Fitch Affirms Lincoln National Corp.'s Ratings; Outlook Stable

CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of Lincoln National Corporation (LNC), including its 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 follows at the end of this release.

Today's rating actions follow Fitch's periodic review of LNC, and reflect the company's improving overall operating performance, good risk-adjusted capitalization, strong competitive position and diverse distribution network, and capable management team. The company'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.

LNC reported net income of $813 million in 2010, up from a loss of $520 million in 2009. For the first quarter of 2011, the company reported net income of $339 million, up from $265 million in the first quarter of 2010. Profitability in 2009 was heavily affected by realized investment losses and other-than-temporary impairments on investments, as well as a $730 million pre-tax impairment charge associated with its annuity operation and remaining media assets. 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.

LNC's statutory capital adequacy is in line with Fitch's expectations. Total adjusted statutory capital of LNC's insurance operating subsidiaries increased by 6.1% in 2010, to $7.1 billion. The increase was driven primarily by statutory earnings, and was net of $684 million in dividends to LNC. The growth in the company's statutory capital was 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. LNC's reported RBC ratio benefits from the use of captive reinsurance associated with the company's variable annuity guarantees and excess life reserves, and this has been factored into Fitch's view of statutory capitalization.

Fitch's concern about LNC's significant equity market exposure reflects the company's 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, although the company has taken steps that Fitch believes have partially mitigated its exposure to this issue. Currently, the company uses a combination of letter of credit-supported reserve financing provided by affiliated reinsurance companies and other structured solutions supported by the issuance of long-term senior notes by the company. The company also introduced in 2010 new secondary guarantee UL products that are designed to be more capital efficient, allowing the company to meet profitability targets and still finance reserves on balance sheet. Fitch would view positively 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 the average for similarly rated peers. At March 31, 2011, under Fitch's current criteria for treatment of hybrids in capital and leverage analysis, LNC's equity credit-adjusted leverage as reported was 22%. Last week LNC issued $300 million of senior unsecured notes, the proceeds of which are expected to be used to redeem the entire outstanding amount of the company's $275 million in 6.75% capital securities due in 2066. The new issuance and subsequent redemption will result in an equity credit-adjusted financial leverage of approximately 23% pro forma as of March 31, 2011, which remains below Fitch's maximum expectation of 25%. However, under Fitch's proposed revised criteria as outlined in 'Exposure Draft: Proposed Revision to Criteria for Treatment of Hybrids in Capital and Leverage Analysis', dated Feb. 10, 2011, LNC's equity credit-adjusted financial leverage is estimated to be between 28% and 29%, which is modestly above expectations for the rating. Fitch anticipates that LNC will, over the next 12-18 months, reduce its equity credit-adjusted leverage through a combination of the repayment of maturing debt, growth in shareholders' equity, and other strategies to lower its interest expense.

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 $198.3 billion, and common equity was $13.1 billion at March 31, 2011.

The key rating drivers that could result in an 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.

The key rating drivers that could result in a 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;

--The company'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';

--6.2% senior notes due Dec. 15, 2011 at 'BBB+';

--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+';

--7.00% 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 Capital VI

--Trust preferred securities at 'BBB-'.

Lincoln National Life Insurance Company

Lincoln Life & Annuity Company of New York

First Penn-Pacific Life Insurance Company

--IFS at 'A+'.

Applicable Criteria and Related Research:

--'Insurance Rating Methodology' (March 31, 2011);

--'Life Insurance Rating Methodology' (March 31, 2011);

--'Fitch's Approach to Rating Insurance Groups' (March 24, 2010).

Applicable Criteria and Related Research:

Insurance Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=614266

Life Insurance Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=612905

Fitch's Approach to Rating Insurance Groups

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=586765

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