SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT UNDER SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended June 30, 1994 Commission file number 1-6028
LINCOLN NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
Indiana 35-1140070
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 East Berry Street, Fort Wayne, Indiana 46802-2706
(Address of Principal Executive Offices)
Registrant's telephone number (219) 455-2000
Common Stock Outstanding July 28, 1994 94,951,076
Indicate by check mark whether registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months(or for such shorter period that the registrant
was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
The exhibit index to this report is located on page 17.
Page 1 of 19
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<TABLE>
PART I - FINANCIAL INFORMATION
<CAPTION>
Item 1 Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30 December 31
(000'S omitted) 1994 1993
ASSETS
Investments:
<S> <C> <C>
Securities available-for-sale, at fair value:
Fixed maturity (cost 1994 - $21,438,155;
1993 - $22,219,285) ------------------ $21,362,749 $23,964,335
Equity (cost 1994 - $913,442;
1993 - $896,477) --------------------- 1,007,873 1,080,301
Mortgage loans on real estate ------------ 2,870,737 3,300,951
Real estate ------------------------------ 645,844 633,103
Policy loans ----------------------------- 536,956 595,085
Other investments ------------------------ 165,536 158,170
Total Investments ---------------------- 26,589,695 29,731,945
Investment in unconsolidated affiliates ---- 89,940 --
Cash and invested cash --------------------- 1,371,235 709,664
Property and equipment --------------------- 188,025 233,467
Deferred acquisition costs ----------------- 2,266,087 2,011,131
Premiums and fees receivable --------------- 711,003 601,883
Accrued investment income ------------------ 426,189 413,144
Assets held in separate accounts ----------- 13,094,929 12,430,577
Federal income taxes ----------------------- 389,145 --
Amounts recoverable from reinsurers -------- 1,857,692 1,460,038
Goodwill ----------------------------------- 148,753 228,530
Other assets ------------------------------- 689,171 559,982
Total Assets ----------------------------- $47,821,864 $48,380,361
<FN>
See notes to consolidated financial statements on page 7.
</TABLE>
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<TABLE>
<CAPTION>
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
-CONTINUED-
June 30 December 31
(000's omitted) 1994 1993
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C>
Liabilities:
Policy liabilities and accruals:
Future policy benefits and
losses, claims and loss expenses ------ $11,424,526 $12,652,036
Unearned premiums ----------------------- 829,490 858,805
Total Policy Liabilities and Accruals - 12,254,016 13,510,841
Contractholder funds ---------------------- 15,805,875 14,872,141
Liabilities related to separate accounts -- 13,094,929 12,430,577
Federal income taxes ---------------------- -- 150,951
Short-term debt --------------------------- 474,032 351,418
Long-term debt ---------------------------- 320,492 335,097
Other liabilities ------------------------- 2,523,544 2,657,015
Total Liabilities ----------------------- 44,472,888 44,308,040
Shareholders' Equity:
Series A Preferred Stock
(6/30/94 liquidation value - $3,645) ----- 1,496 1,553
Series E Preferred Stock
(6/30/94 liquidation value - $151,569) --- 151,206 151,206
Series F Preferred Stock
(6/30/94 liquidation value - $158,707) --- 158,707 158,707
Common Stock ------------------------------ 566,102 543,659
Earned surplus ---------------------------- 2,415,329 2,303,731
Foreign currency translation adjustment --- 4,550 (1,214)
Net unrealized gain on securities
available-for-sale ----------------------- 51,586 914,679
Total Shareholders' Equity -------------- 3,348,976 4,072,321
Total Liabilities
and Shareholders' Equity -------------- $47,821,864 $48,380,361
<FN>
See notes to consolidated financial statements on page 7.
</TABLE>
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<TABLE>
<CAPTION>
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended Three Months Ended
June 30 June 30
(000's omitted) 1994 1993 1994 1993
Revenue:
<S> <C> <C> <C> <C> Insurance premiums ---------- $2,247,536
Insurance fees -------------- 216,866 225,903 111,033 114,805
Net investment income ------- 989,453 1,035,373 487,612 523,539
Equity in earnings of
unconsolidated affiliates - 5,592 -- 4,938 --
Realized gain (loss) on
investments --------------- (28,235) 55,356 (66,330) 45,990
Gain on sale of subsidiary -- 48,842 -- 4,784 --
Other ----------------------- 71,213 75,491 34,692 35,611
Total Revenue ----------- 3,551,267 3,840,917 1,544,431 1,901,910
Benefits and Expenses:
Benefits and settlement
expenses ------------------ 2,450,440 2,619,173 1,107,681 1,232,378
Underwriting, acquisition,
insurance and other expenses 854,431 950,677 383,916 486,750
Interest expense ------------ 22,730 21,903 11,452 10,771
Total Benefits
and Expenses ---------- 3,327,601 3,591,753 1,503,049 1,729,899
Income Before Federal
Income Taxes and
Cumulative Effect of
Accounting Change --- 223,666 249,164 41,382 172,011
Federal Income Taxes ---------- 25,879 52,938 (5,420) 44,795
Income Before
Cumulative Effect of
Accounting Change ----- 197,787 196,226 46,802 127,216
Cumulative Effect of
Accounting Change ----------- -- (96,431) -- --
Net Income -------------- $ 197,787 $ 99,795 $ 46,802 $ 127,216
Earnings Per Share:
Income before cumulative
effect of accounting change - $1.91 $1.94 $ .45 $1.23
Cumulative effect of
accounting change ----------- -- (.95) -- --
Net Income -------------- $1.91 $ .99 $ .45 $1.23
Cash Dividends Per Share -
Common Stock ---------------- $ .82 $ .76 $ .41 $ .38
<FN>
See notes to consolidated financial statements on page 7.
</TABLE>
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<TABLE>
<CAPTION>
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Six Months Ended June 30
Number of Shares Issued Amounts
(000's omitted from dollar amounts) 1994 1993 1994 1993
<S> <C> <C> <C> <C>
Preferred Stock:
(Shares authorized: 10,000,000)
Series A Preferred Stock:
Balance at
beginning of year -------- 47,289 57,716 $ 1,553 $ 1,896
Conversion into
Common Stock ------------- (1,723) (7,006) (57) (230)
Balance at June 30 ------ 45,566 50,710 1,496 1,666
Series E and F Preferred Stock:
Balance at beginning
and end of period -------- 4,417,897 4,417,897 309,913 309,913
Common Stock:
(Shares authorized:
1994 - 800,000,000;
1993 - 400,000,000)
Balance at beginning of year - 94,183,190 84,142,458 543,659 200,986
Conversion of Series A
Preferred Stock ------------ 13,784 56,048 57 230
Public offering of
Common Stock --------------- -- 9,200,000 -- 316,100
Issued for benefit plans ---- 577,666 505,254 22,386 17,551
Balance at June 30 ------ 94,774,640 93,903,760 566,102 534,867
Earned Surplus:
Balance at beginning of year - 2,303,731 2,147,691
Net income ------------------- 197,787 99,795
Cash dividends declared ------ (86,189) (79,936)
Balance at June 30 ------ 2,415,329 2,167,550
Foreign Currency Translation Adjustment:
Accumulated adjustment at
beginning of year ---------- (1,214) 3,643
Change during period --------- 5,764 (3,203)
Balance at June 30 ------ 4,550 440
Net Unrealized Gain (Loss) on
Securities Available-for-Sale:
Balance at beginning of year - 914,679 162,742
Change during period --------- (863,093) 62,260
Balance at June 30 ------ 51,586 225,002
Total Shareholders' Equity
at June 30 ------------ $3,348,976 $3,239,438
Common Stock (assuming conversion
of Series A, E & F Preferred Stock):
End of Period ----------- 103,974,962 103,145,234
Average for the Period -- 103,749,231 101,312,000
<FN>
See notes to consolidated financial statements on page 7.
</TABLE>
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<TABLE>
<CAPTION>
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30
(000's omitted) 1994 1993
<S> <C> <C>
Operating Activities:
Net Income----------------------------------------- $ 197,787 $ 99,795
Adjustments to reconcile net income to net
cash provided by operating activities:
Deferred acquisition costs -------------------- (83,551) (8,692)
Premiums and fees receivable ------------------ (135,000) (94,511)
Accrued investment income --------------------- (41,801) 26,383
Policy liabilities and accruals --------------- 227,980 220,939
Contractholder funds -------------------------- 820,774 589,188
Amounts recoverable from reinsurers ----------- (426,373) (368,442)
Federal income taxes -------------------------- (46,112) (77,686)
Provisions for depreciation ------------------- 28,442 28,152
Realized gain (loss) on investments ----------- 61,513 (55,356)
Gain on sale of subsidiary -------------------- (48,842) --
Cumulative effect of accounting change -------- -- 96,431
Other ----------------------------------------- 28,428 (9,819)
Net Adjustments ----------------------------- 385,458 346,587
Net Cash Provided by Operating Activities --- 583,245 446,382
Investing Activities:
Securities-available-for-sale:
Purchases -------------------------------------- (6,769,656) (4,886,344)
Sales ------------------------------------------ 4,846,477 4,885,041
Maturities ------------------------------------- 719,355 4,300
Fixed maturity securities-held for investment:
Purchases -------------------------------------- -- (3,193,672)
Sales ------------------------------------------ -- 1,165,769
Maturities ------------------------------------- -- 850,223
Purchase of other investments -------------------- (595,307) (577,697)
Sale or maturity of other investments ------------ 973,163 429,902
Sale of subsidiaries ----------------------------- 417,367 --
Increase in cash collateral on
loaned securities ------------------------------ 108,417 104,068
Other -------------------------------------------- (48,151) (214,575)
Net Cash Used in Investing Activities ------ (348,335) (1,432,985)
Financing Activities:
Principal payments on long-term debt ------------- (9,495) (1,387)
Issuance of long-term debt ----------------------- 211 4,430
Net increase (decrease) in short-term debt ------- 123,567 (289,581)
Universal life and investment contract deposits -- 1,203,505 1,320,931
Universal life and investment
contract withdrawals --------------------------- (829,169) (676,355)
Public offering of Common Stock ------------------ -- 316,100
Common Stock issued for benefit plans ------------ 22,386 17,551
Dividends paid to shareholders ------------------- (84,344) (76,234)
Net Cash Provided by Financing Activities -- 426,661 615,455
Net Increase (Decrease) in Cash ------------ 661,571 (371,148)
Cash at Beginning of Year -------------------------- 709,664 1,015,850
Cash at June 30 ---------------------------- $1,371,235 $ 644,702
<FN>
See notes to consolidated financial statements on page 7.
</TABLE>
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LINCOLN NATIONAL CORPORATION
NOTES TO CONSOLIDATED STATEMENTS
1. Basis of Presentation
The accompanying consolidated financial statements include Lincoln National
Corporation ("LNC") and its majority-owned subsidiaries. Less than majority-
owned entities in which LNC has at least a 20% interest are reported on the
equity basis. These unaudited consolidated statements have been prepared in
conformity with generally accepted accounting principles, except that they do
not contain complete notes. However, in the opinion of management, these
statements include all normal recurring adjustments necessary for a fair
presentation of the results. For further information, refer to the
consolidated financial statements included in LNC's annual report to
shareholders or Form 10-K for the year ended December 31, 1993.
Operating results for the six months ended June 30, 1994 are not necessarily
indicative of the results that may be expected for the full year ending
December 31, 1994.
2. Federal Income Taxes
The effective tax rate on net income is lower than the prevailing corporate
federal income tax rate. The difference for both 1993 and 1994 resulted
principally from tax-exempt investment income. The six months ended June 30,
1994 also was affected by the fact that no income taxes were payable on the
gain on sale of a subsidiary (see note 4).
3. Earnings Per Share
Earnings per share are computed based on the average number of common shares
outstanding (103,749,231 and 101,312,000 for the first six months of 1994 and
1993, respectively) after assuming conversion of the Series A, E and F
Preferred Stock.
4. Sale of Subsidiaries
On February 2, 1994, LNC completed the sale of Security-Connecticut
Corporation through an initial public offering for cash, net of related
expenses, totaling $172.7 million and a promissory note from Security-
Connecticut Corporation for $65.0 million. The loss on sale and disposal
expenses did not differ materially from the estimate recorded in the fourth
quarter of 1993.
The preliminary closing for the partial sale of a wholly owned subsidiary,
EMPHESYS Financial Group, Inc. ("EMPHESYS"), through an initial public
offering was completed on March 21, 1994. EMPHESYS is the parent company of
Employers Health Insurance Company ("Employers Health"). As a result of this
transaction, LNC exchanged 64% of the outstanding stock of EMPHESYS for cash,
net of related expenses, totaling $220.1 million and a promissory note from
EMPHESYS for $50.0 million. This transaction resulted in a gain on sale of
$44.1 million (also $44.1 million pre-tax). The final closing of this partial
sale was completed on April 15, 1994. The impact of the combined March 21st
and April 15th transactions was that LNC exchanged 71% of the outstanding
stock of EMPHESYS for cash, net of related expenses, totaling $244.7 million
plus the $50.0 million promissory note. These transactions resulted in a gain
on sale of $48.8 million (also $48.8 million pre-tax). For the January 1,
1994 through March 21, 1994 period, Employers Health had revenue of $314.9
million and net income of $14.4 million. For the six months and quarter ended
June 30, 1993, Employers Health had revenues of $631.6 million and $318.0
million and net income of $24.0 million and $13.4 million, respectively. This
revenue and net income was recorded within the Employee Life-Health Benefits
segment. The gain on sale and the appropriate portion of the equity in the
earnings of EMPHESYS after March 21, 1994, recognized in accordance with the
equity method of accounting, were reported within "Other Operations".
5. Shareholders' Equity
During the second quarter of 1994, LNC's Articles of Incorporation were
amended to increase the number of authorized shares of Common Stock from
400,000,000 to 800,000,000.
<PAGE>
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LINCOLN NATIONAL CORPORATION
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION
As indicated in the "Notes to Consolidated Statements" (see note 4 on page 7),
LNC completed the sale and partial sale of two of its subsidiaries in the first
six months of 1994. As noted in the following "Review of Consolidated
Operations" and "Review of Consolidated Financial Condition," these sales have
affected the comparability of select line items within the Consolidated
Statements of Income and Consolidated Balance sheets.
REVIEW OF CONSOLIDATED OPERATIONS
The discussion that follows focuses on the results for the six months ended
June 30, 1994 compared to the results for the six months ended June 30, 1993.
The factors affecting the current quarter to prior year quarter comparisons are
essentially the same as the year-to-date factors, except as noted.
Insurance Premiums
Property-Casualty premiums decreased by $74.4 million or 8% compared
with the six months ended June 30, 1993 primarily as the result of
implementing a more stringent underwriting policy to improve loss experience.
Excluding the impact of the subsidiary sold in 1994 (see note 4 on page 7),
health premiums were $350.7 million for the first six months of 1994 which is
essentially the same as the first six months of 1993. Health premiums for the
second half of 1994 are expected to be approximately the same as the first
half number shown above. Life and annuity premiums increased by $165.7
million or 29% compared to the previous year. This increase resulted from an
overall increase in the volume of transactions by the Life Insurance and
Annuities and Life-Health Reinsurance segments. The increase in the Life
Insurance and Annuities segment was the net result of increases in volume
including premiums related to a company acquired by Lincoln National (UK) less
the impact of the sale of Security-Connecticut Corporation (see note 4
on page 7).
Insurance Fees
Excluding the impact of the subsidiary sold in 1994 (see note 4 on page
7), insurance fees from the sale of universal life and other interest
sensitive insurance contracts increased $41.8 million or 24% compared to the
first six months of 1993 as the result of increases in the volume of
transactions in the Life Insurance and Annuities segment.
Net Investment Income
Net investment income decreased $45.9 million or 4% when compared with
the first six months of 1993. This is the net result of a 3% increase in mean
invested assets less the impact of the overall yield on investments dropping
from 7.84% to 7.12%.
Equity in Earnings of Unconsolidated Affiliates
This line was added to the statement of income in 1994 following LNC's
partial sale of its direct writer of health coverages (see note 4 on page 7).
The amount shown represents LNC's share of the total earnings of this company
for the period after the closing of the sale on March 21, 1994.
Gain on Sale of Subsidiary
In the first six months of 1994 LNC recorded the sale of a portion of its
interest in Employers Health Insurance Company (see note 4 on page 7).
Realized Gain (Loss) on Investments
The first six months of 1994 and 1993 had pre-tax realized gain (loss) on
investments of $(28.2) million and $55.4 million, respectively. The gains for
1993 were the result of net gains on the sale of investments, less writedowns
and provision for losses. The losses in 1994 were the result of
net realized investment gains (losses) and some modest writedowns and
<PAGE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION (continued)
REVIEW OF CONSOLIDATED OPERATIONS (continued)
provisions for losses. The investment losses, primarily from the second
quarter, were the result of repositioning a portion of the investment
portfolio during a period of rising interest rates. Fixed maturity and equity
securities that were deemed to have declines in fair value that were other
than temporary were written down. Provision for losses on mortgage loans on
real estate, real estate investments and other investments were established
where the underlying value of the property was deemed to be less than the
carrying value.
The pre-tax writedown of fixed maturity and equity securities for the
first six months of 1994 and 1993 were $7.3 million and $45.2 million,
respectively. In recognition of the current and expected interest rate
environment, these writedowns include a second quarter 1993 writedown of
$33.2 million related to interest only mortgage-backed securities. With the
exception of interest only mortgage-backed securities, the fixed maturity
securities to which these writedowns apply were generally of investment grade
quality at the time of purchase, but were classified as "below investment
grade" at the time of the writedowns. The pre-tax additions to provision for
losses on mortgage loans on real estate and real estate for the first six
months of 1994 and 1993 were $23.6 million and $111.3 million, respectively,
including $64.1 million in 1993 for the adoption of FAS 114. The pre-tax
addition to the provision for losses for other investments for the first six
months of 1994 and 1993 were $5.6 million and $7.3 million, respectively.
The gain (loss) on the sale of investments in the first six months of 1994
and 1993 were the result of gains and losses realized on equity securities
and fixed maturity securities plus the release of mortgage loan reserves on
select properties where the estimated fair value had increased since the prior
quarter. In the second quarter of 1994, LNC completed a bulk sale of
commercial real estate with a value of approximately $150 million. This sale
did not result in any significant gain or loss as the proceeds received were
approximately equal to the carrying value.
Other Revenue
Excluding the impact of the subsidiary sold, other revenue increased $1.4
million or 2% when compared to the first six months of 1993 as the result of an
increase in the Life Insurance and Annuities segment.
Insurance Benefits and Settlement Expenses
Property-Casualty benefits decreased by $69.8 million or 9% when compared
with the first six months of 1993. This decrease was the result of reduced
volumes of insurance written. Catastrophe losses and weather related claims
were essentially the same for both periods. Excluding the impact of the
subsidiary sold in 1994 (see note 4 on page 7), health benefits increased by
$17.3 million or 7% when compared to the first six months of 1993 as a result
of increased claims in the Life Insurance and Annuity and Life-Health
Reinsurance segment first six months of 1993 and 1994. Life and annuity
benefits and settlement expenses increased $100.8 million or 8% when compared
to the first six months of 1993. This increase is the result of increased
volumes of business and poorer mortality in the Life Insurance and Annuities
and Life-Health Reinsurance segments.
Underwriting, Acquisition, Insurance and Other Expenses
Excluding the impact of the various subsidiaries sold this expense
increased $10.6 million or 1% for the six months ended June 30, 1994 as
compared to the first six months of 1993. This increase was the result of
inflation and increased volumes of business in the Life Insurance and
Annuities segment being somewhat offset by lower expenses in the Property-
Casualty segment. The Property-Casualty segment had a decrease in this
expense as it continued to adjust staff levels to the current level of
business.
<PAGE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL I
REVIEW OF CONSOLIDATED OPERATIONS (continued)
Interest Expense
Interest expense increased $800,000 or 4% when compared with the first
six months of 1993. This was the net result of increases in the average debt
outstanding and increases in short-term interest rates less the impact of
changes in the composition of debt outstanding.
Federal Income Taxes
Federal income taxes decreased from $52.9 million in the first six months
of 1993 to $25.9 million in the first six months of 1994 as a result of a
decrease in pre-tax earnings and the lack of any tax expense on the gain on
sale of subsidiary (see note 4 on page 7) less some effect of the continued
movement from taxable securities to tax-exempt securities.
Summary
Net income for the first six months of 1994 was $197.8 million or $1.91
per share compared with $99.8 million or $0.99 per share in the first six
months of 1993. Excluding realized gain (loss) on investments, gain on sale
of subsidiary and the after-tax cumulative effect of implementing the
postretirement benefit accounting change, LNC earned $170.9 million for the
first six months of 1994 compared with $158.8 million for the first six months
of 1993. This increase was due to increases in earnings from the Property-
Casualty Insurance and Life Insurance and Annuity business segments being
partially offset by a modest decrease in Life-Health Reinsurance segment
earnings and the impact of the loss of earnings from subsidiaries sold not
being offset by interest on the proceeds from the sales.
REVIEW OF CONSOLIDATED FINANCIAL CONDITION
Investments
The total investment portfolio decreased $3.1 billion in the first six
months of 1994. Most of this decrease related to fixed maturity securities.
The removal of the investments of the two subsidiaries sold (see note 4 on
page 7) accounted for $2.1 billion of this decrease. The remainder of the
decrease is the result of new purchases of investments from cash flow being
more than offset by the decrease in the fair value of existing investment
securities during the first six months of 1994 due to rising interest rates
during that period.
The quality of LNC's fixed maturity securities portfolio as of June 30,
1994 was as follows:
Treasuries and AAA 37.0% BBB 21.0%
AA 11.0% BB 3.2%
A 25.5% Less than BB 2.3%
As of June 30, 1994, $1.178 billion or 5.5% of fixed maturity securities
was invested in below investment grade securities (less than BBB). This
represents 4.4% of the total investment portfolio. The interest rates
available on these below investment grade securities are significantly higher
than is available on other corporate debt securities. Also, the risk of loss
due to default by the borrower is significantly greater with respect to such
below investment grade securities, because these securities are generally
unsecured, often subordinated to other creditors of the issuer and issued by
companies that usually have high levels of indebtedness. LNC attempts to
minimize the risks associated with these below investment grade securities by
limiting the exposure to any one issuer and by closely monitoring the credit
worthiness of such issuers. During the six months ended June 30, 1994, the
aggregate cost of such investments purchased was $458.5 million. Aggregate
proceeds from such investments sold were $266.4 million, resulting in a
realized pre-tax gain of $3.4 million.
<PAGE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION (continued)
REVIEW OF CONSOLIDATED FINANCIAL CONDITION (continued)
LNC's entire fixed maturity securities portfolio is classified as
"available-for-sale" and is carried at fair value. Equity securities
available-for-sale are also carried at fair value. Changes in fair value, net
of related deferred acquisition costs, amounts required to satisfy
policyholder commitments and taxes, are charged or credited directly to
shareholders' equity.
As of June 30, 1994, mortgage loans on real estate and real estate
represented 10.8% and 2.4% of LNC's total investment portfolio. As of June
30, 1994, the underlying properties supporting the mortgage loans on real
estate consisted of 27% in commercial office buildings, 29% in retail stores,
19% in apartments, 12% in industrial buildings, 2% in hotels/motels and 11% in
other. In addition to the dispersion by property type, the mortgage loan
portfolio is geographically diversified throughout the United States.
Mortgage loans on real estate are actively monitored to identify problem
loans. LNC classifies mortgage loans as problem loans if they are non-accrual
loans (i.e., principal and interest are 60 days past due), restructured loans
(i.e., the terms of the original loan have been modified) or loans not in the
first two categories that are considered impaired. LNC considers a mortgage
loan 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. In addition, LNC also classifies
loans as potential problem loans when available information causes management
to be concerned about the borrowers' ability to comply with the present loan
terms, including the repayment of outstanding interest and principal.
When LNC determines that a loan is impaired as defined above, a provision
for loss is established for the difference between the carrying value of the
mortgage loan and the estimated value. Estimated value is based on either the
present value of expected future cash flows discounted at the loan's effective
interest rate, the loan's observable market price or the fair value of the
collateral. Additional amounts were added to the mortgage loan provision for
losses during 1993 due to the adoption of FAS 114 (see page 9). When a mortgage
loan becomes 60 days past due, all existing accruals for interest due are
reversed and interest is recorded on a cash basis until the mortgage loan is
brought current.
In the first six months of 1994, LNC continued to strengthen its
provision for losses for mortgage loans on real estate. The reserve level and
the ratio of reserves to impaired mortgages both decreased during this period
as the modest increase in reserves was more than offset by the removal of
amounts associated with the bulk sale of approximately $150 million in
commercial real estate.
A summary of LNC's problem mortgage loans on real estate before related
provisions for losses and supplemental information with respect to such loans is
as follows:
June 30 December 31
(in millions) 1994 1993
Problem Loans:
Non-accrual loans ----------------------------------- $182.6 $276.3
Restructured loans ---------------------------------- 30.0 59.8
Other problem loans --------------------------------- 354.1 445.2
Total Problem Loans ---------------------------- $566.7 $781.3
Potential problem loans ------------------------------- $ 61.5 $ 92.1
<PAGE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION (continued)
REVIEW OF CONSOLIDATED FINANCIAL CONDITION (continued)
Impaired loans included in the problem loans shown above along with the
related provision for losses is as follows:
June 30 December 31
(in millions) 1994 1993
Impaired loans ---------------------------------------- $506.5 $725.9
Provision for losses ---------------------------------- 138.3 226.6
Net Impaired loans --------------------------------- $368.2 $499.3
The dollar level of reserves and the ratio of impaired mortgages was lower at
June 30, 1994 than at December 31, 1993 due to the sale of performing and non-
performing mortgage loans and real estate in 1994 as described earlier. Net
impaired loans were 1.4% of total investments at June 30, 1994.
Six Months Ended June 30 (in millions) 1994 1993
Interest Income from Problem Loans:
Amount that would have been
recorded under original terms --------------------- $ 27.4 $41.3
Interest income actually recorded ------------------- 20.9 31.9
As of June 30, 1994, LNC has a commitment to lend $55,000 on a loan shown
within other problem loans above. No other future commitments have been made on
non-accrual or restructured loans.
Investment in Unconsolidated Affiliates
This line was added to the balance sheet in 1994 to accommodate LNC's 29%
equity ownership in EMPHESYS, Financial Group, Inc., following LNC's partial
sale of this company (see note 4 on page 7).
Cash and Invested Cash
Cash and invested cash increased by $661.6 million in the first six
months of 1994. This increase is primarily the result of the receipt of
proceeds from the sale of subsidiaries (see note 4 on page 7). These funds
are pending application for general corporate purposes which may include
additional investments in existing business or the financing of acquisitions.
Assets Held in Separate Accounts
Excluding the December 31, 1993 balance of the subsidiaries that were
sold (see note 4 on page 7), this asset account as well as the corresponding
liability account increased by $678.2 million, reflecting an increase in
annuity and pension funds under management.
Federal Income Taxes
Federal income taxes recoverable at June 30, 1994 of $389.1 million
represents a change of $540.1 million compared to the federal income taxes
payable at December 31, 1993. This is the net result of increases related to
recoverable deferred taxes resulting primarily from life insurance reserve
differences, discounting of unpaid losses, additions to the investment
reserves and postretirement obligations, and the decrease in deferred taxes
payable primarily related to the reduction in unrealized gains on securities
in the first six months of 1994.
Amounts Recoverable from Reinsurers
The increase in amounts recoverable from reinsurers was the result of an
increased volume of business ceded in the life insurance and annuity segment.
<PAGE>
-13-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION (continued)
REVIEW OF CONSOLIDATED FINANCIAL CONDITION (continued)
Goodwill
The decrease in goodwill of $79.7 million is primarily the result of the
sale of subsidiaries during the first quarter of 1994 (see note 4 on page 7).
Other Assets
The increase in other assets of $129.2 million is the result of having a
higher receivable related to the volume of investment security transactions
sold in the last few days of the second quarter of 1994 versus such
transactions at the end of 1993.
Total Liabilities
Excluding the December 31, 1993 liabilities of the subsidiaries that were
sold (see note 4 on page 7) of $1.9 billion, total liabilities increased by
$2.1 million in the first six months of 1994. This increase reflects 1) an
increased level of business as evidenced by an increase of $990.4 million in
contractholder funds, an increase of $678.2 million in the liabilities related
to separate accounts, an increase in the policy liabilities and accruals of
$374.1 million, 2) an increase in debt of $114.3 million and 3) a decrease in
other liabilities of $76.3 million.
Policyholder liabilities as of June 30, 1994 and December 31, 1993
included liabilities for environmental losses of approximately $215.0 million
and $204.0 million respectively. Because of the limited coverages that have
been written by LNC in this market, these reserves represent only 7-8% of
LNC's total property-casualty reserves for both periods (3% based on claims
counts of direct business). These percentages are at this level due to LNC's
concentration of writing coverages for small to medium size companies rather
than the larger companies that tend to incur most of the environmental and
product liability claims. Establishing reserves for environmental losses is
subject to significant uncertainties because of the long reporting delays,
lack of historical data and the unresolved complex legal issues that are
involved. However, based on available information, it is management's
judgement that the appropriate level of reserves have been recorded and that
any unrecorded liability would not be material to LNC's future results of
operations, liquidity or financial condition.
The decrease in other liabilities relates to a decrease in the expected
payouts for security investments purchased in the last few days of the second
quarter of 1994 versus a higher volume of such transactions at the end of
1993.
Shareholders' Equity
Total shareholders' equity decreased $723.3 million in the first six
months of 1994. Excluding the decrease of $863.1 million related to
unrealized gain on securities available-for-sale, shareholders' equity
increased $139.8 million. This increase for the first six months of 1994
was the net result of $197.8 million from net income, $22.4 million from the
issuance of Common Stock related to benefit plans, $5.8 million related to an
increase in the accumulated foreign exchange gain and a decrease of $86.2
million related to the declaration of dividends to stockholders.
Liquidity and Cash Flow
In the insurance industry, liquidity generally refers to the ability of an
enterprise to generate adequate amounts of cash from its normal operations,
including activities in its investment portfolio, to meet its financial
commitments. LNC manages its operations, including prudent investment
portfolio structuring, to provide for appropriate liquidity levels. The
portfolio structuring involves segregating LNC's investments by segments,
sub-segments or type of product. The investments selected for each segregated
portfolio are based on LNC's desire to match characteristics (e.g., duration
and yield) of the underlying liabilities.
<PAGE>
-14-
As indicated by the Consolidated Statements of Cash Flows on page 6,
LNC's business operations generated $583.2 million of cash during the first
six months of 1994.
Although LNC generates adequate cash flow to meet the needs of its normal
operations, periodically LNC may issue debt or equity securities to fund
internal expansion, acquisitions, investment opportunities and the retirement
of LNC's debt and equity. A transaction as described in the preceding
sentence occurred during February 1993, when LNC received $316.1 million in
proceeds from a public offering of 9.2 million shares of its Common Stock. In
March 1994, LNC redeemed its $100 million 8% notes payable due in 1997. This
redemption was funded with additional short-term debt.
As indicated in note 7 to the consolidated financial statements for the
year ended December 31, 1993 (see page 49 of LNC's Form 10-K), LNC has entered
into derivative transactions to reduce its exposure to interest rate
fluctuations. LNC has two significant programs in place primarily within its
Life Insurance and Annuity segment.
First, LNC uses interest rate cap agreements to hedge against the
negative impact of a sustained and significant rise in interest rates.
Interest rate caps are contracts that require counterparties to pay LNC at
specified future dates the amount, if any, by which a specified market
interest rate exceeds the fixed cap rate, applied to a notional principal
amount. As of June 30, 1994 LNC had notional amounts of $4.2 billion with
strike prices ranging from 93 to 343 basis points above prevailing interest
rates. These agreements expire in 1997-2003.
Secondly, LNC uses spread-lock agreements to hedge the value of corporate
bonds against the risk of widening in their yield spreads over the yields of
comparable maturity U.S. Government obligations. Under these agreements, LNC
assumes the right and the obligation to enter into an interest rate swap at a
future date in which LNC would pay a fixed rate equal to a contractually
specified spread over the then prevailing U.S. Treasury rate and receive a
floating rate. As of June 30, 1994, LNC had spread-lock agreements with an
aggregate notional amount of $1.6 billion with 3 to 13 months remaining in the
exercise periods. As of June 30, 1994, these contracts had unrealized gains
of $107,000 and unrealized losses of $2.2 million.
Both of these programs are designed to help ensure LNC's ability to be
able to continue to provide competitive crediting rates to policyholders
during periods when interest rates are rising or corporate bond spreads are
widening. Failure to protect against these two possibilities could result in
policyholders withdrawing their funds for placement in more competitive
products. LNC purchases both types of derivative products from only highly
credit-worthy financial institutions to minimize the possibility of non-
performance.
As indicated earlier LNC's primary derivative programs are designed to
protect the company against interest rate fluctuations. LNC expects to
continue to hedge against interest rate movements, as appropriate.
<PAGE>
-15-
PART II - OTHER INFORMATION AND EXHIBITS
Items 1, 3, 4 (b) and (d) and 5 of this Part II are either
inapplicable or are answered in the negative and are omitted
pursuant to the instructions to Part II.
Item 4. Submission of Matters to a Vote to Securityholders
(a) The matter discussed in (c) below was submitted to a vote at
the Annual Meeting of Shareholders of the Registrant on May 12,
1994.
(c) At the meeting referred to in (a) above, Shareholders of the
Registrant were asked to approve an amendment to the
Registrant's Articles of Incorporation that would increase the
Registrant's authorized Common Stock from 400,000,000 shares to
800,000,000 shares. The results of the vote on this matter was
75,828,877 affirmative votes and 9,108,237 negative votes.
Item 6. Exhibits and Reports on Form 8-K
(a) The following Exhibit of the Registrant is included in this
report. (Note: The number preceding the exhibit corresponds
to the specific number within Item 601 of Regulation S-K.)
11 Computation of Per Share Earnings
(b) No reports on Form 8-K were filed during the quarter ended June
30, 1994.
<PAGE>
-16-
SIGNATURE PAGE
Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly
authorized.
LINCOLN NATIONAL CORPORATION
By /S/ Richard C. Vaughan
Richard C. Vaughan,
Senior Vice President and
Chief Financial Officer
/S/ Donald L. Van Wyngarden
Donald L. Van Wyngarden,
Second Vice President and Controller
Date July 29, 1994
<PAGE>
-17-
LINCOLN NATIONAL CORPORATION
Exhibit Index for the Report on Form 10-Q
for the Quarter Ended June 30, 1994
Exhibit Number Description Page Number
11 Computation of Per Share Earnings 17
<TABLE>
<CAPTION>
LINCOLN NATIONAL CORPORATION AND SUBSIDIARIES
EXHIBIT (11) - COMPUTATION OF PER SHARE EARNINGS
Six Months Three Months
Ended June 30 Ended June 30
PRIMARY 1994 1993 1994 1993
<S> <C> <C> <C>
Average shares outstanding
(assuming conversion of
Series A, E and F
Preferred Stock) ------------- 103,749,231 101,312,000 103,954,236 103,127,193
Net effect of dilutive
stock options (based on
the treasury stock method
using average market price) -- 696,669 789,304 663,047 739,596
Total shares
outstanding ----------- 104,445,900 102,101,304 104,617,283 103,866,789
FULLY DILUTED
Average shares outstanding
(assuming conversion of
Series A, E and F
Preferred Stock) ------------- 103,749,231 101,312,000 103,954,236 103,127,193
Net effect of dilutive
stock options (based on
the treasury stock method
using the end of period
market price, if higher than
average market price) -------- 761,544 807,840 747,263 739,596
Total shares
outstanding ----------- 104,510,775 102,119,840 104,701,499 103,866,789
DOLLAR INFORMATION (000's omitted
Income before the
cumulative effect of
accounting change ------------ $197,787 $196,226 $ 46,802 $127,216
Cumulative effect of
accounting change ------------ -- (96,431) -- --
Net Income -------------- $197,787 $ 99,795 $ 46,802 $127,216
PER SHARE INFORMATION
Primary:
Income before the
cumulative effect of
accounting change ---------- $1.89 $1.92 $ .45 $1.22
Cumulative effect of
accounting change ---------- -- (94) -- --
Net Income ---------- $1.89 $ .98 $ .45 $1.22
Fully Diluted:
Income before the
cumulative effect of
accounting change ---------- $1.89 $1.92 $ .45 $1.22
Cumulative effect of
accounting change ---------- -- (.94) -- --
Net Income ------------ $1.89 $ .98 $ .45 $1.22
<FN>
Notes: 1. Earnings per share are computed based on the average number of
common shares outstanding during each period after assuming
conversion of the Series A, E and F Preferred Stock.
2. LNC does not include the dilutive effect of stock options in the
computation of the earnings per share information appearing on
the consolidated statements of income since it was immaterial.
</FN>
</TABLE>
