and administrative services, while also providing a platform for a wide range of investment vehicles.

  • These services assist companies in administering their employee retirement plans.
  • This segment’s revenue is a function of the value of the assets under management.
  • The segment is also subject to some degree of volatility, particularly from market fluctuations impacting the level of assets under management.

Industry Trends:

  • Increasing Competition: The financial services market, including insurance and retirement, is intensely competitive, with a lot of traditional insurers and fintech players vying for market share and looking for innovative strategies for revenue growth.
  • Technological Disruption: Technological advancements (fintech) and the use of artificial intelligence to offer lower-cost products and services while also increasing efficiency and productivity is also changing the industry’s landscape significantly.
  • Changing Regulations: Insurance products are highly regulated, and companies in this space are regularly impacted by regulatory changes impacting sales processes, product design, and the minimum capital requirements they must meet.

What Makes LNC Different?

  • Established Brand: LNC has an established presence in the US market, having been in the industry for several decades.
  • Diverse Product Portfolio: LNC offers various products including annuities, different life insurances, group protection, and retirement services which offers diversity across several customer segments and product lines.
  • Extensive Distribution Network: They have a large network of agents, advisors and partners across the United States.
  • Sophisticated Risk Management: LNC employs risk management strategies that have performed well over the years.
  • Focus on the Middle Market: The company focuses on the mass affluent market, which are people in the U.S. who are in the upper middle class and lower upper class, these are people who have not been primarily targeted by large insurance companies and thus creates a unique position in the market.

Financial Analysis:

  • Revenue Trends:
    • The company’s financial statements are complex. LNC’s 10-Q report for the quarter ended September 30, 2023, does not present a comparison of numbers with the previous period but does show that operating revenues were $4.18 billion for the three months ended September 30, 2023, and $12.73 billion for the nine months ended September 30, 2023.
    • The company states that in the first quarter, they continue to expand their product lines and have shown continued success in the structured annuity and the indexed life insurance products.
  • Profit Margins:
    • LNC’s reported net loss was $563 million for the three months ended September 30, 2023, and net income was $1.51 billion for the nine months ended September 30, 2023. The company has taken some hits to its profits recently and must improve efficiency to achieve sustainable margins.
  • Balance Sheet:
    • LNC has $335 billion in total assets and $355 billion in total liabilities, and stockholders equity was $172 billion, as of the end of September 2023.
    • They have significant investments in fixed maturity AFS securities, mortgage loans on real estate, and derivatives which make the balance sheet volatile.
    • The long-term debt to equity ratio is fairly high, indicating that the business does have quite a bit of leverage.
    • The level of cash and cash equivalents is quite low given the size of the company and the debt on the balance sheet.
  • Capital Structure:
    • The company maintains a target capital structure, and its debt levels have an impact on its credit ratings, according to recent reports.
    • The company has taken a more conservative approach with its capital structure and maintains a 15% debt-to-equity ratio over the long term.
    • LNC has the ability to generate capital through a variety of sources, including retained earnings, debt, and equity offerings.
  • Risk management:
    • In addition to having to stay in compliance with regulatory mandates, they must manage risks that are particular to the insurance and finance industry, including interest rate risk, credit risk, market risk, operational risk and liquidity risk.
    • LNC employs a variety of derivative products to hedge many of its exposures.
    • LNC uses stochastic projections of cash flow, along with stress testing, to assess the potential effects of changes in the economy on the insurance business.
    • They try to be forward-looking as possible by updating their assumptions, but cannot do so perfectly.

Risks to the Moat and Business Resilience:

  • Interest Rate Risk: Changes in interest rates, particularly rapidly rising rates, can significantly affect the profitability of LNC’s insurance products. This also could make their bond portfolios less valuable or hurt their ability to pay for their liabilities.
  • Market Volatility: Downturns in the equity market can have a huge effect on variable annuity volumes as well as other investment performance.
  • Credit Risk: Credit risk is primarily associated with corporate bonds and credit exposure in general. Any deterioration in credit quality of their investment portfolio can have a negative effect on solvency and profitability.
  • Regulatory Changes: Changes to laws and regulations that require the company to set aside additional reserves or impact tax structures can impair profits.
  • Competition: LNC is operating in a very competitive market with several established players. The competition can put pressure on product pricing and margins, reducing the company’s ability to generate profits.
  • Insurability Risk: This represents a risk that unexpected events can happen in claims. These can be anything from unusually high claims, or a natural disaster or a pandemic causing very high death rates and disability claims.
  • Operational Risk: As LNC is an insurance company, they rely heavily on the accuracy of their models to be profitable. Furthermore, these are very complicated and need significant attention. A breach in security or a major error in its models can cause massive problems.
  • Management: LNC’s management must be able to keep it competitive amidst the changing landscape to maintain profitability.
  • Reinsurance Risk: The counterparty risk related to reinsurance agreements can have a substantial impact on our results. The company’s reinsurance agreements were revised in 2021 and had a significant impact on the company’s financials.
  • Economic Downturn: In periods of economic distress, it is likely that customers will not buy new insurance products as much, and existing customers may allow their policies to lapse and not pay, or will cancel their policies. This could reduce premiums received.

Recent Concerns and Management’s Response:

  • In the latest 10-Q, LNC states that they have made strategic changes to reduce the company’s volatility and improve the operating income and that the company will be moving toward a less capital-intensive business model by reducing reliance on spread-based businesses like annuities, for example.
  • In the latest earnings call, management has noted that it has seen increased competition for fixed rate annuities and that it has reduced sales in the indexed annuity and variable annuity spaces.
  • Management claims that the company has implemented an effective hedging strategy to cope with interest rate risk and credit risk, as discussed previously, but notes that they expect certain parts of their financials to be more volatile than they have been in the past.
  • Management said it will be reducing its reliance on reinsurance to improve the quality of its earnings and minimize volatility.
  • The company is actively working to improve their returns through both product design and improving operational efficiency.
  • In Q3 2023 they continued their efforts to streamline costs and support growth via targeted investments.
  • Company says they were taking an aggressive approach to de-risking and improving capital.
  • Management states that they are working to improve profitability by growing its business with an emphasis on new and innovative products.

Understandability: 3 / 5

LNC’s business model is reasonably complicated to understand given it is in insurance and financial services which are highly complex industries. The nuances of different insurance products, retirement services, and financial reporting metrics make it difficult to for new investors to fully understand it from just one annual report or earnings call. Investors must dig deep into their financial statements and track industry reports for some time to understand them. Understanding credit and reinsurance agreements and other derivative structures is also essential to make a full assessment of the business. Therefore it gets a 3 out of 5 on this rating.

Balance Sheet Health: 3 / 5 LNC has a moderately healthy balance sheet, but certain risks and areas of concerns exist. They have a lot of debt relative to its equity. Additionally, the financial statements are complex and subject to volatility given market conditions and derivative holdings. That said they have maintained a strong regulatory capital and are managing the balance sheet. This gives a 3/5 rating on this rating.