Every quarter, the S&P Dow Jones Indices organization (a joint venture between S&P Global and CME Group) initiates actions to rebalance the S&P 500 index. The reshuffling removes companies that don't meet the index's requirements and replaces them with newcomers that do, thus keeping the index fresh and in compliance with its mandate. This month, Blackstone(NYSE: BX) was added to the index, while fellow financial stock Lincoln National(NYSE: LNC) got the boot.
Lincoln National has faced challenges over the past few years, which were compounded over the last several quarters. Here's why the company is no longer in the S&P 500.
Lincoln National's struggles
Companies are removed from the S&P 500 index for several reasons. Generally, businesses that are struggling financially or whose market capitalization falls below a certain threshold are on the short list of candidates to be removed. Companies must have a market cap of at least $14.5 billion to get added to the benchmark index. Lincoln Financial's market cap has fallen well below that threshold and currently stands at $4.37 billion.
Its market cap was $14.1 billion a little over a year ago, but it fell like a rock as the company navigated several challenges. In 2020, Lincoln National and all of its life insurance peers struggled amid the pandemic, which caused an uptick in pandemic-related mortalities.
Many life insurers bounced back from the challenges, and stocks like Aflac and Unum Group recovered strongly, returning investors 84% and 135%, respectively, since the start of 2021. Lincoln National lost 42%.
LNC total return level data by YCharts.
A change in assumptions resulted in a multibillion-dollar loss
The pandemic was brutal for many life insurers, but Lincoln National's struggles multiplied last year when it made significant changes to assumptions around its guaranteed universal life policies.
In last year's third quarter, Lincoln National made a $2.2 billion change in life insurance reserves due to policyholders over 75 being more likely to keep their policies active. What resulted was a $2.6 billion loss and a credit rating downgrade from stable to negative by Fitch Ratings.
Compounding Lincoln's problems earlier this year was the failure of SVB Financial's Silicon Valley Bank in March. Lincoln National held $89 million in Silicon Valley's unsecured debt, equal to 1.1% of its year-end surplus. While the amount of exposure wasn't significant, it still brought more negativity to the already struggling company.
Lincoln National is taking steps to shore up its capital position
Lincoln National's financial position worsened last year, too. One crucial metric where we can see this is in its risk-based capital (RBC) ratio. Regulators use this ratio to track how much insurers must hold to cover liabilities. The ratio measures an insurer's surplus and must be above 200% to avoid regulator action.
Lincoln National holds itself to a higher standard, aiming to keep this above 400%. At the end of last year, it dipped to 377%, forcing management to take action.
The insurer suspended all share buybacks during the year, raised $1 billion in preferred stock, cut expenses, and changed its focus to low-guarantee products. At the end of the second quarter, its RBC ratio was still below its target and hovered around 380%.
Image source: Getty Images.
The investor takeaway on Lincoln National
Lincoln National struggled during the pandemic, and then a change in assumptions around some of its annuity products put it on the defensive to rebuild its capital ratios.
Despite the drop in the stock price, Lincoln National trades at 1.2 times its tangible book value, above its 10-year average of 1.06. The insurer has worked to improve its business and balance sheet, but it hasn't been enough, which is why it's now out of the S&P 500 index. Investors will want to avoid the stock until its situation improves.
10 stocks we like better than Lincoln National
When our analyst team has a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
They just revealed what they believe are the ten best stocks for investors to buy right now... and Lincoln National wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of September 18, 2023
SVB Financial provides credit and banking services to The Motley Fool. Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Blackstone and S&P Global. The Motley Fool recommends Aflac and CME Group. The Motley Fool has a disclosure policy.
