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A.M. Best Upholds Lincoln National Rating

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Rating agency A.M. Best has reiterated Lincoln National Corp. (LNC - Free Report) by asserting its credit and financial strength ratings (FSR). This reflects the company’s sustained growth fundamentals along with improved liquidity and book value per share.

Accordingly, A.M. Best affirmed its issuer credit ratings (ICR) of “aa-” and FSR of “A+” for the major subsidiaries of Lincoln, and avowed an “a-” on the holding company’s long-term debt. However, the rating agency has scaled down the ICR and FSR of Lincoln’s separate subsidiary – First Penn-Pacific Life Insurance Co. – to “a+” and “A” from “aa-” and “A+”, respectively. The downgrade was based on the division’s inadequate new business profile. Yet, the outlook for all ratings remains stable.

Overall, the ratings validate Lincoln’s strong and diverse business profile that benefits from improved underwriting results, pricing and distribution channels along with steady investment performance amid the ongoing volatile economic state. The company has also been able to reduce its credit impairments while maintaining a modest financial leverage, coverage ratios and excess liquidity.

These factors have also strengthened Lincoln’s risk-adjusted capitalization and alongside, its competitive leverage against peers such as Manulife Financial Corp. (MFC - Free Report) and Genworth Financial (GNW - Free Report) .

As well, a 50% dividend hike, initiated by Lincoln last month, reflects its strong capital and liquidity position, thereby infusing value-added confidence among investors. Lincoln is expected to further improve its financial leverage in the next 12-18 months, given its prudent capital management.

However, A.M. Best’s optimistic outlook is partially mitigated by some concerns over Lincoln’s declining premiums in fixed annuities and contracting sales in the life insurance business. Moreover, the spread-based business is expected to be consistently hit by the wrath of low interest rate environment that has been shrinking equity returns and constricting the spread.

Additionally, the company has an above-average exposure to variable annuity business, which creates a downward-cyclic effect under the current economic volatility. These factors also limit the growth of alternative investment income. Nevertheless, the rating agency believes that the company’s hedging program is well-placed and an improvement in interest rates and equity markets should enhance its financials.

Earnings Review

Last month, Lincoln reported third-quarter 2012 operating earnings of $1.18 per share significantly surpassing the Zacks Consensus Estimate of $1.01 and the prior-year quarter’s earnings of $1.03 a share, primarily on lower share count.

The modest upside was spurred by improved top line that jumped 16.0% over the prior-year quarter, which was driven by strong distribution network and improved pricing. Moreover, its investment portfolio reflected modest gains, which also drove the book value by 19.5% year over year and return on equity (ROE) to 12.2% from 11.6% in the year-ago period. Lincoln holds excess cash of $600 million as of September 30, 2012.

Based on the pros and cons, the Zacks Consensus Estimate pegs Lincoln’s fourth-quarter 2012 earnings at $1.06 per share, which is about 6% higher than year-ago quarter. For 2012, earnings are expected to grow about 4% over 2011 to $4.33 per share. Over the last 30 days, 14 out of 16 firms have raised their estimates for 2012, while no downward revision was witnessed.

We maintain a Neutral recommendation on Lincoln over the long term. The stock carries a Zacks Rank #2, which implies a Buy rating and indicates slightly improved performance in the near term.

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