The Treasury Department’s decision to expand the scope of the Capital Purchase Program (CPP) to include the nation’s largest insurance companies has created an understandable dilemma for the newly eligible insurers, raising the question of whether or not to accept Treasury’s offer.
On one hand, the global economic outlook, especially as it pertains to the near term direction of the world’s most advanced economies, remains shrouded in uncertainty. A prudent course of action would be to accept the CPP funds as an “insurance policy” against a potential deterioration of credit markets. However, the government’s unprecedented and often irrational intervention into the daily business activities of both commercial banks and auto makers has not gone unnoticed by insurance industry executives, who must now assess the risks of allowing Uncle Sam to insert himself into the insurance industry’s capital structure.
Furthermore, they are forced to estimate a highly unknown yet crucial variable: How will the label “TARP recipient” influence the perceptions and behaviors of potential policy purchasers? At the time of this writing, four of the six major insurers have declined to participate in the CPP program, leaving Hartford (NYSE:HIG) and Lincoln (NYSE:LNC) as the remaining undecided companies. Although we expect Lincoln to accept at least a portion of the $2.5B it was offered by Treasury, we do not believe that the decision, assuming that the choice is to accept the capital, is indicative of any weakness in the company’s current capital cushion, or the expected performance of its investment portfolio.
A review of Lincoln’s most recent 10-Q reveals that, despite an intense recessionary environment, the Company was able to increase revenue in several areas during Q1 ‘09 as compared to Q1 ’08. Insurance premiums increased by 2% or $9M, Group Protection revenue was up 6% or $23M, and revenue for the Insurance Solutions business segment as a whole increased by 3% or $44M. Judging by the revenue picture as a whole, it is clear that the Company was able to weather the bout of consumer panic that ensued following the Lehman collapse quite well, and has not suffered from the collapse in revenue streams that has plagued many companies over the past year. In fact, the Company received 10% less revenue from surrender fees in Q1 ’09 than in Q1 ’08, indicating that clients did not feel the need to “cash out” of policies.
The Company has also taken several prudent and appropriate steps towards bolstering its financial condition. $500M in debt was recently paid down, the dividend has been reduced to 1 cent, and extensive cost-cutting has been deployed, which the Company projects will save up to $250M.
In terms of capital adequacy, Lincoln estimates that its risk based capital ratio currently stands at 380%. To put the figure in perspective, the NAIC considers a RBC ratio in excess of 200% to be indicative of a well-capitalized institution. With an RBC ratio nearly twice of what would be observed at a healthy institution, it appears that Lincoln is not in need of assistance under the CPP program. This reality supports our overall point, which is that for an already well capitalized institution, the receipt of CPP money should be viewed as a net positive. The fact that Lincoln does not require the money to continue operating its business will serve to weaken the government’s influence over business decisions in the event that the Company does opt to receive the funding.
Ultimately, if Lincoln does in fact enter the CPP program, we will view the decision as a testament to Lincoln’s executive team and their ability to act in accordance with the Company’s fiduciary duties to both its shareholders and policyholders. Should the economy take a turn for the worse, it is quite likely that the insurers who declined to participate in CPP will be faced with the embarrassing task of returning to Treasury and requesting entry into the program. Such an about -face would adversely affect the credibility of management and call into question the ability of those executives to navigate economic uncertainties.
We expect Lincoln to accept CPP funding, anticipate that it will be viewed in hindsight as the correct decision, and in the long term, believe the decision will reap rewards for Lincoln stockholders.
Disclosure: No position in HIG or LNC. The author is registered to sell products offered through Lincoln National Corp.
InfoNgen was used to research the content of this article.