LINCOLN NATIONAL CORPORATION
The following Management's Discussion and Analysis ("MD&A") is intended to help
the reader understand the financial condition as of December 31, 2020 , compared
with December 31, 2019 , and the results of operations in 2020 compared to 2019
of Lincoln National Corporation and its consolidated subsidiaries. Discussions
of 2018 items and year-to-year comparisons between 2019 and 2018 that are not
included in this Form 10-K can be found in "Part II - Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations" in our
2019 Form 10-K. Unless otherwise stated or the context otherwise requires,
"LNC," "Company," "we," "our" or "us" refers to Lincoln National Corporation and
its consolidated 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 II - Item 8.
Financial Statements and Supplementary Data," as well as "Part I - Item 1A. Risk
Factors" above.
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 theSecurities and Exchange Commission ("SEC"), theDepartment of Labor or other federal or state regulators or self-regulatory 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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Table of Contents ?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 purchased;
?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. Other sections of this report and other reports that we file with theSEC include additional factors that could affect our businesses and financial performance, including "Part I - Item 1A. Risk Factors" and "Item 7A. Quantitative and Qualitative Disclosures About Market Risk," which are incorporated herein by reference. 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" above for a discussion of our business segments and products. As discussed in Note 3, onMay 1, 2018 , we completed the acquisition fromLiberty Mutual Insurance Company of 100% of the capital stock ofLiberty Life Assurance Company of Boston ("Liberty Life"), an operator of a group benefits business (the "Liberty Group Business") and an individual life and individual and group annuity business. We ceded insurance policies relating to the individual life and individual and group annuity business to third-party reinsurers. The acquisition expanded the scale and capabilities of the Group Protection business while further diversifying the Company's sources of earnings. EffectiveSeptember 1, 2019 , Liberty Life's name was changed toLincoln Life Assurance Company ofBoston ("LLACB"). 38
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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 22. 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. 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 "Part I - Item 1A. Risk Factors" and "Forward-Looking Statements - Cautionary Language" above. Industry Trends
We continue to be influenced by a variety of trends that affect the industry.
COVID-19 Pandemic
The COVID-19 pandemic emerged inthe United States in the first quarter of 2020 and led to an extreme downturn in and volatility of the capital markets, 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. The severe restriction in economic activity caused by the COVID-19 pandemic and increased level of unemployment inthe United States have contributed to increased volatility and uncertainty regarding expectations for the economy and markets going forward. TheNational Bureau of Economic Research , a panel of economists charged with officially designating business cycles, announced inJune 2020 that a recession began inMarch 2020 , ending the longest expansion period inUnited States history. Although states have eased restrictions and the capital markets have mostly recovered, it is unclear when the economy will operate under normal or near-normal conditions. In the third quarter, the economy began to recover from what has been deemed the shortest recession on record inthe United States . However, as 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. As a result of the impacts of the COVID-19 pandemic, we continue to expect higher mortality in our Life Insurance and Group Protection segments in 2021. Separately, we continue to expect increased disability claims in our Group Protection segment related to the economic environment and the increased level of unemployment inthe United States .
Economic Environment
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. Some of our products, principally our fixed annuities and
universal life insurance ("UL"), including indexed universal life insurance
("IUL") and linked-benefit UL, have interest rate guarantees that expose us to
the risk that changes in interest rates or prolonged low interest rates will
reduce our spread, or the difference between the interest that we are required
to credit to contracts and the yields that we are able to earn on our general
account investments supporting our obligations under the contracts.
In response to the economic impact of the COVID-19 pandemic, the Federal Reserve
cut interest rates to near zero in March 2020 and announced in September 2020
its intention to keep interest rates near zero for the foreseeable future. We
expect the continuation of the low interest rate environment to continue to
adversely affect the interest margins of our businesses. For risks related to
sustained low interest rates, see "Significant Operational Matters - Sustained
Low Interest Rate Environment" below and "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."
The economic environment has improved from early in 2020 but there could be
continued weakness in the current environment as a result of restrictions on
economic activity and the increased level of unemployment in the United States .
This could impact select corporate industries and parts of the commercial
mortgage loan market. The current environment could lead to increased credit
defaults and/or negative ratings migrations, resulting in an increase to our
allowance for credit losses and additional write-downs of financial assets for
impairments in our broader investment portfolio.
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Table of Contents Regulatory EnvironmentU.S. -domiciled insurance entities are regulated at the state level, while certain products and services are also subject to federal regulation. Regulators may refine capital requirements and introduce new reserving standards for the life insurance industry. Regulations recently adopted or currently under review can potentially affect the capital requirements and profitability of the industry and result in increased regulation and oversight for the industry. See "Part I - Item 1. Business - Regulatory" and "Part I - Item 1A. Risk Factors - Legislative, Regulatory and Tax" for a discussion of regulatory developments that may impact the Company and the associated risks.
Significant Operational Matters
Actions in Response to the COVID-19 Pandemic
We took several actions during 2020, and expect to continue to take actions, to preserve our liquidity and capital position in response to the COVID-19 pandemic and ensuing economic environment conditions. During the second and third quarters of 2020, we suspended common stock repurchases under our buyback program after repurchasing$225 million of shares in the first quarter of 2020. We resumed common stock repurchases in the fourth quarter of 2020, repurchasing$50 million of shares. Debt financing transactions in the first half of 2020 allowed us to redeem our 2021 and prefund our 2022 senior debt maturities, with our next debt maturity not until 2023. While the COVID-19 pandemic caused distribution disruption, we efficiently moved to a virtual sales environment across all of our distribution channels beginning inmid-March 2020 . In addition, during 2020, we accelerated a plan already in place, in light of the low interest rate environment, to re-price certain products to achieve appropriate returns, shift our sales mix toward shorter-duration products that are less sensitive to interest rates, and add new products that are more capital efficient while increasing consumer choice and expanding customer value propositions. We also continue to focus on expense discipline. During the second quarter of 2020, we implemented a plan that significantly reduced expenses in 2020, and we expect to continue to manage expenses aggressively going forward.
Targeted Annual Operating Earnings Per Share Growth
Growth in operating earnings per share ("EPS") is a key driver of our long-term
performance. We believe that the key drivers to growing our operating EPS over
time include:
?Generating new business and positive net flows through our product development and distribution;
?Capital markets performing in-line with our expectations;
?Expense discipline, our strategic digitization initiative and expense synergies of acquired businesses driving improvement in operating margins; and
?Capital generation and active capital deployment, consisting of returning capital to common stockholders.
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Sources of Earnings
We monitor our sources of earnings as a factor in managing our businesses. This
information may be useful in assessing our risk profile and cost of capital. We
continue to focus on achieving our long-term goal of increasing mortality and
morbidity margins. Growth in this source of earnings component could be driven
by a number of factors, including, but not limited to, pricing actions on our
life and group products and acquiring blocks of mortality/morbidity business.
The following table presents the sources of earnings components of income (loss)
from operations, before income taxes, excluding Other Operations:
For the Years Ended December 31,
2020 2019 2018
Investment spread (1) 16.6% 19.2% 26.4%
Mortality/morbidity (2) 1.4% 23.5% 26.7%
Fees on AUM (3) 88.8% 55.2% 41.4%
VA riders (4) -6.8% 2.1% 5.5%
Total (5) 100.0% 100.0% 100.0%
(1)Investment spread earnings consist primarily of net investment income, net of interest credited, earned on the underlying general account investments supporting our fixed products less related expenses.
(2)Mortality/morbidity earnings result from mortality margins, morbidity margins, and certain expense assessments and related fees that are a function of the rates priced into the product and level of business in force.
(3)Fees on assets under management ("AUM") earnings consist primarily of asset-based fees charged on variable account values less associated benefits and related expenses.
(4)Variable annuity ("VA") riders' earnings consist of fees charged to the contract holder related to guaranteed benefit rider features, less the net valuation premium and associated change in benefit reserves and related expenses.
(5)The sources of earnings components include the effect of unlocking resulting from our annual comprehensive review, which for 2020 and 2019 were significantly unfavorable. See "Critical Accounting Policies and Estimates - DAC, VOBA, DSI and DFEL - Unlocking" below for more information about unlocking.
See Note 22 for additional information on income (loss) from operations by segment.
Sustained Low Interest Rate Environment
Although we have been proactive in our investment strategies, product designs, crediting rate strategies and overall asset-liability practices to mitigate the risk of unfavorable consequences in this type of environment, declines in our spread, or instances where the returns on our general account investments are not enough to support the interest rate guarantees on these products, could have an adverse effect on some of our businesses or results of operations. We have provided disclosures around interest rate spreads and 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" and "Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk."
Variable Annuity Hedge Program Performance
We offer variable annuity products with living benefit guarantees. As described
below in "Critical Accounting Policies and Estimates - Derivatives - GLB," we
use derivative instruments to hedge our exposure to the risks and earnings
volatility that result from the guaranteed living benefit ("GLB") embedded
derivatives and benefit ratio unlocking in certain of our variable annuity
products. The income statement effect due to the change in fair value of these
instruments tends to move in the opposite direction of the change in embedded
derivative reserves and benefit ratio unlocking. These results are excluded from
the Annuities and Retirement Plan Services segments' operating revenues and
income (loss) from operations (see Note 22). See "Realized Gain (Loss) and
Benefit Ratio Unlocking - Variable Annuity Net Derivatives Results" below for
information on our methodology for calculating the non-performance risk ("NPR"),
which affects the discount rate used in the calculation of the GLB embedded
derivative reserves.
We also offer variable annuity products with death benefit guarantees. As
described below in "Critical Accounting Policies and Estimates - Future Contract
Benefits and Other Contract Holder Obligations - GDB," we use derivative
instruments to hedge the income statement effect of the guaranteed death benefit
("GDB") benefit ratio unlocking for movements in equity markets. These results
are excluded from income (loss) from operations (see Note 22).
The costs of derivative instruments that we use to hedge these variable annuity products may increase as a result of a low interest rate environment.
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Table of Contents Earnings from Account Values The Annuities and Retirement Plan Services segments are the most sensitive to the equity markets, as well as, to a lesser extent, our Life Insurance segment. We discuss the earnings effect of the equity markets on account values and the related asset-based earnings below in each business segment's operating results section and "Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Equity Market Risk - Effect of Equity Market Sensitivity."
Strategic Digitization Initiative
We continue to make strategic investments in our businesses to grow revenues, further spur productivity and improve our efficiency and service to our customers. In 2016, we began our enterprise-wide digitization initiative that intends to significantly enhance our customer experience and provide operational efficiencies over time to meet evolving consumer preferences and marketplace shifts. During 2020, we saw benefits of approximately$50 million , pre-tax, net of investment. We expect to see annual benefits of$80 million , pre-tax, net of investment, in 2021, and ultimately$90 million to$150 million as a result of this initiative. Outlook
Management expects to continue focusing on the following in 2021:
?Making investments in our businesses, primarily in technology/digitization (including integrating and consolidating systems and processes), product innovation and distribution, to grow revenues, drive margin expansion and reduce costs;
?Re-pricing products to ensure we are achieving the necessary return on capital;
?Focusing a large majority of our new business mix on products without long-term guarantees, which are less sensitive to interest rates, in line with our long-term growth strategies;
?Adding new products that are more capital efficient while increasing consumer choice and expanding customer value propositions;
?Focusing on expense discipline and managing our expenses aggressively;
?Closely monitoring our capital and liquidity positions taking into account changing economic conditions and monetary policy, ongoing regulatory activities and our capital deployment strategy;
?Closely monitoring ongoing activities in the legal and regulatory environment and taking an active role in the legislative and/or regulatory process;
?Exploring additional reinsurance and other strategies addressing the statutory reserve strain related to certain products, namely our term products; and
?Maintaining risk management and the flexibility to adjust the risk profile of assets within our investment portfolio.
Critical Accounting Policies and Estimates
We have identified the accounting policies below as critical to the
understanding of our results of operations and our financial condition. In
applying these critical accounting policies in preparing our financial
statements, management must use critical assumptions, estimates and judgments
concerning future results or other developments, including the likelihood,
timing or amount of one or more future events. Actual results may differ from
these estimates under different assumptions or conditions. On an ongoing basis,
we evaluate our assumptions, estimates and judgments based upon historical
experience and various other information that we believe to be reasonable under
the circumstances. For a detailed discussion of other significant accounting
policies, see Note 1.
DAC, VOBA, DSI and DFEL
Accounting for intangible assets requires numerous assumptions, such as
estimates of expected future profitability for our operations and our ability to
retain existing blocks of life and annuity business in force. Our accounting
policies for DAC, VOBA, DSI and DFEL affect the Annuities, Retirement Plan
Services, Life Insurance and Group Protection segments.
Deferrals
Qualifying deferrable acquisition expenses are recorded as an asset on our
Consolidated Balance Sheets as DAC for products we sold during a period or VOBA
for books of business we acquired during a period. In addition, we defer costs
associated with DSI and revenues associated with DFEL. DSI increases interest
credited and reduces income when amortized. DFEL is a liability included within
other contract holder funds on our Consolidated Balance Sheets, and when
amortized, increases fee income on our Consolidated Statements of Comprehensive
Income (Loss).
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We incur certain costs that can be capitalized in the acquisition of insurance contracts. Only those costs incurred that result directly from and are essential to the successful acquisition of new or renewal insurance contracts may be capitalized as deferrable acquisition costs. This determination of deferability must be made on a contract-level basis. Some examples of acquisition costs that are subject to deferral include the following:
?Employee, agent or broker commissions;
?Wholesaler production bonuses;
?Renewal commissions and bonuses to agents or brokers;
?Medical and inspection fees;
?Premium-related taxes and assessments; and
?A portion of the salaries and benefits of certain employees involved in the underwriting, contract issuance and processing, medical and inspection and sales force contract selling functions. All other acquisition-related costs, including costs incurred by the insurer for soliciting potential customers, market research, training, administration, management of distribution and underwriting functions, unsuccessful acquisition or renewal efforts and product development, are considered non-deferrable acquisition costs and must be expensed in the period incurred.
In addition, the following indirect costs are considered non-deferrable acquisition costs and must be charged to expense in the period incurred:
?Administrative costs; ?Rent; ?Depreciation; ?Occupancy costs;
?Equipment costs (including data processing equipment dedicated to acquiring insurance contracts);
?Trail commissions; and ?Other general overhead.
Our DAC, VOBA, DSI and DFEL balances (in millions) by business segment as of
Retirement
Plan Life Group
Annuities Services Insurance Protection Total
DAC and VOBA
Gross $ 4,073 $ 232 $ 7,383 $ 187 $ 11,875
Unrealized (gain) loss (291 ) (112 ) (5,660 ) - (6,063 )
Carrying value $ 3,782 $ 120 $ 1,723 $ 187 $ 5,812
DSI
Gross $ 180 $ 13 $ 36 $ - $ 229
Unrealized (gain) loss (16 ) - - - (16 )
Carrying value $ 164 $ 13 $ 36 $ - $ 213
DFEL
Gross $ 293 $ - $ 3,298 $ - $ 3,591
Unrealized (gain) loss (5 ) - (3,185 ) - (3,190 )
Carrying value $ 288 $ - $ 113 $ - $ 401
Fixed maturity available-for-sale ("AFS") securities and certain derivatives are
stated at fair value with unrealized gains and losses included within
accumulated other comprehensive income (loss) ("AOCI"), net of associated DAC,
VOBA, DSI, future contract benefits, other contract holder funds and deferred
income taxes. The unrealized balances in the table above represent the DAC,
VOBA, DSI and DFEL balances for these effects of unrealized gains and losses on
fixed maturity AFS securities and certain derivatives.
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Amortization
DAC for variable annuity and deferred fixed annuity contracts and UL and
variable universal life insurance ("VUL") policies is amortized over the lives
of the contracts in relation to the incidence of EGPs derived from the
contracts. Certain broker commissions or broker-dealer expenses that vary with
and are related to sales of mutual fund products, respectively, are expensed as
incurred rather than deferred and amortized. For our traditional products, we
amortize deferrable acquisition costs either on a straight-line basis or as a
level percent of premium of the related contracts, depending on the block of
business.
EGPs vary based on a number of sources including policy persistency, mortality,
fee income, investment margins, expense margins and realized gains and losses on
investments, including assumptions about the expected level of credit-related
losses. Each of these sources of profit is, in turn, driven by other factors.
For example, assets under management and the spread between earned and credited
rates drive investment margins; net amount at risk drives the level of cost of
insurance charges and reinsurance premiums. The level of separate account assets
under management is driven by changes in the financial markets (equity and bond
markets, hereafter referred to collectively as "equity markets") and net flows.
Realized gains and losses on investments include amounts resulting from
differences in the actual level of impairments and the levels assumed in
calculating EGPs.
We generally amortize DAC, VOBA, DSI and DFEL in proportion to our EGPs for
interest-sensitive products. When actual gross profits are higher in the period
than EGPs, we recognize more amortization than planned. When actual gross
profits are lower in the period than EGPs, we recognize less amortization than
planned. In a calendar year where the gross profits for a certain group of
policies, or "cohorts," are negative, our actuarial process limits, or floors,
the amortization expense offset to zero. For a discussion of the periods over
which we amortize our DAC, VOBA, DSI and DFEL see "DAC, VOBA, DSI and DFEL" in
Note 1.
Unlocking
As discussed and defined in "DAC, VOBA, DSI and DFEL" in Note 1, 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. We may
have unlocking in other quarters as we become aware of information that warrants
updating assumptions outside of our annual comprehensive review.
For illustrative purposes, the following generally presents the hypothetical
effects to net income (loss) attributable to changes in certain assumptions from
those our model projections assume, assuming all other factors remain constant:
Hypothetical
Effect to
Change in
Assumption Net Income (Loss) Description of Expected Effect
Higher equity Increase to fee income and decrease to
markets Favorable changes in reserves.
Lower equity Decrease to fee income and increase to
markets Unfavorable changes in reserves.
Higher investment Increase to interest rate spread on our fixed
margins Favorable product line, including fixed
portion of variable.
Lower investment Decrease to interest rate spread on our fixed
margins Unfavorable product line, including fixed
portion of variable.
Decrease to fee income, partially offset by
Higher lapses Unfavorable decrease to benefits due to
shorter contract life.
Increase to fee income, partially offset by
Lower lapses Favorable increase to benefits due to
longer contract life.
Unfavorable Decrease to fee income and increase to
mortality Unfavorable changes in reserves due to
shorter contract life.
Favorable Increase to fee income and decrease to
mortality Favorable changes in reserves due to
longer contract life.
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Details underlying the effect to net income (loss) from unlocking (in millions)
were as follows:
For the Years Ended December 31,
2020 2019 2018
Income (loss) from operations:
Annuities $ (101 ) $ (93 ) $ 13
Retirement Plan Services (3 ) - (2 )
Life Insurance (440 ) (320 ) (20 )
Excluded realized gain (loss) 58 3 8
Net income (loss) $ (486 ) $ (410 ) $ (1 ) Unlocking was driven primarily by the following:
2020
As part of our annual comprehensive review in the third quarter, 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-yearU.S. Treasury . As a result of these updates, we recorded unfavorable after-tax unlocking of$361 million for Life Insurance,$140 million for Annuities and$7 million for Retirement Plan Services.
?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 maintenance expense and other items.
?
?For excluded realized gain (loss), favorable unlocking was driven by updates to policyholder behavior and separate account fee assumptions, partially offset by unfavorable updates to other items.
2019
As part of our annual comprehensive review in the third quarter, we updated our interest rate assumptions. These updates included lowering starting new money rates to reflect the current interest rate environment; reducing our long-term new money investment yield assumption by 25 basis points, resulting in an ultimate long-term assumption of 3.5% for a 10-yearU.S. Treasury ; and extending the grade-in period from current rates to long-term rates from five years to seven years. As a result of these updates, we recorded unfavorable after-tax unlocking of$225 million for Life Insurance,$63 million for Annuities and$3 million for Retirement Plan Services. ?For Annuities, unfavorable unlocking was driven by updates to interest rate assumptions and other items, partially offset by favorable updates to separate account fee and policyholder behavior assumptions.
?For Retirement Plan Services, unfavorable unlocking impact from updates to interest rate assumptions was entirely offset by favorable updates to separate account fee, maintenance expense and policyholder behavior assumptions.
?For Life Insurance , unfavorable unlocking was driven by updates to mortality margin, interest rate and reinsurance assumptions, partially offset by favorable updates to investment allocation and reserve discount rate assumptions and other items. ?For excluded realized gain (loss), favorable unlocking was driven by updates to capital markets, separate account fee and policyholder behavior assumptions, partially offset by unfavorable updates to other items.
Reversion to the Mean
Because returns within the variable sub-accounts ("variable funds") have a
significant effect on the value of variable annuity and VUL products and the
fees earned on these accounts, EGPs could increase or decrease with movements in
variable fund returns. Significant and sustained changes in variable funds have
had and could in the future have an effect on DAC, VOBA, DSI and DFEL
amortization primarily within our Annuities and RPS segments, as well as, to a
lesser extent, our Life Insurance segment.
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. Under our RTM process, future EGPs
are projected using stochastic modeling of a large number of market scenarios in
conjunction with best estimates of lapse rates, interest rate spreads and
mortality to develop a statistical distribution of the present value of future
EGPs for our variable annuity products. Because variable fund returns are
unpredictable, the underlying premise of this process is that best estimate
projections of future EGPs need not be affected by random short-term and
insignificant deviations from expectations in variable fund returns. However,
long-term or significant deviations from expected variable fund returns require
a change to best estimate projections of EGPs and unlocking of DAC, VOBA, DSI,
DFEL and
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changes in future contract benefits. The statistical distribution is designed to identify when the deviations from expected returns have become significant enough to warrant a change of the future variable fund growth rate assumption.
As discussed above, stochastic modeling is used to develop a range of reasonably possible future EGPs. We compare the range of the present value of the future EGPs from the stochastic modeling to that used in our amortization model. A set of intervals around the mean of these scenarios is utilized to calculate two separate statistical ranges of reasonably possible EGPs. These intervals are then compared to the present value of the EGPs used in the amortization model. If the present value of EGPs utilized for amortization were to exceed the reasonable range of statistically calculated EGPs, a revision of the EGPs used to calculate amortization would be considered. If a revision is deemed necessary, future EGPs would be re-projected using the current account values at the end of the period during which the revision occurred along with a long-term variable fund growth rate assumption such that the re-projected EGPs would be our best estimate of EGPs. Our practice is not necessarily to unlock immediately after exceeding the first of the two statistical ranges, but, rather, if we stay between the first and second statistical range for several quarters, we would likely unlock. Additionally, if we exceed the ranges as a result of a short-term market reaction, we would not necessarily unlock. However, if the second statistical range is exceeded for more than one quarter, it is likely that we would unlock. While this approach reduces adjustments to DAC, VOBA, DSI and DFEL due to short-term fluctuations, significant changes in variable fund returns that extend beyond one or two quarters could result in a significant favorable or unfavorable unlocking. Notwithstanding these intervals, if a severe decline or increase in variable fund values were to occur or should other circumstances suggest that the present value of future EGPs no longer represents our best estimate, we could determine that a revision of the EGPs is necessary. Our long-term variable fund growth rate assumption, which is used in the determination of DAC, VOBA, DSI and DFEL amortization for the variable component of our variable annuity and VUL products, is an immediate decrease of approximately 13% followed by growth going forward of 6.5% to 8.25% depending on the block of business and reflecting differences in contract holder fund allocations between fixed-income and equity-type investments. If we had unlocked our RTM assumption as ofDecember 31, 2020 , we would have recorded favorable unlocking of approximately$365 million , pre-tax, primarily within our Annuities segment. Investments Investments are an integral part of our operations, and we invest in fixed maturity securities that are primarily classified as available-for-sale and carried at fair value with the difference from amortized cost due to factors other than credit loss included in stockholders' equity as a component of AOCI. The difference between amortized cost and fair value due to credit loss impairment is recognized in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). We also invest in equity securities that are carried at fair value with changes in fair value recognized in realized gain (loss). See "Consolidated Investments" below for more information.
Investment Valuation
Our measurement of fair value is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset orNPR , which would include our own credit risk. Our estimate of an exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability ("exit price") in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability ("entry price"). We categorize our financial instruments carried at fair value into a three-level fair value hierarchy, based on the priority of inputs to the respective valuation technique. The three-level hierarchy for fair value measurement is defined in Note 1. 46
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The following summarizes investments on our Consolidated Balance Sheets carried at fair value by pricing source and fair value hierarchy level (in millions) as ofDecember 31, 2020 : 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$ 554 $ 106,696 $ 215 $ 107,465 Priced by independent broker quotations - - 5,296 5,296 Priced by matrices - 14,506 - 14,506 Priced by other methods (1) - - 3,442 3,442 Total$ 554 $ 121,202 $ 8,953 $ 130,709 Percent of total 0% 93% 7% 100%
(1)Represents primarily securities for which pricing models were used to compute fair value.
For the categories and associated fair value of our fixed maturity AFS
securities classified within Level 3 of the fair value hierarchy as of
Our investments are valued using the appropriate market inputs based on the investment type, and include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators and industry and economic events are monitored, and further market data is acquired if certain triggers are met. We incorporate the issuer's credit rating and a risk premium, if warranted, given the issuer's industry and the security's time to maturity. We use an internationally recognized pricing service as our primary pricing source, and we do not adjust prices received from third parties or obtain multiple prices when measuring the fair value of our investments. We generally use prices from the pricing service rather than broker quotes because we have documentation from the pricing service on the observable market inputs they use, as compared to the limited information on the pricing inputs from broker quotes. For private placement securities, we use pricing matrices that utilize observable pricing inputs of similar public securities andTreasury yields as inputs to the fair value measurement. It is possible that different valuation techniques and models, other than those described above, could produce materially different estimates of fair value. When the volume and level of activity for an asset or liability has significantly decreased in relation to normal market activity for the asset or liability, we believe that the market is not active. Activities that may indicate a market is not active include fewer recent transactions in the market, price quotations that lack current information and/or vary substantially over time or among market makers, limited public information, uncorrelated indexes with recent fair values of assets and abnormally wide bid-ask spread. As ofDecember 31, 2020 , we evaluated the markets that our securities trade in and concluded that none were inactive. We will continue to re-evaluate this conclusion, as needed, based on market conditions. We use unobservable inputs to measure the fair value of securities trading in less liquid or illiquid markets with limited or no pricing information. We obtain broker quotes for securities such as synthetic convertibles, index-linked certificates of deposit and collateralized debt obligations when sufficient security structure or other market information is not available to produce an evaluation. For broker-quoted only securities, non-binding quotes from market makers or broker-dealers are obtained from sources recognized as market participants. Broker-quoted securities are based solely on receipt of updated quotes from a single market maker or a broker-dealer recognized as a market participant. Our broker-quoted only securities are generally classified as Level 3 of the fair value hierarchy. As ofDecember 31, 2020 , we used broker quotes for 94 securities as our final price source, representing 1% of total securities owned. In order to validate the pricing information and broker quotes, we employ, where possible, procedures that include comparisons with similar observable positions, comparisons with subsequent sales and observations of general market movements for those security classes. Our primary third-party pricing service has policies and processes to ensure that it is using objectively verifiable observable market data. The pricing service regularly reviews the evaluation inputs for securities covered, including broker quotes, executed trades and credit information, as applicable. If the pricing service determines it does not have sufficient objectively verifiable information about a security's valuation, it discontinues providing a valuation for the security. The pricing service regularly publishes and updates a summary of inputs used in its valuations by major security type. In addition, we have policies and procedures in place to review the process that is utilized by the third-party pricing service and the output that is provided to us by the pricing service. On a periodic basis, we test the pricing for a sample of securities to evaluate the inputs and assumptions used by the pricing service, and we perform a comparison of the pricing service output to an alternative pricing source. In addition, we check prices provided by our primary pricing service to ensure that they are not stale or unreasonable by reviewing the prices for unusual changes from period to period based on certain parameters or for lack of change from one period to the next. If such anomalies in the pricing are observed, we may use pricing information from another pricing source. 47
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Valuation of Alternative Investments
Recognition of investment income on alternative investments is delayed due to the availability of the related financial statements, which are generally obtained from the partnerships' general partners, as our venture capital, real estate and oil and gas portfolios are generally reported to us on a three-month delay, and our hedge funds are reported to us on a one-month delay. In addition, the effect of annual audit adjustments related to completion of calendar-year financial statement audits of the investees are typically received during the first or second quarter of each calendar year. Accordingly, our investment income from alternative investments for any calendar year period may not include the complete effect of the change in the underlying net assets for the partnership for that calendar year period. Recorded audit adjustments affect our investment income on alternative investments in the period that the adjustments are recorded.
Measurement of Allowances for Credit Losses and Recognition of Impairments
As ofJanuary 1, 2020 , we adopted ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which replaced the historical incurred credit loss methodology with an expected credit loss methodology and impacts the way we recognize and measure impairment. See Note 2 for additional information. We regularly review our fixed maturity AFS securities for declines in fair value that we determine to be impairment-related. Realized gains and losses generally originate from asset sales to reposition the portfolio or to respond to product experience. In the process of evaluating whether a security with an unrealized loss reflects declines that are related to credit losses, we consider our ability and intent to sell the security prior to a recovery of value. However, subsequent decisions on securities sales are made within the context of overall risk monitoring, assessing value relative to other comparable securities and overall portfolio maintenance. Although our portfolio managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses attributable to factors other than credit loss until such losses are recovered, the dynamic nature of portfolio management may result in a subsequent decision to sell. These subsequent decisions are consistent with the classification of our investment portfolio as AFS. We expect to continue to manage all non-trading investments within our portfolios in a manner that is consistent with the AFS classification. We consider economic factors and circumstances within industries and countries where recent impairments have occurred in our assessment of the position of securities we own of similarly situated issuers. While it is possible for realized or unrealized losses on a particular investment to affect other investments, our risk management strategy has been designed to identify correlation risks and other risks inherent in managing an investment portfolio. Once identified, strategies and procedures are developed to effectively monitor and manage these risks. The areas of risk correlation that we pay particular attention to are risks that may be correlated within specific financial and business markets, risks within specific industries and risks associated with related parties. When the detailed analysis by our external asset managers and investment portfolio managers leads us to the conclusion that a security's decline in fair value is due to credit loss, a credit loss allowance is recorded. In instances where declines are related to factors other than credit loss, the security will continue to be carefully monitored. There are risks and uncertainties associated with determining whether an investment shows indications of impairment. These include subsequent significant changes in general overall economic conditions, as well as specific business conditions affecting particular issuers, future financial market effects such as interest rate spreads, stability of foreign governments and economies, future rating agency actions and significant accounting, fraud or corporate governance issues that may adversely affect certain investments. In addition, there are often significant estimates and assumptions that we use to estimate the fair values of securities as described in "Investment Valuation" above. We continually monitor developments and update underlying assumptions and financial models based upon new information. For certain securitized fixed maturity AFS securities with contractual cash flows, including asset-backed securities ("ABS"), we use our best estimate of cash flows for the life of the security to determine whether it is credit impaired. In addition, we review for other indicators of impairment as required by the Investments - Debt and Equity Securities Topic of theFinancial Accounting Standards Board ("FASB") Accounting Standards CodificationTM ("ASC"). Write-downs on real estate and other investments are experienced when the estimated value of the asset is deemed to be less than the carrying value. Write-downs and allowance for credit losses for commercial mortgage loans are established when the estimated value of the asset is deemed to be less than the carrying value. All commercial mortgage loans that are impaired are individually reviewed to determine an appropriate credit loss allowance. Changing economic conditions affect our valuation of commercial mortgage loans. Increasing vacancies, declining rents and the like are incorporated into the allowance for credit losses analysis that we perform for monitored loans and may contribute to an increase in the allowance for credit losses. In addition, we continue to monitor the entire commercial mortgage loan portfolio to identify both current and projected future risk based on reasonable and supportable forecasts. Areas of emphasis include properties that have deteriorating credits or have experienced debt-service coverage and/or loan-to-value reduction. Where warranted, we have established or increased our allowance for credit losses based upon this analysis. We have also established an allowance for credit losses on our residential mortgage loan portfolio that includes a specific credit loss allowance for loans that are deemed to be impaired as well as an allowance for credit losses for pools of loans with similar risk characteristics. The allowance for credit losses for the performing population of loans is based on historical performance for similar loans, as well as projected future losses based on modeling, which includes reasonable and supportable forecasts. The historical data utilized in the allowance for credit losses calculation process is adjusted for current economic conditions. 48
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Amortization of DAC, VOBA, DSI and DFEL and changes in other contract holder funds reflect an assumption for an expected level of credit-related investment losses. When actual credit-related investment losses are realized, we recognize a true-up to our DAC, VOBA, DSI and DFEL amortization and changes in other contract holder funds within realized losses reflecting the incremental effect of actual versus expected credit-related investment losses. These actual to expected amortization adjustments could create volatility in net realized gains and losses. Derivatives We maintain an overall risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate risk, foreign currency exchange risk, equity market risk, default risk, basis risk and credit risk. Assessing the effectiveness of these hedging programs and evaluating the carrying values of the related derivatives often involve a variety of assumptions and estimates. Our accounting policies for derivatives and the potential effect on interest spreads in a falling rate environment are discussed in "Item 7A. Quantitative and Qualitative Disclosures About Market Risk," Notes 1 and 6. We carry our derivative instruments at fair value, which we determine through valuation techniques or models that use market data inputs or independent broker quotations. The fair values fluctuate from period to period due to the volatility of the valuation inputs, including but not limited to swap interest rates, interest and equity volatility and equity index levels, foreign currency forward and spot rates, credit spreads and correlations, some of which are significantly affected by economic conditions. The effect to revenue is reported in realized gain (loss) and such amount along with the associated federal income taxes is excluded from income (loss) from operations of our segments. Certain of our variable annuity contracts reported within future contract benefits contain embedded derivatives that are carried at fair value on a recurring basis and are all classified as Level 3 of the fair value hierarchy, including our GLB reserves embedded derivatives, a portion of which may be reported in either other assets or other liabilities. These embedded derivatives are valued based on a stochastic projection of scenarios of the embedded derivative cash flows. The scenario assumptions, at each valuation date, are those we view to be appropriate for a hypothetical market participant and include assumptions for capital markets, actuarial lapse, benefit utilization, mortality, risk margin, administrative expenses and a margin for profit. In addition, anNPR component is determined at each valuation date that reflects our risk of not fulfilling the obligations of the underlying liability. The spread for theNPR is added to the discount rates used in determining the fair value from the net cash flows. We believe these assumptions are consistent with those that would be used by a market participant; however, as the related markets develop, we will continue to reassess our assumptions. It is possible that different valuation techniques and assumptions could produce a materially different estimate of fair value. Changes in the fair value of these embedded derivatives result primarily from changes in market conditions. For more information, see Notes 1 and 21.
GLB
We have a dynamic hedging strategy designed to mitigate selected risk and income
statement volatility caused by changes in the equity markets, interest rates and
market-implied volatilities associated with the guaranteed withdrawal benefit
("GWB") and guaranteed income benefit ("GIB") features that are available in our
variable annuity products. We have certain GLB variable annuity products with
GWB and GIB features that are embedded derivatives. Certain features of these
guarantees have elements of both insurance benefits accounted for under the
Financial Services - Insurance - Claim Costs and Liabilities for Future Policy
Benefits Subtopic of the FASB ASC ("benefit reserves") and embedded derivative
reserves. We calculate the value of the embedded derivative reserve and the
benefit reserve based on the specific characteristics of each GLB feature. In
addition to mitigating selected risk and income statement volatility, the hedge
program is also focused on a long-term goal of accumulating assets that could be
used to pay claims under these benefits.
Changes in the value of the hedge contracts hedge the income statement effect of
changes in GLB embedded derivative reserves and benefit reserves. This dynamic
hedging strategy utilizes options and total return swaps on U.S. -based equity
indices, and futures on U.S. -based and international equity indices, as well as
interest rate futures, interest rate swaps and currency futures. The notional
amounts of the underlying hedge instruments are such that the magnitude of the
change in the value of the hedge instruments due to changes in equity markets,
interest rates and implied volatilities is designed to offset the magnitude of
the change in the GLB embedded derivative reserves and GLB benefit reserves
caused by changes in equity markets, as well as the change in GLB embedded
derivative reserves caused by changes in interest rates and implied
volatilities. See "Realized Gain (Loss) and Benefit Ratio Unlocking - Variable
Annuity Net Derivatives Results" below for information on how we determine our
NPR .
As part of our current hedging program, equity market, interest rate and
market-implied volatility conditions are monitored on a daily basis. We
rebalance our hedge positions based upon changes in these factors as needed.
While we actively manage our hedge positions, these positions may not completely
offset changes in the fair value of embedded derivative reserves and benefit
reserves caused by movements in these factors due to, among other things,
differences in timing between when a market exposure changes and corresponding
changes to the hedge positions, extreme swings in the equity markets, interest
rates and market-implied volatilities, realized market volatility, contract
holder behavior, divergence between the performance of the underlying funds and
the hedging indices, divergence between the actual and expected performance of
the hedge instruments or our ability to purchase hedging instruments at prices
consistent with our desired risk and return trade-off.
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Within our individual annuity business, 59% and 63% of our variable annuity account values contained GLB features as ofDecember 31, 2020 and 2019, respectively. 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 ofDecember 31, 2020 and 2019, 10% of all in-force contracts with a GLB feature were "in the money," and our exposure, after reinsurance, as ofDecember 31, 2020 and 2019, was$582 million and$598 million , respectively. However, the 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. As a result of these factors, the ultimate amount to be paid by us related to GLB guarantees is uncertain and could be significantly more or less than$582 million , net of reinsurance. Our fair value estimates of the GLB embedded derivatives, which are based on detailed models of future cash flows under a wide range of market-consistent scenarios, reflect a more comprehensive view of the related factors and represent our best estimate of the present value of these potential liabilities. The market-consistent scenarios used in the determination of the fair value of the GLB embedded derivatives are similar to those used by an investment bank to value derivatives for which the pricing is not transparent and the aftermarket is nonexistent or illiquid. We use risk-neutralMonte Carlo simulations in our calculation to value the entire block of guarantees, which involve 100 unique scenarios per policy or approximately 47 million scenarios. The market-consistent scenario assumptions, at each valuation date, are those we view to be appropriate for a hypothetical market participant. The market-consistent inputs include, but are not limited to, assumptions for capital markets (e.g., implied volatilities, correlation among indices, risk-free swap curve, etc.), policyholder behavior (e.g., policy lapse, rider utilization, etc.), mortality, risk margins, maintenance expenses and a margin for profit. We believe these assumptions are consistent with those that would be used by a market participant; however, as the related markets develop, we will continue to reassess our assumptions. It is possible that different valuation techniques and assumptions could produce a materially different estimate of fair value. For information on our variable annuity hedge program performance, see our discussion in "Realized Gain (Loss) and Benefit Ratio Unlocking - Variable Annuity Net Derivatives Results" below. The following table presents 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 (in millions) at the levels indicated in the table and excludes the net cost of operating the hedging program. The amounts represent the estimated difference between the change in the portion of GLB reserves that is calculated on a fair value basis and the change in the value of the underlying hedge instruments after the amortization of DAC, VOBA, DSI and DFEL and taxes. These effects do not include any estimate of unlocking that could occur, nor do they estimate any change in theNPR component of the GLB reserve or any estimate of effects to our GLB benefit ratio unlocking. These estimates are based upon the recorded reserves as ofDecember 31, 2020 , and the related hedge instruments in place as of that date. The effects presented in the table below are not representative of the aggregate impacts that could result if a combination of such changes to equity market returns, interest rates and implied volatilities occurred. In-Force Sensitivities Equity Market Return -20% -10% -5% 5%
Hypothetical effect to net income
Interest Rates -50 bps -25 bps +25 bps +50
bps
Hypothetical effect to net income
Implied Volatilities 4% 2% -2%
-4%
Hypothetical effect to net income
(6 )
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The following table shows the effect (dollars in millions) of indicated changes
in instantaneous shifts in equity market returns, interest rate scenarios and
market-implied volatilities:
Assumptions of Changes In
Equity Interest Market
Market Rate Implied Net
Return Yields Volatilities Income
Scenario 1 -5% -12.5 bps +1% $ (14 )
Scenario 2 -10% -25.0 bps +2% (72 )
Scenario 3 -20% -50.0 bps +4% (327 )
?The actual effects of the results illustrated in the two tables above could
vary significantly depending on a variety of factors, many of which are out of
our control, and consideration should be given to the following:
?The analysis is only valid as of
?The analysis assumes instantaneous shifts in the capital market factors and no ability to rebalance hedge positions prior to the market changes;
?The analysis assumes constant exchange rates and implied dividend yields;
?Assumptions regarding shifts in the market factors, such as assuming parallel shifts in interest rate and implied volatility term structures, may be overly simplistic and not indicative of actual market behavior in stress scenarios;
?It is very unlikely that one capital market sector (e.g., equity markets) will sustain such a large instantaneous movement without affecting other capital market sectors; and
?The analysis assumes that there is no tracking or basis risk between the funds and/or indices affecting the GLB reserves and the instruments utilized to hedge these exposures. Index Benefits Our indexed annuity and IUL contracts permit the holder to elect a fixed interest rate return or a return where interest credited to the contracts is linked to the performance of the S&P 500® Index or other indices. Contract holders may elect to rebalance among the various accounts within the product at renewal dates. At the end of each indexed term, which can be up to six years, we have the opportunity to re-price the indexed component by establishing different participation rates, caps, spreads or specified rates, subject to contractual guarantees. We purchase and sell index options that are highly correlated to the portfolio allocation decisions of our contract holders, such that we are economically hedged with respect to equity returns for the current reset period. The mark-to-market of the options held generally offsets the change in value of the embedded derivative within the contract, both of which are recorded as a component of realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). The Derivatives and Hedging and the Fair Value Measurements and Disclosures Topics of the FASB ASC require that we calculate fair values of index options we may purchase or sell in the future to hedge contract holder index allocations in future reset periods. These fair values represent an estimate of the cost of the options we will purchase or sell in the future, discounted back to the date of the balance sheet, using current market indicators of volatility and interest rates. Changes in the fair values of these liabilities are included as a component of realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). For information on our index benefits hedging results, see our discussion in "Realized Gain (Loss) and Benefit Ratio Unlocking" below.
Future Contract Benefits and Other Contract Holder Obligations
Reserves
Reserves are the amounts that, with the additional premiums to be received and
interest thereon compounded annually at certain assumed rates, are calculated to
be sufficient to meet the various policy and contract obligations as they
mature. Establishing adequate reserves for our obligations to contract holders
requires assumptions to be made regarding mortality and morbidity. The
applicable insurance laws under which insurance companies operate require that
they report, as liabilities, policy reserves to meet future obligations on their
outstanding contracts. These laws specify that the reserves shall not be less
than reserves calculated using certain specified mortality and morbidity tables,
interest rates and methods of valuation.
The reserves reported in our consolidated financial statements contained herein
are calculated in accordance with generally accepted accounting principles
("GAAP") and differ from those specified by the laws of the various states and
carried in the statutory financial statements of the life insurance
subsidiaries. These differences arise from the use of mortality and morbidity
tables, interest, persistency and other assumptions that we believe to be more
representative of the expected experience for these contracts than those
required for statutory accounting purposes and from differences in actuarial
reserving methods.
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The assumptions on which reserves are based are intended to represent an estimation of experience for the period that policy benefits are payable. If actual experience is better than or equal to the assumptions, then reserves should be adequate to provide for future benefits and expenses. If experience is worse than the assumptions, additional reserves may be required. This would result in a charge to our net income during the period the increase in reserves occurred. The key experience assumptions include mortality rates, policy persistency and interest rates. We periodically review our experience and update our policy reserves for new issues and reserve for all claims incurred, as we believe appropriate. GDB The reserves related to the GDB features available in our variable annuity products are based on the application of a "benefit ratio" (the present value of total expected benefit payments over the life of the contract divided by the present value of total expected assessments over the life of the contract) to total variable annuity assessments received in the period. The level and direction of the change in reserves will vary over time based on the emergence of the benefit ratio and the level of assessments associated with the variable annuity. We utilize a delta hedging strategy for variable annuity products with a GDB feature, which uses futures and total return swaps on equity market indices to hedge against movements in equity markets. The hedging strategy is designed to hedge our exposure to earnings volatility that results from equity market driven changes in the reserve for GDB contracts. Because the GDB reserves are based upon projected long-term equity market return assumptions, and because the value of the hedging contracts will reflect current capital market conditions, the quarterly changes in values for the GDB reserves and the hedging contracts may not exactly offset each other. For information on our variable annuity hedge program performance, see our discussion in "Realized Gain (Loss) and Benefit Ratio Unlocking - Variable Annuity Net Derivatives Results" below.
UL Products with Secondary Guarantees
We issue UL contracts where we provide a secondary guarantee to the contract holder. The policy can remain in force, even if the base policy account value is zero, as long as contractual secondary guarantee requirements have been met. The reserves related to UL products with secondary guarantees are based on the application of a benefit ratio the same as our GDB features, which are discussed above. The level and direction of the change in reserves will vary over time based on the emergence of the benefit ratio and the level of assessments associated with the contracts. For more discussion, see "Results of Life Insurance" below.
Goodwill and intangible assets with indefinite lives are not amortized, but are reviewed for impairment annually as ofOctober 1 and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Intangibles that do not have indefinite lives are amortized over their estimated useful lives. We perform a quantitative goodwill impairment test where the fair value of the reporting unit is determined and compared to the carrying value of the reporting unit. If the carrying value of the reporting unit exceeds the reporting unit's fair value, goodwill is impaired and written down to the reporting unit's fair value. The results of one test on one reporting unit cannot subsidize the results of another reporting unit. For the purposes of the evaluation of the carrying value of goodwill, our reporting units (Annuities, Retirement Plan Services, Life
Insurance and Group Protection) correspond with our reporting segments.
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. As ofOctober 1, 2020 and 2019, we performed our annual quantitative goodwill impairment test for our reporting units, and, as of each such date, the fair value was in excess of each reporting unit's carrying value for Annuities, Retirement Plan Services, Life Insurance and Group Protection. 52
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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. Examples of unfavorable changes to assumptions or factors that could result in future impairment include, but are not limited to, the following:
?Lower expectations for future sales levels or future sales profitability;
?Higher discount rates on new business assumptions;
?Weakened expectations for the ability to execute future reserve financing transactions for life insurance business over the long-term or expectations for significant increases in the associated costs;
?Legislative, regulatory or tax changes that affect the cost of, or demand for,
our subsidiaries' products, the required amount of reserves and/or surplus, or
otherwise affect our ability to conduct business, including changes to statutory
reserve requirements or changes to risk-based capital ("RBC") requirements; and
?Valuations of significant mergers or acquisitions of companies or blocks of
business that would provide relevant market-based inputs for our impairment
assessment that could support less favorable conclusions regarding the estimated
fair value of our reporting units.
Refer to Note 10 for goodwill and specifically identifiable intangible assets by segment.
Income Taxes
Management uses certain assumptions and estimates in determining the income
taxes payable or refundable for the current year, the deferred income tax
liabilities and assets for items recognized differently in its financial
statements from amounts shown on its income tax returns and the federal income
tax expense. Determining these amounts requires analysis and interpretation of
current tax laws and regulations. Management exercises considerable judgment in
evaluating the amount and timing of recognition of the resulting income tax
liabilities and assets. These judgments and estimates are re-evaluated on a
continual basis as regulatory and business factors change. Legislative changes
to the Internal Revenue Code of 1986, as amended, modifications or new
regulations, administrative rulings, or court decisions could increase or
decrease our effective tax rate.
The application of GAAP requires us to evaluate the recoverability of our
deferred tax assets and establish a valuation allowance, if necessary, to reduce
our deferred tax asset to an amount that is more likely than not to be
realizable. Considerable judgment and the use of estimates are required in
determining whether a valuation allowance is necessary, and if so, the amount of
such valuation allowance. In evaluating the need for a valuation allowance, we
consider many factors, including: the nature and character of the deferred tax
assets and liabilities; taxable income in prior carryback years; future
reversals of existing temporary differences; the length of time carryovers can
be utilized; and any tax planning strategies we would employ to avoid a tax
benefit from expiring unused. Although realization is not assured, management
believes it is more likely than not that the deferred tax assets, including our
net operating loss deferred tax asset, will be realized. For additional
information on our income taxes, see Note 7.
Acquisitions and DispositionsFor information about acquisitions and dispositions, see Note 3.
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RESULTS OF CONSOLIDATED OPERATIONS
Details underlying the consolidated results, deposits, net flows and account values (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Net Income (Loss)
Income (loss) from operations:
Annuities $ 983 $ 954 $ 1,102
Retirement Plan Services 168 172 171
Life Insurance (34 ) 259 645
Group Protection 43 238 187
Other Operations (295 ) (268 ) (225 )
Excluded realized gain (loss),
after-tax (570 ) (627 ) (37 )
Benefit ratio unlocking, after-tax 194 277 (136 )
Net impact from the Tax Cuts and
Jobs Act 37 17 19
Acquisition and integration costs related to mergers and acquisitions, after-tax (15 ) (103 ) (67 ) Gain (loss) on early extinguishment of debt, after-tax (12 ) (33 ) (18 ) Net income (loss)$ 499 $ 886 $ 1,641 For the Years Ended December 31, 2020 2019 2018 Deposits Annuities$ 11,260 $ 14,525 $ 12,363 Retirement Plan Services 10,017 9,465 10,068 Life Insurance 5,890 7,320 6,438 Total deposits$ 27,167 $ 31,310 $ 28,869 Net Flows Annuities$ (341 ) $ 1,851 $ (139 ) Retirement Plan Services 166 620 2,546 Life Insurance 4,137 5,422 4,679 Total net flows$ 3,962 $ 7,893 $ 7,086 As of December 31, 2020 2019 2018 Account Values Annuities$ 157,518 $ 142,128 $ 121,279
Retirement Plan Services 88,307 78,689 67,055 Life Insurance
57,605 54,255 49,589
Total account values
Comparison of 2020 to 2019
Net income decreased due primarily to the following:
?Higher benefits in our Life Insurance and Group Protection segments driven by the COVID-19 pandemic.
?Spread compression due to average new money rates trailing our current portfolio yields, partially offset by actions implemented to reduce interest crediting rates.
?The effect of unlocking.
?Lower prepayment and bond make-whole premiums.
The decrease in net income was partially offset by the following:
?Higher investment income on alternative investments.
?Aggressively managing expenses, and lower incentive compensation as a result of production performance.
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?Lower acquisition and integration costs incurred associated with our 2018 acquisition.
?Growth in average account values, business in force and group earned premiums.
?Lower realized losses.
For a discussion of the expected and potential impacts of the COVID-19 pandemic,
see "Introduction - Executive Summary" above and "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."
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RESULTS OF ANNUITIES
Income (Loss) from Operations
Details underlying the results for Annuities (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Operating Revenues
Insurance premiums (1) $ 121 $ 502 $ 390
Fee income 2,394 2,357 2,342
Net investment income 1,272 1,140 1,005
Operating realized gain (loss) (2) 214 190 192
Amortization of deferred gain on
business sold through reinsurance 29 30 8
Other revenues (3) 425 381 446
Total operating revenues 4,455 4,600 4,383
Operating Expenses
Interest credited 773 698 587
Benefits (1) 696 938 673
Commissions and other expenses 1,854 1,871 1,838
Total operating expenses 3,323 3,507 3,098
Income (loss) from operations before taxes 1,132 1,093 1,285
Federal income tax expense (benefit) 149 139 183
Income (loss) from operations $ 983 $
954
(1)Insurance premiums include primarily our income annuities that have a corresponding offset in benefits. Benefits include changes in income annuity reserves driven by premiums.
(2)See "Realized Gain (Loss) and Benefit Ratio Unlocking" below.
(3)Consists primarily of revenues attributable to broker-dealer services that
are subject to market volatility and the net settlement related to a modified
coinsurance ("Modco") reinsurance transaction.
Comparison of 2020 to 2019
Income from operations for this segment increased due primarily to the following:
?Higher net investment income, net of interest credited, driven by higher average gross fixed account values and investment income on alternative investments within our surplus portfolio.
?Higher fee income driven by higher average daily variable account values.
?Lower commissions and other expenses due to the effect of unlocking, expense management and incentive compensation as a result of production performance, partially offset by higher trail commissions resulting from higher average account values. The increase in income from operations was partially offset by higher benefits, net of changes in income annuity reserves, due to the effect of unlocking, an increase in the growth in benefit reserves driven primarily by equity market performance and an increase in costs associated with our hedge program.
See "Critical Accounting Policies and Estimates - DAC, VOBA, DSI and DFEL - Unlocking" above for information about unlocking.
Additional Information
Strategic near-term actions to re-price certain products and to shift sales from
fixed annuity products to respond to the low interest rate environment have
contributed to lower deposits and negative net flows in 2020. We expect the
trend of negative net flows to persist into 2021. For a discussion of the
expected and potential impacts of the COVID-19 pandemic, see "Introduction -
Executive Summary" above and "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."
New deposits are an important component of net flows and key to our efforts to
grow our business. Although deposits do not significantly affect current period
income from operations, they can significantly impact future income from
operations.
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The other component of net flows relates to the retention of the business. An important measure of retention is the reduction in account values caused by full surrenders, deaths and other contract benefits. These outflows as a percentage of average gross account values were 7%, 9% and 9% in 2020, 2019 and 2018, respectively. Our fixed annuity business includes products with discretionary crediting rates that are reset on an annual basis and are not subject to surrender charges. Our ability to retain annual reset annuities will be subject to current competitive conditions at the time interest rates for these products reset. We expect to manage the effects of spreads on near-term income from operations through portfolio management and, to a lesser extent, crediting rate actions, which assumes no significant changes in net flows into or out of our fixed accounts or other changes that may cause interest rate spreads to differ from our expectations. For information on interest rate spreads and the interest rate risk due to falling 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 "Effect of Interest Rate Sensitivity" and "Interest Rate Risk on Fixed Insurance Businesses - Falling Rates" in "Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk."
Fee Income
Details underlying fee income, account values and net flows (in millions) were
as follows:
For the Years Ended December 31,
2020 2019 2018
Fee Income
Mortality, expense and other
assessments $ 2,381 $ 2,336 $ 2,322
Surrender charges 16 25 30
DFEL:
Deferrals (31 ) (38 ) (39 )
Amortization, net of interest:
Amortization, net of interest,
excluding unlocking 26 34 31
Unlocking 2 - (2 )
Total fee income $ 2,394 $ 2,357 $ 2,342
As of or For the Years Ended
December 31,
2020 2019 2018
Variable Account Value Information
Variable annuity deposits (1) $ 3,978 $ 5,293 $ 5,105
Increases (decreases) in variable
annuity account values:
Net flows (1) (5,262 ) (4,805 ) (4,580 )
Change in market value (1) 16,106 19,844 (5,412 )
Contract holder assessments (1) (2,554 ) (2,491 ) (2,484 )
Transfers to the variable portion
of variable annuity
products from the fixed portion of
variable annuity
products 831 1,760 2,867
Variable annuity account values (1) 128,175 119,047 104,737 Average daily variable annuity account values (1)
116,117 112,978 113,595
Average daily S&P 500® Index (2) 3,218 2,914 2,744
(1)Excludes the fixed portion of variable.
(2)We generally use the S&P 500 Index as a benchmark for the performance of our
variable account values. The account values of our variable annuity contracts
are invested by our policyholders in a variety of investment options including,
but not limited to, domestic and international equity securities and fixed
income, which do not necessarily align with S&P 500 Index performance. See Note
11 for additional information.
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We charge contract holders mortality and expense assessments on variable annuity accounts to cover insurance and administrative expenses. These assessments are a function of the rates priced into the product and the average daily variable account values. Average daily variable account values are driven by net flows and variable fund returns. Charges on GLB riders are assessed based on a contractual rate that is applied either to the account value or the guaranteed amount. We may collect surrender charges when our fixed and variable annuity contract holders surrender their contracts during the surrender charge period to protect us from premature withdrawals. Fee income includes charges on both our variable and fixed annuity products, but excludes the attributed fees on our GLB riders; see "Realized Gain (Loss) and Benefit Ratio Unlocking - Operating Realized Gain (Loss)" below for discussion of these attributed fees.
Net Investment Income and Interest Credited
Details underlying net investment income, interest credited and fixed account values (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Net Investment Income
Fixed maturity AFS securities,
mortgage loans on real estate
and other, net of investment
expenses $ 1,122 $ 1,004 $ 835
Commercial mortgage loan prepayment and bond make-whole premiums (1) 23 29 21 Surplus investments (2) 127 107 149 Total net investment income$ 1,272 $ 1,140 $ 1,005 Interest Credited Amount provided to contract holders$ 755 $ 690 $ 600 DSI deferrals (4 ) (21 ) (43 ) Interest credited before DSI amortization 751 669 557 DSI amortization: Amortization, excluding unlocking 21 26 30 Unlocking 1 3 - Total interest credited$ 773 $ 698 $ 587
(1)See "Consolidated Investments - Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums" below for additional information.
(2)Represents net investment income on the required statutory surplus for this
segment and includes the effect of investment income on alternative investments
for such assets that are held in the portfolios supporting statutory surplus
versus the portfolios supporting product liabilities. See "Consolidated
Investments - Alternative Investments" below for more information on alternative
investments.
As of or For the Years Ended
December 31,
2020 2019 2018
Fixed Account Value Information
Fixed annuity deposits (1) $ 7,282 $ 9,232 $ 7,258
Increases (decreases) in fixed
annuity account values:
Net flows (1) 4,921 6,656 4,441
Contract holder assessments (1) (66 ) (43 ) (31 )
Transfers from the fixed portion of
variable annuity
products to the variable portion of
variable annuity
products (831 ) (1,760 ) (2,867 )
Reinvested interest credited (1) 1,686 1,489 440 Fixed annuity account values (1)(2) 29,343 23,081 16,542 Average fixed account values (1)(2) 25,804 19,717 20,591
(1)Includes the fixed portion of variable.
(2)Net of reinsurance ceded.
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A portion of our investment income earned is credited to the contract holders of our deferred fixed annuity products, including the fixed portion of variable annuity contracts. We expect to earn a spread between what we earn on the underlying general account investments supporting the fixed annuity product line, including the fixed portion of variable annuity contracts, and what we credit to our fixed annuity contract holders' accounts, including the fixed portion of variable annuity contracts. Changes in commercial mortgage loan prepayments and bond make-whole premiums, investment income on alternative investments and surplus investment income can vary significantly from period to period due to a number of factors and, therefore, may contribute to investment income results that are not indicative of the underlying trends.
Benefits
Details underlying benefits (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Benefits
Net death and other benefits,
excluding unlocking $ 553 $ 834 $ 699
Unlocking 143 104 (26 )
Total benefits $ 696 $ 938 $ 673
Benefits for this segment include changes in income annuity reserves driven by
premiums, changes in benefit reserves and costs associated with the hedging of
our benefit ratio unlocking on benefit reserves associated with our variable
annuity GDB and GLB riders. For a corresponding offset of changes in income
annuity reserves, see footnote 1 of "Income (Loss) from Operations" above.
Commissions and Other Expenses
Details underlying commissions and other expenses (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Commissions and Other Expenses
Commissions:
Deferrable $ 480 $ 606 $ 505
Non-deferrable 581 565 573
General and administrative expenses 427 453 425
Inter-segment reimbursement associated with reserve financing and LOC expenses (1) 3 4 4 Taxes, licenses and fees 31 35
34
Total expenses incurred, excluding broker-dealer 1,522 1,663
1,541
DAC deferrals (548 ) (681 ) (578 ) Total pre-broker-dealer expenses incurred, excluding amortization, net of interest 974 982
963
DAC and VOBA amortization, net of interest: Amortization, net of interest, excluding unlocking 401 396
403
Unlocking (14 ) 12 7 Broker-dealer expenses incurred 493 481 465 Total commissions and other expenses$ 1,854 $ 1,871 $ 1,838 DAC Deferrals As a percentage of sales/deposits 4.9% 4.7%
4.7%
(1)Includes reimbursements to Annuities from the Life Insurance segment for reserve financing, net of expenses incurred by Annuities for its use of letters of credit ("LOCs"). The inter-segment amounts are not reported on our Consolidated Statements of Comprehensive Income (Loss).
Commissions and other costs that result directly from and are essential to the
successful acquisition of new or renewal business are deferred to the extent
recoverable and are amortized over the lives of the contracts in relation to
EGPs. Certain types of commissions, such as trail commissions that are based on
account values, are expensed as incurred rather than deferred and amortized.
Broker-dealer expenses that vary with and are related to sales are expensed as
incurred and not deferred and amortized. Fluctuations in these expenses
correspond with fluctuations in other revenues.
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RESULTS OF RETIREMENT PLAN SERVICES
Income (Loss) from Operations
Details underlying the results for Retirement Plan Services (in millions) were
as follows:
For the Years Ended December 31,
2020 2019 2018
Operating Revenues
Fee income $ 253 $ 252 $ 256
Net investment income 933 924 899
Other revenues (1) 27 24 23
Total operating revenues 1,213 1,200 1,178
Operating Expenses
Interest credited 615 585 555
Benefits 2 2 2
Commissions and other expenses 404 418 421
Total operating expenses 1,021 1,005 978
Income (loss) from operations before taxes 192 195 200
Federal income tax expense (benefit) 24 23 29
Income (loss) from operations $ 168 $ 172 $ 171 (1)Consists primarily of mutual fund account program revenues from mid to large employers.
Comparison of 2020 to 2019 Income from operations for this segment decreased due primarily to lower net investment income, net of interest credited, driven by spread compression due to average new money rates trailing our current portfolio yields and lower prepayment and bond make-whole premiums, partially offset by investment income on alternative investments within our surplus portfolio and higher average fixed account values. The decrease in income from operations was partially offset by lower commissions and other expenses driven by expense management and incentive compensation as a result of production performance, partially offset by the effect of unlocking.
See "Critical Accounting Policies and Estimates - DAC, VOBA, DSI and DFEL - Unlocking" above for information about unlocking.
Additional Information
For a discussion of the expected and potential impacts of the COVID-19 pandemic, see "Introduction - Executive Summary" above and "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."
Net flows in this business fluctuate based on the timing of larger plans being implemented and terminating over the course of the year.
New deposits are an important component of net flows and key to our efforts to
grow our business. Although deposits do not significantly affect current period
income from operations, they can significantly impact future income from
operations. The other component of net flows relates to the retention of the
business. An important measure of retention is the reduction in account values
caused by plan sponsor terminations and participant withdrawals. These outflows
as a percentage of average account values were 13%, 12% and 11% for 2020, 2019
and 2018, respectively.
Our net flows are negatively affected by the continued net outflows from our
oldest blocks of annuities business (as presented on our Net Flows By Market
table below as "Multi-Fund® and other"), which are among our higher margin
product lines in this segment, due to the fact that they are mature blocks with
low distribution and servicing costs. The proportion of these products to our
total account values was 19%, 21% and 23% for 2020, 2019 and 2018, respectively.
Due to this expected overall shift in business mix toward products with lower
returns, new deposit production continues to be necessary to maintain earnings
at current levels.
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Our fixed annuity business includes products with discretionary and index-based crediting rates that are reset on either a quarterly or semi-annual basis. Our ability to retain quarterly or semi-annual reset annuities will be subject to current competitive conditions at the time interest rates for these products reset. We expect to manage the effects of spreads on near-term income from operations through portfolio management and, to a lesser extent, crediting rate actions, which assumes no significant changes in net flows into or out of our fixed accounts or other changes that may cause interest rate spreads to differ from our expectations. For information on interest rate spreads and the interest rate risk due to falling 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 "Effect of Interest Rate Sensitivity" and "Interest Rate Risk on Fixed Insurance Businesses - Falling Rates" in "Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk."
Fee Income
Details underlying fee income, net flows and account values (in millions) were
as follows:
For the Years Ended December 31,
2020 2019 2018
Fee Income
Annuity expense assessments $ 184 $ 184 $ 189
Mutual fund fees 68 67 65
Total expense assessments 252 251 254
Surrender charges 1 1 2
Total fee income $ 253 $ 252 $ 256
For the Years Ended December 31,
2020 2019 2018
Net Flows By Market
Small market $ 350 $ 449 $ 290
Mid - large market 792 1,336 3,401
Multi-Fund® and other (976 ) (1,165 ) (1,145 )
Total net flows $ 166 $ 620 $ 2,546
As of or For the Years Ended
December 31,
2020 2019 2018
Variable Account Value Information
Variable annuity deposits (1) $ 1,843 $ 1,880 $ 1,803
Increases (decreases) in variable
annuity account values:
Net flows (1) (333 ) (518 ) (453 )
Change in market value (1) 2,731 3,426 (885 )
Contract holder assessments (1) (156 ) (155 ) (159 )
Variable annuity account values (1) 18,755 16,952 14,413 Average daily variable annuity account values (1)
16,426 15,960 15,989
Average daily S&P 500® Index 3,218 2,914 2,744
(1) Excludes the fixed portion of variable.
As of or For the Years Ended
December 31,
2020 2019 2018
Mutual Fund Account Value Information
Mutual fund deposits $ 5,449 $ 5,602 $ 6,219
Mutual fund net flows 100 1,316
2,902
Mutual fund account values (1) 46,636 41,179
32,876
(1) Mutual funds are not included in the separate accounts reported on our Consolidated Balance Sheets as we do not have any ownership interest in them.
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We charge expense assessments to cover insurance and administrative expenses. Expense assessments are generally equal to a percentage of the daily variable account values. Average daily account values are driven by net flows and the equity markets. Our expense assessments include fees we earn for the services that we provide to our mutual fund programs. We may collect surrender charges when our fixed and variable annuity contract holders surrender their contracts during the surrender charge period to protect us from premature withdrawals.
Net Investment Income and Interest Credited
Details underlying net investment income, interest credited and fixed account values (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Net Investment Income
Fixed maturity AFS securities,
mortgage loans on real estate
and other, net of investment
expenses $ 834 $ 831 $ 806
Commercial mortgage loan prepayment
and bond
make-whole premiums (1) 23 26 18
Surplus investments (2) 76 67 75
Total net investment income $ 933 $ 924 $ 899
Interest Credited $ 615 $ 585 $ 555 (1)See "Consolidated Investments - Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums" below for additional information.
(2)Represents net investment income on the required statutory surplus for this
segment and includes the effect of investment income on alternative investments
for such assets that are held in the portfolios supporting statutory surplus
versus the portfolios supporting product liabilities. See "Consolidated
Investments - Alternative Investments" below for more information on alternative
investments.
As of or For the Years Ended
December 31,
2020 2019 2018
Fixed Account Value Information
Fixed annuity deposits (1) $ 2,725 $ 1,983 $ 2,046
Increases (decreases) in fixed
annuity account values:
Net flows (1) 399 (178 ) 97
Reinvested interest credited (1) 613 585 558
Contract holder assessments (1) (13 ) (12 ) (11 )
Fixed annuity account values (1) 22,916 20,558 19,766 Average fixed account values (1) 21,696 20,119 19,164
(1)Includes the fixed portion of variable.
A portion of our investment income earned is credited to the contract holders of our fixed annuity products, including the fixed portion of variable annuity contracts. We expect to earn a spread between what we earn on the underlying general account investments supporting the fixed annuity product line, including the fixed portion of variable annuity contracts, and what we credit to our fixed annuity contract holders' accounts, including the fixed portion of variable annuity contracts. Commercial mortgage loan prepayments and bond make-whole premiums, investment income on alternative investments and surplus investment income can vary significantly from period to period due to a number of factors and, therefore, may contribute to investment income results that are not indicative of the underlying trends.
Benefits
Benefits for this segment include changes in annuity benefit reserves.
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Commissions and Other Expenses
Details underlying commissions and other expenses (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Commissions and Other Expenses
Commissions:
Deferrable $ 5 $ 6 $ 7
Non-deferrable 71 73 71
General and administrative expenses 304 319 318
Taxes, licenses and fees 16 17 19
Total expenses incurred 396 415 415
DAC deferrals (21 ) (23 ) (22 )
Total expenses recognized before
amortization 375 392 393
DAC and VOBA amortization, net of interest: Amortization, net of interest, excluding unlocking 25 27 25 Unlocking 4 (1 ) 3 Total commissions and other expenses$ 404 $ 418 $ 421 DAC Deferrals As a percentage of annuity sales/deposits 0.5% 0.6% 0.6% Commissions and other costs that result directly from and are essential to the successful acquisition of new or renewal business are deferred to the extent recoverable and are amortized over the lives of the contracts in relation to EGPs. Certain types of commissions, such as trail commissions that are based on account values, are expensed as incurred rather than deferred and amortized. Distribution expenses associated with the sale of mutual fund products are expensed as incurred. 63
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RESULTS OF LIFE INSURANCE
Income (Loss) from Operations
Details underlying the results for Life Insurance (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Operating Revenues
Insurance premiums (1) $ 950 $ 885 $ 817
Fee income 3,727 3,882 3,392
Net investment income 2,823 2,658 2,697
Operating realized gain (loss) (2) (6 ) (6 ) (5 )
Amortization of deferred gain on
business sold through reinsurance 12 - -
Other revenues 10 19 21
Total operating revenues 7,516 7,438 6,922
Operating Expenses
Interest credited 1,491 1,433 1,414
Benefits 4,586 4,183 3,345
Commissions and other expenses 1,506 1,516 1,371
Total operating expenses 7,583 7,132
6,130
Income (loss) from operations before taxes (67 ) 306
792
Federal income tax expense (benefit) (33 ) 47 147 Income (loss) from operations$ (34 ) $ 259 $ 645
(1)Includes term insurance premiums, which have a corresponding partial offset in benefits for changes in reserves.
(2)See "Realized Gain (Loss) and Benefit Ratio Unlocking" below.
Comparison of 2020 to 2019
Income from operations for this segment decreased due primarily to the following:
?Higher benefits due to unfavorable mortality as a result of impacts of the COVID-19 pandemic and growth in business in force, partially offset by the effect of unlocking.
?Lower fee income due to the effect of unlocking, partially offset by growth in business in force.
The decrease in income from operations was partially offset by the following:
?Higher net investment income, net of interest credited, driven by investment income on alternative investments, partially offset by spread compression due to average new money rates trailing our current portfolio yields and lower prepayment and bond make-whole premiums. ?Lower commissions and other expenses due to lower amortization rates, expense management and incentive compensation as a result of production performance, partially offset by the effect of unlocking.
See "Critical Accounting Policies and Estimates - DAC, VOBA, DSI and DFEL - Unlocking" above for information about unlocking.
Strategies to Address Statutory Reserve Strain
Our insurance subsidiaries have statutory surplus and RBC levels above current
regulatory required levels. Term products and other products containing
secondary guarantees require reserves calculated pursuant to the Valuation of
Life Insurance Policies Model Regulation ("XXX"), Actuarial Guideline 38
("AG38") and the principles-based reserving framework. For information on
strategies we use to reduce the statutory reserve strain, see "Review of
Consolidated Financial Condition - Liquidity and Capital Resources - Sources of
Liquidity and Cash Flow - Insurance Subsidiaries' Statutory Capital and Surplus"
below.
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Table of Contents Additional Information Strategic repricing actions to respond to the low interest rate environment have contributed to lower sales for 2020 as compared to 2019. We continue to expect elevated mortality to persist into 2021 as a result of the impacts of the COVID-19 pandemic. For a discussion of the expected and potential impacts of the COVID-19 pandemic, see "Introduction - Executive Summary" above and "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." For information on interest rate spreads and the interest rate risk due to falling 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 "Effect of Interest Rate Sensitivity" and "Interest Rate Risk on Fixed Insurance Businesses - Falling Rates" in "Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk."
Insurance Premiums
Insurance premiums relate to traditional products and are a function of the rates priced into the product and the level of business in force. Business in force, in turn, is driven by sales, persistency and mortality experience.
Fee Income
Details underlying fee income, sales, net flows, account values and in-force face amount (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Fee Income
Cost of insurance assessments $ 2,377 $ 2,280 $ 2,136
Expense assessments 1,502 1,694 1,529
Surrender charges 33 41 45
DFEL:
Deferrals (972 ) (1,063 ) (829 )
Amortization, net of interest:
Amortization, net of interest,
excluding unlocking 514 504 457
Unlocking 273 426 54
Total fee income $ 3,727 $ 3,882 $ 3,392
For the Years Ended December 31,
2020 2019 2018
Sales by Product
UL $ 20 $ 57 $ 43
MoneyGuard® 127 298 226
IUL 91 155 62
VUL 188 265 268
Term 132 144 113
Total individual life sales 558 919 712
Executive Benefits 72 163 52
Total sales $ 630 $ 1,082 $ 764
Net Flows
Deposits $ 5,890 $ 7,320 $ 6,438
Withdrawals and deaths (1,753 ) (1,898 ) (1,759 )
Net flows $ 4,137 $ 5,422 $ 4,679 Contract Holder Assessments
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As of December 31,
2020 2019 2018
Account Values
General account $ 37,496 $ 37,485 $ 36,612
Separate account 20,109 16,770 12,977
Total account values $ 57,605 $ 54,255 $ 49,589
In-Force Face Amount
UL and other $ 358,554 $ 357,726 $ 343,922
Term insurance 535,387 472,050 399,877
Total in-force face amount $ 893,941 $ 829,776 $ 743,799
For the Years Ended December 31,
2020 2019 2018
Average General Account Values
Fee income relates only to interest-sensitive products and includes cost of insurance assessments, expense assessments and surrender charges. Both cost of insurance and expense assessments can have deferrals and amortization related to DFEL. Cost of insurance and expense assessments are deducted from our contract holders' account values. These amounts are a function of the rates priced into the product and premiums received, face amount in force and account values. Business in force, in turn, is driven by sales, persistency and mortality experience. Sales are not recorded as a component of revenues (other than for traditional products) and do not have a significant effect on current quarter income from operations but are indicators of future profitability. For more information on sales, see "Additional Information" above.
Sales in the table above and as discussed above were reported as follows:
?MoneyGuard®, our linked-benefit product - 15% of total expected premium deposits;
?UL, IUL and VUL - first-year commissionable premiums plus 5% of excess premiums received;
?Executive Benefits - single premium bank-owned UL and VUL, 15% of single premium deposits, and corporate-owned UL and VUL, first-year commissionable premiums plus 5% of excess premium received; and
?Term - 100% of annualized first-year premiums.
We monitor the business environment, including but not limited to the regulatory
and interest rate environments, and make changes to our product offerings and
in-force products as needed, and as permitted under the terms of the policies,
to sustain the future profitability of our segment.
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Net Investment Income and Interest Credited
Details underlying net investment income and interest credited (in millions)
were as follows:
For the Years Ended December 31,
2020 2019 2018
Net Investment Income
Fixed maturity AFS securities,
mortgage loans on real estate
and other, net of investment
expenses $ 2,531 $ 2,448 $ 2,366
Commercial mortgage loan prepayment
and bond
make-whole premiums (1) 24 47 28
Alternative investments (2) 140 12 133
Surplus investments (3) 128 151 170
Total net investment income $ 2,823 $ 2,658 $ 2,697
Interest Credited $ 1,491 $ 1,433 $ 1,414 (1)See "Consolidated Investments - Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums" below for additional information.
(2)See "Consolidated Investments - Alternative Investments" below for additional information.
(3)Represents net investment income on the required statutory surplus for this segment and includes the effect of investment income on alternative investments for such assets that are held in the portfolios supporting statutory surplus versus the portfolios supporting product liabilities. A portion of the investment income earned for this segment is credited to contract holder accounts. Statutory reserves will typically grow at a faster rate than account values because of the AG38 reserve requirements. Investments allocated to this segment are based upon the statutory reserve liabilities and are affected by various reserve adjustments, including financing transactions providing relief from AG38 reserve requirements. These financing transactions lead to a transfer of investments from this segment to Other Operations. We expect to earn a spread between what we earn on the underlying general account investments and what we credit to our contract holders' accounts. We use our investment income to offset the earnings effect of the associated growth of our policy reserves for traditional products. Commercial mortgage loan prepayments and bond make-whole premiums and investment income on alternative investments can vary significantly from period to period due to a number of factors, and, therefore, may contribute to investment income results that are not indicative of the underlying trends. Benefits
Details underlying benefits (dollars in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Benefits
Death claims direct and assumed$ 5,521 $ 4,594 $ 4,295 Death claims ceded (2,019 ) (1,689 ) (1,648 ) Reserves released on death (738 ) (616 ) (586 ) Net death benefits 2,764 2,289 2,061 Change in secondary guarantee life insurance product reserves: Change in reserves, excluding unlocking 644 625 676 Unlocking 112 445 (61 ) Change in MoneyGuard® reserves: Change in reserves, excluding unlocking 482 451 385 Unlocking 272 48 (24 ) Other benefits (1) 312 325 308 Total benefits$ 4,586 $ 4,183 $ 3,345 Death claims per$1,000 of in-force 3.21 2.92 2.82
(1)Includes primarily changes in reserves and dividends on traditional and other products.
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Benefits for this segment include claims incurred during the period in excess of the associated reserves for its interest-sensitive and traditional products. In addition, benefits include the change in secondary guarantee and linked-benefit life insurance product reserves. These reserves are affected by changes in expected future trends of assessments and benefits causing unlocking adjustments to these liabilities similar to DAC, VOBA and DFEL. Generally, we have higher mortality in the first quarter of the year due to the seasonality of claims. See "Future Contract Benefits and Other Contract Holder Funds" in Note 1 for additional information.
Commissions and Other Expenses
Details underlying commissions and other expenses (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Commissions and Other Expenses
Commissions $ 687 $ 931 $ 760
General and administrative expenses 557 617 541
Expenses associated with reserve
financing 99 95 91
Taxes, licenses and fees 163 184 179
Total expenses incurred 1,506 1,827 1,571
DAC and VOBA deferrals (788 ) (1,094 ) (914 )
Total expenses recognized before
amortization 718 733 657
DAC and VOBA amortization, net of
interest:
Amortization, net of interest,
excluding unlocking 339 441 545
Unlocking 445 338 165
Other intangible amortization 4 4 4
Total commissions and other
expenses $ 1,506 $ 1,516 $ 1,371
DAC and VOBA Deferrals
As a percentage of sales 125.1% 101.1% 119.6%
Commissions and costs that result directly from and are essential to successful
acquisition of new or renewal business are deferred to the extent recoverable
and for our interest-sensitive products are generally amortized over the life of
the contracts in relation to EGPs. For our traditional products, DAC and VOBA
are amortized on either a straight-line basis or as a level percent of premium
of the related contracts, depending on the block of business. When comparing DAC
and VOBA deferrals as a percentage of sales for 2020 and 2019, the increase was
primarily a result of changes in sales mix to products with higher commission
rates.
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RESULTS OF GROUP PROTECTION
Income (Loss) from Operations
Details underlying the results for Group Protection (in millions) were as
follows:
For the Years Ended December 31,
2020 2019 2018
Operating Revenues
Insurance premiums $ 4,280 $ 4,113 $ 3,383
Net investment income 330 307 260
Other revenues (1) 183 168 114
Total operating revenues 4,793 4,588 3,757
Operating Expenses
Interest credited 5 5 5
Benefits 3,500 3,036 2,455
Commissions and other expenses 1,234 1,246 1,060
Total operating expenses 4,739 4,287 3,520
Income (loss) from operations before taxes 54 301 237
Federal income tax expense (benefit) 11 63 50
Income (loss) from operations $ 43 $ 238 $ 187 (1)Consists of revenue from third parties for administrative services performed, which has a corresponding partial offset in commissions and other expenses.
For the Years Ended
2020 2019 2018
Income (Loss) from Operations by Product Line Life$ (95 ) $ 77 $ 72 Disability 126 169 123 Dental 12 (9 ) (8 ) Total non-medical 43 237 187 Medical - 1 - Income (loss) from operations$ 43 $ 238 $ 187 Comparison of 2020 to 2019 Income from operations for this segment decreased due primarily to higher benefits driven by unfavorable experience in our life and disability businesses and unfavorable reserve adjustments in 2020 as compared to favorable reserve adjustments in 2019 due to modifying certain assumptions on the reserves in these businesses, partially offset by lower incidence in our dental business.
The decrease in income from operations was partially offset by the following:
?Higher insurance premiums due to favorable persistency.
?Higher net investment income, net of interest credited, driven by investment income on alternative investments within our surplus portfolio.
?Lower commissions and other expenses driven by expense management and incentive compensation as a result of production performance.
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Table of Contents Additional Information The total loss ratio for the year endedDecember 31, 2020 , was driven primarily by unfavorable mortality in our life business and unfavorable morbidity in our disability business due primarily to the impacts of the COVID-19 pandemic. Additionally, we experienced higher new claims severity, delays in social security approvals and higher incidence in our disability business, partially offset by lower incidence in our dental business due to the COVID-19 pandemic. We continue to expect an unfavorable loss ratio to persist into 2021 as a result of the impacts of the COVID-19 pandemic. In addition, we anticipate both morbidity headwinds in our disability business related to the economic environment and continued delays in social security approvals to persist into 2021. For a discussion of the expected and potential impacts of the COVID-19 pandemic, see "Introduction - Executive Summary" above and "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." Management compares trends in actual loss ratios to pricing expectations as group-underwriting risks change over time. We expect normal fluctuations in our total loss ratio, as claims experience is inherently uncertain. For every one percent increase in the total loss ratio, we would expect an annual decrease to income from operations of approximately$32 million to$36 million . The effects are symmetrical for a comparable decrease in the loss ratio and, therefore, move in an equal and opposite direction.
For information on the effects of current interest rates on our long-term disability claim reserves, see "Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk - Effect of Interest Rate Sensitivity."
Insurance Premiums
Details underlying insurance premiums (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Insurance Premiums by Product Line Life$ 1,613 $ 1,500 $ 1,246 Disability 2,401 2,320 1,838 Dental 266 293 299 Total insurance premiums$ 4,280 $ 4,113 $ 3,383 Sales by Product Line Life 265 344 222 Disability 397 319 257 Dental 44 89 101 Total sales$ 706 $ 752 $ 580
Our cost of insurance and policy administration charges are embedded in the premiums charged to our customers. The premiums are a function of the rates priced into the product and our business in force. Business in force, in turn, is driven by sales and persistency experience.
Sales relate to new contract holders and new programs sold to existing contract holders. We believe that the trend in sales is an important indicator of development of business in force over time. Sales in the table above are the combined annualized premiums for our products. The decrease in sales when comparing 2020 to 2019 was primarily driven by the impacts of the COVID-19 pandemic, which resulted in fewer cases going to market and a more highly competitive and price-sensitive market.
Net Investment Income
We use our investment income to offset the earnings effect of the associated
build of our reserves, which are a function of our insurance premiums and the
yields on our investments.
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Benefits and Interest Credited
Details underlying benefits and interest credited (in millions) and loss ratios by product line were as follows:
For the Years Ended December 31,
2020 2019 2018
Benefits and Interest Credited by
Product Line
Life $ 1,399 $ 1,045 $ 857
Disability 1,938 1,783 1,386
Dental 168 213 217
Total benefits and interest
credited $ 3,505 $ 3,041 $ 2,460
Loss Ratios by Product Line
Life 86.7% 69.7% 68.8%
Disability 80.5% 76.8% 75.4%
Dental 63.1% 72.8% 72.7%
Total 81.8% 73.9% 72.7%
Generally, we experience higher mortality in the first quarter of the year and higher disability claims in the fourth quarter of the year due to the seasonality of claims. For additional information on our loss ratios, see "Additional Information" above.
Commissions and Other Expenses
Details underlying commissions and other expenses (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Commissions and Other Expenses
Commissions $ 359 $ 367 $ 339
General and administrative expenses 697 741 623 Taxes, licenses and fees 122 114 94 Total expenses incurred 1,178 1,222 1,056 DAC deferrals (92 ) (110 ) (94 ) Total expenses recognized before amortization 1,086 1,112
962
DAC and VOBA amortization, net of interest (1) 115 112
93
Other intangible amortization (1) 33 22 5 Total commissions and other expenses$ 1,234 $ 1,246 $
1,060
DAC Deferrals As a percentage of insurance premiums 2.1% 2.7%
2.8%
(1)See Note 10 for information regarding intangible assets acquired during 2018.
Commissions and other costs that result directly from and are essential to the
successful acquisition of new or renewal business are deferred to the extent
recoverable and are amortized as a level percent of insurance premiums of the
related contracts, depending on the block of business. Certain broker
commissions that vary with and are related to paid premiums are expensed as
incurred rather than deferred and amortized. Generally, we have higher
amortization in the first quarter of the year due to a significant number of
policies renewing in the quarter. The decrease in DAC deferrals as a percentage
of insurance premiums when comparing 2020 to 2019 was primarily driven by lower
deferrable acquisition costs incurred in 2020, some of which resulted from lower
sales due to the impacts of the COVID-19 pandemic, and higher persistency.
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RESULTS OF OTHER OPERATIONS
Income (Loss) from Operations
Details underlying the results for Other Operations (in millions) were as
follows:
For the Years Ended December 31,
2020 2019 2018
Operating Revenues
Insurance premiums (1) $ 21 $ 13 $ 11
Net investment income 152 194 224
Amortization of deferred gain on
business sold through reinsurance - - 1
Other revenues 12 13 (1 )
Total operating revenues 185 220 235
Operating Expenses
Interest credited 39 58 56
Benefits 117 110 106
Other expenses 69 62 25
Interest and debt expense 269 284 274
Strategic digitization expense 68 66 76
Total operating expenses 562 580
537
Income (loss) from operations before taxes (377 ) (360 )
(302 )
Federal income tax expense (benefit) (82 ) (92 ) (77 )
Income (loss) from operations $ (295 ) $ (268 ) $ (225 ) (1)Includes our disability income business, which has a corresponding offset in benefits for changes in reserves.
Comparison of 2020 to 2019
Loss from operations for Other Operations increased due primarily to the following:
?Lower net investment income, net of interest credited, related to lower allocated investments driven by a decline in excess capital retained by Other Operations.
?Less favorable income tax benefits driven by lower excess tax benefits associated with stock-based compensation.
?Higher benefits attributable to unfavorable experience and reserve adjustments in our run-off disability income business.
The increase in loss from operations was partially offset by lower interest and debt expense driven by a decline in average interest rates.
Additional Information
We expect to continue making investments as part of our strategic digitization initiative, which are expected to be more than offset by the associated expense savings in the business segments. For more information, see "Introduction - Executive Summary - Significant Operational Matters - Strategic Digitization Initiative."
Net Investment Income and Interest Credited
We utilize an internal formula to determine the amount of capital that is
allocated to our business segments. Investment income on capital in excess of
the calculated amounts is reported in Other Operations. If our business segments
require increases in statutory reserves, surplus or investments, the amount of
excess capital that is retained by Other Operations would decrease and net
investment income would be negatively affected.
Write-downs for impairments decrease the recorded value of investments owned by
the business segments. These write-downs are not included in the income from
operations of our business segments. When impairment occurs, assets are
transferred to the business segments' portfolios and will reduce the future net
investment income for Other Operations. Statutory reserve adjustments for our
business segments can also cause allocations of investments between the business
segments and Other Operations.
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The majority of our interest credited relates to our reinsurance operations sold toSwiss Re Life & Health America, Inc. ("Swiss Re") in 2001. A substantial amount of the business was sold through indemnity reinsurance transactions, which is still recorded in our consolidated financial statements. The interest credited corresponds to investment income earnings on the assets we continue to hold for this business. There is no effect to income or loss in Other Operations or on a consolidated basis for these amounts because interest earned on the blocks that continue to be reinsured is passed through to Swiss Re in the form of interest credited. Benefits
Benefits are recognized when incurred for institutional pension products and disability income business.
Other Expenses
Details underlying other expenses (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
General and administrative expenses: Branding$ 43 $ 45 $
40
Other (1) 46 36
10
Total general and administrative expenses 89 81
50
Taxes, licenses and fees (2) (11 ) (7 ) (13 ) Other (3) (9 ) (12 ) (12 ) Total other expenses$ 69 $ 62 $ 25
(1)Includes expenses that are corporate in nature including charitable contributions, the portion of our deferred compensation plan expense attributable to participants' selection of LNC stock as the measure for their investment return and other expenses not allocated to our business segments.
(2)Includes state guaranty funds assessments to cover losses to contract holders of insolvent or rehabilitated insurance companies. Mandatory assessments may be partially recovered through a reduction in future premium taxes in some states.
(3)Consists of reimbursements to Other Operations from the Life Insurance segment for the use of proceeds from certain issuances of senior notes that were used as long-term structured solutions, net of expenses incurred by Other Operations for its access to a financing facility and issuance of LOCs.
Interest and Debt Expense
Our current level of interest expense may not be indicative of the future due
to, among other things, the timing of the use of cash, the availability of funds
from our inter-company cash management program and the future cost of capital.
For additional information on our financing activities, see "Review of
Consolidated Financial Condition - Liquidity and Capital Resources - Sources of
Liquidity and Cash Flow - Financing Activities" below.
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REALIZED GAIN (LOSS) AND BENEFIT RATIO UNLOCKING
Details underlying realized gain (loss), after-DAC (1) and benefit ratio unlocking (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Components of Realized Gain (Loss),
Pre-Tax
Total operating realized gain
(loss) $ 208 $ 184 $ 187
Total excluded realized gain (loss) (721 ) (794 ) (46 )
Total realized gain (loss), pre-tax
Reconciliation of Excluded Realized Gain (Loss) Net of Benefit Ratio Unlocking, After-Tax Total excluded realized gain (loss)$ (570 ) $ (627 ) $ (37 ) Benefit ratio unlocking 194 277 (136 ) Excluded realized gain (loss) net of benefit ratio unlocking, after-tax$ (376 ) $ (350 ) $ (173 ) Components of Excluded Realized Gain (Loss) Net of Benefit Ratio Unlocking, After-Tax Realized gain (loss) related to certain financial assets$ (136 ) $ (58 ) $ (66 ) Realized gain (loss) on the mark-to-market on certain instruments (2) 33 (95 ) 7 Variable annuity net derivatives results: Hedge program performance, including unlocking for GLB reserves hedged (564 ) (97 ) (137 ) GLB NPR component 293 (41 ) 57 Total variable annuity net derivatives results (271 ) (138 ) (80 ) Indexed annuity forward-starting option (2 ) (59 ) (34 ) Excluded realized gain (loss) net of benefit ratio unlocking, after-tax$ (376 ) $ (350 ) $ (173 )
(1)DAC refers to the associated amortization of DAC, VOBA, DSI and DFEL and changes in other contract holder funds and funds withheld reinsurance assets and liabilities.
(2)As ofDecember 31, 2020 , theModco investment portfolio included fixed maturity securities classified as AFS with changes in fair value recorded in other comprehensive income (loss) ("OCI"). Since the corresponding and offsetting changes in fair value of the embedded derivatives related to theModco investment portfolio are recorded in realized gain (loss), volatility can occur within net income (loss). See Note 9 for more information.
Comparison of 2020 to 2019
We had higher realized losses due primarily to the following:
?Unfavorable variable annuity net derivatives results driven by unfavorable hedge program performance due to more volatile markets, partially offset by favorable GLB NPR component results. An update to ourNPR input to the fair value calculation of our GLB embedded derivatives and the effect of unlocking drove favorable GLB NPR component results, partially offset by our associated reserves decreasing and credit spreads narrowing.
?Higher losses related to certain financial assets due to an increase in our allowance for credit losses.
The higher realized losses were partially offset by the following:
?Gains on the mark-to-market on certain instruments due primarily to favorable
changes in the fair value of embedded derivatives related to certain
?Lower losses related to our indexed annuity forward-starting option driven by the effect of unlocking and a decrease in option costs.
The above components of excluded realized gain (loss) are described net of benefit ratio unlocking, after-tax.
See "Critical Accounting Policies and Estimates - DAC, VOBA, DSI and DFEL - Unlocking" above for more information about unlocking.
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Operating Realized Gain (Loss)
Operating realized gain (loss) includes indexed annuity and IUL net derivatives results representing the net difference between the change in the fair value of the options that we hold and a portion of the change in the fair value of the embedded derivative liabilities of our indexed annuity and IUL products. The portion of the change in the fair value of the embedded derivative liabilities reported in operating realized gain (loss) represents the amount that is credited to the indexed annuity and IUL contracts. Our GWB, GIB and 4LATER® features have elements of both benefit reserves and embedded derivative reserves. We calculate the value of the benefit reserves and the embedded derivative reserves based on the specific characteristics of each GLB feature. For our GLBs that meet the definition of an embedded derivative under the Derivatives and Hedging Topic of the FASB ASC, we record them at fair value on our Consolidated Balance Sheets with changes in fair value recorded in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). In bifurcating the embedded derivative, we attribute to the embedded derivative the portion of total fees collected from the contract holder that relates to the GLB riders (the "attributed fees"). These attributed fees represent the present value of future claims expected to be paid for the GLB at the inception of the contract (the "net valuation premium") plus a margin that a theoretical market participant would include for risk/profit (the "risk/profit margin"). We also include the risk/profit margin portion of the GLB attributed rider fees in operating realized gain (loss) and include the net valuation premium of the GLB attributed rider fees in excluded realized gain (loss). For our Annuities and Retirement Plan Services segments, the excess of total fees collected from the contract holders over the GLB attributed rider fees is reported in fee income.
Realized Gain (Loss) Related to Certain Financial Assets
For information on realized gain (loss) related to certain financial assets, see Note 16.
Gain (Loss) on the Mark-to-Market on Certain Instruments
Gain (loss) on the mark-to-market on certain instruments, including those
associated with our consolidated variable interest entities ("VIEs") represents
changes in the fair values of certain derivative investments (not including
those associated with our variable annuity net derivatives results), reinsurance
related embedded derivatives and trading securities.
See Note 4 for information about our consolidated VIEs.
Variable Annuity Net Derivatives Results
Our variable annuity net derivatives results include the net valuation premium, the change in the GLB embedded derivative reserves and the change in the fair value of the derivative instruments we own to hedge them, including the cost of purchasing the hedging instruments. In addition, these results include the changes in reserves not accounted for at fair value and results from benefit ratio unlocking on our GDB and GLB riders and the change in the fair value of the derivative instruments we own to hedge the benefit ratio unlocking on our GDB and GLB riders. We use derivative instruments to hedge our exposure to the risks and earnings volatility that result from changes in the GLB embedded derivative reserves. The change in fair value of these derivative instruments is designed to generally offset the change in embedded derivative reserves. Our variable annuity net derivatives results can be volatile, especially when sudden and significant changes in equity markets and/or interest rates occur. We do not attempt to hedge the change in theNPR component of the liability. TheNPR factors affect the discount rate used in the calculation of the GLB embedded derivative reserve. Our methodology for calculating theNPR component of the embedded derivative reserve utilizes an extrapolated 30-yearNPR spread curve applied to a series of expected cash flows over the expected life of the embedded derivative. Our cash flows consist of both expected fees to be received from contract holders and benefits to be paid, and these cash flows are different on a pre- and post-NPR basis. We utilize a model based on our holding company's credit default swap ("CDS") spread adjusted to reflect the credit quality of our insurance subsidiary as the issuing entity. Because the guaranteed benefit liabilities are contained within our insurance subsidiaries, we apply items, such as the effect of our insurance subsidiaries' claims-paying ratings compared to holding company credit risk and the over-collateralization of insurance liabilities, in order to determine factors that are representative of a theoretical market participant's view of theNPR of the specific liability within our insurance subsidiaries. 75
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Details underlying our variable annuity hedging program (dollars in millions)
were as follows:
As of As of As of As of As of
December 31, September 30, June 30, March 31, December 31,
2020 2020 2020 2020 2019
Variable annuity hedge program
assets (liabilities) $ 2,284 $ 4,040 $
4,903
Variable annuity reserves - asset (liability): Embedded derivative reserves, pre-NPR (1)$ 198 $ (1,543 ) $ (2,498 ) $ (3,968 ) $ 620 NPR 333 717 (19 ) 99 (120 ) Embedded derivative reserves 531 (826 ) (2,517 ) (3,869 ) 500 Insurance benefit reserves (1,150 ) (1,314 ) (1,239 ) (1,525 ) (958 ) Total variable annuity reserves - asset (liability)$ (619 ) $ (2,140 ) $ (3,756 ) $ (5,394 ) $ (458 ) 10-year CDS spread 1.25% 1.34% 1.14% 1.56% 1.14%NPR factor related to 10-year CDS spread 0.70% 0.80% 0.13% 0.22% 0.13%
(1)Embedded derivative reserves in an asset (liability) position indicate we estimate the present value of future benefits to be less (greater) than the present value of future net valuation premiums.
The following shows the hypothetical effect (in millions) to net income (loss)
for changes in the
Hypothetical
Effect
NPR factor:
Down 70 basis points to zero $ (365 )
Up 20 basis points 47
See "Critical Accounting Policies and Estimates - Derivatives - GLB" above for additional information about our guaranteed benefits.
Indexed Annuity Forward-Starting Option
The liability for the forward-starting option reflects changes in the fair value
of embedded derivative liabilities related to index options we may purchase or
sell in the future to hedge contract holder index allocations applicable to
future reset periods for our indexed annuity products accounted for under the
Derivatives and Hedging and the Fair Value Measurements and Disclosures Topics
of the FASB ASC. These fair values represent an estimate of the cost of the
options we will purchase or sell in the future, discounted back to the date of
the balance sheet, using current market indications of volatility and interest
rates, which can vary significantly from period to period due to a number of
factors and therefore can provide results that are not indicative of the
underlying trends.
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CONSOLIDATED INVESTMENTS
Details underlying our consolidated investment balances (in millions) were as
follows:
Percentage of
Total Investments
As of December 31, As of December 31,
2020 2019 2020 2019
Investments
Fixed maturity AFS securities $ 123,044 $ 105,200 79.9% 78.7%
Trading securities 4,501 4,673 2.9% 3.5%
Equity securities 129 103 0.1% 0.1%
Mortgage loans on real estate 16,763 16,339 10.9% 12.2%
Real estate 10 11 0.0% 0.0%
Policy loans 2,426 2,477 1.6% 1.8%
Derivative investments 3,109 1,911 2.0% 1.4%
Alternative investments 1,944 1,821 1.3% 1.4%
Other investments 2,030 1,162 1.3% 0.9%
Total investments $ 153,956 $ 133,697 100.0% 100.0%
Investment Objective
Investments are an integral part of our operations. We follow a balanced
approach to investing for both current income and prudent risk management, with
an emphasis on generating sufficient current income, net of income tax, to meet
our obligations to customers, as well as other general liabilities. This
balanced approach requires the evaluation of expected return and risk of each
asset class utilized, while still meeting our income objectives. This approach
is important to our asset-liability management because decisions can be made
based upon both the economic and current investment income considerations
affecting assets and liabilities. For a discussion of our risk management
process, see "Item 7A. Quantitative and Qualitative Disclosures About Market
Risk."
Investment Portfolio Composition and Diversification
Fundamental to our investment policy is diversification across asset classes.
Our investment portfolio, excluding cash and invested cash, is composed of fixed
maturity securities, mortgage loans on real estate, real estate (either
wholly-owned or in joint ventures) and other long-term investments. We purchase
investments for our segmented portfolios that have yield, duration and other
characteristics that take into account the liabilities of the products being
supported.
We have the ability to maintain our investment holdings throughout credit cycles
because of our capital position, the long-term nature of our liabilities and the
matching of our portfolios of investment assets with the liabilities of our
various products.
?
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Fixed Maturity and Equity Securities Portfolios
In 2020, we adopted ASU 2016-13, which resulted in a new recognition and
measurement of credit losses on most financial assets. See Note 2 for additional
information. Fixed maturity securities consist of portfolios classified as AFS
and trading. Details underlying our fixed maturity AFS securities by industry
classification (in millions) are presented in the tables below. These tables
agree in total with the presentation of fixed maturity AFS securities in Note 5;
however, the categories below represent a more detailed breakout of the fixed
maturity AFS portfolio. Therefore, the investment classifications listed below
do not agree to the investment categories provided in Note 5.
As of December 31, 2020
Net %
Amortized Gross Unrealized Fair Fair
Cost (1) Gains Losses Value Value
Fixed Maturity AFS Securities
Industry corporate bonds:
Financial services $ 15,889 $ 2,836 $ 32 $ 18,693 15.2%
Basic industry 4,719 992 3 5,708 4.6%
Capital goods 7,323 1,402 13 8,712 7.1%
Communications 4,331 1,036 4 5,363 4.4%
Consumer cyclical 5,707 926 12 6,621 5.4%
Consumer non-cyclical 16,600 3,412 17 19,995 16.3%
Energy 5,605 877 24 6,458 5.2%
Technology 4,590 742 7 5,325 4.3%
Transportation 3,450 619 12 4,057 3.3%
Industrial other 2,082 224 6 2,300 1.9%
Utilities 14,096 3,198 6 17,288 14.1%
Government related entities 1,885 398 14 2,269 1.8%
Collateralized mortgage and other
obligations ("CMOs"):
Agency backed 1,874 216 1 2,089 1.7%
Non-agency backed 433 53 - 486 0.4%
Mortgage pass through securities
("MPTS"):
Agency backed 457 44 - 501 0.4%
Commercial mortgage-backed
securities ("CMBS"):
Agency backed 20 1 - 21 0.0%
Non-agency backed 1,370 114 - 1,484 1.2%
Asset-backed securities ("ABS"):
Collateralized loan obligations
("CLOs") 5,571 23 11 5,583 4.5%
Credit card 78 31 1 108 0.1%
Equipment receivables 15 - - 15 0.0%
Home equity 303 52 1 354 0.3%
Manufactured housing 7 1 - 8 0.0%
Student loans 17 1 - 18 0.0%
Other 1,050 50 2 1,098 0.9%
Municipals:
Taxable 5,249 1,532 - 6,781 5.5%
Tax-exempt 111 29 - 140 0.1%
Government:
United States 397 88 1 484 0.4%
Foreign 384 87 1 470 0.4%
Hybrid and redeemable preferred
securities 548 97 30 615 0.5%
Total fixed maturity AFS securities 104,161 19,081 198 123,044 100.0%
Trading Securities (2) 4,072 477 48 4,501
Equity Securities 132 21 24 129
Total fixed maturity AFS, trading
and equity securities $ 108,365 $ 19,579 $ 270 $ 127,674
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As of December 31, 2019
Gross Unrealized %
Amortized Losses and Fair Fair
Cost Gains OTTI (3) Value Value
Fixed Maturity AFS Securities
Industry corporate bonds:
Financial services $ 13,991 $ 1,632 $ 43 $ 15,580 14.8%
Basic industry 4,570 491 6 5,055 4.8%
Capital goods 6,700 760 10 7,450 7.1%
Communications 4,314 654 7 4,961 4.7%
Consumer cyclical 5,335 536 9 5,862 5.6%
Consumer non-cyclical 14,215 1,813 21 16,007 15.2%
Energy 6,080 649 44 6,685 6.4%
Technology 4,039 382 4 4,417 4.2%
Transportation 3,283 309 2 3,590 3.4%
Industrial other 1,563 98 2 1,659 1.6%
Utilities 13,533 1,861 20 15,374 14.6%
Government related entities 1,794 294 12 2,076 2.0%
CMOs:
Agency backed 1,893 108 9 1,992 1.9%
Non-agency backed 527 49 (18 ) 594 0.6%
MPTS:
Agency backed 622 33 - 655 0.6%
CMBS:
Agency backed 20 1 - 21 0.0%
Non-agency backed 1,018 44 - 1,062 1.0%
ABS:
CLOs 3,612 7 8 3,611 3.4%
Credit card 78 22 1 99 0.1%
Equipment receivables 20 1 - 21 0.0%
Home equity 369 15 (27 ) 411 0.4%
Manufactured housing 9 - - 9 0.0%
Student loans 30 1 - 31 0.0%
Other 692 16 1 707 0.7%
Municipals:
Taxable 4,675 1,091 7 5,759 5.5%
Tax-exempt 103 22 - 125 0.1%
Government:
United States 384 51 - 435 0.4%
Foreign 329 64 - 393 0.4%
Hybrid and redeemable preferred
securities 497 82 20 559 0.5%
Total fixed maturity AFS securities 94,295 11,086 181 105,200 100.0%
Trading Securities (2) 4,330 353 10 4,673
Equity Securities 123 5 25 103
Total fixed maturity AFS, trading
and equity securities $ 98,748 $ 11,444 $
216
(1)Represents amortized cost, net of allowance for credit losses.
(2)Certain of our trading securities support ourModco reinsurance agreements and the investment results are passed directly to the reinsurers. See "Trading Securities" below for more information.
(3)Other-than-temporary impairment ("OTTI") includes unrealized (gains) and losses on credit-impaired securities related to changes in the fair value of such securities subsequent to the impairment measurement date.
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Table of ContentsFixed Maturity AFS Securities In accordance with the fixed maturity AFS accounting guidance, we reflect stockholders' equity as if unrealized gains and losses were actually recognized and consider all related accounting adjustments that would occur upon such a hypothetical recognition of unrealized gains and losses. Such related balance sheet effects include adjustments to the balances of DAC, VOBA, DFEL, future contract benefits, other contract holder funds and deferred income taxes. Adjustments to each of these balances are charged or credited to AOCI. For instance, DAC is adjusted upon the recognition of unrealized gains or losses because the amortization of DAC is based upon an assumed emergence of gross profits on certain insurance business. Deferred income tax balances are also adjusted because unrealized gains or losses do not affect actual taxes currently paid.
The quality of our fixed maturity AFS securities portfolio, as measured at estimated fair value and by the percentage of fixed maturity AFS securities invested in various ratings categories, relative to the entire fixed maturity AFS security portfolio (in millions) was as follows:
As of December 31, 2020 As of
Rating
Agency Net
NAIC Equivalent Amortized Fair % of Amortized Fair % of
Designation Designation
(1) (1) Cost Value Total Cost Value Total
1 AAA / AA / A $ 57,934 $ 69,226 56.3% $
51,367
2 BBB 41,970 49,390 40.1% 39,473 43,460 41.3%
Total investment grade
securities 99,904 118,616 96.4% 90,840 101,695 96.7%
Below Investment Grade
Securities
3 BB 2,959 3,157 2.6% 2,309 2,388 2.3%
4 B 1,249 1,218 1.0% 960 955 0.9%
CCC and
5 lower 46 48 0.0% 158 136 0.1%
In or near
6 default 3 5 0.0% 28 26 0.0%
Total below investment grade
securities 4,257 4,428 3.6% 3,455 3,505 3.3%
Total fixed maturity AFS
securities $ 104,161 $ 123,044 100.0% $
94,295
Total securities below investment grade as a percentage of total fixed maturity AFS securities 4.1% 3.6%
3.7% 3.3%
(1)Based upon the rating designations determined and provided by theNational Association of Insurance Commissioners ("NAIC") or the major credit rating agencies (Fitch Ratings ("Fitch"), Moody's Investors Service ("Moody's") andS&P Global Ratings ("S&P")). For securities where the ratings assigned by the major credit rating agencies are not equivalent, the second lowest rating assigned is used. For those securities where ratings by the major credit rating agencies are not available, which does not represent a significant amount of our total fixed maturity AFS securities, we base the ratings disclosed upon internal ratings. Comparisons between the NAIC designations and rating agency designations are published by the NAIC. The NAIC assigns securities quality designations and uniform valuations, which are used by insurers when preparing their annual statements. The NAIC designations are similar to the rating agency designations of the Nationally Recognized Statistical Rating Organizations for marketable bonds. NAIC designations 1 and 2 include bonds generally considered investment grade (rated Baa3 or higher by Moody's, or rated BBB- or higher by S&P and Fitch) by such ratings organizations. However, securities designated NAIC 1 and 2 could be deemed below investment grade by the rating agencies as a result of the current RBC rules for residential mortgage-backed securities ("RMBS") and CMBS for statutory reporting. NAIC designations 3 through 6 include bonds generally considered below investment grade (rated Ba1 or lower by Moody's, or rated BB+ or lower by S&P and Fitch). As ofDecember 31, 2020 , and 2019, 78% and 87%, respectively, of the total fixed maturity AFS securities in an unrealized loss position were investment grade. See Note 5 for maturity date information for our fixed maturity investment portfolio. Our gross unrealized losses recognized in OCI on fixed maturity AFS securities as ofDecember 31, 2020 , decreased by$45 million sinceDecember 31, 2019 . For further information on our unrealized losses on fixed maturity AFS securities, see "Composition by Industry Categories of our Unrealized Losses onFixed Maturity AFS Securities " below. 80
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We believe the unrealized loss position as ofDecember 31, 2020 , did not require an impairment recognized in earnings as: (i) we did not intend to sell these fixed maturity AFS securities; (ii) it is not more likely than not that we will be required to sell the fixed maturity AFS securities before recovery of their amortized cost basis; and (iii) the difference in the fair value compared to the amortized cost was due to factors other than credit loss. This conclusion is consistent with our asset-liability management process. Management considers the following as part of the evaluation:
?The current economic environment and market conditions;
?Our business strategy and current business plans;
?The nature and type of security, including expected maturities and exposure to general credit, liquidity, market and interest rate risk;
?Our analysis of data from financial models and other internal and industry sources to evaluate the current effectiveness of our hedging and overall risk management strategies;
?The current and expected timing of contractual maturities of our assets and liabilities, expectations of prepayments on investments and expectations for surrenders and withdrawals of life insurance policies and annuity contracts;
?The capital risk limits approved by management; and
?Our current financial condition and liquidity demands.
To determine the recoverability of a debt security, we consider the facts and circumstances surrounding the underlying issuer including, but not limited to, the following:
?Historical and implied volatility of the security;
?The extent to which the fair value has been less than amortized cost;
?Adverse conditions specifically related to the security or to specific conditions in an industry or geographic area;
?Failure, if any, of the issuer of the security to make scheduled payments; and
?Recoveries or additional declines in fair value subsequent to the balance sheet date.
As reported on our Consolidated Balance Sheets, we had$155.7 billion of investments and cash, which exceeded the liabilities for our future obligations under insurance policies and contracts, net of amounts recoverable from reinsurers, which totaled$129.7 billion as ofDecember 31, 2020 . If it were necessary to liquidate fixed maturity AFS securities prior to maturity or call to meet cash flow needs, we would first look to those fixed maturity AFS securities that are in an unrealized gain position, which had a fair value of$117.0 billion as ofDecember 31, 2020 , rather than selling fixed maturity AFS securities in an unrealized loss position. The amount of cash that we have on hand at any point in time takes into account our liquidity needs in the future, other sources of cash, such as the maturities of investments, interest and dividends we earn on our investments and the ongoing cash flows from new and existing business. See "Fixed Maturity AFS Securities - Evaluation for Recovery of Amortized Cost" in Notes 1 and 5 for additional discussion.
As of
Trading Securities
Trading securities, which in certain cases support reinsurance funds withheld and ourModco reinsurance agreements, are carried at fair value and changes in fair value are recorded in net income as they occur. Investment results for these certain portfolios, including gains and losses from sales, are passed directly to the reinsurers through the contractual terms of the reinsurance arrangements. Offsetting these amounts in certain cases are corresponding changes in fair value of the embedded derivative liability associated with the underlying reinsurance arrangement. See Notes 1 and 9 for more information regardingModco .
Our fixed maturity securities include mortgage-backed securities ("MBS"). These
securities are subject to risks associated with variable prepayments. This may
result in differences between the actual cash flow and maturity of these
securities than that expected at the time of purchase. Securities that have an
amortized cost greater than par and are backed by mortgages that prepay faster
than expected will incur a reduction in yield or a loss. Those securities with
an amortized cost lower than par that prepay faster than expected will generate
an increase in yield or a gain. In addition, we may incur reinvestment risks if
market yields are lower than the book yields earned on the securities.
Prepayments occurring slower than expected have the opposite effect. The degree
to which a security is susceptible to either gains or losses is influenced by:
the difference between its amortized cost and par; the relative sensitivity of
the underlying mortgages backing the assets to prepayment in a changing interest
rate environment; and the repayment priority of the securities in the overall
securitization structure.
We limit the extent of our risk on MBS by prudently limiting exposure to the
asset class, by generally avoiding the purchase of securities with a cost that
significantly exceeds par, by purchasing securities with improving collateral
performance, and by primarily investing in securities that are current pay and
senior priority in their trust structure. A significant amount of assets in our
MBS portfolio are either guaranteed by U.S. government-sponsored enterprises,
supported in the securitization structure by junior securities or purchased at
discounted prices significantly lower than their expected recovery value,
enabling the assets to achieve high investment grade status.
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Our exposure to subprime mortgage lending is limited to investments in banks and other financial institutions that may be affected by subprime lending and direct investments in ABS and RMBS. Mortgage-related ABS are backed by home equity loans and RMBS are backed by residential mortgages. These securities are backed by loans that are characterized by borrowers of differing levels of creditworthiness: prime; Alt-A; and subprime. Prime lending is the origination of residential mortgage loans to customers with excellent credit profiles. Alt-A lending is the origination of residential mortgage loans to customers who have prime credit profiles but lack documentation to substantiate income. Subprime lending is the origination of loans to customers with weak or impaired credit profiles. Delinquency and loss rates on residential mortgages and home equity loans have been showing positive trends, and, as long as the unemployment rate remains stable to improving, we expect these trends to continue. We continue to expect to receive payments in accordance with contractual terms for a significant amount of our securities, largely due to the seniority of the claims on the collateral of the securities that we own. The tranches of the securities will experience losses according to their seniority level with the least senior (or most junior), typically the unrated residual tranche, taking the first loss. Our ABS home equity and RMBS had a market value of$3.6 billion and a net unrealized gain of$366 million as ofDecember 31, 2020 . ? 82
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The market value of fixed maturity AFS securities and trading securities backed by subprime loans was$322 million and represented less than 1% of our total investment portfolio as ofDecember 31, 2020 . Fixed maturity AFS securities represented$309 million , or 96%, and trading securities represented$13 million , or 4%, of the subprime exposure as ofDecember 31, 2020 . The table below summarizes our investments in fixed maturity AFS securities backed by pools of residential mortgages (in millions) as ofDecember 31, 2020 : Subprime/ Agency Prime Alt-A Option ARM (1) Total Net Net Net Net Net Amortized Fair Amortized Fair Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value Cost Value Cost Value Type RMBS$ 2,331 $ 2,591 $ 136 $ 150 $ 109 $ 125 $ 188 $ 210 $ 2,764 $ 3,076 ABS home equity 1 1 29 30 36 46 237 277 303 354 Total by type (2)(3)$ 2,332 $ 2,592 $ 165 $ 180 $ 145 $ 171 $ 425 $ 487 $ 3,067 $ 3,430 Rating AAA$ 1,893 $ 2,110 $ 6$ 6 $ - $ - $ - $ -$ 1,899 $ 2,116 AA 439 482 18 19 7 7 7 7 471 515 A - - 12 11 5 5 35 36 52 52 BBB - - 3 3 10 11 11 11 24 25 BB and below - - 126 141 123 148 372 433 621 722 Total by rating (2)(3)(4)$ 2,332 $ 2,592 $ 165 $ 180 $ 145 $ 171 $ 425 $ 487 $ 3,067 $ 3,430 Origination Year 2010 and prior $ 536$ 610 $ 144 $ 158 $ 144 $ 170 $ 425 $ 487 $ 1,249 $ 1,425 2011 57 63 - - - - - - 57 63 2012 29 30 - - - - - - 29 30 2013 168 186 - - - - - - 168 186 2014 71 82 2 1 - - - - 73 83 2015 177 195 15 17 - - - - 192 212 2016 571 617 - - 1 1 - - 572 618 2017 289 321 - - - - - - 289 321 2018 231 268 - - - - 231 268 2019 180 196 1 1 - - - - 181 197 2020 23 24 3 3 - - - - 26 27 Total by origination year (2)(3)$ 2,332 $ 2,592 $ 165 $ 180 $ 145 $ 171 $ 425 $ 487 $ 3,067 $ 3,430
Total fixed maturity AFS securities backed by pools of residential mortgages as a percentage of total fixed maturity AFS securities
2.9% 2.8%
Total prime, Alt-A and subprime/option ARM as a percentage of total fixed maturity AFS securities
0.7% 0.7%
(1)Includes the net amortized cost and fair value of option adjustable rate
mortgages ("ARM") within RMBS, totaling
(2)Does not include the amortized cost of trading securities totaling
(3)Does not include the fair value of trading securities totaling$137 million that primarily support ourModco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers. The$137 million in trading securities consisted of$123 million prime,$1 million Alt-A and$13 million subprime. (4)Based upon the rating designations determined and provided by the major credit rating agencies (Fitch, Moody's and S&P). For securities where the ratings assigned by the major credit agencies are not equivalent, the second lowest rating assigned is used. For those securities where ratings by the major credit rating agencies are not available, which does not represent a significant amount of our total fixed maturity AFS securities, we base the ratings disclosed upon internal ratings.
None of these investments included any direct investments in subprime lenders or mortgages. We are not aware of material exposure to subprime loans in our alternative asset portfolio.
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The following summarizes our investments in AFS securities backed by pools of
commercial mortgages (in millions) as of
Multiple Property Single Property Total
Net Net Net
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
Type
CMBS (1)(2) $ 1,370 $ 1,481 $ 20 $ 24 $ 1,390 $ 1,505
Rating
AAA $ 1,280 $ 1,387 $ 4 $ 5 $ 1,284 $ 1,392
AA 90 94 11 13 101 107
A - - 5 6 5 6
Total by rating (1)(2)(3) $ 1,370 $ 1,481 $ 20 $ 24 $ 1,390 $ 1,505
Origination Year
2010 and prior $ 12 $ 14 $ 11 $ 14 $ 23 $ 28
2011 4 4 - - 4 4
2012 27 27 - - 27 27
2013 147 152 - - 147 152
2014 14 14 - - 14 14
2015 26 28 - - 26 28
2016 112 120 4 5 116 125
2017 323 361 - - 323 361
2018 169 195 - - 169 195
2019 298 326 298 326
2020 238 240 5 5 243 245
Total by origination year (1)(2)
Total fixed maturity AFS securities backed by pools of commercial mortgages as a percentage of total fixed maturity AFS securities
1.3% 1.2%
(1)Does not include the amortized cost of trading securities totaling
(2)Does not include the fair value of trading securities totaling$134 million that primarily support ourModco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers. The$134 million in trading securities consisted of$62 million of multiple property CMBS and$72 million of single property CMBS. (3)Based upon the rating designations determined and provided by the major credit rating agencies (Fitch, Moody's and S&P). For securities where the ratings assigned by the major credit rating agencies are not equivalent, the second lowest rating assigned is used. For those securities where ratings by the major credit rating agencies are not available, which does not represent a significant amount of our total fixed maturity AFS securities, we base the ratings disclosed upon internal ratings.
As of
Composition by Industry Categories of our Unrealized Losses on
When considering unrealized gain and loss information, it is important to
recognize that the information relates to the position of securities at a
particular point in time and may not be indicative of the position of our
investment portfolios subsequent to the balance sheet date. Further, because the
timing of the recognition of realized investment gains and losses through the
selection of which securities are sold is largely at management's discretion, it
is important to consider the information provided below within the context of
the overall unrealized gain or loss position of our investment portfolios. These
are important considerations that should be included in any evaluation of the
potential effect of securities in an unrealized loss position on our future
earnings.
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The composition by industry categories of all fixed maturity AFS securities in an unrealized loss position (in millions) as ofDecember 31, 2020 , was as follows: % % Net Net Gross Gross % Amortized Amortized Unrealized Unrealized Fair Fair Cost Cost Losses Losses Value Value Finance companies$ 98 1.6% $ 25 12.6%$ 73 1.2% Banking 345 5.5% 17 8.6% 328 5.4% Government owned, no guarantee 84 1.3% 14 7.1% 70 1.2% ABS 1,885 30.3% 13 6.6% 1,872 31.0% Independent 171 2.7% 13 6.6% 158 2.6% Healthcare 596 9.6% 11 5.6% 585 9.7% Aerospace and defense 188 3.0% 11 5.6% 177 3.0% Integrated 50 0.8% 8 4.0% 42 0.7% Property and casualty 56 0.9% 7 3.5% 49 0.8% Technology 339 5.4% 7 3.5% 332 5.5% Transportation services 127 2.0% 6 3.0% 121 2.0% Industrial - other 156 2.5% 6 3.0% 150 2.5% Airlines 92 1.6% 6 3.0% 86 1.4% Industries with unrealized losses less than$5 million 2,043 32.8% 54
27.3% 1,989 33.0%
Total by industry
Total by industry as a percentage of total fixed maturity AFS securities 6.0% 100.0% 4.9% As ofDecember 31, 2020 , the net amortized cost and fair value of securities subject to enhanced analysis and monitoring for potential changes in unrealized loss position was$38 million and$37 million , respectively. 85
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Mortgage Loans on Real Estate
The following tables summarize key information on mortgage loans on real estate
(in millions):
As of December 31, 2020
Commercial Residential Total %
Credit Quality Indicator
Current $ 16,230 $ 666 $ 16,896 99.6%
Delinquent (1) - 42 42 0.2%
Foreclosure (2) - 29 29 0.2%
Total mortgage loans on real estate before
allowance 16,230 737 16,967 100.0%
Allowance for credit losses (187 ) (17 ) (204 )
Total mortgage loans on real estate $ 16,043 $ 720 $ 16,763
As of December 31, 2019
Commercial Residential Total %
Credit Quality Indicator
Current $ 15,606 $ 718 $ 16,324 99.9%
Delinquent (1) - 9 9 0.1%
Foreclosure (2) - 8 8 0.0%
Total mortgage loans on real estate before
allowance 15,606 735 16,341 100.0%
Allowance for credit losses - (2 )
(2 )
Total mortgage loans on real estate
(1)As of
(2)As of
As ofDecember 31, 2020 , there were 4 specifically identified impaired commercial mortgage loans on real estate with a carrying value of$1 million and 76 specifically identified impaired residential mortgage loans on real estate with an aggregate carrying value of$34 million . As ofDecember 31, 2019 , there was one specifically identified impaired commercial mortgage loan on real estate with a carrying value of less than$1 million and four specifically identified impaired residential mortgage loans on real estate with an aggregate carrying value of$1 million . The total outstanding principal and interest on commercial mortgage loans on real estate that were two or more payments delinquent as ofDecember 31, 2020 and 2019, was less than$1 million . The total outstanding principal and interest on residential mortgage loans on real estate that were three or more payments delinquent as ofDecember 31, 2020 and 2019, was$41 million and$9 million , respectively.
See Note 1 for more information regarding our accounting policy relating to the impairment of mortgage loans on real estate.
The carrying value of mortgage loans on real estate by business segment (in
millions) was as follows:
As of December 31,
2020 2019
Segment
Annuities $ 5,934 $ 5,453
Retirement Plan Services 4,152 4,096
Life Insurance 3,979 4,096
Group Protection 1,374 1,361
Other Operations 1,324 1,333
Total mortgage loans on real estate
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The composition of commercial mortgage loans (in millions) by property type, geographic region and state is shown below:
As of December 31, 2020 As of December 31, 2020
Carrying Carrying
Value % Value %
Property Type State
Apartment $ 5,194 32.4% CA $ 3,843 24.0%
Office building 3,910 24.4% TX 1,665 10.4%
Industrial 3,180 19.8% NY 1,130 7.0%
Retail 2,580 16.1% FL 774 4.8%
Other commercial 715 4.4% GA 718 4.4%
Hotel/motel 245 1.5% MD 707 4.4%
Mixed use 219 1.4% PA 661 4.1%
Total $ 16,043 100.0% WA 605 3.8%
Geographic Region TN 564 3.5%
Pacific 4,772 29.7% OH 556 3.5%
South Atlantic 3,513 21.9% VA 549 3.4%
Middle Atlantic 2,030 12.7% NC 364 2.3%
West South Central 1,808 11.3% AZ 348 2.2%
East North Central 1,393 8.7% WI 332 2.1%
Mountain 816 5.1% IL 324 2.0%
East South Central 690 4.3% OR 323 2.0%
West North Central 492 3.1% MA 314 2.0%
New England 489 3.0% Non U.S. 40 0.2%
Non-U.S. 40 0.2% All other states 2,226 13.9%
Total $ 16,043 100.0% Total $ 16,043 100.0%
The following table shows the principal amount (in millions) of our commercial
and residential mortgage loans by year in which the principal is contractually
obligated to be repaid:
As of December 31, 2020
Commercial Residential Total %
Principal Repayment Year
2020 $ 900 $ 9 $ 909 5.4%
2021 944 9 953 5.6%
2022 863 9 872 5.1%
2023 1,304 10 1,314 7.8%
2024 1,202 10 1,212 7.1%
2025 and thereafter 11,036 668 11,704 69.0%
Total $ 16,249 $ 715 $ 16,964 100.0%
See Note 5 for information regarding our loan-to-value and debt-service coverage ratios and our allowance for credit losses.
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Table of Contents Alternative Investments
Investment income (loss) on alternative investments by business segment (in millions) was as follows:
For the Years Ended December 31,
2020 2019 2018
Annuities $ 23 $ 2 $ 27
Retirement Plan Services 14 2 15
Life Insurance 140 15 161
Group Protection 15 2 14
Other Operations 5 1 5
Total (1) $ 197 $ 22 $ 222 (1)Includes net investment income on the alternative investments supporting the required statutory surplus of our insurance businesses.
As ofDecember 31, 2020 and 2019, alternative investments included investments in 271 and 258 different partnerships, respectively, and the portfolio represented approximately 1% of total investments. The partnerships do not represent off-balance sheet financing and generally involve several third-party partners. Some of our partnerships contain capital calls, which require us to contribute capital upon notification by the general partner. These capital calls are contemplated during the initial investment decision and are planned for well in advance of the call date. The capital calls are not material in size and are not material to our liquidity. Alternative investments are accounted for using the equity method of accounting and are included in other investments on our Consolidated Balance Sheets.
Non-Income Producing Investments
As of
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Net Investment Income
Details underlying net investment income (in millions) and our investment yield
were as follows:
For the Years Ended December 31,
2020 2019 2018
Net Investment Income
Fixed maturity AFS securities $ 4,334 $ 4,281 $ 4,209
Trading securities 202 191 84
Equity securities 3 4 4
Mortgage loans on real estate 677 629 496
Real estate 1 1 1
Policy loans 125 129 123
Invested cash 12 40 26
Commercial mortgage loan prepayment
and bond make-whole premiums (1) 82 119 79
Alternative investments (2) 197 22 222
Consent fees 7 8 4
Other investments 45 30 23
Investment income 5,685 5,454 5,271
Investment expense (175 ) (231 ) (186 )
Net investment income $ 5,510 $ 5,223 $ 5,085 (1)See "Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums" below for additional information.
(2)See "Alternative Investments" above for additional information.
For the Years Ended December
31,
2020 2019 2018
Interest Rate Yield
Fixed maturity AFS securities, mortgage loans on
real estate and other, net of investment expenses 4.12% 4.35% 4.44%
Commercial mortgage loan prepayment and bond make-whole premiums 0.06% 0.10%
0.07%
Alternative investments 0.16% 0.02%
0.21%
Net investment income yield on invested assets 4.34% 4.47%
4.72%
We earn investment income on our general account assets supporting fixed annuity, term life, whole life, UL, interest-sensitive whole life and the fixed portion of retirement plan and VUL products. The profitability of our fixed annuity and life insurance products is affected by our ability to achieve target spreads, or margins, between the interest income earned on the general account assets and the interest credited to the contract holder on our average fixed account values, including the fixed portion of variable. Net investment income and the interest rate yield table each include commercial mortgage loan prepayments and bond make-whole premiums, alternative investments and contingent interest and standby real estate equity commitments. These items can vary significantly from period to period due to a number of factors and, therefore, can provide results that are not indicative of the underlying trends.
Commercial Mortgage Loan Prepayment and Bond Make-Whole Premiums
Prepayment and make-whole premiums are collected when borrowers elect to call or prepay their debt prior to the stated maturity. A prepayment or make-whole premium allows investors to attain the same yield as if the borrower made all scheduled interest payments until maturity. These premiums are designed to make investors indifferent to prepayment.
The increase in prepayment and make-whole premiums when comparing 2020 to 2019 was attributable primarily to increased refinancing activity.
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Impairments on
See "Critical Accounting Policies and Estimates - Measurement of Allowances for
Credit Losses and Recognition of Impairments" above for information on our
portfolio management strategy. Details underlying credit loss expense incurred
as a result of impairments that were recognized in net income (loss) and
included in realized gain (loss) on fixed maturity AFS securities (in millions)
were as follows:
For the Years Ended December 31,
2020 2019 2018
Credit Loss Expense Recognized in Net Income (Loss) (1)
Fixed maturity AFS securities:
Corporate bonds $ (24 ) $ (14 ) $ (5 )
RMBS (1 ) (1 ) (1 )
ABS (1 ) (1 ) (1 )Gross credit loss expense recognized in net income (loss) (26 )
(16 ) (7 )
Associated amortization of DAC, VOBA, DSI and DFEL 1 1 -
Net credit loss expense recognized in net income (loss)
(1)Upon adoption of ASU 2016-13, we recognized credit loss expense incurred and write-downs taken as a result of impairments through net income (loss) for the year endedDecember 31, 2020 . Prior to the adoption of ASU 2016-13, we recognized write-downs taken as a result of OTTI through net income (loss) for the year endedDecember 31, 2019 . The$26 million of impairments recognized in net income (loss) during the year endedDecember 31, 2020 , were all credit-related impairments. The increase in credit losses was primarily attributable to the destabilization of the energy industry. For a discussion of the expected and potential impacts of the COVID-19 pandemic, see "Introduction - Executive Summary" above and "Part I - Item 1A. Rick 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." REINSURANCE Our insurance companies cede insurance to other companies. The portion of our life insurance risks exceeding each of our insurance companies' retention limit is reinsured with other insurers. We seek life and annuity reinsurance coverage to limit our exposure to mortality losses and/or to enhance our capital and risk management. We acquire other reinsurance as applicable with retentions and limits that management believes are appropriate for the circumstances. The consolidated financial statements included in "Item 8. Financial Statements and Supplementary Data" reflect insurance premiums, insurance fees, benefits and DAC amortization net of insurance ceded. Our insurance companies remain liable if their reinsurers are unable to meet contractual obligations under applicable reinsurance agreements. We utilize inter-company reinsurance agreements to manage our statutory capital position as well as our hedge program for variable annuity guarantees. With regard to risk retention from a consolidated basis, these inter-company agreements do not have an effect on our consolidated financial statements. For information regarding reserve financing and LOC expenses from inter-company reinsurance agreements, see "Review of Consolidated Financial Condition - Liquidity and Capital Resources - Uses of Capital - Contractual Obligations" below. We focus on obtaining reinsurance from a diverse group of reinsurers. We have established standards and criteria for our use and selection of reinsurers. In order for a new reinsurer to participate in our current program, we generally require the reinsurer to have anA.M. Best rating of A+ or greater or an S&P rating of AA- or better and a specified RBC percentage (or similar capital ratio measure). If the reinsurer does not have these ratings, we may require them to post collateral as described below; however, we may waive the collateral requirements based on the facts and circumstances. In addition, we may require collateral from a reinsurer to mitigate credit/collectability risk. Typically, in such cases, the reinsurer must either maintain minimum specified ratings and RBC ratios or establish the specified quality and quantity of collateral. Similarly, we have also required collateral in connection with books of business sold pursuant to indemnity reinsurance agreements. Reinsurers, including affiliated reinsurers, that are not licensed, accredited or authorized in the state of domicile of the reinsured ("ceding company"), i.e., unauthorized reinsurers, are required to post statutorily prescribed forms of collateral for the ceding company to receive reinsurance credit. The three primary forms of collateral are: (i) qualifying assets held in a reserve credit trust; (ii) irrevocable, unconditional, evergreen LOCs issued by a qualifiedU.S. financial institution; and (iii) assets held by the ceding company in a segregated funds withheld account. Collateral must be maintained in accordance with the rules of the ceding company's state of domicile and must be readily accessible by the ceding company to cover claims under the reinsurance agreement. Accordingly, our insurance subsidiaries require unauthorized reinsurers to post acceptable forms of collateral to support their reinsurance obligations to us. As a result of ourModco agreement with Athene to reinsure fixed and fixed indexed annuity products, we recorded a$5.8 billion deposit asset reflected within other assets on our Consolidated Balance Sheets as ofDecember 31, 2020 . For additional information, see Note 9. 90
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Our amounts recoverable from reinsurers represent receivables from and reserves ceded to reinsurers. As ofDecember 31, 2020 , 85%, or$14.1 billion , of our total reinsurance recoverable was secured by collateral for our benefit. Of this amount,$13.8 billion was held by reinsurers in reserve credit trusts (such reserve credit trusts are held by non-affiliated reinsurers; therefore, they are not reflected on our Consolidated Balance Sheets),$1.9 billion was reflected as funds withheld reinsurance liabilities on our Consolidated Balance Sheets as ofDecember 31, 2020 , although only$151 million can be utilized as collateral due to excess funds withheld above the reinsurance recoverable from our reinsurers, and$151 million was secured by LOCs for which we are the beneficiary, an off-balance sheet arrangement. We regularly evaluate the financial condition of our reinsurers and monitor concentration risk with our largest reinsurers at least annually. We monitor all of our existing reinsurers' financial strength ratings on a monthly basis. We also monitor our reinsurers' financial health, trends and commitment to the reinsurance business, statutory surplus, RBC levels, statutory earnings and fluctuations, current claims payment aging and our reinsurers' own reinsurers. In addition, we present at least annually information regarding our reinsurance exposures to theFinance Committee of our Board of Directors. For more discussion of our counterparty risk with our reinsurers, see "Part I - Item 1A. Risk Factors - Operational Matters - We face risks of non-collectability of reinsurance and increased reinsurance rates, which could materially affect our results of operations." Under certain indemnity reinsurance agreements, two of our insurance subsidiaries, LNL and LLANY, provide 100% indemnity reinsurance for the business assumed; however, the third-party insurer, or the "cedent," remains primarily liable on the underlying insurance business. These indemnity reinsurance arrangements require that our subsidiary, as the reinsurer, maintain certain insurer financial strength ratings and capital ratios. If these ratings or capital ratios are not maintained, depending upon the reinsurance agreement, the cedent may recapture the business, or require us to place assets in trust or provide LOCs at least equal to the relevant statutory reserves. Under the LNL reinsurance arrangement, we held approximately$2.9 billion of statutory reserves as ofDecember 31, 2020 . LNL must maintain anA.M. Best financial strength rating of at least B++, an S&P financial strength rating of at least BBB- and a Moody's financial strength rating of at least Baa3. This arrangement may require LNL to place assets in trust equal to the relevant statutory reserves. Under LLANY's largest indemnity reinsurance arrangement, we held approximately$1.2 billion of statutory reserves as ofDecember 31, 2020 . LLANY must maintain anA.M. Best financial strength rating of at least B+, an S&P financial strength rating of at least BB+ and a Moody's financial strength rating of at least Ba1, as well as maintain an RBC ratio of at least 160% or an S&P capital adequacy ratio of 100%, or the cedent may recapture the business. Under two other LLANY arrangements, by which we established$672 million of statutory reserves as ofDecember 31, 2020 , LLANY must maintain anA.M. Best financial strength rating of at least B++, an S&P financial strength rating of at least BBB- and a Moody's financial strength rating of at least Baa3. One of these arrangements also requires LLANY to maintain an RBC ratio of at least 185% or an S&P capital adequacy ratio of 115%. Each of these arrangements may require LLANY to place assets in trust equal to the relevant statutory reserves. See "Item 1. Business - Financial Strength Ratings" for a description of our financial strength ratings. For more information about reinsurance, see Notes 9 and 14 and "Review of Consolidated Financial Condition - Liquidity and Capital Resources - Sources of Liquidity and Cash Flow -Insurance Subsidiaries' Statutory Capital and Surplus" below. For factors that could cause actual results to differ materially from those set forth in this section, see "Part I - Item 1A. Risk Factors" and "Forward-Looking Statements - Cautionary Language" above. REVIEW OF CONSOLIDATED FINANCIAL CONDITION Liquidity and Capital Resources Overview Liquidity refers to the ability of an enterprise to generate adequate amounts of cash from its normal operations to meet cash requirements with a prudent margin of safety. Our principal sources of cash flow from operating activities are insurance premiums and fees and investment income, while sources of cash flows from investing activities result from maturities and sales of investments. Our operating activities provided (used) cash of$534 million ,$(2.7) billion and$1.9 billion in 2020, 2019 and 2018, respectively. When considering our liquidity and cash flow, it is important to distinguish between the needs of our insurance subsidiaries and the needs of the holding company, LNC. As a holding company with no operations of its own, LNC is largely dependent upon the dividend capacity of its insurance subsidiaries as well as their ability to advance or repay funds to it through inter-company borrowing arrangements, which may be affected by factors influencing the insurance subsidiaries' RBC and statutory earnings performance. The sources of liquidity and cash flow of the holding company are principally comprised of dividends and interest payments from subsidiaries, augmented by holding company short-term investments, bank lines of credit and the ongoing availability of long-term public financing under anSEC -filed shelf registration statement. These sources of liquidity and cash flow support the general corporate needs of the holding company, including its common stock dividends, interest and debt service, funding of callable securities, securities repurchases, acquisitions and investment in core businesses. 91
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Disruptions, uncertainty or volatility in the capital and credit markets, including any current or future impacts related to the COVID-19 pandemic, may materially affect our business operations and results of operations. These poor market conditions may reduce our insurance subsidiaries' statutory surplus and RBC requiring them to retain more capital and may pressure their ability to pay dividends to LNC, which may lead us to take steps to preserve or raise additional capital. We monitor and adjust our liquidity and capital plans in light of market conditions, as well as changing needs and opportunities. Available liquidity consists of cash and invested cash, excluding cash held as collateral, and certain short-term investments that can be readily converted into cash. As ofDecember 31, 2020 , the holding company had available liquidity of$754 million , which includes amounts related to the pre-funding of our$300 million senior notes due 2022. Based on the sources of liquidity and cash flow available to us as discussed below, we currently expect to be able to meet the holding company's ongoing cash needs and to have sufficient capital to offer downside protection. For factors that could cause actual results to differ materially from those set forth in this section and that could affect our expectations for liquidity and capital, see "Part I - Item 1A. Risk Factors" and "Forward-Looking Statements - Cautionary Language" above. For a discussion of the expected and potential impacts of the COVID-19 pandemic, see "Introduction - Executive Summary" above and "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."
Sources of Liquidity and Cash Flow
Details underlying the primary sources of our holding company cash flows (in
millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Dividends from Subsidiaries
The Lincoln National Life Insurance
Company $ 660 $ 600 $ 910
First Penn-Pacific - - 15
Lincoln Investment Management
Company 25 30 25
Lincoln National Management
Corporation 5 5 -
Lincoln National Reinsurance
Company (Barbados) Limited 150 195 75
Total dividends from subsidiaries
Loan Repayments and Interest from Subsidiaries Interest on inter-company notes$ 123 $ 132 $ 145 Other Cash Flow Items Amounts received from (paid for taxes on) stock option exercises and restricted stock, net$ (2 ) $ (10 ) $ 2 The table above focuses on significant and recurring cash flow items and excludes the effects of certain financing activities, namely the periodic issuance and retirement of debt and cash flows related to our inter-company cash management program (discussed below). Taxes have been eliminated from the analysis due to a tax sharing agreement among our primary subsidiaries resulting in a modest effect on net cash flows at the holding company. Also excluded from this analysis is the modest amount of investment income on short-term investments of the holding company. See "Part IV - Item 15(a)(2) Financial Statement Schedules - Schedule II - Condensed Financial Information of Registrant" for the parent company cash flow statement.
Restrictions on Subsidiaries' Dividends and Other Payments
We are a holding company that transacts substantially all of our business
directly and indirectly through subsidiaries. Our primary assets are the stock
of our operating subsidiaries. Our ability to meet our obligations on our
outstanding debt and to pay dividends and our general and administrative
expenses depends on the surplus and earnings of our subsidiaries and the ability
of our subsidiaries to pay dividends or to advance or repay funds to us.
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Our insurance subsidiaries are subject to certain insurance department regulatory restrictions as to the transfer of funds and payment of dividends to the holding company. UnderIndiana laws and regulations, ourIndiana insurance subsidiaries, including our primary insurance subsidiary,The Lincoln National Life Insurance Company ("LNL"), may pay dividends to LNC without prior approval of the Indiana Insurance Commissioner (the "Commissioner") only from unassigned surplus or must receive prior approval of the Commissioner to pay a dividend if such dividend, along with all other dividends paid within the preceding 12 consecutive months, would exceed the statutory limitation. The current statutory limitation is the greater of 10% of the insurer's contract holders' surplus, as shown on its last annual statement on file with the Commissioner or the insurer's statutory net gain from operations for the previous 12 months, but in no event to exceed statutory unassigned surplus.Indiana law gives the Commissioner broad discretion to disapprove requests for dividends in excess of these limits. LNL's subsidiaries, theLincoln Life & Annuity Company of New York ("LLANY"), aNew York -domiciled insurance company, and LLACB, aNew Hampshire -domiciled insurance company, are bound by similar restrictions, underNew York law andNew Hampshire law, respectively. Under bothNew York andNew Hampshire law, the applicable statutory limitation on dividends is equal to the lesser of 10% of surplus to contract holders as of the end of the immediately preceding calendar year or net gain from operations for the immediately preceding calendar year, not including realized capital gains.Indiana law also provides that following the payment of any dividend, the insurer's contract holders' surplus must be reasonable in relation to its outstanding liabilities and adequate for its financial needs, and permits the Commissioner to bring an action to rescind a dividend that violates these standards. In the event the Commissioner determines that the contract holders' surplus of one subsidiary is inadequate, the Commissioner could use his or her broad discretionary authority to seek to require us to apply payments received from another subsidiary for the benefit of that insurance subsidiary. We expect our direct domestic insurance subsidiaries could pay dividends to LNC of approximately$865 million in 2021 without prior approval from the respective state commissioners. The amount of surplus that our insurance subsidiaries could pay as dividends is constrained by the amount of surplus we hold to maintain our ratings, to provide an additional layer of margin for risk protection and for future investment in our businesses. We maintain an investment portfolio of various holdings, types and maturities. These investments are subject to general credit, liquidity, market and interest rate risks. An extended disruption in the credit and capital markets could adversely affect LNC and its subsidiaries' ability to access sources of liquidity, and there can be no assurance that additional financing will be available to us on favorable terms, or at all, in the current market environment. In addition, further impairment could reduce our statutory surplus, leading to lower RBC ratios and potentially reducing future dividend capacity from our insurance subsidiaries.
Our insurance subsidiaries must maintain certain regulatory capital levels. We utilize the RBC ratio as a primary measure of the capital adequacy of our insurance subsidiaries. The RBC ratio is an important factor in the determination of the credit and financial strength ratings of LNC and its subsidiaries, as a reduction in our insurance subsidiaries' surplus may affect their RBC ratios and dividend-paying capacity. For a discussion of RBC ratios, see "Part I - Item 1. Business - Regulatory - Insurance Regulation -Risk-Based Capital ." Our regulatory capital levels are also affected by statutory accounting rules, which are subject to change by each applicable insurance regulator. Our term products and UL products containing secondary guarantees require reserves calculated pursuant to XXX and AG38, respectively. Our insurance subsidiaries employ strategies to reduce the strain caused by XXX and AG38 by reinsuring the business to reinsurance captives. Our captive reinsurance and reinsurance subsidiaries provide a mechanism for financing a portion of the excess reserve amounts in a more efficient manner. We use long-dated LOCs and debt financing as well as other financing strategies to finance those reserves. Included in the LOCs issued as ofDecember 31, 2020 , was approximately$2.1 billion of long-dated LOCs issued to support inter-company reinsurance arrangements for UL products containing secondary guarantees ($201 million will expire in 2024 and$1.9 billion relates to arrangements that will expire by 2031). For information on the LOCs, see the credit facilities table in Note 13. Our captive reinsurance and reinsurance subsidiaries have also issued long-term notes of$3.6 billion to finance a portion of the excess reserves as ofDecember 31, 2020 ; of this amount,$2.6 billion involve exposure to VIEs. For information on these long-term notes issued by our captive reinsurance and reinsurance subsidiaries, see Note 4. We have also used the proceeds from senior note issuances of$875 million to execute long-term structured solutions primarily supporting reinsurance of UL products containing secondary guarantees. LOCs and related capital market solutions lower the capital effect of term products and UL products containing secondary guarantees. Our captive reinsurance and reinsurance subsidiaries free up capital the insurance subsidiaries can use for any number of purposes, including paying dividends to the holding company. The NAIC's adoption of the Valuation Manual that defines a principles-based reserving framework for newly issued life insurance policies was effectiveJanuary 1, 2017 . We adopted the framework for our newly issued term business in 2017 and phased in the framework throughJanuary 1, 2020 , for all other newly issued life insurance products. We continue to analyze the effects of principles-based reserving on the use of captive reinsurance and reinsurance subsidiaries and third-party reinsurance for reserve financing transactions for our life insurance business. For more information on the NAIC's adoption of principles-based reserving, see "Part I - Item 1. Business - Regulatory - Insurance Regulation." 93
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Statutory reserves established for variable annuity contracts and riders are sensitive to changes in the equity markets and interest rates, and are affected by the level of account values relative to the level of any guarantees, product design and reinsurance arrangements. As a result, the relationship between reserve changes and equity market performance is non-linear during any given reporting period. Market conditions greatly influence the ultimate capital required due to its effect on the valuation of reserves and derivative assets hedging these reserves. We also utilize inter-company reinsurance arrangements to manage our hedge program for variable annuity guarantees. Changes in equity markets may also affect the capital position of our insurance subsidiaries. We may decide to reallocate available capital among our insurance subsidiaries, including our captive reinsurance subsidiaries, which would result in different RBC ratios for our insurance subsidiaries. In addition, changes in the equity markets can affect the value of our variable annuity and variable universal life insurance separate accounts. When the market value of our separate account assets increases, the statutory surplus within our insurance subsidiaries also increases. Contrarily, when the market value of our separate account assets decreases, the statutory surplus within our insurance subsidiaries may also decrease, which may affect RBC ratios, and in the case of our separate account assets becoming less than the related product liabilities, we must allocate additional capital to fund the difference. We continue to analyze the use of our existing captive reinsurance structures, as well as additional third-party reinsurance arrangements, and our current hedging strategies relative to managing the effects of equity markets and interest rates on the statutory reserves, statutory capital and the dividend capacity of our life insurance subsidiaries.
Financing Activities
Although our subsidiaries currently generate adequate cash flow to meet the needs of our normal operations, periodically we may issue debt or equity securities to maintain ratings and increase liquidity, as well as to fund internal growth, acquisitions and the retirement of our debt and equity securities.
We currently have an effective shelf registration statement, which allows us to issue, in unlimited amounts, securities, including debt securities, preferred stock, common stock, warrants, stock purchase contracts, stock purchase units and depository shares.
Details underlying debt and financing activities (in millions) for the year ended December 31, 2020, were as follows:
Maturities, Change
Repayments in Fair
Beginning and Value Other Ending
Balance Issuance Refinancing Hedges Changes (1) Balance
Short-Term Debt
Current maturities of
long-term debt $ 300 $ - $ (300 ) $ - $ - $ -
Long-Term Debt
Senior notes $ 4,610 $ 800 $ (296 ) $ 117 $ (6 ) $ 5,225
Bank borrowings 250 500 (500 ) - (1 ) 249
Capital securities (2) 1,207 - - - 1 1,208
Total long-term debt $ 6,067 $ 1,300 $ (796 ) $ 117 $ (6 ) $ 6,682
(1)Includes the non-cash reclassification of long-term debt to current maturities of long-term debt, accretion (amortization) of discounts and premiums, amortization of debt issuance costs and amortization of adjustments from discontinued hedges, as applicable.
(2)To hedge the variability in rates, we purchased interest rate swaps to lock in a fixed rate of approximately 5% over the remaining terms of the capital securities.
During March 2020, we entered into a $500 million floating-rate loan maturing on
March 30, 2022 (the "2022 Term Loan"). In addition, during March 2020, we
unwound the fair value hedge on our 7.00% senior notes due 2040 and entered into
two fair value hedges on the same notes, which generated capital deployed for
general corporate purposes. During May 2020, we completed the issuance and sale
of $500 million aggregate principal amount of our 3.40% senior notes due 2031
and $300 million aggregate principal amount of our 4.375% senior notes due 2050.
We used the net proceeds from the offering to fund the redemption of our $296
million 4.85% senior notes due 2021 and to repay the 2022 Term Loan. For more
information, see Note 13.
We have not accounted for repurchase agreements, securities lending transactions
or other transactions involving the transfer of financial assets with an
obligation to repurchase the transferred assets as sales. For information about
our collateralized financing transactions on our investments, see "Payables for
Collateral on Investments" in Note 5.
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If current credit ratings or claims-paying ratings were downgraded in the future, terms in our derivative agreements may be triggered, which could negatively affect overall liquidity. For the majority of our derivative counterparties, there is a termination event with respect to LNC if its long-term senior debt ratings drop below BBB-/Baa3 (S&P/Moody's); or with respect to LNL if its financial strength ratings drop below BBB-/Baa3 (S&P/Moody's). Our long-term senior debt held a rating of A-/Baa1 (S&P/Moody's) as of December 31, 2020. In addition, contractual selling agreements with intermediaries could be negatively affected, which could have an adverse effect on overall sales of annuities, life insurance and investment products. See "Part I - Item 1A. Risk Factors - Liquidity and Capital Position - A decrease in the capital and surplus of our insurance subsidiaries may result in a downgrade to our credit and insurer financial strength ratings" and "Part I - Item 1A. Risk Factors - Covenants and Ratings - A downgrade in our financial strength or credit ratings could limit our ability to market products, increase the number or value of policies being surrendered and/or hurt our relationships with creditors" for more information. See "Part I - Item 1. Business - Financial Strength Ratings" for additional information on our current financial strength ratings. Our indicative credit ratings published by the primary rating agencies are set forth below. Securities are rated at the time of issuance so actual ratings may differ from the indicative ratings. There may be other rating agencies that also provide credit ratings, which we do not disclose in our reports. The long-term credit rating scales ofA.M. Best , Fitch, Moody's and S&P are characterized as follows: ?A.M. Best - aaa to c ?Fitch -AAA to D ?Moody's - Aaa to C ?S&P -AAA to D As of February 12, 2021, our indicative long-term credit ratings as published by the principal rating agencies that rate our long-term credit were as follows: A.M. Best Fitch Moody's S&P a- BBB+ Baa1 A- (7th of 22) (8th of 21) (8th of 21) (7th of 22) The short-term credit rating scales ofA.M. Best , Fitch, Moody's and S&P are characterized as follows: ?A.M. Best - AMB-1+ to AMB-4 ?Fitch - F1+ to D ?Moody's - P-1 to NP ?S&P - A-1+ to D
As of February 12, 2021, our indicative short-term credit ratings as published by the principal rating agencies that rate our short-term credit were as follows:
AMB-1 F2 P-2 A-2
(2nd of 6) (3rd of 8) (2nd of 4) (3rd of 7)
A downgrade of our debt ratings could affect our ability to raise additional
debt with terms and conditions similar to our current debt, and accordingly,
likely increase our cost of capital. In addition, a downgrade of these ratings
could make it more difficult to raise capital to refinance any maturing debt
obligations, to support business growth at our insurance subsidiaries and to
maintain or improve the current financial strength ratings of our principal
insurance subsidiaries described in "Part I - Item 1. Business - Financial
Strength Ratings."
All ratings are on outlook stable. All of our ratings are subject to revision or
withdrawal at any time by the rating agencies, and therefore, no assurance can
be given that we can maintain these ratings. Each rating should be evaluated
independently of any other rating.
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Management monitors the covenants associated with LNC's capital securities.
If
we fail to meet capital adequacy or net income and stockholders' equity levels
(also referred to as "trigger events"), terms in the agreements may be
triggered, which would require us to make interest payments in accordance with
an alternative coupon satisfaction mechanism ("ACSM"). This would generally
require us to use commercially reasonable efforts to pay interest in full on the
capital securities with the net proceeds from sales of our common stock and
warrants to purchase our common stock with an exercise price greater than the
market price. We would have to utilize the ACSM until the trigger events above
no longer existed. If we were required to utilize the ACSM and were successful
in selling sufficient shares of common stock or warrants to satisfy the interest
payment, we would dilute the current holders of our common stock. Furthermore,
while a trigger event is occurring and if we do not pay accrued interest in
full, we may not, among other things, pay dividends on or repurchase our capital
stock. We have not triggered either the net income test or the overall
stockholders' equity test looking forward to the quarters ending March 31, 2021,
and June 30, 2021. For more information, see "Part I - Item 1A. Risk Factors -
Covenants and Ratings - We will be required to pay interest on our capital
securities with proceeds from the issuance of qualifying securities if we fail
to achieve specified capital adequacy or net income and stockholders' equity
levels, which would dilute the current holders of our common stock."
Alternative Sources of Liquidity
Inter-company Cash Management Program
In order to manage our capital more efficiently, we have an inter-company cash management program where certain subsidiaries can lend to or borrow from the holding company to meet short-term borrowing needs. The cash management program is essentially a series of demand loans between LNC and participating subsidiaries that reduces overall borrowing costs by allowing LNC and its subsidiaries to access internal resources instead of incurring third-party transaction costs. As of December 31, 2020, the holding company had a net outstanding receivable (payable) of $(254) million from (to) certain subsidiaries resulting from loans made by subsidiaries in excess of amounts placed (borrowed) by the holding company and subsidiaries in the inter-company cash management account. Any change in holding company cash management program balances is offset by the immediate and equal change in holding company cash and invested cash. The holding company had an average borrowing balance of $1.0 billion from the cash management program during 2020. The holding company had a maximum and minimum amount of financing from the cash management program during 2020 of $1.4 billion and $322 million, respectively. Loans under the cash management program are permitted under applicable insurance laws subject to certain restrictions. For ourIndiana andNew Hampshire -domiciled insurance subsidiaries, the borrowing and lending limit is currently 3% of the insurance company's admitted assets as of its most recent year end. For ourNew York -domiciled insurance subsidiary, it may borrow from LNC less than 2% of its admitted assets as of its most recent year end but may not lend any amounts to LNC.
Facility Agreement for Senior Notes Issuance
During August 2020, LNC entered into a facility agreement with aDelaware trust that gives LNC the right over a 10-year period to issue, from time to time, up to $500 million of 2.330% senior notes to the trust in exchange for a corresponding amount ofU.S. Treasury securities held by the trust. By agreeing to purchase the 2.330% senior notes in exchange forU.S. Treasury securities upon exercise of the issuance right, the trust will provide a source of liquid assets for the Company. For additional details, see Note 13.
Federal Home Loan Bank
Our primary insurance subsidiary, LNL, is a member of the Federal Home Loan Bank
("FHLB") of Indianapolis ("FHLBI"). Membership allows LNL access to the FHLBI's
financial services, including the ability to obtain loans and to issue funding
agreements as an alternative source of liquidity that are collateralized by
qualifying mortgage-related assets, agency securities or U.S. Treasury
securities. Borrowings under this facility are subject to the FHLBI's discretion
and require the availability of qualifying assets at LNL. As of December 31,
2020, LNL had an estimated maximum borrowing capacity of $7.0 billion under the
FHLBI facility and maximum available borrowing based on qualifying assets of
$4.4 billion. As of December 31, 2020, LNL had outstanding borrowings of $3.1
billion reported within payables for collateral on investments on the
Consolidated Balance Sheets. In October 2020, LLANY became a member of the
Federal Home Loan Bank of New York ("FHLBNY") with an estimated maximum
borrowing capacity of $750 million. Borrowings under this facility are subject
to the FHLBNY's discretion and require the availability of qualifying assets at
LLANY. As of December 31, 2020, there were no outstanding borrowings. For
additional details, see "Payables for Collateral on Investments" in Note 5.
Securities Lending Programs and Repurchase Agreements
Our insurance subsidiaries, by virtue of their general account fixed-income
investment holdings, can access liquidity through securities lending programs
and repurchase agreements. As of December 31, 2020, our insurance subsidiaries
had securities pledged under securities lending agreements with a carrying value
of $115 million. In addition, our insurance subsidiaries had access to $750
million through a committed repurchase agreement. The cash received in our
securities lending programs and repurchase agreements is typically invested in
cash and invested cash or fixed maturity AFS securities. For additional details,
see "Payables for Collateral on Investments" in Note 5.
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Collateral on Derivative Contracts
Our cash flows associated with collateral received from counterparties (when we are in a net payable position) and posted with counterparties (when we are in a net receivable position) change as the market value of the underlying derivative contract changes. The net collateral position depends on changes in interest rates and equity markets related to the amount of the exposures hedged. As of December 31, 2020, we were in a net collateral payable position of $1.9 billion compared to $830 million as of December 31, 2019. During 2020, our net collateral payable position increased due primarily to decreasing interest rates that increased the fair values of our associated over-the-counter derivative investments. In the event of adverse changes in fair value of our derivative instruments, we may need to post collateral with a counterparty. If we do not have sufficient high quality securities or cash and invested cash to provide as collateral, we have committed liquidity sources through facilities that can provide up to $1.25 billion of additional liquidity to help meet collateral needs. Access to such facilities is contingent upon interest rates having achieved certain threshold levels. In addition to these facilities, we have the facility agreement for senior notes issuance, the FHLB facilities and the repurchase agreements discussed above as well as the five-year revolving credit facility discussed in Note 13 to leverage that would be eligible for collateral posting. For additional information, see "Credit Risk" in Note 6.
Uses of Capital
Our principal uses of cash are to pay policy claims and benefits, operating expenses, commissions and taxes, to purchase new investments, to purchase reinsurance, to fund policy surrenders and withdrawals, to pay dividends to our stockholders, to repurchase our stock and to repay debt.
Return of Capital to Common Stockholders
One of the Company's primary goals is to provide a return to our common stockholders through share price accretion, dividends and stock repurchases. In determining dividends, the Board of Directors takes into consideration items such as current and expected earnings, capital needs, rating agency considerations and requirements for financial flexibility. On November 3, 2020, our Board of Directors approved an increase to the quarterly dividend on our common stock from $0.40 to $0.42 per share. The amount and timing of share repurchases depends on key capital ratios, rating agency expectations, the generation of free cash flow and an evaluation of the costs and benefits associated with alternative uses of capital. Free cash flow for the holding company generally represents the amount of dividends and interest received from subsidiaries less interest paid on debt. During the second and third quarters of 2020, we suspended common stock repurchases under our buyback program; however, we resumed common stock repurchases in the fourth quarter of 2020. We may repurchase additional shares of common stock during 2021 depending on market conditions and alternative uses of capital. For more information regarding share repurchases, see "Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities - (c) Issuer Purchases of Equity Securities."
Details underlying this activity (in millions) were as follows:
For the Years Ended December 31,
2020 2019 2018
Dividends to common stockholders $ 311 $ 298 $
286
Repurchase of common stock 275 640
810
Total cash returned to stockholders $ 586 $ 938 $
1,096
Number of shares repurchased 4.9 10.4 13.2
Other Uses of Capital
In addition to the amounts in the table above in "Return of Capital to Common
Stockholders," other uses of holding company cash flow (in millions) were as
follows:
For the Years Ended December 31,
2020 2019 2018
Debt service (interest paid) $ 277 $ 288 $ 286
Capital contribution to subsidiaries 518 50 502
Total $ 795 $ 338 $ 788
The above table focuses on significant and recurring cash flow items and
excludes the effects of certain financing activities, namely the periodic
retirement of debt and cash flows related to our inter-company cash management
account. Taxes have been eliminated from the analysis due to a tax sharing
agreement among our primary subsidiaries resulting in a modest effect on net
cash flows at the holding company.
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Table of Contents Contractual Obligations
Details underlying our future estimated cash payments for our contractual obligations (in millions) as of December 31, 2020, were as follows:
Less More
Than 1 - 3 3 - 5 Than
1 Year Years Years 5 Years Total
Future contract benefits and other
contract holder
obligations (1) $ 23,152 $ 45,371 $ 44,020 $ 391,562 $ 504,105
Short-term and long-term debt (2) - 800 550 4,981 6,331
Reserve financing and LOC expenses
(3) 68 128 109 317 622
Payables for collateral on
investments (4) 3,245 - - - 3,245
Operating leases (5) 51 89 51 47 238
Finance leases (5) 62 151 24 4 241
Certain financing arrangements (6) 4 30 190 9 233
Retirement and other plans (7) 110 212 206 484 1,012
Total $ 26,692 $ 46,781 $ 45,150 $ 397,404 $ 516,027
(1)Estimates are based on financial projections over 40 years and are not discounted for the time value of money. New business issued or acquired, business ceded or sold, changes to or variances from actuarial assumptions and economic conditions will cause these amounts to change over time, possibly materially. See Note 1 for details of what these liabilities include and represent.
(2)Represents principal amounts of debt only. See Note 13 for additional information.
(3)Estimates are based on the level of capacity we expect to utilize during the life of the LOCs and other reserve financing arrangements. See Note 13 for additional information.
(4)Excludes collateral payable held for derivative investments. See Note 5 for additional information.
(5)See Note 14 for additional information.
(6)Represents certain financing arrangements that did not meet the requirements to be classified as a sale-leaseback arrangement.
(7)Includes anticipated funding for benefit payments for our retirement and postretirement plans through 2030 and known payments under deferred compensation arrangements. In addition to these benefit payments, we periodically fund the employees' defined benefit plans. The majority of contributions and benefit payments are made by our insurance subsidiaries with little effect on holding company cash flow. See Note 18 for additional information. Due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits as of December 31, 2020, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority. Therefore, $51 million of unrecognized tax benefits and its associated interest have been excluded from the contractual obligations table above. See Note 7 for additional information.
Contingencies and Off-Balance Sheet Arrangements
During August 2020, LNC entered into a facility agreement with aDelaware trust that gives LNC the right over a 10-year period to issue, from time to time, up to $500 million of 2.330% senior notes to the trust in exchange for a corresponding amount ofU.S. Treasury securities held by the trust. The issuance right will be exercised automatically in full upon our failure to make certain payments to the trust, if the failure to pay is not cured within 30 days, or upon certain bankruptcy events involving LNC. We are also required to exercise the issuance right in full if our consolidated stockholders' equity (excluding AOCI) falls below $2.75 billion, subject to adjustment from time to time in certain cases, and upon certain other events described in the facility agreement. For more information, see Note 13. Other than as described above, we do not have any off-balance sheet arrangements that are reasonably likely to have a material effect on our financial condition, results of operations, liquidity or capital resources. 98
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Table of Contents
Details underlying our contingent commitments (in millions) as of December 31,
2020, were as follows:
Amount of Commitment Expiring per Period Total
Less Than 1 - 3 3 - 5 After Amount
1 Year Years Years 5 Years Committed
Credit facilities (1) $ - $ - $ 2,250 $ 1,944 $ 4,194
Investment commitments (2) 1,665 295 613 281 2,854
Total $ 1,665 $ 295 $ 2,863 $ 2,225 $ 7,048
(1)See Note 13 for additional information.
(2)See Note 5 for additional information.
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