Fitch Ratings has affirmed Lincoln National Corporation's (LNC) long-term Issuer Default Rating (IDR) at 'A-', and the Insurer Financial Strength (IFS) ratings of LNC's insurance operating subsidiaries at 'A+'. The Rating Outlook is Stable. A full list of rating actions is shown below.
Fitch's rating actions reflect LNC's improving overall operating performance, solid risk-adjusted capitalization, strong competitive position, diverse distribution network and capable management team. LNC's ratings also reflect the significant exposure of its earnings to the performance of equity markets, above average financial leverage, and longer-term issues around funding the growth in reserves associated with secondary guarantees on universal life policies.
For the nine months ended Sept. 30, 2011, LNC reported net income of $808 million, up from $785 million and a net loss of $587 million for the same period in 2010 and 2009, respectively. Profitability in 2009 was heavily affected by realized investment losses and other-than-temporary impairments on investments, as well as a $602 million pre-tax impairment charge associated with its annuity operations. In addition to much lower impairments, 2010 and 2011 profitability has been supported by higher asset-based fee revenue, improved spread income from interest-sensitive products, and lower amortization of intangibles.
Fitch considers LNC's statutory capital adequacy to be strong and, based upon current estimates of risk-based capital (RBC), modestly above Fitch's expectations for the company's current rating. Total adjusted statutory capital of LNC's insurance operating subsidiaries increased by 6.1% in 2010, to $7.1 billion, and has increased an additional 7.1% to an estimated $7.6 billion at Sept. 30, 2011. The increase has been driven primarily by statutory earnings, and was net of $684 million in dividends to LNC in 2010 and $550 million through the first three quarters of 2011. Growth in LNC 's statutory capital has been key to an improvement in its reported risk-based capital (RBC) ratio, which improved from 450% of the company action level at Dec. 31, 2009, to 491% at Dec. 31, 2010. The use of captive reinsurance associated with LNC's excess life reserves and variable annuity guarantees benefits the level of reported RBC in the case of excess life reserves, and benefits the stability of reported RBC in the case of variable annuity guarantees. This has been factored into Fitch's view of LNC's statutory capitalization.
Fitch's concern about LNC's significant equity market exposure reflects above average exposure to the variable annuity business. While LNC has in place a hedging program that has been effective in mitigating the risk associated its variable annuity business, Fitch remains concerned about capital and earnings volatility in an unexpected, but still plausible, severe stress scenario.
Fitch also remains concerned about LNC's reserve funding challenges and pricing risk associated with the its exposure to no lapse guarantee universal life (UL) insurance. However, LNC has taken meaningful steps that Fitch believes have partially mitigated its exposure to this issue. Currently, LNC uses a combination of letter of credit-supported reserve financing provided by affiliated reinsurance companies and other structured solutions supported by LNC's issuance of long-term senior notes. LNC also introduced in 2010 new secondary guarantee UL products that are designed to be more capital efficient, which should allow LNC to meet the business's profitability targets and still finance reserves on balance sheet. Fitch would view positively continued substantive progress in LNC's ability to implement long-term solutions for reserve financing that more closely align asset/liability duration and reduce refinancing risks.
Fitch considers LNC's current financial leverage to be above-average for similarly rated peers. At Sept. 30, 2011, under Fitch's current criteria for treatment of hybrids in capital and leverage analysis, LNC's financial leverage was approximately 27%. This is modestly above Fitch's expectations of 25% or below for LNC's current rating. Fitch anticipates that LNC will reduce its financial leverage over the next 12-18 months through a combination of the repayment of maturing debt, growth in shareholders' equity, and other strategies to lower its interest expense.
Fitch has completed a review of the strategic importance of LNC's rated insurance operating companies. In accordance with Group Rating Methodology, Fitch has changed the strategic category for First Penn-Pacific Life Insurance Company (First Penn-Pacific) to Important from Core. This determination was driven in part by the fact that First Penn-Pacific is no longer writing new business. While Fitch believes First Penn-Pacific does provide some strategic value to the combined group, in Fitch's opinion, the value provided does not meet the threshold necessary to remain Core to the group. Despite the change in First Penn-Pacific's category of strategic importance, given the broader LNC group's willingness and ability to provide support, it has retained the group IFS rating of 'A+'.
Lincoln National Corp., headquartered in Radnor, PA, markets a broad range of insurance and asset accumulation products and financial advisory services primarily to the affluent market segment. The company's consolidated assets were $197.7 billion, and common equity was $14.9 billion at September 30, 2011.
Key rating triggers that may precipitate a rating upgrade include:
--Capital and earnings above current expectations for a prolonged period;
--Trend of holding company liquidity managed at 12-18 months of debt service and common stock dividends;
--Trend of leverage maintained between 20-25% with EBIT coverage in the range of 8x-10x.
Conversely, key rating triggers that may lead to a rating downgrade include:
--Capital and earnings below expectations for a prolonged period. Fitch would expect RBC of 400% under normal conditions and 325% under stressed conditions;
--Leverage maintained above 30% and Total Financing and Commitments ratio above 1.5x;
--Cash coverage at hold co below 1.0x interest/dividend needs;
--Reputational or legal issues, due to sales misconduct, for example, that could materially affect the company's competitive position;
--Industry wide negative tax or regulatory changes that materially affect LNC's operating profitability or competitiveness;
-- LNC's GAAP-based interest coverage remains below 5x for an extended period of time;
--LNC triggers a debt covenant.
Fitch has affirmed the following ratings with a Stable Outlook:
Lincoln National Corporation
--Long-term IDR at 'A-';
--Short-term IDR at 'F2';
--CP at 'F2';
--5.65% senior notes due Aug. 27, 2012 at 'BBB+';
--4.75% senior notes due Jan. 27, 2014 at 'BBB+';
--4.75% senior notes due Feb. 15, 2014 at 'BBB+';
--4.30% senior notes due June. 15, 2015 at 'BBB+';
--7% senior notes due March 15, 2018 at 'BBB+';
--8.75% senior notes due July 1, 2019 at 'BBB+';
--6.25% senior notes due Feb. 15, 2020 at 'BBB+';
--4.85% senior notes due June 24, 2021 at 'BBB+
--6.15% senior notes due April 7, 2036 at 'BBB+';
--6.3% senior notes due Oct. 9, 2037 at 'BBB+';
--7% senior notes due June. 15, 2040 at 'BBB+';
--7% junior subordinated debentures due May 17, 2066 at 'BBB-';
--6.05% junior subordinated debentures due April 20, 2067 at 'BBB-'.
Lincoln National Life Insurance Company
Lincoln Life & Annuity Company of New York
First Penn-Pacific Life Insurance Company
--IFS at 'A+'.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Insurance Rating Methodology' (Sept. 22, 2011)
--'Lincoln National Corporation and Insurance Operating Subsidiaries' (Sept. 21, 2011).
Applicable Criteria and Related Research:
Insurance Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=651018
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.
Contacts:
Fitch Ratings
Brian Bertsch, +1-212-908-0549
Media Relations,
New York
brian.bertsch@fitchratings.com
or
Primary
Analyst:
Bradley S. Ellis, CFA, +1-312-368-2089
Director
Fitch,
Inc.
70 W. Madison St., 13th Floor
Chicago, IL 60602
or
Secondary
Analyst:
Douglas L. Meyer, CFA, +1-312-368-2061
Managing
Director
or
Committee Chairperson:
Martha L. Butler, CFA,
+1-312-368-3191
Senior Director