Turnaround Of Lincoln National Corporation Ongoing

seekingalpha11-02

Lincoln National Corporation is in the midst of a turnaround, recovering from significant setbacks in 2022, particularly in its Life insurance segment.The company has made strategic changes, including...

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Over the last few years, the stock fell significantly from its all-time highs. LNC 5Y Price History (Seeking Alpha) After making some fundamental changes, a gradual recovery has followed. After looking at the progress so far and the newly released third quarter results, I concluded the company has reached important milestones in its transformation, but more remains to be done. Q3 results have created a discount to the balance sheet, so I've ultimately come away viewing LNC as a Buy until the gap closes. The Problems For most of the past decade, Lincoln was on a path of general growth, both in revenue and in earnings. Effects of COVID notwithstanding, 2022 posed a decisive reversal of these trends. Author's display of 10K data Lincoln deals in life insurance and workplace benefits. The setback was primarily driven by the Life business. The biggest hit was a $1.8 billion balance sheet loss, which then-CFO Randy Freitag explained in the Q3 2023 earnings call:  About 70% of the $1.8 billion impact was driven by changes in our long-term expectations around lapsation. As a reminder, a lapse occurs when a policyholder runs out of account value and decides to not pay additional premium to keep their policy in-force. Coming into 2022, we have limited policyholder behavior experience. Combining our own data with a significant amount of experience contained in the industry study that I referenced on last quarter's call gave us the credible data needed to update our assumptions, with the result being that we now are assuming significantly greater persistency than we had been previously.  In short, better data and post-pandemic behaviors indicated that lapses on the Life products would be much lower than expected, creating a larger, long-term liability and pushing Lincoln into unhealthy capital ratios. This forced them to hurry into establishing reserves for this larger liability. Author's display of 10K data In order to stabilize and maintain liquidity, share repurchases declined and halted entirely in 2023. Quarterly Dividend History (Seeking Alpha) Similarly, they stopped increasing their dividend and focused on maintaining current levels. Author's display of 10K data Illustrating the impact that these moves had on tangible book value, we see a sharp drop between 2022 and 2023. Turning It Around In the near-two years that followed, Lincoln began work to transform the business and get it into segments with lower risk and better upside potential. Q4 2023 Company Presentation Toward the end of 2023, management had decided on greater emphasis of the Group Protection segment. These products include disability, accident, vision, dental, and similar types of policies. Q4 2023 Company Presentation They also considered completely rethinking their reinsurance strategy, along with potentially selling off non-core businesses.   Q2 2024 Company Presentation Coming into 2024, sales in the Life products were slowed down in order to address the previous risks.   Q3 2024 Company Presentation With these changes in place, Lincoln began to post improved numbers, with its risk-based capital ratio returning to well over 400% (where it had been prior to 2022). Similarly, leverage ratio has fallen below 30%.   Group Protection Stats (Q3 2024 Company Presentation) Additionally, the company is delivering on its improvements in the Group Protection segment, with margins up and loss ratios on its policies declining. While management continues to guide for further improvements, I believe these signs show that the turnaround is underway and successful so far. Valuation With a financial, I typically prefer to look to tangible book value per share to value a business.   TBV Per Share 10Y History (Seeking Alpha) TBV per share was well over $100 at its peak. Naturally, I don't think Lincoln is under any obligation to return to those levels, particularly as those were based on misguided assumptions about the inherent risks of their Life products. While stabilizing the balance sheet has about doubled the value from its lowest point, the upper limits remain unclear, particularly as management has guided to return to buybacks once more progress is made. Buybacks would have a shrinking effect on TBV per share unless done at a discount. With Q3 results out, there is a slight discount to its TBV per share and additional upside requires us to imagine that Lincoln will continue to grow the balance sheet and not weaken it with buybacks at or above TBV per share. For my part, and given the recency of the troubles and the ongoing nature of the turnaround, I would want to see more of a discount to TBV than is currently priced on the market. Life and Fraternal Market Share (National Association of Insurance Commissioners) That said, I am not terribly worried about Lincoln. Ranked at #6, they are a leading insurer, and the broader market remains highly fragmented. There is opportunity for deeper penetration that will allow for TBV to grow over time. The question, of course, is how they do that, knowing full well that lapses will be lower. As CEO Ellen Cooper explained during Q2 earnings: We view the market as competitive, and it always has been, but largely rational. We have seen an uptick in some new entrants into the market..they have not had a material impact on the market to date. I want to also just mention that success in the Group business is very much predicated on really having the proper balance as we have been messaging between prioritizing margin over growth, and then importantly, operational and service needs. So it's possible, but it doesn't sound easy. With TBV per share over $40, we at least get a modest discount in spite of the challenges. Future Outlook While Q3 results are fresh off the presses, these are the new details that I would keep in mind as more quarters come out  New divestitures of non-core business New business entry (similar to Bermuda operations in Q2) Changes to dividend/buyback policy  Each of these things can directly impact the valuation, both in terms of the current TBV and the growth assumptions we can make going forward. Divestitures in particular would be telling of what they consider to be a low-ROE business and lower TBV per share. Conclusion Lincoln National Corporation seems to be through the worst of its setbacks in 2022. Still, the company is going through evolution and improvement. This could mean that additional upside exists for growth of TBV, and the current price gives a discount for the current value.  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