LNC and the various Fort Wayne operating businesses own or lease approximately 1.5 million square feet of office space in the Fort Wayne area. The businesses operating in Indianapolis, Indiana; suburban Chicago, Illinois; Philadelphia, Pennsylvania; and areas near London, England own or lease another 1.0 million square feet of office space. An additional 1.6 million square feet of office space is owned or leased in other U.S. cities and foreign countries for branch offices and other smaller operations. The square feet of office space utilized for this third group is less than prior years and will be reduced by approximately 500,000 square feet over the next few years due to the consolidation of offices within the Property-Casualty segment (see note 12 to the consolidated financial statements on page 67). As shown in the notes to the consolidated financial statements (see note 7 to the consolidated financial statements on page 57), the rental expense on operating leases for office space and equipment for continuing operations totaled $71.6 million for 1996. Office space rent expense accounts for $56.5 million of this total. This discussion regarding properties does not include information on investment properties.
Assets(1) --------------------- 71,713.4 63,257.7 48,864.8 47,825.1 39,042.2 Long-term debt ---------------- 626.3 659.3 474.2 422.2 489.8 Minority interest-preferred securities of subsidiary companies(2) ----------------- 315.0 -- -- -- -- Shareholders' equity(1) ------- 4,470.0 4,378.1 3,042.1 4,072.3 2,826.9 Market value of common stock(1) -------------- $52.50 $53.75 $35.00 $43.50 $37.00
Income from operations(1)---------- $434.1 $306.5 $389.8 $343.5 $240.6 Realized gain (loss) on investments, net of related amortization, expenses and taxes --------------- 79.5 136.4 (88.7) 170.3 118.6 Gain (loss) on sale of affiliates/ operating property, net of taxes - -- 39.3 48.8 (98.5) -- Cumulative effect of accounting change (postretirement benefits) - -- -- -- (96.4) -- Net Income --------------------- $513.6 $482.2 $349.9 $318.9 $359.2
The pages to follow review LNC's results of operations and financial condi- tion. 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.
This "Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the audited financial statements and accompanying notes presented on pages 36 through 68.
(2) Income from operations and net income of the annuities and pension sub- segments for 1993 include an increase in the estimate of net investment income ($26.0 million after-tax) related to a refinement in the method used to calculate its estimated effective yields on mortgage-backed securities.
LNC's Life Insurance and Annuities segment reported its seventh consecutive year of record earnings in 1996. Income from operations increased 16% to $290.8 million in 1996 from $251.6 million in 1995. This increase was produced primarily through the continued growth of annuity business in the United States and increased unit-linked life insurance and pension business in the United Kingdom.
Profile The Life Insurance and Annuities segment is composed of the operations of Lincoln National Life ("Lincoln Life"), Lincoln National(UK) plc ("Lincoln (UK)") First Penn-Pacific ("First Penn"), Lincoln Life & Annuity Company of New York and American States Life. As shown above, this segment has combined annuity, 401(k) retirement plan, life insurance and pension account values of $52.3 billion. This segment's family of companies have more than $88 billion of life insurance in-force.
Based in Fort Wayne, Ind., Lincoln Life is the 12th largest life insurer in the United States as measured by assets (Best's Review, Life-Health Edition, September 1996). Lincoln (UK), located in Uxbridge, England, is the 8th largest unit-linked life insurer in the United Kingdom as measured by 1995
First Penn, headquartered in Oakbrook Terrace, Ill., is known for product innovations such as MoneyGuard, a life insurance policy with long-term care benefits. Lincoln Life & Annuity Company of New York, based in Syracuse, N.Y., was established in 1996. American States Life, based in Indianapolis, serves the income protection needs of individuals who are clients of independent agencies associated with American States Insurance Company, LNC's property-casualty affiliate.
Varied Distribution The five companies in LNC's Life Insurance and Annuities segment reach their customers through multiple distribution channels that include career agents, independent agencies, insurance brokers, banks, stockbrokers and financial planners in the U.S. and, in the U.K., a direct sales force and tied agents.
First Penn offers annuities through banks, universal life insurance through independent marketers and life insurance through brokers and Lincoln Financial Group agents. Lincoln Life & Annuity Company of New York distributes annuities, 401(k) and insurance products in the state of New York through brokers. The universal and term life insurance products of American States Life are offered through 4,800 independent property-casualty agencies.
Annuities The combined annuity earnings of Lincoln Life, Lincoln Life & Annuity Company of New York and First Penn grew nearly 11% to a record $165.0 million in 1996. The engine of this growth was a 25% rise in annuity account values, which reached $38.0 billion at the end of the year. Business from Lincoln Life career agents represents half of this total. Business from stockbrokers and financial planners contributes 39% of annuity account values. The remaining 11% is from financial institutions.
The acquisition of a block of group tax-qualified annuity business from UNUM, completed in the fourth quarter of 1996, added $2.7 billion to annuity account values in 1996. With this transaction, Lincoln Life became one of the nation's four largest writers of tax-qualified annuities for employees of non- profit organizations (Best's Policy Reports, July 1996).
According to the most recent statistics available, Lincoln Life was the nation's leading writer of individual annuities and the second largest writer of individual variable annuities in 1995 (Best's Policy Reports, July 1996). Approximately half of Lincoln Life's annuity business is variable and not subject to interest rate risk.
U.S. Life Insurance Operating income from this segment's life insurance operations in the United States was $48.7 million, a 10% increase from 1995. Combined universal life and variable universal life account values increased 9% in 1996 to $2.9 billion. Across the industry, life insurance sales have been flat to declining for several years. Since 1994, however, life insurance sales by Lincoln Life and First Penn have been compounding in excess of 25%.
Lincoln (UK) Income from operations for Lincoln (UK) advanced to $66.0 million in 1996, up from $45.9 million in 1995. Production of new business at LNC's British life insurance and pension company increased 21% in 1996. Twenty-seven percent of the Life Insurance and Annuities segment's $88 billion of life insurance in- force is with this LNC affiliate. Lincoln (UK) grew rapidly in 1995 with the acquisition of two companies. Efforts to realize expense savings from the merging of their operations will continue in 1997. Agent recruitment, training and teleservicing support also are priorities at Lincoln (UK) in 1997.
Pensions Lincoln Life's pension business is focused on 401(k) retirement plan sales and service. By targeting companies with fewer than 100 employees, 90% of which have not yet established 401(k) plans, Lincoln Life's new 401(k) deposits have averaged annual increases of 30% for 10 years. Total 401(k) deposits in 1996 increased 6% over 1995, when total deposits rose 37%. The service capacity demanded by this steep increase in volume has put pressure on 401(k) earnings.
Outlook Annuities growth and transformation benefits figure prominently in this segment's near-term forecast. Annuities grew to 38% of LNC's total operating earnings in 1996 and are expected to continue to drive earnings over the next several years. Access to New York's annuity market through a new subsidiary promises to boost annuity earnings even higher. The initial phase of Lincoln Life's transformation efforts is expected to conclude by the end of 1997. This endeavor aims at raising service levels to match the best service available from Lincoln Life's competitors, including the top mutual fund companies. Results were evident in the closing months of 1996: Increased life insurance and annuity business in the fourth quarter was attributable in part to transformation-related service enhancements.
Sales and In-Force Individual Life Sales (in billions) $ 26.6 $22.7 $19.9 $17.3 $14.0
(1) Income from operations and net income for 1995 and 1993 include the impact of a change in estimate of the reserve level needed for LNC's disability income business ($121.6 million and $32.8 million after-tax, respectively).
LNC's Reinsurance segment, conducted through the Lincoln National Reinsurance companies ("LNRC"), reported record income from operations of $74.0 million in 1996. For the year, LNRC's individual and group life business in-force increased an impressive 13% to $160.9 billion.
Profile LNRC is one of the leading life-health reinsurers in the world, based on net premium income (LNC Report and Swiss Re, Economic Studies, June 1996). LNRC reported to regulatory authorities consolidated, worldwide net premium income of $2.1 billion in 1996. However, LNRC does not peg its stature solely on its size. Nor does it compete primarily on the basis of price. LNRC brings value to the marketplace by expanding the reinsurance concept beyond traditional risk transfer. LNRC develops mass customized risk management solutions to share risk, knowledge, capital and strategic alliance capabilities.
Knowledge Management An underwriting manual introduced by LNRC more than a decade ago quickly set the industry standard for life and health risk selection. This manual is used to assist in making underwriting decisions at approximately 500 North American life and health insurance companies. Lincoln National Risk Management ("LNRM"), an LNRC company, develops proprietary knowledge-based systems that are used throughout the insurance industry.
Five other proprietary knowledge-based systems similarly leverage LNRC's knowledge throughout the industry. A health insurance counterpart to LUS, Individual Medical Expense Underwriting System, is in production. Lincoln Mortality System, patent pending, aids the development of preferred term life products. Life Claim System ("LCS") processes claims for life and disability income coverage. Remote Data Capture is a laptop-based system for agents and brokers to collect and analyze the data necessary to complete or take life insurance applications. Datalliance [registered trademark], an electronic data interchange switchboard, links agents, insurers, information sources and reinsurers.
Group Markets LNRC's mass customization approach is well suited to the group life and health market's wide range of clients, which includes life and health insurers, financial services companies, HMOs and other managed health care entities, self-funded employer coverage plans and associations. Operating earnings from group life and health business in 1996 decreased $6.2 million from the previous year to $19.0 million. An increase in claims was the primary factor. Total revenue in the group markets grew 16% to $289.5 million.
Financial Reinsurance As the financial reinsurance marketplace evolves, regulatory changes have spurred a move away from using reinsurance as a means of providing capital for insurance companies. However, LNRC's financial reinsurance operating earnings grew by more than $6 million in 1996 to $16.4 million, halting a two-year decline. Trends are emerging that represent growth opportunities in this business. For example, as the property-casualty insurance industry consolidates, some companies are seeking financial reinsurance and finite risk solutions rather than traditional catastrophic reinsurance. LNRC is well positioned to take advantage of this shift. The use of annuity reinsurance to cover investment risk is another growth opportunity, as is the development of blended reinsurance and capital markets instruments.
LNC took a charge against earnings of $121.6 million, after-tax, in the fourth quarter of 1995 to strengthen reserves related to its direct and reinsurance individual disability income business. The reserves were established assuming that recent experience would continue. If incidence levels or claim terminations vary significantly from LNC's assumptions, further adjustments to reserves may be required.
Outlook LNRC's organizational shift in 1996 to a global reinsurance consultant that senses and responds to client needs with mass customized solutions is expected to significantly enhance revenue growth. LNRC also should benefit by continuing to build partnerships with financial institutions that are entering life insurance markets. LNRC's goal is to exceed $100 million in annual operating earnings by the year 2000.
(4) A company-defined term for losses caused by wind, hail, water (including freezing water) and earthquake, regardless of the size of any individual event, including the catastrophe losses shown above.
(5) The combined loss and expense ratio is the ratio of losses and loss expenses incurred to net earned premiums plus the ratio of underwriting expense to net premiums written.
Profile LNC's Property-Casualty segment consists primarily of American States and its consolidated subsidiaries. American States offers a broad spectrum of personal and commercial lines insurance in most of the United States. The company's market focus is on providing commercial insurance to small-to medium-sized businesses and preferred personal lines coverage to individuals. The greatest concentration of business and market share is in eight "core" states in the Midwest and Pacific Northwest, where half of American States' net written premium is produced. Headquartered in Indianapolis, American States ranks 31st among property-casualty insurers in the United States, as measured by net written premium (A.M. Best Aggregates & Averages, 1996).
Distribution American States has strong, long-term relationships with nearly 4,800 independent local agencies. Two-thirds have represented American States for 10 or more years. Nearly 600 of these agencies are associated with banks.
Commercial Lines Commercial lines business represented 57% of the Property-Casualty segment's total net written premium for 1996. Commercial lines had a $20.8 million underwriting loss in 1996, compared with a $26.9 million loss in 1995. The commercial lines combined ratio improved to 103.2% in 1996, compared with 105.0% in 1995. Natural peril losses contributed 7.6 points to the commercial lines combined ratio in 1996, compared with 5.4 points in 1995.
American States is noted as the nation's second largest writer of commercial lines insurance for small-to medium-sized businesses with 50 or fewer employees and the largest operating through the independent agency system (Conning & Co. Study, 1995). American States targets small-to medium-sized businesses engaged in retail, wholesale, service, contracting and other trades. Its commercial clients include relatively few manufacturing and industrial operations. American States' long-term relationships with independent agencies are especially important in this market: Independent agencies dominate the distribution of commercial lines products to small-to medium-sized businesses.
Automation Edge American States, through interactive systems available in its agents' offices, provides fully automated policy production and services in both personal and commercial lines. The result: It's easier and more economical for an agency to do business with American States. The company uses knowledge-based systems in its claims operation and is implementing knowledge-based underwriting systems in its personal lines business. American States also is developing knowledge-based applications for selected commercial lines business. The company's strides in automation are enabling it to consolidate offices and empower agents at the point of sale.
(1) This segment was added in April 1995 following the acquisition of Delaware Management Holdings, Inc. (see note 12 to the consolidated financial statements on page 67). Assets managed shown above includes data for Delaware Management Holdings, Inc. prior to the April 1995 acquisition.
Profile LNC began reporting Investment Management as a separate business segment in April 1995 when LNC completed its strategic acquisition of Delaware Management Holdings, Inc. ("Delaware"). Although investment management has long been an area of expertise within LNC, the addition of Delaware signaled LNC's intention to expand its role as a money manager and meet its objective to become a top-tier company in the financial services industry. Particular emphasis is being given to accelerating the growth of Delaware's mutual funds operation.
The companies that comprise the Investment Management segment are: Delaware; Lynch & Mayer, Inc.; Vantage Global Advisors, Inc. ("Vantage"); and, through 1996, Lincoln Investment Management, Inc. Delaware is located in Philadelphia. Lynch & Mayer and Vantage each have separate headquarters in New York City. Lincoln Investment Management is based in Fort Wayne, Ind.
Delaware is best known for a conservative, "value" investment style that focuses on stocks with above-average dividend yields. Delaware also is recognized for its small-cap and mid-cap growth investment styles and its expertise in municipal and high-yield bonds. Delaware's London operation adds to the overall international expertise of Lincoln National.
Lynch & Mayer pursues a growth investment style and specializes in mid-cap and large-cap equities, as well as investment partnerships. Vantage invests in undervalued companies that have strong potential for above-average growth. It employs a disciplined, systematic, risk-controlled investment approach.
Distribution Multiple distribution channels enable LNI to deliver its broad range of products to an expanding community of retail and institutional investors. LNI's retail mutual funds are marketed through: regional and national broker/dealers; financial planners; insurance agents, including those associated with the regional marketing offices of Lincoln Life; and banks. LNI's institutional products are marketed primarily by its sales force in conjunction with pension consultants. They also are offered to defined benefit and defined contribution plan sponsors, endowments, foundations and insurance companies.
Delaware is the platform from which LNI has launched a more aggressive retail mutual fund strategy. As part of this strategy, LNC announced plans in January 1997 to acquire Voyageur Fund Managers, Inc. ("Voyageur"). Completion of the acquisition is expected in the spring of 1997. Minneapolis-based Voyageur manages 23 open-end single-state municipal bond funds, nine other open-end retail mutual funds, six closed-end funds, four national tax-free funds and several retail unit investment trusts. The Voyageur acquisition will add $2.8 billion to LNI's assets under management.
Among institutional investment managers, Delaware produced strong results in the value equity category, with a return of 21.1% that qualified as second- quartile performance as measured by Callan's Yield Universe. In the international equity category, Delaware's return of 22.4% exceeded the 6.05% return for its comparative Morgan Stanley Capital International Europe, Australia, Far East index.
(1) Includes results through March 31, 1995. Activity subsequent to that date was recorded within the "Investment Management" segment of business.
The loss from operations shown above includes the earnings from LNC's investment in an unconsolidated affiliate engaged in the employee life-health benefits business (prior to the sale of this holding in October 1995, as described in note 12 to the consolidated financial statements on page 67), certain other operations that are not directly related to the business segments and unallocated corporate revenues and expenses (i.e., corporate investment income, interest expense on short-term and long-term borrowings, and corporate overhead expenses).
Health premiums decreased $16.8 million or 2% in 1996 as a result of increased volumes of business in the Reinsurance segment being more than offset by decreases in the Life Insurance and Annuities segment due to the withdrawal from the disability income business. Excluding the activity of its direct
writer of employee life-health coverages, which was sold in 1994 (see note 12 to the consolidated financial statements on page 67), LNC's health premiums increased $97.5 million or 14% in 1995. The increases in both years were the result of increased volumes of business in the Reinsurance segment.
Property-casualty premiums decreased $70.0 million or 4% in 1996 following decreases of 2% in 1995 and 7% in 1994. These decreases were the result of a program initiated in 1992 that involved a re-evaluation of underwriting actions with a focus on account selection, risk evaluation and pricing. A special emphasis is being placed on reversing the downward trend of the last three years and increasing premiums in 1997. However, the volume of premium that this segment will produce in 1997 is partially dependent upon whether the property-casualty insurance marketplace allows price increases that are necessary to maintain and improve profitability.
Net Investment Income Net investment income increased $114.7 million or 5% in 1996. The impact of a 7% increase in mean invested assets was partially offset by: 1) a decrease in the yield on investments from 7.75% to 7.61% (all calculations on a cost basis) and; 2) a charge of $4.1 million in 1996 versus a benefit of $20.3 million in 1995 from the recurring adjustment of discount on mortgage-backed securities. Net investment income increased $256.6 million or 13% in 1995 as the result of a 5% increase in mean invested assets, an increase in the yield on investments from 7.30% to 7.75% and a benefit of $20.3 million in 1995 versus a charge of $13.2 million in 1994 from the recurring adjustments of discount on mortgaged-backed securities. The increase in mean invested assets for both years was the result of increased volumes of business in the Life Insurance and Annuities segment.
Equity in Earnings of Unconsolidated Affiliates This line was added to the 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. See note 12 to the consolidated financial statements on page 67. Since this holding represented the bulk of LNC's unconsolidated affiliates, the activity in this account was minimal in 1996.
Realized Gain (Loss) on Investments The pre-tax realized gain (loss) on investments, net of related amortization, was $128.1 million, $215.6 million and $(130.8) million in 1996, 1995 and 1994, respectively. The after-tax gain (loss) in 1996, 1995 and 1994 was $79.5 million, $136.4 million and $(88.7) million, respectively. These gains and losses were the result of the sale of investments, write-downs and provisions for losses. During 1996, LNC completed a bulk sale of performing and non-performing mortgage loans and real estate holdings through a sealed bid process. The selling price for these holdings was $6.1 million in excess of the carrying value, resulting in a gain on sale. The losses in 1994 were the result of net realized investment gains being more than offset by: 1) realized investment losses and; 2) writedowns of security investments and provisions for losses for mortgage loans and real estate. The investment losses in 1994, primarily in the second and third quarters, were the result of realizing investment losses to recover capital gains taxes paid in prior years.
were classified as "below-investment-grade" at the time of the write-downs. Also, write-downs and allowances for losses on select mortgage loans on real estate, real estate and other investments were established when the underlying value of the property was deemed to be less than the carrying value. These write-downs and provisions for losses are disclosed within the notes to the accompanying financial statements (see note 3 to the consolidated financial statements on page 46).
Gain on Sale of Affiliates/Operating Property In 1995, LNC recorded the gain on sale of the remaining 29% of the employee life-health benefits company. Also in 1995, LNC recorded an allowance for the expected loss related to its decision to sell certain of its operating properties used in its Property-Casualty segment. In 1994, LNC recorded a gain on the sale of 71% of its interest in its primary direct writer of employee life-health benefits. See note 12 to the consolidated financial statements on page 67 for additional information.
Benefits and Settlement Expenses Life and annuity benefit and settlement expenses decreased $37.7 million or 2% in 1996 as compared to 1995. This decrease was the result of decreased volumes of business and improved mortality in the Life Insurance and Annuities segment being partially offset by increases in volume in the Reinsurance segment. Life and annuity benefit and settlement expenses in 1995 decreased $92.3 million or 4% as compared to 1994. This decrease was the net result of an increase of 6% from the U.S. portion of the Life Insurance and Annuities segment and decreases of 2% from the Reinsurance segment and 60% from the United Kingdom portion of the Life Insurance and Annuities segment. The decrease in the United Kingdom component relates to the change in classification of life and annuity premiums noted above. The increase in life and annuity benefits expense in 1997 is expected to parallel the growth in life and annuity premiums.
Health benefits increased $39.9 million or 6% in 1996 compared to 1995 health benefits after excluding the special addition to the disability income reserve in 1995. Excluding the activity of its primary direct writer of employee life-health benefits, which was sold in 1994 (see note 12 to the consolidated financial statements on page 67), and the special addition to the disability income reserves in 1995, LNC's health benefits increased $92.7 million or 17% in 1995 as the result of increased volumes of business in the Reinsurance segment and Life Insurance and Annuities segment. See note 2 to the consolidated financial statements on page 45 regarding the special addition to the disability income reserve.
Property-casualty benefits decreased by $7.1 million or 1% in 1996 compared to 1995. This decrease is the net result of a reduction in the volumes of insurance being partially offset by increases in catastrophe and storm losses. In 1995, property-casualty benefits decreased by $53.0 million or 4% compared to 1994. This decrease was the net result of moderate decreases in the volume of business being partially offset by increases in catastrophe and storm losses. Assuming average catastrophe and storm loss experience in 1997, the increase in property-casualty benefits is expected to parallel the change in property-casualty premiums.
During the 1997-1999 period LNC's business units are expected to redirect a portion of their internal data processing efforts and contract with outside consultants to ensure that all computer software systems will accommodate dates that extend into the next century. Expenditures for outside consultants, that are above normal system enhancements and upgrades, have been estimated to be $20 million ($13 million after-tax). These expenditures are not material to the consolidated financial statements of LNC.
Federal Income Taxes Federal income taxes increased $34.8 million or 24% in 1996 primarily as the result of an increase in pre-tax earnings. Federal income taxes increased $118.0 million in 1995. This increase was the result of: 1) higher pre-tax earnings in 1995 and; 2) lower 1994 taxes because no tax expense was recorded on the 1994 gain on sale of 71% of LNC's primary direct writer of employee life-health benefit coverages (see note 12 to the consolidated financial statements on page 67). Pre-tax earnings in 1994 were lower than 1993 and 1995 due to: 1) the absence of earnings from subsidiaries sold in 1994 and; 2) the realization of losses on the sale of investments during 1994 versus the realization of gains on investments in 1993 and 1995. Tax benefits from 1994 realized losses result from the carryback of such losses to realized gains recognized in prior years.
Summary Net income for 1996 was $513.6 million compared with $482.2 million in 1995. Excluding realized gain (loss) on investments, gain (loss) on sale of affiliates/operating property and special 1995 additions to the disability income reserves and the after-tax impact of expenses associated with the 1995 charge for realignment of division offices in the Property-Casualty segment, all net of taxes, LNC earned $434.1 million for 1996 compared to $441.8 million in 1995. This decrease is the net result of increased earnings in the Reinsurance and Life Insurance and Annuities segments being more than offset by the decrease in Property-Casualty segment earnings. Net income for 1995 was $482.2 million compared with $349.9 million in 1994. Excluding realized gain (loss) on investments and gain on sale of affiliates/operating property, LNC earned $306.5 million for 1995 compared to $389.8 million in 1994. This decrease is the net result of increased earnings in the Life Insurance and Annuities segment and Investment Management segment being more than offset by decreases within the Reinsurance and Property-Casualty segments.
Investments The investment portfolio, excluding cash and invested cash, is comprised of fixed maturity securities; equities; mortgage loans on real estate; real estate, either wholly owned or joint ventures; and other long-term investments. LNC purchases investments for its segmented portfolios with yield, duration and other characteristics that take into account the liabilities of the products being supported. The total investment portfolio increased $2.1 billion in 1996. This increase was the net result of decreases in the fair value of securities available-for-sale being more than offset by the new purchases of investments from cash flow generated by the business units.
LNC's entire fixed maturity and equity securities portfolio is classified as "available-for-sale" and is carried at fair value. Changes in fair values, net of related deferred acquisition costs, amounts required to satisfy policyholder commitments and taxes are charged or credited directly to shareholders' equity. Note 3 to the consolidated financial statements (see page 46) shows the gross unrealized gains and losses as of December 31, 1996.
Investment in Unconsolidated Affiliates This line was added to the balance sheet in 1994 following LNC's sale of 71% of the ownership of its primary direct writer of employee life-health coverages. The minimal balance at December 31, 1996 and 1995 is due to the October 1995 sale of the remaining 29% ownership in this company. See note 12 to the consolidated financial statements on page 67.
Cash and Invested Cash Cash and invested cash decreased by $341.1 million in 1996. This decrease is the result of investing a portion of the operating cash flow that had previously been invested in short-term investments pending the placement of funds in longer term investments.
Assets Held in Separate Accounts This asset account, as well as the corresponding liability account, increased by $6.0 billion in 1996 as a result of increases in annuity and pension funds under management.
Goodwill The decrease of $22.0 million in this balance sheet account in 1996 represents the amortization for the year.
The property-casualty liabilities for unpaid claims and claims expense were $2.5 billion and $2.6 billion at December 31, 1996 and 1995, respectively. These liabilities include liabilities for environmental claims of $265 million and $256 million, respectively. At December 31, 1996 and 1995, these amounts include approximately $153 million and $140 million of reserve for claims that have been incurred but not reported, and approximately $44 million and $47 million of related claim expenses, respectively. Because of the limited coverages that have been written by LNC, these environmental claims represent only 11% of LNC's total property-casualty policy liabilities (2.3% based on claim counts of direct business) and less than 2% of LNC's total policy liabilities. Paid environmental claims and claim expenses totaled approximately $13.8 million in 1996 compared with approximately $15.5 million in 1995.
In addition to liabilities for environmental claims, LNC has other areas where changes in estimates of related liabilities required could occur in the near term. These areas include claims for disability income coverages, liabilities and recoveries related to inappropriate selling of pension products in the United Kingdom, liabilities for marketing and compliance issues and the reserve for the run-off of group pension annuities (see note 7 to the consolidated financial statements on page 57).
The increase in other liabilities relates to an increase in the expected payouts for security investments purchased in the last few days of 1996 versus a lower volume of such transactions late in 1995.
Shareholders' Equity Total shareholders' equity increased $91.8 million during the year ended December 31, 1996. Excluding the decrease of $263.5 million related to a decline in the unrealized gain (loss) on securities available-for-sale, shareholders' equity increased $358.0 million. This increase in shareholders' equity was the net result of increases due to $513.6 million of net income, $15.0 million from the gain on sale of a minority interest in a subsidiary, $2.8 million from the issuance of common stock related to benefit plans, $53.1 million related to an increase in the accumulated foreign exchange gain and decreases of $194.2 million related to the declaration of dividends to shareholders and $35.0 million for the retirement of common stock.
Capital adequacy is a primary measure used by insurance regulators to determine the financial stability of an insurance company. In the U.S., risk- based capital guidelines are used by the National Association of Insurance Commissioners to determine the amount of capital that represents minimum acceptable operating amounts related to insurance and investment risks. Regulatory action is triggered when an insurer's statutory-basis capital falls below the formula-produced capital level. At December 31, 1996, statutory- basis capital for each of LNC's U.S. life and property-casualty insurance subsidiaries was substantially in excess of regulatory action levels of risk- based capital required by the jurisdiction of domicile except for one property-casualty company. This company is servicing a closed block of business and therefore operates at minimum capital levels.
As noted above, shareholders' equity includes net unrealized gain (loss) on securities available-for-sale. At December 31, 1996, the book value of $43.00 per share included $3.97 of unrealized gains on securities and at December 31, 1995, the book value of $41.89 per share included $6.68 of unrealized gains on securities.
Assets of $15.6 billion supports the biggest category of accumulation and investment oriented insurance products, fixed deferred annuities. For these products, LNC may adjust renewal crediting rates monthly or annually, subject to guaranteed minimums ranging from 3.0% to 4.5%. The higher minimums apply to in-force blocks of older products that no longer are sold. LNC has $3.6 billion in assets supporting universal life insurance on which it has the right to adjust renewal crediting rates subject to guaranteed minimums ranging from 4% to 5% at December 31, 1996. Annuity and universal life insurance customers have the right to surrender their policies at account value less a surrender charge that grades to zero over periods ranging from 5 to 10 years from policy issue date or, in some cases, the date of each premium received.
Other General Account Insurance Products. LNC also has $11.2 billion of assets supporting general account products, including disability income, property casualty insurance and term life insurance. For these products, the liability cash flows may have actuarial uncertainty. However, their amounts and timing do not vary significantly with interest rates. LNC limits interest rate risk by analyzing the duration of the projected cash flows and structuring investment portfolios with similar durations.
Debt. LNC has short-term and long-term debt of which $650.1 million is at fixed rates and $165.2 million is at floating rates. LNC manages the timing of maturities and the mixture of fixed-rate and floating-rate debt as part of the process of integrated management of interest rate risk for the entire enterprise.
LNC believes that the portfolios supporting its accumulation and investment oriented insurance products have a prudent degree of call protection in each category of liability and on a consolidated basis. The mortgage-backed securities ("MBS") portion of the portfolio, including collateralized mortgage obligations ("CMOs"), represents a total of $4.4 billion or 19% of the $22.8 billion of general account assets supporting such products. LNC's MBS portfolio has better call protection than the MBS pass-through market in general. This is because of its 45% concentration in protected amortization class CMOs.
Default Risk. In assessing the risk that the rate of default losses for each category of asset may be higher than the rates assumed in pricing its products, LNC considers the entire $34.0 billion portfolio of invested assets, taking diversification into account. Of this total, $16.5 billion consists of corporate bonds and $3.3 billion consists of commercial mortgages. LNC manages the risk of adverse default experience on these investments by applying disciplined credit evaluation and underwriting standards, prudently limiting allocations to lower-quality, higher-yielding investments, and diversifying exposures by issuer, industry, region and property type. For each counter-party or borrowing entity and its affiliates, LNC's exposures from all transactions are aggregated and managed in relation to formal limits set by rating quality and industry group. LNC remains exposed to occasional adverse cyclical economic downturns during which default rates may be significantly higher than the long-term historical average used in pricing.
Derivatives As indicated in note 7 to the consolidated financial statements (see page 59), LNC has entered into derivative transactions to reduce its exposure to interest rate fluctuations, the widening of bond yield spreads over comparable maturity U.S. Government obligations, foreign exchange risk and fluctuations in Financial Times Stock Exchange ("FTSE") index. A discussion of LNC's seven significant programs using derivative agreements and contracts follows. Six programs are used within the Life Insurance and Annuities segment and the Reinsurance segment. The seventh program relates to foreign exchange risk on an investment in a foreign subsidiary is used within Other Operations.
Year Ended December 31 (in millions) 1996 1997 1998 1999 2000 2001
4) LNC uses exchange-traded financial futures contracts and options on financial futures to hedge against interest rate risks and to manage duration of a portion of its fixed maturity securities. Financial futures contracts obligate LNC to buy or sell a financial instrument at a specified future date for a specified price. They may be settled in cash or through delivery of the financial instrument. Cash settlements on the change in market values of financial futures contracts are made daily. Put options on a financial futures contract give LNC the right, but not the obligation, to assume a long or short position in the underlying futures contract at a specified price during a specified time period.
6) LNC uses a combination of foreign exchange forward contracts, foreign currency options, and foreign currency swaps to hedge some of the foreign exchange risk related to its investments in fixed maturity securities denominated in foreign currencies. The foreign currency forward contracts obligate LNC to deliver a specified amount of currency at a future date at a specified exchange rate. As of December 31, 1996, LNC had a short position in foreign exchange forward contracts with a notional amount of $251.6 million.
Foreign currency options give LNC the right, but not the obligation, to buy or sell a foreign currency at a specific exchange rate during a specified time period. At December 31, 1996, LNC had long and short positions in foreign currency options with notional amounts of $24.7 million and $25.5 million, respectively.
The value of the foreign exchange forward contracts at any given point fluctuates according to the underlying level of exchange rate and interest rate differentials. At December 31, 1996, LNC did not have any open foreign exchange forward contracts related to its investment in subsidiary companies.
The first five programs discussed above are designed to help LNC achieve more stable margins while providing competitive crediting rates to policyholders during periods when interest rates are rising, corporate bond spreads are widening or the FTSE index is rising. Failure to maintain competitive crediting rates could cause policyholders to withdraw their funds and place them in more competitive products. The other two programs discussed above are designed to reduce LNC's risk related to changes in foreign currency exchange rates.
The Consolidated Statements of Cash Flows on page 41 indicate that operating activities provided cash of $1.2 billion, $1.9 billion and $1.2 billion in 1996, 1995 and 1994, respectively. This statement also classifies the other sources and uses of cash by investing activities and financing activities and discloses the amount of cash available at the end of the year to meet LNC's obligations.
LNC's insurance subsidiaries are subject to certain insurance department regulatory restrictions as to the transfer of funds and payments of dividends to the holding company (see note 7 to the consolidated financial statements on page 56). However, these restrictions pose no short-term liquidity concerns for the holding company. The financial strength and stability of the subsidiaries permit ready access to short-term or long-term credit sources for the holding company.
Effect of Inflation As indicated earlier in this review of consolidated operations, inflation affects LNC's revenues and expenses. LNC's insurance affiliates, as well as other companies in the insurance industry, attempt to minimize the effect of inflation 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.
(in millions, except per share) 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
(1) The fourth quarter of 1995 includes a change in estimate related to LNC's disability income business (see note 2 to the consolidated financial statements on page 45).
Series A preferred stock (1996 liquidation value - $2,951) ------------ 1,212 1,335
See notes to the consolidated financial statements on pages 42 - 68.
Gain on sale of affiliates/ operating property ----------------- -- 54,195 48,842
Income Before Federal Income Taxes and Minority Interest ------------ 712,265 626,575 376,281
Series A Preferred Stock: Balance at beginning-of-year ----------- $ 1,335 $ 1,420 $ 1,553 Conversion into common stock ----------- (123) (85) (133) Balance at End-of-Year --------------- 1,212 1,335 1,420
Balance at beginning-of-year ------------ 2,775,718 2,479,532 2,303,731 Net income ------------------------------ 513,558 482,186 349,898 Realized gain (loss) on sale of minority interest in subsidiary ----------------- 34,121 -- --
Dividends declared: Series A preferred stock -------------- (112) (123) (134) Series E and F preferred stock -------- -- (8,532) (17,065) Common stock -------------------------- (194,036) (177,345) (156,898)
Series A Preferred Stock: Balance at beginning-of-year -------- 40,646 43,218 47,289 Conversion into common stock -------- (3,761) (2,572) (4,071) Balance Issued and Outstanding at End-of-Year ------------------- 36,885 40,646 43,218
Series E and F Preferred Stock: Balance at beginning-of-year ------- -- 4,417,897 4,417,897 Conversion into common stock ------- -- (4,417,897) -- Balance Issued and Outstanding at End-of-Year ------------------ -- -- 4,417,897
Shares forfeited under benefit plans -- (112,120) (54,556) (16,403) Retirement of common stock ------------ (694,582) -- (500,000) Balance Issued and Outstanding at End-of-Year --------------------- 103,658,575 104,185,117 94,477,942
Securities available-for-sale: Purchases ----------------------------- (14,310,549)(15,327,959)(13,383,236) Sales --------------------------------- 13,324,606 14,253,858 10,352,938 Maturities ---------------------------- 1,048,306 1,051,471 1,106,687 Purchase of other investments ----------- (2,343,735) (1,770,790) (1,696,570) Sale or maturity of other investments --- 2,195,664 1,103,380 1,755,113 Sale of affiliates ---------------------- -- 186,900 417,367 Purchase of affiliates/business --------- (71,593) (736,966) -- Increase (decrease) in cash collateral on loaned securities ------------------- (97,257) (39,223) (149,597) Other ----------------------------------- (150,972) (148,029) 94,566
Net Cash Provided by (Used in) Financing Activities ----------------- (1,172,616) 38,330 652,485
less allowances for depreciation. The cost for both mortgage loans and real estate and investment real estate is adjusted for declines in value that are other than temporary. Also, allowances for losses are established, as appropriate, for real estate holdings that are in the process of being sold. Real estate acquired through foreclosure proceedings is recorded at fair value on the settlement date which establishes a new cost basis. If a subsequent periodic review of a foreclosed property indicates the fair value, less estimated costs to sell, is lower than the carrying value at the settlement date, the carrying value is adjusted to the lower amount. Any changes to the reserves for mortgage loans on real estate and real estate are reported as realized gain (loss) on investments.
Realized gain (loss) on sale of affiliates/operating property, net of taxes, is recognized in net income. Realized gain (loss) on sale of minority interests in subsidiaries is reflected directly in shareholders' equity net of deferred taxes, if any.
Derivatives. LNC hedges certain portions of its exposure to interest rate fluctuations, the widening of bond yield spreads over comparable maturity U.S. Government obligations, fluctuations in the Financial Times Stock Exchange ("FTSE") index and foreign exchange risk by entering into derivative transactions. A description of LNC's accounting for its hedge of such risks is discussed in the following two paragraphs.
Premiums and Fees. Revenue for universal life and other interest-sensitive life insurance policies consists of policy charges for the cost of insurance, policy initiation and administration, and surrender charges that have been assessed. Traditional individual life-health and annuity premiums are
recognized as revenue over the premium-paying period of the policies. Group health and property-casualty premiums are prorated over the contract term of the policies.
Assets Held in Separate Accounts/Liabilities Related to Separate Accounts. These assets and liabilities represent segregated funds administered and invested by LNC's insurance subsidiaries for the exclusive benefit of pension and variable life and annuity contractholders. The fees received by LNC's insurance subsidiaries for administrative and contractholder maintenance services performed for these separate accounts are included in LNC's consolidated statements of income.
Goodwill and Other Intangible Assets. The cost of acquired subsidiaries or blocks of business in excess of the fair value of net assets (goodwill) is amortized using the straight-line method over periods that generally correspond with the benefits expected to be derived from the acquisitions. Goodwill recorded subsequent to 1994 is amortized over 20 to 25 years. Goodwill arising prior to 1995 is generally amortized over 40 years.
Other intangible assets for the non-insurance subsidiaries (i.e., institutional customer relationships, covenants not to compete and mutual fund customer relationships) have been recorded in connection with the acquisition of an asset management services company. These assets are amortized on a straight-line basis over 6 to 15 years.
Policy Liabilities and Accruals. The liabilities for future policy benefits and expenses for universal and variable universal life insurance policies consist of policy account balances that accrue to the benefit of the policyholders, excluding surrender charges. The liabilities for future policy benefits and expenses for traditional life policies and immediate and deferred
paid-up annuities are computed using a net level premium method and assumptions for investment yields, mortality and withdrawals based principally on company experience projected at the time of policy issue, with provision for possible adverse deviations. Interest assumptions for traditional direct individual life reserves for all policies range from 2.6% to 8.4% graded to 5.7% after 30 years depending on time of policy issue. Interest rate assumptions for reinsurance reserves range from 5.0% to 11.0% graded to 8.0% after 20 years. The interest assumptions for immediate and deferred paid-up annuities range from 4.5% to 8.0%.
Stock Options. LNC recognizes compensation expense for its stock option incentive plans using the intrinsic value method of accounting. Under the terms of the intrinsic value method, compensation cost is the excess, if any, of the quoted market price of the stock at the grant date, or other measurement date, over the amount an employee must pay to acquire the stock.
Fixed maturity securities available-for-sale: Gross gain ----------------------------------- $ 219.5 $ 257.7 $ 87.8 Gross loss ----------------------------------- (214.1) (95.8) (331.2) Equity securities available-for-sale: Gross gain ----------------------------------- 206.9 160.6 92.6 Gross loss ----------------------------------- (54.2) (60.0) (80.8) Other investments ----------------------------- 40.3 61.9 19.6 Related restoration or amortization of deferred acquisition costs, provision for policyholder commitments and capital gains expenses ------- (70.3) (108.8) 81.2 Total -------------------------------------- $ 128.1 $ 215.6 $(130.8)
Fixed maturity securities --------------------- $ 12.3 $ 19.9 $ 19.5 Equity securities ----------------------------- 4.9 3.7 8.7 Mortgage loans on real estate ----------------- 3.1 14.2 18.2 Real estate ----------------------------------- 4.6 (9.2) 14.9 Other long-term investments ------------------- (0.8) (4.6) 1.7 Guarantees ------------------------------------ 0.2 (2.6) 2.5 Total --------------------------------------- $ 24.3 $ 21.4 $ 65.5
The change in unrealized appreciation (depreciation) on investments in fixed maturity and equity securities is as follows:
The cost, gross unrealized gain and loss, and fair value of securities available-for-sale are as follows: Fair December 31 (in millions) Cost Gain Loss Value 1996: Corporate bonds -------------------- $15,934.2 $ 700.0 $ 95.9 $16,538.3 U.S. Government bonds -------------- 1,512.4 52.8 19.5 1,545.7 Foreign governments bonds ---------- 1,671.2 149.6 31.7 1,789.1 Mortgage-backed securities: Mortgage pass-through securities - 1,331.3 28.8 7.0 1,353.1 Collateralized mortgage obligations --------------------- 3,931.3 170.8 11.0 4,091.1 Other mortgage-backed securities - .8 .4 -- 1.2 State and municipal bonds ---------- 2,200.5 138.3 5.5 2,333.3 Redeemable preferred stocks -------- 249.0 7.6 2.0 254.6 Total fixed maturity securities -- 26,830.7 1,248.3 172.6 27,906.4 Equity securities ------------------ 797.2 240.2 44.7 992.7 Total ---------------------------- $27,627.9 $1,488.5 $ 217.3 $28,899.1
Future maturities of fixed maturity securities available-for-sale are as follows: Fair December 31 (in millions) Cost Value
Due in one year or less ------------------------------ $ 585.1 $ 588.1 Due after one year through five years ---------------- 5,450.7 5,611.2 Due after five years through ten years --------------- 6,933.6 7,167.2 Due after ten years ---------------------------------- 8,597.9 9,094.5 Subtotal ------------------------------------------- 21,567.3 22,461.0 Mortgage-backed securities --------------------------- 5,263.4 5,445.4 Total ---------------------------------------------- $26,830.7 $27,906.4
Mortgage loans on real estate are considered impaired when, based on current information and events, it is probable that LNC will be unable to collect all amounts due according to the contractual terms of the loan agreement. When LNC determines that a loan is impaired, the cost is adjusted or a provision for loss is established equal to the difference between the initial cost of the mortgage loan and the estimated value. Estimated value is based on: 1) the present value of expected future cash flows discounted at the loan's effective interest rate; 2) the loan's observable market price or; 3) the fair value of the collateral. The provision for losses is reported as realized gain (loss) on investments. Mortgage loans deemed to be uncollectible are charged against the allowance for losses and subsequent recoveries, if any, are credited to the allowance for losses.
The allowance for losses is maintained at a level believed adequate by management to absorb estimated probable credit losses. Management's periodic evaluation of the adequacy of the allowance for losses is based on LNC's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay (including the timing of future payments), the estimated value of the underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires estimating the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.
Impaired loans with allowance for losses --------- $ 71.9 $150.9 Allowance for losses ----------------------------- (12.4) (29.6) Impaired loans with no allowance for losses ------ 2.3 2.2 Net impaired loans ----------------------------- $ 61.8 $123.5
Balance at beginning-of-year -------------------- $ 29.6 $ 62.7 $226.6 Provisions for losses --------------------------- 3.1 14.2 18.2 Releases due to write-downs --------------------- -- (11.9) -- Releases due to sales --------------------------- (19.9) (20.2) (163.2) Releases due to foreclosures -------------------- (.4) (15.2) (18.9) Balance at end-of-year ------------------------ $ 12.4 $ 29.6 $ 62.7
Average recorded investment in impaired loans --- $139.6 $189.6 $498.1 Interest income recognized on impaired loans ---- 12.7 16.9 38.3
As of December 31, 1996, LNC's investment commitments for fixed maturity securities (primarily private placements), mortgage loans on real estate and real estate were $388,100,000.
For the year ended December 31, 1996, fixed maturity securities available-for- sale, mortgage loans on real estate and real estate investments which were non-income producing were not significant.
Current ----------------------------------------------- $ 16.1 $ (7.2) Deferred ---------------------------------------------- (49.8) (121.2) Total ----------------------------------------------- $(33.7)$(128.4)
Deferred tax liabilities: Deferred acquisition costs ---------------------------- 431.4 415.0 Premiums and fees receivable -------------------------- 55.7 44.6 Gain on investments ----------------------------------- 35.1 -- Net unrealized gain on securities available-for-sale--- 425.4 717.0 Present value of business in-force -------------------- 220.4 148.7 Other ------------------------------------------------- 108.8 113.4 Total deferred tax liabilities ---------------------- 1,276.8 1,438.7
Cash paid for Federal income taxes in 1996, 1995 and 1994 was $143,800,000, $38,300,000 and $70,900,000, respectively. The cash paid in 1995 is net of a $147,400,000 cash refund related to the carryback of 1994 capital losses to prior years.
At December 31, 1996, LNC had net operating loss carryforwards of $149,900,000 for Federal income tax purposes related to its foreign life reinsurance companies that expire in years 2005 through 2009. Delaware Management Holdings, Inc. ("Delaware"), acquired in 1995, has net operating loss carryforwards for Federal income tax purposes of $107,400,000 at December 31, 1996, which expire in the years 2002 through 2010. These carryforwards will only be available to reduce the respective taxable income of the foreign life reinsurance companies and Delaware.
Prior to 1984, a portion of the life companies' current income was not subject to income tax, but was accumulated for income tax purposes in a memorandum account designated as the "policyholders' surplus account". Due to changes in
the tax law, the total of the life companies' balances in their respective "policyholders' surplus accounts" have not increased since December 31, 1983. However, the portion of current income on which income taxes have been paid continues to accumulate in a memorandum account designated as the "shareholders' surplus account", and this balance is available for dividends to shareholders without additional payment of tax. The December 31, 1996 total of the life companies' account balances for their "shareholders' surplus accounts" was $1,855,000,000. Should dividends to shareholders for each life company exceed its respective "shareholders' surplus account", amounts would be transferred from its respective "policyholders' surplus account" and would be subject to Federal income tax at that time. Under existing or foreseeable circumstances, LNC neither expects nor intends that distribution will be made from the $213,600,000 "policyholders' surplus account" that would result in any such tax. Accordingly, no provision for deferred income taxes has been provided by LNC on its "policyholders' surplus account". In the event that such excess distributions were made, it is estimated that income taxes of approximately $74,800,000 would be due.
The balance sheet captions, "Real Estate" and "Property and Equipment," are shown net of allowances for depreciation and valuation allowances for operating property held-for-sale as follows:
Balance at beginning-of-year ----------------- $407.4 $ 38.0 $ 67.7 Acquisitions of insurance companies/business - 163.5 388.7 -- Divestitures of insurance companies ---------- -- -- (25.5) Interest accrued on unamortized balance ------ 37.9 30.7 3.6 Amortization of asset ------------------------ (47.6) (50.0) (7.8) Foreign Exchange Adjustment ------------------ 41.1 -- -- Balance at end-of-year --------------------- 602.4 407.4 38.0 Other intangible assets (non-insurance) ------ 106.0 121.5 4.8 Total other intangible assets at end-of-year ---------------------------- $708.4 $528.9 $ 42.8
Plus: Provision for claims and claim expenses arising in the current year, net of reinsurance ------- 1,245.6 1,234.0 1,340.6 Decrease in estimated claims and claim expenses arising in prior years, net of reinsurance ---- (43.2) (24.5) (78.2) Total incurred claims and claim expenses, net of reinsurance ------------------------- 1,202.4 1,209.5 1,262.4
Total liability for claims and claim expenses at end-of-year, net of reinsurance --------- 2,305.8 2,406.3 2,499.4
The reconciliation shows a decrease of $43,200,000, $24,500,000, and $78,200,000 to the December 31, 1995, 1994 and 1993 liability for claims and claim expenses, respectively, arising in prior years. Such reserve adjustments, which affected current operations during 1996, 1995 and 1994, respectively, resulted from developed claims for prior years being different than anticipated when liabilities for claims and claim expenses were originally estimated. The favorable development trends are reflective of the changes in underwriting practices adopted during the last few years. These development trends have been considered in establishing current year reserves.
Cash paid for interest for 1996, 1995 and 1994 was $79,900,000, $73,200,000, and $47,900,000, respectively.
Pension Plans - U.S. LNC maintains funded defined benefit pension plans for most of its U.S. employees and, prior to January 1, 1995, full-time agents. The benefits for employees are based on total years of service and the highest 60 months of compensation during the last 10 years of employment. The benefits for agents were based on a percentage of each agent's yearly earnings. The plans are funded by contributions to tax-exempt trusts. LNC's funding policy is consistent with the funding requirements of Federal law and regulations. Contributions are intended to provide not only the benefits attributed to service to date, but also those expected to be earned in the future. Plan assets consist principally of listed equity securities, corporate obligations and government bonds.
All benefits applicable to the funded defined benefit plan for agents were frozen as of December 31, 1994. The curtailment of this plan did not have a significant effect on net pension cost for 1994. Effective January 1, 1995, pension benefits for agents have been provided by a new defined contribution plan. Contributions to this plan are based on 2.3% of an agent's earnings up to the social security wage base and 4.6% of any excess.
LNC also sponsors three types of unfunded, nonqualified, defined benefit plans for certain U.S. employees, agents and directors. A supplemental retirement plan provides defined benefit pension benefits in excess of limits imposed by Federal tax law. A salary continuation plan provides certain officers of LNC defined pension benefits based on years of service and final monthly salary upon death or retirement. A retirement plan for outside directors provides benefits based on years of service and the amount of the retainer paid during the last year of service. Due to the adoption of a value sharing plan in 1996, no additional retainer fees are being added to this retirement plan for outside directors.
The status of the funded defined benefit pension plans and the amounts recognized on the balance sheets are as follows:
Actuarial present value of benefit obligation: Vested benefits ---------------------------------------- $(399.2) $(369.7) Nonvested benefits ------------------------------------- (16.3) (20.8) Accumulated benefit obligation ----------------------- (415.5) (390.5) Effect of projected future compensation increases ------ (95.1) (99.4) Projected benefit obligation ------------------------- (510.6) (489.9) Plan assets at fair value ------------------------------ 486.8 449.6 Projected benefit obligations in excess of plan assets ------------------------------- (23.8) (40.3) Unrecognized net loss ---------------------------------- 21.7 43.2 Unrecognized prior service cost ------------------------ 2.7 3.0 Prepaid (accrued) pension cost included in other liabilities ----------------------------------- $ 0.6 $ 5.9
The status of the unfunded defined benefit pension plans and the amounts recognized on the balance sheets are as follows:
Actuarial present value of benefit obligation: Vested benefits --------------------------------------- $(27.6) $(25.4) Nonvested benefits ------------------------------------ (3.1) (3.3) Accumulated benefit obligation ---------------------- (30.7) (28.7) Effect of projected future compensation increases ----- (6.9) (7.5) Projected benefit obligation ------------------------ (37.6) (36.2) Unrecognized transition obligation -------------------- .1 .2 Unrecognized net loss --------------------------------- 5.5 7.3 Unrecognized prior service cost ----------------------- .4 .4 Accrued pension cost included in other liabilities -- $(31.6) $(28.3)
The determination of the projected benefit obligation for the defined benefit plans was based on the following assumptions:
Rate of increase in compensation: Salary continuation plan ---------------------------- 5.5 6.0 6.5 All other plans ------------------------------------- 4.5 5.0 5.0
Expected long-term rate of return on plan assets ---- 9.0 9.0 9.0
Service cost-benefits earned during the year -------- $21.0 $17.0 $22.1 Interest cost on projected benefit obligation ------- 35.0 32.0 30.0 Actual return on plan assets ------------------------ (45.6) (82.4) 9.7 Net amortization (deferral) ------------------------- 7.7 52.4 (40.2) Net pension cost ---------------------------------- $18.1 $19.0 $21.6
401(k) Plans. LNC also sponsors contributory defined contribution plans for eligible U.S. employees and agents. LNC's contributions to the 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. Expense for these plans amounted to $25,400,000, $20,700,000 and $29,400,000 in 1996, 1995 and 1994, respectively.
Postretirement Medical and Life Insurance Benefit Plans. LNC sponsors unfunded defined benefit plans that provide postretirement medical and life insurance benefits to full-time U.S. employees and agents who, depending on the plan, have worked for LNC 10 to 15 years and attained age 55 to 60. Medical benefits are also available to spouses and other dependents of employees and agents. For medical benefits, limited contributions are required from individuals retired prior to November 1, 1988. Contributions for later retirees, which can be adjusted annually, are based on such items as years of service at retirement and age at retirement. Life insurance benefits are noncontributory, however, participants can elect supplemental contributory benefits.
Accumulated postretirement benefit obligation: Retirees -------------------------------------------- $ (73.8) $ (88.7) Fully eligible active plan participants ------------- (22.9) (24.2) Other active plan participants ---------------------- (40.1) (40.0) Accumulated postretirement benefit obligation ----- (136.8) (152.9) Unrecognized gain ----------------------------------- (25.9) (6.3) Accrued plan cost included in other liabilities --- $(162.7) $(159.2)
The fair value of options granted after December 31, 1994, used as a basis for the above pro forma disclosures, was estimated as of the date of grant using a Black-Scholes option pricing model. For 1996, the option pricing assumptions include a dividend yield of 4.1%; an expected volatility of 18%; a risk-free interest rate of 6.5% and an expected life of 5 years. For 1995, the option pricing assumptions include a dividend yield of 4.4%; an expected volatility of 22%; a risk-free interest rate of 6.3% and an expected life of 5 years. The weighted-average fair values per option granted during 1996 and 1995 were $7.35 and $7.15, respectively.
Information with respect to the incentive plans involving stock options is as follows: Options Outstanding Weighted- Shares Average Available Exercise for Grant Shares Price Balance at January 1, 1994 1,332,618 2,441,852 $28.80 Additional authorized ---------- 7,650,000 Granted ------------------------ (442,100) 442,100 39.49 Exercised ---------------------- -- (122,963) 25.43 Expired ------------------------ (7,000) -- -- Forfeited ---------------------- 105,203 (88,800) 33.76 Restricted stock awarded ------- (215,707) Balance at December 31, 1994 - 8,423,014 2,672,189 30.56
Granted ------------------------ (636,500) 636,500 45.69 Exercised ---------------------- -- (273,967) 26.68 Expired ------------------------ (1,600) (1,000) 27.75 Forfeited ---------------------- 151,818 (38,650) 36.03 Restricted stock awarded ------- (55,538) Balance at December 31, 1996 - 7,206,091 3,155,163 36.29
Options Outstanding Options Exercisable Weighted- Average Weighted- Number Weighted- Range of Number Out- Remaining Average Exercisable Average Exercise standing at Contractual Exercise at Exercise Prices Dec 31, 1996 Life (Years) Price Dec 31, 1996 Price $10-$20 51,690 .96 $19.25 51,690 $19.25 21- 30 1,080,811 3.64 25.91 1,080,811 25.91 31- 40 899,976 5.96 39.58 565,261 39.63 41- 50 1,095,236 8.78 44.22 135,257 43.04 51- 60 27,450 9.38 52.23 250 52.85 $10-$60 3,155,163 1,833,269
Restricted stock (non-vested stock) awarded from 1994 through 1996 was as follows:
Year Ended December 31 1996 1995 1994 Restricted stock (number of shares) ------------ 55,538 335,126 215,707 Weighted-average price per share at time of grant -------------------------------------- $46.16 $41.09 $40.56
Statutory Information and Restrictions Net income as determined in accordance with statutory accounting practices for LNC's insurance subsidiaries was as follows:
Shareholders' equity as determined in accordance with statutory accounting practices for LNC's insurance subsidiaries was as follows:
December 31 (in millions) 1996 1995 Life-health insurance --------------------- $2,080.5 $1,908.5 Property-casualty insurance --------------- 919.7 1,004.2
The National Association of Insurance Commissioners is involved in a multi-year project to examine and challenge the appropriateness of current statutory accounting principles. This project could result in changes to statutory accounting practices that could cause changes to the statutory net income and shareholders' equity data shown above.
it is reasonably possible that a change in estimate of required reserve levels could occur in the near term. It is not possible to provide a meaningful estimate of a range of possible outcomes at this time.
Disability Income Claims The liability for disability income claims net of the related asset for amounts recoverable from reinsurers at December 31, 1996 and 1995 is a net liability of $1,561,000,000 and $1,541,000,000, respectively, excluding deferred acquisition costs. This liability is based on the assumption that recent experience will continue in the future. If incidence levels or claim termination rates vary significantly from this assumption, adjustments to reserves may 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 and updates the level of these reserves on an ongoing basis (see note 2 on page 45).
United Kingdom Pension Products Operations in the U.K. include the sale of pension products to individuals. Regulatory agencies have raised questions as to what constitutes appropriate advice to individuals who bought pension products as an alternative to participation in an employer sponsored plan. In cases of inappropriate advice, LNC may have to do extensive investigation and put the individual in a position similar to what would have been attained if the individual had remained in the employer sponsored plan. Liabilities of $86,700,000, which are net of expected recoveries, have been established for the estimated cost of this issue following regulatory guidance as to activities to be undertaken. These liabilities were booked net of expected recoveries of $31,400,000 from previous owners of companies acquired over the last few years as specified in the indemnification clauses of the purchase agreements. These liabilities and recoveries are based on various estimates that are subject to considerable uncertainty. Accordingly, these liabilities 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.
Marketing and Compliance Issues Regulators continue to focus on market conduct and compliance issues. Under certain circumstances companies operating in the insurance and financial services markets have been held responsible for providing incomplete or misleading sales materials and for replacing existing policies with policies that were less advantageous to the policyholder. LNC's management continues to monitor the company's sales materials and compliance procedures and is making an extensive effort to minimize any potential liability. However, due to the uncertainty surrounding such matters, it is not possible to provide a meaningful estimate of the range of potential outcomes at this time.
Group Pension Annuities The liabilities for guaranteed interest and group pension annuity contracts, which are no longer sold by LNC, are supported by a single portfolio of assets that attempts to match the duration of these liabilities. Due to the long-term nature of group pension annuities and the resulting inability to exactly match cash flows, a risk exists that future cash flows from investments will not be reinvested at rates as high as currently earned by the portfolio. Accordingly, these liabilities 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.
Total rental expense on operating leases in 1996, 1995 and 1994 was $71,600,000, $65,600,000 and $51,400,000, respectively. Future minimum rental commitments are as follows (in millions):
Insurance Ceded and Assumed LNC's insurance companies cede insurance to other companies. The portion of risks exceeding each company's retention limit is reinsured with other insurers. LNC seeks reinsurance coverage within the business segments that sell life insurance to limit its liabilities. Industry regulations prescribe the maximum coverage that LNC can retain on an individual insured. As of December 31, 1996, LNC's maximum retention on a single insured was $3,000,000. Portions of LNC's deferred annuity business have also been co-insured with other companies to limit its exposure to interest rate risks. At December 31, 1996, the reserves associated with these reinsurance arrangements totaled $1,817,100,000. Effective January 1, 1997, catastrophe reinsurance arrangements for property-casualty coverages provided for a recovery of an average of approximately 90% of losses in excess of $30,000,000 up to $180,000,000 per occurrence. To cover products other than life and property- casualty insurance, LNC acquires other insurance coverages with retentions and limits that management believes are appropriate for the circumstances. The accompanying financial statements reflect premiums, benefits and settlement expenses and deferred acquisition costs, net of insurance ceded (see note 5 on page 52). LNC's insurance companies remain liable if their reinsurers are unable to meet contractual obligations under applicable reinsurance agreements.
Certain LNC insurance companies assume insurance from other companies. At December 31, 1996, LNC's insurance companies have provided $828,300,000 of statutory surplus relief to other insurance companies under reinsurance transactions. Generally, such amounts are offset by corresponding receivables from the ceding company, which are secured by future profits on the reinsured business. However, LNC's insurance companies are subject to the risk that the ceding company may become insolvent and the right of offset would not be permitted.
Vulnerability from Concentrations At December 31, 1996, LNC did not have a material concentration of financial instruments in a single investee, industry or geographic location. Also at December 31, 1996, LNC did not have a concentration of: 1) business transactions with a particular customer, lender or distributor; 2) revenues from a particular product or service; 3) sources of supply of labor or services used in the business or; 4) a market or geographic area in which business is conducted that makes it vulnerable to an event that is at least reasonably possible to occur in the near term and which could cause a severe impact to LNC's financial condition, except for the market and geographic concentration described in the following paragraph.
Other Contingency Matters LNC and its subsidiaries are involved in various pending or threatened legal proceedings arising from the conduct of business. In some instances, these proceedings include claims for unspecified or substantial 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 these proceedings ultimately will be resolved without materially affecting the consolidated financial position of LNC.
Guarantees LNC has guarantees with off-balance-sheet risks whose contractual amounts represent credit exposure. Outstanding guarantees with off-balance-sheet risks, shown in notional or contract amounts along with their carrying value and estimated fair values, are as follows: Assets (Liabilities) Notional or Carrying Fair Carrying Fair Contract Amounts Value Value Value Value December 31 (in millions) 1996 1995 1996 1996 1995 1995
Industrial revenue bonds ------ $ 36.4 $ 63.5 $(1.8) -- $ (7.1) $ -- Real estate partnerships ------ 3.5 6.4 -- -- -- -- Mortgage loan pass-through certificates ----------------- 50.3 63.6 -- -- -- -- Total guarantees ----------- $ 90.2 $133.5 $(1.8) -- $ (7.1) $ --
Equity indexed derivatives: Call options ------------------ 14.7 13.3 10.5 10.5 8.0 8.0
Foreign currency derivatives: Forward exchange forward contracts: Foreign subsidiary ----------- -- 398.8 -- -- (5.4) (5.4) Foreign investments ---------- 251.6 15.7 (.2) (.2) (.6) (.6) Foreign currency options ------ 50.2 99.2 (.3) (.3) 1.9 1.4 Foreign currency swaps -------- 15.0 15.0 (2.1) (2.1) .4 .4 Total foreign currency derivatives --------------- 316.8 528.7 (2.6) (2.6) (3.7) (4.2)
Interest Rate Caps. The interest rate cap agreements, which expire in 1997 through 2003, entitle LNC to receive payments from the counterparties on specified future reset dates, contingent on future interest rates. For each cap, the amount of such quarterly payments, if any, is determined by the excess of a market interest rate over a specified cap rate multiplied by the notional amount divided by four. The purpose of LNC's interest rate cap agreement program is to protect its annuity line of business from the effect of fluctuating interest rates. The premium paid for the interest rate caps is included in other assets ($20,800,000 as of December 31, 1996) and is being amortized over the terms of the agreements. This amortization is included in net investment income.
Swaptions. Swaptions, which expire in 2002, entitle LNC to receive settlement payments from the counterparties on specified expiration dates, contingent on future interest rates. For each swaption, the amount of such settlement payments, if any, is determined by the present value of the difference between the fixed rate on a market rate swap and the strike rate multiplied by the notional amount. The purpose of LNC's swaption program is to protect the assets supporting its annuity line of business from the effect of fluctuating interest rates. The premium paid for the swaptions is included in other assets ($11,000,000 as of December 31, 1996) and is being amortized over the terms of the agreements. This amortization is included in net investment income.
Mortgage Loans on Real Estate. The estimated fair value of mortgage loans on real estate was established using a discounted cash flow method based on credit rating, maturity and future income when compared to the expected yield for mortgages having similar characteristics. The ratings for mortgages in good standing are based on property type, location, market conditions, occupancy, debt service coverage, loan to value, caliber of tenancy, borrower and payment record. Fair values for impaired mortgage loans are based on: 1) the present value of expected future cash flows discounted at the loan's effective interest rate; 2) the loan's market price or; 3) the fair value of the collateral if the loan is collateral dependent.
Investment Type Insurance Contracts. The balance sheet captions, "Future Policy Benefits, Claims and Claim Expenses" and "Contractholder Funds," include investment type insurance contracts (i.e. deposit contracts and guaranteed interest contracts). The fair values for the deposit contracts and certain guaranteed interest contracts are based on their approximate surrender values. The fair values for the remaining guaranteed interest and similar contracts are estimated using discounted cash flow calculations. These calculations are based on interest rates currently offered on similar contracts with maturities that are consistent with those remaining for the contracts being valued.
The carrying values and estimated fair values of LNC's financial instruments are as follows: Carrying Fair Carrying Fair Value Value Value Value December 31 (in millions) 1996 1996 1995 1995
Fixed maturities securities -------- $27,906.4 $27,906.4 $25,834.5 $25,834.5 Equity securities ------------------ 992.7 992.7 1,164.8 1,164.8 Mortgage loans on real estate ------ 3,273.0 3,386.3 3,186.9 3,371.9 Policy loans ----------------------- 758.2 747.1 602.6 594.7 Other investments ------------------ 459.7 459.7 371.8 371.8 Cash and invested cash ------------- 1,231.7 1,231.7 1,572.9 1,572.9 Investment type insurance contracts: Deposit contracts and certain guaranteed interest contracts --- (18,710.5)(18,328.5)(15,620.2)(15,410.2) Remaining guaranteed interest and similar contracts ----------- (2,539.0) (2,508.7) (3,024.0) (3,125.1) Short-term debt -------------------- (189.0) (189.0) (426.8) (426.8) Long-term debt --------------------- (626.3) (622.7) (659.3) (713.4) Minority interest-preferred securities of subsidiary companies- (315.0) (315.7) -- -- Guarantees ------------------------- (1.8) -- (7.1) -- Derivatives ------------------------ 36.9 24.0 31.4 13.5 Investment commitments ------------- -- .3 -- .8
As of December 31, 1996 and 1995, the carrying value of the deposit contracts and certain guaranteed contracts is net of deferred acquisition costs of $176,000,000 and $336,000,000, respectively, excluding adjustments for deferred acquisition costs applicable to changes in fair value of securities. The carrying values of these contracts are stated net of deferred acquisition costs so that they are comparable with the fair value basis.
LNC has four business segments: Life Insurance and Annuities, Reinsurance, Property-Casualty and Investment Management. The Life Insurance and Annuities segment offers annuities, universal life, pension products and other individual coverages through a network of career agents, independent general agencies, and insurance agencies located within a variety of financial institutions. These products are sold throughout the United States. Similar products are offered within the United Kingdom through sales representatives. Reinsurance sells reinsurance products and services to insurance companies, HMOs, self-funded employers and other primary risk accepting organizations in the U.S. and economically attractive international markets. Effective in the fourth quarter of 1995, operating results of the direct disability income business previously included in the Life Insurance and Annuities segment, were included in the Reinsurance segment. This direct disability income business, which is no longer being sold, is now managed by the Reinsurance segment along with its own disability income business. The Property-Casualty segment writes both commercial and personal coverages throughout most of the United States through a network of independent agencies. The Investment Management segment offers a variety of asset management services to institutional and retail customers primarily throughout the United States. Activity which is not included in the major business segments is shown as "Other Operations."
Financial data by segment for 1994 through 1996 is as follows:
Net Investment Income: Life Insurance and Annuities ----------- $1,857.7 $1,859.5 $1,619.2 Reinsurance ---------------------------- 263.7 164.1 125.5 Property-Casualty ---------------------- 244.0 238.8 241.1 Investment Management ------------------ .9 .5 -- Employee Life-Health Benefits ---------- -- -- 10.8 Other Operations ----------------------- (.4) (11.6) (1.8) Total -------------------------------- $2,365.9 $2,251.3 $1,994.8
Net income (loss): Life Insurance and Annuities ----------- $329.9 $334.1 $ 94.1 Reinsurance ---------------------------- 85.7 (42.0) 67.1 Property-Casualty ---------------------- 144.3 166.3 171.6 Investment Management ------------------ 16.9 19.0 -- Employee Life-Health Benefits ---------- -- -- 14.4 Other Operations (includes interest expense) ------------------------------ (63.2) 4.8 2.7 Total -------------------------------- $513.6 $482.2 $349.9
Assets: Life Insurance and Annuities ----------- $61,002.4 $52,465.8 $40,758.4 Reinsurance ---------------------------- 5,196.1 5,220.3 2,653.5 Property-Casualty ---------------------- 4,901.4 5,126.0 4,966.6 Investment Management ------------------ 640.0 632.4 -- Other Operations ----------------------- (26.5) (186.8) 486.3 Total -------------------------------- $71,713.4 $63,257.7 $48,864.8
In July 1996, Lincoln National Capital I issued 8,600,000 shares or $215,000,000, 8.75% Quarterly Interest Preferred Securities ("QUIPS"). In August 1996, Lincoln National Capital II issued 4,000,000 shares or $100,000,000, 8.35% Trust Originated Preferred Securities ("TOPrS"). Both issues mature in 2026 at $25 per share and are redeemable in whole or in part at LNC's option any time after 2001. LNC may offer and sell up to an additional $185,000,000 of securities under this shelf registration.
During November 1994 and the fourth quarter of 1996, LNC purchased and retired 500,000 and 694,582 shares, respectively, of its common stock at a total cost of $18,400,000 and $35,000,000.
Earnings per share are computed based on the average number of common shares outstanding during each year (1996 - 104,560,826; 1995 - 104,115,650; 1994 - 103,863,196) after assuming conversion of any outstanding series A, E and F preferred stock. The dilutive effect of stock options is not material to the computation of earnings per share.
In 1994, LNC completed the sale of 71% of EMPHESYS (parent company of Employers Health Insurance Company, which comprised LNC's Employee Life-Health Benefit segment) for $244,700,000 of cash, net of related expenses, and a $50,000,000 promissory note. A gain on sale of $48,800,000 (also $48,800,000 after-tax) was recognized in 1994 in "Other Operations". EMPHESYS had revenue and net income of $314,900,000 and $14,400,000, respectively, during the three months of ownership in 1994. In October 1995, LNC completed the sale of its remaining 29% ownership in EMPHESYS. As a result of this transaction, LNC received cash of $186,900,000 and recorded pre-tax gain on sale of $89,700,000 ($58,300,000 after-tax) in the "Other Operations" segment.
In April 1995, LNC completed the acquisition of Delaware Management Holdings, Inc. ("Delaware"). Delaware provides a variety of asset management services through its operating companies. The purchase price, including LNC's expenses associated with the acquisition, was $305,000,000. This acquisition also involved the assumption of $25,000,000 in short-term debt and $180,000,000 (face amount) in long-term debt. In May 1995, this debt was repaid from the proceeds of an LNC debt offering of $200,000,000 plus available cash. This acquisition, which was accounted for using purchase accounting, resulted in goodwill of $339,900,000 and other intangible assets of $131,500,000. The results of Delaware's operations are included in LNC's consolidated financial statements from April 3, 1995. The Delaware acquisition agreement included a provision for contingent payments of $22,500,000 based on the levels of future investment management revenues. Any such additional payments would be accounted for as goodwill. Based on a reassessment as of December 31, 1996, these contingent payments are expected to be approximately one-half of the $22,500,000.
In October 1995, LNC approved a realignment plan for its Property-Casualty segment, that included the consolidation of field operations from 20 divisional offices to four regional offices. Certain of the locations were to remain service offices. Those office buildings owned by LNC that were not to be used as regional offices were to be sold. Management estimated that the pre-tax costs of realignment and the loss on sale of office buildings would approximate $21,000,000 and $28,400,000, respectively ($13,700,000 and $18,500,000 after-tax, respectively). Accordingly, net income decreased by $32,200,000 during the fourth quarter of 1995. The cost of the realignment and the loss on sale of office buildings that occurred in 1996 did not differ materially from the 1995 estimates.
In May 1996, 16.7% of American States Financial Corporation ("ASFC"), the holding company of LNC's principal property-casualty subsidiary, was sold to the public in the form of an initial public offering of its common stock. ASFC received net proceeds of $215,200,000 from the sale of this 16.7% minority interest and LNC recorded a non-taxable realized gain, net of expenses directly in shareholders' equity of $15,000,000. LNC continues to fully consolidate this operation within its financial statements and tax reporting.
In January 1997, LNC announced that it signed a definitive agreement to acquire Voyageur Fund Managers, Inc. ("Voyageur"). The purchase will be completed by issuing approximately $70,000,000 of LNC common stock to the current owners of Voyageur. This transaction, which is expected to close in the second quarter of 1997, will be accounted for using purchase accounting and, accordingly, the results of Voyageur's operations will be included in LNC's consolidated financial statements from the closing date.