LINCOLN NATIONAL CORPORATION Index to Management's Discussion and Analysis of Financial Condition and Results
of Operations
Page
Forward-Looking Statements - Cautionary Language 48
Introduction 49
Executive Summary 49
Critical Accounting Policies and Estimates 50
Results of Consolidated Operations 52
Results of Annuities 54
Results of Retirement Plan Services 58
Results of Life Insurance 62
Results of Group Protection 67
Results of Other Operations 71
Realized Gain (Loss) 73
Consolidated Investments 75
Liquidity and Capital Resources 87
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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
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
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
?The impact of Regulation Best Interest or other regulations adopted by the
?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, including the adoption effective
?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
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 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)
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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 second quarter of 2022. We continue to monitor
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
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 "Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk" in our 2021 Form 10-K.
Spark Initiative
In the fourth quarter of 2021, we formally communicated our new expense savings initiative, the Spark Initiative. Because we have almost completed the investments related to our strategic digitization initiative first announced in 2016, beginning in the fourth quarter of 2021, we integrated the actual and expected remaining amounts associated with that initiative into the amounts associated with the Spark Initiative. For more information about the Spark Initiative, see "Part II - Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Introduction - Executive Summary" 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.
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Table of Contents 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
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 ofMarch 31, 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$ 461 $ 97,456 $ 193 $ 98,110 Priced by independent broker quotations - - 4,411 4,411 Priced by matrices - 14,256 - 14,256 Priced by other methods (1) - - 3,853 3,853 Total$ 461 $ 111,712 $ 8,457 $ 120,630 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 13 herein.
Derivatives
Our accounting policies for derivatives and the potential effect on interest spreads in a falling rate environment are discussed in Note 5 herein and "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 GLB features.
The proportion of our variable annuity account values that contained GLB
features to our total annuity account values, net of reinsurance, was 49% and
52% as of
For information on our variable annuity hedge program performance, see our discussion in "Realized Gain (Loss) - Variable Annuity Net Derivative Results" below.
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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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