(1) Income from continuing operations for 1997, 1995 and 1993 includes the impact of the changes in estimate of the reserve level needed for LNC's disability income business ($130.0 million, $121.6 million and $32.8 million, after-tax, respectively). Also 1997 includes a change in estimate for reserves for 1) Lincoln UK's pension business of $174.9 million after-tax and 2) Reinsurance's personal accident programs of $113.7 million after-tax.
First Penn offers annuities through banks, universal life insurance through independent marketers and life insurance through brokers and LFA agents.
Complementary Approaches: Delaware, Lynch & Mayer and Vantage operate autonomously and are encouraged to preserve their distinctive investment styles. Their breadth of complementary styles and strengths is a prudent way to diversify risks, especially in the sometimes uncertain and volatile investment markets.
Delaware, founded in 1929 and acquired by LNC in 1995, is best known for a conservative, "value" investment style that focuses on stocks with above average dividend yields. It is also recognized for its small-cap and mid-cap growth investment styles and its expertise in municipal and high-yield bonds. It is active in both retail and institutional business. Its subsidiary Delaware International Advisors, Ltd., was formed in 1990 and provides international investment expertise from its base in London.
Net income (loss) shown above for "Other Operations" includes the items described above under loss from operations plus the realized gain (loss) on sale of certain investments, the gain (loss) on sale of subsidiaries (see note 11 to the consolidated financial statements on page 64) and the cumulative effect of the 1993 accounting change for the consolidated group of companies related to postretirement benefits.
Use Of Derivatives: The primary use of derivatives at LNC is to hedge interest rate risk that is embedded in either life and annuity product liabilities or investment portfolios. To a lesser extent, derivatives are also used to hedge exposures to foreign currency and equity market risks.
Century Compliance The year 2000 issue is pervasive and complex and affects virtually every aspect of LNC's businesses. LNC's computer systems and interfaces with the computer systems of vendors, suppliers, customers and business partners are particularly vulnerable. The inability to properly recognize date sensitive electronic information and transfer data between systems could cause errors or even a complete systems failure which would result in a temporary inability to process transactions correctly and engage in normal business activities for one or more of LNC's businesses. LNC is redirecting a large portion of its internal information technology efforts and contracting with outside consultants to update its systems to accommodate the year 2000. Also, LNC has initiated formal
Deferred Acquisition Costs Deferred acquisition costs decreased $65.9 million in 1997. This decrease was the net result of an increase related to the growth in business being more than offset by decreases related to the write-off of such costs in conjunction with the strengthening of disability income reserves (see note 2 to the consolidated financial statements on page 43) and reductions related to the increase in unrealized gain on securities available-for-sale.
Amounts Recoverable from Reinsurers The increase of $22.3 million in amounts recoverable from reinsurers was the result of an increased volume of business ceded in the Life Insurance and Annuities segment.
Other Assets The decrease in other assets of $51.6 million is the result of having a lower receivable related to investment securities sold in the last few days of 1997 versus the end of 1996.
LNC believes that the portfolios supporting its accumulation and investment oriented insurance products have a prudent degree of call protection individually and on a consolidated basis. The mortgage-backed securities ("MBS") and asset- backed securities ("ABS") portion of the portfolio represents a total of $4.5 billion or 20% of the $22.4 billion of general account assets supporting such products. Of this portfolio, 13% of general account assets or $3.0 billion is subject to residential prepayment risk from investments made in Collateralized Mortgage Obligations ("CMOs"), mortgage pass-throughs, manufactured housing and home equity loans. LNC's MBS portfolio has equal to or slightly less prepayment risk than the MBS pass-through market in general primarily due to holding more seasoned securities in the portfolio. Due to the combination of recent lower interest rates and increased efficiency by mortgage-holders in exercising their prepayment options, the riskiness of these securities has increased over the last few years without a compensating adjustment to risk premiums. This trend has also reduced the degree of protection provided by the purchase of protected amortization class CMOs. As a result, LNC has reduced its exposure to the MBS asset class in recent years.
Interest Rate Risk--Rising Rates. For both annuities and universal life insurance, a rapid and sustained rise in interest rates poses risks of deteriorating spreads and high surrenders. The portfolios supporting these products have fixed-rate assets laddered over maturities generally ranging from one to ten years or more. Accordingly, the earned rate on each portfolio lags behind changes in market yields. As rates rise, the lag may be increased by slowing MBS prepayments. The greater and faster the rise in interest rates, the more the earned rate will tend to lag behind market rates. If LNC sets renewal crediting rates to earn the desired spread, the gap between its renewal crediting rates and competitors' new money rates may be wide enough to cause increased surrenders. If LNC credits more competitive renewal rates to limit surrenders, its spreads will narrow. LNC devotes extensive effort to evaluating these risks by simulating asset and liability cash flows for a wide range of interest rate scenarios. Such analysis has led to adjustments in the target maturity structure and to hedging the risk of rising rates by buying out-of-the-money interest rate cap agreements and swaptions (see discussion below). With this hedge, the potential adverse impact of a rapid and sustained rise in rates is kept within corporate risk tolerances. LNC believes that the risks of rising interest rates are also mitigated by its emphasis on periodic premium products.
Change in Estimate for Disability Income Reserve. During the fourth quarter of 1995, LNC completed an in-depth review of the experience of its disability income business. As a result of this study, and based on the assumption that recent experience would continue in the future, net income was decreased by $121,600,000 or $1.15 per share ($187,000,000 pre-tax) as a result of strengthening the disability income reserve by $103,700,000 and writing-off deferred acquisition costs of $83,300,000 in the Reinsurance segment.
The cost, gross unrealized gain and loss, and fair value of securities available-for-sale are as follows:
The average recorded investment in impaired loans and the interest income recognized on impaired loans were as follows:
Long-term debt less current portion: 7 1/8% notes payable, due 1999 . . . . . . . . . $ 99.7 $ 99.5 7 5/8% notes payable, due 2002 . . . . . . . . . 99.4 99.3 7 1/4% notes payable, due 2005 . . . . . . . . . 191.4 197.9 9 1/8% notes payable, due 2024 . . . . . . . . . 119.8 199.1 Mortgages and other notes payable. . . . . . . . .7 30.5 Total long-term debt. . . . . . . . . . . . $511.0 $626.3
Marketing and Compliance Issues Regulators continue to focus on market conduct and compliance issues. Under certain circumstances companies operating in the insurance and financial services markets have been held responsible for providing incomplete or misleading sales materials and for replacing existing policies with policies that were less advantageous to the policyholder. LNC's management continues to monitor the company's sales materials and compliance procedures and is making an extensive effort to minimize any potential liability. 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.
Two lawsuits involve alleged fraud in the sale of interest sensitive universal and whole life insurance policies. These two suits have been filed as class actions against Lincoln Life, although the court has not certified a class in either case. Plaintiffs seek unspecified damages and penalties for themselves and on behalf of the putative class. While the relief sought in these cases is substantial, the cases are in the early stages of litigation, and it is premature to make assessments about potential loss, if any. Management intends to defend these suits vigorously. The amount of liability, if any, which may arise as a result of these suits cannot be reasonably estimated at this time.