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 suburban Chicago, Illinois; Philadelphia, Pennsylvania; Hartford, Connecticut and areas near London, England own or lease another 700,000 square feet of office space. An additional 1.0 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. As shown in the notes to the consolidated financial statements (see note 7 to the consolidated financial statements on page 54), the rental expense on operating leases for office space and equipment for continuing operations totaled $62.5 million for 1997. Office space rent expense accounts for $47.2 million of this total. This discussion regarding properties does not include information on investment properties.
Year Ended December 31 (in millions) 1997 1996 1995 1994 1993
Income (loss) from continuing operations (1) . . . . . . . . . $(50.7) $298.8 $140.9 $218.6 $197.5 Realized gain (loss) on investments, net of associated amortization of deferred policy acquisition costs, investment expenses and income taxes 72.9 57.6 102.2 (101.9) 73.8 Gain (loss) on sale of subsidiary, net of taxes . . . . . . . . . . . -- -- 58.3 48.8 (98.5) Cumulative effect of accounting change (postretirement benefits). . -- -- -- -- (96.4)
Net Income (Loss) from Continuing Operations . . . . . . . . . . . . $ 22.2 $356.4 $301.4 $165.5 $ 76.4
This "Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the audited consolidated financial statements and accompanying notes presented on pages 34 through 66.
LNC's Life Insurance and Annuities segment reported record income from operations of $255.8 million in 1997, a 20% increase over the $212.5 million reported in 1996. The continuing double-digit growth in the annuity business was the primary factor in this segment's earnings performance.
Profile: The Life Insurance and Annuities segment is composed of Lincoln National Life Insurance Company ("Lincoln Life"), First Penn-Pacific Life Insurance Company ("First Penn") and Lincoln Life & Annuity Company of New York ("LLANY"). As shown above, account values for this segment's annuities, 401(k) retirement plans, life insurance and pensions total $53.7 billion as of December 31, 1997. Life insurance in-force for these companies as of December 31, 1997, totaled $63.5 billion, an increase of 29% in comparison with $49.1 billion as of December 31, 1996.
LNC completed the acquisition of a block of individual life insurance and annuities business on January 2, 1998, from CIGNA Corporation, adding a career agency system of 600 producers; a life brokerage operation; an annuity distribution system; and $41 billion of individual life insurance in-force.
Varied Distribution: Products from the companies in this segment are sold through multiple distribution channels, reflecting a marketplace where consumers increasingly want to do business on their own terms. These channels are career agents, independent agencies, insurance brokers, banks, stockbrokers and financial planners.
Lincoln Life's and LLANY's wealth accumulation and wealth protection products include: fixed and variable annuities; tax-deferred annuities; term, universal and variable universal life insurance; and 401(k) retirement plans. These products are sold in 50 states through the 68 regional offices of Lincoln Financial Advisors ("LFA"), a broker/dealer that serves approximately 2,200 career agents and 15,600 insurance brokers, as well as through 51,800 stockbrokers and financial planners. The network of agencies and career agents includes 30 and 600, respectively, that were added January 2, 1998 as the result of the acquisition of a block of individual life insurance and annuity business (see note 11 to the consolidated financial statements on page 64).
Annuities: Annuity earnings in this segment increased 23% in 1997, reaching a record $203.0 million. As of December 31, 1997, annuity account values were $44.6 billion, up from $38.0 billion the year before. Variable annuity account values at year-end were $27.3 billion, while fixed annuities represented $17.2 billion.
Annuity deposits in 1997 were $4.0 billion. Annuity deposits sold through producers were $2.2 billion, while annuity deposits sold through stockbrokers were $1.7 billion. The latter compares with $2.0 billion in deposits from stockbrokers in 1996. American Funds Distributors ("AFD"), which markets the American Legacy variable annuity product sold through stockbrokers, plans to expand its annuity distribution staff and to be more aggressive in product innovations.
Pensions: This segment's pension business is focused on 401(k) retirement plans for businesses with fewer than 100 employees. Account values for these plans were $3.4 billion as of December 31, 1997, a 17% increase over 1996. Deposits totaled $742 million.
(1) This segment was added in 1997 (with restatement of prior year amounts) as required by the adoption of Financial Accounting Standard No. 131 (see note 2 to the consolidated financial statements on page 43). Lincoln UK was previously reported with the Life Insurance and Annuities segment.
Profile: Lincoln UK offers life, investment and income protection and retirement planning products primarily through 1,800 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 variable life products sold in the U.S. After rapid growth prompted by the acquisition of three life insurance companies between 1993 and 1995, its home office operations are divided between Uxbridge, Middlesex, and Barnwood, Gloucester, England.
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. In December 1993, regulatory agencies raised questions as to whether individuals who bought pensions in the UK and exited employer plans between 1988 and 1993 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.
Outlook: With resolution to the "pension mis-selling" situation expected in 1998, Lincoln UK expects a stable earnings picture going forward. Lincoln UK anticipates growing faster than the rest of the U.K. life insurance industry through increased distribution, a superior trained sales force, improved products and investment performance and suitable acquisitions.
(1) Income (loss) from operations and net income (loss) for 1997, 1995 and 1993 include the impact of a change in estimate of the reserve level needed for LNC's disability income business ($130.0 million, $121.6 million and $32.8 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 is also charged with managing LNC's activities in several emerging markets. In 1997, LNC entered into a joint venture through the purchase of 49% of Seguros Serfin Lincoln which sells insurance products through Banca Serfin, Mexico's oldest and third largest bank. This joint venture enables LNC to leverage the insurance expertise of this segment in an under-insured market with long-term potential. In addition, LNC maintains representative offices in China (Beijing, Shanghai, Guangzhou) and is working to gain a license to conduct insurance business in the People's Republic of China.
Mass Customization: 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. More than 600 such customized transactions were completed by Lincoln Re in 1997. 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%.
Knowledge Management: Lincoln Re's intellectual capital is critical to its success. It demonstrated this more than a decade ago by introducing an underwriting manual that quickly became the industry standard for life and health risk selection. The formation of Lincoln National Risk Management ("LNRM") to develop proprietary knowledge-based systems was the next step. Today, its systems are used throughout the insurance industry.
The most recent addition to the Lincoln Re portfolio is the Lincoln Mortality System which aids insurers developing preferred term life insurance products.
Alliance Management: 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 a Lincoln Re client do business.
Financial Reinsurance: Income from operations declined slightly in the financial reinsurance area in 1997. Income from operations was $14.4 million, compared with $16.4 million in 1996.
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 as it seeks to exceed $100 million in annual operating earnings.
Assets Under Management Retail-Fixed . . . . . . . . . . . . . $ 6.9 $ 4.6 $ 4.8 Retail-Equity . . . . . . . . . . . . 15.6 11.5 8.8 Total Retail . . . . . . . . . . . 22.5 16.1 13.6
(2) Certain amounts previously shown in the 1996 and 1995 columns have been reallocated to "Other Operations" in order to conform to the 1997 presentation.
The decrease in income from operations was attributable to increased expenses related to efforts to expand retail operations at Delaware Management Holdings, Inc. ("Delaware"). These efforts included increasing marketing personnel, broadening product offerings and upgrading customer service.
The return for the Social Awareness Fund managed by Vantage was 36.1% in 1997, well ahead of the 29.9% return for the top decile variable annuity in the Morningstar Growth Universe. This performance earned an 8th place ranking among 885 variable annuity funds in that Morningstar category. Also, over the long term, the fund was the top ranked fund in Growth Universe for three and five years versus the 637 and 414 of such funds.
Among institutional investment managers, Delaware produced strong results in the value equity category, with a return of 32.2% that qualified as a top quintile performance as measured by Callan's Value Universe. In the international equity category, Delaware's return of 7.9% exceeded the 1.8% return for its comparative Morgan Stanley Capital International Europe, Australia, Far East (EAFE) index.
Outlook: The Investment Management segment's objective is to reach $50 billion in retail fund assets and $80 billion in total assets under management by the end of 2000. Steady progress was made toward this objective in 1997 and further progress is expected through internal growth and niche acquisitions.
(1) The data shown in the 1996 and 1995 columns includes amounts previously shown within the Investment Management segment. These reallocations were initiated in order to conform to the 1997 presentation.
Lincoln Investment Management provides investment advisory services and asset management services for LNC's Corporate portfolios and entities not owned by LNC.
Corporate interest expense included within the LNC financing line above was greater for 1995 - 1996 than years prior to 1995 as the result of additions to long-term debt and minority interest-preferred securities of subsidiary companies. The 1997 amount was less than the 1995 - 1996 due to reduced interest expense and investment earnings in the fourth quarter of 1997 that resulted from the use of proceeds from the sale of discontinued operations (see liquidity and cash flow discussion on page 31). This benefit will not continue into 1998 as most of these funds were used to purchase a block of individual life and annuity business on January 2, 1998 (see note 12 to the consolidated financial statements on page 65).
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 81% of the investment portfolio.
Net Investment Income Net investment income increased $162.9 million or 8% in 1997 as the net result of a 9% increase in mean invested assets, a decrease in the yield on investments from 7.52% to 7.46% and a benefit of a reduction in the recurring adjustments of discount on mortgaged-backed securities. In 1997, this adjustment was a charge of $.4 million versus a charge of $7.6 million in 1996. Net investment income increased $108.2 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 7.67% to 7.52% (all calculations on a cost basis) and; 2) a charge of $7.6 million in 1996 versus a benefit of $27.5 million in 1995 from the recurring adjustment of discount on mortgage-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.
Gain on Sale of Subsidiaries In 1995, LNC recorded the gain on sale of the remaining 29% of the employee life-health benefits company.
Life Insurance and Annuity Benefits Life insurance and annuity benefits in 1997 increased $322.4 million or 16% as compared to 1996. This increase was the result of increases of $89.4 million or 6% from the Life Insurance and Annuities segment, $25.6 million or 7% from the Reinsurance segment and $207.1 million from the Lincoln UK segment. The Lincoln UK increase includes a change in estimate for its pension mis-selling liability (see note 2 to the consolidated financial statements on page 43). Life insurance and annuity benefits increased $5.1 million in 1996 as compared to 1995. This increase was the result of decreased volumes of business and improved mortality in the Life Insurance and Annuities segment being essentially offset by
Underwriting, Acquisition, Insurance and Other Expenses These 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 acquisition of blocks of business/subsidiary companies (see note 11 to the consolidated financial statements on page 64) and the write-off of deferred acquisition costs associated with the disability income business (see note 2 to the consolidated financial statements on page 43). These expenses increased $186.7 million or 15% in 1996 as the result of increased business volumes in all business segments and the addition of the operating costs of companies acquired in 1995 and 1996. In 1998, all business segments will continue to adjust staff levels as appropriate to match business volumes.
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 64).
During 1996 and 1997, LNC identified expenditures of approximately $11 million ($7 million after-tax) that it had spent to address this issue. LNC's financial plans for 1998-2000 include expected expenditures of an additional $39 million ($25 million after-tax) on this issue. The cost of addressing year 2000 issues and the timeliness of completion will be closely monitored by management and are 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. Nevertheless, there can be no guarantee that these estimated costs will be achieved and actual results could differ significantly from those anticipated. 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.
As a result of the purchase of a block of individual life insurance and annuity business in January of 1998, select balance sheet accounts described below will increase (see note 12 to the consolidated financial statements on page 65).
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 on page 45 shows the gross unrealized gains and losses as of December 31, 1997.
Premiums and Fees Receivable Premiums and fees receivable decreased $39.8 million in 1997 as the result of decreased volumes of business in the Reinsurance segment more than offsetting the increase in volumes of business in the Investment Management segment.
Other Intangible Assets The decrease of $94.5 million is the net result of additions related to the purchase of subsidiary (see note 11 to the consolidated financial statements on page 64) being more than offset by the on-going amortization and an adjustment to the Lincoln UK amount to more closely conform this segments classifications to LNC's U.S. operations.
Total Liabilities Total liabilities from continuing operations increased by $9.1 billion in 1997. The primary item underlying this increase is the increase of $8.3 billion related to separate accounts (see explanation under "Assets Held in Separate Accounts" above). The increase of $808.4 million in insurance policy and claim reserves is the result of increased volumes of business and reserve strengthening as described in note 2 to the consolidated financial statements on page 43. The reduction in contractholder funds is the net result of new deposits being more than offset by the withdrawal of guaranteed interest contract funds because of the decision to exit this business. The increases in the other liability categories essentially offset the reduction in contractholder funds. The increase in other liabilities relates to an increase in the expected payouts for securities purchased in the last few days of 1996 versus a lower volume of such transactions late in 1995.
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, 1997, statutory-basis capital for each of LNC's U.S. insurance subsidiaries was substantially in excess of regulatory action levels of risk-based capital required by the jurisdiction of domicile.
1) Interest Rate Risk Accumulation and Investment Oriented Insurance Products. General account assets supporting accumulation and investment oriented insurance products total $22.4 billion or 75% of total invested assets. Fixed maturity and equity securities are held at fair value on the balance sheet, mortgage loans on real estate are held at amortized cost and real estate is held at cost less depreciation while liabilities are generally held at account values less surrender charges (see note 1 to the consolidated financial statements on page 40). The fair values for mortgage loans on real estate and guaranteed interest rate contracts are calculated on a discounted cash flow basis while fixed annuities and other deposit liabilities are at policy cash surrender value (see note 8 to the consolidated financial statements on page 58).
With respect to these products, LNC seeks to earn a stable and profitable spread between investment income and interest credited to account values. If LNC has adverse experience on investments that cannot be passed through to customers, its spreads are reduced. Alternatively, LNC may seek to maintain spreads and this may result in crediting rates that are not competitive in the market place. This strategy could result in adverse surrender experience on policies and could force LNC to liquidate a portion of its portfolio to fund excess cash surrender value benefits.
LNC does not view the near term risk to spreads over the next twelve months to be material. The combination of a probable range of interest rate changes over the next twelve months, asset-liability management strategies, flexibility in adjusting crediting rate levels and protection afforded by policy surrender charges and other switching costs all work together to minimize this risk. The interest rate scenarios of concern are those in which there is a substantial, relatively rapid increase or decrease in interest rates that is then sustained over a long period.
Fixed Deferred Annuities. 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. Annuity 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. Due to LNC's ability to change crediting rates to reflect investment experience, the underlying assets are assumed to be a good proxy for the interest rate risk inherent in these liabilities. This assumption is appropriate for probable movements in interest rates over the next 12 months. This assumption may not be appropriate for a substantial, relatively rapid increase or decrease in interest rates that is then sustained over a long period.
Guaranteed Interest Contracts and Group Pension Annuities. LNC has assets totaling $3.4 billion that support guaranteed interest contracts, group pension annuities and immediate annuities. Generally, the cash flows expected on these liabilities do not vary with fluctuations in market interest rates and are not adjustable by LNC. Accordingly, if experience on the assets supporting these products is more adverse than the assumptions used in pricing the products, spreads will tend to be below expectations. LNC limits exposure to interest rate risk by managing the duration and maturity structure of each investment portfolio in relation to the liabilities it supports.
Derivatives. As indicated in note 7 to the consolidated financial statements on page 56, LNC has entered into derivative transactions to reduce its exposure to rapid rises in interest rates. The four programs discussed below are used to help LNC achieve more stable margins while providing competitive crediting rates to policyholders during periods when interest rates are rising. Failure to maintain competitive crediting rates could cause policyholders to withdraw their funds and place them in more competitive products.
For future periods, the fair value of LNC's interest rate caps and swaptions depends on the levels of interest rates on U.S. Treasury securities with maturities of two, five, seven and 10 years and U.S. dollar swap rates with five, seven and 10 year maturities. The table below analyzes fair value levels at December 31, 1997 and for the next five years if the rates were 2%, 4%, 6%, 8%,10% or 12% higher than they were at December 31, 1997. In relation to the level of these rates at December 31, 1997, the cap and swaption rates were from 2.24% to 5.04% out-of-the-money, i.e., higher. The table below shows the fair value levels of interest rate caps and swaptions under these scenarios.
LNC uses interest rate swap agreements to hedge its exposure to floating rate bond coupon payments, replicating a fixed rate bond. An interest rate swap is a contractual agreement to exchange payments at one or more times based on the actual or expected price, level, performance or value of one or more underlying interests. LNC is required to pay the counterparty the stream of variable coupon payments generated from the bonds, and in turn, receives a fixed payment from the counterparty, at a predetermined interest rate. As of December 31, 1997, LNC had a swap agreement with a notional amount of $10.0 million that expires in 2000.
In addition to continuing existing programs, LNC may use derivative products in other strategies to limit risk and enhance returns, particularly in the management of investment spread businesses. LNC has established policies, guidelines and internal control procedures for the use of derivatives as tools to enhance management of the overall portfolio of risks assumed in LNC's operations.
The table below provides a general measure of LNC's significant interest rate risk (principal amounts are shown by year of maturity and include amortization of premiums and discounts) as of December 31, 1997.
pre-tax loss. The aggregate USD equivalent of forward currency positions hedging the portfolio was $172.8 million; the unhedged amount of the portfolio was $347.0 million. A 10% adverse currency move has thus been reduced to $34.7 million pre-tax through hedging. This number is approximate because not all foreign currency derivatives are "at- the-money spot." The table below shows LNC's exposure to foreign currency securities. Also included is the relevant information relating the foreign currency derivatives that are hedging the currency risk of these securities. The table below presents the principal (notional) amount in U.S. dollar equivalents by expected maturity for LNC's foreign currency denominated investments.
Foreign Currency Forward Contracts. LNC uses foreign currency forward contracts to actively hedge some of the foreign exchange risk related to its investments in fixed maturity securities denominated in foreign currencies. LNC typically engages in short-term currency forward contracts of less than six months and actively monitors currency markets in determining those currencies to hedge, the duration of the hedge and the nominal amount to hedge. A foreign currency forward contract obligates LNC to deliver a specified amount of currency at a future date at a specified exchange rate. 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. As of December 31, 1997, LNC had agreements with notional amounts of $163.1 million in foreign exchange forward contracts for an average overall hedge ratio of 38%. These contracts include hedges against British Pounds (60% hedged), Japanese Yen (73% hedged) and Italian Lira (25% hedged) with average forward foreign exchange rates of 1.610, 120.750 and 1826.100, respectively. LNC periodically uses foreign exchange forward contracts to hedge against foreign exchange risk related to LNC's investment in its British subsidiary, Lincoln National (UK). As of December 31, 1997, LNC did not have any open foreign exchange forward contracts related to its investment in Lincoln National (UK).
U.S. Equities . . . . . . $ 498.1 $ 498.1 $ 547.9 $ 448.3 Foreign Equities . . . . . 157.7 157.7 173.5 141.9 Emerging Market Equities . 4.6 4.6 5.1 4.1 Sub-Total . . . . . . . 660.4 660.4 726.5 594.3
LNC uses Over-the-Counter ("OTC") foreign currency equity call options to hedge against the foreign equity market risk component contained in its U.K. unit-linked annuities which are a function of the Financial Times Stock Exchange ("FTSE") index. These call options require the counterparties to pay LNC at specified future expiration dates the amount, if any, of the percentage increase in the FTSE index over the strike price defined in the contract, applied to a notional amount. As of December 31, 1997, LNC had agreements with notional amounts of $14.1 million. The call options expirations are matched to the liabilities and expire in 1998 through 2001.
LNC is depending on the ability of derivative product dealers and their guarantors to honor their obligations to pay the contract amounts under interest rate cap agreements, swaptions, spread-lock agreements, interest rate swaps, call options, foreign currency exchange contracts, foreign currency options and foreign currency swaps. In order to minimize the risk of default losses, LNC diversifies its exposures among several dealers and limits the amount of exposure in accordance with the credit rating of each dealer or its guarantor. LNC generally limits its selection of counterparties that are obligated under these derivative contracts to those with an A credit rating or above.
Credit-Related Derivatives. LNC periodically uses spread-lock agreements to hedge a portion of the value of its fixed maturity securities against the risk of widening in the spreads between their yields and the yields of comparable maturity U.S. or other Government obligations. The actual risk being hedged by these agreements is the potential widening of bond spreads that would be caused by widening swap spreads. Under these agreements, LNC assumed the right and the obligation to enter into an interest rate swap at a future date in which LNC would pay a fixed rate equal to a contractually specified spread over the yield of a specified Government security and receive a floating rate. As of December 31, 1997, LNC did not have any open spread-lock agreements.
LIQUIDITY AND CASH FLOW Liquidity refers to the ability of an enterprise to generate adequate amounts of cash from its normal operations to meet cash requirements with a prudent margin of safety. Because of the interval of time from receipt of a deposit or premium until payment of benefits or claims, LNC and other insurers employ investment portfolios as an integral element of operations. By segmenting its investment portfolios along product lines, LNC enhances the focus and discipline it can apply to managing the liquidity as well as the interest rate and credit risk of each portfolio commensurate with the profile of the liabilities. For example, portfolios backing products with less certain cash flows and/or withdrawal provisions are kept more liquid than portfolios backing products with more predictable cash flows.
The consolidated statements of cash flows on page 37 indicate that operating activities provided cash of $1.1 billion, $1.4 billion and $2.2 billion in 1997, 1996 and 1995, 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.
Recent transactions also include LNC's purchase and retirement of 4,948,900 and 694,582 shares of common stock at a cost of $325.3 million and $35.0 million in 1997 and 1996, respectively. The 4,948,900 shares purchased in 1997 includes 4,370,000 shares at a cost of $294.9 million that have been purchased since the June 1997 board authorization to repurchase up to $500 million of common stock.
The table above shows the cash flow activity for the holding company from 1995 through 1997. The line, "net tax receipts from (payments to) subsidiaries", recognizes that the holding company receives tax payments from subsidiaries, pays the consolidated tax liability and reimburses subsidiaries for the tax effect of any taxable operating and capital losses.
See notes to the consolidated financial statements on pages 40 - 65.
Use of Estimates. The nature of the insurance and investment management businesses requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
For the mortgage-backed securities portion of the fixed maturity securities portfolio, LNC recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When estimates of prepayments change, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied at the time of acquisition. This adjustment is reflected in net investment income.
Mortgage loans on real estate are carried at the outstanding principal balances less unaccrued discounts. Investment real estate is carried at cost 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.
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, 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.
Hedge accounting is applied as indicated above after LNC determines that the items to be hedged expose LNC to interest rate fluctuations, the widening of bond yield spreads over comparable maturity U.S. Government obligations, fluctuations in the FTSE index, increased liabilities associated with certain reinsurance agreements and foreign exchange risk. Moreover, the derivatives used are designated as a hedge and reduce the indicated risk by having a high correlation between changes in the value of the derivatives and the items being hedged at both the inception of the hedge and throughout the hedge period. Should such criteria not be met or if the hedged items have been sold, terminated or matured, the change in value of the derivatives is included in net income.
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 earned by LNC's insurance subsidiaries for administrative and contractholder maintenance services performed for these separate accounts are included in insurance fee revenue.
Deferred Acquisition Costs. Commissions and other costs of acquiring universal life insurance, variable universal life insurance, traditional life insurance, unit-linked products, 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-health and annuity acquisition costs are being amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy reserves.
Benefits and Expenses. Benefits for universal and variable universal life insurance policies include interest credited to policy account balances and benefit claims incurred during the period in excess of policy account balances. Interest crediting rates associated with funds invested in the insurance company's general account during 1995 through 1997 ranged from 5.9% to 8.0%. Interest and debt expense includes interest on Minority Interest-Preferred Securities of Subsidiary Companies.
With respect to its insurance and investment contract liabilities, LNC continually reviews its: 1) overall reserve position; 2) reserving techniques and; 3) reinsurance arrangements. As experience develops and new information becomes known, liabilities are adjusted as deemed necessary. The effects of changes in estimates are included in the operating results for the period in which such changes occur.
Change in Estimate for United Kingdom Pension Mis-selling. During the fourth quarter of 1997, an in-depth review was completed of the United Kingdom regulatory environment, settlements to date and the remaining liability established to settle claims associated with this business. As a result of this study, the Lincoln UK segment strengthened its liability by $199,400,000 reducing net income by $174,900,000 after-tax or $1.70 per share.
Earnings per Share. Financial Accounting Standard No. 128 entitled "Earnings per Share" ("FAS 128") issued in February 1997, was adopted by LNC during the fourth quarter of 1997. All prior period earnings per share amounts have been restated to conform to the provisions of this standard. See note 10 on page 63 for further earnings per share disclosures.
Reporting Comprehensive Income. Financial Accounting Standard No. 130 entitled "Reporting Comprehensive Income" ("FAS 130") issued in June 1997 was adopted by LNC during the fourth quarter of 1997 on a retroactive basis as permitted by the standard. FAS 130 requires that select changes in shareholders' equity be added to net income and reported as Comprehensive Income. LNC reported this information within the consolidated statements of shareholders' equity (see page 38). This standard also requires disclosures related to the tax effects of each component of comprehensive income (see note 10 on page 64).
Year Ended December 31 (in millions) 1997 1996 1995 Fixed maturity securities available-for-sale: Gross gain . . . . . . . . . . . . . . $240.0 $ 209.5 $ 245.9 Gross loss . . . . . . . . . . . . . (91.5) (202.6) (90.6) Equity securities available-for-sale: Gross gain . . . . . . . . . . . . . . 136.8 152.7 97.5 Gross loss . . . . . . . . . . . . . (41.8) (37.8) (46.9) Other investments . . . . . . . . . . (32.3) 40.4 36.9 Amortization of deferred acquisition costs, provision for policyholder commitments and capital gains expenses . . . . . . . . (88.6) (69.7) (85.2) Total . . . . . . . . . . . . . . $122.6 $ 92.5 $ 157.6
Year Ended December 31 (in millions) 1997 1996 1995 Fixed maturity securities . . .. . . . . $ 13.1 $ 12.3 $ 13.6 Equity securities . . . . . . . . . . . .3 3.2 .3 Mortgage loans on real estate . . . . . . (8.9) 3.1 14.1 Real estate . . . . . . . . . . . . . . . (13.6) 4.6 (9.2) Other long-term investments . . . . . . . (6.5) (.8) (4.7) Guarantees . . . . . . . . . . . . . . . -- .2 (2.6) Total . . . . . . . . . . . . . . . $(15.6) $ 22.6 $ 11.5
At December 31, 1997, the par value, amortized cost and estimated fair value of investments in mortgage-backed securities summarized by interest rates of the underlying collateral are as follows:
Treasuries and AAA . . . . . . . . . . . . . . . . . . . . . . . . . . 27.6% AA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.5 A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28.1 BBB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29.5 BB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Less than BB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.9 100.0%
Impaired loans along with the related allowance for losses are as follows:
Impaired 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.
As of December 31, 1997, LNC's investment commitments for fixed maturity securities (primarily private placements), mortgage loans on real estate and real estate were $367,900,000.
For the year ended December 31, 1997, fixed maturity securities available-for-sale, mortgage loans on real estate and real estate investments which were non-income producing were not significant.
December 31 (in millions) 1997 1996 Mortgage loans on real estate. . . . . . . . . . . $ 5.0 $12.4 Real estate . . . . . . . . . . . . . . . . . . . 1.5 3.0 Guarantees . . . . . . . . . . . . . . . . . . . . .8 1.8
December 31 (in millions) 1997 1996 Current . . . . . . . . . . . . . . . . . . . . . . . $(431.8) $ 20.7 Deferred . . . . . . . . . . . . . . . . . . . . . . (56.0) (182.2)
Total for continuing operations . . . . . . . . (487.8) (161.5) Discontinued operations. . . . . . . . . . . . . . . -- 127.8
December 31 (in millions) 1997 1996 Deferred tax assets: Insurance and investment contract liabilities .......... $ 914.3 $ 752.7 Net operating loss ..................................... 66.3 90.0 Postretirement benefits other than pensions ............ 39.4 36.6 Other .................................................. 102.9 108.7 Total deferred tax assets ........................... 1,122.9 988.0 Valuation allowance for deferred tax assets ............ 43.5 -- Net deferred tax asset .............................. 1,079.4 988.0
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, 1997 total of the life companies' account balances for their "shareholders' surplus accounts" was $2,074,000,000. 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 $196,000,000 "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 $68,600,000 would be due.
LNC has declared its intention to reinvest the undistributed earnings of Lincoln National (UK) and will not provide U.S. income tax on these undistributed earnings. At December 31, 1997, for the years covered by this declaration there was a deficit in earnings for Lincoln National (UK).
Year Ended December 31 (in millions) 1997 1996 1995 Insurance assumed. . . . . . . . . . . $1,079.1 $1,201.0 $1,247.9 Insurance ceded . . . . . . . . . . . . 315.0 168.6 391.0 Net reinsurance premiums . . . . . $ 764.1 $1,032.4 $ 856.9
The income statement caption, "Benefits," is net of reinsurance recoveries of $393,000,000, $250,100,000, and $386,900,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
A reconciliation of the present value of business in-force for LNC's insurance subsidiaries included in other intangible assets is as follows:
Details underlying the balance sheet captions, "Short-term and Long-term Debt," are as follows:
Finally, LNC maintains a revolving credit agreement with a group of domestic and foreign banks in the aggregate amount of $750,000,000. This agreement, which expires in October 2001, provides for interest on borrowings based on various money market indices. Under the terms of this agreement, debt levels must remain below 45% of adjusted consolidated net worth if debt ratings fall below a prescribed level. LNC's current debt ratings are above this prescribed level. LNC must maintain a prescribed level of adjusted consolidated net worth. At December 31, 1997, LNC had no outstanding borrowings under this agreement. During 1997, 1996 and 1995, fees paid for maintaining revolving credit agreements amounted to $670,000, $715,000, and $649,000, respectively.
Cash paid for interest for 1997, 1996 and 1995 was $96,000,000; $83,200,000, and $73,200,000, respectively.
Incentive Plans. LNC has various incentive plans for key employees, agents and directors of LNC and its subsidiaries that provide for the issuance of stock options, stock appreciation rights, restricted stock awards and stock incentive awards. These plans are comprised primarily of stock option incentive plans. Stock options granted under the stock option incentive plans are at the market value at the date of grant and, subject to termination of employment, expire 10 years from the date of grant. Such options are transferable only upon death and are exercisable one year from date of grant for options issued prior to 1992. Options issued subsequent to 1991 are exercisable in 25% increments on the option issuance anniversary in the four years following issuance.
Restricted stock (non-vested stock) awarded from 1995 through 1997 was as follows:
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 1,1995 . . . . . . 8,423,014 2,672,189 30.56 Granted . . . . . . . . . . . . . . . (510,150 510,150 42.57 Exercised . . . . . . . . . . . . . . . -- (313,612) 25.70 Expired . . . . . . . . . . . . . . . . (5,273) (275) 19.97 Forfeited . . . . . . . . . . . . . . . 175,446 (36,172) 34.64 Restricted stock awarded . . . . . . . (335,126) Balance at December 31, 1995. . . . 7,747,911 2,832,280 33.21
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
Additional authorized . . . . . . . . . 11,613,256 Granted. . . . . . . . . . . . . . . . (1,094,229) 1,094,229 59.49 Exercised . . . . . . . . . . . . . . -- (903,407) 31.67 Expired . . . . . . . . . . . . . . . . -- (783) 71.07 Forfeited . . . . . . . . . . . . . . . 60,797 (44,316) 46.43 Restricted stock awarded . . . . . . . (118,836) Balance at December 31, 1997 . . . 17,667,079 3,300,886
December 31 1997 1996 1995 Options exercisable (number of shares) . . . .1,601,972 1,833,269 1,647,872
Other Benefit Plans. LNC maintains defined benefit pension plans for its U.S. and U.K. employees and a defined contribution plan for its U.S. agents. LNC also maintains 401(k) Plans, deferred compensation plans and postretirement medical and life insurance plans for its U.S. employees and agents. The aggregate expenses and accumulated obligations for these plans are not material to LNC's consolidated statements of income or financial position for any of the periods shown in the accompanying consolidated financial statements.
Shareholders' equity as determined in accordance with statutory accounting practices for LNC's insurance subsidiaries was $2,660,900,000 and $1,990,700,000 for December 31, 1997 and 1996, respectively.
LNC's insurance subsidiaries are subject to certain insurance department regulatory restrictions as to the transfer of funds and payments of dividends to LNC. In 1998, LNC's insurance subsidiaries can transfer up to $44,200,000 without seeking prior approval from the insurance regulators.
Total rental expense on operating leases in 1997, 1996 and 1995 was $62,500,000, $54,500,000 and $49,500,000, respectively. Future minimum rental commitments are as follows (in millions):
Information Technology Commitment In February 1998, Lincoln Life signed a seven-year contract with IBM Global Services for information technology services for the Fort Wayne operations. Annual costs are dependent on usage but are expected to range from $33,600,000 to $56,800,000.
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. Prior to December 31, 1997, LNC had limited its maximum coverage that it would retain on a single individual to $3,000,000. Based on a review of the capital assigned to the insurance business and the amount of business in-force (including the addition of the block of business described in note 11), effective in January 1998, LNC will change the amount it will retain on a single individual to $10,000,000. 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, 1997, the reserves associated with these reinsurance arrangements totaled $1,760,000,000. To cover products other than life 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 deferred acquisition costs, net of insurance ceded (see note 5 on page 49). 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, 1997, LNC's insurance companies have provided $245,800,000 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, 1997, LNC did not have a material concentration of financial instruments in a single investee, industry or geographic location. Also at December 31, 1997, 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.
Interest Rate Caps. The interest rate cap agreements, which expire in 1998 through 2003, entitle LNC to receive quarterly payments from the counterparties on specified future reset dates, contingent on future interest rates. For each cap, the amount of such 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 rising interest rates. The premium paid for the interest rate caps is included in other assets ($13,900,000 as of December 31, 1997) and is being amortized over the terms of the agreements. This amortization is included in net investment income.
Financial Futures. LNC uses exchange-traded financial futures contracts 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.
Call Options. LNC uses both FTSE index and S&P 500 index call options. Call options which expire in 1998 through 2005, provide LNC with settlement payments from the counterparties on specified expiration dates. The payment, if any, is the percentage increase in the index, over the strike price defined in the contract, applied to the notional amount. The purpose of LNC's FTSE call option program is to offset the cost of increases in the liabilities of certain single premium investment contracts which are tied to the FTSE index. The purpose of LNC's S&P 500 call option program is to offset the increase in its liabilities resulting from certain reinsurance agreements which guarantee payment of the appreciation of the S&P 500 index on certain underlying annuity products. The premium paid for the S&P 500 index call options is included in other assets ($1,200,000 as of December 31, 1997) and is being amortized over the terms of the agreements. This amortization is included in net investment income.
Additional Derivative Information. Expenses for the agreements and contracts described above amounted to $10,000,000 and $8,000,000 in 1997 and 1996, respectively. Deferred losses of $600,000 as of December 31, 1997, were the result of: 1) terminated and expired spread-lock agreements and; 2) financial futures contracts. These losses are included with the related fixed maturity securities to which the hedge applied and are being amortized over the life of such securities.
Other Investments, and Cash and Invested Cash. The carrying value for assets classified as other investments, and cash and invested cash in the accompanying balance sheets approximates their fair value.
The remainder of the balance sheet captions "Future Policy Benefits, Claims and Claim Expenses" and "Contractholder Funds" that do not fit the definition of "investment type insurance contracts" are considered insurance contracts. Fair value disclosures are not required for these insurance contracts and have not been determined by LNC. It is LNC's position that the disclosure of the fair value of these insurance contracts is important because readers of these financial statements could draw inappropriate conclusions about LNC's shareholders' equity determined on a fair value basis. It could be misleading if only the fair value of assets and liabilities defined as financial instruments are disclosed. LNC and other companies in the insurance industry are monitoring the related actions of the various rule-making bodies and attempting to determine an appropriate methodology for estimating and disclosing the "fair value" of their insurance contract liabilities.
Short-term and Long-term Debt. Fair values for long-term debt issues are estimated using discounted cash flow analysis based on LNC's current incremental borrowing rate for similar types of borrowing arrangements. For short-term debt, the carrying value approximates fair value.
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. 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 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."
Outstanding series A preferred stock has full voting rights, subject to adjustment if LNC is in default as to the payment of dividends. If LNC is liquidated or dissolved, holders of series A preferred stock will be entitled to payments of $80.00 per share. The difference between the aggregate preference on liquidation value and the financial statement balance for the series A preferred stock was $1,650,000 at December 31, 1997.
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, 1997, there were 100,859,478 Rights outstanding.
During 1997 and 1996, LNC purchased and retired 4,948,900 and 694,582 shares, respectively, of its common stock at a total cost of $325,300,000 and $35,000,000. 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.
Per share amounts for net income from continuing operations are shown on the income statement using 1) an earnings per common share basic calculation and 2) an earnings per common share-assuming dilution calculation. A reconciliation of the factors used in the two calculations are as follows:
Adjustments to deferred acquisition costs and amounts required to satisfy policyholder commitments are netted against the Deferred Acquisition Costs asset line and included within the Insurance Policy and Claim Reserve line on the balance sheet, respectively.
In January and April 1995, LNC completed the acquisitions of Liberty Life Assurance Company and Laurentian Financial Group plc, respectively. These companies provide unit-linked life and pension products in the United Kingdom. The combined purchase price was $274,500,000 including the assumption of $44,000,000 in debt. These acquisitions, which were accounted for using purchase accounting, resulted in other intangible assets of $388,700,000. The results of these operations are included in LNC's consolidated financial statements from their respective purchase dates.
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 $294,900,000 to repurchase 4,370,000 shares of its own common stock, $85,000,000 to purchase a 49% ownership in Seguros Serfin Lincoln and $99,800,000 to retire a portion of its long-term debt. Also, $447,600,000 was set aside to cover the income taxes related to the sale of discontinued operations and $1,642,500,000 was set aside for use in purchasing a block of individual life insurance and annuity business in January 1998 (see note 12 below). The remainder was used to pay off a portion of LNC's short-term debt and to invest for general corporate purposes, which could include additional acquisitions of business or companies.
Year Ended Nine Months Ended December 31 September 30, 1997 1996 1995
Revenue ....................... $1,538.5 $1,987.7 $2,046.8 Benefits and expenses ......... 1,363.6 1,799.0 1,834.6 Pre-tax net income ........ 174.9 188.7 212.2 Federal income taxes .......... 40.0 31.5 31.4 Net income ................ $ 134.9 $ 157.2 $ 180.8
We have audited the accompanying consolidated balance sheets of Lincoln National Corporation as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, 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.