LINCOLN NATIONAL CORP
Item 1. Business
OVERVIEW
Lincoln National Corporation (“LNC,” which also may be referred to as “Lincoln,” “we,” “our” or “us”) is a holding company, which operates multiple insurance and retirement businesses through subsidiary companies. Through our business segments, we sell a wide range of wealth protection, accumulation, retirement income and group protection products and solutions. LNC was organized under the laws of the state of Indiana in 1968. We currently maintain our principal executive offices in Radnor, Pennsylvania. “Lincoln Financial Group” is the marketing name for LNC and its subsidiary companies. As of December 31, 2020, LNC had consolidated assets of $365.9 billion and consolidated stockholders’ equity of $22.7 billion.
We provide products and services and report results through four segments as follows:
Business Segments
Annuities
Retirement Plan Services
Life Insurance
Group Protection
We also have Other Operations, which includes the financial data for operations that are not directly related to the business segments.
The results of Lincoln Financial Network (“LFN”) and Lincoln Financial Distributors (“LFD”), our retail and wholesale distributors, respectively, are included in the segments for which they distribute products. LFD distributes our individual products and services, retirement plans and corporate-owned universal life insurance and variable universal life insurance (“COLI”) and bank-owned universal life insurance and variable universal life insurance (“BOLI”) products and services. The distribution occurs primarily through consultants, brokers, planners, agents, financial advisers, third-party administrators (“TPAs”) and other intermediaries. Group Protection distributes its products and services primarily through employee benefit brokers, TPAs and other employee benefit firms. As of December 31, 2020, LFD had approximately 560 internal and external wholesalers (including sales and relationship managers). As of December 31, 2020, LFN offered LNC and non-proprietary products and advisory services through a national network of approximately 13,500 active producers who placed business with us within the last 24 months.
Financial information in the tables that follow is presented in accordance with United States of America generally accepted accounting principles (“GAAP”), unless otherwise indicated. We provide revenues, income (loss) from operations and assets attributable to each of our business segments and Other Operations in Note 22.
Acquisitions and Dispositions
On May 1, 2018, we completed the acquisition from Liberty Mutual Insurance Company of 100% of the capital stock of Liberty 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 (the “Liberty Life Business”). In connection with the acquisition, Liberty Life sold the Liberty Life Business on May 1, 2018, by entering into reinsurance agreements and related ancillary documents with Protective Life Insurance Company and its wholly-owned subsidiary, Protective Life and Annuity Insurance Company (together with Protective Life Insurance Company, “Protective”), providing for the reinsurance and administration of the Liberty Life Business. Liberty Life’s excess capital of $1.8 billion was paid to Liberty Mutual Insurance Company through an extraordinary dividend at the acquisition date. We paid $1.5 billion of cash to Liberty Mutual Insurance Company to acquire the Liberty Group Business. Effective September 1, 2019, Liberty Life’s name was changed to Lincoln Life Assurance Company of Boston (“LLACB”).
For further information about acquisitions and dispositions, see Note 3.
BUSINESS SEGMENTS AND OTHER OPERATIONS
ANNUITIES
Overview
The Annuities segment provides tax-deferred investment growth and lifetime income opportunities for its clients by offering variable annuities, fixed (including indexed) annuities and indexed variable annuities. The “fixed” and “variable” classifications describe whether we or the contract holders bear the investment risk of the assets supporting the contract. With “indexed variable” annuities, the extent to which we or the contract holders bear the investment risk of the assets is based on the investment allocations. The annuity classification also determines the manner in which we earn investment margin profits from these products, either as investment spreads for fixed products, as asset-based fees charged to variable products, or as both for indexed variable products.
Annuities have several features that are attractive to customers. Annuities are unique in that contract holders can select a variety of payout alternatives to provide an income flow for life. Many annuity contracts also include guarantee features (living and death benefits) that are not found in any other investment vehicle and that, we believe, make annuities attractive especially in times of economic uncertainty. In addition, growth on the underlying principal in certain annuities is granted tax-deferred treatment, thereby deferring the tax consequences of the growth in value until withdrawals are made from the accumulation values, often at lower tax rates occurring during retirement.
Products
In general, an annuity is a contract between an insurance company and an individual in which the insurance company, after receipt of one or more premium payments, agrees to pay an amount of money either in one lump sum or on a periodic basis (i.e., annually, semi-annually, quarterly or monthly), beginning on a certain date and continuing for a period of time as specified in the contract or as requested. Periodic payments can begin within 12 months after the premium is received (referred to as an immediate annuity) or at a future date in time (referred to as a deferred annuity). This retirement vehicle helps protect an individual from outliving his or her money.
Variable Annuities
A variable annuity provides the contract holder the ability to direct the investment of premium deposits into one or more variable sub-accounts (“variable funds”) offered through the product (“variable portion”) and, for a specified period, into a fixed account (if available) with a guaranteed return (“fixed portion”). The value of the variable portion of the contract holder’s account varies with the performance of the underlying variable funds chosen by the contract holder.
Our variable funds include the Managed Risk Strategies fund options, a series of funds that embed volatility risk management and, with some funds, capital protection strategies inside the funds themselves. These funds seek to reduce equity market volatility risk for both the contract holder and us. As of December 31, 2020 and 2019, the Managed Risk Strategies funds totaled $43.0 billion and $42.0 billion, respectively, or 34% of total variable annuity product account values.
We charge mortality and expense assessments and administrative fees on variable annuity accounts to cover insurance and administrative expenses. These assessments are built into accumulation unit values, which when multiplied by the number of units owned for any variable fund equals the contract holder’s account value for that variable fund. In addition, for some contracts, we impose surrender charges, which are typically applicable to withdrawals during the early years of the annuity contract, with a declining level of surrender charges over time.
We offer guaranteed benefit riders with certain of our variable annuity products, such as a guaranteed death benefit (“GDB”), a guaranteed withdrawal benefit (“GWB”), a guaranteed income benefit (“GIB”) and a combination of such benefits. In 2020, 69% of our variable annuity deposits were on products without guaranteed living benefit (“GLB”) riders, compared to 47% in 2019.
The GDB features offered include those where we contractually guarantee to the contract holder that upon death, depending on the particular product, we will return no less than: the current contract value; the total deposits made to the contract, adjusted to reflect any partial withdrawals; or the highest contract value on a specified anniversary date adjusted to reflect any partial withdrawals following the contract anniversary.
We offer optional benefit riders including the Lincoln Lifetime IncomeSM Advantage 2.0 (Managed Risk), Lincoln Market SelectSM Advantage and Max 6 SelectSM Advantage riders. All provide contract holders with protected lifetime income that is based on a maximum rate of the income base that grows annually at either the greater of a specified simple rate (available each year a withdrawal is not taken for a specified period of time) or account value growth. The riders provide higher income if the contract holder delays withdrawals. The Lincoln Lifetime Income Advantage 2.0 (Managed Risk) and Lincoln Market Select Advantage riders are hybrid benefit riders combining aspects of GWB and GIB that provide a specified maximum rate of the income base or income through the i4LIFE® Advantage rider with the GIB. The Lincoln Max 6 Select Advantage rider provides contract holders with protected lifetime income up to a specified maximum rate of the income base and a different specified maximum rate of the income base if the account value falls to zero. Contract holders under the Lincoln Lifetime Income SM Advantage 2.0 (Managed Risk) rider are subject to the allocation of their account value to our Managed Risk Strategies fund options and certain fixed-income options. Contract holders under the Lincoln Market Select SM Advantage and Lincoln Max 6 Select SM Advantage riders are subject to restrictions on the allocation of their account value within the various investment choices.
We also offer the American Legacy® Target Date Income variable annuity with an optional Target Date Income Benefit rider, which combines target date investing with a protected lifetime income. Contract holders who elect the Target Date Income Benefit are automatically allocated to the Target Date Fund based on their year of birth. The protected lifetime income is based on a percentage rate of income for their age at the time of purchase of the optional rider, which will grow at the greater of a specified simple rate (available each year a withdrawal is not taken for a specified period of time) or account value growth.
In addition, we offer the i4LIFE® Advantage, i4LIFE Advantage Guaranteed Income Benefit (Managed Risk) and i4LIFE Advantage Select Guaranteed Income Benefit riders. These riders allow variable annuity contract holders access and control during a portion of the income distribution phase of their contract. This added flexibility allows the contract holder to access the account value for transfers, additional withdrawals and other service features like portfolio rebalancing. In general, GIB is an optional feature available with the i4LIFE Advantage rider and a non-optional feature on the i4LIFE Advantage Guaranteed Income Benefit (Managed Risk) and i4LIFE Advantage Select Guaranteed Income Benefit riders that guarantees regular income payments will not fall below the greater of a minimum income floor set at benefit issue and 75% of the highest income payment on a specified anniversary date (reduced for any subsequent withdrawals). Contract holders under the i4LIFE Advantage Guaranteed Income Benefit (Managed Risk) rider are subject to the allocation of their account value to our Managed Risk Strategies fund options and certain fixed-income options. Contract holders under the i4LIFE Advantage Select Guaranteed Income Benefit rider are subject to restrictions on the allocation of their account value within the various investment choices.
We also offer the 4LATER® Select Advantage rider. This rider provides a minimum income base used to determine the GIB floor when a client begins income payments under the i4LIFE Advantage Select Guaranteed Income Benefit rider. The 4LATER Select Advantage rider provides growth during the accumulation phase through both an enhancement to the income base each year a withdrawal is not taken for a specified period of time and an annual step-up of the income base to the current contract value. Contract holders under the 4LATER Select Advantage rider are subject to restrictions on the allocation of their account value within the various investment choices.
We design and actively manage the features and structure of our guaranteed benefit riders to maintain a competitive suite of products consistent with profitability and risk management goals. To mitigate the increased risks associated with guaranteed benefits, we utilize a dynamic hedging program. The customized dynamic hedging program uses equity, interest rate and currency futures positions, interest rate and total return swaps and equity-based options depending upon the risks underlying the guarantees. For more information on our hedging program, see “Critical Accounting Policies and Estimates - Derivatives” and “Realized Gain (Loss) and Benefit Ratio Unlocking” in the MD&A. For information regarding risks related to guaranteed benefits, see “
Item 1A. Risk Factors
You should carefully consider the risks described below before investing in our securities. The risks and uncertainties described below are not the only ones facing our Company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of these risks actually occur, our business, financial condition and results of operations could be materially affected. In that case, the value of our securities could decline substantially.
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.
The health, economic and business conditions precipitated by the worldwide COVID-19 pandemic during 2020 adversely affected, and during 2021 are expected to continue to adversely affect, our earnings as well as our business, results of operations and financial condition. As a result of the pandemic and ensuing conditions, we have experienced and expect to continue to experience higher mortality, leading to an elevated incidence and level of life insurance claims. In addition, we have experienced and expect to continue to experience an increase in short-term disability claims related to the pandemic, and, beginning in 2021, we expect we may experience an increase in long-term disability claims due to the recessionary conditions and high levels of unemployment that emerged during 2020. Increased life and disability claim levels adversely affect our earnings. We may also experience an increase in activity such as surrenders of policies, missed premium payments or 401(k) hardship withdrawals due to changes in consumer behavior as a result of financial stress. Because the vast majority of our employees continue to work from home, along with many of our vendors and customers, and such conditions may continue well into 2021, our business operations may be adversely impacted, among other things, due to privacy incidents, cybersecurity incidents, technological issues or operational disruptions on the part of our vendors, and we may experience distribution disruptions as we continue to sell our products virtually.
The severe restriction in economic activity caused by the COVID-19 pandemic and increased level of unemployment in the United States have contributed to increased volatility and uncertainty regarding expectations for the economy and markets going forward. 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 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 a discussion of specific risks related to economic and market conditions and low interest rates see the additional risk factors under “Market Conditions” below.
In addition, although the economic environment has improved from early in 2020, there could be continued weakness in the current environment that 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.
The impacts of the pandemic may also have the effect of increasing the likelihood and/or magnitude of many of the other risks described below, including in particular the risks described under “Liquidity and Capital Position” and “Investments.” The ultimate impact on our business, results of operations and financial condition depends on the severity and duration of the COVID-19 pandemic and related health, economic and business impacts and actions taken by governmental authorities and other third parties in response, each of which is uncertain, rapidly changing and difficult to predict.
Weak conditions in the global capital markets and the economy generally may materially adversely affect our business and results of operations.
Our results of operations are materially affected by conditions in the global capital markets and the economy generally, both in the U.S. and elsewhere around the world. Major central bank policy actions, slowing of global growth, trade policy and political policy uncertainty remain key challenges for markets and our business. These macro-economic conditions have in the past and may in the future have an adverse effect on us given our credit and equity market exposure. In the event of extreme prolonged market events, such as the global credit crisis and recession that occurred during 2008 and 2009, we could incur significant losses. Even in the absence of a market downturn, we are exposed to substantial risk of loss and ratings downgrades due to market volatility.
Factors such as consumer spending, business investment, domestic and foreign government spending, the volatility and strength of the capital markets, the potential for inflation or deflation and uncertainty over domestic and foreign government actions all affect the business and economic environment and, ultimately, the amount and profitability of our business. In an economic downturn characterized by higher unemployment, lower disposable income, lower corporate earnings, lower business investment and lower consumer spending, the demand for our financial and insurance products could be adversely affected. In addition, we have experienced and expect to continue to experience an elevated incidence of claims and could experience an increase in lapses or surrenders of policies. Our contract holders may choose to defer paying insurance premiums or stop paying insurance premiums altogether. Adverse changes in the economy have in the past and could in the future affect earnings negatively and could have a material adverse effect on our business, results of operations and financial condition.
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.
Interest rate fluctuations and/or a sustained period of low interest rates could negatively affect our profitability. Some of our products, principally fixed annuities and UL, including linked-benefit UL, have interest rate guarantees that expose us to the risk that changes in interest rates will reduce our spread, or the difference between the amounts that we are required to pay under the contracts and the amounts we are able to earn on our general account investments intended to support our obligations under the contracts. Spreads are an important component of our net income. 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 a material adverse effect on our businesses or results of operations. In addition, low rates increase the cost of providing variable annuity living benefit guarantees, which could negatively affect our variable annuity profitability.
In periods when interest rates are declining or remain at low levels, we may have to reinvest the cash we receive as interest or return of principal on our investments in lower yielding instruments reducing our spread. Moreover, borrowers may prepay fixed-income securities, commercial mortgages and mortgage-backed securities in our general account in order to borrow at lower market rates, which exacerbates this risk. Lowering interest crediting rates helps to mitigate the effect of spread compression on some of our products. However, because we are entitled to reset the interest rates on our fixed-rate annuities only at limited, pre-established intervals, and since many of our contracts have guaranteed minimum interest or crediting rates, our spreads could still decrease. As of December 31, 2020, 37% of our annuities business, 80% of our retirement plan services business and 88% of our life insurance business with guaranteed minimum interest or crediting rates were at their guaranteed minimums.
Our expectation for future spreads is an important component in the amortization of DAC and value of business acquired (“VOBA”) as it affects the future profitability of the business. Currently, new money rates are at historically low levels, with the Federal Reserve decreasing the target range for the federal funds rate in March 2020 to a range of 0.00% to 0.25%. Due to the continued low interest rate environment, in 2020 we updated our interest rate assumptions for the second year in a row, which included lowering starting new money rates and reducing our long-term new money investment yield assumption. As a result of these updates, we recorded unfavorable after-tax unlocking during 2020, which was most pronounced in our Life Insurance segment. We cannot give assurance that persistent low interest rates will not result in future unfavorable unlocking. For additional information on interest rate risks, see “Part II - Item 7A. Quantitative and Qualitative Disclosures About Market Risk - Interest Rate Risk.”
A decline in market interest rates could also reduce our return on investments that do not support particular policy obligations. During periods of sustained lower interest rates, our recorded policy liabilities may not be sufficient to meet future policy obligations and may need to be strengthened, thereby reducing net income in the affected reporting period. Accordingly, declining interest rates may materially affect our results of operations, financial condition and cash flows and significantly reduce our profitability. In addition, a decline in market interest rates may make it more challenging for us to pass certain asset adequacy tests related to statutory reserves, given the required conservatism of some of the regulations with which we must comply. To meet these requirements, we may be required to post asset adequacy reserves, which, depending on the size of the reserve, could materially affect our financial results.
Increases in market interest rates may also negatively affect our profitability. In periods of rapidly increasing interest rates, we may not be able to replace the assets in our general account with higher yielding assets needed to fund the higher crediting rates necessary to keep our interest-sensitive products competitive. We, therefore, may have to accept a lower spread and thus lower profitability or face a decline in sales and greater loss of existing contracts and related assets. Increases in interest rates may cause increased surrenders and withdrawals of insurance products. In periods of increasing interest rates, policy loans and surrenders and withdrawals of life insurance policies and annuity contracts may increase as contract holders seek to buy products with perceived higher returns. This process may lead to a flow of cash out of our businesses. These outflows may require investments to be sold at a time when the prices of those assets are lower because of the increase in market interest rates, which may result in realized investment losses. A sudden demand among consumers to change product types or withdraw funds could lead us to sell assets at a loss to meet the demand for funds. Furthermore, unanticipated increases in withdrawals and termination may cause a change in our DAC and VOBA assets due to a change in future expected profitability, which would reduce net income. An increase in market interest rates could also have a material adverse effect on the value of our investment portfolio, for example, by decreasing the estimated fair values of the fixed-income securities that comprise a substantial portion of our investment portfolio. An increase in interest rates could also result in decreased fee income associated with a decline in the value of variable annuity account balances invested in fixed-income funds.
Because the equity markets and other factors impact the profitability and expected profitability of many of our products, changes in equity markets and other factors may significantly affect our business and profitability.
The fee income that we earn on variable annuities is based primarily upon account values, and the fee income that we earn on VUL insurance policies is partially based upon account values. Because strong equity markets result in higher account values, strong equity markets positively affect our net income through increased fee income. Conversely, a weakening of the equity markets results in lower fee income and may have a material adverse effect on our results of operations and capital resources.
The increased fee income resulting from strong equity markets increases the estimated gross profits (“EGPs”) from variable insurance products as do better than expected lapses, mortality rates and expenses. As a result, higher EGPs may result in lower net amortized costs related to DAC, deferred sales inducements (“DSI”), VOBA, deferred front-end loads (“DFEL”) and changes in future contract benefits. However, a decrease in the equity markets, as well as worse than expected lapses, mortality rates and expenses, depending upon their significance, may result in higher net amortized costs associated with DAC, DSI, VOBA, DFEL and changes in future contract benefits and may have a material adverse effect on our results of operations and capital resources. If we had unlocked our reversion to the mean (“RTM”) assumption in the corridor as of December 31, 2020, we would have recorded favorable unlocking of approximately $365 million, pre-tax, primarily within our Annuities segment. For further information about our RTM process, see “Critical Accounting Policies and Estimates - DAC, VOBA, DSI and DFEL - Reversion to the Mean” in the MD&A.
Changes in the equity markets, interest rates and/or volatility affect the profitability of our products with guaranteed benefits; therefore, such changes may have a material adverse effect on our business and profitability.
Certain of our variable annuity and fixed indexed annuity products include optional guaranteed benefit riders. These include GDB (variable annuity only), GWB and GIB riders. Both the level of expected payments and expected total assessments used in calculating the benefit reserves are affected by the equity markets. The liabilities related to fair value are impacted by changes in equity markets, interest rates, volatility, foreign exchange rates and credit spreads. Accordingly, strong equity markets, increases in interest rates and decreases in volatility will generally decrease the reserves calculated using fair value. Conversely, a decrease in the equity markets along with a decrease in interest rates and an increase in volatility will generally result in an increase in the reserves calculated using fair value.
Increases in reserves would result in a charge to our earnings in the quarter in which the increase occurs. Therefore, we maintain a customized dynamic hedge program that is designed to mitigate the risks associated with income volatility around the change in reserves on guaranteed benefits. However, the hedge positions may not be effective to exactly offset the changes in the carrying value of the guarantees due to, among other things, the time lag between changes in their values and corresponding changes in the hedge positions, high levels of volatility in the equity markets and derivatives markets, extreme swings in interest rates, contract holder behavior different than expected, a strategic decision to adjust the hedging strategy in reaction to extreme market conditions or inconsistencies between economic and statutory reserving guidelines and divergence between the performance of the underlying funds and hedging indices.
In addition, we remain liable for the guaranteed benefits in the event that derivative or reinsurance counterparties are unable or unwilling to pay, and we are also subject to the risk that the cost of hedging these guaranteed benefits increases, resulting in a reduction to net income. These, individually or collectively, may have a material adverse effect on net income, financial condition or liquidity.
Legislative, Regulatory and Tax
Our businesses are heavily regulated and changes in regulation and in supervisory and enforcement policies may affect our insurance subsidiary capital requirements, reduce our profitability, limit our growth or otherwise adversely affect our business, results of operations and financial condition.
Our insurance subsidiaries are subject to extensive supervision and regulation in the states in which we do business. The insurance departments of the domiciliary states exercise principal regulatory jurisdiction over our insurance subsidiaries. The extent of regulation by the states varies, but, in general, most jurisdictions have laws and regulations governing standards of solvency, adequacy of reserves, reinsurance, capital adequacy, licensing of companies and agents to transact business, prescribing and approving policy forms, regulating premium rates for some lines of business, prescribing the form and content of statutory financial statements and reports, regulating the type and amount of investments permitted, and standards of business conduct. In addition, state insurance holding company laws impose restrictions on certain inter-company transactions and limitations on the amount of dividends that insurance subsidiaries can pay.
State insurance regulators and the NAIC regularly re-examine existing laws and regulations applicable to insurance companies and their products. Changes in these laws and regulations, or in interpretations thereof, sometimes lead to changes in business practices or additional expense, statutory reserves and/or RBC requirements for the insurer and, thus, could have a material adverse effect on our financial condition and results of operations. For example, the NAIC is considering modifications to the ESG used to calculate life and annuity reserves according to the Valuation Manual (e.g. VM-20 and VM-21) and required capital for certain annuities and single premium life insurance products and variable annuities and similar products, which could affect the level and volatility of statutory reserves and required capital for products in scope. The economic scenarios are a key input in the statutory reserve and required capital calculations for certain products, such as variable annuities. If the NAIC adopts an ESG that produces scenarios with characteristics that differ significantly from what the current ESG prescribed in these calculations would produce under the same circumstances, this could have a significant impact on the statutory reserves and required capital for products in scope upon adoption as well as affect how the statutory reserves and required capital for these products respond to changes in market conditions. We are monitoring all potential changes and evaluating the potential impact they could have on our product offerings and financial condition and results of operations. See “Item 1. Business - Regulatory - Insurance Regulation” for a discussion of additional changes under consideration and recent changes implemented by the NAIC, including recent changes to principles-based reserving, changes to the accounting, reserve and RBC regulations related to the variable annuity business, and changes to AG49, and the impact of such changes on our business.
Although we endeavor to maintain all required licenses and approvals, our businesses may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations, which may change from time to time. Also, regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or impose substantial fines. Further, insurance regulatory authorities have relatively broad discretion to issue orders of supervision, which permit such authorities to supervise the business and operations of an insurance company. As of December 31, 2020, no state insurance regulatory authority had imposed on us any material fines or revoked or suspended any of our licenses to conduct insurance business in any state or issued an order of supervision with respect to our insurance subsidiaries that would have a material adverse effect on our results of operations or financial condition.
Compliance with existing and emerging privacy regulations could result in increased compliance costs and/or lead to changes in business practices and policies, and any failure to protect the confidentiality of consumer and client information could adversely affect our reputation and have a material adverse effect on our business, financial condition and results of operations.
Complying with the numerous privacy laws and regulations to which we are subject and other existing, emerging and changing privacy requirements could cause us to incur substantial costs or require us to change our business practices and policies. Non-compliance could result in monetary penalties or significant legal liability. For more information, see “Item 1. Business - Regulatory - Privacy Regulations.”
Many of the associates who conduct our business have access to, and routinely process, personal information of clients through a variety of media, including information technology systems. We rely on various internal processes and controls to protect the confidentiality of consumer and client information that is accessible to, or in the possession of, our company and our associates. It is possible that an associate could, intentionally or unintentionally, disclose or misappropriate confidential consumer or client information or our data could be the subject of a cybersecurity attack. If we fail to maintain adequate internal controls or if our associates fail to comply with our policies and procedures, misappropriation or intentional or unintentional inappropriate disclosure or misuse of consumer or client information could occur. Such internal control inadequacies or non-compliance could materially damage our reputation or lead to regulatory, civil or criminal investigations and penalties, which, in turn, could have a material adverse effect on our business, financial condition and results of operations.
In addition, we analyze customer data to better manage our business. There has been increased scrutiny, including from U.S. state and federal regulators, regarding the use of “big data” techniques such as price optimization. In August 2020, members of the NAIC unanimously adopted guiding principles on artificial intelligence, to inform and articulate general expectations for businesses, professionals and stakeholders across the insurance industry as they implement artificial intelligence tools to facilitate operations. We cannot predict what, if any, actions may be taken with regard to “big data,” but any inquiries and limitations could have a material impact on our business, financial condition and results of operations.
Federal regulatory actions could result in substantial fines, penalties or prohibitions or restrictions on our business activities and could have a material adverse effect on our business, results of operations or financial condition.
Our broker-dealer and investment adviser subsidiaries as well as our variable annuities and variable life insurance products, are subject to regulation and supervision by the SEC and FINRA. Applicable laws and regulations generally grant supervisory agencies and self-regulatory organizations broad administrative powers, including the power to limit or restrict the subsidiaries from carrying on their businesses in the event that they fail to comply with such laws and regulations. The foregoing regulatory or governmental bodies, as well as the DOL and others, have the authority to review our products and business practices and those of our agents, advisers, registered representatives, associated persons and employees. In recent years, there has been increased scrutiny of insurance companies and their affiliates by these bodies, which has included more extensive examinations, regular sweep inquiries and more detailed review of disclosure documents. These regulatory or governmental bodies may bring regulatory or other legal actions against us if, in their view, our practices, or those of our agents or employees, are improper. These actions can result in substantial fines, penalties or prohibitions or restrictions on our business activities and could have a material adverse effect on our business, results of operations or financial condition.
Changes to laws or regulations could adversely affect our distribution model and may result in additional disclosure and other requirements related to the sale and delivery of our products and services, which may adversely affect our business.
In 2019, the SEC approved “Regulation Best Interest,” including a new standard of conduct for broker-dealers under the Exchange Act, which requires a broker-dealer to act in the best interest of a retail customer when making a recommendation of any securities transaction, without putting its financial interests ahead of the interests of a retail customer. Among other things, the final rule includes provisions setting forth certain required disclosures, policies and procedures to identify conflicts of interest, and customer-specific best interest obligations. In addition, the SEC approved the use of a new disclosure document, Form CRS, which is intended to provide retail investors with information about the nature of their relationship with their investment professional and supplements other more detailed disclosures. Regulation Best Interest and Form CRS became effective as of September 10, 2019, with a transition period for compliance through June 30, 2020, as of which date broker-dealers were required to be compliant. The adoption of Regulation Best Interest has not had a material impact on our business to date.
In June 2020, the DOL proposed a new prohibited transaction exemption, which was finalized in December 2020, and will allow the payment of compensation to investment advice fiduciaries who comply with the requirements of the new exemption. The new exemption generally tracks the standard set forth in Regulation Best Interest and went into effect on February 16, 2021. It is uncertain whether there will be efforts to revise the new rule in the future.
In addition to the SEC and DOL rules, the NAIC and several states have either enacted or proposed laws and regulations requiring investment advisers, broker-dealers and/or agents to meet a higher standard of care and provide additional disclosures when providing advice to their clients, resulting in additional requirements related to the sale of our products. For more information on these regulations, see “Item 1. Business - Regulatory - Federal Initiatives - SEC Rules and Other Regulations relating to the Standard of Care Applicable to Investment Advisers and Broker-Dealers.”
Additional disclosure and other requirements could adversely affect our business by causing us to reevaluate or change certain business practices or otherwise. If any revised DOL fiduciary rule or any additional new rules that are implemented are more onerous than Regulation Best Interest, or are not coordinated with Regulation Best Interest, the impact on our business could be substantial. While we continue to monitor and evaluate the various proposals, we cannot predict what other proposals may be made, or what new legislation or regulation may be introduced or become law. Therefore, until such time as final rules or laws are in place, the potential impact on our business is uncertain.
Changes in U.S. federal income tax law could impact our tax costs and the products that we sell.
Changes in tax laws or interpretations of such laws could increase our corporate taxes and negatively impact our results of operations and financial condition. Tax authorities may enact changes in tax law or issue new regulations or other pronouncements that could increase our current tax burden and impose new taxes on our business. Guidance on previously enacted tax law changes could impact our interpretations of existing law and also have an impact on our business.
Following the recent Presidential election, tax policy changes are being considered related to the taxation of individuals and corporations. Changes to the individual tax system could affect the attractiveness of the products we sell, impacting our sales, product profitability and financial results. An increase in the marginal corporate tax rate would negatively impact our earnings and free cash flows and also affect the value of our recorded deferred tax balances.
We continue to monitor and evaluate the various proposals included in the tax plan put forward by the new Administration, and also those that are being considered by the various state and local jurisdictions as a direct or indirect result of the COVID-19 pandemic. Until such time that one or more of these proposals are introduced or enacted into law, the specific impact on our business is uncertain.
Legal and regulatory actions are inherent in our businesses and could result in financial losses or harm our businesses.
We are, and in the future may be, subject to legal and regulatory actions in the ordinary course of our business. Pending legal and regulatory actions include proceedings relating to aspects of our businesses and operations that are specific to us and proceedings that are typical of the businesses in which we operate. Some of these legal proceedings have been brought on behalf of various alleged classes of complainants. In certain of these matters, the plaintiffs are seeking large and/or indeterminate amounts, including punitive or exemplary damages. Substantial legal liability in these or future legal or regulatory actions could have a material financial effect or cause significant harm to our reputation, which in turn could materially harm our business prospects. See Note 14 for a description of legal and regulatory proceedings and actions.
Implementation of the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to the regulation of derivatives transactions will subject us to substantial additional federal regulation, and we cannot predict the effect on our business, results of operations, cash flows or financial condition until final implementation.
Significant rulemaking across numerous agencies within the federal government has been implemented since the enactment of the Dodd-Frank Act in 2010. The Dodd-Frank Act and corresponding global initiatives imposed significant changes to the regulation of derivatives transactions, which we use to mitigate many types of risk in our business. Significantly, swap documentation and processing requirements continue to change in light of rules for margining uncleared swaps. As we prepare to comply with requirements to post initial margin beginning in September 2021, we continue to evaluate the ways we will be required to manage our derivatives trading and the attendant liquidity requirements. Although these rules provide some flexibility in the categories of eligible collateral, we may be required to hold more of our assets in cash and other low-yielding investments in order to satisfy margin requirements. Operational requirements attendant to the new margining regime are potentially burdensome and costly. Swaps clearing requirements may reduce the level of risk exposure we have to our derivatives counterparties (currently managed by holding collateral), but have increased our exposure to central clearinghouses and clearing members with which we transact. Central clearinghouses and regulators alike continue to evaluate the appropriate allocation of risk in the event of the failure of a clearing member or clearinghouse, and the results of these deliberations may change our use of derivatives in ways we cannot yet determine. The standardization of derivatives products for clearing may make customized products unavailable or uneconomical, potentially decreasing the effectiveness of some of our hedging activities. Until the implementation of these provisions is complete, the impact of these provisions on our businesses (including product offerings), results of operations and liquidity and capital resources remains uncertain.
Changes in accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies may adversely affect our financial statements.
Our financial statements are prepared in accordance with GAAP as identified in the Financial Accounting Standards Board (“FASB”) Accounting Standards CodificationTM (“ASC”). From time to time, we are required to adopt new or revised accounting standards or guidance that are incorporated into the FASB ASC. It is possible that future accounting standards we are required to adopt could change the current accounting treatment that we apply to our consolidated financial statements and that such changes could have a material adverse effect on our financial condition and results of operations.
Specifically, in August 2018, the FASB released Accounting Standards Update (“ASU”) 2018-12, Targeted Improvements to the Accounting for Long-Duration Contracts, which is expected to result in significant changes to how we account for and report our insurance contracts (both in-force and new business), including updating assumptions used to measure the liability for future policy benefits for traditional and limited-payment contracts, measurement of market risk benefits and amortization of deferred acquisition costs (“DAC”). These changes will impose special demands on companies in the areas of employee training, internal controls and disclosure and may affect how we manage our business, including business processes such as design of compensation plans, contract fulfillment, product design, etc. The effective date of ASU 2018-12 is January 1, 2023, and there are various transition methods by topic that we may elect upon adoption. We will report results under the new accounting method as of the effective date. We are currently evaluating the impact of adopting this ASU on our consolidated financial condition and results of operations. See Note 2 for more information.
Our domestic insurance subsidiaries are subject to statutory accounting principles (“SAP”). Any changes in the method of calculating reserves for our life insurance and annuity products under SAP may result in increased reserve requirements.
The NAIC also adopts changes to its regulations from time to time, which, depending of the scope of the change, could materially our financial condition and results of operations. See “Item 1. Business - Regulatory - Insurance Regulation.”
Anti-takeover provisions could delay, deter or prevent our change in control, even if the change in control would be beneficial to LNC shareholders.
We are an Indiana corporation subject to Indiana state law. Certain provisions of Indiana law could interfere with or restrict takeover bids or other change in control events affecting us. Under Indiana law, directors may, in considering the best interests of a corporation, consider the effects of any action on shareholders, employees, suppliers and customers of the corporation and the communities in which offices and other facilities are located, and other factors the directors consider pertinent. One statutory provision prohibits, except under specified circumstances, LNC from engaging in any business combination with any shareholder who owns 10% or more of our common stock (which shareholder, under the statute, would be considered an “interested shareholder”) for a period of five years following the time that such shareholder became an interested shareholder, unless such business combination is approved by the Board of Directors prior to such person becoming an interested shareholder.
In addition to the anti-takeover provisions of Indiana law, there are other factors that may delay, deter or prevent our change in control. As an insurance holding company, we are regulated as an insurance holding company and are subject to the insurance holding company acts of the states in which our insurance company subsidiaries are domiciled. The insurance holding company acts and regulations restrict the ability of any person to obtain control of an insurance company without prior regulatory approval. Under those statutes and regulations, without such approval (or an exemption), no person may acquire any voting security of a domestic insurance company, or an insurance holding company which controls an insurance company, or merge with such a holding company, if as a result of such transaction such person would “control” the insurance holding company or insurance company. “Control” is generally defined as the direct or indirect power to direct or cause the direction of the management and policies of a person and is presumed to exist if a person directly or indirectly owns or controls 10% or more of the voting securities of another person.
Liquidity and Capital Position
Adverse capital and credit market conditions may affect our ability to meet liquidity needs, access to capital and cost of capital.
In the event that our current sources of liquidity do not satisfy our needs, we may have to seek additional financing. The availability of additional financing will depend on a variety of factors such as market conditions, the general availability of credit, the volume of trading activities, the overall availability of credit to the financial services industry, our credit ratings and credit capacity, as well as the possibility that customers or lenders could develop a negative perception of our long- or short-term financial prospects if we incur large investment losses or if the level of our business activity decreases due to a market downturn. Similarly, our access to funds may be impaired if regulatory authorities or rating agencies take negative actions against us. See “Review of Consolidated Financial Condition - Liquidity and Capital Resources - Financing Activities” in the MD&A for a description of our credit ratings. Our internal sources of liquidity may prove to be insufficient, and in such case, we may not be able to successfully obtain additional financing on favorable terms, or at all.
Disruptions, uncertainty or volatility in the capital and credit markets may also limit our access to capital required to operate our business, most significantly our insurance operations. Such market conditions may limit our ability to replace, in a timely manner, maturing liabilities; satisfy statutory capital requirements; generate fee income and market-related revenue to meet liquidity needs; and access the capital necessary to grow our business. As such, we may be forced to delay raising capital, issue shorter term securities than we prefer or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our financial flexibility. Our results of operations, financial condition, cash flows and statutory capital position could be materially adversely affected by disruptions in the financial markets.
Because we are a holding company with no direct operations, the inability of our subsidiaries to pay dividends to us in sufficient amounts would harm our ability to meet our obligations.
Our insurance subsidiaries are subject to certain insurance department regulatory restrictions related to the transfer of funds and payment of dividends to LNC, including statutory limitations on the amount of dividends that can be paid. In addition, payments of dividends and advances or repayment of funds to us by our insurance subsidiaries are restricted by the applicable laws of their respective jurisdictions requiring that our insurance subsidiaries hold a specified amount of minimum reserves in order to meet future obligations on their outstanding policies. In order to meet their claims-paying obligations, our insurance subsidiaries regularly monitor their reserves to ensure we hold sufficient amounts to cover actual or expected contract and claims payments. At times, we may determine that reserves in excess of the minimum may be needed to ensure sufficiency. See “Review of Consolidated Financial Condition - Liquidity and Capital Resources - Restrictions on Subsidiaries’ Dividends and Other Payments” in the MD&A for additional information regarding these restrictions and requirements.
Changes in, or reinterpretations of, these laws can constrain the ability of our subsidiaries to pay dividends or to advance or repay funds to us in sufficient amounts and at times necessary to meet our debt obligations and corporate expenses. Requiring our insurance subsidiaries to hold additional reserves has the potential to constrain their ability to pay dividends to the holding company.
The earnings of our insurance subsidiaries impact contract holders’ surplus. Lower earnings constrain the growth in our insurance subsidiaries’ capital, and therefore, can constrain the payment of dividends and advances or repayment of funds to us. In addition, the amount of surplus that our insurance subsidiaries could pay as dividends is constrained by the amount of surplus they hold to maintain their financial strength ratings, to provide an additional layer of margin for risk protection and for future investment in our businesses.
As a result, to the extent our subsidiaries are unable or are materially restricted from being able to pay dividends to us in sufficient amounts, our ability to meet our obligations could be materially affected.
A decrease in the capital and surplus of our insurance subsidiaries may result in a downgrade to our credit and insurer financial strength ratings.
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending on a variety of factors, including the amount of statutory income or losses generated by our insurance subsidiaries (which itself is sensitive to equity market and credit market conditions), the amount of additional capital our insurance subsidiaries must hold to support business growth, changes in reserving requirements, such as principles-based reserving, our inability to obtain reserve relief, changes in equity market levels, the value of certain fixed-income and equity securities in our investment portfolio, the value of certain derivative instruments that do not get hedge accounting treatment, changes in interest rates and foreign currency exchange rates, as well as changes to the NAIC RBC formulas. The RBC ratio is also affected by the product mix of the in-force book of business (i.e., the amount of business without guarantees is not subject to the same level of reserves as the business with guarantees). Most of these factors are outside of our control. Our credit and insurer financial strength ratings are significantly influenced by the statutory surplus amounts and RBC ratios of our insurance company subsidiaries. The RBC ratio of LNL is an important factor in the determination of the credit and financial strength ratings of LNC and its subsidiaries. In addition, rating agencies may implement changes to their internal models that have the effect of increasing or decreasing the amount of statutory capital we must hold in order to maintain our current ratings. In extreme scenarios of equity market declines, the amount of additional statutory reserves that we are required to hold for our variable universal life insurance guarantees and variable annuity guarantees may increase at a rate greater than the rate of change of the markets. Increases in reserves reduce the statutory surplus used in calculating our RBC ratios. To the extent that our statutory capital resources are deemed to be insufficient to maintain a particular rating by one or more rating agencies, we may seek to raise additional capital through public or private equity or debt financing, which may be on terms not as favorable as in the past.
Alternatively, if we were not to raise additional capital in such a scenario, either at our discretion or because we were unable to do so, our financial strength and credit ratings might be downgraded by one or more rating agencies. For more information on risks regarding our ratings, see “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” below.
An inability to access our credit facilities could result in a reduction in our liquidity and lead to downgrades in our credit and financial strength ratings.
We rely on our credit facilities as a potential source of liquidity. We also use the credit facilities as a potential backstop to provide statutory reserve credit, particularly for variable annuities. While our variable annuity hedge assets available to provide reserve credit have normally exceeded the ceded statutory reserves, in certain stressed market conditions, it is possible that these assets could be less than the ceded statutory reserve. Our credit facilities are available to provide reserve credit to LNL in such a case. If we were unable to access our facility in such circumstances, it could materially impact LNL’s capital position. The availability of these facilities could be critical to our credit and financial strength ratings and our ability to meet our obligations as they come due in a market when alternative sources of credit are tight.
In addition, our failure to comply with the covenants in the credit facilities or fulfill the conditions to borrowings, or the failure of lenders to fund their lending commitments (whether due to insolvency, illiquidity or other reasons) in the amounts provided for under the terms of the facilities, would restrict our ability to access these credit facilities when needed and, consequently, could have a material adverse effect on our financial condition and results of operations.
Assumptions and Estimates
As a result of changes in assumptions, estimates and methods in calculating reserves, our reserves for future policy benefits and claims related to our current and future business as well as businesses we may acquire in the future may prove to be inadequate.
We establish and carry, as a liability, reserves based on estimates of how much we will need to pay for future benefits and claims. For our insurance products, we calculate these reserves based on many assumptions and estimates, including, but not limited to, estimated premiums we will receive over the assumed life of the policies, the timing of the events covered by the insurance policies, the lapse rate of the policies, the amount of benefits or claims to be paid and the investment returns on the assets we purchase with the premiums we receive.
The sensitivity of our statutory reserves and surplus established for our variable universal life contracts and variable annuity base contracts and riders to changes in the equity markets will vary depending on the magnitude of the decline. The sensitivity will be affected by the level of account values relative to the level of guaranteed amounts, product design and reinsurance. Statutory reserves for variable annuities depend upon the cumulative equity market impacts on the business in force, and therefore, result in non-linear relationships with respect to the level of equity market performance within any reporting period.
The assumptions and estimates we use in connection with establishing and carrying our reserves are inherently uncertain. Accordingly, we cannot determine with precision the ultimate amount or the timing of the payment of actual benefits and claims or whether the assets supporting the policy liabilities will grow to the level we assume prior to payment of benefits or claims. If our actual experience is
different from our assumptions or estimates, our reserves may prove to be inadequate in relation to our estimated future benefits and claims, which would adversely affect our financial position and results of operations. In addition, increases in reserves have a negative effect on income from operations in the quarter incurred.
We may be required to recognize an impairment of our goodwill or to establish a valuation allowance against our deferred income tax assets.
If our businesses do not perform well and/or their estimated fair values decline or the price of our common stock does not increase, we may be required to recognize an impairment of our goodwill or to establish a valuation allowance against the deferred income tax asset, which could have a material adverse effect on our results of operations and financial condition. For example, during the fourth quarter of 2017, we recorded goodwill impairment of $905 million related to our Life Insurance segment. Future reviews of goodwill could result in an impairment of goodwill, and such write-downs could have a material adverse effect on our net income and book value, although they would not affect the statutory capital of our insurance subsidiaries. As of December 31, 2020, we had a total of $1.8 billion of goodwill on our Consolidated Balance Sheets. For more information on goodwill, see “Critical Accounting Policies and Estimates - Goodwill and Other Intangible Assets” in the MD&A and Note 10. As of December 31, 2020, we had a deferred tax asset of $3.0 billion. If, based on available information, including about the performance of a business and its ability to generate future capital gains, we determine that it is more likely than not that the deferred income tax asset will not be realized, then a valuation allowance must be established with a corresponding charge to net income. Such valuation allowance could have a material adverse effect on our results of operations and financial condition. For more information on our deferred income tax assets, see Note 7.
The determination of the amount of allowance for credit losses and impairments taken on our investments is highly subjective and could materially impact our results of operations or financial condition.
The determination of the amount of allowances and impairments varies by investment type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in allowances and impairments in operations as such evaluations are revised. There can be no assurance that our management has accurately assessed the level of impairments taken and allowances reflected in our financial statements. Furthermore, additional impairments may need to be taken or allowances provided for in the future. Historical trends may not be indicative of future impairments or allowances.
With respect to unrealized losses, we establish deferred tax assets for the tax benefit we may receive in the event that losses are realized. The realization of significant realized losses could result in an inability to recover the tax benefits and may result in the establishment of valuation allowances against our deferred tax assets. Realized losses or impairments may have a material adverse impact on our results of operations and financial condition. See “Critical Accounting Policies and Estimates - Investments” in the MD&A for additional information.
Changes to our valuation of investments and our methodologies, estimations and assumptions could harm our results of operations or financial condition.
During periods of market disruption or rapidly-changing market conditions, such as significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, or infrequent trading, or when market data is limited, our investments may become less liquid and we may base our valuations on less-observable and more subjective inputs, assumptions, or methods that may result in estimated fair values that significantly vary by period, and may exceed the investment’s sale price. Decreases in the estimated fair value of our securities may harm our results of operations or financial condition. See “Critical Accounting Policies and Estimates - Investments” in the MD&A for additional information.
Significant adverse mortality experience may result in the loss of, or higher prices for, reinsurance, which could adversely affect our profitability.
We reinsure a portion of the mortality risk on fully underwritten, newly issued, individual life insurance contracts. We regularly review retention limits for continued appropriateness and they may be changed in the future. In the event that we experience adverse mortality or morbidity experience, a significant portion of that is reimbursed by our reinsurers. Prolonged or severe adverse mortality or morbidity experience could result in increased reinsurance costs and, ultimately, reinsurers being unwilling to offer future coverage. If we are unable to maintain our current level of reinsurance or purchase new reinsurance protection at comparable rates to what we are paying currently, we may have to accept an increase in our net exposures or revise our pricing to reflect higher reinsurance premiums or both. If this were to occur, we may be exposed to reduced profitability and cash flow strain or we may not be able to price new business at competitive rates.
Catastrophes have impacted, and may in the future, adversely impact liabilities for contract holder claims.
Our insurance operations are exposed to the risk of catastrophic mortality, such as a pandemic, an act of terrorism, natural disaster or other event that causes a large number of deaths or injuries, such as the COVID-19 pandemic that emerged during the first quarter of 2020. Neither the length nor severity of the COVID-19 pandemic, nor the likelihood, timing or severity of a future pandemic or other catastrophe, can be predicted. Additionally, the impact of climate change has caused, and may continue to cause, changes in weather patterns, resulting in more severe and more frequent natural disasters such as forest fires, hurricanes, tornados, floods and storm surges. In our group insurance operations, an event that affects the workplace of one or more of our group insurance customers, such as the COVID-19 pandemic, could cause a significant loss due to mortality or morbidity claims. During 2020, we experienced a significant
increase in mortality and morbidity claims associated with the COVID-19 pandemic, which negatively impacted our earnings for the year, as discussed further in “Introduction - Executive Summary” in the MD&A. The continuation of the COVID-19 pandemic, or future pandemics or other catastrophic events could cause a material adverse effect on our results of operations in any period and, depending on their severity, could also materially and adversely affect our financial condition.
The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Pandemics, natural disasters and man-made catastrophes, including terrorism, may produce significant damage in larger areas, especially those that are heavily populated. Claims resulting from natural or man-made catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could materially reduce our profitability or harm our financial condition. Also, catastrophic events could harm the financial condition of our reinsurers and thereby increase the probability of default on reinsurance recoveries. Accordingly, our ability to write new business could also be affected.
Consistent with industry practice and accounting standards, we establish liabilities for claims arising from a catastrophe only after assessing the probable losses arising from the event. We cannot be certain that the liabilities we have established or applicable reinsurance will be adequate to cover actual claim liabilities, and a catastrophic event or multiple catastrophic events could have a material adverse effect on our business, results of operations and financial condition.
Operational Matters
Our enterprise risk management policies and procedures may leave us exposed to unidentified or unanticipated risk, which could negatively affect our businesses or result in losses.
Our policies and procedures to identify, monitor and manage risks may not be fully effective. Many of our methods of managing risk and exposures are based upon our use of observed historical market behavior or statistics based on historical models. As a result, these methods may not predict future exposures, which could be significantly greater than the historical measures indicate, such as the risk of pandemics causing a large number of deaths. Other risk management methods depend upon the evaluation of information regarding markets, clients, catastrophe occurrence or other matters that is publicly available or otherwise accessible to us, which may not always be accurate, complete, up-to-date or properly evaluated. Management of operational, legal and regulatory risks requires, among other things, policies and procedures to record properly and verify a large number of transactions and events, and these policies and procedures may not be fully effective.
We face risks of non-collectability of reinsurance and increased reinsurance rates, which could materially affect our results of operations.
We follow the insurance practice of reinsuring with other insurance and reinsurance companies a portion of the risks under the policies written by our insurance subsidiaries (known as “ceding”). As of December 31, 2020, we ceded $674.3 billion of life insurance in force to reinsurers for reinsurance protection. Although reinsurance does not discharge our subsidiaries from their primary obligation to pay contract holders for losses insured under the policies we issue, reinsurance does make the assuming reinsurer liable to the insurance subsidiaries for the reinsured portion of the risk. As of December 31, 2020, we had $16.5 billion of reinsurance receivables from reinsurers for paid and unpaid losses, for which they are obligated to reimburse us under our reinsurance contracts. Of this amount, $11.3 billion related to reinsurance agreements entered into with Protective in May 2018, providing for the reinsurance and administration of the Liberty Life Business sold to Protective in connection with the Liberty acquisition, and $1.2 billion related to the sale of our reinsurance business to Swiss Re in 2001 through an indemnity reinsurance agreement. The balance of the reinsurance is due from a diverse group of reinsurers. For more information regarding our reinsurance arrangements and exposure, see “Reinsurance” in the MD&A and Note 9.
The collectability of reinsurance is largely a function of the solvency of the individual reinsurers. We perform due diligence on all reinsurers, including, but not limited to, a review of creditworthiness prior to entering into any reinsurance transaction, and we review our reinsurers on an ongoing basis to monitor credit ratings. To support balances due and allow reserve credit when reinsurance is obtained from reinsurers not authorized to transact business in the applicable jurisdictions, we also require assets in trust, LOCs or other acceptable collateral. Despite these measures, the insolvency, inability or unwillingness to make payments under the terms of a reinsurance contract by a large reinsurer or multiple reinsurers could have a material adverse effect on our results of operations and financial condition.
Reinsurers also may attempt to increase rates with respect to our existing reinsurance arrangements. The ability of our reinsurers to increase rates depends upon the terms of each reinsurance contract. Some of our reinsurance contracts contain provisions that limit the reinsurer’s ability to increase rates on in-force business; however, some do not. An increase in reinsurance rates may affect the profitability of our insurance business. Additionally, such a rate increase could result in our recapture of the business, which may result in a need for additional reserves and increase our exposure to claims. While in recent years, we have faced a number of rate increase actions on in-force business, our management of those actions has not had a material effect on our results of operations or financial condition. However, there can be no assurance that the outcome of future rate increase actions would similarly result in no material effect. See Note 14 for a description of reinsurance related actions.
Competition for our employees is intense, and we may not be able to attract and retain the highly skilled people we need to support our business.
Our success depends, in large part, on our ability to attract and retain key people. Intense competition exists for the key employees with demonstrated ability, and we may be unable to hire or retain such employees. The unexpected loss of services of one or more of our key personnel could have a material adverse effect on our operations due to their skills, knowledge of our business, their years of industry experience and the potential difficulty of promptly finding qualified replacement employees. We compete with other financial institutions primarily on the basis of our products, compensation, support services and financial condition. Sales in our businesses and our results of operations and financial condition could be materially adversely affected if we are unsuccessful in attracting and retaining key employees, including financial advisers, wholesalers and other employees, as well as independent distributors of our products.
We may not be able to protect our intellectual property and may be subject to infringement claims.
We may have to litigate to enforce and protect our intellectual property, which represents a diversion of resources that may be significant and may not prove successful. The loss of intellectual property protection or the inability to secure or enforce the protection of our intellectual property assets could have a material adverse effect on our business and our ability to compete.
We also may be subject to costly litigation in the event that another party alleges our operations or activities infringe upon another party’s intellectual property rights. If we were found to have infringed a third-party patent or other intellectual property rights, we could incur substantial liability, and in some circumstances could be enjoined from providing certain products or services to our customers, or alternatively could be required to enter into costly licensing arrangements with third parties, all of which could have a material adverse effect on our business, results of operations and financial condition.
Our information systems may experience interruptions, breaches in security and/or a failure of disaster recovery systems that could result in a loss or disclosure of confidential information, damage to our reputation and impairment of our ability to conduct business effectively.
Our information systems are critical to the operation of our business. We collect, process, maintain, retain and distribute large amounts of personal financial and health information and other confidential and sensitive data about our customers in the ordinary course of our business. Our business therefore depends on our customers’ willingness to entrust us with their personal information. Any failure, interruption or breach in security could result in disruptions to our critical systems and adversely affect our customer relationships.
Publicly reported cyber-security threats and incidents have increased over recent periods. Although our computer systems have in the past been, and will likely in the future be, subject to or targets of unauthorized or fraudulent access, to date, we have not had a material security breach. While we employ a robust and tested information security program, the preventative actions we take to reduce the incidence and severity of cyber incidents and protect our information technology may be insufficient to prevent physical and electronic break-ins, cyberattacks, compromised credentials, fraud, other security breaches or other unauthorized access to our computer systems, and, given the increasing sophistication of cyberattacks, in some cases, such incidents could occur and persist for an extended period of time without detection. As a result, there can be no assurance that any such failure, interruption or security breach will not occur or, if any does occur, that it will be detected in a timely manner or that it can be sufficiently remediated. Such an occurrence may impede or interrupt our business operations and could adversely affect our reputation, business, financial condition and results of operations.
In the event of a disaster such as a natural catastrophe, epidemic, industrial accident, blackout, computer virus, terrorist attack, cyberattack or war, unanticipated problems with our disaster recovery systems could have a material adverse impact on our ability to conduct business and on our results of operations and financial condition, particularly if those problems affect our computer-based data processing, transmission, storage and retrieval systems and destroy valuable data. In addition, in the event that a significant number of our managers were unavailable following a disaster, our ability to effectively conduct business could be severely compromised. These interruptions also may interfere with our suppliers’ ability to provide goods and services and our employees’ ability to perform their job responsibilities.
The failure of our computer systems and/or our disaster recovery plans for any reason could cause significant interruptions in our operations and result in a failure to maintain the security, confidentiality or privacy of sensitive data, including personal information relating to our customers. The occurrence of any such failure, interruption or security breach of our systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and financial liability. Depending on the nature of the information compromised, in the event of a data breach or other unauthorized access to our customer data, we may also have obligations to notify affected individuals about the incident, and we may need to provide some form of remedy, such as a subscription to a credit monitoring service, for the individuals affected by the incident. For more information, see “Legislative, Regulatory and Tax - State Regulation - Compliance with existing and emerging privacy regulations could result in increased compliance costs and/or lead to changes in business practices and policies, and any failure to protect the confidentiality of client information could adversely affect our reputation and have a material adverse effect on our business, financial condition and results of operations.”
Although we conduct due diligence, negotiate contractual provisions and, in many cases, conduct periodic reviews of our vendors, distributors, and other third parties that provide operational or information technology services to us to confirm compliance with our information security standards, the failure of such third parties’ computer systems and/or their disaster recovery plans for any reason
might cause significant interruptions in our operations and result in a failure to maintain the security, confidentiality or privacy of sensitive data, including personal information relating to our customers. Such a failure could harm our reputation, subject us to regulatory sanctions and legal claims, lead to a loss of customers and revenues and otherwise adversely affect our business and financial results. In addition, our cyber liability insurance may not be sufficient to protect us against all losses.
Acquisitions of businesses may not produce anticipated benefits resulting in operating difficulties, unforeseen liabilities or asset impairments, which may adversely affect our operating results and financial condition.
Once completed, an acquired business may not perform as projected, expense and revenue synergies may not materialize as expected and costs associated with the integration may be greater than anticipated. Our financial results could be adversely affected by unanticipated performance issues, unforeseen liabilities, transaction-related charges, diversion of management time and resources to acquisition integration challenges or growth strategies, loss of key employees or customers, amortization of expenses related to intangibles, charges for impairment of long-term assets or goodwill and indemnifications. Factors such as receiving the required governmental or regulatory approvals to merge the acquired entity, delays in implementation or completion of transition activities or a disruption to our or the acquired entity’s business could impact our results.
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.
A downgrade of the financial strength rating of one of our principal insurance subsidiaries could affect our competitive position in the insurance industry by making it more difficult for us to market our products, as potential customers may select companies with higher financial strength ratings, and by leading to increased withdrawals by current customers seeking companies with higher financial strength ratings. This could lead to a decrease in fees as net outflows of assets increase, and therefore, result in lower fee income and lower spread income. Furthermore, sales of assets to meet customer withdrawal demands could also result in losses, depending on market conditions. The interest rates we pay on our borrowings are largely dependent on our credit ratings. A downgrade of our debt ratings could affect our ability to raise additional debt, including bank lines of credit, with terms and conditions similar to our current debt, and accordingly, likely increase our cost of capital.
All of our ratings and ratings of our principal insurance subsidiaries are subject to revision or withdrawal at any time by the rating agencies, and therefore, no assurance can be given that our principal insurance subsidiaries or we can maintain these ratings. See “Item 1. Business - Financial Strength Ratings” and “Liquidity and Capital Resources - Financing Activities” in the MD&A for a description of our 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.
Our outstanding capital securities contain covenants that require us to make interest payments in accordance with an alternative coupon satisfaction mechanism (“ACSM”) if we determine that one of the following triggers exists as of the 30th day prior to an interest payment date, or the “determination date”:
1. LNL’s RBC ratio is less than 175% (based on the most recent annual financial statement filed with the State of Indiana); or
2. (i) The sum of our consolidated net income for the four trailing fiscal quarters ending on the quarter that is two quarters prior to the most recently completed quarter prior to the determination date is zero or negative, and (ii) our consolidated stockholders’ equity (excluding accumulated other comprehensive income (loss) and any increase in stockholders’ equity resulting from the issuance of preferred stock during a quarter), or “adjusted stockholders’ equity,” as of (x) the most recently completed quarter and (y) the end of the quarter that is two quarters before the most recently completed quarter, has declined by 10% or more as compared to the quarter that is ten fiscal quarters prior to the last completed quarter, or the “benchmark quarter.”
The ACSM would generally require us to use commercially reasonable efforts to satisfy our obligation 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, and, in the case of test 2 above, until our adjusted stockholders’ equity amount increased or declined by less than 10% as compared to the adjusted stockholders’ equity at the end of the benchmark quarter for each interest payment date as to which interest payment restrictions were imposed by test 2 above.
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. Our failure to pay interest pursuant to the ACSM will not result in an event of default with respect to the capital securities, nor will a nonpayment of
interest, unless it lasts for ten consecutive years, although such breaches may result in monetary damages to the holders of the capital securities.
The calculations of RBC, net income (loss) and adjusted stockholders’ equity are subject to adjustments and the capital securities are subject to additional terms and conditions as further described in supplemental indentures filed as exhibits to this Form 10-K.
Certain blocks of our insurance business purchased from third-party insurers under indemnity reinsurance agreements may require us to place assets in trust, secure letters of credit or return the business, if the financial strength ratings and/or capital ratios of certain insurance subsidiaries are not maintained at specified levels.
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. Under these types of agreements, as of December 31, 2020, we held statutory reserves of $4.8 billion. 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. See “Item 1. Business - Reinsurance” for a discussion of the indemnity reinsurance arrangements and the financial strength ratings and/or capital ratios that are required to be maintained under such arrangements. As of December 31, 2020, LNL’s and LLANY’s financial strength ratings and RBC ratios exceeded the ratings and ratios required under each agreement. See “Item 1. Business - Financial Strength Ratings” for a description of our financial strength ratings.
If the cedent recaptured the business, LNL and LLANY would be required to release reserves and transfer assets to the cedent. Such a recapture could adversely impact our future profits. Alternatively, if LNL and LLANY established a security trust for the cedent, the ability to transfer assets out of the trust could be severely restricted, thus negatively impacting our liquidity.
Investments
We may have difficulty selling certain holdings in our investment portfolio in a timely manner and realizing full value.
We hold certain investments that may lack liquidity, such as privately placed securities, mortgage loans on real estate, policy loans, limited partnership interests and other investments. These asset classes represented 27% of the carrying value of our total investments as of December 31, 2020. If we require significant amounts of cash on short notice in excess of normal cash requirements or are required to post or return collateral in connection with our investment portfolio, derivatives transactions or securities lending activities, we may have difficulty selling these investments in a timely manner, be forced to sell them for less than we otherwise would have been able to realize, or both.
The reported value of our relatively illiquid types of investments, our investments in the asset classes described in the paragraph above and, at times, our high quality, generally liquid asset classes, do not necessarily reflect the lowest current market price for the asset. If we were forced to sell certain of our assets in the current market, there can be no assurance that we would be able to sell them for the prices at which we have recorded them, and we might be forced to sell them at significantly lower prices.
The amount and timing of income from certain investments can be uneven, and their valuations infrequent or volatile, which can impact the amount of income we record or lead to lower than expected returns, and thereby adversely impact our earnings.
We invest a portion of our investments in investment funds, many of which make private equity investments. The amount and timing of income from such investment funds tends to be uneven as a result of the performance of the underlying investments, including private equity investments. The timing of distributions from the funds, which depends on particular events relating to the underlying investments, as well as the funds’ schedules for making distributions and their needs for cash, can be difficult to predict. In addition, because these funds, and private equity investments, do not trade on public markets and indications of realizable market value may not be readily available, valuations can be infrequent and/or more volatile. As a result, the amount of income that we record from these investments can vary substantially from quarter to quarter, and a sudden or sustained decline in the markets or valuation of one or more substantial investments could result in lower than expected returns earned by our investment portfolio and thereby adversely impact our earnings.
Defaults on our mortgage loans and write-downs of mortgage equity may adversely affect our profitability.
Our mortgage loans face default risk and are principally collateralized by commercial properties. The performance of our mortgage loan investments may fluctuate in the future. In addition, some of our mortgage loan investments have balloon payment maturities. An increase in the default rate of our mortgage loan investments could have a material adverse effect on our business, results of operations and financial condition. Further, any geographic or sector exposure in our mortgage loans may have adverse effects on our investment portfolios and consequently on our consolidated results of operations or financial condition. While we seek to mitigate this risk by having a broadly diversified portfolio, events or developments that have a negative effect on any particular geographic region or sector may have a greater adverse effect on the investment portfolios to the extent that the portfolios are exposed.
The difficulties faced by other financial institutions could adversely affect us.
We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks and other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty. In addition, with respect to secured transactions, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the related loan or derivative exposure. We also may have exposure to these financial institutions in the form of unsecured debt instruments, derivative transactions and/or equity investments. These parties may default on their obligations to us due to bankruptcy, lack of liquidity, downturns in the economy or real estate values, operational failure, corporate governance issues or other reasons. A downturn in the U.S. or other economies could result in increased impairments. There can be no assurance that any such losses or impairments to the carrying value of these assets would not materially and adversely affect our business and results of operations.
Our requirements to post collateral or make payments related to declines in market value of specified assets may adversely affect our liquidity and expose us to counterparty credit risk.
Many of our transactions with financial and other institutions, including settling futures positions, specify the circumstances under which the parties are required to post collateral. The amount of collateral we may be required to post under these agreements may increase under certain circumstances, which could adversely affect our liquidity. In addition, under the terms of some of our transactions, we may be required to make payments to our counterparties related to any decline in the market value of the specified assets.
Competition
Intense competition could negatively affect our ability to maintain or increase our profitability.
Our businesses are intensely competitive. We compete based on a number of factors, including name recognition, service, the quality of investment advice, investment performance, product features, price, perceived financial strength and claims-paying and credit ratings. Our competitors include insurers, broker-dealers, investment advisers, asset managers, hedge funds and other financial institutions. A number of our business units face competitors that have greater market share, offer a broader range of products or have higher financial strength or credit ratings than we do. In recent years, there has been consolidation and convergence among companies in the financial services industry resulting in increased competition from large, well-capitalized financial services firms. Many of these firms also have been able to increase their distribution systems through mergers or contractual arrangements. Furthermore, larger competitors may have lower operating costs and an ability to absorb greater risk while maintaining their financial strength ratings, thereby allowing them to price their products more competitively. Our customers and clients may engage other financial service providers, and the resulting loss of business may harm our results of operations or financial condition.
Our sales representatives are not captive and may sell products of our competitors.
We sell our annuity and life insurance products through independent sales representatives. These representatives are not captive, which means they may also sell our competitors’ products. If our competitors offer products that are more attractive than ours, or pay higher commission rates to the sales representatives than we do, these representatives may concentrate their efforts in selling our competitors’ products instead of ours.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
As of December 31, 2020, LNC and our subsidiaries owned or leased 2.8 million square feet of office and other space. We leased 0.1 million square feet of office space in Philadelphia, Pennsylvania, which includes space for LFN. We leased 0.2 million square feet of office space in Radnor, Pennsylvania, for our corporate center and for LFD. We owned or leased 0.6 million square feet of office space in Fort Wayne, Indiana, primarily for our Annuities and Retirement Plan Services segments. We owned or leased 0.8 million square feet of office space in Greensboro, North Carolina, primarily for our Life Insurance segment. We owned or leased 0.3 million square feet of office space in Omaha, Nebraska, 0.2 million square feet of office space in Atlanta, Georgia, and 0.1 million square feet in Dover, New Hampshire, primarily for our Group Protection segment. An additional 0.5 million square feet of office space is owned or leased in other U.S. cities for branch offices. This discussion regarding properties does not include information on field offices and investment properties.
Item 3. Legal Proceedings
For information regarding legal proceedings, see “Regulatory and Litigation Matters” in Note 14, which is incorporated herein by reference.
Item 4. Mine Safety Disclosures
Not applicable.
Information About our Executive Officers
Our Executive Officers as of February 12, 2021, were as follows:
Name
Age (1)
Position with LNC and Business Experience During the Past Five Years
Dennis R. Glass
President, Chief Executive Officer and Director (since July 2007). President, Chief Operating Officer and Director (April 2006 - July 2007).
Craig T. Beazer
Executive Vice President and General Counsel (since December 2020). Executive Vice President, General Counsel (January 2020 - December 2020) and Secretary (July 2019 - December 2020), KeyCorp, a bank-based financial services company. Deputy General Counsel, KeyCorp (July 2018 - January 2020). Deputy General Counsel and Corporate Secretary, The Bank of New York Mellon Corporation, a global investments company (July 2015 - July 2018).
Lisa M. Buckingham
Executive Vice President and Chief People, Place and Brand Officer (since August 2018). Executive Vice President and Chief Human Resources Officer (March 2011 - August 2018). Senior Vice President and Chief Human Resources Officer (December 2008 - March 2011).
Ellen Cooper
Executive Vice President and Chief Investment Officer (since August 2012).
Randal J. Freitag
Executive Vice President and Chief Financial Officer (since January 2011) and Head of Individual Life (since June 2017). Senior Vice President, Chief Risk Officer (2007 - December 2010). Senior Vice President, Chief Risk Officer and Treasurer (2007 - October 2009).
Wilford H. Fuller
Executive Vice President (since March 2011) and President, Annuity Solutions (since March 2015). President, Lincoln Financial Network (2) (since October 2012). President and CEO, Lincoln Financial Distributors (2) (since February 2009).
Jamie B. Ohl
Executive Vice President (since July 2018), President, Workplace Solutions (since December 2020), and Head of Life and Annuity Operations (since July 2018). President, Retirement Plan Services (August 2015 - December 2020).
Kenneth S. Solon
Executive Vice President, Chief Information Officer and Head of Digital (since July 2018). Executive Vice President, Chief Information Officer and Head of Administrative Services (January 2016 - July 2018). Senior Vice President, Head of Technology (March 2015 - December 2015). Senior Vice President, Head of Shared Services and Technology (January 2010 - March 2015).
(1)Age shown is based on the officer’s age as of February 12, 2021.
(2)Denotes an affiliate of LNC.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a) Stock Market and Dividend Information
Our common stock is traded on the New York stock exchange under the symbol LNC. As of February 12, 2021, the number of shareholders of record of our common stock was 5,913. The dividend on our common stock is declared each quarter by our Board of Directors if we are eligible to pay dividends and the Board determines that we will pay dividends. In determining dividends, the Board takes into consideration items such as our financial condition, including current and expected earnings, projected cash flows and anticipated financing needs. For potential restrictions on our ability to pay dividends, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” and Note 20 in the accompanying notes to the consolidated financial statements presented in “Item 8. Financial Statements and Supplementary Data.”
For information on securities authorized for issuance under equity compensation plans, see “Part III - Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters - Securities Authorized for Issuance Under Equity Compensation Plans,” which is incorporated herein by reference.
(b) Not Applicable
(c) Issuer Purchases of Equity Securities
The following summarizes purchases of equity securities by the issuer during the quarter ended December 31, 2020 (dollars in millions, except per share data):
(c) Total Number
(d) Approximate Dollar
(a) Total
of Shares
Value of Shares
Number
(b) Average
Purchased as Part of
that May Yet Be
of Shares
Price Paid
Publicly Announced
Purchased Under the
Period
Purchased (1)
per Share
Plans or Programs (2)
Plans or Programs (2)
10/1/20 - 10/31/20
-
$
-
-
$
1,239
11/1/20 - 11/30/20
632,468
42.77
632,468
1,212
12/1/20 - 12/31/20
443,658
51.78
443,658
1,189
(1)Of the total number of shares purchased, no shares were received in connection with the exercise of stock options and related taxes. For the quarter ended December 31, 2020, there were 1,076,126 shares purchased as part of publicly announced plans or programs.
(2)On February 19, 2020, our Board of Directors authorized an increase in our securities repurchase authorization, bringing the total aggregate repurchase authorization to $1.66 billion. As of December 31, 2020, our remaining security repurchase authorization was $1.2 billion. The security repurchase authorization does not have an expiration date. 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. Our stock repurchases may be effected from time to time through open market purchases or in privately negotiated transactions and may be made pursuant to an accelerated share repurchase agreement or Rule 10b5-1 plan.
Item 6. Selected Financial Data
The following selected financial data (in millions, except per share data) should be read in conjunction with “
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 U.S. federal tax reform legislation on our business, earnings and capital;
The impact of Regulation Best Interest or other regulations adopted by the Securities and Exchange Commission (“SEC”), the Department 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;
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 the SEC 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
We analyze and manage the risks arising from market exposures of financial instruments, as well as other risks, in an integrated asset-liability management process that considers diversification. By aggregating the potential effect of market and other risks on the entire enterprise, we estimate, review and in some cases manage the risk to our earnings and shareholder value. We have exposures to several market risks including interest rate risk, equity market risk, credit risk and, to a lesser extent, foreign currency exchange risk. The exposures of financial instruments to market risks, and the related risk management processes, are most important to our business where most of the investments support accumulation and investment-oriented insurance products. As an important element of our integrated asset-liability management processes, we use derivatives to minimize the effects of changes in interest levels, the shape of the yield curve, currency movements and volatility. In this context, derivatives serve to minimize interest rate risk by mitigating the effect of significant increases in interest rates on our earnings. Additional market exposures exist in our other general account insurance products and in our debt structure and derivatives positions. Our primary sources of market risk are substantial, relatively rapid and sustained increases or decreases in interest rates or a sharp drop in equity market values. These market risks are discussed in detail in the following pages and should be read in conjunction with our consolidated financial statements and the accompanying Notes presented in “
Item 8. Financial Statements and Supplementary Data
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting for Lincoln National Corporation to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of the consolidated financial statements for external purposes in accordance with United States of America generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with United States of America generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of internal control over financial reporting effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
Management assessed our internal control over financial reporting as of December 31, 2020, the end of our fiscal year. Management based its assessment on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Management’s assessment included evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment.
Based on the assessment, management has concluded that our internal control over financial reporting was effective as of the end of the fiscal year to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external reporting purposes in accordance with United States of America generally accepted accounting principles.
The effectiveness of our internal control over financial reporting as of December 31, 2020, has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included on the following page.
‎
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Lincoln National Corporation
Opinion on Internal Control Over Financial Reporting
We have audited Lincoln National Corporation’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Lincoln National Corporation (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, and the related consolidated statements of comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedules listed in the Index at Item 15(a)(2) and our report dated February 18, 2021 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
February 18, 2021
‎
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Lincoln National Corporation
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Lincoln National Corporation (the Company) as of December 31, 2020 and 2019, and the related consolidated statements of comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes and financial statement schedules listed in the Index at Item 15(a)(2) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 18, 2021 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the Audit Committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
‎
Deferred Acquisition Costs Asset and Future Contract Benefits Liability
Description of the Matter
At December 31, 2020, deferred acquisition costs totaled $5.6 billion and future contract benefits liabilities totaled $40.8 billion, a portion of which related to universal life-type contracts with secondary guarantees and variable annuity contracts with guaranteed benefit riders.
The carrying amount of the deferred acquisition costs related to these products is the total of costs deferred less amortization, which is calculated in relation to the present value of estimated gross profits of the underlying contracts. As described in Notes 1 (see section on DAC, VOBA, DSI and DFEL) and 8 to the consolidated financial statements, there is a significant amount of uncertainty inherent in calculating estimated gross profits as the calculation includes significant management judgment in developing certain assumptions, such as expected future mortality experience, investment margins, capital market performance, retention and rider utilization. Management’s assumptions are adjusted, also known as unlocked, for emerging experience and expected changes in trends. The unlocking results in deferred acquisition cost amortization being recalculated, using the new assumptions for estimated gross profits, that results either in additional or less cumulative amortization expense.
The future contract benefits liability related to these product guarantees is based on estimates of how much the Company will need to pay for future benefits and the amount of fees to be collected from policyholders for these policy features. As described in Note 1 to the consolidated financial statements (see section on Future Contract Benefits and Other Contract Holder Funds), there is significant uncertainty inherent in estimating this liability because there is a significant amount of management judgment involved in developing certain assumptions that impact the liability balance, which are consistent with the assumptions used to amortize the related deferred acquisition cost asset as noted above and which include expected mortality experience, investment margins, capital market performance, retention and rider utilization.
Auditing the valuation of deferred acquisition costs and future contract benefits liabilities related to these products was complex and required the involvement of our actuarial specialists due to the high degree of judgment used by management in setting the assumptions used in the estimate of both the amortization of deferred acquisition costs and the future contract benefits liability related to these products.
How We Addressed the Matter in Our Audit
We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the deferred acquisition costs and future contract benefits liability estimation processes, including, among others, controls related to the review and approval processes that management has in place for the assumptions used in estimating the estimated gross profits related to deferred acquisition costs and the future contract benefits liability. This included testing controls related to management’s evaluation of the need to update assumptions based on the comparison of actual Company experience to previous assumptions and updating investment margins for current and expected future market conditions.
We involved actuarial specialists to assist with our audit procedures which included, among others, an evaluation of the methodology applied by management with those methods used in prior periods. To assess the significant assumptions used by management, we compared the significant assumptions noted above to historical experience, observable market data or management’s estimates of prospective changes in these assumptions. In addition, we performed an independent recalculation of estimated gross profits related to deferred policy acquisition costs and the future policy benefit reserves for a sample of cohorts or contracts which we compared to the actuarial model used by management.
Variable Annuity Guaranteed Living Benefit Riders Embedded Derivatives
Description of the Matter
The Company’s variable annuity guaranteed living benefit riders include an embedded derivative, represented by an asset totaling $450 million as of December 31, 2020, related to the non-life contingent feature of the product which is accounted for at fair value, with changes in fair value recognized in income. As described in Notes 1 (see section on Separate Account Assets and Liabilities), 6 and 21 to the consolidated financial statements, there is a significant amount of estimation uncertainty inherent in measuring the fair value of the embedded derivative because of the sensitivity of certain assumptions underlying the estimate, including stock market performance, policy lapse experience and rider utilization. Management’s assumptions are adjusted over time for emerging experience and expected changes in trends, resulting in changes to the estimated fair value of the embedded derivative.
Auditing the valuation of the embedded derivative related to variable annuity guaranteed living benefit riders was complex and required the involvement of our actuarial specialists due to the high degree of judgment used by management in setting the assumptions used in the estimate of the value of the embedded derivative.
How We Addressed the Matter in Our Audit
We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the embedded derivative estimation process, including, among others, controls related to the review and approval processes that management has in place to develop the assumptions used in measuring the fair value of the embedded derivative. This included testing controls related to management’s evaluation of current and future market conditions and the need to update policy lapse and rider utilization assumptions.
We involved actuarial specialists to assist with our audit procedures which included, among others, an evaluation of the methodology applied by management with those methods used in prior periods. To assess the significant assumptions used by management, we compared the significant assumptions noted above to historical experience, observable market data or management’s estimates of prospective changes in these assumptions. In addition, we performed an independent recalculation of the embedded derivative for a sample of contracts which we compared to the fair value model used by management.
Valuation of Goodwill for the Life Insurance Reporting Unit
Description of the Matter
At December 31, 2020, the Company’s goodwill was $1.8 billion, of which $634 million related to the Company’s Life Insurance reporting unit. As discussed in Notes 1 (see section on Goodwill) and 10 of the consolidated financial statements, goodwill is tested for impairment at least annually at the reporting unit level. Determining the fair value of the Life Insurance reporting unit as part of the goodwill impairment analysis is sensitive to significant assumptions such as the discount rate, which reflects the market expected, weighted-average rate of return adjusted for the risk factors associated with the operations, and other relevant assumptions impacting projected financial information, such as the profitability of new and in-force business, all of which are affected by expectations about future market or economic conditions.
Auditing the fair value of the Company’s Life Insurance reporting unit was complex and required the involvement of our valuation and actuarial specialists due to the high degree of judgment used by management.
How We Addressed the Matter in Our Audit
We obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company’s goodwill impairment review process. This included, among others, controls related to the review and approval processes that management has in place to develop the assumptions used in the estimation process, including management’s determination of the applicable discount rate, and other assumptions for the Life Insurance reporting unit.
We involved actuarial and valuation specialists to assist with our audit procedures which included, among others, an evaluation of the methodology applied by management with those methods used in prior periods. To assess the significant assumptions used by management, we compared the significant assumptions noted above to current industry and economic trends, recent market transactions and other relevant factors. We reviewed the historical accuracy of management’s estimate and performed sensitivity analyses of significant assumptions to evaluate the changes in the fair value of the Life Insurance reporting unit that would result from changes in the assumptions.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 1966.
Philadelphia, Pennsylvania
February 18, 2021
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
As of December 31,
ASSETS
Investments:
Fixed maturity available-for-sale securities, at fair value
(amortized cost: 2020 - $104,174; 2019 - $94,295; allowance for credit losses: 2020 - $13; 2019 - $0)
$
123,044
$
105,200
Trading securities
4,501
4,673
Equity securities
Mortgage loans on real estate, net of allowance for credit losses
(portion at fair value: 2020 - $832; 2019 - $0)
16,763
16,339
Policy loans
2,426
2,477
Derivative investments
3,109
1,911
Other investments
3,984
2,994
Total investments
153,956
133,697
Cash and invested cash
1,708
2,563
Deferred acquisition costs and value of business acquired
5,812
7,694
Premiums and fees receivable
Accrued investment income
1,257
1,148
Reinsurance recoverables, net of allowance for credit losses
16,496
17,144
Funds withheld reinsurance assets
Goodwill
1,778
1,778
Other assets
15,960
16,170
Separate account assets
167,965
153,566
Total assets
$
365,948
$
334,761
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Future contract benefits
$
40,814
$
36,420
Other contract holder funds
105,405
98,018
Short-term debt
-
Long-term debt
6,682
6,067
Reinsurance related embedded derivatives
Funds withheld reinsurance liabilities
1,946
1,810
Payables for collateral on investments
6,222
5,082
Other liabilities
13,823
13,482
Separate account liabilities
167,965
153,566
Total liabilities
343,249
315,072
Contingencies and Commitments (See Note 14)
Stockholders’ Equity
Preferred stock - 10,000,000 shares authorized
-
-
Common stock - 800,000,000 shares authorized; 192,329,691 and 196,668,532 shares
issued and outstanding as of December 31, 2020, and December 31, 2019, respectively
5,082
5,162
Retained earnings
8,686
8,854
Accumulated other comprehensive income (loss)
8,931
5,673
Total stockholders’ equity
22,699
19,689
Total liabilities and stockholders’ equity
$
365,948
$
334,761
‎
See accompanying Notes to Consolidated Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions, except per share data)
For the Years Ended December 31,
Revenues
Insurance premiums
$
5,372
$
5,513
$
4,601
Fee income
6,371
6,497
5,986
Net investment income
5,510
5,223
5,085
Realized gain (loss)
(513
)
(610
)
Amortization of deferred gain on business sold through reinsurance
Other revenues
Total revenues
17,439
17,258
16,424
Expenses
Interest credited
2,923
2,780
2,617
Benefits
8,677
7,880
6,786
Commissions and other expenses
5,064
5,287
4,763
Interest and debt expense
Strategic digitization expense
Total expenses
17,016
16,339
14,539
Income (loss) before taxes
1,885
Federal income tax expense (benefit)
(76
)
Net income (loss)
1,641
Other comprehensive income (loss), net of tax:
Unrealized investment gains (losses)
3,192
5,288
(3,449
)
Foreign currency translation adjustment
(9
)
Funded status of employee benefit plans
(28
)
(7
)
Total other comprehensive income (loss), net of tax
3,258
5,266
(3,465
)
Comprehensive income (loss)
$
3,757
$
6,152
$
(1,824
)
Net Income (Loss) Per Common Share
Basic
$
2.58
$
4.41
$
7.60
Diluted
$
2.56
$
4.38
$
7.40
Cash Dividends Declared Per Common Share
$
1.62
$
1.51
$
1.36
‎
See accompanying Notes to Consolidated Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in millions)
For the Years Ended December 31,
Common Stock
Balance as of beginning-of-year
$
5,162
$
5,392
$
5,693
Stock compensation/issued for benefit plans
Retirement of common stock/cancellation of shares
(128
)
(272
)
(346
)
Balance as of end-of-year
5,082
5,162
5,392
Retained Earnings
Balance as of beginning-of-year
8,854
8,551
8,399
Cumulative effect from adoption of new accounting standards
(203
)
-
(642
)
Net income (loss)
1,641
Retirement of common stock
(147
)
(278
)
(554
)
Common stock dividends declared
(317
)
(305
)
(293
)
Balance as of end-of-year
8,686
8,854
8,551
Accumulated Other Comprehensive Income (Loss)
Balance as of beginning-of-year
5,673
3,230
Cumulative effect from adoption of new accounting standards
-
-
Other comprehensive income (loss), net of tax
3,258
5,266
(3,465
)
Balance as of end-of-year
8,931
5,673
Total stockholders’ equity as of end-of-year
$
22,699
$
19,689
$
14,350
‎
See accompanying Notes to Consolidated Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
For the Years Ended December 31,
Cash Flows from Operating Activities
Net income (loss)
$
$
$
1,641
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating
activities:
Realized (gain) loss
(141
)
Trading securities purchases, sales and maturities, net
(2,510
)
(118
)
Amortization of deferred gain on business sold through reinsurance
(41
)
(31
)
(9
)
Change in:
Deferred acquisition costs, value of business acquired, deferred sales inducements
and deferred front-end loads deferrals and interest, net of amortization
(409
)
(81
)
Premiums and fees receivable
(21
)
(87
)
Accrued investment income
(84
)
(29
)
(17
)
Insurance liabilities and reinsurance-related balances
(699
)
(1,613
)
Accrued expenses
(18
)
(101
)
Federal income tax accruals
(98
)
(227
)
Other
Net cash provided by (used in) operating activities
(2,686
)
1,943
Cash Flows from Investing Activities
Purchases of available-for-sale securities and equity securities
(16,761
)
(15,326
)
(12,650
)
Sales of available-for-sale securities and equity securities
1,426
6,807
3,668
Maturities of available-for-sale securities
5,354
6,571
6,004
Purchase of common stock in acquisition, net of cash acquired
-
-
(1,410
)
Sale of business, net
-
-
(12
)
Purchases of alternative investments
(396
)
(433
)
(314
)
Sales and repayments of alternative investments
Issuance of mortgage loans on real estate
(1,800
)
(4,262
)
(2,927
)
Repayment and maturities of mortgage loans on real estate
1,154
1,163
1,085
Issuance (repayment) of policy loans, net
Net change in collateral on investments, derivatives and related settlements
1,474
Other
(153
)
(261
)
(193
)
Net cash provided by (used in) investing activities
(9,481
)
(5,499
)
(5,815
)
Cash Flows from Financing Activities
Payment of long-term debt, including current maturities
(1,096
)
(308
)
(537
)
Issuance of long-term debt, net of issuance costs
1,289
1,094
Payment related to early extinguishment of debt
(13
)
(42
)
(23
)
Proceeds from sale-leaseback transactions
-
-
Payment related to sale-leaseback transactions
(47
)
(83
)
-
Proceeds from certain financing arrangements
-
Deposits of fixed account values, including the fixed portion of variable
14,034
16,069
13,638
Withdrawals of fixed account values, including the fixed portion of variable
(6,113
)
(5,849
)
(6,007
)
Transfers to and from separate accounts, net
(1,362
)
(2,469
)
Common stock issued for benefit plans
(7
)
(20
)
(6
)
Repurchase of common stock
(275
)
(550
)
(900
)
Dividends paid to common stockholders
(311
)
(303
)
(289
)
Other
(6
)
-
-
Net cash provided by (used in) financing activities
8,092
8,403
4,589
Net increase (decrease) in cash, invested cash and restricted cash
(855
)
Cash, invested cash and restricted cash as of beginning-of-year
2,563
2,345
1,628
Cash, invested cash and restricted cash as of end-of-year
$
1,708
$
2,563
$
2,345
See accompanying Notes to Consolidated Financial Statements
LINCOLN NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Operations, Basis of Presentation and Summary of Significant Accounting Policies
Nature of Operations
Lincoln National Corporation and its majority-owned subsidiaries (“LNC” or the “Company,” which also may be referred to as “we,” “our” or “us”) operate multiple insurance businesses through four business segments. See Note 22 for additional details. The collective group of businesses uses “Lincoln Financial Group” as its marketing identity. Through our business segments, we sell a wide range of wealth protection, accumulation, retirement income and group protection products and solutions. These products primarily include fixed and indexed annuities, variable annuities, universal life insurance (“UL”), variable universal life insurance (“VUL”), linked-benefit UL, indexed universal life insurance (“IUL”), term life insurance, employer-sponsored retirement plans and services, and group life, disability and dental.
Basis of Presentation
The accompanying consolidated financial statements are prepared in accordance with United States of America generally accepted accounting principles (“GAAP”). Certain GAAP policies, which significantly affect the determination of financial condition, results of operations and cash flows, are summarized below.
Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of LNC and all other entities in which we have a controlling financial interest and any variable interest entities (“VIEs”) in which we are the primary beneficiary. As discussed in Note 3, on May 1, 2018, LNC and The Lincoln National Life Insurance Company (“LNL”) completed the acquisition of Liberty Life Assurance Company of Boston (“Liberty Life”). We use the equity method of accounting to recognize all of our investments in limited liability partnerships. All material inter-company accounts and transactions have been eliminated in consolidation.
Our involvement with VIEs is primarily to invest in assets that allow us to gain exposure to a broadly diversified portfolio of asset classes. A VIE is an entity that does not have sufficient equity to finance its own activities without additional financial support or where investors lack certain characteristics of a controlling financial interest. We assess our contractual, ownership or other interests in a VIE to determine if our interest participates in the variability the VIE was designed to absorb and pass onto variable interest holders. We perform an ongoing qualitative assessment of our variable interests in VIEs to determine whether we have a controlling financial interest and would therefore be considered the primary beneficiary of the VIE. If we determine we are the primary beneficiary of a VIE, we consolidate the assets and liabilities of the VIE in our consolidated financial statements.
Accounting Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses for the reporting period. Those estimates are inherently subject to change and actual results could differ from those estimates. Included among the material (or potentially material) reported amounts and disclosures that require extensive use of estimates are: fair value of certain financial assets, derivatives, allowances for credit losses, deferred acquisition costs (“DAC”), value of business acquired (“VOBA”), deferred sales inducements (“DSI”), goodwill and other intangibles, future contract benefits, other contract holder funds including deferred front-end loads (“DFEL”), income taxes including the recoverability of our deferred tax assets, and the potential effects of resolving litigated matters.
Business Combinations
We use the acquisition method of accounting for all business combination transactions, and accordingly, recognize the fair values of assets acquired, liabilities assumed and any noncontrolling interests in our consolidated financial statements. The allocation of fair values may be subject to adjustment after the initial allocation for up to a one-year period as more information becomes available relative to the fair values as of the acquisition date. The consolidated financial statements include the results of operations of any acquired company since the acquisition date.
Fair Value Measurement
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 or non-performance risk (“NPR”), 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”). Pursuant to the Fair Value Measurements and Disclosures Topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards CodificationTM (“ASC”), 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 as follows:
Level 1 - inputs to the valuation methodology are quoted prices available in active markets for identical investments as of the reporting date, except for large holdings subject to “blockage discounts” that are excluded;
Level 2 - inputs to the valuation methodology are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value can be determined through the use of models or other valuation methodologies; and
Level 3 - inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity for the asset or liability, and we make estimates and assumptions related to the pricing of the asset or liability, including assumptions regarding risk.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment.
When a determination is made to classify an asset or liability within Level 3 of the fair value hierarchy, the determination is based upon the significance of the unobservable inputs to the overall fair value measurement. Because certain securities trade in less liquid or illiquid markets with limited or no pricing information, the determination of fair value for these securities is inherently more difficult. However, Level 3 fair value investments may include, in addition to the unobservable or Level 3 inputs, observable components, which are components that are actively quoted or can be validated to market-based sources.
Fixed Maturity Available-For-Sale Securities - Fair Valuation Methodologies and Associated Inputs
Securities classified as available-for-sale (“AFS”) consist of fixed maturity securities and 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.
We measure the fair value of our securities classified as fixed maturity AFS based on assumptions used by market participants in pricing the security. The most appropriate valuation methodology is selected based on the specific characteristics of the fixed maturity security, and we consistently apply the valuation methodology to measure the security’s fair value. Our fair value measurement is based on a market approach that utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. Sources of inputs to the market approach primarily include third-party pricing services, independent broker quotations or pricing matrices. We do not adjust prices received from third parties; however, we do analyze the third-party pricing services’ valuation methodologies and related inputs and perform additional evaluation to determine the appropriate level within the fair value hierarchy.
The observable and unobservable inputs to our valuation methodologies are based on a set of standard inputs that we generally use to evaluate all of our fixed maturity AFS securities. Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators, industry and economic events are monitored, and further market data is acquired if certain triggers are met. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable. For private placement securities, we use pricing matrices that utilize observable pricing inputs of similar public securities and Treasury yields as inputs to the fair value measurement. Depending on the type of security or the daily market activity, standard inputs may be prioritized differently or may not be available for all fixed maturity AFS securities on any given day. For broker-quoted only securities, non-binding quotes from market makers or broker-dealers are obtained from sources recognized as market participants. For securities trading in less liquid or illiquid markets with limited or no pricing information, we use unobservable inputs to measure fair value.
The following summarizes our fair valuation methodologies and associated inputs, which are particular to the specified security type and are in addition to the defined standard inputs to our valuation methodologies for all of our fixed maturity AFS securities discussed above:
Corporate bonds and U.S. government bonds - We also use Trade Reporting and Compliance EngineTM reported tables for our corporate bonds and vendor trading platform data for our U.S. government bonds.
Mortgage- and asset-backed securities (“ABS”) - We also utilize additional inputs, which include new issues data, monthly payment information and monthly collateral performance, including prepayments, severity, delinquencies, step-down features and over collateralization features for each of our mortgage-backed securities (“MBS”), which include collateralized mortgage obligations and mortgage pass through securities backed by residential mortgages (“RMBS”), commercial mortgage-backed securities (“CMBS”), collateralized loan obligations (“CLOs”) and collateralized debt obligations (“CDOs”).
State and municipal bonds - We also use additional inputs that include information from the Municipal Securities Rule Making Board, as well as material event notices, new issue data, issuer financial statements and Municipal Market Data benchmark yields for our state and municipal bonds.
Hybrid and redeemable preferred securities - We also utilize additional inputs of exchange prices (underlying and common stock of the same issuer) for our hybrid and redeemable preferred securities.
In order to validate the pricing information and broker-dealer 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. We have policies and procedures in place to review the process that is utilized by our 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. We also evaluate 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.
Fixed Maturity AFS Securities - Evaluation for Recovery of Amortized Cost
We regularly review our fixed maturity AFS securities (also referred to as “debt securities”) for declines in fair value that we determine to be impairment-related, including those attributable to credit risk factors that may require a credit loss allowance.
For our debt securities, we generally consider the following to determine whether our debt securities with unrealized losses are credit impaired:
The estimated range and average period until recovery;
The estimated range and average holding period to maturity;
Remaining payment terms of the security;
Current delinquencies and nonperforming assets of underlying collateral;
Expected future default rates;
Collateral value by vintage, geographic region, industry concentration or property type;
Subordination levels or other credit enhancements as of the balance sheet date as compared to origination; and
Contractual and regulatory cash obligations.
For a debt security, if we intend to sell a security, or it is more likely than not we will be required to sell a debt security before recovery of its amortized cost basis and the fair value of the debt security is below amortized cost, we conclude that an impairment has occurred and the amortized cost is written down to current fair value, with a corresponding charge to realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). If we do not intend to sell a debt security, or it is not more likely than not we will be required to sell a debt security before recovery of its amortized cost basis but the present value of the cash flows expected to be collected is less than the amortized cost of the debt security (referred to as the credit loss), we conclude that an impairment has occurred, and a credit loss allowance is recorded, with a corresponding charge to realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). The remainder of the decline to fair value related to factors other than credit loss is recorded in other comprehensive income (“OCI”) to unrealized losses on fixed maturity AFS securities on our Consolidated Statements of Stockholders’ Equity, as this amount is considered a noncredit impairment.
When assessing our intent to sell a debt security, or if it is more likely than not we will be required to sell a debt security before recovery of its cost basis, we evaluate facts and circumstances such as, but not limited to, decisions to reposition our security portfolio, sales of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing. 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.
In order to determine the amount of the credit loss for a debt security, we calculate the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows we expect to recover. The discount rate is the effective interest rate implicit in the underlying debt security. The effective interest rate is the original yield, or the coupon if the debt security was previously impaired. See the discussion below for additional information on the methodology and significant inputs, by security type, that we use to determine the amount of a credit loss.
To determine the recovery period 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.
In periods subsequent to the recognition of a credit loss impairment through a credit loss allowance, we continue to reassess the expected cash flows of the debt security at each subsequent measurement date as necessary. If the measurement of credit loss changes, we recognize a provision for (or reversal of) credit loss expense through realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss), limited by the amount that amortized cost exceeds fair value. Losses are charged against the allowance for credit losses when management believes the uncollectibility of a debt security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Accrued interest on debt securities is written-off when deemed uncollectible.
To determine the recovery value of a corporate bond, CLO or CDO, we perform additional analysis related to the underlying issuer including, but not limited to, the following:
Fundamentals of the issuer to determine what we would recover if they were to file bankruptcy versus the price at which the market is trading;
Fundamentals of the industry in which the issuer operates;
Earnings multiples for the given industry or sector of an industry that the underlying issuer operates within, divided by the outstanding debt to determine an expected recovery value of the security in the case of a liquidation;
Expected cash flows of the issuer (e.g., whether the issuer has cash flows in excess of what is required to fund its operations);
Expectations regarding defaults and recovery rates;
Changes to the rating of the security by a rating agency; and
Additional market information (e.g., if there has been a replacement of the corporate debt security).
Each quarter, we review the cash flows for the MBS portfolio, including current credit enhancements and trends in the underlying collateral performance to determine whether or not they are sufficient to provide for the recovery of our amortized cost. To determine recovery value of a MBS, we perform additional analysis related to the underlying issuer including, but not limited to, the following:
Discounted cash flow analysis based on the current cash flows and future cash flows we expect to recover;
Level of borrower creditworthiness of the home equity loans or residential mortgages that back an RMBS or commercial mortgages that back a CMBS;
Susceptibility to fair value fluctuations for changes in the interest rate environment;
Susceptibility to reinvestment risks, in cases where market yields are lower than the securities’ book yield earned;
Susceptibility to reinvestment risks, in cases where market yields are higher than the book yields earned on a security;
Expectations of sale of such a security where market yields are higher than the book yields earned on a security; and
Susceptibility to variability of prepayments.
When evaluating MBS and mortgage-related ABS, we consider a number of pool-specific factors as well as market level factors when determining whether or not the impairment on the security requires a credit loss allowance. The most important factor is the performance of the underlying collateral in the security and the trends of that performance in the prior periods. We use this information about the collateral to forecast the timing and rate of mortgage loan defaults, including making projections for loans that are already delinquent and for those loans that are currently performing but may become delinquent in the future. Other factors used in this analysis include the credit characteristics of borrowers, geographic distribution of underlying loans and timing of liquidations by state. Once default rates and timing assumptions are determined, we then make assumptions regarding the severity of a default if it were to occur. Factors that impact the severity assumption include expectations for future home price appreciation or depreciation, loan size, first lien versus second lien, existence of loan level private mortgage insurance, type of occupancy and geographic distribution of loans. Second lien loans are assigned 100% severity, if defaulted. For first lien loans, we assume a minimum of 30% severity, with higher severity assumed for investor properties and further adjusted by housing price assumptions. Once default and severity assumptions are determined for the security in question, cash flows for the underlying collateral are projected including expected defaults and prepayments. These cash flows on the collateral are then translated to cash flows on our tranche based on the cash flow waterfall of the entire capital security structure. If this analysis indicates the entire principal on a particular security will not be returned, the security is reviewed for a credit loss by comparing the expected cash flows to amortized cost. To the extent that the security has already been impaired through a credit loss allowance or was purchased at a discount, such that the amortized cost of the security is less than or equal to the present value of cash flows expected to be collected, no credit loss allowance is required. Otherwise, if the amortized cost of the security is greater than the present value of the cash flows expected to be collected, and the security was not purchased at a discount greater than the expected principal loss, then an impairment through a credit loss allowance is recognized.
We further monitor the cash flows of all of our debt securities backed by mortgages on an ongoing basis. We also perform detailed analysis on all of our subprime, Alt-A, non-agency residential MBS and on a significant percentage of our debt securities backed by pools of commercial mortgages. The detailed analysis includes revising projected cash flows by updating the cash flows for actual cash received and applying assumptions with respect to expected defaults, foreclosures and recoveries in the future. These revised projected cash flows are then compared to the amount of credit enhancement (subordination) in the structure to determine whether the amortized cost of the security is recoverable. If it is not recoverable, we record an impairment through a credit loss allowance for the security.
Trading Securities
Trading securities consist of fixed maturity securities in designated portfolios, some of which support modified coinsurance (“Modco”) and coinsurance with funds withheld (“CFW”) reinsurance agreements. Investment results for the portfolios that support Modco and CFW reinsurance agreements, including gains and losses from sales, are passed directly to the reinsurers pursuant to contractual terms of the reinsurance agreements. Trading securities are carried at fair value, and changes in fair value and changes in the fair value of embedded derivative liabilities associated with the underlying reinsurance agreements are recorded in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss) as they occur.
Equity Securities
Equity securities are carried at fair value, and changes in fair value are recorded in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss) as they occur. Equity securities consist primarily of common stock of publicly-traded companies, privately placed securities and mutual fund shares. We measure the fair value of our equity securities based on assumptions used by market participants in pricing the security. The most appropriate valuation methodology is selected based on the specific characteristics of the equity security. Fair values of publicly-traded equity securities are determined using quoted prices in active markets for identical or comparable securities. When quoted prices are not available, we use valuation methodologies most appropriate for the specific asset. Fair values for private placement securities are determined using discounted cash flow, earnings multiple and other valuation models. The fair values of mutual fund shares that transact regularly are based on transaction prices of identical fund shares.
Alternative Investments
Alternative investments, which consist primarily of investments in limited partnerships (“LPs”), are included in other investments on our Consolidated Balance Sheets. We account for our investments in LPs using the equity method to determine the carrying value. Recognition of alternative investment income is delayed due to the availability of the related financial statements, which are generally obtained from the partnerships’ general partners. As a result, our private equity investments are generally on a three-month delay and our hedge funds are on a one-month delay. In addition, the impact of audit adjustments related to completion of calendar-year financial statement audits of the investees are typically received during the second quarter of each calendar year. Accordingly, our investment income from alternative investments for any calendar-year period may not include the complete impact of the change in the underlying net assets for the partnership for that calendar-year period.
Payables for Collateral on Investments
When we enter into collateralized financing transactions on our investments, a liability is recorded equal to the cash or non-cash collateral received. This liability is included within payables for collateral on investments on our Consolidated Balance Sheets. Income and expenses associated with these transactions are recorded as investment income and investment expenses within net investment income on our Consolidated Statements of Comprehensive Income (Loss). Changes in payables for collateral on investments are reflected within cash flows from investing activities on our Consolidated Statements of Cash Flows.
Mortgage Loans on Real Estate
Mortgage loans on real estate consist of commercial and residential mortgage loans and are generally carried at unpaid principal balances adjusted for amortization of premiums and accretion of discounts and are net of allowance for credit losses. We carry certain commercial mortgage loans at fair value where the fair value option has been elected. Interest income is accrued on the principal balance of the loan based on the loan’s contractual interest rate. Premiums and discounts are amortized using the effective yield method over the life of the loan. Interest income and amortization of premiums and discounts are reported in net investment income on our Consolidated Statements of Comprehensive Income (Loss) along with mortgage loan fees, which are recorded as they are incurred.
Our policy for commercial mortgage loans is to report loans that are 60 or more days past due, which equates to two or more payments missed, as delinquent. Our policy for residential mortgage loans is to report loans that are 90 or more days past due, which equates to three or more payments missed, as delinquent. We do not accrue interest on loans 90 days past due, and any interest received on these loans is either applied to the principal or recorded in net investment income on our Consolidated Statements of Comprehensive Income (Loss) when received, depending on the assessment of the collectability of the loan. We resume accruing interest once a loan complies with all of its original terms or restructured terms. Mortgage loans deemed uncollectible are charged against the allowance for credit losses, and subsequent recoveries, if any, are likewise credited to the allowance for credit losses. Accrued interest on mortgage loans is written-off when deemed uncollectible.
In connection with our recognition of an allowance for credit losses for mortgage loans on real estate, we perform a quantitative analysis using a probability of default/loss given default/exposure at default approach to estimate expected credit losses in our mortgage loan portfolio as well as unfunded commitments related to commercial mortgage loans, exclusive of certain mortgage loans held at fair value. Our model estimates expected credit losses over the contractual terms of the loans, which are the periods over which we are exposed to credit risk, adjusted for expected prepayments. Credit loss estimates are segmented by commercial mortgage loans, residential mortgage loans, and unfunded commitments related to commercial mortgage loans.
The allowance for credit losses for pooled loans of similar risk (i.e., commercial and residential mortgage loans) is estimated using relevant historical credit loss information adjusted for current conditions and reasonable and supportable forecasts of future conditions. Historical credit loss experience provides the basis for the estimation of expected credit losses with adjustments for differences in current loan-specific risk characteristics, such as differences in underwriting standards, portfolio mix, delinquency level, or term lengths as well as adjustments for changes in environmental conditions, such as unemployment rates, property values, or other factors that management deems relevant. We apply probability weights to the positive, base and adverse scenarios we use. For periods beyond our reasonable and supportable forecast, we use implicit mean reversion over the remaining life of the recoverable, meaning our model will inherently revert to the baseline scenario as the baseline is representative of the historical average over a longer period of time.
Loans are considered impaired when it is probable that, based upon current information and events, we will be unable to collect all amounts due under the contractual terms of the loan agreement. When we determine that a loan is impaired, a specific credit loss allowance is established for the excess carrying value of the loan over its estimated value. The loan’s estimated value is based on: the present value of expected future cash flows discounted at the loan’s effective interest rate; the loan’s observable market price; or the fair value of the loan’s collateral.
Allowance for credit losses are maintained at a level we believe is adequate to absorb current expected lifetime credit losses. Our periodic evaluation of the adequacy of the allowance for credit losses is based on historical loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payments), the estimated value of the underlying collateral, composition of the loan portfolio, current economic conditions, reasonable and supportable forecasts about the future and other relevant factors.
Mortgage loans on real estate are presented net of the allowance for credit losses on our Consolidated Balance Sheets. Changes in the allowance are reported in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). Mortgage loans on real estate deemed uncollectible are charged against the allowance for credit losses, and subsequent recoveries, if any, are credited to the allowance for credit losses, limited to the aggregate of amounts previously charged-off and expected to be charged-off.
Our commercial loan portfolio is primarily comprised of long-term loans secured by existing commercial real estate. We believe all of the commercial loans in our portfolio share three primary risks: borrower credit worthiness; sustainability of the cash flow of the property; and market risk; therefore, our methods of monitoring and assessing credit risk are consistent for our entire portfolio.
For our commercial mortgage loan portfolio, trends in market vacancy and rental rates are incorporated into the analysis that we perform for monitored loans and may contribute to the establishment of (or an increase or decrease in) an allowance for credit losses. In addition, we review each loan individually in our commercial mortgage loan portfolio on an annual basis to identify emerging risks. We focus on properties that experienced a reduction in debt-service coverage or that have significant exposure to tenants with deteriorating credit profiles. Where warranted, we establish or increase a credit loss allowance for a specific loan based upon this analysis.
We measure and assess the credit quality of our commercial mortgage loans by using loan-to-value and debt-service coverage ratios. The loan-to-value ratio compares the principal amount of the loan to the fair value at origination of the underlying property collateralizing the loan and is commonly expressed as a percentage. Loan-to-value ratios greater than 100% indicate that the principal amount is greater than the collateral value. Therefore, all else being equal, a lower loan-to-value ratio generally indicates a higher quality loan. The debt-service coverage ratio compares a property’s net operating income to its debt-service payments. Debt-service coverage ratios of less than 1.0 indicate that property operations do not generate enough income to cover its current debt payments. Therefore, all else being equal, a higher debt-service coverage ratio generally indicates a higher quality loan. These credit quality metrics are monitored and reviewed at least annually.
Most of our off-balance sheet commitments relate to commercial mortgage loans. As such, an allowance for credit losses is developed based on the commercial mortgage loan process outlined above, along with an internally developed conversion factor.
Our residential loan portfolio is primarily comprised of first lien mortgages secured by existing residential real estate. In contrast to the commercial mortgage loan portfolio, residential mortgage loans are primarily smaller-balance homogenous loans that share similar risk characteristics. Therefore, these pools of loans are collectively evaluated for inherent credit losses. Such evaluations consider numerous factors, including, but not limited to borrower credit scores, collateral values, loss forecasts, geographic location, delinquency rates and economic trends. These evaluations and assessments are revised as conditions change and new information becomes available, including updated forecasts, which can cause the allowance for credit losses to increase or decrease over time as such evaluations are revised. Generally, residential mortgage loan pools exclude loans that are nonperforming, as those loans are evaluated individually using the evaluation framework for specific allowance for credit losses described above.
For residential mortgage loans, our primary credit quality indicator is whether the loan is performing or nonperforming. We generally define nonperforming residential mortgage loans as those that are 90 or more days past due and/or in nonaccrual status. There is generally a higher risk of experiencing credit losses when a residential mortgage loan is nonperforming. We monitor and update aging schedules and nonaccrual status on a monthly basis.
Policy Loans
Policy loans represent loans we issue to contract holders that use the cash surrender value of their life insurance policy as collateral. Policy loans are carried at unpaid principal balances.
Real Estate
Real estate includes both real estate held for the production of income and real estate held-for-sale. Real estate held for the production of income is carried at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful life of the asset. We periodically review properties held for the production of income for impairment. Properties whose carrying values are greater than their projected undiscounted cash flows are written down to estimated fair value, with impairment losses reported in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). The estimated fair value of real estate is generally computed using the present value of expected future cash flows from the real estate discounted at a rate commensurate with the underlying risks. Real estate classified as held-for-sale is stated at the lower of depreciated cost or fair value less expected disposition costs at the time classified as held-for-sale. Real estate is not depreciated while it is classified as held-for-sale. Also, valuation allowances are established, as appropriate, for real estate held-for-sale and any changes to the valuation allowances are reported in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). Real estate acquired through foreclosure proceedings is recorded at fair value at the settlement date.
Derivative Instruments
We hedge certain portions of our exposure to interest rate risk, foreign currency exchange risk, equity market risk and credit risk by entering into derivative transactions. All of our derivative instruments are recognized as either assets or liabilities on our Consolidated
Balance Sheets at estimated fair value. We categorized derivatives into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique as discussed above in “Fair Value Measurement.” The accounting for changes in the estimated fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship, and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, we designate the hedging instrument based upon the exposure being hedged: as a cash flow hedge or a fair value hedge.
For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of AOCI and reclassified into net income in the same period or periods during which the hedged transaction affects net income. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of designated future cash flows of the hedged item (hedge ineffectiveness), if any, is recognized in net income during the period of change. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument, as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in net income during the period of change in estimated fair values. For derivative instruments not designated as hedging instruments, but that are economic hedges, the gain or loss is recognized in net income.
We purchase and issue financial instruments and products that contain embedded derivative instruments. When it is determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host for measurement purposes. The embedded derivative is carried at fair value with changes in fair value recognized in net income during the period of change.
We employ several different methods for determining the fair value of our derivative instruments. The fair value of our derivative contracts are measured based on current settlement values, which are based on quoted market prices, industry standard models that are commercially available and broker quotes. These techniques project cash flows of the derivatives using current and implied future market conditions. We calculate the present value of the cash flows to measure the current fair market value of the derivative.
Cash and Invested Cash
Cash and invested cash is carried at cost and includes all highly liquid debt instruments purchased with an original maturity of three months or less.
DAC, VOBA, DSI and DFEL
Acquisition costs directly related to successful contract acquisitions or renewals of UL, VUL, traditional life insurance, annuities and other investment contracts have been deferred (i.e., DAC) to the extent recoverable. VOBA is an intangible asset that reflects the estimated fair value of in-force contracts in a life insurance company acquisition and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the business in force at the acquisition date. Bonus credits and excess interest for dollar cost averaging contracts are considered DSI. Contract sales charges that are collected in the early years of an insurance contract are deferred (i.e., DFEL), and the unamortized balance is reported in other contract holder funds on our Consolidated Balance Sheets.
Both DAC and VOBA amortization, excluding amounts reported in realized gain (loss), is reported within commissions and other expenses on our Consolidated Statements of Comprehensive Income (Loss). DSI amortization, excluding amounts reported in realized gain (loss), is reported in interest credited on our Consolidated Statements of Comprehensive Income (Loss). The amortization of DFEL, excluding amounts reported in realized gain (loss), is reported within fee income on our Consolidated Statements of Comprehensive Income (Loss). The methodology for determining the amortization of DAC, VOBA, DSI and DFEL varies by product type. For all insurance contracts, amortization is based on assumptions consistent with those used in the development of the underlying contract adjusted for emerging experience and expected trends.
Acquisition costs for UL and VUL insurance and investment-type products, which include fixed and variable deferred annuities, are generally amortized over the lives of the policies in relation to the incidence of estimated gross profits (“EGPs”) from surrender charges, investment, mortality net of reinsurance ceded and expense margins and actual realized gain (loss) on investments. Contract lives for UL and VUL policies are estimated to be 40 years based on the expected lives of the contracts. Contract lives for fixed and variable deferred annuities are generally between 15 and 30 years, while some of our fixed multi-year guarantee products have amortization periods equal to the guarantee period. The front-end load annuity product has an assumed life of 25 years. Longer lives are assigned to those blocks that have demonstrated lower lapse experience.
Acquisition costs for all traditional contracts, including traditional life insurance contracts, such as individual whole life, group business and term life insurance, are amortized over the expected premium-paying period that generally results in amortization less than 30 years. Acquisition costs are either amortized on a straight-line basis or as a level percent of premium of the related policies depending on the block of business. There is currently no intangible balance or related amortization for fixed and variable payout annuities.
We account for modifications of insurance contracts that result in a substantially unchanged contract as a continuation of the replaced contract. We account for modifications of insurance contracts that result in a substantially changed contract as an extinguishment of the replaced contract.
The carrying amounts of DAC, VOBA, DSI and DFEL are adjusted for the effects of realized and unrealized gains and losses on securities classified as fixed maturity AFS and certain derivatives and embedded derivatives. Amortization expense of DAC, VOBA, DSI and DFEL reflects 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 within realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss) reflecting the incremental effect of actual versus expected credit-related investment losses. These actual to expected amortization adjustments can create volatility from period to period in realized gain (loss).
During the third quarter of each year, we conduct our annual comprehensive review of the assumptions and the projection models used for our estimates of future gross profits underlying the amortization of DAC, VOBA, DSI and DFEL and the calculations of the embedded derivatives and reserves for life insurance and annuity products. These assumptions include, but are not limited to, capital markets, investment margins, mortality, retention, rider utilization and maintenance expenses (costs associated with maintaining records relating to insurance and individual and group annuity contracts, and with the processing of premium collections, deposits, withdrawals and commissions). Based on our review, the cumulative balances of DAC, VOBA, DSI and DFEL included on our Consolidated Balance Sheets are adjusted with an offsetting benefit or charge to revenue or amortization expense to reflect such change related to our expectations of future EGPs (“unlocking”). We may have unlocking in other quarters as we become aware of information that warrants updating assumptions outside of our annual comprehensive review. We may also identify and implement actuarial modeling refinements that result in increases or decreases to the carrying values of DAC, VOBA, DSI, DFEL, embedded derivatives and reserves for life insurance and annuity products with living benefit and death benefit guarantees.
DAC, VOBA, DSI and DFEL are reviewed to ensure that the unamortized portion does not exceed the expected recoverable amounts.
Reinsurance
Our insurance subsidiaries enter into reinsurance agreements in the normal course of business to limit our exposure to the risk of loss and to enhance our capital management.
In order for a reinsurance agreement to qualify for reinsurance accounting, the agreement must satisfy certain risk transfer conditions that include, among other items, a reasonable possibility of a significant loss for the assuming entity. When we apply reinsurance accounting, premiums, benefits and DAC amortization are reported net of insurance ceded on our Consolidated Statements of Comprehensive Income (Loss). Amounts currently recoverable, such as ceded reserves, are reported in reinsurance recoverables and amounts currently payable to the reinsurers, such as premiums, are included in other liabilities on our Consolidated Balance Sheets. Assets and liabilities and revenue and expenses from certain reinsurance contracts that grant statutory surplus relief to our insurance companies are netted on our Consolidated Balance Sheets and Consolidated Statements of Comprehensive Income (Loss), respectively, if there is a contractual right of offset.
We use deposit accounting to recognize reinsurance agreements that do not transfer significant insurance risk. This accounting treatment results in amounts paid or received by our insurance subsidiaries to be considered on deposit with the reinsurer and such amounts are reported in other assets and other liabilities, respectively, on our Consolidated Balance Sheets. As amounts are paid or received, consistent with the underlying contracts, deposit assets or liabilities are adjusted.
We estimated an allowance for credit losses for all reinsurance recoverables and related reinsurance deposit assets held by our subsidiaries. As such, we performed a quantitative analysis using a probability of loss approach to estimate expected credit losses for reinsurance recoverables, inclusive of similar assets recognized using the deposit method of accounting. The credit loss allowance is a general allowance for pools of receivables with similar risk characteristics segmented by credit risk ratings and receivables assessed on an individual basis that do not share similar risk characteristics where we anticipate a credit loss over the life of reinsurance-related assets.
Our model uses relevant internal or external historical loss information adjusted for current conditions and reasonable and supportable forecasts of future events and conditions in developing our loss estimate. We utilized historical credit rating data to form an estimation of probability of default of counterparties by means of a transition matrix that provides the rates of credit migration for credit ratings transitioning to impairment. We updated reinsurer credit ratings during the quarter to incorporate the most up-to-date information on the current state of the financial stability of our reinsurers. To simulate changes in economic conditions, we used positive, base and adverse scenarios that include varying levels of loss given default assumptions to reflect the impact of changes in severity of losses. We applied probability weights to the positive, base and adverse scenarios. For periods beyond our reasonable and supportable forecasts, we used implicit mean reversion over the remaining life of the recoverable. Additionally, we considered factors that impact our exposure at default that are driven by actuarial expectations around term and mortality assumptions rather than being directly driven by market or economic environment.
Our model estimates the expected credit losses over the life of the reinsurance asset. Credit loss estimates are segmented based on counterparty credit risk. Our modeling process utilizes counterparty credit ratings, collateral types and amounts, and term and run-off assumptions. For reinsurance recoverables that do not share similar risk characteristics, we assessed on an individual basis to determine a specific credit loss allowance.
We estimated expected credit losses over the contractual term of the recoverable, which is the period during which we are exposed to the credit risk. Reinsurance recoverables may not have explicit contractual lives, but are tied to the underlying insurance products; as a result, we estimated the contractual life by utilizing actuarial estimates of the timing of payouts related to those underlying products.
Reinsurance agreements often require the reinsurer to collateralize the recoverable with funds in a trust account for the benefit of the ceding insurance entity that can reduce the expected credit losses on a given agreement. As such, we review reinsurance collateral by individual agreement to sensitize risk of loss based on level of collateralization. This review is driven by the assumption that non-collateralized reinsurance recoverables would have materially higher losses in time of default. Therefore, reinsurance recoverables are pooled as either fully-collateralized or non-collateralized.
Reinsurance recoverables are presented net of the allowance for credit losses on our Consolidated Balance Sheets. Changes in the allowance for credit losses are reported in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss). Reinsurance recoverables deemed uncollectible are charged against the allowance for credit losses, and subsequent recoveries, if any, are credited to the allowance for credit losses, limited to the aggregate of amounts previously charged-off and expected to be charged-off.
Goodwill
We recognize the excess of the purchase price, plus the fair value of any noncontrolling interest in the acquiree, over the fair value of identifiable net assets acquired as goodwill. Goodwill is not amortized, but is reviewed for impairment annually as of October 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.
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 is greater than the reporting unit’s fair value, goodwill is impaired and written down to the reporting unit’s fair value; and a charge is reported in impairment of intangibles on our Consolidated Statements of Comprehensive Income (Loss). The results of one goodwill impairment test on one reporting unit cannot subsidize the results of another reporting unit.
Other Assets and Other Liabilities
Other assets consist primarily of certain reinsurance assets, net of allowance for credit losses, specifically identifiable intangible assets, property and equipment owned by the Company, balances associated with corporate-owned and bank-owned life insurance, receivables resulting from sales of securities that had not yet settled as of the balance sheet date, DSI, operating lease right-of-use (“ROU”) assets, finance lease assets, certain financing arrangements, debt issuance costs associated with line-of-credit arrangements and other receivables and prepaid expenses. Other liabilities consist primarily of certain reinsurance payables, current and deferred taxes, pension and other employee benefit liabilities, derivative instrument liabilities, payables resulting from purchases of securities that had not yet settled as of the balance sheet date, long-term operating lease liabilities, finance lease liabilities, certain financing arrangements, deferred gain on business sold through reinsurance and other accrued expenses.
Other assets and other liabilities on our Consolidated Balance Sheets include guaranteed living benefit (“GLB”) features and remaining guaranteed interest and similar contracts that are carried at fair value, which may be reported in either other assets or other liabilities. The fair value of these items represents approximate exit price including an estimate for our NPR. Certain of these features have elements of both insurance benefits and embedded derivatives. Through our hybrid accounting approach, for reserve calculation purposes we assign product cash flows to the embedded derivative or insurance portion of the reserves based on the life-contingent nature of the benefits. We classify these GLB reserves embedded derivatives in Level 3 within the hierarchy levels described above in “Fair Value Measurement.” We report the insurance portion of the reserves in future contract benefits.
The carrying values of specifically identifiable intangible assets are reviewed at least annually for indicators of impairment in value that are related to credit loss or non-credit, including unexpected or adverse changes in the following: the economic or competitive environments in which the company operates; profitability analyses; cash flow analyses; and the fair value of the relevant business operation. If there was an indication of impairment, then the discounted cash flow method would be used to measure the impairment, and the carrying value would be adjusted as necessary and reported in impairment of intangibles on our Consolidated Statements of Comprehensive Income (Loss). Sales force intangibles are attributable to the value of the new business distribution system acquired through business combinations. These assets are amortized on a straight-line basis over their useful life of 25 years. Specifically identifiable intangible assets also includes the value of customer relationships acquired (“VOCRA”) and value of distribution agreements (“VODA”). The carrying values of VOCRA and VODA are amortized using a straight-line basis over their weighted average life of 20 years and 13 years, respectively. See Note 10 for more information regarding specifically identifiable intangible assets.
Property and equipment owned for company use is carried at cost less allowances for depreciation. Provisions for depreciation of investment real estate and property and equipment owned for company use are computed principally on the straight-line method over the estimated useful lives of the assets, which include buildings, computer hardware and software and other property and equipment. Certain assets on our Consolidated Balance Sheets are related to finance leases and certain financing arrangements and are depreciated in a manner consistent with our current depreciation policy for owned assets. We periodically review the carrying value of our long-lived assets, including property and equipment, for impairment whenever events or circumstances indicate that the carrying amount of such assets may not be fully recoverable. For long-lived assets to be held and used, impairments are recognized when the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. An impairment loss is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value.
Long-lived assets to be disposed of by abandonment or in an exchange for a similar productive long-lived asset are classified as held-for-use until they are disposed. Long-lived assets to be sold are classified as held-for-sale and are no longer depreciated. Certain criteria have to be met in order for the long-lived asset to be classified as held-for-sale, including that a sale is probable and expected to occur within one year. Long-lived assets classified as held-for-sale are recorded at the lower of their carrying amount or fair value less cost to sell.
We lease office space and certain equipment under various long-term lease agreements. We determine if an arrangement is a lease at inception. Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. Our leases do not provide an implicit rate; therefore, we use our incremental borrowing rate at the commencement date in determining the present value of future payments. The ROU asset is calculated using the lease liability carrying amount, plus or minus prepaid/accrued lease payments, minus the unamortized balance of lease incentives received, plus unamortized initial direct costs. Lease terms used to calculate our lease obligation include options when we are reasonably certain that we will exercise such options. Our lease agreements may contain both lease and non-lease components, which are accounted for separately. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.
Other liabilities includes a deferred gain on business sold through reinsurance attributable to a reinsurance agreement with Swiss Re Life & Health America, Inc (“Swiss Re”) effective January 1, 2020. We are recognizing the gain related to this transaction over the period over which the majority of account values are expected to run off, or 15 years.
Other liabilities includes a deferred gain on business sold through reinsurance attributable to our annuity reinsurance agreement with Athene Holding Ltd. (“Athene”) effective October 1, 2018. We are recognizing the gain related to this transaction over the period over which the majority of account values are expected to run off, or 20 years.
Separate Account Assets and Liabilities
We maintain separate account assets, which are reported at fair value. The related liabilities are reported at an amount equivalent to the separate account assets. Investment risks associated with market value changes are borne by the contract holders, except to the extent of minimum guarantees made by the Company with respect to certain accounts.
We issue variable annuity contracts through our separate accounts for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contract holder (traditional variable annuities). We also issue variable annuity and life contracts through separate accounts that may include various types of guaranteed death benefit (“GDB”), guaranteed withdrawal benefit (“GWB”) and guaranteed income benefit (“GIB”) features. The GDB features include those where we contractually guarantee to the contract holder either: return of no less than total deposits made to the contract less any partial withdrawals (“return of net deposits”); total deposits made to the contract less any partial withdrawals plus a minimum return (“minimum return”); or the highest contract value on any contract anniversary date through age 80. The highest contract value is increased by purchase payments and is decreased by withdrawals subsequent to that anniversary date in the same proportion that withdrawals reduce the contract value.
As discussed in Note 6, certain features of these guarantees are accounted for as embedded derivative reserves, whereas other guarantees are accounted for as benefit reserves. Other guarantees contain characteristics of both and are accounted for under an approach that calculates the value of the embedded derivative reserve and the benefit reserve based on the specific characteristics of each GLB feature. We use derivative instruments to hedge our exposure to the risks and earnings volatility that result from the embedded derivatives for living benefits in certain of our variable annuity products. The change in fair value of these instruments tends to move in the opposite direction of the change in the value of the associated reserves. The net impact of these changes is reported as a component of realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).
The “market consistent scenarios” used in the determination of the fair value of the GLB liability 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-neutral Monte 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, as of 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.
Future Contract Benefits and Other Contract Holder Funds
Future contract benefits represent liability reserves that we have established and carry based on estimates of how much we will need to pay for future benefits and claims. Other contract holder funds represent liabilities for fixed account values, including the fixed portion of variable, dividends payable, premium deposit funds, undistributed earnings on participating business and other contract holder funds as well as the carrying value of DFEL discussed above.
The liabilities for future contract benefits and claim reserves for UL and VUL insurance policies consist of contract account balances that are equal to deposits net of withdrawals, excluding surrender charges and fees, plus interest credited, and if applicable an additional reserve for other insurance benefit guarantees. The liabilities for future insurance contract benefits and claim reserves for traditional life policies are computed using assumptions for investment yields, mortality and withdrawals based principally on generally accepted actuarial methods and assumptions at the time of contract issue. Investment yield assumptions for traditional direct individual life reserves for all contracts range from 2.25% to 7.75% depending on the time of contract issue. The investment yield assumptions for immediate and deferred paid-up annuities range from 1.25% to 12.75%. These investment yield assumptions are intended to represent an estimation of the interest rate experience for the period that these contract benefits are payable.
The liabilities for future claim reserves for variable annuity products containing GDB features are calculated by estimating the present value of total expected benefit payments over the life of the contract from inception divided by the present value of total expected assessments over the life of the contract (“benefit ratio”) multiplied by the cumulative assessments recorded from the contract inception through the balance sheet date less the cumulative GDB payments plus interest on the liability. The change in the liability for a period is the benefit ratio multiplied by the assessments recorded for the period less GDB claims paid in the period plus interest. As experience or assumption changes result in a change in expected benefit payments or assessments, the benefit ratio is unlocked, that is, recalculated using the updated expected benefit payments and assessments over the life of the contract since inception. The revised benefit ratio is then applied to the liability calculation described above, with the resulting change in liability reported in benefits on our Consolidated Statements of Comprehensive Income (Loss).
The liability for future claim reserves for long-term disability contracts for incurred and reported claims are calculated based on assumptions as to interest, claim resolution rates and offsets for other insurance including social security. Claim resolution rate assumptions and social security offsets are based on our actual experience. The interest rate assumptions used for discounting claim reserves are based on projected portfolio yield rates, after consideration for defaults and investment expenses, for assets supporting the liabilities. The incurred but not reported claim reserves are based on our experiences as to the reporting lags and ultimate loss experience. Claim reserves are subject to revision as current claim experience and projections of future factors affecting claim experience change. Claim reserves do not include a provision for adverse deviation.
With respect to our future contract benefits and other contract holder funds, we continually review overall reserve position, reserving techniques and reinsurance arrangements. As experience develops and new information becomes known, liabilities are adjusted as deemed necessary. The effects of changes in estimates are included in the operating results for the period in which such changes occur.
The business written or assumed by us includes participating life insurance contracts, under which the contract holder is entitled to share in the earnings of such contracts via receipt of dividends. The dividend scale for participating policies is reviewed annually and may be adjusted to reflect recent experience and future expectations. As of December 31, 2020 and 2019, participating policies comprised less than 1% of the face amount of business in force, and dividend expenses were $53 million, $51 million and $56 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Liabilities for the secondary guarantees on UL-type products are calculated by multiplying the benefit ratio by the cumulative assessments recorded from contract inception through the balance sheet date less the cumulative secondary guarantee benefit payments plus interest. If experience or assumption changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a manner similar to the unlocking of DAC, VOBA, DFEL and DSI. The accounting for secondary guarantee benefits impacts, and is impacted by, EGPs used to calculate amortization of DAC, VOBA, DFEL and DSI.
Certain of our variable annuity contracts reported within future contract benefits contain GLB reserves embedded derivatives, a portion of which may be reported in either other assets or other liabilities, and include guaranteed interest and similar contracts, that are carried at fair value on our Consolidated Balance Sheets, which represents approximate exit price including an estimate for our NPR. Certain of these features have elements of both insurance benefits and embedded derivatives. Through our hybrid accounting approach, for reserve calculation purposes we assign product cash flows to the embedded derivative or insurance portion of the reserves based on the life-contingent nature of the benefits. We classify these GLB reserves embedded derivatives items in Level 3 within the hierarchy levels described above in “Fair Value Measurement.” We report the insurance portion of the reserves in future contract benefits.
The fair value of our indexed annuity contracts is based on their approximate surrender values.
Short-term and Long-term Debt
Short-term debt has contractual or expected maturities of one year or less. Long-term debt has contractual or expected maturities greater than one year.
Contingencies and Commitments
Contingencies arising from environmental remediation costs, regulatory judgments, claims, assessments, guarantees, litigation, recourse reserves, fines, penalties and other sources are recorded when deemed probable and reasonably estimable.
Fee Income
Fee income for investment and interest-sensitive life insurance contracts consists of asset-based fees, percent of premium charges, contract administration charges and surrender charges that are assessed against contract holder account balances. Investment products consist primarily of individual and group variable and fixed deferred annuities. Interest-sensitive life insurance products include UL insurance, VUL insurance and other interest-sensitive life insurance policies. These products include life insurance sold to individuals, corporate-owned life insurance and bank-owned life insurance.
In bifurcating the embedded derivative of our GLB features on our variable annuity products, we attribute to the embedded derivative the portion of total fees collected from the contract holder that relate to the GLB riders (the “attributed fees”), which are not reported within fee income on our Consolidated Statements of Comprehensive Income (Loss). These attributed fees represent the present value of future claims expected to be paid for the GLB at the inception of the contract plus a margin that a theoretical market participant would include for risk/profit and are reported within realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).
The timing of revenue recognition as it relates to fees assessed on investment contracts is determined based on the nature of such fees. Asset-based fees and contract administration charges are assessed on a daily or monthly basis and recognized as revenue as performance obligations are met, over the period underlying customer assets are owned or advisory services are provided. Wholesaling-related 12b-1 fees received from separate account fund sponsors as compensation for servicing the underlying mutual funds are recorded as revenues based on a contractual percentage of the market value of mutual fund assets over the period shares are owned by customers. Net investment advisory fees related to asset management of certain separate account funds are recorded as revenues based on a contractual percentage of the customer’s managed assets over the period advisory services are provided. Percent of premium charges are assessed at the time of premium payment and recognized as revenue when assessed and earned. Certain amounts assessed that represent compensation for services to be provided in future periods are reported as unearned revenue and recognized in income over the periods benefited. Surrender charges are recognized upon surrender of a contract by the contract holder in accordance with contractual terms. For investment and interest-sensitive life insurance contracts, the amounts collected from contract holders are considered deposits and are not included in revenue.
Insurance Premiums
Our insurance premiums for traditional life insurance and group insurance products are recognized as revenue when due from the contract holder. Our traditional life insurance products include those products with fixed and guaranteed premiums and benefits and consist primarily of whole life insurance, limited-payment life insurance, term life insurance and certain annuities with life contingencies. Our group insurance products consist primarily of term life, disability and dental.
Net Investment Income
We earn investment income on the underlying general account investments supporting our fixed products less related expenses. Dividends and interest income, recorded in net investment income, are recognized when earned. Amortization of premiums and accretion of discounts on investments in debt securities are reflected in net investment income over the contractual terms of the investments in a manner that produces a constant effective yield.
For CLOs and MBS, included in the trading and fixed maturity AFS securities portfolios, we recognize income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from originally anticipated prepayments, the retrospective effective yield is recalculated to reflect actual payments to date and a catch up adjustment is recorded in the current period. In addition, the new effective yield, which reflects anticipated future payments, is used prospectively. Any adjustments resulting from changes in effective yield are reflected in net investment income on our Consolidated Statements of Comprehensive Income (Loss).
Realized Gain (Loss)
Realized gain (loss) includes realized gains and losses from the sale of investments, write-downs for impairments of investments and changes in the allowance for credit losses for financial assets, changes in fair value for mortgage loans on real estate accounted for under the fair value option, changes in fair value of equity securities, certain derivative and embedded derivative gains and losses, gains and losses on the sale of subsidiaries and businesses and net gains and losses on reinsurance embedded derivatives and trading securities. Realized gains and losses on the sale of investments are determined using the specific identification method. Realized gain (loss) is recognized in net income, net of associated amortization of DAC, VOBA, DSI and DFEL. Realized gain (loss) is also net of allocations of investment gains and losses to certain contract holders and certain funds withheld on reinsurance arrangements for which we have a contractual obligation.
Other Revenues
Other revenues consists primarily of fees attributable to broker-dealer services recorded as performance obligations are met, either at the time of sale or over time based on a contractual percentage of customer account values, changes in the market value of our seed capital investments, and proceeds from reinsurance recaptures. The broker-dealer services primarily relate to our retail sales network and consist of commission revenue for the sale of non-affiliated securities recorded on a trade date basis and advisory fee income. Advisory fee income is asset-based revenues recorded as earned based on a contractual percentage of customer account values. Other revenues earned by our Group Protection segment consist of fees from administrative services performed, which are recognized as performance obligations are met over the terms of the underlying agreements.
Interest Credited
We credit interest to our contract holder account balances based on the contractual terms supporting our products.
Benefits
Benefits for UL and other interest-sensitive life insurance products include benefit claims incurred during the period in excess of contract account balances. Benefits also include the change in reserves for life insurance products with secondary guarantee benefits, annuity products with guaranteed death and living benefits and certain annuities with life contingencies. For traditional life, group health and disability income products, benefits are recognized when incurred in a manner consistent with the related premium recognition policies.
Strategic Digitization Expense
Strategic digitization expense consists primarily of costs related to our enterprise-wide digitization initiative.
Pension and Other Postretirement Benefit Plans
Pursuant to the accounting rules for our obligations to employees and agents under our various pension and other postretirement benefit plans, we are required to make a number of assumptions to estimate related liabilities and expenses. The mortality assumption is based on actual and anticipated plan experience, determined using acceptable actuarial methods. We use assumptions for the weighted-average discount rate and expected return on plan assets to estimate pension expense. The discount rate assumptions are determined using an analysis of current market information and the projected benefit flows associated with these plans. The expected long-term rate of return on plan assets is based on historical and projected future rates of return on the funds invested in the plan. The calculation of our accumulated postretirement benefit obligation also uses an assumption of weighted-average annual rate of increase in the per capita cost of covered benefits, which reflects a health care cost trend rate.
Stock-Based Compensation
In general, we expense the fair value of stock awards included in our incentive compensation plans. As of the date our stock awards are approved, the fair value of stock options is determined using a Black-Scholes options valuation methodology, and the fair value of other stock awards is based upon the market value of the stock. The fair value of the awards is expensed over the performance or service period, which generally corresponds to the vesting period, and is recognized as an increase to common stock in stockholders’ equity. We apply an estimated forfeiture rate to our accrual of compensation cost. We classify certain stock awards as liabilities. For these awards, the settlement value is classified as a liability on our Consolidated Balance Sheets, and the liability is marked-to-market through net income at the end of each reporting period. Stock-based compensation expense is reflected in commissions and other expenses on our Consolidated Statements of Comprehensive Income (Loss).
Interest and Debt Expense
Interest expense on our short-term and long-term debt is recognized as due and any associated premiums, discounts and debt issuance costs are amortized (accreted) over the term of the related borrowing utilizing the effective interest method. In addition, gains or losses related to certain derivative instruments associated with debt are recognized in interest and debt expense during the period of the change.
Income Taxes
We file a U.S. consolidated income tax return that includes all of our eligible subsidiaries. Ineligible subsidiaries file separate individual corporate tax returns. Subsidiaries operating outside of the U.S. are taxed, and income tax expense is recorded, based on applicable foreign statutes. Deferred income taxes are recognized, based on enacted rates, when assets and liabilities have different values for financial statement and tax reporting purposes. A valuation allowance is recorded to the extent required. 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 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.
Foreign Currency Translation
The balance sheet accounts and income statement items of foreign subsidiaries, reported in functional currencies other than the U.S. dollar are translated at the current and average exchange rates for the year, respectively. Resulting translation adjustments and other translation adjustments for foreign currency transactions that affect cash flows are reported in AOCI, a component of stockholders’ equity.
Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing earnings available to common shareholders by the average common shares outstanding. Diluted EPS is computed assuming the conversion or exercise of dilutive convertible preferred securities, nonvested stock, stock options, performance share units and warrants outstanding during the year.
Our deferred compensation plans allow participants the option to diversify from LNC stock to other investment alternatives. When calculating our weighted-average dilutive shares, we presume the investment option will be settled in cash and exclude these shares from our calculation, unless the effect of settlement in shares would be more dilutive to our diluted EPS calculation.
For any period where a net loss is experienced, shares used in the diluted EPS calculation represent basic shares, as the use of diluted shares would result in a lower loss per share.
2. New Accounting Standards
Adoption of New Accounting Standards
The following table provides a description of our adoption of new Accounting Standards Updates (“ASUs”) issued by the FASB and the impact of the adoption on our financial statements. ASUs not listed below were assessed and determined to be either not applicable or insignificant in presentation or amount.
Standard
Description
Effective Date
Effect on Financial Statements or Other Significant Matters
ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), Measurement of Credit Losses on Financial Instruments and related amendments
These amendments adopt a new model in ASC Topic 326 to measure and recognize credit losses for most financial assets. The ASU requires a financial asset measured at amortized cost to be presented at the net amount expected to be collected over the life of the asset using a credit loss allowance. Changes in the allowance are charged to earnings. The measurement of expected credit losses is based on relevant information about past events, including historical experience, as well as current economic conditions and reasonable and supportable forecasts that affect the collectability of the financial asset. The method used to measure estimated credit losses for fixed maturity AFS securities will be unchanged from current GAAP; however, the amendments require credit losses to be recognized through an allowance rather than as a reduction to the amortized cost of those securities. The amendments permit entities to recognize improvements in credit loss estimates on fixed maturity AFS securities by reducing the allowance account immediately through earnings. The amendments are adopted through a cumulative effect adjustment to the beginning balance of retained earnings as of the first reporting period in which the amendments are effective. Early adoption was permitted for annual periods beginning after December 15, 2018, and interim periods therein.
January 1, 2020
The adoption of this standard and related amendments resulted in the recognition of a cumulative effect decrease of $218 million, net of DAC, VOBA, DSI, DFEL and changes in other contract holder funds, after-tax, to retained earnings. The overall adjustment recorded our allowance for credit losses as of the date of adoption, primarily related to commercial and residential mortgage loans, as well as reinsurance recoverables. Upon adoption of the standard, the concept of other-than-temporary impairment (“OTTI”) no longer exists; however, our prior period presentation herein is reflective of OTTI recorded in those periods.
ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging and Topic 825, Financial Instruments
These amendments clarify the measurement, recognition and presentation of the allowance for credit losses on accrued interest receivable balances; the inclusion of recoveries when estimating the allowance for credit losses; the inclusion of all ASC Topic 944 - Financial Services - Insurance reinsurance recoverables within the scope of ASC 326-20; and provide additional targeted clarifications on the calculation of the allowance for credit losses.
‎
‎These amendments also make targeted clarifications to ASC Topics 815 and 825. Early adoption was permitted.
January 1, 2020
Our adoption of ASU 2016-13 and related amendments is discussed above. The adoption of the remainder of this guidance did not have a material impact on our consolidated financial condition and results of operations.
Standard
Description
Effective Date
Effect on Financial Statements or Other Significant Matters
ASU 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief
The amendments provide entities that have certain instruments within the scope of Subtopic 326-20, Financial Instruments - Credit Losses - Measured at Amortized Cost, with an option to irrevocably elect the fair value option in Subtopic 825-10, Financial Instruments - Overall, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASC Topic 326.
January 1, 2020
We recognized a cumulative effect increase to retained earnings of $15 million, after-tax, by electing the fair value option for certain mortgage loans in connection with our adoption of ASC Topic 326.
ASU 2020-04, Reference Rate Reform (Topic 848)
The amendments in this update provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendments provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions impacted by reference rate reform. If certain criteria are met, an entity will not be required to remeasure or reassess contracts impacted by reference rate reform. Additionally, changes to the critical terms of a hedging relationship affected by reference rate reform will not require entities to de-designate the relationship if certain requirements are met. The expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, with certain exceptions. The amendments are effective for contract modifications made between March 12, 2020, and December 31, 2022.
March 12, 2020 through December 31, 2022
This standard may be elected and applied prospectively as reference rate reform unfolds. We have begun our implementation and are currently evaluating the impact of this ASU on our consolidated financial condition and results of operations.
ASU 2018-12, Targeted Improvements to the Accounting for Long-Duration Contracts and related amendments
These amendments make changes to the accounting and reporting for long-duration contracts issued by an insurance entity that will significantly change how insurers account for long-duration contracts, including how they measure, recognize and make disclosures about insurance liabilities and DAC. Under this ASU, insurers will be required to review cash flow assumptions at least annually and update them if necessary. They also will have to make quarterly updates to the discount rate assumptions they use to measure the liability for future policyholder benefits. The ASU creates a new category of market risk benefits (i.e., features that protect the contract holder from capital market risk and expose the insurer to that risk) that insurers will have to measure at fair value. The ASU provides various transition methods by topic that entities may elect upon adoption. The ASU is currently effective January 1, 2023, and early adoption is permitted.
January 1, 2023
We are currently evaluating the impact of adopting this ASU on our consolidated financial condition and results of operations.
3. Acquisition
On May 1, 2018, we completed the acquisition from Liberty Mutual Insurance Company of 100% of the capital stock of Liberty Life, an operator of a group benefits business (the “Liberty Group Business”) and an individual life and individual and group annuity business (the “Liberty Life Business”). The acquisition expanded the scale and capabilities of the Group Protection business while further diversifying the Company’s sources of earnings. Effective September 1, 2019, Liberty Life’s name was changed to Lincoln Life Assurance Company of Boston (“LLACB”).
In connection with the acquisition and pursuant to the Master Transaction Agreement (“MTA”), dated January 18, 2018, which is filed as Exhibit 2.1 to this Form 10-K, Liberty Life sold the Liberty Life Business on May 1, 2018, by entering into reinsurance agreements and related ancillary documents (including administrative services agreements and transition services agreements) with Protective Life Insurance Company and its wholly-owned subsidiary, Protective Life and Annuity Insurance Company (together with Protective Life Insurance Company, “Protective”), providing for the reinsurance and administration of the Liberty Life Business.
We recognized $85 million of acquisition-related costs, pre-tax, for the year ended December 31, 2018. These costs were included in commissions and other expenses on our Consolidated Statements of Comprehensive Income (Loss).
Since the acquisition date of May 1, 2018, the revenues and net income of the business acquired have been included in our Consolidated Statements of Comprehensive Income (Loss) in the Group Protection segment and were $1.5 billion and $36 million, respectively, for the period ended December 31, 2018.
4. Variable Interest Entities
Consolidated VIEs
Reinsurance Related Notes
We are the sole equity owner of Lincoln Financial Limited Liability Company I (“LFLLCI”), which we formed in July 2013. The activities of LFLLCI relate solely to our captive reinsurance subsidiary, the Lincoln Reinsurance Company of Vermont V (“LRCVV”), and are primarily to acquire, hold and issue notes with LRCVV as well as pay and collect interest on the notes. LFLLCI holds a surplus note issued by LRCVV that had an outstanding principal balance of $611 million as of December 31, 2020. LFLLCI issued a long-term note to LRCVV that has a principal balance that moves concurrently with any variability in the face amount of the surplus note LFLLCI received from LRCVV. We concluded that LFLLCI is a VIE and that LNC is the primary beneficiary as we have the power to direct the most significant activities affecting the performance of LFLLCI.
Asset information (dollars in millions) for the consolidated VIEs included on our Consolidated Balance Sheets was as follows:
As of December 31, 2020
As of December 31, 2019
Number
Number
of
Notional
Carrying
of
Notional
Carrying
Instruments
Amounts
Value
Instruments
Amounts
Value
Assets
Total return swap
$
$
-
$
$
-
There were no gains or losses for consolidated VIEs recognized on our Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2020 and 2019.
Unconsolidated VIEs
Reinsurance Related Notes
Effective September 30, 2014, we entered into a transaction with a non-affiliated VIE whose primary activities are to acquire, hold and issue notes and loans, pay and collect interest on the notes and loans, and enter into derivative instruments. We issued a long-term senior note to the non-affiliated VIE in exchange for a corporate bond AFS security of like principal and duration that was assigned to one of our subsidiaries. The outstanding principal balance of this long-term senior note was $963 million as of December 31, 2020, and it is variable in nature; moving concurrently with any variability in the face amount of the corporate bond AFS security up to a maximum amount of $1.1 billion. We have concluded that we are not the primary beneficiary of the non-affiliated VIE because we do not have power over the activities that most significantly affect its economic performance. In addition, the terms of the senior note provide us with a set-off right with the corporate bond AFS security we purchased from the VIE; therefore, neither appears on our Consolidated Balance Sheets. The VIE has entered into a total return swap with an unaffiliated third party that supports any necessary principal funding of the corporate bond AFS security required by our subsidiaries while the security is outstanding.
Effective October 1, 2017, our captive reinsurance subsidiary, the Lincoln Reinsurance Company of Vermont VI, restructured the $275 million, long-term surplus note which was originally issued to a non-affiliated VIE in October 2015 in exchange for two corporate bond AFS securities of like principal and duration. The activities of the VIE are primarily to acquire, hold and issue notes and loans and to pay and collect interest on the notes and loans. The outstanding principal balance of the long-term surplus note is variable in nature; moving concurrently with any variability in the face amount of the corporate bond AFS securities. We have concluded that we are not the primary beneficiary of the non-affiliated VIE because we do not have power over the activities that most significantly affect its economic performance. As of December 31, 2020, the principal balance of the long-term surplus note was zero and we do not currently have any exposure to this VIE.
Effective November 1, 2019, we entered into a transaction with a non-affiliated VIE whose primary activities are to acquire, hold and issue notes, as well as pay and collect interest on the notes. We issued a long-term senior note to the non-affiliated VIE in exchange for a corporate bond AFS security of like principal and duration that was assigned to one of our subsidiaries. The outstanding principal balance of this long-term senior note was $359 million as of December 31, 2020, and it is variable in nature, moving concurrently with any variability in the face amount of the corporate bond AFS security up to a maximum amount of $500 million. We have concluded that we are not the primary beneficiary of the non-affiliated VIE due to our lack of power over the activities that most significantly affect its economic performance as well as the extent of our obligation to absorb its losses. In addition, the terms of the senior note provide us with a set-off right with the corporate bond AFS security we purchased from the VIE; therefore, neither appears on our Consolidated Balance Sheets.
Structured Securities
Through our investment activities, we make passive investments in structured securities issued by VIEs for which we are not the manager. These structured securities include our ABS, RMBS and CMBS. We have not provided financial or other support with respect to these VIEs other than our original investment. We have determined that we are not the primary beneficiary of these VIEs due to the relative size of our investment in comparison to the principal amount of the structured securities issued by the VIEs and the level of credit subordination that reduces our obligation to absorb losses or right to receive benefits. Our maximum exposure to loss on these structured securities is limited to the amortized cost for these investments. We recognize our variable interest in these VIEs at fair value on our Consolidated Balance Sheets. For information about these structured securities, see Note 5.
Limited Partnerships and Limited Liability Companies
We invest in certain LPs and limited liability companies (“LLCs”), including qualified affordable housing projects, that we have concluded are VIEs. We do not hold any substantive kick-out or participation rights in the LPs and LLCs, and we do not receive any performance fees or decision maker fees from the LPs and LLCs. Based on our analysis of the LPs and LLCs, we are not the primary beneficiary of the VIEs as we do not have the power to direct the most significant activities of the LPs and LLCs.
The carrying amounts of our investments in the LPs and LLCs are recognized in other investments on our Consolidated Balance Sheets and were $2.1 billion and $1.9 billion as of December 31, 2020 and 2019, respectively. Included in these carrying amounts are our investments in qualified affordable housing projects, which were $7 million and $13 million as of December 31, 2020 and 2019, respectively. We do not have any contingent commitments to provide additional capital funding to these qualified affordable housing projects. We receive returns from these qualified affordable housing projects in the form of income tax credits and other tax benefits, which are recognized in federal income tax expense (benefit) on our Consolidated Statements of Comprehensive Income (Loss) and were $1 million and $2 million for the years ended December 31, 2020 and 2019, respectively.
Our exposure to loss is limited to the capital we invest in the LPs and LLCs, and there have been no indicators of impairment that would require us to recognize an impairment loss related to the LPs and LLCs as of December 31, 2020.
5. Investments
Fixed Maturity AFS Securities
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.
The amortized cost, gross unrealized gains, losses, allowance for credit losses and fair value of fixed maturity AFS securities (in millions) were as follows:
As of December 31, 2020
Allowance
Amortized
Gross Unrealized
for Credit
Fair
Cost
Gains
Losses
Losses
Value
Fixed maturity AFS securities:
Corporate bonds
$
86,289
$
16,662
$
$
$
102,789
U.S. government bonds
-
State and municipal bonds
5,360
1,561
-
-
6,921
Foreign government bonds
-
RMBS
2,765
3,076
CMBS
1,390
-
-
1,505
ABS
7,041
-
7,184
Hybrid and redeemable preferred securities
-
Total fixed maturity AFS securities
$
104,174
$
19,081
$
$
$
123,044
The amortized cost, gross unrealized gains, losses, OTTI and fair value of fixed maturity AFS securities (in millions) were as follows:
As of December 31, 2019
Amortized
Gross Unrealized
Fair
Cost
Gains
Losses
OTTI (1)
Value
Fixed maturity AFS securities:
Corporate bonds
$
79,417
$
9,479
$
$
(4
)
$
88,716
U.S. government bonds
-
-
State and municipal bonds
4,778
1,113
-
5,884
Foreign government bonds
-
-
RMBS
3,042
(19
)
3,241
CMBS
1,038
(1
)
1,083
ABS
4,810
(35
)
4,889
Hybrid and redeemable preferred securities
-
Total fixed maturity AFS securities
$
94,295
$
11,086
$
$
(59
)
$
105,200
(1)Prior to the adoption of ASU 2016-13, we recognized the OTTI attributed to noncredit factors as a separate component in OCI referred to as unrealized OTTI on fixed maturity AFS securities. This 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.
The amortized cost and fair value of fixed maturity AFS securities by contractual maturities (in millions) as of December 31, 2020, were as follows:
Amortized
Fair
Cost
Value
Due in one year or less
$
3,319
$
3,344
Due after one year through five years
15,016
16,052
Due after five years through ten years
19,105
21,660
Due after ten years
55,538
70,223
Subtotal
92,978
111,279
Structured securities (RMBS, CMBS, ABS)
11,196
11,765
Total fixed maturity AFS securities
$
104,174
$
123,044
Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.
The fair value and gross unrealized losses of fixed maturity AFS securities (dollars in millions) for which an allowance for credit losses has not been recorded, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:
As of December 31, 2020
Less Than or Equal
Greater Than
to Twelve Months
Twelve Months
Total
Gross
Gross
Gross
Fair
Unrealized
Fair
Unrealized
Fair
Unrealized
Value
Losses
Value
Losses
Value
Losses (1)
Fixed maturity AFS securities:
Corporate bonds
$
3,039
$
$
$
$
3,646
$
U.S. government bonds
-
-
Foreign government bonds
-
-
RMBS
-
ABS
1,527
1,885
Hybrid and redeemable
preferred securities
Total fixed maturity AFS securities
$
4,808
$
$
1,068
$
$
5,876
$
Total number of fixed maturity AFS securities in an unrealized loss position
(1)We recognized $1 million of gross unrealized losses in OCI for fixed maturity AFS securities for which an allowance for credit losses has been recorded.
The fair value and gross unrealized losses, including the portion of OTTI recognized in OCI, of fixed maturity AFS securities (dollars in millions), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:
As of December 31, 2019
Less Than or Equal
Greater Than
to Twelve Months
Twelve Months
Total
Gross
Gross
Gross
Unrealized
Unrealized
Unrealized
Fair
Losses and
Fair
Losses and
Fair
Losses and
Value
OTTI
Value
OTTI
Value
OTTI
Fixed maturity AFS securities:
Corporate bonds
$
2,935
$
$
1,406
$
$
4,341
$
State and municipal bonds
-
RMBS
-
CMBS
-
ABS
1,792
2,095
Hybrid and redeemable
preferred securities
Total fixed maturity AFS securities
$
5,673
$
$
1,848
$
$
7,521
$
Total number of fixed maturity AFS securities in an unrealized loss position
The fair value, gross unrealized losses (in millions) and number of fixed maturity AFS securities where the fair value had declined and remained below amortized cost by greater than 20% were as follows:
As of December 31, 2020
Gross
Number
Fair
Unrealized
of
Value
Losses
Securities (1)
Less than six months
$
$
Six months or greater, but less than nine months
Nine months or greater, but less than twelve months
Twelve months or greater
Total
$
$
(1)We may reflect a security in more than one aging category based on various purchase dates.
The fair value, gross unrealized losses, the portion of OTTI recognized in OCI (in millions) and number of fixed maturity AFS securities where the fair value had declined and remained below amortized cost by greater than 20% were as follows:
As of December 31, 2019
Number
Fair
Gross Unrealized
of
Value
Losses
OTTI
Securities (1)
Less than six months
$
$
$
-
Six months or greater, but less than nine months
-
Twelve months or greater
-
Total
$
$
$
-
(1)We may reflect a security in more than one aging category based on various purchase dates.
Our gross unrealized losses on fixed maturity AFS securities decreased by $45 million for the year ended December 31, 2020. As discussed further below, we believe the unrealized loss position as of December 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. Based upon this evaluation as of December 31, 2020, management believes we have the ability to generate adequate amounts of cash from our normal operations (e.g., insurance premiums, fee income and investment income) to meet cash requirements with a prudent margin of safety without requiring the sale of our impaired securities.
As of December 31, 2020, the unrealized losses associated with our corporate bond, U.S. government bond, state and municipal bond and foreign government bond securities were attributable primarily to widening credit spreads and rising interest rates since purchase. We performed a detailed analysis of the financial performance of the underlying issuers and determined that we expected to recover the entire amortized cost of each impaired security.
Credit ratings express opinions about the credit quality of a security. Securities rated investment grade (those rated BBB- or higher by Standard & Poor’s Rating Services (“S&P”) or Baa3 or higher by Moody’s Investors Service (“Moody’s”)) are generally considered by the rating agencies and market participants to be low credit risk. As of December 31, 2020 and 2019, 96% of the fair value of our corporate bond portfolio was rated investment grade. As of December 31, 2020 and 2019, the portion of our corporate bond portfolio rated below investment grade had an amortized cost of $4.1 billion and $3.2 billion, respectively, and a fair value of $4.2 billion and $3.3 billion, respectively. Based upon the analysis discussed above, we believe that as of December 31, 2020 and 2019, we would have recovered the amortized cost of each corporate bond.
As of December 31, 2020, the unrealized losses associated with our MBS and ABS were attributable primarily to widening credit spreads and rising interest rates since purchase. We assessed for credit impairment using a cash flow model that incorporates key assumptions including default rates, severities and prepayment rates. We estimated losses for a security by forecasting the underlying loans in each transaction. The forecasted loan performance was used to project cash flows to the various tranches in the structure, as applicable. Our forecasted cash flows also considered, as applicable, independent industry analyst reports and forecasts and other independent market data. Based upon our assessment of the expected credit losses of the security given the performance of the underlying collateral compared to our subordination or other credit enhancement, we expected to recover the entire amortized cost of each impaired security.
As of December 31, 2020, the unrealized losses associated with our hybrid and redeemable preferred securities were attributable primarily to wider credit spreads caused by illiquidity in the market and subordination within the capital structure, as well as credit risk of underlying issuers. For our hybrid and redeemable preferred securities, we evaluated the financial performance of the underlying issuers based upon credit performance and investment ratings and determined that we expected to recover the entire amortized cost of each impaired security.
Credit Loss Impairment on Fixed Maturity AFS Securities
We regularly review our fixed maturity AFS securities for declines in fair value that we determine to be impairment-related, including those attributable to credit risk factors that may require an allowance for credit losses. See Note 1 for a detailed discussion regarding our accounting policy relating to the allowance for credit losses on our fixed maturity AFS securities.
Changes in the allowance for credit losses on fixed maturity AFS securities (in millions), aggregated by investment category, were as follows:
For the Year Ended December 31, 2020
Corporate
Bonds
RMBS
ABS
Total
Balance as of beginning-of-year
$
-
$
-
$
-
$
-
Additions for securities for which credit losses were not
previously recognized
Additions from purchases of PCD debt securities (1)
-
-
-
-
Additions (reductions) for securities for which credit losses
were previously recognized
(1
)
-
(1
)
(2
)
Reductions for securities disposed
(17
)
-
-
(17
)
Reductions for securities charged-off
(13
)
-
-
(13
)
Balance as of end-of-year (2)
$
$
$
-
$
(1)Represents purchased credit-deteriorated (“PCD”) fixed maturity AFS securities.
(2)Accrued interest receivable on fixed maturity AFS securities totaled $1.0 billion as of December 31, 2020, and was excluded from the estimate of credit losses.
Changes in the amount of credit loss of OTTI recognized in net income (loss) where the portion related to other factors was recognized in OCI (in millions) on fixed maturity AFS securities were as follows:
For the Years Ended
December 31,
Balance as of beginning-of-year
$
$
Increases attributable to:
Credit losses on securities for which an
OTTI was not previously recognized
Credit losses on securities for which an
OTTI was previously recognized
Decreases attributable to:
Securities sold, paid down or matured
(160
)
(30
)
Balance as of end-of-year
$
$
Trading Securities
Trading securities at fair value (in millions) consisted of the following:
As of December 31,
Fixed maturity securities:
Corporate bonds
$
3,107
$
2,947
U.S. government bonds
-
State and municipal bonds
Foreign government bonds
RMBS
CMBS
ABS
1,238
Hybrid and redeemable preferred securities
Total trading securities
$
4,501
$
4,673
The portion of the market adjustment for trading gains and losses recognized in realized gain (loss) that relate to trading securities still held as of December 31, 2020, 2019 and 2018, was $118 million, $228 million and $(58) million, respectively.
Mortgage Loans on Real Estate
The following provides the current and past due composition of our mortgage loans on real estate (in millions):
As of December 31, 2020
As of December 31, 2019
Commercial
Residential
Total
Commercial
Residential
Total
Current
$
16,245
$
$
16,855
$
15,620
$
$
16,279
30 to 59 days past due
60 to 89 days past due
-
-
90 or more days past due
-
-
Allowance for credit losses
(187
)
(17
)
(204
)
-
(2
)
(2
)
Unamortized premium (discount)
(14
)
(17
)
Mark-to-market gains (losses) (1)
(5
)
-
(5
)
-
-
-
Total carrying value
$
16,043
$
$
16,763
$
15,606
$
$
16,339
(1)Represents the mark-to-market on certain commercial mortgage loans on real estate for which we have elected the fair value option. See Note 21 for additional information.
Our commercial mortgage loan portfolio has the largest concentrations in California, which accounted for 24% of commercial mortgage loans on real estate as of December 31, 2020 and 2019, and Texas, which accounted for 10% and 11% of commercial mortgage loans on real estate as of December 31, 2020 and 2019, respectively.
Our residential mortgage loan portfolio has the largest concentrations in California, which accounted for 32% and 34% of residential mortgage loans on real estate as of December 31, 2020 and 2019, respectively, and Florida, which accounted for 18% and 20% of residential mortgage loans on real estate as of December 31, 2020 and 2019, respectively.
As of December 31, 2020 and 2019, we had 147 and 38 residential mortgage loans, respectively, that were either delinquent or in foreclosure.
For our commercial mortgage loans, there were four specifically identified impaired loans with an aggregate carrying value of $1 million as of December 31, 2020. There was one specifically identified impaired loan with a carrying value of less than $1 million as of December 31, 2019.
For our residential mortgage loans, there were 76 specifically identified impaired loans with an aggregate carrying value of $34 million as of December 31, 2020. There were four specifically identified impaired loans with an aggregate carrying value of $1 million as of December 31, 2019.
Additional information related to impaired mortgage loans on real estate (in millions) was as follows:
For the Years Ended December 31,
Average carrying value for impaired mortgage loans on real estate
$
$
-
$
Interest income recognized on impaired mortgage loans on real estate
-
-
Interest income collected on impaired mortgage loans on real estate
-
-
The amortized cost of mortgage loans on real estate on nonaccrual status (in millions) was as follows:
As of December 31, 2020
As of January 1, 2020
Nonaccrual
Nonaccrual
with no
with no
Allowance
Allowance
for Credit
for Credit
Losses
Nonaccrual
Losses
Nonaccrual
Commercial mortgage loans on real estate
$
-
$
-
$
-
$
-
Residential mortgage loans on real estate
-
-
Total
$
-
$
$
-
$
We use loan-to-value and debt-service coverage ratios as credit quality indicators for our commercial mortgage loans on real estate (dollars in millions) as follows:
As of December 31, 2020
As of December 31, 2019
Debt-
Debt-
Service
Service
Amortized
% of
Coverage
Amortized
% of
Coverage
Loan-to-Value Ratio
Cost
Total
Ratio
Cost
Total
Ratio
Less than 65%
$
15,236
93.8%
2.36
$
14,206
91.0%
2.35
65% to 74%
5.9%
1.69
1,399
9.0%
1.87
75% to 100%
0.3%
1.21
0.0%
1.09
Total
$
16,235
100.0%
$
15,606
100.0%
The amortized cost of commercial mortgage loans on real estate (in millions) by year of origination and credit quality indicator was as follows:
As of December 31, 2020
Debt-
Debt-
Debt-
Service
Service
Service
Less
Coverage
65%
Coverage
75%
Coverage
than 65%
Ratio
to 74%
Ratio
to 100%
Ratio
Total
Origination Year
$
1,504
2.86
$
1.52
$
-
-
$
1,536
3,141
2.25
1.78
1.74
3,401
2,382
2.16
1.49
0.71
2,583
1,786
2.34
1.73
-
-
1,955
1,713
2.37
1.56
1.58
1,909
2015 and prior
4,710
2.38
1.95
1.02
4,851
Total
$
15,236
$
$
$
16,235
We use loan performance status as the primary credit quality indicator for our residential mortgage loans on real estate (dollars in millions) as follows:
As of December 31, 2020
As of December 31, 2019
Amortized
% of
Amortized
% of
Performance Indicator
Cost
Total
Cost (1)
Total
Performing
$
90.4%
$
97.7%
Nonperforming
9.6%
2.3%
Total
$
100.0%
$
100.0%
(1)A valuation allowance of $2 million was established on residential mortgage loans on real estate as of December 31, 2019.
The amortized cost of residential mortgage loans on real estate (in millions) by year of origination and credit quality indicator was as follows:
As of December 31, 2020
Performing
Nonperforming
Total
Origination Year
$
$
$
-
-
-
-
-
-
2015 and prior
-
-
-
Total
$
$
$
Credit Losses on Mortgage Loans on Real Estate
In connection with our recognition of an allowance for credit losses for mortgage loans on real estate, we perform a quantitative analysis using a probability of default/loss given default/exposure at default approach to estimate expected credit losses in our mortgage loan portfolio as well as unfunded commitments related to commercial mortgage loans, exclusive of certain mortgage loans held at fair value. See Note 1 for a detailed discussion regarding our accounting policy relating to the allowance for credit losses on our mortgage loans on real estate.
Changes in the allowance for credit losses on mortgage loans on real estate (in millions) were as follows:
For the Year Ended December 31, 2020
Commercial
Residential
Total
Balance as of beginning-of-year
$
-
$
$
Impact of adopting ASU 2016-13
Additions from provision for credit loss expense (1)
Additions from purchases of PCD mortgage loans on real estate
-
-
-
Additions (reductions) for mortgage loans on real estate for which
credit losses were previously recognized (1)
(53
)
(21
)
(74
)
Balance as of end-of-year (2)
$
$
$
(1)Due to changes in economic projections driven by the impact of the COVID-19 pandemic, the provision for credit loss expense increased by $114 million for the year ended December 31, 2020. For the year ended December 31, 2020, we recognized $2 million of credit loss expense related to unfunded commitments for mortgage loans on real estate.
(2)Accrued interest receivable on mortgage loans on real estate totaled $49 million as of December 31, 2020, and was excluded from the estimate of credit losses.
Changes in the valuation allowance associated with impaired commercial mortgage loans on real estate (in millions) were as follows:
For the Years Ended
December 31,
Balance as of beginning-of-year
$
-
$
Additions
-
-
Charge-offs, net of recoveries
-
(3
)
Balance as of end-of-year
$
-
$
-
Alternative Investments
As of December 31, 2020 and 2019, alternative investments included investments in 271 and 258 different partnerships, respectively, and represented approximately 1% of total investments.
Net Investment Income
The major categories of net investment income (in millions) on our Consolidated Statements of Comprehensive Income (Loss) were as follows:
For the Years Ended December 31,
Fixed maturity AFS securities
$
4,334
$
4,281
$
4,209
Trading securities
Equity securities
Mortgage loans on real estate
Real estate
Policy loans
Invested cash
Commercial mortgage loan prepayment
and bond make-whole premiums
Alternative investments
Consent fees
Other investments
Investment income
5,685
5,454
5,271
Investment expense
(175
)
(231
)
(186
)
Net investment income
$
5,510
$
5,223
$
5,085
Impairments on Fixed Maturity AFS Securities
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,
Credit Loss Expense Recognized in Net Income (Loss) (1)
Fixed maturity AFS securities:
Corporate bonds
$
(25
)
$
(14
)
$
(5
)
RMBS
(1
)
(1
)
(1
)
ABS
-
(1
)
(1
)
Gross credit loss expense recognized in net income (loss)
(26
)
(16
)
(7
)
Associated amortization of DAC, VOBA, DSI and DFEL
-
Net credit loss expense recognized in net income (loss)
$
(25
)
$
(15
)
$
(7
)
(1)For the year ended December 31, 2020, we recognized credit loss expense incurred and write-downs taken as a result of impairments through net income (loss), pursuant to ASU 2016-13. For the years ended December 31, 2019 and 2018, prior to the adoption of ASU 2016-13, we recognized write-downs taken as a result of OTTI through net income (loss).
During the year ended December 31, 2019, we recorded $15 million of OTTI recognized in OCI. During the year ended December 31, 2018, we recorded no OTTI recognized in OCI.
Payables for Collateral on Investments
The carrying value of the payables for collateral on investments included on our Consolidated Balance Sheets and the fair value of the related investments or collateral (in millions) consisted of the following:
As of December 31, 2020
As of December 31, 2019
Carrying
Fair
Carrying
Fair
Value
Value
Value
Value
Collateral payable for derivative investments (1)
$
2,976
$
2,976
$
1,388
$
1,388
Securities pledged under securities lending agreements (2)
Investments pledged for Federal Home Loan Bank of
Indianapolis (“FHLBI”) (3)
3,130
5,049
3,580
5,480
Total payables for collateral on investments
$
6,222
$
8,137
$
5,082
$
6,978
(1)We obtain collateral based upon contractual provisions with our counterparties. These agreements take into consideration the counterparties’ credit rating as compared to ours, the fair value of the derivative investments and specified thresholds that if exceeded result in the receipt of cash that is typically invested in cash and invested cash. See Note 6 for additional information.
(2)Our pledged securities under securities lending agreements are included in fixed maturity AFS securities on our Consolidated Balance Sheets. We generally obtain collateral in an amount equal to 102% and 105% of the fair value of the domestic and foreign securities, respectively. We value collateral daily and obtain additional collateral when deemed appropriate. The cash received in our securities lending program is typically invested in cash and invested cash or fixed maturity AFS securities.
(3)Our pledged investments for FHLBI are included in fixed maturity AFS securities and mortgage loans on real estate on our Consolidated Balance Sheets. The collateral requirements are generally 105% to 115% of the fair value for fixed maturity AFS securities and 155% to 175% of the fair value for mortgage loans on real estate. The cash received in these transactions is primarily invested in cash and invested cash or fixed maturity AFS securities.
We have repurchase agreements through which we can obtain liquidity by pledging securities. The collateral requirements are generally 80% to 95% of the fair value of the securities, and our agreements with third parties contain contractual provisions to allow for additional collateral to be obtained when necessary. The cash received in our repurchase program is typically invested in fixed maturity AFS securities. As of December 31, 2020 and 2019, we were not participating in any open repurchase agreements.
Increase (decrease) in payables for collateral on investments (in millions) consisted of the following:
For the Years Ended December 31,
Collateral payable for derivative investments
$
1,588
$
$
(128
)
Securities pledged under securities lending agreements
(134
)
Securities pledged under repurchase agreements
-
(150
)
(380
)
Investments pledged for FHLBI
(450
)
(350
)
1,030
Total increase (decrease) in payables for collateral on investments
$
1,140
$
$
We have elected not to offset our securities lending transactions in our financial statements. The remaining contractual maturities of securities lending transactions accounted for as secured borrowings (in millions) were as follows:
As of December 31, 2020
Overnight and Continuous
Up to 30 Days
30 - 90
‎Days
Greater Than 90 Days
Total
Securities Lending
Corporate bonds
$
$
-
$
-
$
-
$
Foreign government bonds
-
-
-
Total gross secured borrowings
$
$
-
$
-
$
-
$
As of December 31, 2019
Overnight and Continuous
Up to 30 Days
30 - 90
‎Days
Greater Than 90 Days
Total
Securities Lending
Corporate bonds
$
$
-
$
-
$
-
$
Total gross secured borrowings
$
$
-
$
-
$
-
$
We accept collateral in the form of securities in connection with repurchase agreements. In instances where we are permitted to sell or re-pledge the securities received, we report the fair value of the collateral received and a related obligation to return the collateral in the financial statements. In addition, we receive securities in connection with securities borrowing agreements that we are permitted to sell or re-pledge. As of December 31, 2020, the fair value of all collateral received that we are permitted to sell or re-pledge was $25 million, and we did not re-pledge any of this collateral to cover initial margin and over-the-counter collateral requirements on certain derivative investments as of December 31, 2020.
Investment Commitments
As of December 31, 2020, our investment commitments were $2.9 billion, which included $1.4 billion of LPs, $989 million of mortgage loans on real estate and $508 million of private placement securities.
Concentrations of Financial Instruments
As of December 31, 2020 and 2019, our most significant investments in one issuer were our investments in securities issued by the Federal Home Loan Mortgage Corporation with a fair value of $1.2 billion and $1.3 billion, respectively, or 1% of total investments, and our investments in securities issued by the Federal National Mortgage Association with a fair value of $1.0 billion, or 1% of total investments. These concentrations include fixed maturity AFS, trading and equity securities.
As of December 31, 2020 and 2019, our most significant investments in one industry were our investments in securities in the consumer non-cyclical industry with a fair value of $20.3 billion and $16.3 billion, respectively, or 13% and 12%, respectively, of total investments, and our investments in securities in the financial services industry with a fair value of $19.6 billion and $16.4 billion, respectively, or 13% and 12%, respectively, of total investments. These concentrations include fixed maturity AFS, trading and equity securities.
6. Derivative Instruments
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, basis risk and credit risk. We assess these risks by continually identifying and monitoring changes in our exposures that may adversely affect expected future cash flows and by evaluating hedging opportunities.
Derivative activities are monitored by various management committees. The committees are responsible for overseeing the implementation of various hedging strategies that are developed through the analysis of financial simulation models and other internal and industry sources. The resulting hedging strategies are incorporated into our overall risk management strategies.
See Note 1 for a detailed discussion of the accounting treatment for derivative instruments. See Note 21 for additional disclosures related to the fair value of our derivative instruments and Note 4 for derivative instruments related to our consolidated VIEs.
Interest Rate Contracts
We use derivative instruments as part of our interest rate risk management strategy. These instruments are economic hedges unless otherwise noted and include:
Forward-Starting Interest Rate Swaps
We use forward-starting interest rate swaps designated and qualifying as cash flow hedges to hedge our exposure to interest rate fluctuations related to the forecasted purchases of certain assets and anticipated issuances of fixed-rate securities.
We also use forward-starting interest rate swaps to hedge the interest rate exposure within our life products related to the forecasted purchases of certain assets.
Interest Rate Cap Corridors
We use interest rate cap corridors to provide a level of protection from the effect of rising interest rates for certain life insurance products and annuity contracts. Interest rate cap corridors involve purchasing an interest rate cap at a specific cap rate and selling an interest rate cap with a higher cap rate. For each corridor, the amount of quarterly payments, if any, is determined by the rate at which the underlying index rate resets above the original capped rate. The corridor limits the benefit the purchaser can receive as the related interest rate index rises above the higher capped rate. There is no additional liability to us other than the purchase price associated with the interest rate cap corridor.
Interest Rate Futures
We use interest rate futures contracts to hedge the liability exposure on certain options in variable annuity products. These futures contracts require payment between our counterparty and us on a daily basis for changes in the futures index price.
Interest Rate Swap Agreements
We use interest rate swap agreements to hedge the liability exposure on certain options in variable annuity products.
We also use interest rate swap agreements designated and qualifying as cash flow hedges to hedge the interest rate risk of floating-rate bond coupon payments by replicating a fixed-rate bond.
Finally, we use interest rate swap agreements designated and qualifying as fair value hedges to hedge against changes in the fair value of certain fixed-rate long-term debt and fixed maturity securities due to interest rate risks.
Treasury and Reverse Treasury Locks
We use treasury locks designated and qualifying as cash flow hedges to hedge the interest rate exposure related to our issuance of fixed-rate securities or the anticipated future cash flows of floating-rate fixed maturity securities due to changes in interest rates. In addition, we use reverse treasury locks designated and qualifying as cash flow hedges to hedge the interest rate exposure related to the anticipated purchase of fixed-rate securities or the anticipated future cash flows of floating-rate fixed maturity securities due to changes in interest rates. These derivatives are primarily structured to hedge interest rate risk inherent in the assumptions used to price certain liabilities.
Foreign Currency Contracts
We use derivative instruments as part of our foreign currency risk management strategy. These instruments are economic hedges unless otherwise noted and include:
Currency Futures
We use currency futures to hedge foreign exchange risk associated with certain options in variable annuity products. Currency futures exchange one currency for another at a specified date in the future at a specified exchange rate.
Foreign Currency Swaps
We use foreign currency swaps to hedge foreign exchange risk of investments in fixed maturity securities denominated in foreign currencies. A foreign currency swap is a contractual agreement to exchange one currency for another at specified dates in the future at a specified exchange rate.
We also use foreign currency swaps designated and qualifying as cash flow hedges to hedge foreign exchange risk of investments in fixed maturity securities denominated in foreign currencies.
Foreign Currency Forwards
We use foreign currency forwards to hedge foreign exchange risk of investments in fixed maturity securities denominated in foreign currencies. A foreign currency forward is a contractual agreement to exchange one currency for another at specified dates in the future at a specified current exchange rate.
Equity Market Contracts
We use derivative instruments as part of our equity market risk management strategy that are economic hedges and include:
Call Options Based on the S&P 500® Index and Other Indices
We use call options to hedge the liability exposure on certain options in variable annuity products.
Our indexed annuity and IUL contracts permit the holder to elect an interest rate return or an equity market component, 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 index options 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 participation rates, caps, spreads and specified rates, subject to contractual guarantees. We use call 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.
Consumer Price Index Swaps
We use consumer price index swaps to hedge the liability exposure on certain options in fixed annuity products. Consumer price index swaps are contracts entered into at no cost and whose payoff is the difference between the consumer price index inflation rate and the fixed-rate determined as of inception.
Equity Futures
We use equity futures contracts to hedge the liability exposure on certain options in variable annuity products. These futures contracts require payment between our counterparty and us on a daily basis for changes in the futures index price.
Put Options
We use put options to hedge the liability exposure on certain options in variable annuity products. Put options are contracts that require counterparties to pay us at a specified future date the amount, if any, by which a specified equity index is less than the strike rate stated in the agreement, applied to a notional amount.
Total Return Swaps
We use total return swaps to hedge the liability exposure on certain options in variable annuity products.
In addition, we use total return swaps to hedge a portion of the liability related to our deferred compensation plans. We receive the total return on a portfolio of indexes and pay a floating-rate of interest.
Credit Contracts
We use derivative instruments as part of our credit risk management strategy that are economic hedges and include:
Credit Default Swaps - Buying Protection
We use credit default swaps to hedge the liability exposure on certain options in variable annuity products.
We buy credit default swaps to hedge against a drop in bond prices due to credit concerns of certain bond issuers. A credit default swap allows us to put the bond back to the counterparty at par upon a default event by the bond issuer. A default event is defined as bankruptcy, failure to pay, obligation acceleration or restructuring.
Credit Default Swaps - Selling Protection
We use credit default swaps to hedge the liability exposure on certain options in variable annuity products.
We sell credit default swaps to offer credit protection to contract holders and investors. The credit default swaps hedge the contract holders and investors against a drop in bond prices due to credit concerns of certain bond issuers. A credit default swap allows the investor to put the bond back to us at par upon a default event by the bond issuer. A default event is defined as bankruptcy, failure to pay, obligation acceleration or restructuring.
Embedded Derivatives
We have embedded derivatives that include:
GLB Reserves 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 derivatives accounted for under the Derivatives and Hedging and the Fair Value Measurements and Disclosures Topics of the FASB ASC (“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.
We use a hedging strategy designed to mitigate the risk and income statement volatility caused by changes in the equity markets, interest rates and volatility associated with GLBs offered in our variable annuity products, including products with guaranteed withdrawal benefit and guaranteed income benefit features. Changes in the value of the hedge contracts due to changes in equity markets, interest rates and implied volatilities hedge the income statement effect of changes in embedded derivative GLB reserves caused by those same factors. We rebalance our hedge positions based upon changes in these factors as needed. While we actively manage our hedge positions, these hedge positions may not be totally effective in offsetting changes in the embedded derivative reserve 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 and interest rates, 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 and our ability to purchase hedging instruments at prices consistent with our desired risk and return trade-off.
Indexed Annuity and IUL Contracts Embedded Derivatives
Our indexed annuity and IUL contracts permit the holder to elect an interest rate return or an equity market component, 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 index options 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 participation rates, caps, spreads and specified rates, subject to contractual guarantees. We use 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.
Reinsurance Related Embedded Derivatives
We have certain Modco and coinsurance with funds withheld reinsurance agreements with embedded derivatives related to the withheld assets of the related funds. These derivatives are considered total return swaps with contractual returns that are attributable to various assets and liabilities associated with these reinsurance agreements.
We have derivative instruments with off-balance-sheet risks whose notional or contract amounts exceed the related credit exposure. Outstanding derivative instruments with off-balance-sheet risks (in millions) were as follows:
As of December 31, 2020
As of December 31, 2019
Notional
Fair Value
Notional
Fair Value
Amounts
Asset
Liability
Amounts
Asset
Liability
Qualifying Hedges
Cash flow hedges:
Interest rate contracts (1)
$
2,177
$
$
$
2,387
$
$
Foreign currency contracts (1)
3,089
2,874
Total cash flow hedges
5,266
5,261
Fair value hedges:
Interest rate contracts (1)
1,161
-
1,261
Non-Qualifying Hedges
Interest rate contracts (1)
135,434
1,587
112,921
1,082
Foreign currency contracts (1)
Equity market contracts (1)
74,610
3,486
1,952
43,555
1,442
Credit contracts (1)
-
-
-
-
Embedded derivatives:
GLB direct (2)
-
-
-
-
GLB ceded (2)
-
-
-
Reinsurance related (3)
-
-
-
-
Indexed annuity and IUL contracts (2) (4)
-
3,594
-
2,585
Total derivative instruments
$
216,826
$
6,390
$
7,091
$
163,315
$
4,384
$
4,306
(1)Reported in derivative investments and other liabilities on our Consolidated Balance Sheets.
(2)Reported in other assets and other liabilities on our Consolidated Balance Sheets.
(3)Reported in reinsurance related embedded derivatives on our Consolidated Balance Sheets.
(4)Reported in future contract benefits on our Consolidated Balance Sheets.
The maturity of the notional amounts of derivative instruments (in millions) was as follows:
Remaining Life as of December 31, 2020
Less Than
1 - 5
6 - 10
11 - 30
Over 30
1 Year
Years
Years
Years
Years
Total
Interest rate contracts (1)
$
14,052
$
57,331
$
29,217
$
36,959
$
1,213
$
138,772
Foreign currency contracts (2)
1,062
1,693
-
3,393
Equity market contracts
40,716
19,755
5,831
8,296
74,610
Credit contracts
-
-
-
-
Total derivative instruments
with notional amounts
$
54,995
$
77,548
$
36,110
$
38,664
$
9,509
$
216,826
(1)As of December 31, 2020, the latest maturity date for which we were hedging our exposure to the variability in future cash flows for these instruments was April 20, 2067.
(2)As of December 31, 2020, the latest maturity date for which we were hedging our exposure to the variability in future cash flows for these instruments was June 17, 2050.
‎
The following amounts (in millions) were recorded on the Consolidated Balance Sheets related to cumulative basis adjustments for fair value hedges:
Cumulative Fair Value
Hedging Adjustment
Included in the
Amortized Cost of the
Amortized Cost of the
Hedged
Hedged
Assets / (Liabilities)
Assets / (Liabilities)
As of
As of
As of
As of
December 31,
December 31,
December 31,
December 31,
Line Item in the Consolidated Balance Sheets in
which the Hedged Item is Included
Fixed maturity AFS securities, at fair value
$
$
$
$
Long-term debt (1)
(900
)
(1,035
)
(25
)
(160
)
(1)The balance includes $(370) million and $(118) million of unamortized adjustments from discontinued hedges as of December 31, 2020, and 2019, respectively.
The change in our unrealized gain (loss) on derivative instruments within AOCI (in millions) was as follows:
For the Years Ended December 31,
Unrealized Gain (Loss) on Derivative Instruments
Balance as of beginning-of-year
$
(11
)
$
$
(29
)
Other comprehensive income (loss):
Unrealized holding gains (losses) arising during the period:
Cumulative effect from adoption of
new accounting standard
-
-
(6
)
Cash flow hedges:
Interest rate contracts
(350
)
(201
)
Foreign currency contracts
Change in foreign currency exchange rate adjustment
(174
)
(52
)
Change in DAC, VOBA, DSI and DFEL
(17
)
(4
)
(13
)
Income tax benefit (expense)
(51
)
Less:
Reclassification adjustment for gains (losses)
included in net income (loss):
Cash flow hedges:
Interest rate contracts (1)
Interest rate contracts (2)
(16
)
(5
)
(7
)
Foreign currency contracts (1)
Foreign currency contracts (3)
-
Associated amortization of DAC, VOBA, DSI and DFEL
(1
)
(1
)
(2
)
Income tax benefit (expense)
(10
)
(9
)
(5
)
Balance as of end-of-year
$
(402
)
$
(11
)
$
(1)The OCI offset is reported within net investment income on our Consolidated Statements of Comprehensive Income (Loss).
(2)The OCI offset is reported within interest and debt expense on our Consolidated Statements of Comprehensive Income (Loss).
(3)The OCI offset is reported within realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).
‎
The effects of qualifying and non-qualifying hedges (in millions) on the Consolidated Statements of Comprehensive Income (Loss) were as follows:
Gain (Loss) Recognized in Income
For the Years Ended December 31,
Realized
Net
Interest
Realized
Net
Interest
Gain
Investment
and Debt
Gain
Investment
and Debt
(Loss)
Income
Expense
(Loss)
Income
Expense
Total Line Items in which
the Effects of Fair Value or
Cash Flow Hedges are Recorded
$
(513
)
$
5,510
$
$
(610
)
$
5,223
$
Qualifying Hedges
Gain or (loss) on fair value
hedging relationships:
Interest rate contracts:
Hedged items
-
-
(93
)
Derivatives designated as
hedging instruments
-
(69
)
(136
)
-
(63
)
Gain or (loss) on cash flow
hedging relationships:
Interest rate contracts:
Amount of gain or (loss)
reclassified from AOCI
into income
-
(16
)
-
(5
)
Foreign currency contracts:
Amount of gain or (loss)
reclassified from AOCI
into income
-
-
Non-Qualifying Hedges
Interest rate contracts
1,287
-
-
-
-
Foreign currency contracts
(3
)
-
-
(1
)
-
-
Equity market contracts
-
-
(137
)
-
-
Credit contracts
(6
)
-
-
-
-
-
Embedded derivatives:
GLB
-
-
-
-
Reinsurance related
(65
)
-
-
(324
)
-
-
Indexed annuity and IUL
contracts
(471
)
-
-
(742
)
-
-
The gains (losses) on derivative instruments (in millions) recorded within income (loss) from continuing operations on our Consolidated Statements of Comprehensive Income (Loss) were as follows:
For the Year
Ended
December 31,
Qualifying Hedges
Cash flow hedges:
Interest rate contracts (1)
$
Interest rate contracts (2)
(7
)
Foreign currency contracts (3)
Total cash flow hedges
Fair value hedges:
Interest rate contracts (1)
(14
)
Interest rate contracts (2)
Interest rate contracts (3)
Total fair value hedges
Non-Qualifying Hedges
Interest rate contracts (3)
(150
)
Foreign currency contracts (3)
Equity market contracts (3)
Equity market contracts (4)
(18
)
Embedded derivatives:
GLB (3)
(692
)
Reinsurance related (3)
Indexed annuity and IUL contracts (3)
Total derivative instruments
$
(216
)
(1)Reported in net investment income on our Consolidated Statements of Comprehensive Income (Loss).
(2)Reported in interest and debt expense on our Consolidated Statements of Comprehensive Income (Loss).
(3)Reported in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).
(4)Reported in commissions and other expenses on our Consolidated Statements of Comprehensive Income (Loss).
Gains (losses) recognized as a component of OCI (in millions) on derivative instruments designated and qualifying as cash flow hedges were as follows:
For the Year
Ended
December 31,
Offset to net investment income
$
Offset to realized gain (loss)
Offset to interest and debt expense
(7
)
As of December 31, 2020, $13 million of the deferred net gains (losses) on derivative instruments in AOCI were expected to be reclassified to earnings during the next 12 months. This reclassification would be due primarily to interest rate variances related to our interest rate swap agreements.
For the years ended December 31, 2020 and 2019, there were no material reclassifications to earnings due to hedged firm commitments no longer deemed probable or due to hedged forecasted transactions that had not occurred by the end of the originally specified time period.
Information related to our credit default swaps for which we are the seller (dollars in millions) was as follows:
As of December 31, 2020
Credit
Reason
Nature
Rating of
Number
Maximum
for
of
Underlying
of
Fair
Potential
Credit Contract Type
Maturity
Entering
Recourse
Obligation (1)
Instruments
Value (2)
Payout
Basket credit default swaps
12/20/2025
(3)
(4)
BBB+
$
$
As of December 31, 2019
Credit
Reason
Nature
Rating of
Number
Maximum
for
of
Underlying
of
Fair
Potential
Credit Contract Type
Maturity
Entering
Recourse
Obligation (1)
Instruments
Value (2)
Payout
Basket credit default swaps
12/20/2024
(3)
(4)
BBB+
$
$
(1)Represents average credit ratings based on the midpoint of the applicable ratings among Moody’s, S&P and Fitch Ratings, as scaled to the corresponding S&P ratings.
(2)Broker quotes are used to determine the market value of our credit default swaps.
(3)Credit default swaps were entered into in order to hedge the liability exposure on certain variable annuity products.
(4)Sellers do not have the right to demand indemnification or compensation from third parties in case of a loss (payment) on the contract.
Details underlying the associated collateral of our credit default swaps for which we are the seller if credit risk-related contingent features were triggered (in millions) were as follows:
As of
As of
December 31,
December 31,
Maximum potential payout
$
$
Less: Counterparty thresholds
-
-
Maximum collateral potentially required to post
$
$
Certain of our credit default swap agreements contain contractual provisions that allow for the netting of collateral with our counterparties related to all of our collateralized financing transactions that we have outstanding. If these netting agreements were not in place, our counterparties would have been required to post $1 million of collateral as of December 31, 2020.
Credit Risk
We are exposed to credit losses in the event of non-performance by our counterparties on various derivative contracts and reflect assumptions regarding the credit or NPR. The NPR is based upon assumptions for each counterparty’s credit spread over the estimated weighted average life of the counterparty exposure, less collateral held. As of December 31, 2020, the NPR adjustment was zero. The credit risk associated with such agreements is minimized by entering into agreements with financial institutions with long-standing, superior performance records. Additionally, we maintain a policy of requiring derivative contracts to be governed by an International Swaps and Derivatives Association (“ISDA”) Master Agreement. We are required to maintain minimum ratings as a matter of routine practice in negotiating ISDA agreements. Under some ISDA agreements, our insurance subsidiaries have agreed to maintain certain financial strength or claims-paying ratings. A downgrade below these levels could result in termination of derivative contracts, at which time any amounts payable by us would be dependent on the market value of the underlying derivative contracts. In certain transactions, we and the counterparty have entered into a credit support annex requiring either party to post collateral when net exposures exceed pre-determined thresholds. These thresholds vary by counterparty and credit rating. The amount of such exposure is essentially the net replacement cost or market value less collateral held for such agreements with each counterparty if the net market value is in our favor. We did not have any exposure as of December 31, 2020 or 2019.
The amounts recognized (in millions) by S&P credit rating of counterparty, for which we had the right to reclaim cash collateral or were obligated to return cash collateral, were as follows:
As of December 31, 2020
As of December 31, 2019
Collateral
Collateral
Collateral
Collateral
Posted by
Posted by
Posted by
Posted by
S&P
Counter-
LNC
Counter-
LNC
Credit
Party
(Held by
Party
(Held by
Rating of
(Held by
Counter-
(Held by
Counter-
Counterparty
LNC)
Party)
LNC)
Party)
AA-
$
1,233
$
(371
)
$
$
(167
)
A+
1,119
(445
)
(339
)
A
-
-
A-
(245
)
(51
)
$
2,976
$
(1,061
)
$
1,387
$
(557
)
Balance Sheet Offsetting
Information related to the effects of offsetting on our Consolidated Balance Sheets (in millions) was as follows:
As of December 31, 2020
Embedded
Derivative
Derivative
Instruments
Instruments
Total
Financial Assets
Gross amount of recognized assets
$
4,978
$
1,082
$
6,060
Gross amounts offset
(1,869
)
-
(1,869
)
Net amount of assets
3,109
1,082
4,191
Gross amounts not offset:
Cash collateral
(2,976
)
-
(2,976
)
Non-cash collateral
(56
)
-
(56
)
Net amount
$
$
1,082
$
1,159
Financial Liabilities
Gross amount of recognized liabilities
$
1,456
$
3,986
$
5,442
Gross amounts offset
(330
)
-
(330
)
Net amount of liabilities
1,126
3,986
5,112
Gross amounts not offset:
Cash collateral
(1,061
)
-
(1,061
)
Non-cash collateral
-
-
-
Net amount
$
$
3,986
$
4,051
As of December 31, 2019
Embedded
Derivative
Derivative
Instruments
Instruments
Total
Financial Assets
Gross amount of recognized assets
$
2,619
$
1,437
$
4,056
Gross amounts offset
(708
)
-
(708
)
Net amount of assets
1,911
1,437
3,348
Gross amounts not offset:
Cash collateral
(1,387
)
-
(1,387
)
Non-cash collateral
(242
)
-
(242
)
Net amount
$
$
1,437
$
1,719
Financial Liabilities
Gross amount of recognized liabilities
$
1,005
$
2,921
$
3,926
Gross amounts offset
(138
)
-
(138
)
Net amount of liabilities
2,921
3,788
Gross amounts not offset:
Cash collateral
(557
)
-
(557
)
Non-cash collateral
-
-
-
Net amount
$
$
2,921
$
3,231
7. Federal Income Taxes
The federal income tax expense (benefit) on continuing operations (in millions) was as follows:
For the Years Ended December 31,
Current
$
(61
)
$
$
Deferred
(15
)
(148
)
Federal income tax expense (benefit)
$
(76
)
$
$
A reconciliation of the effective tax rate differences (in millions) was as follows:
For the Years Ended December 31,
Income (loss) before taxes
$
$
$
1,885
Federal statutory rate
21%
21%
21%
Federal income tax expense (benefit) at federal statutory rate
Effect of:
Tax-preferred investment income (1)
(98
)
(99
)
(87
)
Tax credits
(39
)
(40
)
(39
)
Excess tax benefits from stock-based compensation
(9
)
(5
)
Tax impact associated with the Tax Cuts and Jobs Act (2)
(37
)
(17
)
(19
)
Other items
(2
)
Federal income tax expense (benefit)
$
(76
)
$
$
Effective tax rate
-18%
4%
13%
(1)Relates primarily to separate account dividends eligible for the dividends-received deduction.
(2)In 2018, we recognized a $27 million tax benefit from the impact of the reduced federal statutory rate under the Tax Cuts and Jobs Act (the “Tax Act”) on our adoption of an Internal Revenue Service pronouncement related to variable annuity contracts. In 2019, we recognized a $17 million tax benefit from the impact of the reduced corporate tax rate under the Tax Act on our election to revalue policyholder tax reserves. In 2020, we recognized a $37 million tax benefit attributable to the carry back of a 2020 net operating loss under the provisions of the Coronavirus Aid, Relief, and Economic Security Act, which provides for a five-year carryback period.
The federal income tax asset (liability) (in millions) was as follows:
As of December 31,
Current
$
$
Deferred
(3,256
)
(2,443
)
Total federal income tax asset (liability)
$
(3,109
)
$
(2,383
)
Significant components of our deferred tax assets and liabilities (in millions) were as follows:
As of December 31,
Deferred Tax Assets
Future contract benefits and other contract holder funds
$
2,377
$
Reinsurance related embedded derivative asset
Compensation and benefit plans
Intangibles
Tax credits
-
Net operating losses
Other
Total deferred tax assets
$
2,971
$
1,158
Deferred Tax Liabilities
DAC
$
$
VOBA
Net unrealized gain on fixed maturity AFS securities
4,001
2,308
Net unrealized gain on trading securities
Investment activity
1,249
Other
Total deferred tax liabilities
$
6,227
$
3,601
Net deferred tax asset (liability)
$
(3,256
)
$
(2,443
)
As of December 31, 2020, we have $1.0 billion of net operating losses to carry forward to future years. The net operating losses arose in tax year 2018, and under the Tax Act changes, have an unlimited carryforward period. As a result, management believes that it is more likely than not that the deferred tax asset associated with the loss carryforwards will be realized. Inclusive of the tax attribute for the net operating losses, although realization is not assured, management believes that it is more likely than not that we will realize the benefits of all of our deferred tax assets, and, accordingly, no valuation allowance has been recorded.
We are subject to examination by U.S. federal, state, local and non-U.S. income authorities. With few exceptions for limited scope review, we are no longer subject to U.S. federal examinations for years before 2017. In the first quarter of 2021 the Internal Revenue Service commenced an examination of our refund claims for 2014 and 2015 that is anticipated to be completed by the end of 2021. We are currently under examination by several state and local taxing jurisdictions; however, we do not expect these examinations will materially impact us.
A reconciliation of the unrecognized tax benefits (in millions) was as follows:
For the Years Ended
December 31,
Balance as of beginning-of-year
$
$
Increases for prior year tax positions
-
Increases for current year tax positions
-
Balance as of end-of-year
$
$
As of December 31, 2020 and 2019, $51 million and $48 million, respectively, of our unrecognized tax benefits presented above, if recognized, would have affected our federal income tax expense (benefit) and our effective tax rate. We anticipate that it is reasonably possible that unrecognized tax benefits will decrease by $10 million by the end of 2021.
We recognize interest and penalties accrued, if any, related to unrecognized tax benefits as a component of tax expense. For the years ended December 31, 2020, 2019 and 2018, we recognized no interest and penalty expense (benefit), and there was no accrued interest and penalty expense related to the unrecognized tax benefits as of December 31, 2020 and 2019.
8. DAC, VOBA, DSI and DFEL
Changes in DAC (in millions) were as follows:
For the Years Ended December 31,
Balance as of beginning-of-year
$
7,352
$
9,448
$
7,887
Cumulative effect from adoption of new accounting
standard
-
-
Business acquired (sold) through reinsurance
(10
)
-
(246
)
Deferrals
1,446
1,902
1,600
Amortization, net of interest:
Amortization, excluding unlocking, net of interest
(796
)
(950
)
(951
)
Unlocking
(231
)
(489
)
(115
)
Adjustment related to realized (gains) losses
(19
)
(47
)
Adjustment related to unrealized (gains) losses
(2,182
)
(2,613
)
1,320
Balance as of end-of-year
$
5,565
$
7,352
$
9,448
Changes in VOBA (in millions) were as follows:
For the Years Ended December 31,
Balance as of beginning-of-year
$
$
$
Business acquired (sold) through reinsurance
-
-
(11
)
Business acquired
-
-
Deferrals
Amortization:
Amortization, excluding unlocking
(105
)
(114
)
(127
)
Unlocking
(205
)
(60
)
Accretion of interest (1)
Adjustment related to realized (gains) losses
-
(1
)
(2
)
Adjustment related to unrealized (gains) losses
(550
)
Balance as of end-of-year
$
$
$
(1)The interest accrual rates utilized to calculate the accretion of interest ranged from 4.2% to 6.9%.
Estimated future amortization of VOBA, net of interest (in millions), as of December 31, 2020, was as follows:
$
Changes in DSI (in millions) were as follows:
For the Years Ended December 31,
Balance as of beginning-of-year
$
$
$
Business acquired (sold) through reinsurance
-
-
(21
)
Deferrals
Amortization, net of interest:
Amortization, excluding unlocking, net of interest
(20
)
(29
)
(28
)
Unlocking
(1
)
(3
)
-
Adjustment related to realized (gains) losses
(1
)
(1
)
Adjustment related to unrealized (gains) losses
(6
)
(10
)
Balance as of end-of-year
$
$
$
Changes in DFEL (in millions) were as follows:
For the Years Ended December 31,
Balance as of beginning-of-year
$
$
2,769
$
1,445
Cumulative effect from adoption of new accounting
standard
-
-
Deferrals
1,003
1,095
Amortization, net of interest:
Amortization, excluding unlocking, net of interest
(538
)
(544
)
(482
)
Unlocking
(275
)
(426
)
(53
)
Adjustment related to realized (gains) losses
-
(20
)
Adjustment related to unrealized (gains) losses
(468
)
(2,244
)
1,004
Balance as of end-of-year
$
$
$
2,769
9. Reinsurance
The following summarizes reinsurance amounts (in millions) recorded on our Consolidated Statements of Comprehensive Income (Loss), excluding amounts attributable to the indemnity reinsurance agreements with Protective and Swiss Re:
For the Years Ended December 31,
Direct insurance premiums and fee income
$
13,304
$
13,498
$
12,041
Reinsurance assumed
Reinsurance ceded
(1,656
)
(1,579
)
(1,543
)
Total insurance premiums and fee income
$
11,743
$
12,010
$
10,587
Direct insurance benefits
$
10,630
$
9,574
$
8,592
Reinsurance recoveries netted against benefits
(1,953
)
(1,694
)
(1,806
)
Total benefits
$
8,677
$
7,880
$
6,786
Our insurance companies cede insurance to other companies. The portion of our life insurance and annuity risks exceeding each of our insurance companies’ retention limit is reinsured with other insurers. We seek reinsurance coverage to limit our exposure to mortality losses and to enhance our capital management. Reinsurance does not discharge us from our primary obligation to contract holders for losses incurred under the policies we issue. We evaluate each reinsurance agreement to determine whether the agreement provides indemnification against loss or liability.
As of December 31, 2020, the policy for our reinsurance program was to retain up to $20 million on a single insured life. As the amount we retain varies by policy, we reinsured 17% of the mortality risk on newly issued life insurance contracts in 2020.
We focus on obtaining reinsurance from a diverse group of reinsurers, and we monitor concentration as well as financial strength ratings of our reinsurers. Our amounts recoverable from reinsurers represent receivables from and reserves ceded to reinsurers. The amounts recoverable from reinsurers were $16.5 billion and $17.1 billion as of December 31, 2020 and 2019, respectively.
Protective represents our largest reinsurance exposure following the sale of the Liberty Life Business as discussed in Note 3, which resulted in amounts recoverable from Protective of $11.3 billion and $11.8 billion as of December 31, 2020 and 2019, respectively. Protective has funded trusts, of which the balance in the trusts changes as a result of ongoing reinsurance activity, to support the business ceded, which totaled $15.2 billion and $14.7 billion as of December 31, 2020 and 2019, respectively.
Our reinsurance operations were acquired by Swiss Re in December 2001 through a series of indemnity reinsurance transactions. As such, Swiss Re reinsured certain liabilities and obligations under the indemnity reinsurance agreements. As we are not relieved of our liability to the ceding companies for this business, the liabilities and obligations associated with the reinsured policies remain on our Consolidated Balance Sheets with a corresponding reinsurance receivable from Swiss Re, which totaled $1.2 billion and $1.3 billion as of December 31, 2020 and 2019, respectively. Swiss Re has funded a trust, with a balance of $1.2 billion as of December 31, 2020, to support this business. In addition to various remedies that we would have in the event of a default by Swiss Re, we continue to hold assets in support of certain of the transferred reserves. These assets consist of those reported as trading securities and certain mortgage loans. Our liabilities for funds withheld and embedded derivatives as of December 31, 2020, included $151 million and $35 million, respectively, related to the business sold to Swiss Re.
Adoption of ASU 2016-13
In 2020, we adopted ASU 2016-13, which resulted in a new recognition and measurement of credit losses on most financial assets. We established a credit loss allowance of $192 million as of January 1, 2020, for reinsurance-related assets for the risk of credit losses inherent in reinsurance transactions. During 2020, there have not been any changes to the credit loss allowance that would be material to our financial statements. See Note 2 for additional information. See Note 1 for a detailed discussion regarding our accounting policy relating to the allowance for credit losses on our reinsurance-related assets.
Modco Agreements
Some portions of our annuity business have been reinsured on a Modco basis with other companies. In a Modco agreement, we as the ceding company retain the reserves, as well as the assets backing those reserves, and the reinsurer shares proportionally in all financial terms of the reinsured policies based on their respective percentage of the risk. Effective October 1, 2018, we entered into one such Modco agreement with Athene to reinsure fixed and fixed indexed annuity products, which resulted in a deposit asset of $5.8 billion and $6.6 billion as of December 31, 2020 and 2019, respectively, within other assets on our Consolidated Balance Sheets. We held assets in support of reserves associated with the transaction in a Modco investment portfolio, which consisted of the following (in millions):
As of
As of
December 31,
December 31,
Fixed maturity AFS securities
$
1,531
$
2,308
Trading securities
3,357
3,534
Equity securities
Mortgage loans on real estate
Derivative investments
Other investments
Cash and invested cash
Accrued investment income
Other assets
-
Total
$
6,144
$
6,897
In addition, the portfolio was supported by $185 million of over-collateralization and a $170 million letter of credit as of December 31, 2020. As described in Note 1, we recorded a deferred gain on business sold through reinsurance related to the transaction with Athene and amortized $29 million, $30 million and $8 million of the gain during 2020, 2019 and 2018, respectively.
See “Realized Gain (Loss)” in Note 16 for information on reinsurance related embedded derivatives.
10. Goodwill and Specifically Identifiable Intangible Assets
The changes in the carrying amount of goodwill (in millions) by reportable segment were as follows:
For the Year Ended December 31, 2020
Gross
Accumulated
Goodwill
Impairment
Net
as of
as of
Acquisition
Goodwill
Beginning-
Beginning-
Accounting
as of End-
of-Year
of-Year
Adjustments
Impairment
of-Year
Annuities
$
1,040
$
(600
)
$
-
$
-
$
Retirement Plan Services
-
-
-
Life Insurance
2,188
(1,554
)
-
-
Group Protection
-
-
-
Total goodwill
$
3,932
$
(2,154
)
$
-
$
-
$
1,778
For the Year Ended December 31, 2019
Gross
Accumulated
Goodwill
Impairment
Net
as of
as of
Acquisition
Goodwill
Beginning-
Beginning-
Accounting
as of End-
of-Year
of-Year
Adjustments
Impairment
of-Year
Annuities
$
1,040
$
(600
)
$
-
$
-
$
Retirement Plan Services
-
-
-
Life Insurance
2,188
(1,554
)
-
-
Group Protection
-
(4
)
-
Total goodwill
$
3,936
$
(2,154
)
$
(4
)
$
-
$
1,778
The fair values of our reporting units (Level 3 fair value estimates) 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 of October 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.
The gross carrying amounts and accumulated amortization (in millions) for each major specifically identifiable intangible asset class by reportable segment were as follows:
As of December 31, 2020
As of December 31, 2019
Gross
Gross
Carrying
Accumulated
Carrying
Accumulated
Amount
Amortization
Amount
Amortization
Retirement Plan Services:
Mutual fund contract rights (1)
$
$
-
$
$
-
Life Insurance:
Sales force
Group Protection:
VOCRA
VODA
Insurance licenses (1)
-
-
Total
$
$
$
$
(1)No amortization recorded as the intangible asset has indefinite life.
Future estimated amortization of specifically identifiable intangible assets (in millions) as of December 31, 2020, was as follows:
$
Thereafter
11. Guaranteed Benefit Features
Information on the GDB features outstanding (dollars in millions) was as follows:
As of December 31,
2020 (1)
2019 (1)
Return of Net Deposits
Total account value
$
109,856
$
101,601
Net amount at risk (2)
Average attained age of contract holders
66 years
65 years
Minimum Return
Total account value
$
$
Net amount at risk (2)
Average attained age of contract holders
78 years
77 years
Guaranteed minimum return
5%
5%
Anniversary Contract Value
Total account value
$
27,650
$
25,763
Net amount at risk (2)
Average attained age of contract holders
72 years
71 years
(1)Our variable contracts with guarantees may offer more than one type of guarantee in each contract; therefore, the amounts listed are not mutually exclusive.
(2)Represents the amount of death benefit in excess of the account balance that is subject to market fluctuations.
The determination of GDB liabilities is based on models that involve a range of scenarios and assumptions, including those regarding expected market rates of return and volatility, contract surrender rates and mortality experience. The following summarizes the balances of and changes in the liabilities for GDBs (in millions), which were recorded in future contract benefits on our Consolidated Balance Sheets:
For the Years Ended December 31,
Balance as of beginning-of-year
$
$
$
Changes in reserves
(24
)
Benefits paid
(26
)
(20
)
(16
)
Balance as of end-of-year
$
$
$
Variable Annuity Contracts
Account balances of variable annuity contracts, including those with guarantees, (in millions) were invested in separate account investment options as follows:
As of December 31,
Asset Type
Domestic equity
$
70,362
$
64,093
International equity
20,855
19,852
Fixed income
43,521
41,405
Total
$
134,738
$
125,350
Percent of total variable annuity separate account values
98%
98%
Secondary Guarantee Products
Future contract benefits and other contract holder funds include reserves for our secondary guarantee products sold through our Life Insurance segment. Reserves on UL and VUL products with secondary guarantees represented 38% and 37% of total life insurance in-force reserves as of December 31, 2020 and 2019, respectively. UL and VUL products with secondary guarantees represented 31%, 27% and 36% of total life insurance sales for the years ended December 31, 2020, 2019 and 2018, respectively.
12. Liability for Unpaid Claims
The liability for unpaid claims consists primarily of long-term disability claims and is reported in future contract benefits on our Consolidated Balance Sheets. Changes in the liability for unpaid claims (in millions) were as follows:
For the Years Ended December 31,
Balance as of beginning-of-year
$
5,552
$
5,335
$
2,222
Reinsurance recoverable
Net balance as of beginning-of-year
5,400
5,192
2,165
Business acquired (1)
-
-
2,842
Incurred related to:
Current year
3,517
3,193
2,531
Prior years:
Interest
All other incurred (2)
(209
)
(308
)
(208
)
Total incurred
3,456
3,036
2,443
Paid related to:
Current year
(1,707
)
(1,518
)
(1,197
)
Prior years
(1,366
)
(1,310
)
(1,061
)
Total paid
(3,073
)
(2,828
)
(2,258
)
Net balance as of end-of-year
5,783
5,400
5,192
Reinsurance recoverable
Balance as of end-of-year
$
5,934
$
5,552
$
5,335
(1)Represents acquired group life and disability reserves, net, as of May 1, 2018. See Note 3 for additional information.
(2)All other incurred is primarily impacted by the level of claim resolutions in the period compared to that which is expected by the reserve assumption. A negative number implies a favorable result where claim resolutions were more favorable than assumed. Our claim resolution rate assumption used in determining reserves is our expectation of the resolution rate we will experience over the long-term life of the block of claims. It will vary from actual experience in any one period, both favorably and unfavorably.
The interest rate assumption used for discounting long-term claim reserves is an important part of the reserving process due to the long benefit period for these claims. Interest accrued on prior years’ reserves has been calculated on the opening reserve balance less one-half of the prior years’ incurred claim payments at our average reserve discount rate.
Long-term disability benefits may extend for many years, and claim development schedules do not reflect these longer benefit periods. As a result, we use longer term retrospective runoff studies, experience studies and prospective studies to develop our liability estimates. Long-term disability reserves are discounted using rates ranging from 2.75% to 5%. The discount rates vary by year of claim incurral.
 
13. Short-Term and Long-Term Debt
Details underlying short-term and long-term debt (in millions) were as follows:
As of December 31,
Short-Term Debt
Current maturities of long-term debt
$
-
$
Total short-term debt
$
-
$
Long-Term Debt, Excluding Current Portion
Senior notes:
4.85% notes, due 2021 (1)
$
-
$
4.20% notes, due 2022 (1)
4.00% notes, due 2023 (1)
3.35% notes, due 2025 (1)
3.625% notes, due 2026 (1)
3.80% notes, due 2028 (1)
3.05% notes, due 2030 (1)
3.40% notes, due 2031 (1)
-
6.15% notes, due 2036 (1)
6.30% notes, due 2037 (1)(2)
7.00% notes, due 2040 (1)(2)
4.35% notes, due 2048 (1)
4.375% notes, due 2050 (1)
-
Total senior notes
4,868
4,364
Term loans:
LIBOR + 87.5 bps loan, due 2024
Total term loans
Capital securities:
LIBOR + 236 bps, due 2066 (3)
LIBOR + 204 bps, due 2067 (3)
Total capital securities
1,213
1,213
Unamortized premiums (discounts)
(6
)
(4
)
Unamortized debt issuance costs
(38
)
(34
)
Unamortized adjustments from discontinued hedges
Fair value hedge on interest rate swap agreements
Total long-term debt
$
6,682
$
6,067
(1)We have the option to repurchase the outstanding notes by paying the greater of 100% of the principal amount of the notes to be redeemed or the make-whole amount (as defined in each note agreement), plus in each case any accrued and unpaid interest as of the date of redemption.
(2)Categorized as operating debt for leverage ratio calculations as the proceeds were primarily used as a long-term structured solution to reduce the strain on increasing statutory reserves associated with secondary guarantee UL and term policies.
(3)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.
‎
Details underlying the recognition of a gain (loss) on the early extinguishment of debt (in millions) reported within interest expense on our Consolidated Statements of Comprehensive Income (Loss) were as follows:
For the Years Ended December 31,
Principal balance outstanding prior to payoff (1)
$
$
$
Unamortized debt issuance costs and discounts
(2
)
(1
)
(1
)
Amount paid to retire debt
(809
)
(150
)
(309
)
Gain (loss) on early extinguishment of debt, pre-tax
$
(15
)
$
(42
)
$
(23
)
(1)During the second quarter of 2020, we redeemed our $296 million outstanding principal amount of 4.85% senior notes due 2021 and repaid our $500 million LIBOR + 150 bps term loan due 2022 that was issued in the first quarter of 2020. During 2019, we repurchased $105 million of our 6.15% senior notes due 2036 and $4 million of our 4.85% senior notes due 2021. During 2018, we repurchased $287 million of our 8.75% senior notes due 2019.
Future principal payments due on long-term debt (in millions) as of December 31, 2020, were as follows:
$
-
Thereafter
4,981
Total
$
6,331
For our long-term debt outstanding, unsecured senior debt, which consists of senior notes and term loans, ranks highest in priority, followed by capital securities.
Facility Agreement for Senior Notes Issuance
During August 2020, LNC entered into a 10-year facility agreement (the “facility agreement”) with a Delaware trust in connection with the sale by the trust of $500 million of pre-capitalized trust securities in a private placement pursuant to Rule 144A of the Securities Act of 1933, as amended. The trust invested the proceeds from the sale of the trust securities in a portfolio of principal and interest strips of U.S. Treasury securities. The facility agreement provides LNC the right to issue and sell to the trust, on one or more occasions, up to an aggregate principal amount outstanding at any one time of $500 million of LNC’s 2.330% senior notes due August 15, 2030 (“2.330% senior notes”) in exchange for a corresponding amount of U.S. Treasury securities held by the trust. The 2.330% senior notes will not be issued unless and until the issuance right is exercised. In return, LNC pays a semi-annual facility fee to the trust at a rate of 1.691% per year (applied to the unexercised portion of the maximum amount of senior notes that LNC could issue and sell to the trust), and LNC reimburses the trust for its expenses.
The issuance right will be exercised automatically in full upon our failure to make certain payments to the trust, such as paying the facility fee or reimbursing the trust for its expenses, 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.
Prior to any involuntary exercise of the issuance right, LNC has the right to repurchase any or all of the 2.330% senior notes then held by the trust in exchange for U.S. Treasury securities. LNC may redeem any outstanding 2.330% senior notes, in whole or in part, prior to their maturity. Prior to May 15, 2030, the redemption price will equal the greater of par or a make-whole redemption price. After May 15, 2030, any outstanding 2.330% senior notes may be redeemed at par.
Credit Facilities
Credit facilities, which allow for borrowing or issuances of letters of credit (“LOCs”), (in millions) were as follows:
As of December 31, 2020
Expiration
Maximum
LOCs
Date
Available
Issued
Credit Facilities
Five-year revolving credit facility
July 31, 2024
$
2,250
$
LOC facility (1)
August 26, 2031
LOC facility (1)
October 1, 2031
Total
$
4,194
$
2,116
(1)Our wholly-owned subsidiaries entered into irrevocable LOC facility agreements with third-party lenders supporting inter-company reinsurance agreements.
On July 31, 2019, we refinanced our existing credit facility with a syndicate of banks. This facility (the “credit facility”) allows for the issuance of LOCs and borrowing of up to $2.25 billion. The credit facility is unsecured and has a commitment termination date of July 31, 2024. The LOCs under the credit facility are used primarily to satisfy reserve credit requirements of (i) our domestic insurance companies for which reserve credit is provided by our affiliated reinsurance companies and (ii) certain ceding companies of our legacy reinsurance business.
The credit agreement governing the credit facility contains or includes:
Customary terms and conditions, including covenants restricting our ability to incur liens, merge or consolidate with another entity where we are not the surviving entity and dispose of all or substantially all of our assets;
Financial covenants including maintenance of a minimum consolidated net worth (as defined in the credit agreement) equal to the sum of $10.6 billion plus 50% of the aggregate net proceeds of equity issuances received by us as set forth in the credit agreement; and a debt-to-capital ratio as defined in accordance with the credit facility not to exceed 0.35 to 1.00;
A cap on secured non-operating indebtedness and non-operating indebtedness of our subsidiaries equal to 7.5% of total capitalization, as defined in accordance with the credit agreement; and
Customary events of default, subject to certain materiality thresholds and grace periods for certain of those events of default.
Upon an event of default, the credit agreement provides that, among other things, the commitments may be terminated and the loans then outstanding may be declared due and payable. As of December 31, 2020, we were in compliance with all such covenants.
Our LOC facility agreements each contain customary terms and conditions, including early termination fees, covenants restricting the ability of the subsidiaries to incur liens, merge or consolidate with another entity and dispose of all or substantially all of their assets. Upon an event of early termination, the agreements require the immediate payment of all or a portion of the present value of the future LOC fees that would have otherwise been paid. Further, the agreements contain customary events of default, subject to certain materiality thresholds and grace periods for certain of those events of default. The events of default include payment defaults, covenant defaults, material inaccuracies in representations and warranties, bankruptcy and liquidation proceedings and other customary defaults. Upon an event of default, the agreements provide that, among other things, obligations to issue, amend or increase the amount of any LOC shall be terminated and any obligations shall become immediately due and payable. As of December 31, 2020, we were in compliance with all such covenants.
Shelf Registration
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.
Certain Debt Covenants on Capital Securities
Our $1.2 billion in principal amount of capital securities outstanding contain certain covenants that require us to make interest payments in accordance with an alternative coupon satisfaction mechanism (“ACSM”) if we determine that one of the following trigger events exists as of the 30th day prior to an interest payment date (“determination date”):
LNL’s risk-based capital (“RBC”) ratio is less than 175% (based on the most recent annual financial statement filed with the State of Indiana); or
(i) The sum of our consolidated net income for the four trailing fiscal quarters ending on the quarter that is two quarters prior to the most recently completed quarter prior to the determination date is zero or negative; and (ii) our consolidated stockholders’ equity (excluding AOCI and any increase in stockholders’ equity resulting from the issuance of preferred stock during a quarter), or “adjusted stockholders’ equity,” as of (x) the most recently completed quarter and (y) the end of the quarter that is two quarters before the most recently completed quarter, has declined by 10% or more as compared to the quarter that is 10 fiscal quarters prior to the last completed quarter, or the “benchmark quarter.”
The ACSM would generally require us to use commercially reasonable efforts to satisfy our obligation 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 no longer existed. Our failure to pay interest pursuant to the ACSM will not result in an event of default with respect to the capital securities nor will a nonpayment of interest unless it lasts for 10 consecutive years, although such breaches may result in monetary damages to the holders of the capital securities. As of December 31, 2020, we were in compliance with all such covenants.
14. Contingencies and Commitments
Contingencies
Regulatory and Litigation Matters
Regulatory bodies, such as state insurance departments, the SEC, Financial Industry Regulatory Authority and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws, laws governing the activities of broker-dealers, registered investment advisers and unclaimed property laws.
LNC is involved in various pending or threatened legal or regulatory proceedings, including purported class actions, arising from the conduct of business both in the ordinary course and otherwise. In some of the matters, very large and/or indeterminate amounts, including punitive and treble damages, are sought. Modern pleading practice in the U.S. permits considerable variation in the assertion of monetary damages or other relief. Jurisdictions may permit claimants not to specify the monetary damages sought or may permit claimants to state only that the amount sought is sufficient to invoke the jurisdiction of the trial court. In addition, jurisdictions may permit plaintiffs to allege monetary damages in amounts well exceeding verdicts obtained in the jurisdiction for similar matters. This variability in pleadings, together with the actual experiences of LNC in litigating or resolving through settlement numerous claims over an extended period of time, demonstrates to management that the monetary relief which may be specified in a lawsuit or claim bears little relevance to its merits or disposition value.
Due to the unpredictable nature of litigation, the outcome of a litigation matter and the amount or range of potential loss at particular points in time is normally difficult to ascertain. Uncertainties can include how fact finders will evaluate documentary evidence and the credibility and effectiveness of witness testimony, and how trial and appellate courts will apply the law in the context of the pleadings or evidence presented, whether by motion practice, or at trial or on appeal. Disposition valuations are also subject to the uncertainty of how opposing parties and their counsel will themselves view the relevant evidence and applicable law.
We establish liabilities for litigation and regulatory loss contingencies when information related to the loss contingencies shows both that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. It is possible that some matters could require us to pay damages or make other expenditures or establish accruals in amounts that could not be estimated as of December 31, 2020. While the potential future charges could be material in the particular quarterly or annual periods in which they are recorded, based on information currently known by management, management does not believe any such charges are likely to have a material adverse effect on LNC’s financial condition.
For some matters, the Company is able to estimate a reasonably possible range of loss. For such matters in which a loss is probable, an accrual has been made. For such matters where a loss is believed to be reasonably possible, but not probable, no accrual has been made. Accordingly, the estimate contained in this paragraph reflects two types of matters. For some matters included within this estimate, an accrual has been made, but there is a reasonable possibility that an exposure exists in excess of the amount accrued. In these cases, the estimate reflects the reasonably possible range of loss in excess of the accrued amount. For other matters included within this estimation, no accrual has been made because a loss, while potentially estimable, is believed to be reasonably possible but not probable. In these cases, the estimate reflects the reasonably possible loss or range of loss. As of December 31, 2020, we estimate the aggregate range of reasonably possible losses, including amounts in excess of amounts accrued for these matters as of such date, to be up to approximately $90 million. Any estimate is not an indication of expected loss, if any, or of the Company’s maximum possible loss exposure on such matters.
For other matters, we are not currently able to estimate the reasonably possible loss or range of loss. We are often unable to estimate the possible loss or range of loss until developments in such matters have provided sufficient information to support an assessment of the range of possible loss, such as quantification of a damage demand from plaintiffs, discovery from other parties and investigation of factual allegations, rulings by the court on motions or appeals, analysis by experts and the progress of settlement negotiations. On a quarterly and annual basis, we review relevant information with respect to litigation contingencies and update our accruals, disclosures and estimates of reasonably possible losses or ranges of loss based on such reviews.
Certain reinsurers have sought rate increases on certain yearly renewable term agreements. We are disputing the requested rate increases under these agreements. We will initiate arbitration proceedings, as necessary, under these agreements in order to protect our contractual rights. Additionally, reinsurers have initiated, and may in the future initiate, arbitration proceedings against us. We believe it is unlikely the outcome of these disputes will have a material adverse effect on our financial condition. For more information about reinsurance, see Note 9.
Cost of Insurance Litigation
Glover v. Connecticut General Life Insurance Company and The Lincoln National Life Insurance Company, filed in the U.S. District Court for the District of Connecticut, No. 3:16-cv-00827, is a putative class action that was served on LNL on June 8, 2016. Plaintiff is the owner of a universal life insurance policy who alleges that LNL charged more for non-guaranteed cost of insurance than permitted by the policy. Plaintiff seeks to represent all universal life and variable universal life policyholders who owned policies containing non-guaranteed cost of insurance provisions that are similar to those of Plaintiff’s policy and seeks damages on behalf of all such policyholders. On January 11, 2019, the court dismissed Plaintiff’s complaint in its entirety. In response, Plaintiff filed a motion for leave to amend the complaint, which we have opposed.
Hanks v. Lincoln Life & Annuity Company of New York (“LLANY”) and Voya Retirement Insurance and Annuity Company (“Voya”), filed in the U.S. District Court for the Southern District of New York, No. 1:16-cv-6399, is a putative class action that was served on LLANY on August 12, 2016. Plaintiff owns a universal life policy originally issued by Aetna (now Voya) and alleges that (i) Voya breached the terms of the policy when it increased non-guaranteed cost of insurance rates on Plaintiff’s policy; and (ii) LLANY, as reinsurer and administrator of Plaintiff’s policy, engaged in wrongful conduct related to the cost of insurance increase and was unjustly enriched as a result. Plaintiff seeks to represent all owners of Aetna life insurance policies that were subject to non-guaranteed cost of insurance rate increases in 2016 and seeks damages on their behalf. On March 13, 2019, the court issued an order granting plaintiff’s motion for class certification for the breach of contract claim and denying such motion with respect to the unjust enrichment claim against LLANY, and, on September 12, 2019, the court issued an order approving the parties’ joint stipulation of dismissal with respect to the unjust enrichment claim and dismissed LLANY as a defendant in the case. In light of LLANY’s role as reinsurer and administrator under the 1998 coinsurance agreement with Aetna (now Voya), and of the parties’ rights and obligations thereunder, LLANY continues to be actively engaged in the defense of this case. On September 30, 2020, the court denied plaintiff’s motion for summary judgment and granted in part Voya’s motion for summary judgment. The court has not yet set a trial date, and we continue to vigorously defend this action.
EFG Bank AG, Cayman Branch, et al. v. The Lincoln National Life Insurance Company, pending in the U.S. District Court for the Eastern District of Pennsylvania, No. 2:17-cv-02592, is a civil action filed on February 1, 2017. Plaintiffs own Legend Series universal life insurance policies originally issued by Jefferson-Pilot (now LNL). Plaintiffs allege that LNL breached the terms of policyholders’ contracts when it increased non-guaranteed cost of insurance rates beginning in 2016. We are vigorously defending this matter.
In re: Lincoln National COI Litigation, pending in the U.S. District Court for the Eastern District of Pennsylvania, Master File No. 2:16-cv-06605-GJP, is a consolidated litigation matter related to multiple putative class action filings that were consolidated by an order dated March 20, 2017. In addition to consolidating a number of existing matters, the order also covers any future cases filed in the same district related to the same subject matter. Plaintiffs own universal life insurance policies originally issued by Jefferson-Pilot (now LNL). Plaintiffs allege that LNL and LNC breached the terms of policyholders’ contracts by increasing non-guaranteed cost of insurance rates beginning in 2016. Plaintiffs seek to represent classes of policyowners and seek damages on their behalf. We are vigorously defending this matter.
In re: Lincoln National 2017 COI Rate Litigation, Master File No. 2:17-cv-04150 is a consolidated litigation matter related to multiple putative class action filings that were consolidated by an order of the court in March 2018. Plaintiffs own universal life insurance policies originally issued by former Jefferson-Pilot (now LNL). Plaintiffs allege that LNL and LNC breached the terms of policyholders’ contracts by increasing non-guaranteed cost of insurance rates beginning in 2017. Plaintiffs seek to represent classes of policyholders and seek damages on their behalf. We are vigorously defending this matter.
Iwanski v. First Penn-Pacific Life Insurance Company (“FPP”), No. 2:18-cv-01573 filed in the U.S. District Court for the District Court, Eastern District of Pennsylvania is a putative class action that was filed on April 13, 2018. Plaintiff alleges that defendant FPP breached the terms of his life insurance policy by deducting non-guaranteed cost of insurance charges in excess of what is permitted by the policies. Plaintiff seeks to represent all owners of universal life insurance policies issued by FPP containing non-guaranteed cost of insurance provisions that are similar to those of Plaintiff’s policy and seeks damages on their behalf. Breach of contract is the only cause of action asserted. We are vigorously defending this matter.
TVPX ARS INC., as Securities Intermediary for Consolidated Wealth Management, LTD. v. The Lincoln National Life Insurance Company, filed in the U.S. District Court for the Eastern District of Pennsylvania, No. 2:18-cv-02989, is a putative class action that was filed on July 17, 2018. Plaintiff alleges that LNL charged more for non-guaranteed cost of insurance than permitted by the policy. Plaintiff seeks to represent all universal life and variable universal life policyholders who own policies issued by LNL or its predecessors containing non-guaranteed cost of insurance provisions that are similar to those of Plaintiff’s policy and seeks damages on behalf of all such policyholders. We are vigorously defending this matter.
LSH Co. and Wells Fargo Bank, National Association, as securities intermediary for LSH Co. v. Lincoln National Corporation and The Lincoln National Life Insurance Company, pending in the U.S. District Court for the Eastern District of Pennsylvania, No. 2:18-cv-05529, is a civil action filed on December 21, 2018. Plaintiffs own universal life insurance policies originally issued by Jefferson-Pilot (now LNL). Plaintiffs allege that LNL breached the terms of policyholders’ contracts when it increased non-guaranteed cost of insurance rates in 2016 and 2017. We are vigorously defending this matter.
Vida Longevity Fund, LP v. Lincoln Life & Annuity Company of New York, pending in the U.S. District Court for the Southern District of New York, No. 1:19-cv-06004, is a putative class action that was filed on June 27, 2019. Plaintiff alleges that LLANY charged more for non-guaranteed cost of insurance than was permitted by the policies. Plaintiff seeks to represent all current and former owners of universal life (including variable universal life) policies who own or owned policies issued by LLANY and its predecessors in interest that were in force at any time on or after June 27, 2013, and which contain non-guaranteed cost of insurance provisions that are similar to those of Plaintiff’s policies. Plaintiff also seeks to represent a sub-class of such policyholders who own or owned “life insurance policies issued in the State of New York.” Plaintiff seeks damages on behalf of the policyholder class and sub-class. We are vigorously defending this matter.
Other Litigation
Andrew Nitkewicz v. Lincoln Life & Annuity Company of New York, pending in the U.S. District Court for the Southern District of New York, No. 1:20-cv-06805, is a putative class action that was filed on August 24, 2020. Plaintiff Andrew Nitkewicz, as trustee of the Joan C. Lupe Trust, seeks to represent all current and former owners of universal life (including variable universal life) policies who own or owned policies issued by LLANY and its predecessors in interest that were in force at any time on or after June 27, 2013, and for which planned annual, semi-annual, or quarterly premiums were paid for any period beyond the end of the policy month of the insured’s death. Plaintiff alleges LLANY failed to refund unearned premium in violation of New York Insurance Law Section 3203(a)(2) in connection with the payment of death benefit claims for certain insurance policies. Plaintiff seeks compensatory damages and pre-judgment interest on behalf of the various classes and sub-class. We are vigorously defending this matter.
Commitments
Leases
As of December 31, 2020 and 2019, we recognized operating lease ROU assets of $182 million and $233 million, respectively, and associated lease liabilities of $194 million and $240 million, respectively. The weighted-average discount rate and remaining lease term were 3.2% and six years, respectively, as of December 31, 2020 and 2019. Operating lease expense for the years ended December 31, 2020, 2019 and 2018, was $50 million, $54 million and $50 million, respectively, and reported in commissions and other expenses on our Consolidated Statements of Comprehensive Income (Loss).
As of December 31, 2020 and 2019, the net book value of assets recorded as finance leases was $75 million and $128 million, respectively, and the associated accumulated amortization was $398 million and $345 million, respectively. These assets will continue to be amortized on a straight-line basis over the assets’ remaining lives. The weighted-average discount rate and remaining lease term were 2.2% and two years, respectively, as of December 31, 2020 and 2019.
Finance lease expense (in millions) was as follows:
For the Years Ended
December 31,
Amortization of ROU assets (1)
$
$
Interest on lease liabilities (2)
Total
$
$
(1)Amortization of ROU assets is reported in commissions and other expenses on our Consolidated Statements of Comprehensive Income (Loss).
(2)Interest on lease liabilities is reported in interest and debt expense on our Consolidated Statements of Comprehensive Income (Loss).
The table below presents cash flow information (in millions) related to leases:
For the Years Ended
December 31,
Supplemental Cash Flow Information
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
$
$
Financing cash flows from finance leases
Supplemental Non-cash Information
ROU assets obtained in exchange for new lease obligations:
Operating leases
$
$
Our future minimum lease payments (in millions) under non-cancellable leases as of December 31, 2020, were as follows:
Operating
Finance
Leases
Leases
$
$
Thereafter
Total future minimum lease payments
Less: Amount representing interest
Present value of minimum lease payments
$
$
As of December 31, 2020, we had no leases that had not yet commenced.
Vulnerability from Concentrations
As of December 31, 2020, we did not have a concentration of: business transactions with a particular customer or lender; sources of supply of labor or services used in the business; or a market or geographic area in which business is conducted that makes us vulnerable to an event that is at least reasonably possible to occur in the near term and which could cause a severe impact to our financial condition. For information on our investment and reinsurance concentrations, see Notes 5 and 9, respectively.
Other Contingency Matters
State guaranty funds assess insurance companies to cover losses to contract holders of insolvent or rehabilitated companies. Mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. We have accrued for expected assessments and the related reductions in future state premium taxes, which net to assessments (recoveries) of $(9) million and $(12) million as of December 31, 2020 and 2019, respectively.
15. Shares and Stockholders’ Equity
Common Shares
The changes in our common stock (number of shares) were as follows:
For the Years Ended December 31,
Common Stock
Balance as of beginning-of-year
196,668,532
205,862,760
218,090,114
Stock issued for exercise of warrants
-
258,633
212,670
Stock compensation/issued for benefit plans
547,209
942,318
800,325
Retirement/cancellation of shares
(4,886,050
)
(10,395,179
)
(13,240,349
)
Balance as of end-of-year
192,329,691
196,668,532
205,862,760
Common Stock as of End-of-Year
Basic basis
192,329,691
196,668,532
205,862,760
Diluted basis
193,672,296
199,196,043
209,034,686
Our common stock is without par value.
Average Shares
A reconciliation of the denominator (number of shares) in the calculations of basic and diluted earnings (loss) per common share was as follows:
For the Years Ended December 31,
Weighted-average shares, as used in basic calculation
193,610,225
200,608,737
215,936,448
Shares to cover exercise of outstanding warrants
-
58,765
568,602
Shares to cover non-vested stock
687,240
973,901
1,534,142
Average stock options outstanding during the year
746,742
1,507,049
1,739,029
Assumed acquisition of shares with assumed proceeds
from exercising outstanding warrants
-
(9,594
)
(81,260
)
Assumed acquisition of shares with assumed
proceeds and benefits from exercising stock
options (at average market price for the year)
(576,582
)
(1,033,507
)
(1,074,406
)
Shares repurchasable from measured but
unrecognized stock option expense
(2,445
)
(217
)
(14,600
)
Average deferred compensation shares
-
-
944,151
Weighted-average shares, as used in diluted calculation
194,465,180
202,105,134
219,552,106
In the event the average market price of LNC common stock exceeds the issue price of stock options and the options have a dilutive effect to our EPS, such options will be shown in the table above.
We have participants in our deferred compensation plans who selected LNC stock as the measure for the investment return attributable to all or a portion of their deferral amounts. For the year ended December 31, 2018, the effect of settling this obligation in LNC stock (“equity classification”) was more dilutive than the scenario of settling in cash (“liability classification”). Therefore, for our EPS calculation for this period, we added these shares to the denominator and adjusted the numerator to present net income as if the shares had been accounted for under equity classification by removing the mark-to-market adjustment included in net income attributable to these deferred units of LNC stock. The amount of this adjustment was $18 million for the year ended December 31, 2018.
The outstanding warrants issued in 2009, each representing the right to purchase one share of our common stock, expired on July 10, 2019.
AOCI
The following summarizes the components and changes in AOCI (in millions):
For the Years Ended December 31,
Unrealized Gain (Loss) on AFS Securities
Balance as of beginning-of-year
$
5,983
$
$
3,486
Cumulative effect from adoption of new accounting standards
-
Unrealized holding gains (losses) arising during the year
7,925
9,267
(6,274
)
Change in foreign currency exchange rate adjustment
(107
)
Change in DAC, VOBA, DSI, future contract benefits and other contract holder funds
(3,569
)
(2,462
)
1,748
Income tax benefit (expense)
(970
)
(1,457
)
Less:
Reclassification adjustment for gains (losses) included in net income (loss)
(53
)
(28
)
(42
)
Associated amortization of DAC, VOBA, DSI and DFEL
(12
)
(20
)
Income tax benefit (expense)
Balance as of end-of-year
$
9,611
$
5,983
$
Unrealized OTTI on AFS Securities
Balance as of beginning-of-year
$
$
$
(Increases) attributable to:
Cumulative effect from adoption of new accounting standards
(45
)
-
Gross OTTI recognized in OCI during the year
-
(16
)
-
Change in DAC, VOBA, DSI and DFEL
-
-
Income tax benefit (expense)
-
-
Decreases attributable to:
Changes in fair value, sales, maturities or other settlements of AFS securities
-
(19
)
Change in DAC, VOBA, DSI and DFEL
-
(1
)
(6
)
Income tax benefit (expense)
-
(6
)
Balance as of end-of-year
$
-
$
$
Unrealized Gain (Loss) on Derivative Instruments
Balance as of beginning-of-year
$
(11
)
$
$
(29
)
Cumulative effect from adoption of new accounting standard
-
-
(6
)
Unrealized holding gains (losses) arising during the year
(257
)
(93
)
Change in foreign currency exchange rate adjustment
(174
)
(52
)
Change in DAC, VOBA, DSI and DFEL
(17
)
(4
)
(13
)
Income tax benefit (expense)
(51
)
Less:
Reclassification adjustment for gains (losses) included in net income (loss)
Associated amortization of DAC, VOBA, DSI and DFEL
(1
)
(1
)
(2
)
Income tax benefit (expense)
(10
)
(9
)
(5
)
Balance as of end-of-year
$
(402
)
$
(11
)
$
Foreign Currency Translation Adjustment
Balance as of beginning-of-year
$
(17
)
$
(23
)
$
(14
)
Foreign currency translation adjustment arising during the year
(9
)
Balance as of end-of-year
$
(12
)
$
(17
)
$
(23
)
Funded Status of Employee Benefit Plans
Balance as of beginning-of-year
$
(327
)
$
(299
)
$
(257
)
Cumulative effect from adoption of new accounting standard
-
-
(35
)
Adjustment arising during the year
(20
)
(12
)
Income tax benefit (expense)
(13
)
(8
)
Balance as of end-of-year
$
(266
)
$
(327
)
$
(299
)
‎
The following summarizes the reclassifications out of AOCI (in millions) and the associated line item in the Consolidated Statements of Comprehensive Income (Loss):
For the Years Ended December 31,
Unrealized Gain (Loss) on AFS Securities
Gross reclassification
$
(53
)
$
(28
)
$
(42
)
Total realized gain (loss)
Associated amortization of DAC,
VOBA, DSI and DFEL
(12
)
(20
)
Total realized gain (loss)
Reclassification before income
Income (loss) from continuing
tax benefit (expense)
(21
)
(40
)
(62
)
operations before taxes
Income tax benefit (expense)
Federal income tax expense (benefit)
Reclassification, net of income tax
$
(17
)
$
(32
)
$
(49
)
Net income (loss)
Unrealized OTTI on AFS Securities
Gross reclassification
$
-
$
$
Total realized gain (loss)
Change in DAC, VOBA, DSI and DFEL
-
-
-
Total realized gain (loss)
Reclassification before income
Income (loss) from continuing
tax benefit (expense)
-
operations before taxes
Income tax benefit (expense)
-
(1
)
(2
)
Federal income tax expense (benefit)
Reclassification, net of income tax
$
-
$
$
Net income (loss)
Unrealized Gain (Loss) on Derivative Instruments
Gross reclassifications:
Interest rate contracts
$
$
$
Net investment income
Interest rate contracts
(16
)
(5
)
(7
)
Interest and debt expense
Foreign currency contracts
Net investment income
Foreign currency contracts
-
Total realized gain (loss)
Total gross reclassifications
Associated amortization of DAC,
VOBA, DSI and DFEL
(1
)
(1
)
(2
)
Commissions and other expenses
Reclassifications before income
Income (loss) from continuing
tax benefit (expense)
operations before taxes
Income tax benefit (expense)
(10
)
(9
)
(5
)
Federal income tax expense (benefit)
Reclassifications, net of income tax
$
$
$
Net income (loss)
616. Realized Gain (Loss)
Details underlying realized gain (loss) (in millions) reported on our Consolidated Statements of Comprehensive Income (Loss) were as follows:
For the Years Ended December 31,
Fixed maturity AFS securities:
Gross gains
$
$
$
Gross losses
(84
)
(73
)
(80
)
Credit loss benefit (expense) (1)
(26
)
-
-
Gross OTTI
-
(16
)
(7
)
Realized gain (loss) on equity securities (2)
(6
)
(17
)
Credit loss benefit (expense) on mortgage loans on real estate
(117
)
(1
)
Other gain (loss) on investments
(7
)
(9
)
Associated amortization of DAC, VOBA, DSI and DFEL
and changes in other contract holder funds
(13
)
(22
)
Total realized gain (loss) related to certain financial assets
(164
)
(73
)
(84
)
Realized gain (loss) on the mark-to-market on certain instruments (3)(4)
(127
)
Indexed annuity and IUL contracts net derivatives results: (5)
Gross gain (loss)
(80
)
(51
)
Associated amortization of DAC, VOBA, DSI and DFEL
(25
)
Variable annuity net derivatives results: (6)
Gross gain (loss)
(367
)
(389
)
Associated amortization of DAC, VOBA, DSI and DFEL
(20
)
(35
)
Total realized gain (loss)
$
(513
)
$
(610
)
$
(1)Includes changes in the allowance for credit losses as well as direct write-downs to amortized cost as a result of negative credit events.
(2)Includes market adjustments on equity securities still held of $8 million and $(4) million for the years ended December 31, 2020 and 2019, respectively.
(3)Represents changes in the fair values of certain derivative investments (not including those associated with our variable and indexed annuity and IUL contracts net derivative results), reinsurance related embedded derivatives mortgage loans on real estate accounted for under the fair value option and trading securities. See Notes 1 and 9 for information regarding Modco.
(4)Includes gains and losses from fair value changes on mortgage loans on real estate accounted for under the fair value option of $(24) million for the year ended December 31, 2020.
(5)Represents the net difference between the change in fair value of the index options that we hold and the change in the fair value of the embedded derivative liabilities of our indexed annuity and IUL contracts along with 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.
(6)Includes the net difference in the change in embedded derivative reserves of our GLB riders and the change in the fair value of the derivative instruments we own to hedge the change in embedded derivative reserves on our GLB riders and the benefit ratio unlocking on our GLB and GDB riders, including the cost of purchasing the hedging instruments.
17. Commissions and Other Expenses
Details underlying commissions and other expenses (in millions) were as follows:
For the Years Ended December 31,
Commissions
$
2,183
$
2,549
$
2,256
General and administrative expenses
2,072
2,210
1,953
Expenses associated with reserve financing and LOCs
DAC and VOBA deferrals and interest, net of amortization
(156
)
(540
)
(402
)
Broker-dealer expenses
Specifically identifiable intangible asset amortization
Taxes, licenses and fees
Acquisition and integration costs related to mergers and acquisitions
Total
$
5,064
$
5,287
$
4,763
18. Retirement and Deferred Compensation Plans
Defined Benefit Pension and Other Postretirement Benefit Plans
We maintain U.S. defined benefit pension plans in which certain U.S. employees and agents are participants, and a U.K. plan we retained after the sale of the Lincoln UK business. Our defined benefit pension plans are closed to new entrants and existing participants do not accrue any additional benefits. We comply with the minimum funding requirements in both the U.S. and the U.K. In accordance with such practice, we were not required to make contributions but elected to contribute $2 million for the year ended December 31, 2019. We do not expect to be required to make any contributions to these pension plans in 2021. We sponsor other postretirement benefit plans that provide health care and life insurance to certain retired employees and agents. Total net periodic cost (recovery) for these plans was $(11) million, $8 million and $(2) million during 2020, 2019 and 2018, respectively. In 2021, we expect the plans to make benefit payments of approximately $110 million.
Information (in millions) with respect to these plans was as follows:
As of or For the Years Ended December 31,
Other Postretirement
Pension Plans
Benefit Plans
Fair value of plan assets
$
1,670
$
1,520
$
$
Projected benefit obligation
1,698
1,646
Funded status
$
(28
)
$
(126
)
$
(13
)
$
(9
)
Amounts Recognized on the
Consolidated Balance Sheets
Other assets
$
$
$
-
$
-
Other liabilities
(116
)
(138
)
(13
)
(9
)
Net amount recognized
$
(28
)
$
(126
)
$
(13
)
$
(9
)
Weighted-Average Assumptions
Benefit obligations:
Weighted-average discount rate
2.58%
3.14%
2.96%
3.50%
Net periodic benefit cost:
Weighted-average discount rate
3.12%
4.10%
3.50%
4.50%
Expected return on plan assets
6.10%
6.48%
6.50%
6.50%
The increase in the fair value of plan assets during the reporting period was driven by market performance. The weighted average discount rate was determined based on a corporate yield curve as of December 31, 2020, and projected benefit obligation cash flows. The expected return on plan assets was determined based on historical and expected future returns of the various asset categories, using the plans’ target plan allocation. We reevaluate these assumptions each plan year.
‎
The following summarizes our fair value measurements of our benefit plans’ assets (in millions) on a recurring basis by asset category:
As of December 31,
Fixed maturity securities:
Corporate bonds
$
$
U.S. government bonds
Foreign government bonds
State and municipal bonds
Limited partnerships and common and
preferred stock
Bulk annuity insurance policy
Cash and invested cash
Other investments
Total
$
1,736
$
1,589
See “Fair Value Measurement” in Note 1 for discussion on how we categorize our pension plans’ assets into the three-level fair value hierarchy. See “Financial Instruments Carried at Fair Value” in Note 21 for a summary of our fair value measurement of our pension plans’ assets by the three-level fair value hierarchy.
Defined Contribution Plans
We sponsor tax-qualified defined contribution plans for eligible employees and agents. We administer these plans in accordance with the plan documents and various limitations under section 401(a) of the Internal Revenue Code of 1986. For the years ended December 31, 2020, 2019 and 2018, expenses for these plans were $100 million, $104 million and $93 million, respectively.
Deferred Compensation Plans
We sponsor non-qualified, unfunded, deferred compensation plans for certain current and former employees, agents and non-employee directors. The results of certain notional investment options within some of the plans are hedged by total return swaps. Our expenses increase or decrease in direct proportion to the change in market value of the participants’ investment options. Participants of certain plans are able to select our stock as a notional investment option; however, it is not hedged by the total return swaps and is a primary source of expense volatility related to these plans. For the years ended December 31, 2020, 2019 and 2018, expenses for these plans were $35 million, $28 million and $4 million, respectively. For further discussion of total return swaps related to our deferred compensation plans, see Note 6.
Information (in millions) with respect to these plans was as follows:
As of December 31,
Total liabilities (1)
$
$
Investments dedicated to fund liabilities (2)
(1)Reported in other liabilities on our Consolidated Balance Sheets.
(2)Reported in other assets on our Consolidated Balance Sheets.
19. Stock-Based Incentive Compensation Plans
We sponsor stock-based incentive compensation plans for our employees and directors and for the employees and agents of our subsidiaries that provide for the issuance of stock options, performance shares, and restricted stock units (“RSUs”), among other types of awards. We issue new shares to satisfy option exercises and vested performance shares and RSUs.
Total compensation expense (in millions) by award type for our stock-based incentive compensation plans was as follows:
For the Years Ended December 31,
Stock options
$
$
$
Performance shares
RSUs
Total
$
$
$
Recognized tax benefit
$
$
$
Total unrecognized compensation expense (in millions) and expected weighted-average life (in years) by award type for our stock-based incentive compensation plans was as follows:
For the Years Ended December 31,
Weighted-
Weighted-
Weighted-
Average
Average
Average
Expense
Period
Expense
Period
Expense
Period
Stock options
$
0.7
$
0.9
$
1.1
Performance shares
1.3
1.3
0.9
RSUs
1.2
1.4
1.2
Total unrecognized stock-based
incentive compensation expense
$
$
$
Stock Options
The option price assumptions used for our stock option awards were as follows:
For the Years Ended December 31,
Weighted-average fair value per option granted
$
12.25
$
13.23
$
18.74
Weighted-average assumptions:
Dividend yield
3.0%
2.8%
2.1%
Expected volatility
30.1%
26.9%
27.2%
Risk-free interest rate (1)
0.3-1.4%
2.1-2.5%
2.5-2.9%
Expected life (in years)
5.8
5.8
5.8
(1)Risk-free interest rate expressed as a range and not a weighted average.
The fair value of options is determined using a Black-Scholes options valuation model with the assumptions disclosed in the table above. The dividend yield is based on the expected dividend rate during the expected life of the option. Expected volatility is based on the implied volatility of exchange-traded securities and the historical volatility of the LNC stock price. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life of the options granted represents the weighted-average period of time from the grant date to the date of exercise, expiration or cancellation based upon historical behavior.
Generally, stock options have a maximum contractual term of ten years and vest ratably over a three year period based solely on a service condition. Information with respect to our incentive plans involving stock options with service conditions (aggregate intrinsic value shown in millions) was as follows:
Weighted-
Weighted-
Average
Average
Remaining
Aggregate
Exercise
Contractual
Intrinsic
Shares
Price
Term
Value
Outstanding as of December 31, 2019
2,894,656
$
55.67
Granted
837,329
60.86
Exercised
(146,370
)
32.70
Forfeited or expired
(126,656
)
62.72
Outstanding as of December 31, 2020
3,458,959
$
57.64
6.46
$
Vested or expected to vest as of December 31, 2020 (1)
3,181,759
$
56.93
6.32
$
Exercisable as of December 31, 2020
2,141,140
$
54.26
5.12
$
(1)Includes estimated forfeitures.
The total fair value of stock options with service conditions that vested during the years ended December 31, 2020, 2019 and 2018 was $8 million, $7 million and $6 million, respectively. The total intrinsic value of such options exercised during the years ended December 31, 2020, 2019 and 2018, was $3 million, $3 million and $11 million, respectively.
We award to certain agents stock options that have a maximum contractual term of five years and generally vest ratably over a two year period depending on the satisfaction of the performance conditions. Information with respect to our incentive plans involving stock options with performance conditions (aggregate intrinsic value shown in millions) was as follows:
Weighted-
Weighted-
Average
Average
Remaining
Aggregate
Exercise
Contractual
Intrinsic
Shares
Price
Term
Value
Outstanding as of December 31, 2019
209,104
$
61.17
Granted
56,125
23.49
Exercised
(17,687
)
45.60
Forfeited or expired
(38,892
)
59.29
Outstanding as of December 31, 2020
208,650
$
52.70
2.20
$
Vested or expected to vest as of December 31, 2020 (1)
190,370
$
54.74
2.03
$
Exercisable as of December 31, 2020
172,006
$
57.21
1.82
$
(1)Includes estimated forfeitures.
The total fair value of stock options with performance conditions that vested during the years ended December 31, 2020, 2019 and 2018, was less than $1 million, $1 million and $1 million, respectively. The total intrinsic value of such options exercised during the years ended December 31, 2020, 2019 and 2018, was less than $1 million, $1 million and $2 million, respectively.
Performance Shares
LNC performance shares vest, if at all, on the third anniversary of the grant date; depending on the achievement level of performance measures pre-determined by the Compensation Committee for the three year performance period, payout could range from zero to 200% of the target award.
Information with respect to our performance shares was as follows:
Weighted-
Average
Grant-Date
Shares
Fair Value
Outstanding as of December 31, 2019 (1)
471,071
$
77.29
Granted
233,039
64.62
Vested
(134,282
)
79.61
Forfeited
(27,120
)
70.54
Outstanding as of December 31, 2020 (1)
542,708
$
71.61
(1)Represents target award amounts.
RSUs
LNC RSUs generally cliff vest on the third anniversary of the grant date, based solely on a service condition. Information with respect to our RSUs was as follows:
Weighted-
Average
Grant-Date
Shares
Fair Value
Outstanding as of December 31, 2019
1,551,129
$
70.09
Granted
623,599
60.83
Vested
(413,309
)
70.96
Forfeited
(103,517
)
66.48
Outstanding as of December 31, 2020
1,657,902
$
66.62
20. Statutory Information and Restrictions
The Company’s domestic life insurance subsidiaries prepare financial statements in accordance with statutory accounting principles (“SAP”) prescribed or permitted by the insurance departments of their states of domicile, which may vary materially from GAAP.
Prescribed SAP includes the Accounting Practices and Procedures Manual of the National Association of Insurance Commissioners (“NAIC”) as well as state laws, regulations and administrative rules. Permitted SAP encompasses all accounting practices not so prescribed. The principal differences between statutory financial statements and financial statements prepared in accordance with GAAP are that statutory financial statements do not reflect DAC, some bond portfolios may be carried at amortized cost, assets and liabilities are presented net of reinsurance, contract holder liabilities are generally valued using more conservative assumptions and certain assets are non-admitted.
Our insurance subsidiaries are subject to the applicable laws and regulations of their respective states of domicile. Changes in these laws and regulations could change capital levels or capital requirements for our insurance subsidiaries.
Statutory capital and surplus, net gain (loss) from operations, after-tax, net income (loss) and dividends to the LNC holding company amounts (in millions) below consist of all or a combination of the following entities: LNL, LLANY, LLACB, FPP, Lincoln Reinsurance Company of South Carolina, Lincoln Reinsurance Company of Vermont I, Lincoln Reinsurance Company of Vermont III, Lincoln Reinsurance Company of Vermont IV, Lincoln Reinsurance Company of Vermont V, Lincoln Reinsurance Company of Vermont VI and Lincoln Reinsurance Company of Vermont VII.
As of December 31,
U.S. capital and surplus
$
8,938
$
8,564
For the Years Ended December 31,
U.S. net gain (loss) from operations, after-tax
$
(271
)
$
$
U.S. net income (loss)
1,019
U.S. dividends to LNC holding company
Comparison of 2020 to 2019
Statutory net income (loss) decreased due primarily to increases in benefits and unfavorable reserve strain on certain products, partially offset by favorable equity markets.
Comparison of 2019 to 2018
Statutory net income (loss) decreased due primarily to lower dividends from affiliates, unfavorable reserve strain on certain products, and integration costs incurred as part of the acquisition of Liberty Life. See Note 3 for information regarding the acquisition.
State Prescribed and Permitted Practices
The states of domicile of the Company’s insurance subsidiaries have adopted certain prescribed or permitted accounting practices that differ from those found in NAIC SAP. These prescribed practices are the calculation of reserves on universal life policies based on the Indiana universal life method as prescribed by the state of Indiana for policies issued before January 1, 2006, the use of a more conservative valuation interest rate on certain annuities prescribed by the states of Indiana and New York and use of the continuous Commissioners’ Annuity Reserve Valuation Method in the calculation of reserves as prescribed by the state of New York. The statutory permitted practice allows accounting for certain call option derivative assets at amortized cost and allows determining certain indexed annuity and indexed life statutory reserve calculations with the assumption that the market value of the related liability call option(s) associated with the current index term is zero. At the conclusion of the index term, credited interest is reflected in the reserve as realized, based on actual index performance.
The Vermont reinsurance subsidiaries also have certain accounting practices permitted by the state of Vermont that differ from those found in NAIC SAP. One permitted practice involves accounting for the lesser of the face amount of all amounts outstanding under an LOC and the value of the Valuation of Life Insurance Policies Model Regulation (“XXX”) additional statutory reserves as an admitted asset and a form of surplus as of December 31, 2020 and 2019. Another permitted practice involves the acquisition of an LLC note in exchange for a variable value surplus note that is recognized as an admitted asset and a form of surplus as of December 31, 2020 and 2019. Lastly, the state of Vermont has permitted a practice to account for certain excess of loss reinsurance agreements with unaffiliated reinsurers as an asset and form of surplus as of December 31, 2020 and 2019. These permitted practices are related to structures that continue to be allowed in accordance with the grandfathered structures under the provisions of Actuarial Guideline 48 (“AG48”) or are compliant under AG48 requirements.
The favorable (unfavorable) effects on statutory surplus compared to NAIC statutory surplus from the use of these prescribed and permitted practices (in millions) were as follows:
As of December 31,
State Prescribed Practices
Calculation of reserves using the Indiana universal life method
$
$
Conservative valuation rate on certain annuities
(44
)
(49
)
Calculation of reserves using continuous CARVM
(1
)
-
State Permitted Practice
Derivative instruments and equity indexed reserves
(100
)
-
Vermont Subsidiaries Permitted Practices (1)
Lesser of LOC and XXX additional reserve as surplus
1,897
1,947
LLC notes and variable value surplus notes
1,640
1,648
Excess of loss reinsurance agreements
(1)These permitted practices are related to structures that continue to be allowed in accordance with the grandfathered structures under the provisions of AG48 or are compliant under AG48 requirements.
The NAIC has adopted RBC requirements for life insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks. The requirements provide a means of measuring the minimum amount of statutory surplus appropriate for an insurance company to support its overall business operations based on its size and risk profile. Under RBC requirements, regulatory compliance is determined by the ratio of a company’s total adjusted capital, as defined by the NAIC, to its company action level of RBC (known as the “RBC ratio”), also as defined by the NAIC. The company action level may be triggered if the RBC ratio is between 75% and 100%, which would require the insurer to submit a plan to the regulator detailing corrective action it proposes to undertake. As of December 31, 2020, the consolidated RBC ratio for LNC’s statutory insurance companies was in excess of four times the aforementioned company action level RBC.
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. Under Indiana laws and regulations, our Indiana insurance subsidiaries, including our primary insurance subsidiary, LNL, may pay dividends to LNC without prior approval of the Indiana Insurance Commissioner (the “Commissioner”), only from unassigned surplus and 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, LLANY, a New York-domiciled insurance company, and LLACB, a New Hampshire-domiciled company, are bound by similar restrictions, under the laws of New York and New Hampshire, respectively. Under both New York and New Hampshire law, the applicable statutory limitation on dividends is equal to the lesser of 10% of surplus to contract holders as of the immediately preceding calendar year or net gain from operations for the immediately preceding calendar year, not including realized capital gains. We expect our direct domestic insurance subsidiaries could pay dividends to LNC of approximately $865 million in 2021 without prior approval from the respective Commissioner of Insurance.
All payments of principal and interest on surplus notes between LNC and our insurance subsidiaries must be approved by the respective Commissioner of Insurance.
21. Fair Value of Financial Instruments
The carrying values and estimated fair values of our financial instruments (in millions) were as follows:
As of December 31, 2020
As of December 31, 2019
Carrying
Fair
Carrying
Fair
Value
Value
Value
Value
Assets
Fixed maturity AFS securities
$
123,044
$
123,044
$
105,200
$
105,200
Trading securities
4,501
4,501
4,673
4,673
Equity securities
Mortgage loans on real estate
16,763
18,219
16,339
16,872
Derivative investments (1)
3,109
3,109
1,911
1,911
Other investments
3,974
3,974
2,983
2,983
Cash and invested cash
1,708
1,708
2,563
2,563
Other assets:
GLB direct embedded derivatives
GLB ceded embedded derivatives
Indexed annuity ceded embedded derivatives
Separate account assets
167,965
167,965
153,566
153,566
Liabilities
Future contract benefits - indexed annuity
and IUL contracts embedded derivatives
(3,594
)
(3,594
)
(2,585
)
(2,585
)
Other contract holder funds:
Remaining guaranteed interest and similar contracts
(1,854
)
(1,854
)
(1,900
)
(1,900
)
Account values of certain investment contracts
(40,947
)
(49,745
)
(38,639
)
(46,822
)
Short-term debt
-
-
(300
)
(304
)
Long-term debt
(6,682
)
(7,067
)
(6,067
)
(6,217
)
Reinsurance related embedded derivatives
(392
)
(392
)
(327
)
(327
)
Other liabilities:
Derivative liabilities (1)
(906
)
(906
)
(349
)
(349
)
GLB ceded embedded derivatives
-
-
(9
)
(9
)
Benefit Plans’ Assets (2)
1,736
1,736
1,589
1,589
(1)We have master netting agreements with each of our derivative counterparties, which allow for the netting of our derivative asset and liability positions by counterparty.
(2)Included in the funded statuses of the benefit plans, which is reported in other liabilities on our Consolidated Balance Sheets. Refer to Note 18 for information regarding our benefit plans.
Valuation Methodologies and Associated Inputs for Financial Instruments Not Carried at Fair Value
The following discussion outlines the methodologies and assumptions used to determine the fair value of our financial instruments not carried at fair value on our Consolidated Balance Sheets. Considerable judgment is required to develop these assumptions used to measure fair value. Accordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of our financial instruments.
Mortgage Loans on Real Estate
The fair value of mortgage loans on real estate, excluding mortgage loans accounted for using the fair value option, is established using a discounted cash flow method based on credit rating, maturity and future income. The ratings for mortgages in good standing are based on property type, location, market conditions, occupancy, debt-service coverage, loan-to-value, quality of tenancy, borrower and payment record. The fair value for impaired mortgage loans is based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s market price or the fair value of the collateral if the loan is collateral dependent. The inputs used to measure the fair value of our mortgage loans on real estate are classified as Level 2 within the fair value hierarchy.
Other Investments
The carrying value of our assets classified as other investments approximates fair value. Other investments includes primarily LPs and other privately held investments that are accounted for using the equity method of accounting and the carrying value is based on our proportional share of the net assets of the LPs. Other investments also includes Federal Home Loan Bank (“FHLB”) stock carried at cost and periodically evaluated for impairment based on ultimate recovery of par value. The inputs used to measure the fair value of our LPs, other privately held investments and FHLB stock are classified as Level 3 within the fair value hierarchy. The remaining assets in other investments include cash collateral receivables and securities that are not LPs or other privately held investments. The inputs used to measure the fair value of these assets are classified as Level 1 within the fair value hierarchy.
Separate Account Assets
Separate account assets are primarily carried at fair value. A portion of our separate account assets includes LPs, which are accounted for using the equity method of accounting. The carrying value is based on our proportional share of the net assets of the LPs and approximates fair value. The inputs used to measure the fair value of the separate account asset LPs are classified as Level 3 within the fair value hierarchy.
Other Contract Holder Funds
Other contract holder funds include remaining guaranteed interest and similar contracts and account values of certain investment contracts. The fair value for the remaining guaranteed interest and similar contracts is estimated using discounted cash flow calculations as of the balance sheet date. These calculations are based on interest rates currently offered on similar contracts with maturities that are consistent with those remaining for the contracts being valued. As of December 31, 2020 and 2019, the remaining guaranteed interest and similar contracts carrying value approximated fair value. The fair value of the account values of certain investment contracts is based on their approximate surrender value as of the balance sheet date. The inputs used to measure the fair value of our other contract holder funds are classified as Level 3 within the fair value hierarchy.
Short-Term and Long-Term Debt
The fair value of short-term and long-term debt is based on quoted market prices. The inputs used to measure the fair value of our short-term and long-term debt are classified as Level 2 within the fair value hierarchy.
Fair Value Option
Mortgage loans on real estate, net of allowance for credit losses, as reported on our Consolidated Balance Sheets, includes commercial mortgage loans for which the fair value option was elected. The fair value option allows us to elect fair value as an alternative measurement for mortgage loans not otherwise reported at fair value. We have made these elections for certain mortgage loans associated with Modco agreements to help mitigate the inconsistency in earnings that would otherwise result from the use of embedded derivatives included with these loans. Changes in fair value are reflected in realized gain (loss) on our Consolidated Statement of Comprehensive Income (Loss) for commercial mortgage loans. Changes in fair value due to instrument-specific credit risk are estimated using changes in credit spreads and quality ratings for the period reported. Due to lack of observable inputs as a result of a change to a third-party pricing source, certain mortgage loans electing the fair value option were categorized as Level 3 as of December 31, 2020.
The fair value and aggregate contractual principal for mortgage loans where the fair value option was elected (in millions) was as follows:
As of
December 31,
Commercial mortgage loans: (1)
Fair value
$
Aggregate contractual principal
(1)As of December 31, 2020, no loans for which the fair value option has been elected were in non-accrual status and none were more than 90 days past due and still accruing interest.
Financial Instruments Carried at Fair Value
We did not have any assets or liabilities measured at fair value on a nonrecurring basis as of December 31, 2020 or 2019.
The following summarizes our financial instruments carried at fair value (in millions) on a recurring basis by the fair value hierarchy levels:
As of December 31, 2020
Quoted
Prices
in Active
Markets for
Significant
Significant
Identical
Observable
Unobservable
Total
Assets
Inputs
Inputs
Fair
(Level 1)
(Level 2)
(Level 3)
Value
Assets
Investments:
Fixed maturity AFS securities:
Corporate bonds
$
-
$
97,668
$
5,121
$
102,789
U.S. government bonds
State and municipal bonds
-
6,921
-
6,921
Foreign government bonds
-
RMBS
-
3,074
3,076
CMBS
-
1,505
-
1,505
ABS
-
6,614
7,184
Hybrid and redeemable preferred securities
Mortgage loans on real estate
-
-
Trading securities
3,852
4,501
Equity securities
Derivative investments (1)
-
1,733
3,575
5,308
Cash and invested cash
-
1,708
-
1,708
Other assets:
GLB direct embedded derivatives
-
-
GLB ceded embedded derivatives
-
-
Indexed annuity ceded embedded derivatives
-
-
Separate account assets
167,351
-
167,957
Total assets
$
1,160
$
291,333
$
12,068
$
304,561
Liabilities
Future contract benefits - indexed annuity
and IUL contracts embedded derivatives
$
-
$
-
$
(3,594
)
$
(3,594
)
Reinsurance related embedded derivatives
-
(392
)
-
(392
)
Other liabilities:
Derivative liabilities (1)
-
(1,072
)
(2,033
)
(3,105
)
Total liabilities
$
-
$
(1,464
)
$
(5,627
)
$
(7,091
)
Benefit Plans’ Assets
$
$
1,529
$
-
$
1,736
‎
As of December 31, 2019
Quoted
Prices
in Active
Markets for
Significant
Significant
Identical
Observable
Unobservable
Total
Assets
Inputs
Inputs
Fair
(Level 1)
(Level 2)
(Level 3)
Value
Assets
Investments:
Fixed maturity AFS securities:
Corporate bonds
$
-
$
84,435
$
4,281
$
88,716
U.S. government bonds
State and municipal bonds
-
5,884
-
5,884
Foreign government bonds
-
RMBS
-
3,230
3,241
CMBS
-
1,082
1,083
ABS
-
4,621
4,889
Hybrid and redeemable preferred securities
Trading securities
3,957
4,673
Equity securities
Derivative investments (1)
-
1,212
1,735
2,947
Cash and invested cash
-
2,563
-
2,563
Other assets:
GLB direct embedded derivatives
-
-
GLB ceded embedded derivatives
-
-
Indexed annuity ceded embedded derivatives
-
-
Separate account assets
152,916
-
153,555
Total assets
$
1,215
$
260,661
$
8,602
$
270,478
Liabilities
Future contract benefits - indexed annuity
and IUL contracts embedded derivatives
$
-
$
-
$
(2,585
)
$
(2,585
)
Reinsurance related embedded derivatives
-
(327
)
-
(327
)
Other liabilities:
Derivative liabilities (1)
-
(518
)
(867
)
(1,385
)
GLB ceded embedded derivatives
-
-
(9
)
(9
)
Total liabilities
$
-
$
(845
)
$
(3,461
)
$
(4,306
)
Benefit Plans’ Assets
$
$
1,394
$
-
$
1,589
(1)Derivative investment assets and liabilities are presented within the fair value hierarchy on a gross basis by derivative type and not on a master netting basis by counterparty.
The following summarizes changes to our financial instruments carried at fair value (in millions) and classified within Level 3 of the fair value hierarchy. This summary excludes any effect of amortization of DAC, VOBA, DSI and DFEL. The gains and losses below may include changes in fair value due in part to observable inputs that are a component of the valuation methodology.
For the Year Ended December 31, 2020
Gains
Issuances,
Transfers
Items
(Losses)
Sales,
Into or
Included
in
Maturities,
Out
Beginning
in
OCI
Settlements,
of
Ending
Fair
Net
and
Calls,
Level 3,
Fair
Value
Income
Other (1)
Net
Net (3)
Value
Investments: (5)
Fixed maturity AFS securities:
Corporate bonds
$
4,281
$
(8
)
$
$
$
$
5,121
U.S. government bonds
-
-
-
-
Foreign government bonds
(20
)
-
RMBS
-
-
-
(9
)
CMBS
(1
)
-
-
-
-
ABS
-
(201
)
Hybrid and redeemable
preferred securities
-
(2
)
Mortgage loans on real estate
-
(1
)
(10
)
Trading securities
-
(32
)
(1
)
Equity securities
-
Derivative investments
(363
)
(216
)
1,542
Other assets: (6)
GLB direct embedded derivatives
-
-
-
-
GLB ceded embedded derivatives
-
-
-
Indexed annuity ceded embedded derivatives
-
(915
)
-
Future contract benefits - indexed annuity
and IUL contracts embedded derivatives (6)
(2,585
)
(1,009
)
-
-
-
(3,594
)
Other liabilities - GLB ceded embedded
derivatives (6)
(9
)
-
-
-
-
Total, net
$
5,141
$
$
$
(284
)
$
$
6,441
‎
For the Year Ended December 31, 2019
Gains
Issuances,
Transfers
Items
(Losses)
Sales,
Into or
Included
in
Maturities,
Out
Beginning
in
OCI
Settlements,
of
Ending
Fair
Net
and
Calls,
Level 3,
Fair
Value
Income
Other (1)
Net
Net (3)
Value
Investments: (5)
Fixed maturity AFS securities:
Corporate bonds
$
3,269
$
$
$
$
(49
)
$
4,281
U.S. government bonds
-
-
-
-
Foreign government bonds
-
(25
)
-
RMBS
-
-
(17
)
CMBS
-
(7
)
ABS
-
(486
)
Hybrid and redeemable
preferred securities
-
-
-
Trading securities
-
(268
)
Equity securities
(12
)
-
-
Derivative investments
-
Other assets: (6)
GLB direct embedded derivatives
-
-
-
GLB ceded embedded derivatives
(12
)
-
-
-
Indexed annuity ceded embedded derivatives
-
(133
)
-
Future contract benefits - indexed annuity
and IUL contracts embedded derivatives (6)
(1,305
)
(900
)
-
(380
)
-
(2,585
)
Other liabilities - GLB ceded embedded
derivatives (6)
-
(9
)
-
-
-
(9
)
Total, net
$
4,014
$
(417
)
$
$
2,013
$
(822
)
$
5,141
‎
For the Year Ended December 31, 2018
Purchases,
Gains
Issuances,
Transfers
Items
(Losses)
Sales,
Into or
Included
in
Maturities,
Out
Beginning
in
OCI
Settlements,
of
Ending
Fair
Net
and
Calls,
Level 3,
Fair
Value
Income
Other (1)
Net (2)
Net (3)(4)
Value
Investments: (5)
Fixed maturity AFS securities:
Corporate bonds
$
3,091
$
$
(199
)
$
$
(62
)
$
3,269
U.S. government bonds
-
-
(5
)
-
-
Foreign government bonds
-
(1
)
-
-
RMBS
-
-
(12
)
CMBS
-
-
(39
)
ABS
-
(1
)
(206
)
Hybrid and redeemable
preferred securities
-
(1
)
-
-
Equity AFS securities
-
-
-
(162
)
-
Trading securities
(5
)
-
(7
)
Equity securities
-
(1
)
-
-
Derivative investments
(69
)
-
Other assets: (6)
GLB direct embedded derivatives
(780
)
-
-
-
GLB ceded embedded derivatives
-
-
-
Indexed annuity ceded embedded derivatives
(117
)
-
1,008
-
Future contract benefits - indexed annuity
and IUL contracts embedded derivatives (6)
(1,418
)
-
(85
)
-
(1,305
)
Other liabilities - GLB ceded embedded
-
-
-
-
-
-
derivatives (6)
(67
)
-
-
-
-
Total, net
$
3,139
$
(437
)
$
(271
)
$
2,045
$
(462
)
$
4,014
(1)The changes in fair value of the interest rate swaps are offset by an adjustment to derivative investments (see Note 6).
(2)Issuances, sales, maturities, settlements, calls, net, includes financial instruments acquired in the Liberty Life transaction as follows: corporate bonds of $67 million and ABS of $17 million.
(3)Transfers into or out of Level 3 for fixed maturity AFS and trading securities are reported at amortized cost as of the beginning-of-year. For fixed maturity AFS and trading securities, the difference between beginning-of-year amortized cost and beginning-of-year fair value was included in OCI and earnings, respectively, in the prior years.
(4)Transfers into or out of Level 3 for FHLB stock between equity securities and other investments are reported at cost on our Consolidated Balance Sheets.
(5)Amortization and accretion of premiums and discounts are included in net investment income on our Consolidated Statements of Comprehensive Income (Loss). Gains (losses) from sales, maturities, settlements and calls and credit loss expense are included in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).
(6)Gains (losses) from the changes in fair value are included in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).
The following provides the components of the items included in issuances, sales, maturities, settlements and calls, net, excluding any effect of amortization of DAC, VOBA, DSI and DFEL and changes in future contract benefits, (in millions) as reported above:
For the Year Ended December 31, 2020
Issuances
Sales
Maturities
Settlements
Calls
Total
Investments:
Fixed maturity AFS securities:
Corporate bonds
$
1,126
$
(250
)
$
(43
)
$
(237
)
$
(132
)
$
Foreign government bonds
-
-
(20
)
-
-
(20
)
ABS
-
-
(76
)
-
Hybrid and redeemable preferred
securities
(4
)
-
-
-
Mortgage loans on real estate
(15
)
-
-
-
Trading securities
(126
)
(40
)
(166
)
-
(32
)
Equity securities
(2
)
-
-
-
Derivative investments
(412
)
(471
)
-
-
(363
)
Other assets - indexed annuity ceded
embedded derivatives
-
-
(940
)
-
(915
)
Future contract benefits - indexed annuity
-
and IUL contracts embedded derivatives
(284
)
-
-
-
-
Total, net
$
2,366
$
(809
)
$
(574
)
$
(1,135
)
$
(132
)
$
(284
)
For the Year Ended December 31, 2019
Issuances
Sales
Maturities
Settlements
Calls
Total
Investments:
Fixed maturity AFS securities:
Corporate bonds
$
1,170
$
(28
)
$
(78
)
$
(156
)
$
(30
)
$
Foreign government bonds
-
-
(25
)
-
-
(25
)
RMBS
-
-
-
-
CMBS
-
-
(2
)
-
ABS
(8
)
-
(19
)
-
Trading securities
-
-
(22
)
-
Equity securities
(33
)
-
-
-
Derivative investments
(63
)
(331
)
-
-
Other assets - indexed annuity ceded
embedded derivatives
-
-
(189
)
-
(133
)
Future contract benefits - indexed annuity
and IUL contracts embedded derivatives
(591
)
-
-
-
(380
)
Total, net
$
2,786
$
(132
)
$
(434
)
$
(177
)
$
(30
)
$
2,013
‎
For the Year Ended December 31, 2018
Issuances
Sales
Maturities
Settlements
Calls
Total
Investments:
Fixed maturity AFS securities:
Corporate bonds
$
$
(161
)
$
(3
)
$
(277
)
$
(77
)
$
U.S. government bonds
-
(5
)
-
-
-
(5
)
RMBS
-
-
-
-
CMBS
-
-
(4
)
-
ABS
(17
)
-
-
-
Trading securities
(24
)
-
-
-
Equity securities
(1
)
-
-
-
-
Derivative investments
(426
)
-
-
Other assets - indexed annuity ceded
embedded derivatives
1,030
-
-
(22
)
-
1,008
Future contract benefits - indexed annuity
and IUL contracts embedded derivatives
(284
)
-
-
-
(85
)
Total, net
$
2,399
$
$
(429
)
$
(104
)
$
(77
)
$
2,045
The following summarizes changes in unrealized gains (losses) included in net income, excluding any effect of amortization of DAC, VOBA, DSI and DFEL and changes in future contract benefits, related to financial instruments carried at fair value classified within Level 3 that we still held (in millions):
For the Years Ended December 31,
GLB
$
$
1,015
$
(75
)
Derivative investments
Embedded derivatives - indexed annuity
and IUL contracts
(97
)
(38
)
Total, net (1)
$
1,841
$
1,086
$
(23
)
(1)Included in realized gain (loss) on our Consolidated Statements of Comprehensive Income (Loss).
The following summarizes changes in unrealized gains (losses) included in OCI, net of tax, excluding any effect of amortization of DAC, VOBA, DSI and DFEL and changes in future contract benefits, related to financial instruments carried at fair value classified within Level 3 that we still held (in millions):
For the
Year Ended
December 31,
Fixed maturity AFS securities:
Corporate bonds
$
Foreign government bonds
ABS
Hybrid and redeemable preferred securities
(3
)
Total, net
$
‎
The following provides the components of the transfers into and out of Level 3 (in millions) as reported above:
For the Year Ended December 31, 2020
Transfers
Transfers
Into
Out of
Level 3
Level 3
Total
Investments:
Fixed maturity AFS securities:
Corporate bonds
$
$
(243
)
$
U.S. government bonds
(5
)
-
RMBS
(10
)
(9
)
ABS
(221
)
(201
)
Hybrid and redeemable preferred
securities
-
Mortgage loans on real estate
-
Trading securities
(34
)
(1
)
Equity securities
-
Derivative investments
-
(216
)
(216
)
Total, net
$
1,212
$
(729
)
$
For the Year Ended December 31, 2019
Transfers
Transfers
Into
Out of
Level 3
Level 3
Total
Investments:
Fixed maturity AFS securities:
Corporate bonds
$
$
(222
)
$
(49
)
U.S. government bonds
-
RMBS
-
(17
)
(17
)
CMBS
-
(7
)
(7
)
ABS
(495
)
(486
)
Trading securities
(273
)
(268
)
Total, net
$
$
(1,014
)
$
(822
)
For the Year Ended December 31, 2018
Transfers
Transfers
Into
Out of
Level 3
Level 3
Total
Investments:
Fixed maturity AFS securities:
Corporate bonds
$
$
(140
)
$
(62
)
RMBS
-
(12
)
(12
)
CMBS
(40
)
(39
)
ABS
-
(206
)
(206
)
Equity AFS securities
-
(162
)
(162
)
Trading securities
-
(7
)
(7
)
Equity securities
-
Total, net
$
$
(567
)
$
(462
)
Transfers into and out of Level 3 are generally the result of observable market information on a security no longer being available or becoming available to our pricing vendors. For the years ended December 31, 2020, 2019 and 2018, transfers in and out of Level 3 were attributable primarily to the securities’ observable market information no longer being available or becoming available. In 2020, transfers into Level 3 included certain commercial mortgage loans electing the fair value option. The transfers were due to a lack of observable valuation inputs used by a third-party pricing source. In 2018, transfers into or out of Level 3 also included FHLB stock between equity securities and other investments at cost on our Consolidated Balance Sheets.
‎
The following summarizes the fair value (in millions), valuation techniques and significant unobservable inputs of the Level 3 fair value measurements as of December 31, 2020:
Weighted
Average
Fair
Valuation
Significant
Assumption or
Input
Value
Technique
Unobservable Inputs
Input Ranges
Range (1)
Assets
Investments:
Fixed maturity AFS and
trading securities:
Corporate bonds
$
3,370
Discounted cash flow
Liquidity/duration adjustment (2)
0.2
%
-
19.9
%
1.8
%
Foreign government
bonds
Discounted cash flow
Liquidity/duration adjustment (2)
6.0
%
-
6.0
%
6.0
%
ABS
Discounted cash flow
Liquidity/duration adjustment (2)
3.5
%
-
3.5
%
3.5
%
Equity securities
Discounted cash flow
Liquidity/duration adjustment (2)
4.5
%
-
6.0
%
5.6
%
Other assets - GLB direct
and ceded embedded
derivatives
Discounted cash flow
Long-term lapse rate (3)
%
-
%
(10)
%
Utilization of guaranteed withdrawals (4)
%
-
%
%
Claims utilization factor (5)
%
-
%
(10)
%
Premiums utilization factor (5)
%
-
%
(10)
%
NPR (6)
0.06
%
-
1.35
%
0.95
%
Mortality rate (7)
(9)
(10)
Volatility (8)
%
-
%
14.53
%
Indexed annuity ceded
embedded derivatives
Discounted cash flow
Lapse rate (3)
%
-
%
(10)
%
Mortality rate (7)
(9)
(10)
Liabilities
Future contract benefits -
indexed annuity and IUL
contracts embedded
derivatives
$
(3,594
)
Discounted cash flow
Lapse rate (3)
%
-
%
(10)
%
Mortality rate (7)
(9)
(10)
(1)Unobservable inputs were weighted by the relative fair value of the instruments, unless otherwise noted.
(2)The liquidity/duration adjustment input represents an estimated market participant composite of adjustments attributable to liquidity premiums, expected durations, structures and credit quality that would be applied to the market observable information of an investment.
(3)The lapse rate input represents the estimated probability of a contract surrendering during a year, and thereby forgoing any future benefits. The range for indexed annuity and IUL contracts represents the lapse rates during the surrender charge period.
(4)The utilization of guaranteed withdrawals input represents the estimated percentage of contract holders that utilize the guaranteed withdrawal feature.
(5)The utilization factors are applied to the present value of claims or premiums, as appropriate, in the GLB reserve calculation to estimate the impact of inefficient withdrawal behavior, including taking less than or more than the maximum guaranteed withdrawal.
(6)The NPR input represents the estimated additional credit spread that market participants would apply to the market observable discount rate when pricing a contract. The NPR input was weighted by the absolute value of the sensitivity of the reserve to the NPR assumption.
(7)The mortality rate input represents the estimated probability of when an individual belonging to a particular group, categorized according to age or some other factor such as gender, will die.
(8)The volatility input represents overall volatilities assumed for the underlying variable annuity funds, which include a mixture of equity and fixed-income assets. Fair value of the variable annuity GLB embedded derivatives would increase if higher volatilities were used for valuation. Volatility assumptions vary by fund due to the benchmarking of different indices. The volatility input was weighted by the relative account value assigned to each index.
(9)The mortality rate is based on a combination of company and industry experience, adjusted for improvement factors.
(10)A weighted average input range is not a meaningful measurement for lapse rate, utilization factors or mortality rate.
From the table above, we have excluded Level 3 fair value measurements obtained from independent, third-party pricing sources. We do not develop the significant inputs used to measure the fair value of these assets and liabilities, and the information regarding the significant inputs is not readily available to us. Independent broker-quoted fair values are non-binding quotes developed by market makers or broker-dealers obtained from third-party sources recognized as market participants. The fair value of a broker-quoted asset or liability is based solely on the receipt of an updated quote from a single market maker or a broker-dealer recognized as a market participant as we do not adjust broker quotes when used as the fair value measurement for an asset or liability. Significant increases or decreases in any of the quotes received from a third-party broker-dealer may result in a significantly higher or lower fair value measurement.
Changes in any of the significant inputs presented in the table above would have resulted in a significant change in the fair value measurement of the asset or liability as follows:
Investments - An increase in the liquidity/duration adjustment input would have resulted in a decrease in the fair value measurement.
Indexed annuity and IUL contracts embedded derivatives - For direct embedded derivatives, an increase in the lapse rate or mortality rate inputs would have resulted in a decrease in the fair value measurement.
GLB embedded derivatives - Assuming our GLB direct embedded derivatives are in a liability position: an increase in our lapse rate, NPR or mortality rate inputs would have resulted in a decrease in the fair value measurement; and an increase in the utilization of guaranteed withdrawal or volatility inputs would have resulted in an increase in the fair value measurement.
For each category discussed above, the unobservable inputs are not inter-related; therefore, a directional change in one input would not have affected the other inputs.
As part of our ongoing valuation process, we assess the reasonableness of our valuation techniques or models and make adjustments as necessary. For more information, see Note 1.
22. Segment Information
We provide products and services and report results through our Annuities, Retirement Plan Services, Life Insurance and Group Protection segments. As discussed in Note 3, we completed the acquisition of Liberty Life during the second quarter of 2018. Related results are included within the Group Protection segment. We also have Other Operations, which includes the financial data for operations that are not directly related to the business segments. Our reporting segments reflect the manner by which our chief operating decision makers view and manage the business. The following is a brief description of these segments and Other Operations.
The Annuities segment provides tax-deferred investment growth and lifetime income opportunities for its clients by offering fixed (including indexed) and variable annuities.
The Retirement Plan Services segment provides employer-sponsored defined benefit and individual retirement accounts, as well as individual and group variable annuities, group fixed annuities and mutual-fund based programs in the retirement plan marketplace.
The Life Insurance segment focuses in the creation and protection of wealth through life insurance products, including term insurance, a linked-benefit product (which is a UL policy linked with riders that provide for long-term care costs), IUL and both single and survivorship versions of UL and VUL, including corporate-owned UL and VUL and bank-owned UL and VUL products.
The Group Protection segment offers group non-medical insurance products, including short and long-term disability, absence management services, term life, dental, vision and accident and critical illness benefits and services to the employer marketplace through various forms of employee-paid and employer-paid plans.
Other Operations includes investments related to the excess capital in our insurance subsidiaries; benefit plan net liability; the unamortized deferred gain on indemnity reinsurance related to the sale of reinsurance; the results of certain disability income business; our run-off institutional pension business, the majority of which was sold on a group annuity basis; debt costs; strategic digitization expense; and other corporate investments.
Segment operating revenues and income (loss) from operations are internal measures used by our management and Board of Directors to evaluate and assess the results of our segments. Income (loss) from operations is GAAP net income excluding the after-tax effects of the following items, as applicable:
Realized gains and losses associated with the following (“excluded realized gain (loss)”):
Sales or disposals and impairments of financial assets;
Changes in the fair value of equity securities;
Changes in the fair value of derivatives, embedded derivatives within certain reinsurance arrangements and trading securities (“gain (loss) on the mark-to-market on certain instruments”);
Changes in the fair value of the derivatives we own to hedge our GDB riders within our variable annuities;
Changes in the fair value of the embedded derivatives of our GLB riders reflected within variable annuity net derivative results accounted for at fair value;
Changes in the fair value of the derivatives we own to hedge our GLB riders reflected within variable annuity net derivative results; and
Changes in the fair value of the 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 at fair value (“indexed annuity forward-starting option”);
Changes in reserves resulting from benefit ratio unlocking on our GDB and GLB riders (“benefit ratio unlocking”);
Income (loss) from reserve changes, net of related amortization, on business sold through reinsurance;
Gains (losses) on early extinguishment of debt;
Losses from the impairment of intangible assets;
Income (loss) from discontinued operations;
Acquisition and integration costs related to mergers and acquisitions; and
Income (loss) from the initial adoption of new accounting standards, regulations, and policy changes including the net impact from the Tax Cuts and Jobs Act.
Operating revenues represent GAAP revenues excluding the pre-tax effects of the following items, as applicable:
Excluded realized gain (loss);
Revenue adjustments from the initial adoption of new accounting standards;
Amortization of DFEL arising from changes in GDB and GLB benefit ratio unlocking; and
Amortization of deferred gains arising from reserve changes on business sold through reinsurance.
The tables below reconcile our segment measures of performance to the GAAP measures presented in our Consolidated Statements of Comprehensive Income (Loss) (in millions):
For the Years Ended December 31,
Revenues
Operating revenues:
Annuities
$
4,455
$
4,600
$
4,383
Retirement Plan Services
1,213
1,200
1,178
Life Insurance
7,516
7,438
6,922
Group Protection
4,793
4,588
3,757
Other Operations
Excluded realized gain (loss), pre-tax
(721
)
(794
)
(46
)
Amortization of DFEL associated with benefit ratio unlocking, pre-tax
(2
)
(5
)
Total revenues
$
17,439
$
17,258
$
16,424
For the Years Ended December 31,
Net Income (Loss)
Income (loss) from operations:
Annuities
$
$
$
1,102
Retirement Plan Services
Life Insurance
(34
)
Group Protection
Other Operations
(295
)
(268
)
(225
)
Excluded realized gain (loss), after-tax
(570
)
(627
)
(37
)
Benefit ratio unlocking, after-tax
(136
)
Net impact from the Tax Cuts and Jobs Act
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)
$
$
$
1,641
Other segment information (in millions) was as follows:
For the Years Ended December 31,
Net Investment Income
Annuities
$
1,272
$
1,140
$
1,005
Retirement Plan Services
Life Insurance
2,823
2,658
2,697
Group Protection
Other Operations
Total net investment income
$
5,510
$
5,223
$
5,085
For the Years Ended December 31,
Amortization of DAC and VOBA, Net of Interest
Annuities
$
$
$
Retirement Plan Services
Life Insurance
Group Protection
Total amortization of DAC and VOBA, net of interest
$
1,315
$
1,324
$
1,241
For the Years Ended December 31,
Federal Income Tax Expense (Benefit)
Annuities
$
$
$
Retirement Plan Services
Life Insurance
(33
)
Group Protection
Other Operations
(82
)
(92
)
(77
)
Excluded realized gain (loss)
(151
)
(167
)
(9
)
Gain (loss) on early extinguishment of debt
(3
)
(9
)
(5
)
Benefit ratio unlocking
(36
)
Net impact from the Tax Cuts and Jobs Act
(37
)
(17
)
(19
)
Acquisition and integration costs related to
mergers and acquisitions
(5
)
(28
)
(19
)
Total federal income tax expense (benefit)
$
(76
)
$
$
As of December 31,
Assets
Annuities
$
184,678
$
167,443
Retirement Plan Services
45,372
40,184
Life Insurance
101,941
92,561
Group Protection
10,201
9,467
Other Operations
23,756
25,106
Total assets
$
365,948
$
334,761
23. Supplemental Disclosures of Cash Flow Data
The following summarizes our supplemental cash flow data (in millions):
For the Years Ended December 31,
Interest paid
$
$
$
Income taxes paid (received)
Significant non-cash investing and financing transactions:
Equity securities received in exchange of
fixed maturity AFS securities
-
-
Reduction of other investments in connection with
the expiration of a repurchase agreement
-
(150
)
-
Investments received in financing transactions
-
-
24. Quarterly Results of Operations (Unaudited)
The unaudited quarterly results of operations (in millions, except per share data) were as follows:
For the Three Months Ended
March 31,
June 30,
September 30,
December 31,
Total revenues
$
4,425
$
3,517
$
5,361
$
4,135
Total expenses
4,391
3,678
4,901
4,046
Net income (loss)
(94
)
Earnings (loss) per common share - basic:
Net income (loss)
0.27
(0.49
)
2.06
0.74
Earnings (loss) per common share - diluted:
Net income (loss)
0.15
(0.49
)
2.01
0.74
Total revenues
$
3,965
$
4,310
$
4,638
$
4,344
Total expenses
3,697
3,889
4,888
3,863
Net income (loss)
(161
)
Earnings (loss) per common share - basic:
Net income (loss)
1.23
1.80
(0.81
)
2.18
Earnings (loss) per common share - diluted:
Net income (loss)
1.22
1.79
(0.83
)
2.15
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(a)Conclusions Regarding Disclosure Controls and Procedures
We maintain disclosure controls and procedures, which are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. As of the end of the period required by this report, we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us and our consolidated subsidiaries required to be disclosed in our periodic reports under the Exchange Act.
(b)Management’s Report on Internal Control Over Financial Reporting
Management’s Report on Internal Control Over Financial Reporting is included on page 106 of “Item 8. Financial Statements and Supplementary Data” and is incorporated herein by reference.
A control system, no matter how well designed and operated, can provide only reasonable assurance that the control system’s objectives will be met. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. Projections of any evaluation of controls’ effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
(c)Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting (as that term is defined in rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2020, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Information required by this item relating to our executive officers is incorporated by reference to “Part I - Information About our Executive Officers” of this Form 10-K. Information required by this item relating to our directors and corporate governance matters is incorporated by reference to the sections captioned “Governance of the Company - Our Corporate Governance Guidelines,” “Governance of the Company - Director Nomination Process,” “Governance of the Company - Board Committees - Current Committee Membership and Meetings Held During 2020,” “Governance of the Company - Board Committees - Audit Committee,” “Agenda Item 1 - Election of Directors” and “General Information - Shareholder Proposals for the 2022 Annual Meeting” of LNC’s Proxy Statement for the Annual Meeting scheduled for June 3, 2021.
‎
Item 11. Executive Compensation
Information required by this item is incorporated by reference to the sections captioned “Compensation of Outside Directors,” “Compensation Discussion & Analysis,” “Executive Compensation Tables” and “Compensation Committee Interlocks and Insider Participation” of LNC’s Proxy Statement for the Annual Meeting scheduled for June 3, 2021.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information required by this item is incorporated by reference to the section captioned “Security Ownership” of LNC’s Proxy Statement for the Annual Meeting scheduled for June 3, 2021.
Securities Authorized for Issuance Under Equity Compensation Plans
The table below provides information as of December 31, 2020, regarding securities authorized for issuance under LNC’s equity compensation plans. See Note 19 to the consolidated financial statements included in “Part II - Item 8. Financial Statements and Supplementary Data” of this Form 10-K for a brief description of our equity compensation plans.
Number of
Weighted-
Number of
Securities To Be
Average
Securities Remaining
Issued Upon
Exercise
Available For Future
Exercise of
Price of
Issuance Under
Outstanding
Outstanding
Equity Compensation
Options,
Options,
Plans (Excluding
Warrants
Warrants
Securities Reflected
and Rights
and Rights
in Column (a))
(a)
(b)
(c)
Plan Category
Equity compensation plans approved by shareholders
7,213,000
(1)
$
57.36
(2)
5,662,207
(3)
Equity compensation plans not approved by shareholders
-
-
-
Total
7,213,000
$
57.36
5,662,207
(1)This amount includes the following:
1,085,416 representing the number of performance shares based on the maximum number of shares potentially payable under the awards (i.e. 200% of target). 542,708 represents the target number of performance shares that were outstanding as of December 31, 2020, as set forth in Note 19 of the Notes to the Consolidated Financial Statements, included in Part II, Item 8 of this Form 10-K. The performance share awards have not been earned as of December 31, 2020. The number of shares, if any, to be issued pursuant to such awards will be determined based upon performance over the applicable three-year performance period. The performance shares are all granted under either the LNC 2009 Amended and Restated Incentive Compensation Plan (“the 2009 ICP”) or the LNC 2014 Incentive Compensation Plan (“the 2014 ICP”);
1,657,902 outstanding restricted stock units, which were granted under the 2009 ICP, 2014 ICP or the LNC 2020 Incentive Compensation Plan (the “2020 ICP”);
3,458,959 outstanding stock options with service conditions granted under the 2009 ICP, the 2014 ICP or the LNC Stock Option Plan for Non-Employee Directors (which has expired and, as a result, no additional awards may be granted under this plan);
208,650 outstanding stock options with performance conditions granted under the 2009 ICP; and
802,073 outstanding deferred stock units, which have been granted under deferred compensation plans for our employees and non-employee directors from the 2009 ICP, the 2014 ICP, the 2020 ICP or the LNC Deferred Compensation Plan for Non-Employee Directors (the “Directors’ DCP”). These outstanding deferred stock units are vested and are not included in Note 19 of the Notes to the Consolidated Financial Statements, included in Part II - Item 8 of this Form 10-K.
(2)The price in column (b) reflects the weighted average price of all outstanding options under any plan that, as of December 31, 2020, had been granted but not forfeited, expired or exercised. Performance shares, restricted stock units, and deferred stock units are not included in determining the weighted average in column (b) because they have no exercise price.
(3)Includes up to:
431,916 securities available for issuance in connection with awards under the 2009 ICP;
5,165,512 securities available for issuance in connection with awards under the 2020 ICP; and
64,779 securities available for issuance in connection with deferred stock units under the Directors’ DCP, which are vested upon grant.
Shares that may be issued in payment of awards, other than stock options and stock appreciation rights, reduce the number of securities remaining available for future issuance under the 2009 ICP at a ratio of 1.63 to 1. Shares that may be issued in payment of awards granted under the 2014 ICP and the 2020 ICP reduce the number of securities remaining available for future issuance under such plans at a ratio of 1 to 1.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information required by this item is incorporated by reference to the sections captioned “Related-Party Transactions” and “Governance of the Company - Director Independence” of LNC’s Proxy Statement for the Annual Meeting scheduled for June 3, 2021.
Item 14. Principal Accounting Fees and Services
Information required by this item is incorporated by reference to the sections captioned “Agenda Item 2 - Ratification of Appointment of Independent Registered Public Accounting Firm” of LNC’s Proxy Statement for the Annual Meeting scheduled for June 3, 2021.
PART IV
Item 15. Exhibits, Financial Statement Schedules
(a) (1) Financial Statements
The following Consolidated Financial Statements of Lincoln National Corporation are included in Part II - Item 8:
Management Report on Internal Control Over Financial Reporting
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets - December 31, 2020 and 2019
Consolidated Statements of Comprehensive Income (Loss) - Years ended December 31, 2020, 2019 and 2018
Consolidated Statements of Stockholders’ Equity - Years ended December 31, 2020, 2019 and 2018
Consolidated Statements of Cash Flows - Years ended December 31, 2020, 2019 and 2018
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedules
The Financial Statement Schedules are listed in the Index to Financial Statement Schedules on page FS-1, which is incorporated herein by reference.
(a) (3) Listing of Exhibits
The Exhibits are listed in the Index to Exhibits beginning on page 198, which is incorporated herein by reference.
(c) The Financial Statement Schedules for Lincoln National Corporation begin on page FS-2, which are incorporated herein by reference.
INDEX TO EXHIBITS
2.1
Master Transaction Agreement, dated as of January 18, 2018, by and among The Lincoln National Life Insurance Company, for the limited purposes set forth therein, LNC, Liberty Mutual Insurance Company, Liberty Mutual Fire Insurance Company, for the limited purposes set forth therein, Liberty Mutual Group Inc., Protective Life Insurance Company and for the limited purposes set forth therein, Protective Life Corporation, is incorporated by reference to Exhibit 2.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on January 22, 2018.**
3.1
Restated Articles of Incorporation of LNC are incorporated by reference to Exhibit 3.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on August 14, 2017.
3.2
Amended and Restated Bylaws of LNC (effective August 19, 2020) are incorporated by reference to Exhibit 3.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on August 20, 2020.
4.1
Indenture of LNC, dated as of September 15, 1994, between LNC and The Bank of New York, as trustee, is incorporated by reference to Exhibit 4(c) to LNC’s Registration Statement on Form S-3/A (File No. 33-55379) filed with the SEC on September 15, 1994.
4.2
First Supplemental Indenture, dated as of November 1, 2006, to Indenture dated as of September 15, 1994, is incorporated by reference to Exhibit 4.4 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2006.
4.3
Junior Subordinated Indenture, dated as of May 1, 1996, between LNC and The Bank of New York Trust Company, N.A. (successor in interest to J.P. Morgan Trust Company and The First National Bank of Chicago) is incorporated by reference to Exhibit 4(j) to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2001.
4.4
Third Supplemental Junior Subordinated Indenture dated May 17, 2006, to Junior Subordinated Indenture, dated as of May 1, 1996, is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on May 17, 2006.
4.5
Fourth Supplemental Junior Subordinated Indenture, dated as of November 1, 2006, to Junior Subordinated Indenture, dated May 1, 1996, is incorporated by reference to Exhibit 4.9 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2006.
4.6
Fifth Supplemental Junior Subordinated Indenture, dated as of March 13, 2007, to Junior Subordinated Indenture, dated May 1, 1996, is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on March 13, 2007.
4.7
Senior Indenture, dated as of March 10, 2009, between LNC and the Bank of New York Mellon, is incorporated by reference to Exhibit 4.1 to LNC’s Form S-3ASR (File No. 333-157822) filed with the SEC on March 10, 2009.
4.8
First Supplemental Indenture, dated as of August 18, 2020, to Senior Indenture dated as of March 10, 2009 between LNC and the Bank of New York Mellon, is incorporated by reference to Exhibit 4.4 to LNC’s Form S-3ASR (File No. 333-249058) filed with the SEC on September 25, 2020.
4.9
Junior Subordinated Indenture, dated as of March 10, 2009, between LNC and the Bank of New York Mellon, is incorporated by reference to Exhibit 4.3 to LNC’s Form S-3ASR (File No. 333-157822) filed with the SEC on March 10, 2009.
4.10
Form of 7.00% Capital Securities due 2066 of LNC is incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on May 17, 2006.
4.11
Form of 6.15% Senior Notes due April 6, 2036 is incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on April 7, 2006.
4.12
Form of 6.05% Capital Securities due 2067 is incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on March 13, 2007.
4.13
Form of 6.30% Senior Notes due 2037 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on October 9, 2007.
4.14
Form of 7.00% Senior Notes due 2040 is incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on June 18, 2010.
4.15
Form of 4.20% Senior Notes due 2022 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on March 29, 2012.
4.16
Form of 4.00% Senior Notes due 2023 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on August 16, 2013.
4.17
Form of 3.350% Senior Notes due 2025is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on March 10, 2015.
4.18
Form of 3.625% Senior Notes due 2026 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on December 12, 2016.
4.19
Form of 4.00% Senior Notes due 2023 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File no. 1-6028) filed with the SEC on February 12, 2018.
4.20
Form of 3.800% Senior Notes due 2028 is incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on February 12, 2018.
4.21
Form of 4.350% Senior Notes due 2048 is incorporated by reference to Exhibit 4.3 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on February 12, 2018.
4.22
Form of 3.050% Senior Notes due 2030 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on August 19, 2019.
4.23
Form of 3.400% Senior Notes due 2031, incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on May 15, 2020.
4.24
Form of 4.375% Senior Notes due 2050, incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on May 15, 2020.
4.25
Description of Securities Registered Pursuant to Section 12 of the Exchange Act is filed herewith.
10.1
LNC 2014 Incentive Compensation Plan (effective May 22, 2014) is incorporated by reference to Exhibit 10.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on May 28, 2014.*
10.2
LNC 2009 Amended and Restated Incentive Compensation Plan (as amended and restated on May 14, 2009) is incorporated by reference to Exhibit 4 to LNC’s Proxy Statement (File No. 1-6028) filed with the SEC on April 9, 2009.*
10.3
LNC Stock Option Plan for Non-Employee Directors is incorporated by reference to Exhibit 5 to LNC’s Proxy Statement (File No. 1-6028) filed with the SEC on April 4, 2007.*
10.4
Non-Qualified Stock Option Agreement for the LNC Stock Option Plan for Non-Employee Directors is incorporated by reference to Exhibit 10.3 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on May 10, 2007.*
10.5
Non-Employee Director Fees are filed herewith.*
10.6
Amended and Restated LNC Supplemental Retirement Plan is incorporated by reference to Exhibit 10.10 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2007.*
10.7
The Severance Plan for Officers of LNC (Amended and Restated effective as of February 27, 2019) is incorporated by reference to Exhibit 10.1 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2019.*
10.8
Amendment No 1. to the Severance Plan for Officers of LNC, effective January 1, 2020, is incorporated by reference to Exhibit 10.8 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2019.*
10.9
The LNC Outside Directors’ Value Sharing Plan, last amended March 8, 2001, is incorporated by reference to Exhibit 10(e) to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2001.*
10.10
LNC Deferred Compensation and Supplemental/Excess Retirement Plan, as amended and restated effective January 1, 2020, is incorporated by reference to Exhibit 10.10 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2019.*
10.11
Amendment No. 1 to the LNC Deferred Compensation and Supplemental/Excess Retirement Plan is filed herewith.*
10.12
LNC 1993 Stock Plan for Non-Employee Directors, as last amended May 10, 2001, is incorporated by reference to Exhibit 10(g), to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2001.*
10.13
Amendment No. 2 to the LNC 1993 Stock Plan for Non-Employee Directors (effective February 1, 2006) is incorporated by reference to Exhibit 10.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on January 13, 2006.*
‎
10.14
LNC Executives’ Severance Benefit Plan (effective August 7, 2008) is incorporated by reference to Exhibit 10.3 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended June 30, 2008.*
10.15
Amendment No. 1 to the LNC Executives’ Severance Benefit Plan (effective November 9, 2011) is incorporated by reference to Exhibit 10.22 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2011.*
10.16
Amended and Restated LNC Excess Retirement Plan is incorporated by reference to Exhibit 10.26 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2007.*
10.17
Amendment No. 1 to the Amended and Restated LNC Excess Retirement Plan is filed herewith.*
10.18
Amendment No. 2 to the Amended and Restated LNC Excess Retirement Plan is filed herewith.*
10.19
Amendment No. 3 to the Amended and Restated LNC Excess Retirement Plan is filed herewith.*
10.20
Amendment No. 4 to the Amended and Restated LNC Excess Retirement Plan is filed herewith.*
10.21
Amendment No. 5 to the Amended and Restated LNC Excess Retirement Plan is filed herewith.*
10.22
LNC Deferred Compensation Plan for Non-Employee Directors, as amended and restated November 5, 2008, is incorporated by reference to Exhibit 10.23 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2008.*
10.23
Form of Indemnification between LNC and each director is incorporated by reference to Exhibit 10.1 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended September 30, 2009.*
10.24
Form of Non-Qualified Stock Option Award Agreement is incorporated by Reference to Exhibit 10.35 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2012.*
10.25
Amendment #1 to the Form of Non-Qualified Stock Option Award Agreements, effective August 13, 2014, is incorporated by reference to Exhibit 10.28 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2014.*
10.26
Amendment #2 to the Form of Non-Qualified Stock Option Award Agreements, effective August 13, 2014, is incorporated by reference to Exhibit 10.29 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2014.*
10.27
Form of Nonqualified Stock Option Agreement under the LNC 2014 Incentive Compensation Plan is incorporated by reference to Exhibit 10.2 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2015.*
10.28
Form of Restricted Stock Unit Award Agreement for Senior Management Committee (Other than CEO) is incorporated by reference to Exhibit 10.1 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2016.*
10.29
Form of Nonqualified Stock Option Award Agreement for Senior Management Committee (Other than CEO) is incorporated by reference to Exhibit 10.1 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2017.*
10.30
Form of Performance Cycle Agreement for Senior Management Committee (Other than CEO) is incorporated by reference to Exhibit 10.3 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2016.*
10.31
Form of Nonqualified Stock Option Agreement for CEO is incorporated by reference to Exhibit 10.1 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2020.*
10.32
Form of Long-Term Incentive Award Program Performance Cycle Agreement for CEO is incorporated by reference to Exhibit 10.2 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2020.*
10.33
Form of Restricted Stock Unit Award Agreement for CEO is incorporated by reference to Exhibit 10.3 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2020.*
10.34
Form of Nonqualified Stock Option Agreement for Senior Management Committee (“SMC”) is incorporated by reference to Exhibit 10.4 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2020.*
10.35
Form of Long-Term Incentive Award Program Performance Cycle Agreement for SMC (other than CEO) is incorporated by reference to Exhibit 10.5 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2020.*
10.36
Form of Restricted Stock Unit Award Agreement for SMC (other than CEO) is incorporated by reference to Exhibit 10.6 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2020.*
10.37
Lincoln National Corporation 2020 Incentive Compensation Plan, incorporated by reference to Exhibit 4.3 to LNC’s Registration Statement on Form S-8 (File No. 333-239117) filed with the SEC on June 12, 2020.*
10.38
LNC Domestic Relocation Policy Home Sale Assistance Plan, effective as of September 6, 2007, is incorporated by reference to Exhibit 10.35 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2009.*
10.39
Stock and Asset Purchase Agreement by and among LNC, The Lincoln National Life Insurance Company, Lincoln National Reinsurance Company (Barbados) Limited and Swiss Re Life & Health America Inc. dated July 27, 2001 is incorporated by reference to Exhibit 99.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on August 1, 2001. Omitted schedules and exhibits listed in the Agreement will be furnished to the SEC upon request.
10.40
Indemnity Reinsurance Agreement, dated as of January 1, 1998, between Connecticut General Life Insurance Company and Lincoln Life & Annuity Company of New York is incorporated by reference to Exhibit 10.67 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2008.**
10.41
Coinsurance Agreement, dated as of October 1, 1998, AETNA Life Insurance and Annuity Company and Lincoln Life & Annuity Company of New York is incorporated by reference to Exhibit 10.68 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2008.**
10.42
Credit Agreement, dated as of July 31, 2019, among LNC, as an Account Party and Guarantor, the Subsidiary Account Parties, as additional Account Parties, Bank of America, N.A. as administrative agent, and the other lenders named therein, is incorporated by reference to Exhibit 10.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on July 31, 2019.
Subsidiaries List.
Consent of Independent Registered Public Accounting Firm.
31.1
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101).
*This exhibit is a management contract or compensatory plan or arrangement.
** Schedules to the agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. LNC will furnish supplementally a copy of the schedule to the SEC, upon request.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, LNC has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LINCOLN NATIONAL CORPORATION
Dated: February 18, 2021
By:
/s/ Randal J. Freitag
Randal J. Freitag
Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on February 18, 2021.
Signature
Title
/s/ Dennis R. Glass
President, Chief Executive Officer and Director
Dennis R. Glass
(Principal Executive Officer)
/s/ Randal J. Freitag
Executive Vice President and Chief Financial Officer
Randal J. Freitag
(Principal Financial Officer)
/s/ Christine A. Janofsky
Senior Vice President and Chief Accounting Officer
Christine A. Janofsky
(Principal Accounting Officer)
/s/ Deirdre P. Connelly
Director
Deirdre P. Connelly
/s/ William H. Cunningham
Director
William H. Cunningham
/s/Reginald E. Davis
Director
Reginald E. Davis
/s/ George W. Henderson, III
Director
George W. Henderson, III
/s/ Eric G. Johnson
Director
Eric G. Johnson
/s/ Gary C. Kelly
Director
Gary C. Kelly
/s/ M. Leanne Lachman
Director
M. Leanne Lachman
/s/ Michael F. Mee
Director
Michael F. Mee
/s/ Patrick S. Pittard
Director
Patrick S. Pittard
/s/ Lynn M. Utter
Director
Lynn M. Utter
Index to Financial Statement Schedules
I
- Summary of Investments - Other than Investments in Related Parties
FS-2
II
- Condensed Financial Information of Registrant
FS-3
III
- Supplementary Insurance Information
FS-6
IV
- Reinsurance
FS-8
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions, are inapplicable, or the required information is included in the consolidated financial statements, and therefore omitted. See “Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates” on page 42 for more detail on items contained within these schedules.
‎
FS-1
LINCOLN NATIONAL CORPORATION
SCHEDULE I - CONSOLIDATED SUMMARY OF INVESTMENTS - OTHER THAN
INVESTMENTS IN RELATED PARTIES
(in millions)
Column A
Column B
Column C
Column D
As of December 31, 2020
Fair
Carrying
Type of Investment
Cost
Value
Value
Fixed Maturity Available-For-Sale Securities (1)
Bonds:
U.S. government bonds
$
$
$
Foreign government bonds
State and municipal bonds
5,360
6,921
6,921
Public utilities
14,096
17,288
17,288
All other corporate bonds
72,193
85,501
85,501
Mortgage-backed and asset-backed securities
11,196
11,765
11,765
Hybrid and redeemable preferred securities
Total fixed maturity available-for-sale securities
104,174
123,044
123,044
Equity Securities
Common stocks:
Public utilities
Banks, trusts and insurance companies
Industrial, miscellaneous and all other
Non-redeemable preferred securities
Total equity securities
Trading securities
4,072
4,501
4,501
Mortgage loans on real estate (2)
16,972
18,219
16,763
Real estate
N/A
Policy loans
2,426
N/A
2,426
Derivative investments (3)
3,109
3,109
Other investments
3,974
3,974
3,974
Total investments
$
132,670
$
153,956
(1)For investments deemed to have declines in value that are impairment-related, an allowance for credit losses is recorded to reduce the carrying value to their estimated realizable value.
(2)Mortgage loans on real estate are generally carried at unpaid principal balances adjusted for amortization of premiums and accretion of discounts and are net of allowance for credit losses. We carry certain commercial mortgage loans at fair value where the fair value option has been elected.
(3)Derivative investment assets were offset by $906 million in derivative liabilities reflected in other liabilities on our Consolidated Balance Sheets.
‎
FS-2
LINCOLN NATIONAL CORPORATION
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
(Parent Company Only) (in millions, except share data)
As of December 31,
ASSETS
Investments in subsidiaries (1)
$
27,677
$
24,029
Other investments
Cash and invested cash
Loans and accrued interest to subsidiaries (1)
2,960
2,446
Other assets
Total assets
$
31,767
$
27,462
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Common stock dividends payable
$
$
Derivative investments liability
Short-term debt
-
Long-term debt
6,682
6,067
Loans from subsidiaries (1)
1,424
Payables for collateral on investments
Other liabilities
Total liabilities
9,068
7,773
Contingencies and Commitments
Stockholders’ Equity
Preferred stock - 10,000,000 shares authorized
-
-
Common stock - 800,000,000 shares authorized
5,082
5,162
Retained earnings
8,686
8,854
Accumulated other comprehensive income (loss)
8,931
5,673
Total stockholders’ equity
22,699
19,689
Total liabilities and stockholders’ equity
$
31,767
$
27,462
(1)Eliminated in consolidation.
‎
FS-3
LINCOLN NATIONAL CORPORATION
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Parent Company Only) (in millions)
For the Years Ended December 31,
Revenues
Dividends from subsidiaries (1)
$
$
$
1,025
Interest from subsidiaries (1)
Net investment income
Realized gain (loss)
-
Total revenues
1,001
1,183
Expenses
Operating and administrative expenses
Interest - subsidiaries (1)
Interest - other
Total expenses
Income (loss) before federal income taxes, equity in income (loss) of subsidiaries
Federal income tax expense (benefit)
(45
)
(52
)
(42
)
Income (loss) before equity in income (loss) of subsidiaries
Equity in income (loss) of subsidiaries
(172
)
Net income (loss)
1,641
Other comprehensive income (loss), net of tax:
Unrealized investment gains (losses)
3,192
5,288
(3,449
)
Foreign currency translation adjustment
(9
)
Funded status of employee benefit plans
(28
)
(7
)
Total other comprehensive income (loss), net of tax
3,258
5,266
(3,465
)
Comprehensive income (loss)
$
3,757
$
6,152
$
(1,824
)
(1)Eliminated in consolidation.
‎
FS-4
LINCOLN NATIONAL CORPORATION
SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
STATEMENTS OF CASH FLOWS
(Parent Company Only) (in millions)
For the Years Ended December 31,
Cash Flows from Operating Activities
Net income (loss)
$
$
$
1,641
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Equity in (income) loss of subsidiaries greater than distributions (1)
(243
)
(756
)
Realized (gain) loss
-
(2
)
(3
)
Change in federal income tax accruals
Other
(27
)
Net cash provided by (used in) operating activities
Cash Flows from Investing Activities
Capital contribution to subsidiaries (1)
(518
)
(50
)
(502
)
Net change in collateral on investments, derivatives and related settlements
(303
)
(279
)
Net cash provided by (used in) investing activities
(821
)
(329
)
(413
)
Cash Flows from Financing Activities
Payment of long-term debt, including current maturities
(1,096
)
(308
)
(537
)
Issuance of long-term debt, net of issuance costs
1,289
1,094
Payment related to early extinguishment of debt
(13
)
(42
)
(23
)
Increase (decrease) in loans from subsidiaries, net (1)
Increase (decrease) in loans to subsidiaries, net (1)
(514
)
(70
)
(48
)
Common stock issued for benefit plans
(7
)
(20
)
(6
)
Repurchase of common stock
(275
)
(550
)
(900
)
Dividends paid to common stockholders
(311
)
(303
)
(289
)
Other
(6
)
-
-
Net cash provided by (used in) financing activities
(368
)
(285
)
(657
)
Net increase (decrease) in cash, invested cash and restricted cash
(463
)
(200
)
Cash, invested cash and restricted cash as of beginning-of-year
Cash, invested cash and restricted cash as of end-of-year
$
$
$
(1) Eliminated in consolidation.
‎
FS-5
LINCOLN NATIONAL CORPORATION
SCHEDULE III - CONDENSED SUPPLEMENTARY INSURANCE INFORMATION
(in millions)
Column A
Column B
Column C
Column D
Column E
Column F
Other
Future
Contract
DAC and
Contract
Unearned
Holder
Insurance
Segment
VOBA
Benefits
Premiums (1)
Funds
Premiums
As of or For the Year Ended December 31, 2020
Annuities
$
3,782
$
4,183
$
-
$
35,218
$
Retirement Plan Services
-
22,912
-
Life Insurance
1,723
20,127
-
39,797
Group Protection
5,986
-
4,280
Other Operations
-
10,507
-
7,265
Total
$
5,812
$
40,814
$
-
$
105,405
$
5,372
As of or For the Year Ended December 31, 2019
Annuities
$
3,790
$
3,862
$
-
$
29,493
$
Retirement Plan Services
-
20,553
-
Life Insurance
3,519
16,249
-
39,941
Group Protection
5,601
-
4,113
Other Operations
-
10,699
-
7,837
Total
$
7,694
$
36,420
$
-
$
98,018
$
5,513
As of or For the Year Ended December 31, 2018
Annuities
$
3,660
$
3,509
$
-
$
23,493
$
Retirement Plan Services
-
19,761
-
Life Insurance
6,151
13,139
-
40,997
Group Protection
5,396
-
3,383
Other Operations
-
12,596
-
6,785
Total
$
10,264
$
34,648
$
-
$
91,233
$
4,601
(1)Unearned premiums are included in Column C, future contract benefits.
‎
FS-6
LINCOLN NATIONAL CORPORATION
SCHEDULE III - CONDENSED SUPPLEMENTARY INSURANCE INFORMATION (Continued)
(in millions)
Column A
Column G
Column H
Column I
Column J
Column K
Benefits
Amortization
Net
and
of DAC
Other
Investment
Interest
and
Operating
Premiums
Segment
Income
Credited
VOBA
Expenses
Written
As of or For the Year Ended December 31, 2020
Annuities
$
1,272
$
1,245
$
$
1,467
$
-
Retirement Plan Services
-
Life Insurance
2,823
6,077
-
Group Protection
3,505
1,120
-
Other Operations
-
-
Total
$
5,510
$
11,600
$
1,294
$
4,138
$
-
As of or For the Year Ended December 31, 2019
Annuities
$
1,140
$
1,248
$
$
1,463
$
-
Retirement Plan Services
-
Life Insurance
2,658
5,616
-
Group Protection
3,041
1,134
-
Other Operations
-
-
Total
$
5,223
$
10,660
$
1,368
$
4,352
$
-
As of or For the Year Ended December 31, 2018
Annuities
$
1,005
$
1,465
$
$
1,428
$
-
Retirement Plan Services
-
Life Insurance
2,697
4,759
-
Group Protection
2,460
-
Other Operations
-
-
Total
$
5,085
$
9,403
$
1,204
$
3,955
$
-
‎
FS-7
LINCOLN NATIONAL CORPORATION
SCHEDULE IV - CONSOLIDATED REINSURANCE
(in millions)
Column A
Column B
Column C
Column D
Column E
Column F
Ceded
Assumed
Percentage
to
from
of Amount
Gross
Other
Other
Net
Assumed
Description
Amount
Companies
Companies
Amount
to Net
As of or For the Year Ended December 31, 2020
Individual life insurance in-force (1)
$
1,653,625
$
674,256
$
7,875
$
987,244
0.8%
Premiums:
Life insurance and annuities (2)
10,474
1,621
8,941
1.0%
Accident and health insurance
2,830
2,802
0.2%
Total premiums
$
13,304
$
1,656
$
$
11,743
As of or For the Year Ended December 31, 2019
Individual life insurance in-force (1)
$
1,524,977
$
628,654
$
7,611
$
903,934
0.8%
Premiums:
Life insurance and annuities (2)
10,725
1,545
9,262
0.9%
Accident and health insurance
2,773
2,748
0.3%
Total premiums
$
13,498
$
1,579
$
$
12,010
As of or For the Year Ended December 31, 2018
Individual life insurance in-force (1)
$
1,420,500
$
667,900
$
8,700
$
761,300
1.1%
Premiums:
Life insurance and annuities (2)
9,742
1,509
8,314
1.0%
Accident and health insurance
2,299
2,273
0.4%
Total premiums
$
12,041
$
1,543
$
$
10,587
(1)Includes Group Protection segment and Other Operations in-force amounts.
(2)Includes insurance fees on universal life and other interest-sensitive products.
FS-8