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

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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.

Following several years of adjustments to product features and pricing, the profitability of Lincoln’s current variable annuity product line is improving and the company has been able to generate returns on equity above 20 percent, helped in part by higher-than-expected fees driven by rising equity markets. Lincoln has also been able to maintain relatively stable variable annuity production since the financial crisis. Recently, as some large competitors pulled back from the market, variable annuity sales for Lincoln and others increased, on more favorable terms for the insurers. Lincoln’s variable annuity sales increased to $10.3 billion as of the end of September 2013, already surpassing the $9.8 billion of full-year 2012 sales.

Lincoln’s quarterly variable annuity sales levels have been very stable. The company’s 6 percent to 7 percent market share of the variable annuity sector has made it the fifth-largest participant in the sector for each of the past five years, according to the Morningstar Annuity Research Center.

Shachar Gonen is assistant vice president, analyst, at Moody’s Investor Service. This analysis appeared in Moody’s Credit Outlook for Nov. 4, 2013. The entire report can be found here.

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