Lincoln National’s reinsurance of variable annuity guarantees is credit positive

Last Wednesday, Lincoln National Corp. (Baa1 stable) announced that it had entered into an agreement to reinsure living benefit guarantees of up to $4 billion for new variable annuity sales. The transaction is credit positive because it provides full risk transfer for the guarantees and will enhance Lincoln’s risk/return.

In October, Lincoln entered into a reinsurance treaty covering a portion of new sales of its guaranteed living benefit rider on its flagship variable annuity product, Lincoln ChoicePlus Assurance. Under the terms of the treaty, the reinsurer, Union Hamilton Reinsurance, Ltd. (unrated), a subsidiary of Wells Fargo & Company (A2 review for downgrade), will provide 50 percent coinsurance on up to $8 billion of new living benefit guarantee sales occurring through year-end 2014. The reinsurance will only cover the living benefit guarantee, and Lincoln will retain all other product cash flows. Detailed terms of the reinsurance contract have not been disclosed.

The reinsurance agreement does not provide any immediate capital benefits to Lincoln because the transaction covers only prospective business. However, Lincoln’s overall product risk will be reduced given the improved risk and return characteristics of the variable annuity business when the equity market, interest rate, and policyholder behavior risks (e.g., customer decisions on when to lapse the contract, when to utilize lifetime income/withdrawal benefits, etc.) associated with the reinsured portion of the living benefit rider are eliminated.

The reinsurance of variable annuity living benefits is one of the few transactions of its kind since the financial crisis. We believe reinsurers should find variable annuity living benefits more attractive now given pricing increases and the reduced risk profile of current products.