As of December 31, 2008, LNC and our subsidiaries owned or leased approximately 3.9 million square feet of office space. As of December 31, 2008, we leased 0.4 million square feet of office space in Philadelphia, Pennsylvania for the Investment Management segment and for LFN. Beginning in the second quarter of 2008, we leased 0.2 million square feet of office space in Radnor, Pennsylvania for our corporate center and for LFD. We owned or leased 0.8 million square feet of office space in Fort Wayne, Indiana, primarily for our Retirement Solutions - Annuities and Retirements Solutions - Defined Contribution segments. We owned or leased 0.8 million square feet of office space in Greensboro, North Carolina, primarily for our Insurance Solutions - Life Insurance segment. We owned or leased 0.3 million square feet of office space in Omaha, Nebraska, primarily for our Insurance Solutions - Group Protection segment. An additional 1.4 million square feet of office space is owned or leased in other U.S. cities and the U.K. for branch offices and other operations. As provided in Note 14, the rental expense on operating leases for office space and equipment totaled $63 million for 2008. This discussion regarding properties does not include information on investment properties.
Certain reclassifications have been made to prior periods’ financial information. Included in these reclassifications is the change in our definition of segment operating revenues and income (loss) from operations as discussed above. In addition, we have reclassified the results of certain derivatives and embedded derivatives to realized gain (loss), which were previously reported within insurance fees, net investment income, interest credited or benefits. The associated amortization expense of deferred acquisition costs (“DAC”) and value of business acquired (“VOBA”) (previously reported within underwriting, acquisition, insurance and other expenses), deferred sales inducements (“DSI”) (previously reported within interest credited), deferred front-end loads (“DFEL”) (previously reported within insurance fees) and changes in contract holder funds (previously reported within benefits) have also been reclassified to realized gain (loss). See “Basis of Presentation” in Note 1 for details.
Legislative, regulatory or tax changes, both domestic and foreign, that affect the cost of, or demand for, LNC’s products, the required amount of reserves and/or surplus, or otherwise affect our ability to conduct business, including changes to statutory reserves and/or risk-based capital (“RBC”) requirements related to secondary guarantees under universal life and variable annuity products such as Actuarial Guideline 43 (also known as “VACARVM”); restrictions on revenue sharing and 12b-1 payments; and the potential for U.S. Federal tax reform;
In March 2007, the FASB Board ratified the consensus reached in EITF Issue No. 06-10, “Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements” (“EITF 06-10”). EITF 06-10 requires an employer to recognize a liability related to a collateral assignment split-dollar life insurance arrangement in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” if the employer has agreed to maintain a life insurance policy during the employee’s retirement. In addition, based on the split-dollar arrangement, an asset should be recognized by the employer for the estimated future cash flows to which the employer is entitled. The adoption of EITF 06-10 can be recognized either as a change in accounting principle through a cumulative-effect adjustment to retained earnings or through retrospective application to all prior periods. The consensus is effective for fiscal years beginning after December 15, 2007, including interim periods within those fiscal years.
Assets” (“EITF 99-20”) for holders of beneficial interests to estimate cash flow using current information and events that a market participant would use in determining the current fair value and other-than-temporary impairment of the beneficial interest. FSP 99-20-1 removes the reference to a market participant and requires that an other-than-temporary impairment be recognized in earnings when it is probable that there has been an adverse change in the holder’s estimated cash flows from the cash flows previously projected, which is consistent with the impairment model used in SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” FSP 99-20-1 is effective for interim and annual reporting periods ending after December 15, 2008, and must be applied prospectively at the balance sheet date of the reporting period for which the assessment of cash flows is made. We adopted the guidance in FSP 99-20-1 as of December 31, 2008. The adoption did not have a material impact on our consolidated financial condition or results of operations.
SFAS No. 160 - Noncontrolling Interests in Consolidated Financial Statements - an Amendment of Accounting Research Bulletin No. 51
See Note 16 for a comprehensive listing of realized gain (loss) reported on our Consolidated Statements of Income.
The carrying values of securities pledged under securities lending agreements were $427 million and $655 million as of December 31, 2008 and 2007, respectively. The fair values of these securities were $410 million and $634 million as of December 31, 2008 and 2007, respectively. The carrying value and fair value of the collateral payable held for derivatives is $2.8 billion as of December 31, 2008. We did not have a collateral payable for derivatives as of December 31, 2007.
Our hedging strategy is designed to mitigate the risk and income statement volatility caused by changes in the equity markets, interest rates and volatility associated with living benefit guarantees offered in our variable annuities including the Lincoln SmartSecurity® Advantage guaranteed withdrawal benefit (“GWB”) feature, the 4LATER® Advantage GIB feature and the i4LIFE® Advantage GIB feature that is available in our variable annuity products. Certain features of these guarantees, notably our GIB and 4LATER® features have elements of both insurance benefits accounted for under SOP 03-1 and embedded derivatives accounted for under SFAS 133 and SFAS 157. We weight these features and their associated reserves accordingly based on their hybrid nature. The change in estimated fair value of the portion of guarantee features that are considered to be derivatives under SFAS 133 is reported in net income. The hedging strategy is designed such that changes in the value of the hedge contracts generally offset changes in the value of the embedded derivative of the GWB and GIB. As part of our current hedging program, equity markets, interest rates and volatility in market conditions are monitored on a daily basis. We rebalance our hedge positions based upon changes in these factors as needed. While we actively manage our hedge positions, our hedge positions may not be totally effective to offset changes in assets and liabilities caused by movements in these factors due to, among other things, differences in timing between when a market exposure changes and corresponding changes to the hedge positions, extreme swings in the equity markets and interest rates, market volatility, contract holder behavior, divergence between the performance of the underlying funds and the hedging indices, divergence between the actual and expected performance of the hedge instruments, or our ability to purchase hedging instruments at prices consistent with our desired risk and return trade-off.
We use foreign currency swaps, which are traded over-the-counter, to hedge some of the foreign exchange risk of investments in fixed maturity securities denominated in foreign currencies. A foreign currency swap is a contractual agreement to exchange the currencies of two different countries at a specified rate of exchange in the future. Gains or losses on foreign currency swaps hedging foreign exchange risk exposure on foreign currency bond coupon payments are reclassified from accumulated OCI to net income as the related bond interest is accrued.
We are subject to annual tax examinations from the Internal Revenue Service (“IRS”). During the third quarter of 2008, the IRS completed its examination for tax years 2003 and 2004 resulting in a proposed assessment. We believe a portion of the assessment is inconsistent with the existing law and are protesting it through the established IRS appeals process. We do not anticipate that any adjustments that might result from such audits would be material to our consolidated results of operations or financial condition. We are currently under audit by the IRS for years 2005 and 2006. The Jefferson-Pilot subsidiaries acquired in the April 2006 merger are subject to a separate IRS examination cycle. For the former Jefferson-Pilot Corporation and its subsidiaries, the IRS is examining tax year ended April 2, 2006.
Included in the business sold to Swiss Re through indemnity reinsurance in 2001 was disability income business. As of December 31, 2008, there were approximately $1.0 billion of reserves on this business. Under the reinsurance agreement with Swiss Re, there was a recoverable of approximately $900 million and a corresponding funds withheld liability of approximately $840 million. As previously disclosed, we had entered into arbitration regarding Swiss Re’s obligation to pay reinsurance recoverables on certain of this disability income business. As of December 31, 2008, the amount due from Swiss Re was approximately $53 million related to this disability income business. In late January 2009, we were notified of the arbitration panel’s decision to order a rescission of the underlying reinsurance agreement. As a result of the ruling, a rescission of the reinsurance agreement previously in place would result in our writing down this receivable. However, we expect that such a write-down would be partially offset by other items including the release of our embedded derivative liability related to the funds withheld nature of the reinsurance agreements for this business. We believe that the rescission will result in the elimination of the recoverable and corresponding funds withheld liability as well as our being responsible for paying claims on the business and establishing sufficient reserves to support the liabilities. Because the decision leaves it to the parties to effectuate the rescission, we expect to begin negotiations with Swiss Re regarding various aspects of the rescission. In addition, we would expect to carry out a review of the adequacy of the reserves supporting the liabilities. We are also currently evaluating our options in light of the arbitration panel’s ruling; however, based on currently available information and our views of the manner in which the rescission will be effectuated, we do not currently expect the rescission to have a material adverse effect on our results of operations, liquidity or capital resources.
The revolving credit facilities allow for borrowing or issuances of letters of credit (“LOCs”). Because commitments associated with LOCs may expire unused, these amounts do not necessarily reflect our future cash funding requirements, however the issuance of LOCs reduces availability of funds from the credit facilities. These LOCs support our reinsurance needs and specific treaties associated with our reinsurance business sold to Swiss Re in 2001. LOCs are used primarily to satisfy the U.S. regulatory requirements of domestic clients who have contracted with the reinsurance subsidiaries not domiciled in the U.S. and for reserve credit provided by our affiliated offshore reinsurance company to our domestic insurance companies for ceded business.
Federal and state regulators continue to focus on issues relating to fixed and variable insurance products, including, but not limited to, suitability, replacements and sales to seniors. Like others in the industry, we have received inquiries including requests for information regarding sales to seniors from the Financial Industry Regulatory Authority, and we have responded to these inquiries. We continue to cooperate fully with such authority.
Information with respect to DIUS restricted stock units classified as equity was as follows:
Segment operating revenues and income (loss) from operations are internal measures used by our management and Board of Directors to evaluate and assess the results of our segments. Income (loss) from operations is GAAP net income excluding the after-tax effects of the following items, as applicable:
Operating revenues represent GAAP revenues excluding the pre-tax effects of the following items, as applicable:
See Note 1 for a description of the reclassification of certain derivatives and embedded derivatives, which resulted in increases (decreases) to total revenues and total benefits and expenses of $68 million, $(24) million, $(47) million, $(41) million and $(7) million, for the three months ended March 31, 2008, December 31, 2007, September 30, 2007, June 30, 2007 and March 31, 2007, respectively.