Dividend stocks can be an excellent source of passive income and can help you grow your wealth over time. Companies with stocks that have high dividend yields can be quite appealing. One such dividend stock with a high yield of 8.6% is Lincoln National (LNC 1.42%), a life insurance and retirement benefits company.
While its ultra-high-dividend yield makes it an appealing stock to consider for income investors, the stock price has taken a hit over the last year. That's because it has exposure to SVB Financial, the holding company of Silicon Valley Bank, which was seized by regulators last month. Here's what you should consider before buying Lincoln National for its dividend.
Lincoln National struggled while the insurance industry bounced back
Lincoln National is a holding company that operates multiple insurance and retirement businesses through its subsidiaries. It provides life insurance, group insurance for companies, and retirement planning services.
While life insurers struggled during the pandemic from COVID-19-related mortalities, many staged a recovery last year as claims payouts declined. Since the start of 2022, the iShares U.S. Insurance ETF has gained 5.8%, and some top life insurers saw stock gains of 26% or more during the year. Lincoln National hasn't enjoyed the same success, with the stock price falling 67.8% since the start of last year.
IAK Total Return Level data by YCharts.
What is weighing down Lincoln National?
The insurer's struggles came to light in the third quarter of 2022 when it did its annual review of deferred acquisition costs and reserve assumptions. In that quarter, Lincoln National posted a $2.6 billion loss, with $2.2 billion coming from a change in life insurance reserves the company is required to set aside. The reserve build came as data showed that people over 75 years old were more likely to keep Lincoln National's guaranteed universal life insurance policies than the company expected. There was also a $634 million reduction in life insurance unit goodwill.
These issues weakened Lincoln National and resulted in a rating downgrade from stable to negative by Fitch Ratings. One reason for the rating downgrade was the change in its risk-based capital (RBC) ratio. The RBC is a ratio that regulators use to track how much capital an insurer should hold to cover its liabilities. This ratio measures an insurer's surplus; the higher the percentage, the more sound a company's financial position is.
An RBC below 200% requires regulatory action, but companies hold themselves to a much higher standard for their business. Lincoln National's management team wants to see this ratio above 400%. So when its RBC fell from 427% to 377% by the end of the year, it had to take action and rebuild its capital. To do so, Lincoln National suspended share buybacks through 2023, raised $1 billion through preferred stock, cut expenses, and directed its focus to low-guarantee products.
As if that wasn't enough, Lincoln National also got caught up in the failure of Silicon Valley Bank, holding $89 million in unsecured debt in its parent company, SVB Financial, which equals 1.1% of its total year-end surplus.
Is its dividend sustainable?
Lincoln National doesn't usually pay out a hefty dividend yield; its average dividend yield over the last 10 years is 2.2%. The only reason its dividend currently yields 8.5% is because of the big decline in its share price over the past year. Despite the sell-off, its valuation aligns with recent history.
LNC PE Ratio data by YCharts.
Suneet Kamath, an analyst at Jefferies, cited concern over Lincoln National's financial position in notes to investors in recent months. Kamath estimates that Lincoln National's normalized free cash flow will come in around $200 million in 2023 -- down dramatically from its prior annual level of $900 million. While Kamath expects free cash flow to improve modestly to $400 million or $500 million by 2024, it still "leaves little margin for error."
Lincoln National is working to improve its capital position, but its lackluster performance when other life insurers were recovering has me skeptical. The company said it will suspend its share repurchase program through 2023. Last year it spent $550 million in share repurchases and another $310 million in dividends.
While suspending the share buyback program could keep the dividend payment intact, its financial position has me doubting that its high dividend yield is sustainable. Lincoln National may present an opportunity for investors with a high tolerance for risk. However, income investors looking for a reliable stream of passive income should look elsewhere until the insurer's financial situation improves.
