November 22, 2017 / 5:19 PM / a year ago

Fitch Affirms Lincoln National Corp.'s Ratings; Outlook Revised to Positive

(The following statement was released by the rating agency) NEW YORK, November 22 (Fitch) Fitch Ratings has affirmed the Insurer Financial Strength (IFS) ratings of Lincoln National Corporation's (LNC) life insurance operating subsidiaries at 'A+' (Strong). Fitch has also affirmed LNC's senior unsecured debt at 'BBB+'. The Rating Outlook for all ratings has been revised to Positive from Stable. A full list of rating actions follows at the end of this release. The Positive Outlook reflects LNC's consistently strong operating and financial profile over the last two to three years. Growth in operating earnings has been driven by higher asset-based fee income as well as generally stable in-force mortality experience and improved group segment performance. Fitch views the diversification of business segments as a primary factor in the improving trend in LNC's performance. Fitch considers LNC's current operating profitability to be comparable with higher rated peers and above expectations for the company's current rating category. Continued strong operating performance and maintenance of a strong financial profile are key factors toward considering future positive rating actions. KEY RATING DRIVERS Today's rating actions reflect LNC's strong operating performance, strong reported risk-adjusted capitalization, very strong business profile and strong interest coverage and financial flexibility. LNC's ratings also reflect the above-average exposure of its earnings and capital to interest rates and the performance of equity markets, which is partially mitigated by the company's strong hedging program. LNC reported pre-tax operating earnings of $1.6 billion for the first nine months in 2017, up 9% from the same period in the prior year, and translates to a strong 13.5% return on equity compared to 12.4% as of 2016. The company's varying segments produce a good mix of earnings from service and asset-based fee income, mortality experience and spread income. This diversity has served to dampen earnings volatility at the consolidated level. Improved group segment performance, consistent performance of the retirement business, and strong growth of the company's in-force life insurance have all supported improved consolidated earnings results. Over the last two years, group segment profitability has shown improvement in both profitability and consistency of results as company actions on pricing of its book of business as well as investments in its claims management processes have improved loss ratios. Strong sales and stable in-force performance in life insurance as well as relatively consistent results in the retirement business have also supported the improved earnings trend at the consolidated level. Strong equity markets have supported higher average account values and have been the driver of higher asset based fee income, which has largely offset negative net flows in the annuities segment. Fitch does not view current equity market performance as sustainable, which may pressure the company's asset based fee income going forward. In response to marketplace trends, LNC expanded its annuity offerings over the past year to include broader investment options and product design changes, as well as expanded distribution capabilities. While these efforts are still in early stages, additional incremental sales have been generated as a result and are part of the company's strategy to return to positive net flows for the segment. Fitch considers LNC's statutory capitalization to be strong. The company reported a strong RBC at 489% as of year-end 2016, which is well above the company's stressed scenario RBC target of 400%. LNC's Prism capital model score is 'Strong' for year-end 2016. LNC's financial leverage was within rating expectations at 24% as of Sept. 30, 2017. Over 2015 and 2016, the company prefunded upcoming maturities as well as tendered and redeemed higher coupon debt and replaced with lower coupon debt. As a result, financial leverage remained relatively flat during this time period and declined incrementally over 2017 due to growth in shareholder's equity. Fitch expects leverage to remain in the 20%-25% range. GAAP interest coverage improved to 10.5x for the first three quarters 2017 compared to 7x in 2016. LNC's interest coverage improved significantly through both improvements in earnings and reduced run rate interest expense. The company's lower run rate interest expense was a result of the replacement of maturing debt and the active tender of higher coupon debt with lower coupon debt over the last two to three years. Fitch expects GAAP interest coverage for LNC to remain between 9x and 11x over the intermediate term. Fitch considers LNC's business profile to be Very Strong as one of the top U.S. life and annuity insurance companies with operating scale efficiencies, strong distribution capabilities, a strong brand name, and good business diversification. Fitch's view of LNC's business profile also considers higher earnings exposure to equity markets given the company's asset-based fee businesses and exposure to VA guarantees as well as above-average exposure to reserve funding challenges and interest rate risk associated with universal life insurance policies with secondary guarantees (ULSG). Fitch's concern about the company's equity market exposure reflects its strong position in the VA market and above-average exposure to guarantees associated with its VA book. LNC employs a number of sophisticated ALM testing techniques and hedging strategies to manage and mitigate its exposure to equity market and interest rate risks. Fitch believes that the hedging program has performed very well over the past several years, with hedge assets consistently remaining significantly above VA guarantee liabilities. Fitch expects pressure from ongoing low interest rates to remain a headwind given the company's significant block of spread-based business. Additionally, LNC's exposure to universal life with secondary guarantees, one of the more interest rate sensitive life products, is above-average relative to the industry. LNC's sales of life products with secondary guarantees in 2016 accounted for approximately 33% of the company's total life insurance sales. The company's in-force ULSG block is performing well, and it has not reported any reserve increases associated with the block. RATING SENSITIVITIES Key rating sensitivities that may precipitate a rating upgrade include: --Prolonged strong operating performance generating GAAP Operating ROE in excess of 11% and fixed charge interest coverage of 9.5x; --A Fitch Prism capital model score solidly within the 'Strong' category and reported RBC above 450%; --Trend of holding-company liquidity managed at 12-18 months of debt service and common stock dividends; --Leverage maintained below 25%. Failure to continue meeting the key rating sensitivities for a ratings upgrade will result in revision of the Outlook back to Stable. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Lincoln National Corporation --Long-term IDR at 'A-'; --Short-term IDR at 'F2'; --Commercial Paper at 'F2'; --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+ --4.20% senior notes due March 15, 2022 at 'BBB+'; --4.00% senior notes due Sept. 1, 2023 at 'BBB+'; --3.35% senior notes due March 9, 2025 at 'BBB+'; --3.63% senior notes due Dec. 12, 2026 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 'BB+'; --6.05% junior subordinated debentures due April 20, 2067 at 'BB+'. Lincoln National Life Insurance Company Lincoln Life & Annuity Company of New York First Penn-Pacific Life Insurance Company --IFS at 'A+'. The Rating Outlook is revised to Positive from Stable. Contact: Primary Analyst Nelson Ma, CFA Director +1-212-908-0273 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Bradley S. Ellis, CFA Director +1-312-368-2089 Committee Chairperson Martha M. Butler, CFA Senior Director +1-312-368-3191 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: Additional information is available on Applicable Criteria Insurance Rating Methodology (pub. 26 Apr 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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