The pages to follow review LNC's results of operations and financial condition. Historical financial information is presented and analyzed. Where appropriate, factors that may affect future financial performance are identified and discussed. Actual results could differ materially from those indicated in forward-looking statements due to, among other specific changes currently not known, subsequent significant changes in: the company (e.g., acquisitions and divestitures), financial markets (e.g., interest rates and securities markets), legislation (e.g., taxes and product taxation), regulations (e.g., insurance and securities regulations), acts of God (e.g., hurricanes, earthquakes and storms), other insurance risks (e.g., policyholder mortality and morbidity) and competition.
Individual Markets: Strong sales in recent years contributed to record income from operations for individual markets in 1997. Income from operations was $71.9 million, a 44% increase over 1996. Very favorable life mortality throughout the year was an integral factor in the strong performance. Sales volume, measured by face amount of new business, was a record $39.5 billion in 1997.
Total Return Strategy: LNC follows a total return strategy that focuses on the economic value of its assets in addition to current income. This approach permits LNC to be more effective in its asset-liability management efforts, since decisions can be made based upon the true economic value of assets and true economic value of liabilities. The total return approach requires the evaluation of risk and expected return of each asset class utilized.
Equity in Earnings of Unconsolidated Affiliates This line was added to the consolidated statements of income in 1994 to report the earnings from the remaining 29% ownership following LNC's sale of 71% of the ownership of its primary direct writer of employee life-health benefit coverages. LNC sold its 29% interest in this company in October 1995. This accounts for the minimal amounts since that date. In 1998, equity in earnings of unconsolidated affiliates is expected to increase due to the investment in a 49% joint venture in Mexico in December 1997, known as Seguros Serfin Lincoln.
Federal Income Taxes Federal income taxes decreased from $147.7 million in 1996 to $12.7 million in 1997 as the result of a decrease in pre-tax earnings. Federal income taxes increased $34.7 million or 31% in 1996 as the result of an increase in the pre-tax earnings.
Assets. While LNC invests in equity assets with the expectation of achieving higher returns than would be available in its core fixed-income investments, the returns on, and values of, these equity investments are subject to somewhat greater market risk than its fixed income investments. These investments, however, add diversification benefits to LNC's fixed income investments. The table below shows the sensitivity of price changes to LNC's equity assets owned as of December 31, 1997.
Derivatives Hedging Equity Risks. LNC has two programs hedging equity market risk in annuities issued in the U.K. and U.S. that contain equity features.
Information with respect to incentive plan stock options outstanding at December 31, 1997 is as follows:
Disability Income Claims The liability for disability income claims net of the related asset for amounts recoverable from reinsurers at December 31, 1997 and 1996 is a net liability of $1,654,000,000 and $1,561,000,000, respectively, excluding deferred acquisition costs. The December 31, 1997 amount includes a change in estimate for this liability (see note 2 on page 43). This liability is based on the assumption that recent experience will continue in the future. If incidence levels and/or claim termination rates fluctuate significantly from the assumptions underlying the reserves, adjustments to reserves could be required in the future. Accordingly, this liability may prove to be deficient or excessive. However, it is management's opinion that such future development will not materially affect the consolidated financial position of LNC. LNC reviews reserve levels on an ongoing basis.
Personal Accident Programs LNC's Reinsurance segment accepts personal accident reinsurance programs from insurance companies. Most of these programs are presented to the company by independent brokers who represent the ceding companies. Certain excess of loss personal accident reinsurance programs created in the London market during 1993-1996 are producing significant losses. Such programs represented approximately 2.5% of the total programs written during this period. Based on a review of the programs, LNC strengthened its reserve for losses during the fourth quarter of 1997 by $175,000,000 (see note 2 on page 43). This reserve is based on various estimates that are subject to considerable uncertainty. Accordingly, this reserve may prove to be deficient or excessive. However, it is management's opinion that such future development will not materially affect the consolidated financial position of LNC. LNC is involved in an on-going investigation to determine the way these programs were designed and to evaluate all legal and other remedies which may exist to minimize future losses.
The future commitments include amounts for space and equipment to be used by the personnel that were added on January 2, 1998 as a result of the purchase of a block of individual life and annuity business (see note 11 on page 64).
A reconciliation and discussion of the notional or contract amounts for the significant programs using derivative agreements and contracts is as follows:
Minority Interest - Preferred Securities of Subsidiary Companies. Fair values for minority interest- preferred securities of subsidiary companies are based on quoted market prices less the unamortized cost of issue.