(By Mani) Lincoln National Corp. (NYSE:LNC) is a deep value play in life insurance sector, given its disciplined growth strategy through its industry leading distribution; and its capital management flexibility.
Philadelphia-based Lincoln National had assets under management of $168 billion as of June 30, 2012. Through its affiliated companies, it offers annuities; life, group life, disability and dental insurance, 401(k) and 403(b) plans, and savings plans. The company does its business in the name of Lincoln Financial.
Despite the challenges it faced as a result of the financial crisis, the company's industry leading distribution power remains intact. The company is in a strong capital position even after it spent s over $860 million in share repurchases and dividends, as well as $225 million of net debt repayment since the fourth quarter of 2010.
Given the company's emphasis on not being the price/feature leader in the market, its variable annuity (VA) product features appear to be less aggressive when compared to competitors.
"We would argue that across these variables, LNC has been positioned at the "safer" end of the industry, which has allowed it to maintain its consistent market presence without any large swings in sales," UBS analyst Suneet Kamath wrote in a note to clients.
The company has also showed willingness to "pivot" across product should any product become less favorable in a particular macro environment.
For instance, the company dialed sales of universal life products back, which has been its bread-and-butter, as these products contain a significant amount of interest rate risks that are exacerbated by the current low interest rate environment.
On the other hand, it shifted its emphasis to the "pivot products" such as indexed universal life, variable universal life, and term life products.
"One benefit of LNC's "willingness to shrink" is the impact on free cash flow. Every $1 of lower life insurance premium, LNC frees up $1 of capital, which can be redeployed for further share repurchase," Kamath said.
However, the company has underperformed the market since Sept. 30, 2008 as its stock performance has demonstrated a strong correlation with the 10-year Treasury yield, on concerns over the company's exposure to interest rates through its life insurance and annuity products. Investors, too, are keenly focused on the impact of low interest rates.
However, the company's own stress scenario suggests it would still have a capital margin of $700 million to $800 million in an environment that includes a 10-year Treasury yield of 1.5 percent in 2012 and worse trends in other macro variables such as equity market levels, unemployment rates and credit losses relative to what is the case currently.
"As such, our assumption is that any potential reserve build due to low rates would likely be much lower than what appears to be priced into the stock and a few years away. Over this period, LNC would continue to generate capital (i.e., add to book value), suggests the stock is being overly penalized for this issue," Kamat said.
Separately, Lincoln National has indicated that its life insurance reserves are roughly $8 billion redundant assuming a new investment rate of 4-4.5 percent. A 10-year Treasury yield of 2 percent for 10 years would reduce this "excess" by roughly $2 billion to $6 billion.
"While it is likely that the reduction in excess reserves assuming a 1.5% 10-year Treasury yield would not be linear, to us, a $6 billion cushion starting point seems to imply the stock is overly discounting this concern," the analyst added.
For the second quarter, Lincoln National earned $324 million or $1.10 per share, compared to $304 million or 95 cents per share for the year-ago quarter. Total revenues for the second quarter grew to $2.90 billion from $2.81 billion a year ago. Analysts polled by Thomson Reuters expected the company to earn $1.00 per share on revenue of $2.86 billion for the second quarter.
The continued capital redeployment should eventually ease investors' concern over interest rate risk and reserve adequacy. As of June 30, 2012, book value per share of common stock was $38.68 up 5 percent from $36.73 a year ago.