LNC and the various Fort Wayne operating businesses own or lease approximately 1.6 million square feet of office space in the Fort Wayne area. Businesses operating in suburban Chicago, Illinois; Philadelphia, Pennsylvania; Hartford, Connecticut and the United Kingdom own or lease another 1.2 million square feet of office space. An additional 1.1 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. LNC expects to move its corporate headquarters from Fort Wayne to Philadelphia in mid-1999. The future lease commitments shown within note 7 includes a commitment for 30,000 square feet in Philadelphia for LNC's headquarters. As shown in the notes to the consolidated financial statements (see note 7 to the consolidated financial statements on page 55), the rental expense on operating leases for office space and equipment for continuing operations totaled $81.3 million for 1998. Office space rent expense accounts for $63.2 million of this total. This discussion regarding properties does not include information on investment properties.
On pages 9 through 18, the financial results of LNC's four business segments and other operations are presented and discussed. Within these business segment discussions, reference is made to "Income from Operations". This alternative measure of earnings is defined as "Net income less realized gain (loss) on sale of investments, gain (loss) on sale of subsidiaries and restructuring charges, all net of taxes." Page 19 discusses factors affecting LNC's consolidated investment performance. Pages 20 through 34 discuss factors that have affected specific elements of the consolidated financial statements as well as information pertaining to LNC as a whole.
Profile: LNC's Insurance and Annuities segment is composed of Lincoln National Life Insurance Company ("Lincoln Life"), First Penn-Pacific Life Insurance Company ("First Penn"), Lincoln Life & Annuity Company of New York ("LLANY") and Lincoln Financial Advisors Corporation ("LFA"). As shown above, account values for this segment's annuities, life insurance, 401(k) retirement plans and other pensions totaled $66.4 billion as of December 31, 1998. Life insurance in force for these companies as of December 31,1998, totaled $161.9 billion, an increase of 157% in comparison with $63.1 billion as of December 31, 1997.
National Branding Campaign: As part of our strategy to gain name recognition on a national level, we kicked off an aggressive branding campaign where we introduced our new marketing name, Lincoln Financial Group. Print ads emphasizing our ability to provide "clear and understandable solutions in a complex world," appeared in high profile business and lifestyle publications. Also, part of our strategic targeting was our participation with other nationally branded companies in an ESPN cable "Sports Century" sponsorship, an 18-month long special series of programs commemorating highlights in sports during the past century.
LFA includes a network of regional financial planning offices that serve as the preferred distributor of Lincoln Life products. LFA offers a full range of financial planning services and investments and is a securities broker/dealer and registered investment advisor.
Lincoln Life formed a strategic alliance with BDO Seidman, LLP, one of the top 10 accounting and consulting firms serving the dynamic entrepreneurial business market. Through this alliance, LFA planners will offer estate planning, business continuity planning, investment management services and financial planning to BDO Seidman's client base at more than 40 offices across the country.
First Penn offers linked benefit, universal and term life insurance and fixed annuities through stockbrokers, financial planners, banks, independent agents and LFA. Life products are available for individual and worksite markets. First Penn designs, managers distribution and administers fixed annuities sold through banks for Lincoln Life.
Annuities: Lincoln Life is a leading writer of annuities in the United States (National Underwriter, August 1998). Annuity earnings in this segment increased 27% in 1998, reaching a record $257.6 million. As of December 31, 1998, annuity account values were $51.5 billion, up from $44.6 billion the year before. Variable annuity account values at year-end were $33.4 billion, while fixed annuities represented $18.1 billion.
Lincoln is working with American Funds Distributors ("AFD") on a number of initiatives aimed at further strengthening sales. The American Legacy variable annuity products are marketed to stockbrokers by AFD and to banks through Lincoln Financial Institutions Group, a strategic business unit of First Penn.
In response to the increased demand for multi-manager products, Lincoln introduced the Delaware Lincoln ChoicePlus (Service Mark) variable annuity in the fourth quarter of 1998. This new product contains 30 variable investment options in addition to a number of fixed account options. Delaware Distributors LP wholesales the Delaware Lincoln ChoicePlus variable annuity.
During 1998, Lincoln also introduced two new multi-manager products in the employer-sponsored market. Lincoln Alliance gives an employer more choices by offering a solid, fixed annuity foundation, combined with a vast array of mutual funds. In addition, the Lincoln/Delaware Advantage product offers the investment stability of a Lincoln Life fixed annuity and the investment performance and diversity available through the Delaware family of funds. The product is targeted at the mid- to large-size employer in the health care industry. Finally, eAnnuity (Trade Mark), the first variable annuity targeted to the self-directed investor and sold completely online, was also launched.
Life Insurance: In 1998, Lincoln began building a life insurance platform that allowed the company to quickly achieve scale, deliver higher growth and better financial performance, as well as leverage its expertise in serving the super affluent market. Operating income from life insurance was $147.0 million as of December 31, 1998, four times higher than 1997, as a result of the businesses acquired from CIGNA and Aetna. Combined universal life, whole life, variable life and interest sensitive whole life insurance account values tripled in 1998 to $9.2 billion. Individual life insurance sales, as measured by face amount of in force, nearly doubled for the year to $36.6 billion.
Pensions: This segment's pension business is focused on 401(k) retirement plans for businesses with fewer than 200 employees. Account values for these plans were $3.7 billion as of December 31, 1998, a 9% increase over 1997. To better service the retirement services market and to achieve economies of scale, Lincoln Life's 401(k) retirement plans were combined with the Investment Management segment's defined contributions effective January 1999.
Outlook: The Life Insurance and Annuities segment has laid the foundation for increased sales in the future. With the kickoff of an aggressive national branding campaign, were moving forward to build national brand recognition. In addition, a well-balanced distribution system, coupled with product improvements, new product introductions and strategic partnerships will help in strengthening our market presence and will be the driving forces in placing our annuities and life insurance operations among the top five.
(1) Income (loss) from operations and net income (loss) for 1997 include a charge of $174.9 million ($199.4 million pre-tax) for a change in estimate of the cost of settling pension mis-selling liabilities (see note 2 to the consolidated financial statements on page 45). (2) Net Initial Commissions is a measure used by Lincoln UK to measure sales progress and future profitability.
Profile: Lincoln UK offers life, investment, protection and retirement planning products primarily through 1,630 direct sales representatives and tied agents. Lincoln UK sells predominantly unit-linked products where the investment risk is borne by the policyholder. These products are similar to the variable life products sold in the United States. Home office operations are divided between Uxbridge, Middlesex, and Barnwood, Gloucester, England.
Product Development: Lincoln UK relaunched Financial Foundations, its flagship unit-linked life insurance product with improved features allowing it to be much more competitive in the marketplace. Since its relaunch in mid-1998, sales are 20% ahead of the same period last year, and now represent over 25% of new business. In response to a UK government promotional program on individual savings, plans also are under way to relaunch a wide range of medium- to long-term savings products this year, including a new tax preferred Individual Savings Account (ISA) product.
National Branding Campaign: During 1998, Lincoln UK took major steps to develop its brand awareness in the UK with two key initiatives - the Company's first ever integrated television and print advertising campaign, as well as participation in top level sports sponsorship.
The sponsorship was widely acclaimed by the public, sales advisors and members of staff as one of the most positive name awareness promotions ever to have been undertaken by Lincoln UK.
Markets: Account values in the unit-linked asset business were $6.3 billion as of December 31, 1998, an increase of 11% over the year before. Net initial commission values were $54.9 million, slightly lower than the $55.4 million in 1997. Individual life insurance in force as of December 31, 1998, was $25.0 billion.
Pension Product Mis-selling: A charge of $174.9 million after-tax was taken in the fourth quarter of 1997 to increase reserves for liabilities in the so-called "pension mis-selling" situation in the United Kingdom. Regulatory agencies raised questions as to whether individuals who bought pensions in the UK and exited employer plans were given appropriate advice by insurance agents and brokers. The regulatory agencies asked the insurance companies to review their cases and to provide redress to those individuals harmed by the activities of agents or brokers. As a result of what the government viewed as a slow response by the insurance industry, regulators have set targets, publicly named companies that it sees as tardy in their resolution of cases and taken disciplinary actions.
Lincoln UK is committed to completing its review as quickly as possible so that appropriate action can be taken. The regulatory agency deadline for Lincoln UK to complete phase one of its review was December 31, 1998. The achievement of this target was a critical milestone for the company. Lincoln has made offers of redress, or provided reassurance that redress is not required to all its priority policyholders. The segment has also obtained acceptance of offers or, in accordance with the regulatory agency requirements, believe they can demonstrate that every effort to obtain their acceptance has been made. Nearly 11,000 cases have been assessed by a dedicated team of 170 full-time staff at four locations. The company is well positioned to deal with phase two of the review, which began on January 4, 1999. This will entail the review of the balance of policyholders who took out personal pensions between April 1988 and June 1994 and have not had their cases reviewed under phase one.
(1) Income (loss) from operations and net income (loss) for 1997 and 1995 include the impact of a change in estimate of the reserve level needed for LNC's disability income business ($130.0 million, and $121.6 million after-tax, respectively). Also, income (loss) from operations and net income (loss) for 1997 include a charge of $113.7 million after-tax for the impact of a change in estimate of the reserve level needed for personal accident programs.
Lincoln Re's approach is that the traditional risk-transfer commodity business is in decline and that today's reinsurer must provide innovative, tailored programs. As a result, Lincoln Re uses a mass customization approach. This involves packaging and distributing modular pricing, underwriting, systems, alliance resources, marketing consultation, product development and claims management components to meet the needs of client companies. It has a current client base of more than 1,700 U.S. and 350 international companies, and a client retention rate of more than 95%.
In 1998, Lincoln Re introduced the industry's first browser-based life underwriting manual on CD-ROM to its reinsurance clients, enabling faster, more efficient underwriting of life insurance policies. Lincoln Re also entered into a strategic alliance with Cybertek, a major developer of administrative solutions in the life insurance business. Cybertek is working to incorporate the Lincoln Underwriting System into its base product.
Lincoln Re's approach also involves the capabilities of more than 40 alliance partners. These include direct marketers, medical equipment suppliers, electronic information providers, specialized legal firms, accountants, variable life and annuity administrators, all ready to form a "virtual organization" to help Lincoln Re clients do business.
Individual Markets: Strong sales in recent years contributed to record income from operations for individual markets in 1998. Income from operations was $83.5 million, a 16% increase over 1997. Very favorable life mortality throughout the year was an integral factor in the strong performance. Sales volume, measured by face amount of new business, was a record $78.1 billion in 1998, nearly double the amount of last year.
Financial Reinsurance: Income from operations was $15.2 million, slightly higher than income from operations of $14.4 million in 1997.
Outlook: Lincoln Re continues to enhance its reputation as a leading life-health reinsurer in the world with the development of new knowledge-based tools and marketing methods. It continues to build partnerships inside and outside the traditional insurance marketplace.
(1) Data shown in the 1995 column is for a partial year, as this segment was added in April 1995 following the acquisition of Delaware Management Holdings, Inc.
LNC's Investment Management segment reported record income from operations of $20.8 million in 1998, compared with $4.5 million in 1997. The segment's 1998 operating income, excluding amortization of goodwill and other intangible assets, was $49.6 million. The improvement was driven by increased revenues due to record levels of inflows, higher net sales and the impact of the market levels during the year.
Domestic institutional assets represent $21.5 billion of the Investment Management segment's total assets under management, while domestic retail assets were $25.2 billion. International equity and global bond assets managed by Delaware International Advisers, Ltd. account for $12.1 billion ($10.7 billion institutional, $1.4 billion retail).
Complementary Approaches: Delaware, Lynch & Mayer and Vantage are encouraged to preserve their complementary and distinctive investment styles. Diversity of investment styles, as well as diversity of clients served, are prudent ways to diversify risk in varying market environments.
Lynch & Mayer pursues a "growth" investment style and specializes in mid-cap and large-cap equities. Vantage invests in undervalued companies that have strong potential for above-average growth. It employs a disciplined, systematic, risk-controlled investment approach, which delivers growth at a reasonable price (GARP). Vantage is especially well known for its socially responsible investing expertise, the practice of aligning investment objectives with social concerns in one investment portfolio.
Distribution: Multiple distribution channels enable the businesses in the Investment Management segment to deliver their broad range of products to an expanding community of retail and institutional investors. Delaware markets its mutual funds through regional and national broker/dealers, financial planners, banks, and insurance agents, including those associated with the regional marketing offices of Lincoln Life. Institutional products are marketed primarily by each company's sales force through pension consultants and directly to defined benefit and defined contribution plan sponsors, endowments, foundations and insurance companies.
Institutional Investments: The institutional investment management business had assets under management of $32.2 billion as of December 31, 1998, compared with $31.5 billion at December 31, 1997. LNIC's institutional inflows of $6.2 billion for 1998, were 22% higher than the $5.1 billion in 1997. Institutional net cash flows, however, declined slightly to ($2.2) billion for 1998 versus ($2.0) billion for 1997, largely due to client losses resulting from underperformance in Lynch & Mayer's mid- and large-cap growth products.
Investment Performance: As of December 31, 1998, Delaware had 16 funds, representing 28% of the company's mutual fund assets under management, ranked as four- and five-star funds by Morningstar, Inc., a service that assigns risk-adjusted performance ratings to mutual funds. One star is the lowest rating; five
Outlook: The rapid growth of Delaware's retail mutual fund business, both through internal efforts and selective acquisitions, continues to be an essential component of LNC's long-term strategy. Given the improvements realized in 1998, LNC is well positioned for accelerating this growth.
The income (loss) from operations shown above includes the earnings from Lincoln Investment Management, certain other operations that are not directly related to the business segments and unallocated corporate revenues and expenses, such as corporate investment income, interest expense on short-term and long-term borrowings, and corporate overhead expenses. Prior to the date of sale in October 1995, Other Operations also include LNC's investment in an unconsolidated affiliate engaged in the employee life-health benefits business.
Lincoln Investment Management provides investment advisory services and asset management services for LNC's Corporate portfolios as well as entities not owned by LNC.
Net income (loss) shown above for "Other Operations" includes the items described above under loss from operations plus the realized gain (loss) on sale of certain investments, the gain (loss) on sale of subsidiaries (see note 11 to the consolidated financial statements on page 65) and a restructuring charge. The 1998 restructuring charge is the result of an organizational/expense review and represents severance pay and space abandonment charges because of staff reductions in the parent and other select companies.
(1) See Investment Management segment data on page 16 for additional detail.
Asset Diversification: Fundamental to LNC's investment policy is diversification across asset classes. LNC's investment portfolio, excluding cash and invested cash, is composed of fixed maturity securities; equities; mortgage loans on real estate; real estate either wholly owned or in joint ventures and other long-term investments. LNC purchases investments that have yield, duration and other characteristics which take into account the liabilities of the products being supported. The dominant investment held is fixed maturity securities, which represent approximately 80% of the investment portfolio.
Fixed Maturity Performance: In 1998, the LNC fixed maturity portfolio produced a return of 7.57%, compared to the Lehman Brothers Government/Corporate index (68% government bonds, 32% corporate bonds) which produced 9.47%. The underperformance relative to the index during 1998 is due to the investment strategy of investing in bonds with sufficient spread to support long-term insurance liabilities. During 1998, LNC experienced extreme spread widening in all sectors which had the effect of reducing returns. The spread widening was caused by the Emerging Markets crisis and the subsequent flight to high quality U.S. treasury bonds by global investors. The government bond component of the index performed very well relative to corporate bonds.
Use of Derivatives: The primary use of derivatives at LNC is to hedge interest rate risk that is embedded in either life insurance and annuity product liabilities or investment portfolios. To a lesser extent, derivatives are also used to hedge exposures to foreign currency and equity market risks.
Life Insurance and Annuity Premiums Life insurance and annuity premiums increased $229.4 million or 30% in 1998 and $27.5 million or 4% in 1997 as the result of increases in volumes of business in the Life Insurance & Annuities and Reinsurance segments. A portion of the increase from the Life Insurance and Annuities segment in 1998 is the result of the acquisition of the blocks of business. Barring the passage of unfavorable tax legislation that would eliminate the tax-advantages for some of LNC's life and annuity products, LNC expects growth in life insurance and annuity premiums in 1999.
Health Premiums Health premiums within the Reinsurance segment increased $62.6 million or 11% in 1998 after decreasing $218.0 million or 28% in 1997. The 1997 reduction included planned cut backs in the level of business.
Insurance Fees Insurance fees from universal life, other interest-sensitive life insurance contracts and variable life insurance contracts increased $442.4 million or 53% in 1998 and $118.7 million or 17% in 1997. These increases are the result of an increase in the volume of transactions (including the addition of two blocks of business in 1998 as described in note 11 to the consolidated financial statements on page 66) and a market-driven increase in the value of existing customer accounts upon which some of the fees are based in the Life Insurance & Annuities and Lincoln UK segments. The growth in fees from this business is expected to continue in 1999.
Other Revenue and Fees Other revenue and fees increased $103.8 million in 1998 and $18.9 million in 1997 as the result of increases in the volume of transactions in each of the business segments.
Total Revenue The level of revenue produced for select revenues listed above, primarily the fee based revenues, such as insurance fees and investment advisory fees, fluctuates from year to year because of changes in the equity investment markets. For example, a 1% change in the equity investment market, as represented by a measure such as the S&P 500, increases or decreases total revenue by approximately $4.5 million based on the business currently managed. Although the impact is not dollar for dollar because of the impact of Federal income taxes, such changes in revenues also increases or decreases LNC's earnings. Barring a major drop in the equity markets, LNC expects to produce revenues in future years in excess of the revenues produced for the year ended December 31, 1998.
statements on page 45. Health benefits increased $159.5 million in 1997 as the net result of decreased volumes of business being more than offset by additions to the reserves for disability income business and personal accident programs within the Reinsurance segment.
Underwriting, Acquisition, Insurance and Other Expenses These expenses increased $364.4 million or 23% in 1998 as the result of increased business volumes in all business segments, the addition of the operating costs associated with the block of business acquired in January 1998 and increased expenditures related to Year 2000 issues. Underwriting, Acquisition, Insurance and other expenses increased $144.4 million or 10% in 1997. The primary drivers behind this increase beyond the general inflation rate was increased business volumes in the various segments due to general growth and the one-time and on-going costs associated with the acquisition of the two blocks of business (see note 11 to the consolidated financial statements on page 66) and the write-off of deferred acquisition costs associated with the disability income business (see note 2 to the consolidated financial statements on page 45). In 1999, all business segments will continue to adjust staff levels as appropriate to match business volumes.
Interest and Debt Expense Interest and debt expense increased $24.6 million or 27% in 1998 and $7.8 million or 9% in 1997. These increases were the result of increases in the average debt outstanding and the impact of changes in the composition of debt outstanding (see page 32). During 1998, Moody's re-affirmed LNC's debt ratings as A2 ("Very Good, Strong or High"), Standard and Poor's changed its rating from A to A- ("both Very Good, Strong or High") and Duff & Phelps changed its rating from AA- ("Excellent") to A+ ("Very Good, Strong or High").
Discontinued Operations In 1997, lines were added to the income statement to accommodate the operating activity and gain on sale associated with LNC's decision to sell its 83.3% ownership in American States Financial Corporation (see note 11 to the consolidated financial statements on page 65.
Century Compliance The Year 2000 issue is pervasive and complex and affects virtually every aspect of LNC's businesses. LNC's computer systems and interfaces with the computer systems of vendors, suppliers, customers and business partners are particularly vulnerable. LNC and its operating subsidiaries have been redirecting a large portion of internal Information Technology ("IT") efforts and contracting with outside consultants to update systems to address Year 2000 issues. Experts have been engaged to assist in developing work plans and cost estimates and to complete remediation activities.
For the year ended December 31, 1998, LNC identified expenditures of $37.5 million ($24.4 million after-tax) to address this issue. This brings the expenditures for 1996-1998 to $48.5 million ($31.5 million after-tax). LNC's financial plans for 1999-2000 include expected expenditures of an additional $44.4 million ($28.9 million after-tax) bringing estimated overall Year 2000 expenditures to $92.9 million ($60.4 million after-tax). Because updating systems and procedures is an integral part of LNC's on-going operations, approximately 50% of expenditures shown above are expected to continue after all Year 2000 issues have been resolved. Actual Year 2000 expenditures through December 31, 1998 and future Year 2000 expenditures are expected to be funded from operating cash flows. The anticipated cost of addressing Year 2000 issues is based on management's current best estimates which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third party modification plans and other factors. Such costs will be monitored closely by management. Nevertheless, there can be no guarantee that actual costs will not be higher than these estimated costs. Specific factors that might cause such differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer problems and other uncertainties.
The current scope of the overall Year 2000 program includes the following four major project areas: 1) addressing the readiness of business applications, operating systems and hardware on mainframe, personal computer and Local Area Network platforms (IT); 2) addressing the readiness of non-IT embedded software and equipment (non-IT); 3) addressing the readiness of key business partners and 4) establishing year 2000 contingency plans.
The projects to address IT and non-IT readiness have four major phases. Phase one involves raising awareness and creating an inventory of all IT and non-IT assets. The second phase consists of assessing all items inventoried to initially determine whether they are affected by the Year 2000 issue and preparing general plans and strategies. The third phase entails the detailed planning and remediation of affected systems and equipment. The last phase consists of testing to verify Year 2000 readiness.
Concurrent with the IT and non-IT projects, the readiness of key business partners is being reviewed and Year 2000 contingency plans are being developed. The most significant categories of key business partners are financial institutions, software vendors, and utility providers (gas, electric and telecommunications). Surveys have been mailed to these key business partners. Based on responses received, current levels of readiness are being assessed, follow-up contacts are underway, alternative strategies are being developed and testing is being scheduled where feasible. This effort is expected to continue well into 1999. As noted above, software vendor assessments are considered part of the IT projects and, therefore, would follow the schedule shown above for such projects.
Investments The investment portfolio, excluding cash and invested cash, is comprised of fixed maturity and equity securities; 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 $8.1 billion in 1998. This increase was the net result of increases from 1) the addition of $7.7 billion in invested assets related to the two blocks of business acquired in 1998, 2) the increase in fair value of securities available-for-sale and 3) the new purchases of investments from cash flow generated by the business units being partially offset by the continuation of fixed annuity contractholders opting to transfer funds to variable annuity contracts.
LNC maintains a high-quality fixed maturity securities portfolio. As of December 31, 1998, $9.9 billion or 32.7% of its fixed maturity securities portfolio had ratings of AA or better. Fixed maturity securities with below- investment-grade ratings (BB or less) were $2.1 billion or 7.0% of the total fixed maturity securities portfolio (see note 3 to the consolidated financial statements on page 47). The below-investment-grade fixed maturity securities represent 5.6% of LNC's total investment portfolio. The interest rates available on these below- investment-grade securities are significantly higher than are available on other corporate debt securities. Also, the risk of loss due to default by the borrower is significantly greater with respect to such below investment grade securities because these securities are generally unsecured, often subordinated to other creditors of the issuer and issued by companies that usually have high levels of indebtedness. LNC attempts to minimize the risks associated with these below investment grade securities by limiting the exposure to any one issuer and by closely monitoring the credit worthiness of such issuers. For the year ended December 31, 1998, the aggregate cost of below investment grade securities purchased was $1.6 billion. Aggregate proceeds from such investments sold were $1.1 billion, resulting in a realized pre-tax loss at the time of sale of $55.2 million.
LNC's fixed maturity securities available-for-sale include mortgage-backed securities. The mortgage-backed securities included in LNC's investment portfolio are subject to risks associated with variable prepayments. This may result in these securities having a different actual cash flow and maturity than planned at the time of purchase. Securities that have an amortized cost greater than par and backed by mortgages that prepay faster than expected will incur a reduction in yield or a loss. Those securities with an amortized cost lower than par that prepay faster than expected will generate an increase in yield or a gain. In addition, LNC may incur reinvestment risks if market yields are lower than the book yields earned on the securities. Prepayments occurring slower than expected have the opposite impact. LNC may incur disinvestment risks if market yields are higher than the book yields earned on the securities and LNC is forced to sell the securities. The degree to which a security is susceptible to either gains or losses is influenced by 1) the difference between its amortized cost and par, 2) the relative sensitivity of the underlying mortgages backing the assets to
prepayment in a changing interest rate environment and 3) the repayment priority of the securities in the overall securitization structure.
Cash and Invested Cash Cash and invested cash decreased by $1.4 billion in 1998. This decrease is the result of paying out the funds that had been accumulated at the end of 1997 in anticipation of the purchase of a block of individual life and annuity business on January 2, 1998 (see note 11 to the consolidated financial statements on page 66).
Deferred Acquisition Costs Deferred acquisition costs increased $340.6 million in 1998. This increase was the net result of an increase related to the growth in business being partially offset by reductions related to the increase in unrealized gain on securities available-for-sale.
Assets Held in Separate Accounts This asset account, as well as the corresponding liability account, increased by $6.3 billion in 1998 as a result of increases in annuity and pension funds under management. This increase resulted from new deposits, market appreciation and the continuation of fixed annuity contractholders opting to transfer funds to variable annuity contracts.
Amounts Recoverable from Reinsurers The increase of $776.3 million in amounts recoverable from reinsurers was the result of an increased volume of business ceded in the Life Insurance and Annuities segment.
Goodwill and Other Intangible Assets The increase of $1.0 billion and $1.2 billion, respectively, is the net result of additions related to business acquired (see note 11 to the consolidated financial statements on page 66) being more than the on-going amortization.
issuing new debt in the first and third quarters of 1998 (see note 5 to the consolidated financial statements on page 51). The decrease in the remaining liabilities of $225.4 is the net amount from an increase in the expected payouts for securities purchased in the last few days of 1998 versus a lower volume of such transactions late in 1997 being more than offset by the Federal income tax decrease.
Although LNC generates adequate cash flow to meet the needs of its normal operations, periodically LNC may issue debt or equity securities to fund internal expansion, acquisitions, investment opportunities and the retirement of LNC's debt and equity. In April 1998, LNC filed a shelf registration for $1.3 billion which included the right to offer regular debt, preferred stock, common stock or various forms of hybrid securities. This $1.3 billion filing included an aggregate of $300 million that had not been utilized from a previously filed shelf registration. In December, 1998 LNC combined the unused portion of another previously filed shelf
registration. The combination of these two filings, less securities offered in 1998 (see below), resulted in an unused balance as of December 31, 1998 of $825 million that would allow LNC to issue various securities. The hybrid securities offerings utilize six subsidiaries (Lincoln National Capital I, II, III, IV, V and VI) which were formed for the specific purpose of issuing such securities. All of these subsidiaries' common securities are owned by LNC. Cash funds are also available from LNC's revolving credit agreement, which provides for borrowing up to $750 million (see note 5 to the consolidated financial statements on page 52).
In 1998, LNC issued $300 million of long-term debt, $200 million of Series C Trust Originated Preferred Securities and $230 million of FELINE PRIDES. Also LNC purchased and retired; 623,281; 4,948,900 and 694,582 shares of common stock at a cost of $46.9 million; $325.3 million and $35.0 million in 1998, 1997 and 1996, respectively. The 5,572,181 shares purchased in 1997 - 1998 includes 4,993,281 shares at a cost of $341.8 million that have been purchased since the June 1997 board authorization to repurchase up to $500 million of common stock. This leaves a Board authorization to repurchase an additional $158.2 million of LNC's common stock as of December 31, 1998. Also LNC issued 1,323,144 shares of LNC common stock in 1997 to purchase subsidiary companies.
Another transaction that occurred in 1997 that had a major impact on LNC's cash flow was the sale of a subsidiary for $2.65 billion (see note 11 to the consolidated financial statements on page 65). LNC used these proceeds to 1) repurchase $341.8 million of its own common stock, 2) retire $86.7 million in long-term debt, 3) fund the purchase of a 49% interest in Seguros Serfin Lincoln for $85.0 million, 4) pay the $447.6 million of taxes related to the gain on sale of discontinued operations and 5) purchase a block of individual life insurance and annuity business for $1.4 billion (see note 11 to the consolidated financial statements on page 66). The remaining balance was initially applied to pay off a portion of LNC's short-term debt and invested for general corporate purposes, then later used to fund a portion of the purchase of another block of individual life insurance business.
In order to maximize the use of available cash, the holding company (Lincoln National Corporation) maintains a facility where subsidiaries can borrow from the holding company to meet their short-term needs and can invest their short-term funds with the holding company. Depending on the overall cash availability or need, the holding company invests excess cash in short-term investments or borrows funds in the financial markets. In addition to facilitating the management of cash, the holding company receives dividends from its subsidiaries, invests in operating companies, maintains an investment portfolio and pays shareholder dividends and certain corporate expenses.
Effect of Inflation 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.
(1)Net income (loss) from continuing operations for the second and fourth quarters of 1997 include special charges for changes in estimates on reserves. The discontinued operations amount for the fourth quarter of 1997 includes the gain on sale of the discontinued operations. See notes 2 and 11 to the consolidated financial statements on pages 45 and 65, respectively.
Consolidated Financial Statements The consolidated financial statements of Lincoln National Corporation and Subsidiaries follow on pages 36 through 67.
Investments. LNC classifies its fixed maturity and equity securities as available-for-sale and, accordingly, such securities are carried at fair value. The cost of fixed maturity securities is adjusted for amortization of premiums and discounts. The cost of fixed maturity and equity securities is adjusted for declines in value that are other than temporary.
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, commodity risk, credit risk, fluctuations in certain stock indices, increased liabilities associated with certain reinsurance agreements and foreign exchange risk by entering into derivative transactions. A description of LNC's accounting for its hedging of such risks is discussed in the following two paragraphs.
The premiums paid for interest rate caps, swaptions, put options and S&P call options are deferred and amortized to net investment income on a straight-line basis over the term of the respective derivative. Any settlement received in accordance with the terms of the interest rate caps is also recorded as net investment income. Realized gain (loss) from the termination of the interest rate caps is included in net income. Settlements received on swaptions are deferred and amortized over the life of the hedged assets as an adjustment to yield. Swaptions, put options, spread-lock agreements, interest rate swaps, commodity swaps and financial futures that hedge fixed maturity securities available-for-sale are carried at fair value. The change in fair value is reflected directly in shareholders' equity. Realized gain (loss) from the settlement of such derivatives is deferred and amortized over the life of the hedged assets as an adjustment to the yield. Over-the-counter call options are carried at fair value. The change in fair value is reflected directly in shareholders' equity. Any gain (loss) realized upon termination of these call options is included in net income. Foreign exchange forward contracts, which hedge LNC's investment in its British subsidiary, Lincoln National (UK), are carried at fair value. The change in fair value and realized gain (loss) on such contracts is reflected directly in the foreign currency translation adjustment component of shareholders' equity. Foreign exchange forward contracts, foreign currency options and foreign currency swaps, which hedge some of the foreign exchange risk of investments in fixed maturity securities denominated in foreign currencies, are carried at fair value. The change in fair value is included in shareholders' equity. Realized gain (loss) from the settlement of such derivatives is included in net income.
Investment Advisory Fees. As specified in the investment advisory agreements with the mutual funds, fees are determined and recognized as revenues monthly, based on the average daily net assets of the mutual funds managed. Investment advisory contracts generally provide for the determination and payment of advisory fees based on market values of managed portfolios at the end of a calendar month or quarter. Investment management and advisory contracts are renewable annually with cancellation clauses ranging from 30 to 90 days.
Deferred Acquisition Costs. Commissions and other costs of acquiring universal life insurance, variable universal life insurance, unit-linked products, traditional life insurance, annuities and group health insurance which vary with and are primarily related to the production of new business, have been deferred to the extent recoverable. Acquisition costs for universal and variable universal life insurance policies and unit-linked products are being amortized over the lives of the policies in relation to the incidence of estimated gross profits from surrender charges and investment, mortality, and expense margins, and actual realized gain
(loss) on investments. That amortization is adjusted retrospectively when estimates of current or future gross profits to be realized from a group of products are revised. Traditional life acquisition costs are being amortized over periods of 10 to 30 years on either a straight-line basis or as a level percent of premium of the related policies depending on the block of business. Annuity acquisition costs are amortized over a period of 15 years for more recently issued policies, and over the surrender charge period for all other policies. For all policies, amortization is based on assumptions consistent with those used in the development of the underlying policy form adjusted for emerging experience.
Insurance and Investment Contract Liabilities. The liabilities for future policy and claim reserves 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 insurance policy and claim reserves for traditional life policies are computed using assumptions for investment yields, mortality and withdrawals based principally on generally accepted actuarial methods and assumptions at the time of policy issue. Interest assumptions for traditional direct individual life reserves for all policies range from 2.5% to 7.0% depending on the 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 7.75%.
Foreign Exchange. LNC's foreign subsidiaries' balance sheet accounts and income statement items are translated at the current exchange and average exchange rates for the year, respectively. Resulting translation adjustments are reported as a component of shareholders' equity. Other translation adjustments for foreign currency transactions that affect cash flows are reported in earnings.
Change in Estimate for Disability Income Reserve. During the second quarter of 1997, LNC conducted an additional in-depth review of loss experience on its disability income business. As a result of this study, the reserve level was deemed to be inadequate to meet future obligations if current incidence levels were to continue in the future. In order to address this situation, LNC's Reinsurance segment strengthened its disability income reserve by $92,800,000, wrote-off deferred acquisition costs of $71,100,000 and reduced related assets by $36,100,000. Combined these actions reduced net income in the second quarter of 1997 by $130,000,000 or $1.23 per share ($200,000,000 pre-tax).
The amortized cost, gross unrealized gain and loss, and fair value of securities available-for-sale are as follows:
Par value, amortized cost and estimated fair value of investments in asset/mortgage-backed securities summarized by interest rates of the underlying collateral are as follows:
Treasuries and AAA............................................. 25.6% AA............................................................. 7.0 A.............................................................. 27.5 BBB............................................................ 32.9 BB............................................................. 4.3 Less than BB................................................... 2.7 ----- 100.0%
Mortgage loans on real estate which are primarily held in the Life Insurance and Annuities segment 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.
Impaired mortgage loans with no allowance for losses are a result of: 1) direct write-downs or; 2) collateral dependent loans where the fair value of the collateral is greater than the recorded investment in the loan.
Balance at beginning-of-year............ $5.0 $12.4 $29.6 Provisions for losses................... .7 .8 3.1 Releases due to write-downs............. -- -- -- Releases due to sales................... (.9) (4.8) (19.9) Releases due to foreclosures............ -- (3.4) (.4) ---- ----- ----- Balance at end-of-year.............. $4.8 $ 5.0 $12.4
Average recorded investment in impaired loans..$33.4 $74.9 $139.6 Interest income recognized on impaired loans... 3.5 7.0 12.7
The cost information for mortgage loans on real estate, real estate and other long-term investments are net of allowances for losses. The balance sheet account for other liabilities includes a reserve for guarantees of third-party debt. The amount of allowances and reserves for such items is as follows:
income tax purposes of $79,100,000 at December 31, 1998, which expire in the years 2003 through 2008. These carryforwards will only be available to reduce the respective taxable income of the foreign life reinsurance companies and Delaware.
Under prior Federal income tax law, one-half of the excess of a life insurance company's income from operations over its taxable investment income was not taxed, but was set aside in a special tax account designated as "Policyholders' Surplus." LNC has approximately $196,000,000 of untaxed "Policyholders' Surplus" on which no payment of Federal income taxes will be required unless it is distributed as a dividend, or under other specified conditions. Barring the passage of unfavorable tax legislation, LNC does not believe that any significant portion of the account will be taxed in the foreseeable future and no related deferred tax liability has been recognized. If the entire balance of account became taxable under the current Federal rate, the tax would be approximately $68,600,000.
Reinsurance transactions included in the income statement captions, "Insurance Premiums" and "Insurance Fees," are as follows:
The income statement caption, "Benefits," is net of reinsurance recoveries of $1,056,800,000; $393,000,000 and $250,100,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
The combined U.S. and U.K. commercial paper outstanding at December 31, 1998 and 1997, had a blended weighted average interest rate of approximately 6.67% and 7.03%, respectively.
mark of Merrill Lynch & Co. Inc.). The purchasers of such securities were also provided stock purchase contract agreements that indicate they will receive a specified amount of LNC common stock on or before the August 2001 maturity date of the FELINE PRIDES. A portion of the issuance costs associated with this offering along with the present value of the payments associated with the stock purchase agreements were charged to the common stock line within shareholders' equity. In December 1998, LNC filed a shelf registration with the Securities Exchange Commission that combines unused portions of the April 1998 registration ($640,000,000) and the May 1996 registration ($185,000,000) resulting in an active shelf registration allowing LNC to sell up to an additional $825,000,000 of securities.
The funds raised in 1998 from the various public offerings of securities described above were used to acquire a block of individual life insurance business from Aetna (see note 11 on page 66).
Cash paid for interest for 1998, 1997 and 1996 was $108,300,000; $96,000,000 and $83,200,000, respectively.
Information with respect to incentive plan stock options outstanding at December 31, 1998 is as follows:
Restricted stock (non-vested stock) awarded from 1996 through 1998 was as follows:
Statutory Information and Restrictions Net income (loss) as determined in accordance with statutory accounting practices for LNC's insurance subsidiaries was $(1,452,400,000); $345,200,000 and $384,600,000 for 1998, 1997 and 1996, respectively. The 1998 amounts includes the statutory ceding commissions associated with the acquisition of two blocks
Shareholders' equity as determined in accordance with statutory accounting practices for LNC's insurance subsidiaries was $2,952,500,000 and $2,660,900,000 for December 31, 1998 and 1997, respectively.
The National Association of Insurance Commissioners is involved in a multi-year project to examine and challenge the appropriateness of current statutory accounting practices. 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.
LNC's insurance subsidiaries are subject to certain insurance department regulatory restrictions as to the transfer of funds and payments of dividends to LNC. Based upon these regulations, and without giving effect to the 1998 acquisitions, (see note 11 on page 66), LNC's insurance subsidiaries would have been able to pay dividends to LNC in 1999 of approximately $603,400,000 without obtaining specific approval from the insurance commissioners. LNC's primary insurance subsidiary, Lincoln National Life Insurance Company ("Lincoln Life") acquired a block of individual life insurance and annuity business from CIGNA in January 1998 and a block of individual life insurance from Aetna in October 1998. These acquisitions were structured as indemnity reinsurance transactions. The statutory accounting regulations do not allow goodwill to be recognized on indemnity reinsurance transactions and therefore, the related statutory ceding commission flows through the statement of operations as an expense resulting in a reduction of earned surplus. As a result of these acquisitions, Lincoln Life's statutory earned surplus is negative and it is necessary for Lincoln Life to obtain the prior approval of the Indiana Insurance Commissioner before paying any dividends to LNC until such time as statutory earned surplus is positive. It is expected that statutory earned surplus will return to a positive position within two-three years from the closing of the Aetna transaction described above assuming a level of statutory earnings coinciding with recent earnings patterns. If statutory earnings are less than recent patterns due, for example, to adverse operating conditions or further indemnity reinsurance transactions of this nature or if dividends are approved or paid at amounts higher than recent history, the statutory earned surplus may not return to a positive position as soon as expected. Although no assurance can be given, management believes that the approvals for the payment of dividends in amounts consistent with those paid in the past can be obtained. In the event such approvals are not obtained, management believes that LNC can obtain the funds required to satisfy its obligations from its existing credit facilities and other sources.
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, an extensive investigation has to be done and the individual put in a position similar to what would have been attained if the individual had remained in the employer sponsored plan. At December 31, 1998 and 1997, liabilities of $202,100,000, and $291,000,000, respectively, had been established for this issue. The decrease in the level of the reserve reflects the settlement payouts that occurred during 1998. These liabilities, 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. The expected recoveries from previous owners of companies acquired over the last few years as specified in the indemnification clauses of the purchase agreements at December 31, 1998 and 1997 were $84,900,000 and $113,000,000, respectively . These liabilities and recoveries are based on various estimates that are subject to considerable uncertainty. Also, there is further uncertainty from the regulator perspective as additional guidelines were issued in December of 1998 that extended the review to a wider range client population. These guidelines specify actions expected from the companies that issued such products. 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.
Personal Accident Programs LNC's Reinsurance segment accepts personal accident reinsurance programs from other insurance companies. Most of these programs are presented to the Reinsurance segment by independent brokers who represent the ceding companies. Certain excess of loss personal accident reinsurance programs created in the London market during 1993-1996 have produced and have potential to produce significant losses. At December 31, 1998 and 1997, liabilities of $177,400,000 and $186,300,000, respectively had been established for such programs. This reserve is based on various estimates that are subject to considerable uncertainty. Accordingly, this reserve may prove to be deficient or excessive. However, it is management's opinion that such future development will not materially affect the consolidated financial position of LNC.
LNC continues to investigate its personal accident reinsurance programs to determine if there are additional programs including certain workers compensation programs which may produce losses. At this time LNC 1) does not have sufficient information to determine whether or not it is probable that additional losses have been incurred and 2) can not accurately estimate the ultimate cost or timing of the outcome on these programs.
Euro Conversion LNC owns operating companies in Europe and conducts business with companies located within Europe. LNC has modified its systems, financial activities and currency risk exposures to align with the first phase of the European union's conversion to a new common currency (the euro) that was adopted January 1, 1999. It is management's opinion the additional phases of this conversion, which will be implemented during the next few years, will not materially affect the consolidated financial condition of LNC.
Total rental expense on operating leases in 1998, 1997 and 1996 was $81,300,000, $62,500,000 and $54,500,000, respectively. Future minimum rental commitments are as follows (in millions):
1999 - $55.0 2001 - $48.2 2003 - $ 36.1 2000 - 51.6 2002 - 41.9 Thereafter - 217.1
Associated with these transactions, LNC's insurance companies have obtained letters of credit in favor of various insurance companies. This allows the ceding companies to take statutory reserve credit. The letters of credit issued by the banks represent a guarantee of performance under the reinsurance agreements. At December 31, 1998, there was a total of $656,200,000 in outstanding bank letters of credit. In exchange for the letters of credit, LNC paid the banks approximately $1,637,000 in fees in 1998.
Other Contingency Matters 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. LNC maintains professional liability insurance coverage for claims in excess of $5 million. The degree of applicability of this coverage will depend on the specific facts of each proceeding. 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 suits will not have a material adverse effect on the consolidated financial condition of LNC.
Four lawsuits involving alleged fraud in the sale of interest sensitive universal life and whole life insurance have been filed as class actions against Lincoln Life, although the court has not certified a class in any of these cases. Plaintiffs seek unspecified damages and penalties for themselves and on behalf of the putative class. While the relief sought in these cases is substantial, it is premature to make assessments about the potential loss, if any, because the status of the cases ranges from the early stages of litigation to the dismissal and appeals stage. Management intends to defend these suits vigorously. The amount of liability, if any, which may arise as a result of these suits cannot be reasonably estimated at this time.
rehabilitated companies. Mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. LNC has accrued for expected assessments net of estimated future premium tax deductions.
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:
A reconciliation of the notional or contract amounts for the significant programs using derivative agreements and contracts is as follows:
Put Options. LNC uses put options, combined with various perpetual fixed income securities, and interest rate swaps to replicate a fixed income, fixed maturity investment. The put options give LNC the right, but not the obligation, to sell to the counterparty of the agreement the specified securities on a specified date at a fixed price.
Commodity Swap. LNC uses a commodity swap to hedge its exposure to fluctuations in the price of gold, which is the underlying variable in determining the periodic interest payments associated with a fixed income security. A commodity swap is a contractual agreement to exchange a certain amount of a particular commodity for a fixed amount of cash. LNC owns a fixed income security that meets its coupon payment obligations in gold bullion. LNC is obligated to pay to the counterparty the gold bullion, and in return receives from the counterparty a stream of fixed income payments. The fixed income payments are the product of the swap notional multiplied by the fixed rate stated in the swap agreement. The net receipts/payments from commodity swaps are recorded in net investment income.
Additional Derivative Information. Expenses for the agreements and contracts described above amounted to $11,600,000 and $10,000,000 in 1998 and 1997, respectively. Deferred gains of $64,800,000 as of December 31, 1998, were the result of: 1) terminated and expired spread-lock agreements and; 2) terminated
interest rate swaps. These gains are included with the related fixed maturity securities to which the hedge applied or as deferred liabilities and are being amortized over the life of such securities.
Short-term and Long-term Debt. Fair values for long-term debt issues are based on quoted market prices or estimated using discounted cash flow analysis based on LNC's current incremental borrowing rate for
similar types of borrowing arrangements where quoted prices are not available. For short-term debt, the carrying value approximates fair value.
As of December 31, 1998 and 1997, the carrying value of the deposit contracts and certain guaranteed contracts is net of deferred acquisition costs of $52,600,000 and $96,400,000, 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, Lincoln UK, Reinsurance 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. The Lincoln UK segment offers similar products 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. 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."
"Other Operations" includes operations not directly related to the business segments and unallocated corporate items (i.e., corporate investment income, interest expense on corporate debt and unallocated overhead expenses). LNC's other operations also includes data for its investment management company that services LNC's business segments.
Financial data by segment for 1996 through 1998 is as follows:
Substantially all of LNC's foreign operations are conducted by Lincoln National (UK) plc, a United Kingdom company. The data for this company is shown above under the Lincoln UK segment heading. Foreign intracompany revenue is not significant. All earnings from LNC's U.K. operations have been retained in the U.K.
LNC has outstanding one common share purchase right ("Right") on each outstanding share of LNC's common stock. A Right will also be issued with each share of LNC's common stock that is issued before the Rights become exercisable or expire. If a person or group announces an offer that would result in beneficial ownership of 15% or more of LNC's common stock, the Rights will become exercisable and each Right will entitle its holder to purchase one share of LNC's common stock for $200. Upon the acquisition of 15% or more of LNC's common stock, each holder of a Right (other than the person acquiring the 15% or more) will have the right to acquire the number of shares of LNC common stock that have a market value of two times the exercise price of the Right. If LNC is acquired in a business combination transaction in which LNC does not survive, each holder of a Right (other than the acquiring person) will have the right to acquire common stock of the acquiring person having a market value of two times the exercise price of the Right. LNC can redeem each Right for one cent at any time prior to the tenth day after a person or group has acquired 15% or more of LNC's common stock. The Rights expire on November 14, 2006. As of December 31, 1998, there were 101,055,587 Rights outstanding.
During 1998, 1997 and 1996, LNC purchased and retired 623,281; 4,948,900 and 694,582 shares, respectively, of its common stock at a total cost of $46,900,000; $325,300,000 and $35,000,000, respectively. The common stock account was reduced for these purchases in proportion to the percentage of share acquired. The remainder of the purchase price was charged to retained earnings.
The "Net Unrealized Gain (Loss) on Securities Available-for-Sale" shown above is net of realized gain (loss) on investments. Following is the detail of the realized gain (loss) on investments and gross unrealized gain (loss) on securities available-for-sale:
In April 1997, LNC completed the acquisition of Voyageur Fund Managers, Inc. ("Voyageur") for $74,000,000. While this includes cash paid out for expenses associated with the purchase, the bulk of the purchase price was covered by the issuance of 1,323,144 shares of LNC common stock to the previous owners of Voyageur. Purchase accounting has been applied to this acquisition resulting in intangible assets of $78,900,000. Voyageur's operating results are included in LNC's consolidated financial statements from the closing date.
On June 9, 1997, LNC announced that it agreed to sell its 83.3% ownership in American States Financial Corporation for $2,650,000,000. As this sale resulted in an exit from the property-casualty business (previously a business segment), the financial data from the units being sold are shown as discontinued operations in the accompanying financial statements. June 9, 1997, is the measurement date for purposes of discontinued operations. Following the closing of this transaction on October 1, 1997, the gain on sale of $776,900,000 ($1,224,500,000 pre-tax) was recorded within discontinued operations. LNC used these proceeds to repurchase $341,800,000, (4,993,281 shares) of its own common stock, retire $86,700,000 of long-term debt, purchase a 49% ownership in Seguros Serfin Lincoln for $85,000,000 pay income taxes of $447,600,000 related to the sale of discontinued operations and purchase a block of individual life insurance and annuity business for $1,642,500,000 (see below). The remainder was used to pay off a portion of LNC's short-term debt and to invest for general corporate purposes, then later used to fund a portion of the purchase of another block of individual life insurance business.
The consolidated proforma results of operations shown below assumes that the two blocks of business described in the preceding paragraphs were purchased on January 1, 1997.
We have audited the accompanying consolidated balance sheets of Lincoln National Corporation as of December 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lincoln National Corporation at December 31, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.