entities and blocks of business - directly or by means of reinsurance transactions); financial markets (e.g., interest rates and securities markets); competitors and competing products and services; LNC’s ability to operate its businesses in a relatively normal manner; legislation (e.g., corporate, individual, estate and product taxation); the price of LNC’s stock; accounting principles generally accepted in the United States; regulations (e.g., insurance and securities regulations); and debt and claims-paying ratings issued by nationally recognized statistical rating organizations.
To protect itself from a variety of equity market and interest rate risks that are inherent in many of LNC’s life insurance and annuity products, LNC uses various derivative instruments. Assessing the effectiveness of these hedging programs and evaluating the carrying values of the related derivatives often involves a variety of assumptions and estimates. LNC’s accounting policies for derivatives are discussed within Results of Consolidated Operations, Consolidated Investments and within the discussion of Quantitative and Qualitative Disclosures About Market Risk. In addition, discussion of the potential impact on interest rate risk in a falling rate environment is included in the “Interest Rate Risk - Falling Rates” section within LNC’s discussion of Quantitative and Qualitative Disclosures About Market Risk.
No change in equity markets from December 31, 2002 through March 31, 2003.
The above table excludes the impact of an impairment of the deferred dealer commission asset within the Investment Management segment. For instance, a review of the deferred dealer commission asset was performed as of March 10, 2003. Based on information currently available, it is estimated that a decline of approximately 3% in the equity markets from March 10, 2003 levels may trigger a loss, which would range from approximately $7.4 million to $11.4 million after-tax with the application of assumed discount rates ranging between 10% to 18% for purposes of measuring the fair value of the deferred dealer commission asset. The estimated balance of the deferred dealer commission asset as of March 10, 2003 was approximately $50 million.
In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, “Business Combinations” (“FAS 141”), and No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”). FAS 141 is effective for all business combinations initiated after June 30, 2001, and FAS 142 is effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized, but are subject to impairment tests conducted at least annually in accordance with the new standards. Intangible assets that do not have indefinite lives continue to be amortized over their estimated useful lives. LNC adopted FAS 142 on January 1, 2002. After consideration of the provisions of the new standards regarding proper classification of goodwill and other intangible assets on the consolidated balance sheet, LNC did not reclassify any goodwill or other intangible balances held as of January 1, 2002.
fixed products. These increases were partially offset by the negative effect of the equity markets on VUL account values.
Further affecting some split dollar programs have been accounting reforms under Sarbanes-Oxley, which prohibit publicly traded companies from extending credit to their directors or executives. However, most of the products sold by LNC for use in split dollar arrangements are sold to closely held companies, limited partnerships and family owned businesses, not for publicly traded companies. Segment management believes that given LNC’s target market, and the fact that the amount of split dollar sales in relationship to the level of total first year life premium sold is insignificant to the Life Insurance segment, the impacts of these changes should have minimal overall effect on sales.
Assets under management increased $1.1 billion to $87.6 billion at the end of 2002. The increase was the result of a $3.0 billion increase in insurance assets (i.e. primarily general account assets of LNC’s insurance subsidiaries). In addition, institutional assets under management increased $0.7 billion as positive net inflows of $2.1 billion offset the reduction in assets of $1.4 billion resulting from the negative performance of the equity markets. Retail assets under management decreased $2.6 billion as the equity markets reduced assets by $3.4 billion, more than offsetting the $0.8 billion positive net flows.
The gross realized gains on fixed maturity and equity securities were $181.2 million, $223.2 million and $204.5 million, in 2002, 2001 and 2000, respectively. Gross realized losses on fixed maturity and equity securities were $609.9 million, $459.7 million and $266.8 million, respectively. Included within losses are write-downs for impairments of $321.5 million, $252.9 million and $55.8 million in 2002, 2001 and 2000, respectively.
For traded and private securities held by LNC at December 31, 2001 that were subject to enhanced analysis and monitoring for potential changes in unrealized loss status, the fair value, amortized cost, unrealized loss and total time period that the security has been in an unrealized loss position are presented in the table below.
On August 16, 2001, LNC settled mandatory stock purchase contracts issued in conjunction with the FELINE PRIDES financing. This action resulted in the issuance of 4.6 million shares of LNC stock at $49.67 per share. Investors had the option of settling the purchase contract with separate cash or by having the collateral securing their purchase obligations sold. In the case of investors who held the Trust Originated Preferred Securities (“TOPrS”) as collateral for the purchase contracts, they were permitted to enter into a remarketing process with proceeds used to settle the contracts. On August 13, 2001, the remarketing failed resulting in the retirement of $225 million TOPrS. A total of $5 million of two-year TOPrS remain outstanding which represents investors who chose to settle with separate cash and hold onto their TOPrS until maturity.
On November 19, 2001, LNC issued 6.9 million shares of $172.5 million 7.65% Trust Preferred Securities (“TRUPS”) through Lincoln National Capital V. In conjunction with the $172.5 million TRUPS issue, LNC executed a $172.5 million notional amount interest rate swap that effectively converted the 7.65% fixed rate coupon on the TRUPS into a LIBOR-based floating rate obligation. On December 7, 2001, LNC issued $250 million 6.20% ten-year senior notes.
In September 2001, LNC redeemed $215 million 8.75% Quarterly Income Preferred Securities which were issued by Lincoln National Capital I in July 1996. In November 2001, Lincoln National Capital V issued 6,900,000 shares of $172.5 million 7.65% Trust Preferred Securities (“TRUPS”). In conjunction with the $172.5 million TRUPS issue, LNC executed an interest rate swap in the amount of 172.5 million notional that effectively converted the 7.65% fixed rate into a LIBOR-based floating interest rate.
In 2002, all plans have projected benefit obligations in excess of plan assets. In 2001, the funded status amounts in the pension benefits columns above combine plans with projected benefit obligations in excess of plan assets and plans with plan assets in excess of projected benefit obligations. At December 31, 2001, for plans that had projected benefit obligations in excess of plan assets, the aggregate projected benefit obligations
As required by Statement of Financial Accountant Standards No. 87, “Employer’s Accounting for Pensions,” for plans where the accumulated benefit obligation exceeds the fair value of plan assets, LNC has recognized the minimum pension liability of the unfunded accumulated benefit obligation as a liability with an offsetting adjustment to Other Comprehensive Income, net of tax impact. As of December 31, 2002, this minimum pension liability amounted to $64.8 million ($99.7 million pre-tax) for U.S. pension plans. In addition, as of December 31, 2002 and 2001, for the non-U.S. defined benefit plan, a minimum pension liability of $33.0 million ($50.9 million pre-tax) and $36.0 million, respectively, was recorded in Accumulated Other Comprehensive Income (see below for further discussion of the non-U.S. defined benefit plan). The total amount recorded in Accumulated Other Comprehensive Income as of December 31, 2002 and 2001 was $97.8 million and $36.0 million, respectively.
Certain LNC insurance companies assume insurance from other companies. At December 31, 2002, LNC’s insurance companies provided $80.2 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. LNC’s reinsurance operations were acquired by Swiss Re on December 7, 2001. The transaction structure involved a series of indemnity reinsurance transactions combined with the sale of certain stock companies that comprised LNC’s reinsurance operation. Under the indemnity reinsurance agreements, Swiss Re reinsured certain liabilities and obligations of LNC. Because LNC is not relieved of its legal liability to the ceding companies, the liabilities and obligations associated with the reinsured contracts remain on the balance sheets of LNC with a corresponding reinsurance receivable from Swiss Re.
By using derivative instruments, LNC is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair value gain in the derivative. When the fair value of a derivative contract is positive, this generally indicates that the counterparty owes LNC and, therefore, creates a payment risk for LNC. When the fair value of a derivative contract is negative, LNC owes the counterparty and therefore LNC has no payment risk. LNC minimizes the credit (or payment) risk in derivative instruments by entering into transactions with high quality counterparties that are reviewed periodically by
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.
LNC reports operations not directly related to the business segments and unallocated corporate items (i.e., corporate investment income, interest expense on corporate debt, unallocated overhead expenses, and the operations of LFA and LFD) in “Other Operations”. As noted above, the financial results of the former Reinsurance segment were moved to Other Operations upon the close of the transaction with Swiss Re in December 2001.
LNC’s common and series A preferred stock is without par value.
transferred to Swiss Re as part of its acquisition of LNC’s reinsurance operations. As of December 31, 2002, a balance of $2.5 million (pre-tax) remains in the restructuring reserve for the Lincoln UK restructuring plan and is expected to be utilized in completion of this plan. Details of the Lincoln UK restructuring plan are provided below.