In December 1999, management initiated a plan to change the structure of LNC's internal organization in a manner that, beginning in 2000, will cause the composition of its reportable segments to change. During the first quarter of 2000, execution of the planned changes will be finalized so that for the quarter ending March 31, 2000, decisions about resource allocation and performance assessment will be made separately for a Life Insurance Segment and an Annuities Segment. As of March 31, 2000, financial reporting for the two separate segments will be presented and the corresponding information for earlier periods will be restated to reflect the new segment reporting structure.
Results of Operations (1): The Life Insurance and Annuities segment's financial results, sales, first year premiums, account values and in-force were as follows:
Annuities: Annuities' results for 1999 and 1998 were primarily driven by growth in separate account fee income from variable annuities, along with improved investment spreads on fixed annuity accounts. Separate account fee income generated from variable annuities consists of mortality and expense assessments. Separate account fee income increases proportionately with the growth in the underlying market value of separate account assets. The growth in market value of separate account assets results from variable annuity cash flows (deposits net of withdrawals), market appreciation and investment income associated with the underlying separate account assets. In 1999, the growth in the market value of separate account assets was due primarily to stock market appreciation partially offset by net withdrawals. In 1998, the growth in market value was due primarily to stock market appreciation bolstered by modest net deposits.
Other: Other had an increase in loss from operations of $42.8 million in 1999 and a decrease in income from operations of $22.8 million in 1998. The results for 1999 and 1998 were due primarily to increased expenses for Y2K, branding and other general administrative expenses that were not allocated to the life insurance business or annuities business.
Annuities: Lincoln Life is a leading writer of annuities in the United States, ranking 9th in individual variable annuity sales (VARDS Industry Sales and Asset Survey, 1999). As noted previously, total annuity deposits in 1999 were $4.7 billion.
Exchange Rate Ratio -- U.S. Dollars to Pounds Sterling Average for the Year 1.617 1.658 1.644 1.567 1.582 End of Year 1.615 1.660 1.651 1.713 1.553
The growth in income from operations of $13.7 million or 66% in 1999 was primarily attributable to cost savings related to the downsizing of Lynch & Mayer and the integration of the Lincoln Life 401(k) business into Delaware and an increase in other revenue and fees. Other revenue and fees increased due to an increase in Delaware's accounting and record-keeping fees resulting from an increase in accounts being serviced and an increase in distribution income resulting from higher retail sales by Delaware over 1998.
During the fourth quarter of 1999, LNC determined that part of rent expense related to abandoned office space included in (3) above would not be incurred due to the landlord allowing Lynch & Mayer to surrender the lease, rather than to sublease the space. As a result, the original estimate was reduced by $3.0 million (pre-tax). This reduction was recorded in the fourth quarter of 1999 as a reversal to the restructuring charge and related reserve. All expenditures under this restructuring plan are expected to be completed by the second quarter of 2000. As of December 31, 1999, $13.4 million (pre-tax) has been expended or written-off under this restructuring plan and all 34 positions have been eliminated. In addition, during the fourth quarter of 1999, $1.5 million (pre-tax) associated with lease terminations was released into income.
Corporate interest expense reported within the LNC financing line above was more in 1999 than 1998 due to higher average debt outstanding. Corporate interest expense in 1997 was less than the other years shown due to reduced interest expense and investment earnings in the fourth quarter of 1997 that resulted from the use of proceeds from the sale of discontinued operations (see "Liquidity and Cash Flow" discussion for further details). This benefit did not continue into 1998 as most of these funds were used to purchase blocks of individual life insurance and annuity business in January and October of 1998 (see Note 11 to the consolidated financial statements).
Investment Objective: Invested assets are an integral part of the Life Insurance and Annuities, Lincoln UK and Reinsurance segments' operations. For discussion of external assets under management, i.e. retail and institutional assets, see the Investment Management segment discussion starting on page 19. LNC follows a balanced approach of investing for both current income and prudent risk management, with an emphasis on generating sufficient current income to meet LNC's obligations. This approach requires the evaluation of risk and expected return of each asset class utilized, while still meeting the income objectives of LNC. This approach also permits LNC to be more effective in its asset-liability management, since decisions can be made based upon both the economic and current investment income considerations affecting assets and liabilities.
Securities Available-for-Sale: LNC's entire fixed maturity and equity securities portfolio is classified as "available-for-sale" and is carried at fair value on its balance sheet. Because the general intent of the "available-for-sale" accounting rules is to reflect shareholders' equity as if unrealized gains and losses were actually recognized, it is necessary for LNC to consider all related accounting adjustments that would occur upon such a hypothetical recognition of unrealized gains and losses. Such related balance sheet effects include adjustments to the balances of deferred acquisition costs, policyholder commitments and deferred income taxes. Adjustments to each of these balances are charged or credited directly to shareholders' equity as part of LNC's "available-for-sale" accounting. For instance, deferred acquisition costs are adjusted upon the recognition of unrealized gains or losses since the amortization of deferred acquisition costs is based upon an assumed emergence of gross profits on certain insurance business. In a similar manner, adjustments to the balances of policyholder reserves or commitments are made because LNC has either a contractual obligation or has a consistent historical practice of making allocations of investment gains or losses to certain policyholders. Deferred income tax balances are also adjusted, since unrealized gains or losses do not affect actual taxes currently paid. See Note 3 to the consolidated financial statements for details of the gross unrealized gains and losses as of December 31, 1999.
Net Investment Income: Net investment income increased $126.1 million or 4.7% in 1999 due to a 6.9% increase in mean invested assets offset by a decrease in the yield on investments from 7.36% to 7.21% (all calculations on a cost basis). The increase in mean invested assets in 1999 was due to increased volumes of business in the Life Insurance and Annuities segment. Net investment income increased $430.6 million or 19% in 1998 as the net result of a 20% increase in mean invested assets offset by a decrease in the yield on investments from 7.46% to 7.36% (all calculations on a cost basis). The increase in mean invested assets was the result of increased volumes of business in all the business segments and funds held in Other Operations that were applied toward the purchase of a block of business in October of 1998 (see Note 11 to the consolidated financial statements). The increase in the Life Insurance and Annuities segment includes the impact of the acquisition of the blocks of business in 1998 (see Note 11 to the consolidated financial statements).
LNC's insurance affiliates, as well as other companies in the insurance industry, attempt to minimize the effect of inflation on their revenues and expenses by anticipating inflationary trends in the pricing of their products. Inflation, except for changes in interest rates, does not have a significant effect on LNC's balance sheet due to the minimal amount of dollars invested in property, plant and equipment and the absence of inventories.
LNC businesses have not identified any major problems in their business processing. Minor problems have been resolved quickly. LNC businesses have not experienced any significant interruption in service to clients or business partners or in reporting to regulators.
Other assets 675,669 467,984 ------------- ----------- Total Assets $103,095,733 $ 93,836,260
Change in Estimate for HMO Excess-of-Loss Reinsurance Programs. During the third quarter of 1999, reported claims experience for certain HMO excess-of-loss reinsurance programs deteriorated causing loss ratios to significantly exceed pricing assumptions. The unfavorable loss ratio development related primarily to business written in 1998 and 1997. Time lags in the reporting of claims experience to Lincoln Re by clients and larger than anticipated costs for prescription drugs were significant factors that led to losses exceeding pricing assumptions. As a result of these developments, the reserve level for these programs was deemed inadequate to meet future obligations. Consequently, Lincoln Re took a charge in the third quarter of 1999 of $25.0 million after-tax or $0.12 per share ($38.5 million pre-tax) to strengthen reserves for claims on the HMO excess-of-loss reinsurance programs.
Year Ended December 31 (in millions) 1999 1998 1997 ----------------------------------------------------------------------------------------------- Fixed maturity securities available-for-sale: Gross gain $129.1 $211.7 $240.0 Gross loss (251.7) (211.2) (91.5) Equity securities available-for-sale: Gross gain 97.0 107.8 136.8 Gross loss (36.5) (50.4) (41.8) Other investments 49.3 11.9 (32.3) Associated amortization of deferred acquisition costs, provision for policyholder commitments and investment expenses 15.8 (50.8) (88.6) ------ ------ ------ Total $ 3.0 $ 19.0 $122.6
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures: 8.75% Quarterly Income Preferred Securities 215.0 215.0 8.35% Trust Originated Preferred Securities 100.0 100.0 7.40% Trust Originated Preferred Securities 200.0 200.0 7.75% FELINE PRIDES 230.0 230.0 -------- -------- Total 745.0 745.0 -------- -------- Total Debt $1,917.1 $1,771.8
401(k) and Profit Sharing Plans. LNC also sponsors contributory defined contribution plans for eligible U.S. employees and agents. These plans include 401(k) plans and a profit sharing plan for eligible employees of Delaware Management Holdings, Inc. ("DMH"). LNC's contributions to the 401(k) plans are equal to a participant's pre-tax contribution, not to exceed 6% of base pay, multiplied by a percentage, ranging from 25% to 150%, which varies according to certain incentive criteria as determined by LNC's Board of Directors. LNC's contributions to the profit sharing plan of DMH is equal to an amount, if any, determined in accordance with a resolution of the Board of Directors. Each plan year's contribution is allocated in the proportion that the plan compensation of each eligible participant bears to the total plan compensation of all eligible participants for such plan year. Compensation is defined as all of an eligible participant's plan year earnings and is subject to the limitation of Section 401(a) of the Internal Revenue Code of 1986, as amended. In 1999, 1998 and 1997, the Board of Directors issued a resolution authorizing a 15% contribution. Expense for the 401(k) and profit sharing plans amounted to $29.0 million, $18.8 million and $17.6 million in 1999, 1998 and 1997, respectively.
Year Ended December 31 1999 1998 1997 ------------------------------------------------------------------------------------------------ Dividend yield 2.7% 3.6% 3.8% Expected volatility 29.7% 20.4% 19.0% Risk-free interest rate 5.4% 5.6% 6.6% Expected life (in years) 5.5 6.1 6.0 Weighted-average fair values per option granted $14.31 $9.08 $5.62
LNC and its subsidiaries are involved in various pending or threatened legal proceedings arising from the conduct of business. Most of these proceedings are routine in the ordinary course of business. In some instances, these proceedings include claims for compensatory and punitive damages and similar types of relief in addition to amounts for alleged contractual liability or requests for equitable relief. After consultation with legal counsel and a review of available facts, it is management's opinion that the ultimate liability, if any, under these proceedings will not have a material adverse effect on the consolidated financial position of LNC.
Net Income (Loss) from Continuing Operations: Life Insurance and Annuities $ 504.4 $ 387.8 $ 306.5 Lincoln UK (18.2) 71.7 (106.8) Reinsurance 33.7 102.2 (136.4) Investment Management 24.6 22.0 6.1 Other Operations (includes interest expense) (84.1) (73.9) (47.2) -------- -------- -------- Total Net Income from Continuing Operations 460.4 509.8 22.2 Discontinued Operations -- -- 911.8 -------- -------- -------- Total Net Income $ 460.4 $ 509.8 $ 934.0
Denominator: [number of shares] Weighted-average shares, as used in basic calculation 197,817,053 200,714,158 204,991,114 Shares to cover conversion of preferred stock 491,014 542,038 574,154 Shares to cover non-vested stock 347,145 456,576 417,328 Average stock options outstanding during the period 8,464,229 6,390,310 6,399,078 Assumed acquisition of shares with assumed proceeds and benefits from exercising stock options (at average market price for the year). (6,796,998) (4,840,628) (4,389,900) Average deferred compensation shares 95,236 -- -- ----------- ----------- ----------- Weighted-average shares, as used in diluted calculation 200,417,679 203,262,454 207,991,774
Nine Months Ended September 30, (in millions) 1997 -------------------------------------------------------------------------------------------- Revenue $1,538.5 Benefits and expenses 1,363.6 -------- Pre-tax net income 174.9 Federal income taxes 40.0 -------- Net income from discontinued operations $ 134.9
For the 1998 acquisitions noted above, other intangible assets represent the present value of future profits on the blocks of acquired insurance business. Goodwill is amortized over 40 years and other intangible assets are amortized over the expected lives of the business acquired.