Despite missing its third-quarter net income estimate, Lincoln Financial Group and analysts who follow the company had upbeat expectations for the major annuity provider. UBS analysts gave Lincoln National Corp. stock (LNC.N, LNC US) a “buy” rating with a price target of $64. Annuity income from operations was up 6 percent from third-quarter 2014. The percentage of variable annuity deposits, for products without living benefits, was up 3 percent from the same period.

High market volatility, a peak in the mortality rate in the first half of the year and a legal settlement were also cited as contributing factors as outlying negatives.   

“Our franchise remains strong as we delivered double-digit growth in consolidated net flows, which is helping drive underlying earnings growth in all businesses,” Dennis R. Glass, president and CEO for the group, stated in the company's October 28 release. “Our annual assumption review reduced earnings per share without compromising steady growth in book value per share, highlighting the overall strength of our balance sheet.”

During the October 29 earnings call, CEO Glass said the Department of Labor's deliberations over current prohibitions against commissions for financial advisors handling rollovers into VAs are the “biggest focus for LNC, which is pretty optimistic, and the coalition of annuity manufacturers.” They are all “trying to anticipate the outcome, what the rules will be,” while making back-up plans and devising business models, he said. Some proposals involve the use of IRAs, which might allow for commissions.     

It is routine for insurers to review their DAC (deferred acquisition costs – the cost of acquiring a new customer over the duration of the insurance contract) annually. And it's common for them to do this comparison between actual experience and their assumptions during the third quarter. A higher mortality rate in the first half of this year lowered Lincoln's life insurance earnings. But analysts have absorbed the drop as not significant given performance across operations.

Gross annuity deposits in the third quarter were $3.3 billion for net flows of $536 million – a 5 percent decrease from the prior year, but UBS analysts, Suneet Kamath, CFA, and Daniel Berman, along with associate analyst Jack Hwang, noted, “higher-than-expected fixed indexed annuity sales offset lower variable annuity production.”

“Insurers hold capital to back the obligations they make to policyholders and stabilize those values through hedging programs, but market movements can cause that level to fluctuate,” says Tamiko Toland, Managing Director, Retirement Income Consulting for Annuity Insight. “Lincoln’s hedging program missed the mark – technically 'breakage' -- by $18 million, which “is not that bad given that markets in August were very volatile.”

“In fact, Lincoln's actual holding capital still exceeds the requirement for what it ought to hold for its obligations, even with an $18 million 'breakage,'” says Toland. “There is no point at which Lincoln is not covering its obligation to policyholders by any kind of calculation or accounting regime.”

Lincoln's operating EPS of $1.11, for the quarter, also fell below the estimate of $1.53 EPS by UBS, which referred to the drop as “sticker shock,” as well as the analysts' consensus of $1.50 EPS. Net income of $227 million fell below the comparable 2014 third-quarter of  $439 million. Income from operations of $289 million paled with 3Q 2014 of $414 million.  Yet, UBS analysts were satisfied with the overall performance.  UBS analysts Kamath Berman and Hwang wrote in their October 29th report, “...we feel a -13.5 percent normalized ROE (return on equity) in a challenging environment is pretty attractive for a stock trading near book value, and with a cleaner balance sheet post the 3Q:15 DAC charge. We'll take it.”