LNC and the various operating businesses own or lease approximately 4.0 million square feet of office space. The governance group for LNC and the Investment Management segment lease 0.3 million square feet of office space in Philadelphia, Pennsylvania. The operating units in the Fort Wayne, Indiana area own or lease 1.6 million square feet. Also, businesses operating in suburban Chicago, Illinois; Hartford, Connecticut and the United Kingdom own or lease another 1.1 million 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), the rental expense on operating leases for office space and equipment for continuing operations totaled $81.5 million for 1999. Office space rent expense accounts for $61.8 million of this total. This discussion regarding properties does not include information on investment properties.
(in millions, except per share data) December 31 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------------------------------ Assets $103,095.7 $93,836.3 $77,174.7 $71,713.4 $63,257.7 Long-term debt 712.0 712.2 511.0 626.3 659.3 Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures 745.0 745.0 315.0 315.0 -- Shareholders' equity 4,263.9 5,387.9 4,982.9 4,470.0 4,378.1
(1) Factors affecting the comparability of net income from continuing operations and net income from continuing operations for the 1995-1999 period are shown on page 8 (see "Supplemental Data"). Other factors affecting comparability are shown within the results of operations by segment (see pages 10 through 23).
(2) Per share amounts and number of shares repurchased were also affected by the 1999 two-for-one split of LNC's common stock (see Note 10 to the consolidated financial statements) and by the issuance of 2,796,224 shares of common stock in 1997 and the retirement of 7,675,000; 1,246,562; 9,897,800 and 1,238,164 shares of common stock in 1999, 1998, 1997 and 1996, respectively.
Year Ended December 31 (in millions) 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------------------------------ Income (loss) from continuing operations (1) $475.5 $530.4 $(50.7) $298.8 $140.9 Realized gain (loss) on investments, net of associated amortization of deferred policy acquisition costs, provision for policyholder commitments, investment expenses and income taxes 3.8 13.7 72.9 57.6 102.2 Gain (loss) on sale of subsidiary, net of income taxes -- -- -- -- 58.3 Restructuring charges, net of income taxes (18.9) (34.3) -- -- -- ----------- --------- --------- --------- --------- Net Income from Continuing Operations $460.4 $509.8 $22.2 $356.4 $301.4
Discontinued Operations: Income prior to disposal -- -- 134.9 Gain on disposal -- -- 776.9 ----------- --------- --------- Net Income $460.4 $509.8 $934.0
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).
During 1998, LNC implemented a restructuring plan relating to the integration of existing life and annuity operations with the new business operations acquired from CIGNA Corporation ("CIGNA"). A second restructuring plan relating to the streamlining of LNC's corporate center operations was also implemented during 1998. The aggregate charges associated with these two unrelated restructuring plans totaled $34.3 million after-tax ($52.8 million pre-tax). The restructuring plan relating to the integration of existing life and annuity operations with the new business operations acquired from CIGNA is expected to be completed in early 2000 and the restructuring plan relating to the streamlining of LNC's corporate center is expected to be completed by the end of 2000 except for rents on abandoned facilities which are expected to be completed by the end of 2004. Actual pre-tax costs totaling $50.0 million have been expended or written off for both plans through December 31, 1999. The remaining aggregate reserve balance of $4.7 million for the restructuring plan relating to LNC's corporate center is anticipated to be utilized in the completion of this restructuring plan. (See Note 12 to the consolidated financial statements for details regarding both of these restructuring plans.)
During 1999, LNC implemented restructuring plans relating to 1) the downsizing and consolidation of the operations of Lynch & Mayer, Inc., 2) the discontinuance of HMO excess-of-loss reinsurance programs and 3) the streamlining of Lincoln UK's operations. The aggregate charges associated with these three unrelated restructuring plans totaled $21.8 million after-tax ($31.8 million pre-tax). The component elements of these aggregate pre-tax costs include $8.3 million for employee severance and termination benefits, write-off of impaired assets of $9.8 million, and other costs of $13.7 million. During the fourth quarter of 1999, $3.0 million (pre-tax) of the original charge recorded for the Lynch & Mayer, Inc. restructuring plan was reversed due primarily to a change in estimate for space cost. In addition, during the fourth quarter of 1999, $1.5 million (pre-tax) associated with lease terminations was released into income. Details of each of these three restructuring plans are discussed in the results of operations for the Investment Management, Reinsurance and Lincoln UK segments, respectively, and in Note 12 to the consolidated financial statements.
Through targeted advertising and special sponsorships, Lincoln Financial Group ("LFG"), the marketing name for LNC, continued building its brand on a national basis using print, cable and interactive media. In addition, LNC continued its branding campaign in the UK to develop brand awareness in the UK.
As part of its branding strategy, LNC created a new web site, www.lfg.com, with consumer-friendly features that set it apart from its competitors. The age-based planning tool and easy-to-understand terms and concepts help to demystify the process of financial planning and empower consumers to take the steps necessary to achieve financial success.
Profile: LNC's Life 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 ("Lincoln Life New York"), AnnuityNet, Inc., Lincoln Financial Advisors Corporation ("LFA") and Sagemark Consulting, Inc. ("Sagemark").
Lincoln Life, First Penn and Lincoln Life New York earned charter memberships in the Insurance Marketplace Standards Association ("IMSA"), an independent, voluntary organization created by the American Council of Life Insurance. IMSA membership demonstrates a company's commitment to honesty, fairness and integrity in all customer contacts involving sales and service of individual life and annuity products.
Sales -- Face Amount (in billions) Term Insurance $24.5 $27.6 $16.2 $13.3 $2.2 Universal Life and Other 12.2 9.0 2.2 2.9 2.8
(1) The 1995-1998 data was restated from the prior year as follows: a) the 401(k) portion of a subsegment (Pensions) previously included in this segment was moved under the direction of the Investment Management segment and b) the remaining portion of this subsegment (Pensions) which is business that is in run-off has been moved to other operations.
The Life Insurance and Annuities segment reported net income of $504.4 million in 1999, $387.8 million in 1998 and $306.5 million in 1997. The Life Insurance and Annuities segment reported record income from operations of $500.4 million in 1999, $405.2 million in 1998 and $262.5 million in 1997.
Life Insurance: Life insurance results for 1999 were driven by increased premiums from universal life and variable life products, and increased investment margins and insurance fee income attributable to increased account values. The increased sales volume (premiums and deposits) was a result of expanded distribution channels along with new product introductions. Distribution capacity was bolstered by the business acquired from CIGNA and Aetna, Inc. on January 2, 1998 and October 1, 1998, respectively.
In reviewing the results of fixed annuities, investment spread is a key performance measure. LNC defines investment spread as the difference between the average net investment income earned on the underlying investment portfolio and the average crediting rates paid on the fixed annuity accounts. Net investment income includes investment management expenses, default costs and portfolio risk management expenses. The investment spreads on fixed annuities were 1.62%, 1.54% and 1.31% in 1999, 1998 and 1997, respectively, an increase of eight basis points and 23 basis points from 1998 and 1997, respectively.
Despite the fact that persistency has been favorable relative to product pricing and the total number of accounts is increasing, LNC is concerned with the growing levels of withdrawals. LNC was an early entrant into the variable annuity business and has a seasoned book of business. Consequently, LNC has many annuity accounts that are out of the surrender charge period, which is the period during which a policyholder must pay a surrender charge to terminate the account. These seasoned accounts are potentially more vulnerable to competitors that may offer customers products with financial incentives designed to increase market share.
From a product design perspective, LNC continues to develop incentive programs that promote annuity persistency, particularly on business beyond the surrender charge period, both at the individual producer and sales management levels. Changes in producers' compensation structures that are aligned with persistency goals are important to effectively manage these issues. In addition, LNC is evaluating a variety of policyholder incentives that are designed to attract new deposits. Other design enhancements to existing products are constantly being made, many of which also improve persistency. LNC has also developed new, more competitive products for use in the large case employer market. Overall, these efforts represent a balanced approach to responding to competitive pressures, while maintaining appropriate profitability levels and ensuring that the product serves the long-term needs of LNC's annuity account holders.
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 distribution channels include career agents, independent agencies, insurance brokers, banks, stockbrokers, financial planners and the Internet.
LFA and Sagemark have a network of regional financial planning offices that serve as the preferred distributor of Lincoln Life products. LFA and Sagemark offer a full range of financial planning services and investments and each is a securities broker/dealer and registered investment advisor.
Life Insurance: Ranking 9th in new annualized premiums (Life Insurance Marketing Resource Association, U.S. Individual Life Insurance Sales, Fourth Quarter 1999), Lincoln Life continued to successfully build its life insurance platform, leveraging its expertise in serving the super-affluent market. Combined universal life, variable life and interest-sensitive whole life insurance account values were $10.4 billion at December 31, 1999. As noted above, first year premiums, a key indicator of growth, increased 40% for the year to $570 million.
The initiatives undertaken in 1998 related to marketing the American Legacy product line paid off in 1999. Deposits for the American Legacy variable annuity products reached a record high of $2.0 billion in 1999. The growth was primarily due to product enhancements and Lincoln Life's strong partnership with AFD, the nation's third largest mutual fund company. The American Legacy variable products are marketed to stockbrokers by AFD. Plans for 2000 include the introduction of a new American Legacy variable annuity product in New York through Lincoln Life New York.
Outlook: The Life Insurance and Annuities segment has laid the foundation for future growth. New product introductions, enhancements to existing products, a well-balanced distribution system and strategic partnerships are all critical factors in LNC's goal to place its life insurance and annuities operations among the top five in the industry. Barring a major drop in the overall stock market, LNC expects the Life Insurance and Annuities segment to generate revenues in future years in excess of revenues produced for the year ended December 31, 1999.
Results of Operations: Lincoln UK's financial results, net initial commission value, account values, in-force and exchange rates were as follows:
Year Ended December 31 (in millions) 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------------------------------ Financial Results Income (Loss) from Operations (1) $(13.9) $70.9 $(108.3) $66.1 $45.9 Realized Gain (Loss) on Investments 2.2 0.8 1.5 (0.1) (0.2) Restructuring Charge (6.5) -- -- -- -- ----------- --------- --------- --------- --------- Net Income (Loss) (1) $(18.2) $71.7 $(106.8) $66.0 $45.7 Net Initial Commission Value (2) $51.4 $54.9 $55.4 $47.2 $39.4
December 31 (in billions) 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------------------------------ Unit-Linked Assets $7.2 $6.3 $5.6 $5.1 $4.3
The increase in 1998 income from operations of $179.2 million or 165% from 1997 was due primarily to the special charge of $174.9 million that was recorded in 1997 for reserve strengthening related to the UK pension product mis-selling. The remaining increase resulted from higher sales volumes due to product enhancements.
United Kingdom Pension Product Mis-selling: During the fourth quarter of 1999, LNC took a charge of $126.1 million after-tax or $0.64 per share ($194.0 million pre-tax) to further strengthen its reserve for pension mis-selling in the UK. This additional reserve strengthening was made following: 1) the mandate issued by the Financial Services Authority, the UK regulating body, for the use of more up to date mortality rates in determining redress and reduced interest rate assumptions to be used in calculating redress, thereby causing the amount of redress to increase and 2) the change to guidance that would have allowed a simplified process for the calculation and payment of redress for certain policy groups and 3) the inclusion of redress relating to additional voluntary contributions made to pension plans by individuals, retroactive to 1988.
Tax Benefit Relating to Decision to Explore Exit of UK Insurance Market: When LNC decided to explore exiting the UK insurance market, LNC was required to change its method of accounting for Lincoln UK's taxes. In the fourth quarter of 1999, LNC recorded a $42.1 million tax benefit relating to this matter.
During 1999, Lincoln UK launched its Individual Savings Account ("ISA"), a government promoted product which features tax benefits and low charges aimed at encouraging savings in the lower earning sector of the market. Lincoln UK also revamped its pension product line in 1999 in response to the government's planned introduction of the Stakeholder Pension in April 2001.
Strategic Review: Trends in the UK for pension and life insurance businesses are changing rapidly, due in large part to government mandated product design changes that are expected to be imposed upon the industry within the next year or two. In anticipation of these marketplace changes, a review of strategic alternatives for Lincoln UK was initiated in early 1999. From this review, it was determined that significant changes in Lincoln UK's operations are necessary to enable Lincoln UK to have continued growth in the UK marketplace.
External consultants were engaged to assist in the process and significant internal resources were devoted to implementing this transformation program that encompassed Lincoln UK's markets and products, distribution, investment performance and cost structure. In the fourth quarter of 1999, Lincoln UK implemented a restructuring plan and signed an investment management outsourcing agreement with Goldman Sachs Asset Management International ("GSAM").
Profile: LNC's Reinsurance segment ("Lincoln Re") is one of the leading life-health reinsurers in the world. Lincoln Re reported consolidated, worldwide net premium income of $2.8 billion in 1999. This compares with $2.1 billion of net premium income reported in 1998. Lincoln Re maintains offices in a number of U.S. cities and has offices in Toronto, Brussels, Buenos Aires, London, Mexico City, Manila, Singapore, and Tokyo. In addition, Lincoln Re maintains representative offices in China (Beijing, Shanghai and Guangzhou) and, in 1998, signed a letter of intent with Ping An, the largest private insurance company in the People's Republic of China with a national charter, to work towards creating a joint venture that will sell reinsurance products and services.
Lincoln Re's strategic 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 and variable life and annuity administrators, all ready to form a "virtual organization" to help Lincoln Re's clients do business.
Year Ended December 31 (in millions) 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------------------------------ Financial Results by Source Individual Markets $91.9 $83.5 $71.9 $49.9 $43.4 Group Markets (1.6) 1.6 3.4 10.2 10.5 Financial Reinsurance 21.7 17.1 15.5 17.5 11.0 Other (1.5) (0.9) (0.3) (0.3) 0.7 ----------- --------- --------- --------- --------- Income from Operations, excluding Exited Businesses 110.5 101.3 90.5 77.3 65.6 Exited Businesses (2) (72.2) 0.2 (242.1) (3.3) (118.3) ----------- --------- --------- --------- --------- Income (Loss) from Operations (2) 38.3 101.5 (151.6) 74.0 (52.7)
December 31 (in billions) 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------------------------------ Individual and Group Life Insurance In-Force Face Amount $340.8 $250.3 $183.5 $160.9 $142.8
(2) Exited businesses, income (loss) from operations and net income (loss) for 1999 include the impact of changes in estimates of reserves for HMO excess-of-loss reinsurance programs of $25.0 million, after-tax and workers' compensation carve-out business underwritten by Unicover Managers, Inc. of $40.4 million, after-tax. Also, exited businesses, income (loss) from operations and net income (loss) for 1997 and 1995 include the impact of the changes in estimate of the reserve level needed for LNC's disability income business ($130.0 million and $121.6 million, after-tax, respectively). Finally, exited businesses, income (loss) from operations and net income (loss) for 1997 include the impact of a change in estimate of the reserve level needed for personal accident programs of $113.7 million, after-tax.
Lincoln Re reported net income (loss) of $33.7 million in 1999, $102.2 million in 1998 and $(136.4) million in 1997. In 1999, Lincoln Re reported income from operations of $103.7 million exclusive of special charges totaling $65.4 million (after-tax) reported in exited businesses for reserve strengthening for the HMO excess-of-loss programs and settlement costs associated with the workers' compensation carve-out business underwritten by Unicover Managers, Inc. This compares with $101.5 million in 1998 and $92.1 million in 1997 exclusive of special charges totaling $243.7 million (after-tax) reported in exited businesses for reserve strengthening in the disability income and personal accident businesses.
The increase in income from operations (exclusive of special charges) of $2.2 million or 2.2% in 1999 was the result of increased sales volumes in the individual life reinsurance and financial reinsurance businesses offset by losses in the group markets business and exited businesses. Individual life revenues increased $180.5 million or 28% from 1998 as a result of record sales in 1999, but increases in benefits payments and operating expenses resulting from the addition of $90.5 billion of in-force (face amount) business resulted in only an $8.4 million or 10% increase in income from operations for the individual life business. Financial reinsurance revenues increased $65.2 million or 23% from 1998 and income from operations kept pace by increasing $4.6 million or 27% from 1998. Group markets had an increased loss of $3.2 million over 1998 and exited businesses had an increased loss of $7.0 million (exclusive of special charges) over 1998 due to higher benefit expenses and operating expenses in 1999.
Group Markets: During 1999, LNC conducted a comprehensive review of the group markets business. This comprehensive review led to a decision to re-focus its activity on employer stop-loss and group life businesses. As a result of this decision, LNC announced its exit from the HMO excess-of-loss and group carrier medical reinsurance businesses and announced the acquisition of the John Alden employer stop-loss business. The decision to exit the HMO excess-of-loss and group carrier medical reinsurance businesses, represents a sharpened focus on the lower-volatility, mortality-based businesses which plays to LNC's strength and in which LNC has experienced far more consistent earnings growth.
The John Alden employer medical stop-loss business, which was acquired in November 1999 for $41.5 million, solidified Lincoln Re's position as a leader in the employer stop-loss market.
Financial Reinsurance: Income from operations for financial reinsurance was a record $21.7 million or an increase of 27% over income from operations of $17.1 million in 1998. This business continues to report steady earnings growth.
Exited Businesses: Exited businesses include lines that Lincoln Re is no longer growing, but continues to manage. These businesses include group carrier medical reinsurance, HMO excess-of-loss reinsurance, personal accident which also includes Unicover workers' compensation programs, direct and reinsurance disability income businesses and investment in Seguros Serfin Lincoln. Significant developments with respect to these exited businesses are discussed below.
Personal Accident Programs: During the fourth quarter of 1999, LNC conducted an in-depth review of its exposure related to its participation in workers' compensation carve-out (i.e., life and health risks associated with workers' compensation coverage) programs managed by Unicover Managers, Inc. As a result of this review as well as settlement proceedings conducted to resolve this issue, LNC took a net charge of $40.4 million after-tax or $0.20 per share ($62.2 million pre-tax) in the fourth quarter of 1999.
Outlook: Lincoln Re continues to enhance its reputation as a leading life-health reinsurer in the world. Life mortality management is its core strength and is the foundation for future growth.
Complementary Approaches: Diversity of investment styles, as well as diversity of clients served, are prudent ways to diversify risk in varying market environments. Delaware, long known for a conservative, "value" equity investment style has increasingly been recognized for expertise in the small-cap and mid-cap "growth" styles and in municipal and high-yield bond investing. The company also has significant global and international equity and fixed income investment expertise.
Year Ended December 31 (in millions) 1999 1998 1997 1996 1995 (2) ------------------------------------------------------------------------------------------------------ Financial Results Revenues: Investment Advisory Fees $248.6 $249.0 $229.9 $199.8 $134.7 Investment Advisory Fees At Cost (3) 37.7 47.9 46.2 43.7 32.2 Other Revenue and Fees 117.0 102.6 78.9 60.1 38.5 Income: Income (Loss) from Operations $34.6 $20.9 $(0.8) $2.3 $10.7 Realized Gain (Loss) on Investments (0.8) 1.1 6.9 6.3 6.7 Restructuring Charge (9.2) -- -- -- -- ----------- --------- --------- --------- --------- Net Income 24.6 22.0 6.1 8.6 17.4
Income from Operations -- Excluding Amortization of Intangibles $62.3 $49.6 $26.3 $26.2 $25.5
At Cost Operations 35.9 39.4 35.6 37.4 36.4 ----------- --------- --------- --------- --------- Total Assets Under Management $97.3 $100.9 $92.1 $82.9 $77.1
(1) The 1995-1998 data was restated from prior year as follows: a) LNC's internal investment advisor was moved from Other Operations to this segment and b) Lincoln Life's 401(k) business was moved from the Life Insurance and Annuities segment to this segment due to changes in reporting relationship for these units.
(3) Fees "at cost" are calculated on an expense-sharing basis and do not include a profit margin.
Investment advisory fees for the segment were relatively flat from 1998 because of a slight overall decrease in external assets under management (retail and institutional). External assets under management were $61.4 billion at December 31, 1999, $61.5 billion at December 31, 1998 and $56.5 billion at December 31, 1997. The change in assets under management of $(0.1) billion from 1998 was attributed to net cash outflows of $4.3 billion partially offset by $4.2 billion in market appreciation. The net cash outflows for the segment were primarily due to Delaware's value style being out of favor, as well as investment performance issues in the institutional accounts and domestic mutual funds. The primary performance issues centered around all of Lynch & Mayer's portfolios and Delaware's value portfolios, which under performed the S&P 500 and Russell 1000 Value indices, respectively, in 1999.
Although the overall net cash flows were negative, the international business had net inflows of $2.8 billion. The international net inflows were the result of an industry-wide trend toward the globalization of pension investments. In addition, Delaware's domestic retail growth funds and institutional growth accounts experienced significant asset growth during 1999. Delaware's retail growth assets under management increased $2.2 billion or 129% to $3.9 billion at December 31, 1999 from $1.7 billion at December 31, 1998 and its institutional growth assets grew 103% to $0.9 billion. These increases in the growth assets were the result of positive cash flows and strong performance experienced in this area.
The growth in income from operations of $21.7 million in 1998 was due primarily to an increase in investment advisory fees, distribution income and other fees associated with the growth of external assets under management and an increase in retail sales. The change in external assets under management of $5.0 billion or 9% was caused by market appreciation of $5.8 billion, which was slightly offset by net cash outflows of $0.8 billion. The net cash outflows consisted of net institutional outflows of $2.7 billion offset by net retail inflows of $1.9 billion. The institutional net outflows were a result of poor investment performance and a move to indexing by pension funds. Delaware's value and Lynch & Mayer's growth investment styles under performed the Russell 1000 Value and S&P 500 indices, respectively, in 1998. Retail sales in 1998 were bolstered by expanded wholesaling capabilities and product enhancements.
The addition of the multi-manager Delaware-Lincoln ChoicePlusSM variable annuity product in late 1998 has further broadened and diversified Delaware's product line, while the expansion of the wholesaling group has enabled Delaware to strengthen its retail sales presence.
Delaware continues to strengthen the foundation of its customer service in order to consistently achieve exceptional customer service. Delaware received excellent ratings in the 1999 DALBAR Broker/Dealer Survey that rates the quality of marketing and service of approximately 25 large mutual fund complexes. High ratings are important because quality service is a key factor in obtaining shelf space with brokers and other investment professionals. In DALBAR 1999 Broker/Dealer Survey, Delaware captured the prestigious DALBAR Pyramid award for outstanding service provided by its main office operations. Delaware's main office operations ranked number one in nine of ten categories when compared to firms of similar size. These high rankings illustrate the firm's continuing commitment to exceeding customer expectations.
Investment Performance: As of December 31, 1999, Delaware had 13 funds whose A shares had received four- and five-star rankings by Morningstar, Inc., (a service that assigns rankings to mutual funds according to their investment styles with one star as the lowest to five stars as the highest), compared to 16 four- and five-star funds as of December 31, 1998. As of December 31, 1999, four-and-five-star ranked A shares at Delaware represented 19% of all its mutual fund A shares.
In what was acknowledged by many observers to be a difficult year for fixed-income investments, Delaware's one-year performance in the Aggregate Fixed-Income category was (1.17%) after fees, compared to performance of (0.82%) for the Lehman Brothers Aggregate Bond Index. Its five-year Aggregate Fixed-Income performance was 7.47% after fees, slightly below the Lehman Brothers Aggregate Bond Index return of 7.73%. The after-fees performance of Delaware's Aggregate Fixed-Income category is based on the fees for Delaware Balanced and Delaware Global mutual funds, which are higher than the fees for Delaware Aggregate Fixed-Income separately managed accounts. If Delaware Aggregate Fixed-Income account fees were used instead, after-fees returns would be higher for one year (1.06%) and for five years 7.64%.
Year Ended December 31 (in millions) 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------------------------------ Financial Results by Source LNC Financing $(83.5) $(52.5) $(31.9) $(49.7) $(52.7) LNC Operations -- (18.5) (18.4) (14.8) (19.5) Other Corporate (0.4) 2.9 (2.2) (0.9) (1.5) Earnings from Unconsolidated Affiliate -- -- -- -- 13.7 ----------- --------- --------- --------- --------- Loss from Operations (83.9) (68.1) (52.5) (65.4) (60.0)
Realized Gain (Loss) on Investments (0.2) 8.5 5.4 2.2 6.1 Gain on Sale of Subsidiaries -- -- -- -- 58.3 Restructuring Charge -- (14.3) -- -- -- ----------- --------- --------- --------- --------- Net Income (Loss) $(84.1) $(73.9) $(47.1) $(63.2) $4.4
(1) Data for LNC's internal investment advisor for 1995-1998 was moved from Other Operations to the Investment Management segment due to a change in the reporting relationship.
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 on sale of subsidiaries and restructuring charges. The 1998 restructuring charge was 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 (see Note 12 to the consolidated financial statements).
The consolidated investments on the balance sheet classified by investment advisor, mean invested assets, net investment income and investment yield are as follows:
Investment Yield (ratio of net investment income to mean invested assets) 7.21% 7.36% 7.46% 7.52% 7.67%
(1) See Investment Management segment data starting on page 19 for additional detail.
Mortgage-Backed Securities: 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 expected at the time of purchase. Securities that have an amortized cost greater than par and are 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.
LNC limits the extent of its risk on mortgage-backed securities by prudently limiting exposure to the asset class, by generally avoiding the purchase of securities with a cost that significantly exceeds par, by purchasing securities backed by stable collateral, and by concentrating on securities with enhanced priority in their trust structure. Such securities with reduced risk typically have a lower yield (but higher liquidity) than higher-risk mortgage-backed securities. At selected times, higher-risk securities may be purchased if they do not compromise the safety of the general portfolio. At December 31, 1999, LNC did not have a significant amount of higher-risk mortgage-backed securities. There are negligible default risks in the mortgage-backed securities portfolio as a whole as the vast majority of the assets are either guaranteed by U.S. government-sponsored entities or are supported in the securitization structure by junior securities enabling the assets to achieve high investment grade status. See Note 3 to the consolidated financial statements for additional detail about the underlying collateral.
Fixed Maturity Performance: In 1999, the performance of LNC's fixed maturity portfolio was measured against investment income and risk management measures. The portfolios have exceeded the investment income benchmark by $87.6 million. The investment income measure is a forecasted investment income target based upon the assets at the beginning of the year, expected new investment spreads, and adjusted for interest rate movements during the year. The portfolios' performance exceeded the risk management measure by 89 basis points in 1999. The risk management measure is a weighted composite benchmark, constructed from thirteen industry calculated asset class indices. The indices are related to each of the major asset classes utilized by Lincoln Investment Management. The performance relative to the income measure was exceeded due to a number of factors, primarily asset allocation strategies, credit spread widening and interest rate increases. The risk management measure was exceeded due to maintenance of strong underwriting guidelines in asset selection and the contributions of the strong U.S. economy.
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 41 indicate that operating activities provided cash of $1.6 billion, $1.2 billion and $1.0 billion in 1999, 1998 and 1997, 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.
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). 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). 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.
As of December 31, 1999, LNC's senior debt ratings included Moody's at A2 ("Very Good, Strong or High"), Standard and Poor's A- ("Very Good, Strong or High") and Duff & Phelps at A+ ("Very Good, Strong or High") and LNC's commercial paper ratings included Moody's at P-1 ("Superior"), Standard and Poor's at A-2 ("Strong") and Duff & Phelps at D-1 ("High Grade"). During November of 1999, Standard and Poor's affirmed its senior debt rating and lowered its commercial paper rating from A-1 ("Superior") to A-2 ("Strong"). In December 1999, Moody's put LNC's senior debt and commercial paper ratings under review for possible downgrade. Although the short-term borrowing rate on the issuance of commercial paper will increase approximately 0.10% per annum as a result of the noted events, management believes that liquidity will not be adversely impacted.
During November of 1999, Standard and Poor's also lowered its commercial paper rating for Lincoln National (UK) PLC from A-1 ("Superior") to A-2 ("Strong"). Management believes that given the reduced number of investors for commercial paper with ratings below A-1 and the regular liquidity problems around the time of the UK's Monetary Policy Committee meeting, it will on occasion be difficult for Lincoln National (UK) PLC to issue commercial paper and it will therefore have to draw upon alternative short-term borrowing facilities in the form of bank loans. When this occurs, it is likely to cause an increase in its borrowing rate of approximately 0.20% per annum, but management believes that liquidity will not be adversely impacted.
During May 1999, LNC's Board of Directors approved a two-for-one stock split for its common stock. The record date for the stock split was June 4, 1999 and the additional shares were distributed to shareholders on June 21, 1999.
As noted above, shareholders' equity includes net unrealized gain (loss) on securities available-for-sale. At December 31, 1999, the book value of $21.76 per share included $2.38 of unrealized losses on securities and at December 31, 1998, the book value of $26.59 per share included $2.73 of unrealized gains on securities.
For the year ended December 31, 1999, LNC identified expenditures of $44.5 million ($28.9 million after-tax) to address this issue. This brings the expenditures for 1996-1999 to $91.6 million ($59.5 million after-tax). Because updating systems and procedures is an integral part of LNC's on-going operations, most of the expenditures shown above for 1999 are expected to continue after all Year 2000 issues have been resolved. All Year 2000 expenditures have been funded from operating cash flows.
The scope of the overall Year 2000 program included 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. LNC companies completed these projects prior to year-end.
(in millions, except per share data) Operating Results by Quarter 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr ------------------------------------------------------------------------------------------ 1999 Data Premiums and other considerations $963.9 $981.5 $939.7 $1,108.1 Net investment income 709.5 700.8 697.1 700.1 Realized gain (loss) on investments 1.9 (4.0) 5.4 (0.3)
(1) Net income for the third and fourth quarters of 1999 includes special charges for changes in estimates of reserves and the fourth quarter includes a charge for estimated settlement costs for participation in workers' compensation carve-out business and a tax benefit related to the release of a tax valuation allowance.
December 31 (000s omitted) 1999 1998 ---------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities related to separate accounts 53,654,223 43,408,858 ------------- ----------- Total Insurance and Investment Contract Liabilities 94,807,744 84,301,904
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures 745,000 745,000
Year Ended December 31 (000s omitted) 1999 1998 1997 ----------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income $ 460,354 $ 509,775 $ 933,988 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Deferred acquisition costs (309,318) (208,150) 1,754 Premiums and fees receivable (14,817) 3,151 39,836 Accrued investment income (4,683) (101,555) (5,426) Policy liabilities and accruals 443,713 1,055,277 540,676 Contractholder funds 918,762 800,678 636,600 Amounts recoverable from reinsurers (316,982) (775,064) (22,252) Federal income taxes 40,410 (205,198) 255,105 Equity in undistributed earnings of unconsolidated affiliates (5,797) (1,636) (2,081) Provisions for depreciation 57,169 58,070 58,136 Amortization of goodwill and other intangible assets 167,173 137,508 82,396 Realized (gain) loss on investments (2,955) (19,034) (122,570) Gain on sale of subsidiaries/discontinued operations -- -- (1,192,226) Other 202,294 (4,660) (169,362) ---------- --------- ---------- Net Adjustments 1,174,969 739,387 100,586 ---------- --------- ---------- Net Cash Provided by Operating Activities 1,635,323 1,249,162 1,034,574
(000s omitted except for Year Ended December 31 per share amounts) 1999 1998 1997 ----------------------------------------------------------------------------------------------------- Series A Preferred Stock: Balance at beginning-of-year $ 1,083 $ 1,153 $ 1,212 Conversion into common stock (135) (70) (59) ---------- ---------- ---------- Balance at End-of-Year 948 1,083 1,153
Common Stock: Balance at beginning-of-year 994,472 966,461 904,331 Conversion of series A preferred stock 135 70 59 Issued for benefit plans 51,288 50,666 34,592 Shares forfeited under benefit plans (3,274) (1,919) (1,393) Issued for acquisition of subsidiaries 2,793 -- 74,390 Retirement of common stock (38,315) (5,972) (45,518) Issuance costs related to FELINE PRIDES -- (14,834) -- ---------- ---------- ---------- Balance at End-of-Year 1,007,099 994,472 966,461
Balance at beginning-of-year 202,111,174 201,718,956 207,317,150 Conversion of series A preferred stock 65,632 34,112 28,704 Issued for benefit plans 1,026,130 1,651,554 1,518,660 Shares forfeited under benefit plans (100,933) (46,886) (43,982) Issued for purchase of subsidiaries 67,895 -- 2,796,224 Retirement of common stock (7,675,000) (1,246,562) (9,897,800) ------------- ----------- --------- Balance Issued and Outstanding at End-of-Year 195,494,898 202,111,174 201,718,956
Basis of Presentation. The accompanying consolidated financial statements include Lincoln National Corporation ("LNC") and its majority-owned subsidiaries. Through subsidiary companies, LNC operates multiple insurance and investment management businesses divided into four business segments (see Note 9). The collective group of companies uses "Lincoln Financial Group" as its marketing identity. Less than majority-owned entities in which LNC has at least a 20% interest are reported on the equity basis. These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States.
Realized gain (loss) on investments is recognized in net income, net of associated amortization of deferred acquisition costs and investment expenses, using the specific identification method. Changes in the fair values of securities carried at fair value are reflected directly in shareholders' equity, after deductions for related adjustments for deferred acquisition costs and amounts required to satisfy policyholder commitments that would have been recorded had these securities been sold at their fair value, and after deferred taxes or credits to the extent deemed recoverable.
Derivatives. For the years ended December 31, 1999, 1998 and 1997, LNC hedged certain portions of its exposure to interest rate fluctuations, the widening of bond yield spreads over comparable maturity U.S. Government obligations, credit risk, foreign exchange risk, commodity risk and fluctuations in certain stock indices by entering into derivative transactions. A description of LNC's accounting for its hedging of such risks is discussed in the following two paragraphs.
Derivative balances are carried in other investments. The premiums paid for interest rate caps and swaptions are deferred and amortized to net investment income on a straight-line basis over the term of the respective derivative. Interest rate caps that hedge interest credited on fixed annuity liabilities are carried at amortized cost. 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. 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. Settlements on interest rate swaps and commodity swaps are recognized in net investment income. Realized gain (loss) from the termination of swaptions, put options, spread-lock agreements, interest rate swaps, commodity swaps and financial futures are deferred and amortized over the life of the hedged assets as an adjustment to the yield. Over-the-counter call options which hedge liabilities tied to certain stock indices are carried at fair value. The change in fair value is reflected directly in net income. Settlements received and gain (loss) realized upon termination of these call options is included in net income. 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. Settlements received and realized gain (loss) from the termination of such derivatives is included in net income.
Loaned Securities. Securities loaned are treated as collateralized financing transactions and a liability is recorded equal to the cash collateral received which is typically greater than the market value of the related securities loaned. In other instances, LNC will hold as collateral securities with a market value at least equal to the securities loaned. Securities held as collateral are not recorded in LNC's balance sheet in accordance with accounting guidance for secured borrowings and collateral. LNC's agreements with third parties generally contain contractual provisions to allow for additional collateral to be obtained when necessary. LNC values collateral daily and obtains additional collateral when deemed appropriate.
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 typically are renewable annually with cancellation clauses ranging up to 90 days.
Goodwill and Other Intangible Assets. Goodwill, as measured by the excess of the cost of acquired subsidiaries or businesses over the fair value of net assets acquired, is amortized using the straight-line method over periods of 20 to 40 years in accordance with the benefits expected to be derived from the acquisitions.
The carrying values of goodwill and other intangible assets are reviewed periodically for indicators of impairment in value and are adjusted as necessary.
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 2.25% to 7.50% depending on the time of policy issue. Interest rate assumptions for reinsurance reserves range from 5.0% to 11.0% graded to a range of 5.5% to 8.0% after a minimum of 20 years. The interest assumptions for immediate and deferred paid-up annuities range from 2.25% to 14.50%.
Earnings per Share. Basic earnings per share is computed by dividing earnings available to common shareholders by the average common shares outstanding. Diluted earnings per share is computed assuming the conversion or exercise of dilutive convertible preferred securities, non-vested stock, stock options and deferred compensation shares outstanding during the year.
Change in Estimate for Disability Income Reserve. During the second quarter of 1997, LNC conducted an 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 $92.8 million, wrote-off deferred acquisition costs of $71.1 million and reduced related assets by $36.1 million. Combined these actions reduced net income in the second quarter of 1997 by $130.0 million or $0.62 per share ($200.0 million pre-tax).
Change in Estimate for United Kingdom Pension Mis-selling. During the fourth quarter of 1997, an in-depth review was completed of the UK 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 reserve by $199.4 million reducing net income in the fourth quarter of 1997 by $174.9 million after-tax or $0.85 per share.
During the fourth quarter of 1999, LNC recorded a charge of $126.1 million after-tax or $0.64 per share ($194.0 million pre-tax) to further strengthen its reserve for pension mis-selling in the UK. The additional reserve strengthening was made following: 1) the mandate issued by the Financial Services Authority, the UK regulating body, for the use of more up to date mortality rates in determining redress and reduced interest rate assumptions to be used in calculating redress, thereby causing the amount of redress to increase and 2) the change to guidance that would have allowed a simplified process for the calculation and payment of redress for certain policy groups and the inclusion of redress relating to additional voluntary contributions made to pension plans by individuals, retroactive to 1988.
Change in Estimate for Personal Accident Programs. During the fourth quarter of 1997, an in-depth review was completed of certain excess-of-loss personal accident reinsurance programs written by LNC's Reinsurance segment. Based on a concern that these programs were generating claims substantially in excess of expectations, an investigation and audit was conducted covering all such programs. While LNC continues to investigate the manner in which these programs were designed and all legal remedies available, it was determined that the incurred but not reported reserve liability related to this business should be strengthened. Accordingly, a charge of $175.0 million ($113.7 million after-tax or $0.55 per share) was taken in the fourth quarter of 1997.
Amortized Fair December 31, 1999 (in millions) Cost Value ------------------------------------------------------------------------------ Due in one year or less $871.7 $871.5 Due after one year through five years 5,506.4 5,452.7 Due after five years through ten years 8,365.3 8,093.0 Due after ten years 9,139.1 8,867.4 --------- --------- Subtotal 23,882.5 23,284.6 Asset and mortgage-backed securities 4,474.6 4,404.0 --------- --------- Total $28,357.1 $27,688.6
Par value, amortized cost and estimated fair value of investments in asset and mortgage-backed securities summarized by interest rates of the underlying collateral are as follows:
December 31 1999 ------------------------------------------------------------- Treasuries and AAA 22.8% AA 7.0 A 29.8 BBB 32.5 BB 4.9 Less than BB 3.0 ------------- 100.0%
Year Ended December 31 (in millions) 1999 1998 1997 ----------------------------------------------------------------------------------------------- Fixed maturity securities $2,232.9 $2,065.8 $1,832.1 Equity securities 20.1 22.9 19.2 Mortgage loans on real estate 369.2 383.6 279.2 Real estate 64.1 86.8 99.4 Policy loans 116.5 99.5 44.5 Invested cash 110.2 156.7 102.4 Other investments 51.8 88.4 20.6 -------- -------- -------- Investment revenue 2,964.8 2,903.7 2,397.4 Investment expense 157.3 222.3 146.6 -------- -------- -------- Net investment income $2,807.5 $2,681.4 $2,250.8
Provisions (credits) for write-downs and net changes in allowances for loss, which are included in the realized gain (loss) on investments shown above, are as follows:
Year Ended December 31 (in millions) 1999 1998 1997 ----------------------------------------------------------------------------------------------- Fixed maturity securities $17.2 $60.0 $ 13.1 Equity securities (4.4) 3.4 0.3 Mortgage loans on real estate (0.1) (0.2) (8.9) Real estate -- (7.2) (13.6) Other long-term investments (7.6) 5.4 (6.5) Guarantees -- (0.5) -- ----- ----- ------- Total $ 5.1 $60.9 $(15.6)
During the second quarter of 1998, LNC purchased three bonds issued with offsetting interest rate characteristics. Subsequent to the purchase of these bonds, interest rates increased and the value of one of these bonds decreased. This bond was sold at the end of the second quarter 1998 and a realized loss of $28.8 million ($18.7 million after-tax) was recorded. The other two bonds are still owned by LNC and are producing net investment income on an annual basis of $9.9 million ($6.4 million after-tax). Subsequent to these transactions being recorded, the Emerging Issues Task Force of the Financial Accounting Standards Board reached consensus with regard to accounting for this type of investment strategy. LNC is not required to apply the new accounting rules, however, if such rules were applied, the realized loss on the sale of $28.8 million ($18.7 million after-tax) on one of these bonds recorded at the end of the second quarter of 1998 would be reduced to $8.8 million ($5.7 million after-tax) and the difference would be applied as a change in the carrying amount of the two bonds that remain in LNC's portfolio. Also, net investment income for the year ended December 31, 1999 and 1998 would be less than reported by $2.3 million ($1.5 million after-tax) and $1.9 million ($1.2 million after-tax), respectively.
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.
December 31 (in millions) 1999 1998 ------------------------------------------------------------------------------ Impaired loans with allowance for losses $35.1 $37.0 Allowance for losses (4.7) (4.8) Impaired loans with no allowance for losses -- 2.2 ----- ----- Net impaired loans $30.4 $34.4
As of December 31, 1999 and 1998, LNC had restructured mortgage loans of $3.3 million and $32.0 million, respectively. LNC recorded $0.3 million and $3.1 million of interest income on these restructured mortgage loans in 1999 and 1998, respectively. Interest income in the amount of $0.4 million and $3.2 million would have been recorded on these mortgage loans according to their original terms in 1999 and 1998, respectively. As of December 31, 1999 and December 31, 1998, LNC had no outstanding commitments to lend funds on restructured mortgage loans.
For the year ended December 31, 1999, fixed maturity securities available-for-sale, mortgage loans on real estate and real estate investments which were non-income producing were not significant.
Year Ended December 31 (in millions) 1999 1998 1997 ----------------------------------------------------------------------------------------------- Tax rate times pre-tax income from continuing operations $199.5 $244.1 $12.2 Effect of: Tax-preferred investment income (47.7) (51.1) (34.8) Change in valuation allowance (38.2) (5.3) 43.5 Other items (4.0) (0.1) (8.2) ------ ------ ----- Provision for income taxes $109.6 $187.6 $12.7 Effective tax rate 19% 27% 36%
December 31 (in millions) 1999 1998 -------------------------------------------------------------------------------------------- Deferred tax assets: Insurance and investment contract liabilities $1,252.8 $1,386.3 Net operating loss 186.7 103.1 Postretirement benefits other than pensions 46.5 39.9 Compensation related 74.4 48.7 Net unrealized loss on securities available-for-sale 232.3 -- Other 76.2 98.6 -------- -------- Total deferred tax assets 1,868.9 1,676.6 Valuation allowance for deferred tax assets 229.0 38.2 -------- -------- Net deferred tax assets 1,639.9 1,638.4 Deferred tax liabilities: Deferred acquisition costs 572.3 214.9 Premiums and fees receivable 23.4 11.6 Investments related 66.2 24.8 Net unrealized gain on securities available-for-sale -- 542.0 Present value of business in-force 473.7 625.9 Other 174.7 8.8 -------- -------- Total deferred tax liabilities 1,310.3 1,428.0 -------- -------- Net deferred tax asset $ 329.6 $ 210.4
At December 31, 1998, LNC held a $38.2 million tax valuation allowance relating to the Lincoln UK segment. When LNC management announced its intention to explore exiting the UK insurance market, LNC was required to change its method of accounting for Lincoln UK's taxes. Previously, taxes were computed based upon LNC's intention to permanently reinvest earnings in the UK subsidiaries. Under this approach, Lincoln UK was unable to recognize UK tax benefits for a portion of the pension mis-selling losses recorded in 1997 since UK tax law restricted the use of these losses. However, when the decision was made in the fourth quarter of 1999 that earnings would no longer be permanently reinvested, U.S. tax rules rather than UK tax rules became the primary factor in determining the overall deferred taxes for the segment. LNC was required to adjust the level of deferred taxes based upon U.S. tax rules, under the new operating assumption that earnings from Lincoln UK will ultimately be repatriated to LNC. Accordingly, LNC eliminated the $38.2 million valuation allowance and reduced its deferred tax liabilities by another $3.9 million in the fourth quarter of 1999. A tax benefit of $42.1 million was reported by LNC in the fourth quarter relating to these matters.
At December 31, 1999, LNC had net operating losses for Federal income tax purposes of: $374.2 million for foreign life reinsurance companies that expire in years 2007 through 2014; $79.1 million for Delaware Management Holdings, Inc. ("Delaware") that expire in years 2003 through 2008 and $80.4 million for Lincoln Life & Annuity Company of New York ("Lincoln Life New York") that expire in the year 2013. The majority of these tax net operating loss carryovers relate to LNC's foreign life reinsurance operations. These companies will utilize their respective tax net operating losses as the reinsurance business on their books runs off. Thus, although these net operating losses are generally subject to limitations that require the companies generating the loss to have future taxable income, LNC has determined that it is more likely than not that these net operating losses will be fully utilized within the allowable carryforward period. Because the Delaware and Lincoln Life New York net operating losses can be used in future consolidated tax returns with LNC, management also concluded that it is more likely than not that these net operating losses will also be fully utilized within the allowable carryforward period.
The income statement caption, "Benefits", is net of reinsurance recoveries of $0.825 billion; $1.057 billion and $0.393 billion for the years ended December 31, 1999, 1998 and 1997, respectively.
Details underlying the income statement caption, "Underwriting, Acquisition, Insurance and Other Expenses", are as follows:
A reconciliation of the present value of insurance business acquired included in other intangible assets is as follows:
2000 - $89.6 2002 - $88.1 2004 - $81.5 2001 - 88.3 2003 - 84.7 Thereafter - 1,222.0
Details underlying the balance sheet caption, "Contractholder Funds", are as follows:
Details underlying the balance sheet captions related to total debt are as follows:
LNC also has access to capital from minority interest in preferred securities of subsidiary companies. In May 1996, LNC filed a shelf registration with the Securities and Exchange Commission that would allow LNC to offer and sell up to $500 million of various forms of hybrid securities. These securities, which combine debt and equity characteristics, are offered through a series of three subsidiaries (Lincoln National Capital I, II and III). These subsidiaries were formed solely for the purpose of issuing preferred securities and lending the proceeds to LNC. The common securities of these subsidiaries are owned by LNC. The only assets of Lincoln National Capital I, II and III are the notes receivable from LNC for such loans. Distributions are paid by these subsidiaries to the preferred securityholders on a quarterly basis. The principal obligations of these subsidiaries are irrevocably guaranteed by LNC. Upon liquidation of these subsidiaries, the holders of the preferred securities would be entitled to a fixed amount per share plus accumulated and unpaid distributions. LNC reserves the right to: 1) redeem the preferred securities at a fixed price plus accumulated and unpaid distributions and; 2) extend the stated redemption date up to 19 years if certain conditions are met.
In April 1998, LNC filed a shelf registration with the Securities and Exchange Commission, that would allow LNC to offer and sell up to $1.3 billion of various securities, including regular debt, preferred stock, common stock or hybrid securities. This filing included an aggregate of $300 million from a previous filing that had not been utilized. In conjunction with this shelf registration, three additional subsidiaries were added (Lincoln National Capital IV, V and VI) to accommodate the issuance of additional preferred securities. The purpose and terms of these new subsidiaries essentially parallel Lincoln National Capital I, II and III.
Finally, LNC maintains a revolving credit agreement with a group of domestic and foreign banks in the aggregate amount of $750 million. This agreement, which expires in October 2001, provides for interest on borrowings based on various money market indices. Under the terms of this agreement, LNC must maintain a prescribed level of adjusted consolidated net worth. At December 31, 1999, LNC had no outstanding borrowings under this agreement. During 1999, 1998 and 1997, fees paid for maintaining revolving credit agreements amounted to $633,000, $662,000 and $670,000, respectively.
Pension and Other Postretirement Benefit Plans -- U.S. LNC maintains funded defined benefit pension plans for most of its U.S. employees, and prior to January 1, 1995, most full-time agents. Benefits for employees are based on total years of service and the highest 60 months of compensation during the last 10 years of employment. All benefits applicable to the funded defined benefit plan for agents were frozen as of December 31, 1994. The plans are funded by contributions to tax-exempt trusts. LNC's funding policy is consistent with the funding requirements of Federal law and regulations. Contributions are intended to provide not only the benefits attributed to service to date, but also those expected to be earned in the future. Effective January 1, 1998, the defined benefit pension plans were amended to increase benefits for certain retired individuals. The effect of this amendment was to increase the pension benefit obligation by $10.7 million.
LNC sponsors three types of unfunded, nonqualified, defined benefit plans for certain U.S. employees and agents. Supplemental retirement plans provide defined benefit pension benefits in excess of limits imposed by Federal tax law. A salary continuation plan provides certain officers of LNC defined pension benefits based on years of service and final monthly salary upon death or retirement. A supplemental executive retirement plan effective January 1, 1998 provides defined pension benefits for certain executives who became employees of LNC as a result of the acquisition of a block of individual life insurance and annuity business from CIGNA Corporation ("CIGNA"). Benefits payable under this plan are based on years of service and the highest 36 consecutive months of compensation and are reduced by the benefit payable to the employee from the CIGNA plan. The adoption of this plan resulted in an increase in the pension benefits obligation of $8.4 million during the year ended December 31, 1998.
Funded (underfunded) status of the plans $(44.6) $(123.5) $(108.0) $(111.1) Unrecognized net actuarial (gains) losses (54.3) 45.4 -- -- Unrecognized prior service cost 8.2 9.3 3.3 3.4 ------ ------- ------- ------- Prepaid (accrued) benefit cost $(90.7) $(68.8) $(104.7) $(107.7)
Weighted-average assumptions as of December 31: Weighted-average discount rate 7.75% 6.25% 7.75% 6.25% Expected return on plan assets 9.00% 9.17% -- -- Rate of increase in compensation: Salary continuation plan 5.50% 5.50% -- -- All other plans 4.50% 4.50% 4.50% 4.50%
Plan assets for both the funded employees and agents plans consist principally of listed equity securities, corporate obligations and government bonds.
The components of net defined benefit pension plan and postretirement benefit plan costs are as follows:
Effective January 1, 1995, LNC established a defined contribution plan for its U.S. agents. Contributions to this plan are based on a percentage of the agents' annual compensation as defined in the plan. Expense for this plan amounted to $2.1 million, $1.9 million and $1.8 million in 1999, 1998 and 1997, respectively.
Pension Plan -- Non U.S. The employees of LNC's primary foreign subsidiary are covered by a defined benefit pension plan. The plan provides death and pension benefits based on final pensionable salary. At December 31, 1999 and 1998, plan assets were in excess of or (under) the projected benefit obligations by $(0.8) million and $(12.4) million, respectively, and were included in other liabilities in LNC's balance sheet. Net pension costs for the foreign plan were $3.6 million, $2.9 million and $2.0 million for 1999, 1998 and 1997, respectively.
Effective January 1, 1998, LNC assumed the liabilities for a non-contributory defined contribution plan covering certain highly compensated former CIGNA agents and employees. Contributions for this plan are made annually based upon varying percentages of annual eligible earnings as defined in the plan. Expense for this plan amounted to $1.7 million and $0.9 million in 1999 and 1998, respectively.
In the fourth quarter of 1999, LNC modified the terms of the deferred compensation plans to provide that plan participants that selected LNC stock as the measure for their investment return would receive shares of LNC stock in satisfaction of this portion of their deferral. In addition, participants were precluded from diversifying any portion of their deferred compensation plan account that is measured by LNC's stock performance. As a result of these modifications to the plans, ongoing changes in value of LNC's stock no longer affect the expenses associated with this portion of the deferred compensation plans.
The total liabilities associated with these plans were $119.3 million and $104.4 million at December 31, 1999 and 1998, respectively.
Incentive Plans. LNC has various incentive plans for 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 awarded under the stock option incentive plans are granted with an exercise price equal to the market value of LNC stock 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. Options granted prior to 1992 are exercisable one year after the date of grant and options issued subsequent to 1991 become exercisable in 25% increments over the four year period following the option grant anniversary date. A "reload option" feature was added on May 14, 1997. In most cases, persons exercising an option after that date have been granted new options in an amount equal to the number of matured shares tendered to exercise the original option award. The reload options are granted for the remaining term of the related original option and have an exercise price equal to the market value of LNC stock at the date of the reload award. Reload options can be exercised two years after the grant date if the value of the new option has appreciated by at least 25%.
As a result of pending changes in the interpretation of the existing accounting rules for stock options, LNC has decided not to continue issuing stock options to agents that do not meet the stringent definition of a common law employee that is expected to be included in this new accounting guidance. In the fourth quarter of 1999, LNC decided to design a stock appreciation right program as a replacement to the existing agent stock option program. This new stock appreciation right program is expected to be adopted in early 2000, with the first awards under the program expected to be made in the first quarter of 2000.
Options Outstanding Options Exercisable ------------------------------------------------ ------------------------------- Weighted- Average Weighted- Weighted- Range of Number Remaining Average Number Average Exercise Outstanding at Contractual Exercise Exercisable at Exercise Prices Dec. 31, 1999 Life (Years) Price Dec. 31, 1999 Price ---------------------------------------------------------------------------------------------------------------- $10 - $20 1,302,788 3.16 $17.54 1,302,788 $17.54 21 - 30 3,143,934 6.70 26.00 2,291,189 25.19 31 - 40 208,281 8.21 37.41 76,158 35.49 41 - 50 4,860,753 8.40 44.77 1,323,367 44.86 51 - 60 4,148,679 9.36 50.85 147,936 50.88 -------------- ----------- $10 - $60 13,664,435 5,141,438
LNC recognizes compensation expense for its stock option incentive plans using the intrinsic value based method of accounting (see Note 1) and provides the required pro forma information for stock options granted after December 31, 1994. Accordingly, no compensation expense has been recognized for stock option incentive plans. Had compensation expense for LNC's stock option incentive plans been determined based on the estimated fair value at the grant dates for awards under those plans, LNC's pro forma net income and earnings per share for the last three years (1999, 1998 and 1997) would have been $443.0 million ($2.21 per diluted share); $501.0 million ($2.46 per diluted share) and $930.5 million ($4.47 per diluted share), respectively (a decrease of $17.4 million or $.09 per diluted share; $8.8 million or $.04 per diluted share and $3.5 million or $.02 per diluted share, respectively). These effects on pro forma net income and earnings per share of expensing the estimated fair value of stock options are not necessarily representative of the effects on reported net income for future years due to factors such as the vesting period of the stock options and the potential for issuance of additional stock options in future years.
Year Ended December 31 1999 1998 1997 ------------------------------------------------------------------------------------------------ Restricted stock (number of shares) 57,012 876,006 237,672 Weighted-average price per share at time of grant $43.91 $41.25 $30.99
The number of shares and the per share data for prior years throughout this note has been restated to reflect the impact of the 1999 two-for-one stock split (see Note 10).
Shareholders' equity as determined in accordance with statutory accounting practices for LNC's insurance subsidiaries was $1.809 billion and $2.953 billion for December 31, 1999 and 1998, respectively.
In 1998, the National Association of Insurance Commissioners adopted codified statutory accounting principles (the "Codification"). The Codification is effective on January 1, 2001 and the first statement to be reported on a Codification basis will be the March 31, 2001 statement. Management believes that the changes to statutory accounting practices resulting from the Codification will not cause material changes to the statutory net income and shareholders' equity data shown above.
The liabilities for disability income claims net of the related assets for amounts recoverable from reinsurers at December 31, 1999 and 1998 were $1.316 billion and $1.813 billion, respectively, excluding deferred acquisition costs. The liability is based on the assumption that recent experience will continue in the future. If incidence levels and/or claim termination rates fluctuate significantly from the assumptions underlying the reserves, adjustments to reserves could be required in the future. Accordingly, this liability may prove to be deficient or excessive. However, it is management's opinion that such future development will not materially affect the consolidated financial position of LNC.
In the past, LNC's Reinsurance segment accepted personal accident reinsurance programs from other insurance companies. Most of these programs were 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 from 1993 to 1996 have produced and have potential to produce significant losses. The liabilities for these programs, net of related assets recoverable from reinsurers, were $174.7 million and $177.4 million at December 31, 1999 and 1998, respectively.
Regulators continue to focus on market conduct and compliance issues. Under certain circumstances, companies operating in the insurance and financial services markets have been held responsible for providing incomplete or misleading sales materials and for replacing existing policies with policies that were less advantageous to the policyholder. LNC's management continues to monitor the company's sales materials and compliance procedures and is making an extensive effort to minimize any potential liability. Due to the uncertainty surrounding such matters, it is not possible to provide a meaningful estimate of the range of potential outcomes at this time; however, it is management's opinion that such future development will not materially affect the consolidated financial position of LNC.
UK regulators continue to focus on industry-wide marketing and compliance issues. Under certain circumstances companies operating in the insurance and financial services markets may be held responsible for providing incomplete or misleading sales materials and information when selling endowment polices. As no official pronouncement regarding an investigation into mis-selling of endowments has been made, it is not possible to provide a meaningful estimate of the potential outcome of this matter at the present time. However, it is management's opinion that the resolution of this matter will not materially affect the consolidated financial position of LNC.
Under the terms of the Shareholders Agreement with GFS, LNC had the right to put its investment in SSL to GFS for an amount equal to the LNC's initial investment in SSL plus a 7% annual return. LNC has given GFS notice of its decision to exercise its put. Given these contractual rights and the status of ongoing discussions with GFS and IPAB concerning these matters, LNC believes that it will recover the value of its investment in SSL along with a 7% annual return on that investment.
Total rental expense on operating leases in 1999, 1998 and 1997 was $81.5 million, $81.3 million and $62.5 million, respectively. Future minimum rental commitments are as follows (in millions):
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 $33.6 million to $56.8 million.
Certain LNC insurance companies assume insurance from other companies. At December 31, 1999, LNC's insurance companies have provided $386.8 million 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.
With the recent filing of a lawsuit alleging fraud in the sale of interest-sensitive universal and whole life insurance policies, Lincoln Life now has three such actions pending. While each of these lawsuits seeks class action status, the court has not certified a class in any of them. In each of these lawsuits, plaintiffs seek unspecified damages and penalties for themselves and on behalf of the putative class. While the relief sought in these lawsuits is substantial, they are in the discovery stages of litigation, and it is premature to make assessments about potential loss, if any. Management intends to defend these lawsuits vigorously. The amount of liability, if any, which may arise as a result of these lawsuits cannot be reasonably estimated at this time. In a fourth lawsuit, a settlement has been preliminarily approved by the court and a class has been conditionally certified for settlement purposes. Two prior similar lawsuits have been previously resolved and dismissed.
LNC has guarantees with off-balance-sheet risks whose contractual amounts represent credit exposure. Guarantees with off-balance-sheet risks having contractual values of $52.3 million and $58.0 million were outstanding at December 31, 1999 and 1998, respectively.
Assets (Liabilities) -------------------------------------------- Notional or Carrying Fair Carrying Fair Contract Amounts Value Value Value Value -------------------- ----- ----- ----- ----- December 31 (in millions) 1999 1998 1999 1999 1998 1998 --------------------------------------------------------------------------------------------------------------- Interest rate derivatives: Interest rate cap agreements $2,508.8 $4,108.8 $ 5.2 $ 3.2 $ 9.3 $ 0.9 Swaptions 1,837.5 1,899.5 10.8 10.8 2.5 2.5 Interest rate swap agreements 630.9 258.3 (19.5) (19.5) 9.9 9.9 Put options 21.3 21.3 1.9 1.9 2.2 2.2 -------- -------- ----- ----- ----- ----- Total interest rate derivatives 4,998.5 6,287.9 (1.6) (3.6) 23.9 15.5
Interest Rate Cap Agreements Swaptions -------------------- -------------------- December 31 (in millions) 1999 1998 1999 1998 --------------------------------------------------------------------------------------- Balance at beginning-of-year $4,108.8 $4,900.0 $1,899.5 $1,752.0 New contracts -- 708.8 -- 218.3 Terminations and maturities (1,600.0) (1,500.0) (62.0) (70.8) -------- -------- -------- -------- Balance at end-of-year $2,508.8 $4,108.8 $1,837.5 $1,899.5
Foreign Currency Derivatives ----------------------------------------- Foreign Exchange Foreign Currency Forward Contracts Swaps ----------------- ----------------- December 31 (in millions) 1999 1998 1999 1998 --------------------------------------------------------------------------------------- Balance at beginning-of-year $ 1.5 $163.1 $47.2 $15.0 New contracts 42.7 419.8 -- 39.2 Terminations and maturities (44.2) (581.4) (3.0) (7.0) ----- ------ ----- ----- Balance at end-of-year $ -- $ 1.5 $44.2 $47.2
Commodity Call Options Call Options Swaps (Based on FTSE) (Based on S&P) ----------------- ----------------- ------------------ December 31 (in millions) 1999 1998 1999 1998 1999 1998 --------------------------------------------------------------------------------------------------------------- Balance at beginning-of-year $ 8.1 $-- $11.1 $14.1 $ 79.9 $ 5.3 New contracts -- 8.1 -- -- 52.9 74.6 Terminations and maturities (8.1) -- (6.6) (3.1) (3.2) -- Foreign exchange adjustment -- -- (0.2) 0.1 -- -- ----- ---- ----- ----- ------ ----- Balance at end-of-year $ -- $8.1 $ 4.3 $11.1 $129.6 $79.9
Interest Rate Cap Agreements. The interest rate cap agreements, which expire in 2000 through 2006, 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 quarterly payments, if any, is determined by the excess of a market interest rate over a specified cap rate multiplied by the notional amount divided by four. The purpose of LNC's interest rate cap agreement program is to protect its annuity line of business from the effect of rising interest rates. The premium paid for the interest rate caps is included in other investments (amortized cost of $5.2 million as of December 31, 1999) and is being amortized over the terms of the agreements. This amortization is included in net investment income.
Swaptions. Swaptions, which expire in 2000 through 2003, entitle LNC to receive settlement payments from the counterparties on specified expiration dates, contingent on future interest rates. For each swaption, the amount of such settlement payments, if any, is determined by the present value of the difference between the fixed rate on a market rate swap and the strike rate multiplied by the notional amount. The purpose of LNC's swaption program is to protect its annuity line of business from the effect of rising interest rates. The premium paid for the swaptions is included in other investments (amortized cost of $12.2 million as of December 31, 1999) and is being amortized over the terms of the agreements. This amortization is included in net investment income.
Spread-Lock Agreements. Spread-lock agreements provide for a lump sum payment to or by LNC, depending on whether the spread between the swap rate and a specified Government note is larger or smaller than a contractually specified spread. Cash payments are based on the product of the notional amount, the spread between the swap rate and the yield of an equivalent maturity Government security, and the price sensitivity of the swap at that time. The purpose of LNC's spread-lock program is to protect a portion of its fixed maturity securities against widening spreads. While spreadlocks are used periodically, there are no spreadlock agreements outstanding at December 31, 1999.
Financial Futures Contracts. 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. Financial futures contracts were terminated in 1997.
Interest Rate Swap Agreements. 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 interest rates. LNC is required to pay the counterparty to the agreements the stream of variable interest payments based on the coupon payments from the hedged bonds, and in turn, receives a fixed payment from the counterparty, at a predetermined interest rate. The net receipts/payments from interest rate swaps are recorded in net investment income. LNC also uses interest rate swap agreements to hedge its exposure to interest rate fluctuations related to the anticipated purchase of assets to support newly acquired blocks of business or to extend the duration of certain portfolios of assets. Once the assets are purchased, the gains (losses) resulting from the termination of the swap agreements will be applied to the basis of the assets. The gains (losses) will be recognized in earnings over the life of the assets. The anticipated purchase of assets to support newly acquired blocks of business was completed in 1999. The anticipated purchase of assets related to extending the duration of certain portfolios of assets is expected to be completed in 2000.
Additional Derivative Information. Expenses for the agreements and contracts described above amounted to $9.9 million, $11.6 million and $10.0 million in 1999, 1998 and 1997, respectively. Deferred gains of $0.1 million as of December 31, 1999 were the result of 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.
LNC is exposed to credit loss in the event of nonperformance by counterparties on various derivative contracts. However, LNC does not anticipate nonperformance by any of the counterparties. The credit risk associated with such agreements is minimized by purchasing such agreements from financial institutions with long-standing, superior performance records. The amount of such exposure is essentially the net replacement cost or market value less collateral held for such agreements with each counterparty if the net market value is in LNC's favor. At December 31, 1999, the exposure was $19.7 million.
The following discussion outlines the methodologies and assumptions used to determine the estimated fair value of LNC's financial instruments. Considerable judgment is required to develop these fair values. Accordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of LNC's financial instruments.
Mortgage Loans on Real Estate. The estimated fair value of mortgage loans on real estate was established using a discounted cash flow method based on credit rating, maturity and future income. The ratings for mortgages in good standing are based on property type, location, market conditions, occupancy, debt service coverage, loan to value, caliber of tenancy, borrower and payment record. Fair values for impaired mortgage loans are based on: 1) the present value of expected future cash flows discounted at the loan's effective interest rate; 2) the loan's market price or; 3) the fair value of the collateral if the loan is collateral dependent.
Investment Type Insurance Contracts. The balance sheet captions, "Future Policy Benefits, Claims and Claim Expenses" and "Contractholder Funds", include investment type insurance contracts (i.e. deposit contracts and guaranteed interest contracts). The fair values for the deposit contracts and certain guaranteed interest contracts are based on their approximate surrender values. The fair values for the remaining guaranteed interest and similar contracts are estimated using discounted cash flow calculations. These calculations are based on interest rates currently offered on similar contracts with maturities that are consistent with those remaining for the contracts being valued.
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.
Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Solely Junior Subordinated Debentures. Fair values for company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures are based on quoted market prices less the unamortized cost of issue.
LNC has four business segments: Life Insurance and Annuities, Lincoln UK, Reinsurance and Investment Management. The Life Insurance and Annuities segment offers annuities, life insurance, 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 UK through sales representatives. Reinsurance sells reinsurance products and services to insurance companies, 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. It also includes activity of LNC's internal investment advisor, Lincoln Investment Management. Activity which is not included in the major business segments is shown as "Other Operations."
Financial data by segment for 1997 through 1999 is as follows:
Net Investment Income: Life Insurance and Annuities $2,356.4 $2,184.3 $1,770.8 Lincoln UK 75.3 87.9 85.2 Reinsurance 310.3 307.8 284.4 Investment Management 56.9 65.4 72.3 Other Operations 8.6 36.0 38.1 -------- -------- -------- Total $2,807.5 $2,681.4 $2,250.8
Realized Gain (Loss) on Investments and Subsidiaries: Life Insurance and Annuities $ 5.0 $ 6.2 $ 76.7 Lincoln UK 3.0 1.1 2.1 Reinsurance (2.1) 1.5 23.6 Investment Management (1.1) 1.8 11.3 Other Operations (1.8) 8.4 8.9 -------- -------- -------- Total $ 3.0 $ 19.0 $ 122.6
Net Income (Loss) from Continuing Operations before Federal Income Taxes: Life Insurance and Annuities $ 705.0 $ 520.6 $ 403.5 Lincoln UK (100.1) 106.9 (96.8) Reinsurance 49.2 156.7 (210.2) Investment Management 40.6 38.8 16.9 Other Operations (includes interest expense) (124.7) (125.6) (78.5) -------- -------- -------- Total $ 570.0 $ 697.4 $ 34.9
Income Tax Expense (Benefit): Life Insurance and Annuities $ 200.6 $ 132.8 $ 97.0 Lincoln UK (81.9) 35.2 10.0 Reinsurance 15.5 54.5 (73.8) Investment Management 16.0 16.8 10.8 Other Operations (40.6) (51.7) (31.3) -------- -------- -------- Total $ 109.6 $ 187.6 $ 12.7
Year Ended December 31 (in millions) 1999 1998 1997 ------------------------------------------------------------------------------------------------- Assets: Life Insurance and Annuities $ 81,299.1 $73,966.1 $57,070.5 Lincoln UK 9,712.8 8,757.3 7,923.8 Reinsurance 6,766.1 6,408.0 5,540.2 Investment Management 1,484.1 1,622.6 1,756.7 Other Operations (includes interest expense) 3,833.6 3,082.3 4,883.5 ---------- --------- --------- Total $103,095.7 $93,836.3 $77,174.7
Select data shown above for 1998 and 1997 for the Life Insurance & Annuities segment, Investment Management segment and Other Operations has been reclassified due to a change in the reporting relationship for LNC's internal investment advisor and 401(k) pension operations.
Year Ended December 31 (in millions) 1999 1998 1997 --------------------------------------------------------------------------- Revenue $ 572.4 $ 606.3 $ 576.3 Net Income (Loss) before Federal Income Taxes (60.4) 134.0 (69.1) Income Tax Expense (Benefit) (56.6) 45.2 21.2 -------- -------- -------- Net Income (Loss) $ (3.8) $ 88.8 $ (90.3) Assets (at end of year) $9,820.0 $9,164.2 $8,173.0
All of the issued and outstanding series A preferred stock is $3 cumulative convertible and is convertible at any time into shares of common stock. The conversion rate is sixteen shares of common stock for each share of series A preferred stock, subject to adjustment for certain events. The series A preferred stock is redeemable at the option of LNC at $80 per share plus accrued and unpaid dividends. 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 per share. The difference between the aggregate preference on liquidation value and the financial statement balance for the series A preferred stock was $1.4 million at December 31, 1999.
During May 1999, LNC's Board of Directors approved a two-for-one stock split for its common stock. The record date for the stock split was June 4, 1999 and the additional shares were distributed to shareholders on June 21, 1999. The consolidated financial statements including per share disclosures in these notes, have been adjusted to reflect the effects of the common stock split for all periods presented.
Year Ended December 31 1999 1998 1997 ----------------------------------------------------------------------------------------------------------- Numerator: [millions] Net income as used in basic calculation $ 460.3 $ 509.7 $ 22.1 Dividends on convertible preferred stock 0.1 0.1 0.1 ------ ------ ----- $ 460.4 $ 509.8 $ 22.2
LNC has stock options outstanding which were issued at prices that are above the current average market price of LNC common stock. In the event the average market price of LNC's common stock exceeds the issue price of stock options, such options would be dilutive to LNC's earnings per share and will be shown in the table above. During 1999, LNC changed its deferred compensation plans so that participants selecting LNC stock for measuring the investment return attributable to their deferral amounts will be paid out in LNC stock. The obligation to satisfy these deferred compensation plan liabilities is dilutive and is shown in the table above. Also, LNC has purchase contracts outstanding which require the holder to purchase LNC common stock by August 16, 2001. These purchase contracts were issued in conjunction with the FELINE PRIDES financing. The common shares involved are not currently dilutive to LNC's earnings per share and will not be dilutive in the future except during periods when the average market price of LNC's common stock exceeds a stated threshold price of $55.725 per share.
December 31 (in millions) 1999 1998 --------------------------------------------------------------------------------------------- Fair value of securities available-for-sale $28,292.6 $30,775.7 Cost of securities available-for-sale 28,838.6 29,076.3 --------- --------- Unrealized gain (loss) (546.0) 1,699.4 Adjustments to deferred acquisition costs 257.3 (243.8) Amounts required to satisfy policyholder commitments (84.3) (646.2) Deferred income credits (taxes) (79.7) (261.0) --------- --------- Net unrealized gain (loss) on securities available-for-sale for continuing operations (452.7) 548.4 Change in fair value of derivatives designated as a hedge (classified as other investments) (13.0) 4.0 --------- --------- Net unrealized gain (loss) on securities available-for-sale $ (465.7) $ 552.4
Details underlying "Unrealized Gain (Loss) on Securities Available-for-Sale, Net of Reclassification Adjustment" shown on the Consolidated Statements of Shareholders' Equity are as follows:
In April 1997, LNC completed the acquisition of Voyageur Fund Managers, Inc. ("Voyageur") for $74.0 million. While this includes cash paid out for expenses associated with the purchase, the bulk of the purchase price was covered by the issuance of 2,646,288 shares of LNC common stock to the previous owners of Voyageur. Purchase accounting has been applied to this acquisition resulting in intangible assets of $78.9 million. 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 billion. 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 $776.9 million ($1.225 billion pre-tax) was recorded within discontinued operations. LNC used these proceeds to repurchase $341.8 million, (4,993,281 shares) of its own common stock, retire $86.7 million of long-term debt, purchase a 49% ownership in Seguros Serfin Lincoln for $85.0 million, pay income taxes of $447.6 million related to the sale of discontinued operations and purchase a block of individual life insurance and annuity business for $1.643 billion (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.
On October 1, 1998, LNC acquired a block of individual life insurance from Aetna for $1.0 billion. Funding used to complete this acquisition was primarily from public securities offered in 1998 (see Note 5). This transaction was accounted for using purchase accounting and, accordingly, the operating results generated by this block of business after the closing date are included in LNC's consolidated financial statements. At the time of closing, this block of business had liabilities, measured on a statutory basis, of $3.3 billion. These liabilities became LNC's obligations at the time of closing. At closing, LNC received assets, measured on a historical statutory basis, equal to the liabilities. On August 7, 1998, LNC announced that it had reached an agreement to sell the sponsored life business acquired as part of the Aetna block of business. The sale closed on October 14, 1998 with an effective date of October 1, 1998 at a sales price of $99.5 million. During 1997, after deducting the sponsored life income statement amounts, the Aetna block produced premiums and fees of $227.8 million and net income of $65.0 million on the basis of generally accepted accounting principles (prior to adjustments required by purchase accounting). As of December 31, 1999 the application of purchase accounting to this block of business, net of the sponsored life business and amortization, resulted in goodwill and other intangibles of $225.6 million and $775.2 million, respectively.
Year Ended December 31 (in millions, except per share data) 1998 1997 ------------------------------------------------------------------------------------- Revenue $6,469.4 $6,366.4 Income from continuing operations 547.3 145.5 Net income 547.3 1,057.3
During 1998, LNC implemented a restructuring plan relating to the integration of existing life and annuity operations with the new business operations acquired from CIGNA, and a second restructuring plan related to downsizing LNC's corporate center operations. The aggregate charges associated with these two unrelated restructuring plans totaled $34.3 million after-tax ($52.8 million pre-tax). These aggregate pre-tax costs include $19.6 million for employee severance and termination benefits, $9.9 million for asset impairments and $23.3 million for costs relating to exiting business activities. As of December 31, 1999, actual pre-tax costs of $50.0 million have been expended or written-off under these restructuring plans and a balance of $4.7 million pre-tax related to the downsizing of LNC's corporate center operations remains in the restructuring reserves for these 1998 plans. LNC anticipates that the remaining reserves will be utilized in completing this restructuring plan. Details of each of these 1998 restructuring plans are provided below.
During the first quarter of 1998, the operations of the Life Insurance and Annuities segment were restructured to downsize and integrate existing operations with the new business operations acquired from CIGNA. LNC recorded a charge of $30.8 million (pre-tax) related to this restructuring plan. This charge was included in Underwriting, Acquisition, Insurance and Other Expenses on the Consolidated Statement of Income for the year ended December 31, 1998. The overall objective of this restructuring plan is to downsize the existing life insurance operations in Fort Wayne, Indiana and to move the platform for these operations to Hartford, Connecticut. The restructuring plan identified $10.7 million (pre-tax) for severance and employee termination costs related to the elimination of 211 positions and $20.1 million (pre-tax) for the merging and closing of field offices and for the merging and reduction of duplicative policyholder administrative systems. These actions were required as part of this restructuring plan in order to eliminate redundancies in existing operations resulting from the acquisition of the CIGNA block of business. These restructuring activities are expected to be completed in early 2000. As of December 31, 1999, $32.7 million (pre-tax) was expended or written-off under this restructuring plan and all 211 positions have been eliminated. The amount of $1.9 million (pre-tax) that was expended in excess of the restructuring charge of $30.8 million pre-tax was expensed as incurred and reduced 1999 income from operations. Any additional expenditures made in 2000 will be expensed as incurred.
During the fourth quarter of 1998, LNC completed an organizational expense review that centered around the size and make-up of the parent company. LNC recorded a restructuring charge of $22 million (pre-tax) relating to the restructuring plan that resulted from this review. This charge was included in Underwriting, Acquisition, Insurance and Other Expenses on the Consolidated Statement of Income for the year ended December 31, 1998. The objectives of this restructuring plan are to realign the activities and functions conducted within the parent company, in light of the series of acquisitions and divestitures that LNC executed in recent years, and to reduce overall costs in response to increasing competitive pressures in the businesses that LNC operates. To achieve these objectives, the restructuring plan includes reductions in the number of corporate center employees along with a reduction in the size of LNC's facilities. The following activities and associated costs are included in this restructuring plan: (1) $8.9 million for severance and termination benefits related to the elimination of 143 positions, (2) $9.9 million for the write-off of leasehold improvements related to abandoned facilities and other impaired assets, and (3) $3.2 million for rents on abandoned facilities. All expenditures for severance and termination benefits under the plan are expected to be complete by the end of 2000. Expenditures for rents on abandoned facilities are expected to be complete by the end of 2004 consistent with the remaining lease commitment. As of December 31, 1999, $17.3 million (pre-tax) has been expended or written-off under this restructuring plan and 101 positions have been eliminated. LNC estimated a reduction in future expenses of $15 million to $20 million per year after the plan was fully implemented. The total annualized cost reduction achieved through December 31, 1999 was $19.5 million.
In 1999, LNC implemented three different restructuring plans relating to 1) the downsizing and consolidation of the operations of Lynch & Mayer, Inc., 2) the discontinuance of HMO excess-of-loss reinsurance programs and 3) the streamlining of Lincoln UK's operations. The aggregate charges associated with these three unrelated restructuring plans totaled $21.8 million after-tax ($31.8 million pre-tax). These aggregate pre-tax costs include $8.3 million for employee severance and termination benefits, $9.8 million for asset impairments and $13.7 million for costs relating to exiting business activities. As of December 31, 1999, actual pre-tax costs of $15.5 million have been expended or written-off under these restructuring plans. During the fourth quarter of 1999, $3.0 million (pre-tax) of the original charge recorded for the Lynch & Mayer, Inc. restructuring plan was reversed due primarily to a change in estimate for space cost. This reversal reduced the reported fourth quarter 1999 restructuring charges. In addition, during the fourth quarter of 1999, $1.5 million (pre-tax) associated with lease terminations was released into income. As of December 31, 1999, a balance of $13.3 million (pre-tax) remains in the restructuring reserves for these 1999 plans. LNC anticipates that the remaining reserves will be utilized in completing these restructuring plans. Details of each of these 1999 restructuring plans are provided below.
We have audited the accompanying consolidated balance sheets of Lincoln National Corporation as of December 31, 1999 and 1998, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. 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.