UNITED STATES 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 September 30, 1998 Commission file number 1-6028
LINCOLN NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
Indiana 35-1140070
(State of incorporation) (I.R.S. Employer Identification No.)
200 East Berry Street, Fort Wayne, Indiana 46802-2706
(Address of principal executive offices)
Registrant's telephone number (219) 455-2000
As of October 30, 1998 LNC had 101,037,820 shares of Common Stock outstanding.
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 periods 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 23.
Page 1 of 25
<PAGE>
2
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30 December 31
(000's omitted) 1998 1997
--------------- ---- ----
<S> <C> <C>
ASSETS
Investments:
Securities available-for-sale, at fair value:
Fixed maturity (cost 1998 - $26,609,826;
1997 - $22,626,036)......................................... $28,553,977 $24,066,376
Equity (cost 1998 - $470,230;
1997 - $517,156)............................................ 504,899 660,428
Mortgage loans on real estate................................... 4,329,293 3,288,112
Real estate..................................................... 459,551 575,956
Policy loans.................................................... 1,517,090 763,148
Other investments............................................... 399,079 464,826
---------- -----------
Total Investments............................................. 35,763,889 29,818,846
Investment in unconsolidated affiliates........................... 17,363 20,975
Cash and invested cash............................................ 2,725,355 3,794,706
Property and equipment............................................ 200,879 189,811
Deferred acquisition costs........................................ 1,847,952 1,623,845
Premiums and fees receivable...................................... 241,606 197,509
Accrued investment income......................................... 547,249 423,008
Assets held in separate accounts.................................. 37,559,012 37,138,845
Amounts recoverable from reinsurers............................... 2,454,518 2,350,766
Goodwill.......................................................... 1,153,069 457,729
Other intangible assets........................................... 1,241,755 613,909
Other assets...................................................... 853,547 544,759
----------- ------------
Total Assets.................................................. $84,606,194 $77,174,708
</TABLE>
See notes to consolidated financial statements on pages 7 - 13.
<PAGE>
3
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
-CONTINUED-
<TABLE>
<CAPTION>
September 30 December 31
(000's omitted) 1998 1997
--------------- ---- ----
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Insurance and Investment Contract Liabilities:
Insurance policy and claim reserves.................................. $16,263,693 $11,266,272
Contractholder funds................................................. 20,532,312 20,063,393
Liabilities related to separate accounts ........................... 37,559,012 37,138,845
---------- ----------
Total Insurance and Investment Contract Liabilities............... 74,355,017 68,468,510
Federal income taxes................................................... 2,986 487,805
Short-term debt........................................................ 354,438 297,208
Long-term debt......................................................... 711,950 511,037
Minority interest - preferred securities
of subsidiary companies.............................................. 745,000 315,000
Other liabilities...................................................... 2,909,195 2,112,233
----------- ----------
Total Liabilities................................................. 79,078,586 72,191,793
Shareholders' Equity:
Series A preferred stock-10,000,000 shares authorized
(9/30/98 liquidation value - $2,645).................................. 1,086 1,153
Common stock - 800,000,000 shares authorized........................... 972,960 966,461
Retained earnings...................................................... 3,720,003 3,533,105
Accumulated Other Comprehensive Income:
Foreign currency translation adjustment.............................. 59,827 46,204
Net unrealized gain on securities available-for-sale................. 773,732 435,992
--------- ----------
Total Accumulated Other Comprehensive Income...................... 833,559 482,196
--------- ----------
Total Shareholders' Equity........................................ 5,527,608 4,982,915
---------- ----------
Total Liabilities and Shareholders' Equity ...................... $84,606,194 $77,174,708
</TABLE>
See notes to consolidated financial statements on pages 7 - 13.
<PAGE>
4
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30 September 30
(000's omitted, except per share amounts) 1998 1997 1998 1997
----------------------------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Insurance premiums ......................................... $1,108,096 $ 983,546 $ 386,532 $ 353,132
Insurance fees.............................................. 919,450 611,736 291,148 220,345
Investment advisory fees ................................... 169,510 152,334 52,470 51,871
Net investment income....................................... 1,966,687 1,665,655 649,608 548,470
Equity in earnings of unconsolidated affiliates............. 800 1,593 (738) 319
Realized gain (loss) on investments......................... 22,711 71,602 (26,753) 56,966
Other revenue and fees ..................................... 185,850 106,701 65,324 35,922
-------- ---------- --------- ---------
Total Revenue............................................ 4,373,104 3,593,167 1,417,591 1,267,025
Benefits and Expenses:
Benefits.................................................... 2,349,283 2,149,555 766,143 730,357
Underwriting, acquisition,
insurance and other expenses ............................ 1,414,098 1,175,760 471,824 338,799
Interest and debt expense ................................. 83,578 70,017 32,538 24,483
---------- --------- ---------- ---------
Total Benefits and Expenses ............................ 3,846,959 3,395,332 1,270,505 1,093,639
--------- ---------- --------- ---------
Net Income From Continuing Operations
Before Federal Income Taxes .......................... 526,145 197,835 147,086 173,386
Federal income taxes ....................................... 141,974 37,886 33,637 48,499
--------- --------- --------- ---------
Net Income From Continuing Operations .................. 384,171 159,949 113,449 124,887
Discontinued Operations (Net of income taxes):
Net income prior to disposal................................ -- 134,886 -- 46,367
Gain on sale ............................................... -- -- -- --
--------- ---------- ---------- ----------
Net Income ............................................. $ 384,171 $ 294,835 $ 113,449 $ 171,254
Earnings Per Common Share-Basic:
Restated Restated
Net Income From Continuing Operations ...................... $3.83 $1.55 $1.13 $1.22
Discontinued Operations..................................... -- 1.31 -- .46
------ ----- ----- ----
Net Income............................................... $3.83 $2.86 $1.13 $1.68
Earnings Per Common Share-Diluted:
Net Income From Continuing Operations ...................... $3.77 $1.53 $1.11 $1.20
Discontinued Operations..................................... -- 1.29 -- .45
------ ----- ------ -----
Net Income............................................... $3.77 $2.82 $1.11 $1.65
</TABLE>
See notes to consolidated financial statements on pages 7 - 13.
<PAGE>
5
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Nine Months Ended September 30
Number of Shares Amounts
(000's omitted from dollar amounts) 1998 1997 1998 1997
----------------------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Series A Preferred Stock:
Balance at beginning-of-year ................. 35,091 36,885 $ 1,153 $ 1,212
Conversion into common stock ................. (2,025) (1,659) (67) (55)
------- ------ ----- -----
Balance at September 30.................. 33,066 35,226 1,086 1,157
Common Stock:
Balance at beginning-of-year ................. 100,859,478 103,658,575 966,461 904,331
Conversion of series A preferred stock........ 16,200 13,272 67 55
Issued for benefit plans ................... 779,130 527,466 27,238 19,572
Issued for purchase of subsidiary............. -- 1,320,902 -- 68,688
Retirement of common stock ................... (623,281) (3,318,000) (5,972) (27,499)
Certain issuance costs related to
FELINE PRIDES................................ -- -- (14,834) --
------------ ----------- ----------- ---------
Balance at September 30 ................ 101,031,527 102,202,215 972,960 965,147
Retained Earnings:
Balance at beginning-of-year.................. 3,533,105 3,082,368
Comprehensive income.......................... 735,534 444,246
Less other comprehensive income (loss):
Foreign currency translation.................. 13,623 (32,412)
Net unrealized gain on securities
available-for-sale........................... 337,740 181,823
------- -------
Net Income............................... 384,171 294,835
Retirement of common stock.................... (40,899) (182,625)
Dividends declared:
Series A preferred ($2.25 per share).......... (77) (80)
Common stock (1998-$1.56 1997-$1.47).......... (156,297) (151,200)
--------- ---------
Balance at September 30.................. 3,720,003 3,043,298
Foreign Currency Translation Adjustment:
Accumulated adjustment at
beginning-of-year........................... 46,204 66,454
Change during the period...................... 13,623 (32,412)
------ ------
Balance at September 30.................. 59,827 34,042
Net Unrealized Gain on
Securities Available-for-Sale:
Balance at beginning-of-year.................. 435,992 415,591
Change during the period...................... 337,740 181,823
-------- --------
Balance at September 30.................. 773,732 597,414
Total Shareholders' Equity
at September 30........................ $5,527,608 $4,641,058
Common Stock at End of Quarter:
Assuming conversion of preferred stock........ 101,296,055 102,484,023
Diluted basis................................. 101,957,711 103,620,358
</TABLE>
See notes to consolidated financial statements on pages 7 - 13.
<PAGE>
6
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine months Ended
September 30
(000's omitted) 1998 1997
--------------- ---- ----
<S> <C> <C>
Cash Flows from Operating Activities:
Net income.............................................................. $ 384,171 $ 294,835
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Deferred acquisition costs.......................................... (152,233) 350
Premiums and fees receivable........................................ (44,096) (3,555)
Accrued investment income........................................... (124,241) (34,443)
Policy liabilities and accruals..................................... 171,341 124,855
Contractholder funds................................................ 592,868 524,545
Amounts recoverable from reinsurers................................. (103,753) 33,283
Federal income taxes................................................ 134,467 (138,295)
Equity in earnings of unconsolidated affiliates..................... (800) (1,593)
Provisions for depreciation ...................................... 40,676 43,626
Amortization of goodwill and other intangible assets................ 89,426 66,362
Realized gain on investments........................................ (22,711) (71,602)
Other............................................................... (110,981) (37,092)
------- -------
Net Adjustments................................................... 469,963 649,645
------- -------
Net Cash Provided by Operating Activities......................... 854,134 944,480
Cash Flows from Investing Activities:
Securities-available-for-sale:
Purchases............................................................. (8,927,928) (8,045,600)
Sales................................................................. 7,091,988 7,279,137
Maturities............................................................ 1,494,166 1,084,569
Purchase of other investments........................................... (948,151) 1,595,145
Sale or maturity of other investments................................... 1,332,759 1,647,524
Purchase of affiliates/blocks of business............................... (1,426,000) --
Increase in cash collateral on loaned securities........................ 256,954 126,818
Other .................................................................. (143,519) 60,377
--------- ---------
Net Cash Provided by (Used in) Investing Activities............... (1,269,731) 557,680
Cash Flows from Financing Activities:
Principal payments on long-term debt/transfer to short-term debt........ (99,883) (113,550)
Issuance of long-term debt.............................................. 300,796 943
Net increase in short-term debt......................................... 57,231 274,804
Issuance of preferred securities of subsidiary companies................ 430,000 --
Certain issuance costs related to FELINE PRIDES......................... (14,834) --
Universal life and investment contract deposits......................... 886,049 775,128
Universal life and investment contract withdrawals...................... (2,036,732) (1,994,749)
Common stock issued for benefit plans................................... 27,238 19,572
Retirement of common stock.............................................. (46,871) (210,124)
Dividends paid to shareholders.......................................... (156,748) (151,958)
---------- ----------
Net Cash Used in Financing Activities............................. (653,754) (1,399,394)
Net Increase (Decrease) in Cash................................... (1,069,351) 102,226
Cash at Beginning-of-Year................................................. 3,794,706 1,144,766
---------- ----------
Cash at September 30.............................................. $2,725,355 $1,246,992
</TABLE>
See notes to consolidated financial statements on pages 7 - 13.
<PAGE>
7
LINCOLN NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. 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.
During 1998, the collective group of companies adopted "Lincoln Financial Group"
as its marketing identity. Operations are divided into four business segments.
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. These financial statements should be read in
conjunction with the consolidated audited financial statements and the
accompanying notes included in LNC's latest annual report on Form 10-K for the
year ended December 31, 1997.
Operating results for the nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the full year
ending December 31, 1998.
2. Investments
In June 1998, the Financial Accounting Standards Board, issued an accounting
standard entitled "Accounting for Derivative Instruments and Hedging Activities"
("FAS 133"). This standard indicates that adoption may occur at the beginning of
any fiscal quarter but no later than the first quarter of 2000. While LNC has
not completed the analysis necessary to provide a precise estimate of the effect
of this statement or to specify the quarter in which it plans to adopt the
standard, it is not expected to have a material effect on LNC's financial
position or results of operations.
During the second quarter of 1998, LNC purchased two bonds issued by different
issuers with offsetting interest rate characteristics. Subsequent to these
transactions being recorded, regulators that monitor accounting activity have
discussed the possibility of having companies change the accounting initially
applied to such transactions to treat such investments as a unit. One
alternative proposed would require the realized loss on the sale of $20.0
million ($13.0 million after-tax) on one of these bonds recorded by LNC at the
end of the second quarter of 1998 to be reversed and the amount applied as a
change in the carrying amount of the bond that remains in LNC's portfolio. Also,
net investment income for the third quarter of 1998 would be less than reported
by $2.5 million ($1.6 million after-tax). The timing for a final decision on
this matter is not known at this time.
3. Federal Income Taxes
The effective tax rate on net income is lower than the prevailing corporate
federal income tax rate. The difference for both 1998 and 1997 resulted
principally from tax-preferred investment income.
4. Debt and Preferred Securities of Subsidiary Companies
Debt. In March 1998, LNC issued notes of $100 million, 6.5% due 2008 and $200
million, 7% due 2018. The proceeds from these offerings were used to pay off a
portion of LNC's short-term debt and to invest for general corporate purposes,
which could include additional acquisitions of business or companies.
Shelf Registration. 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 and 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.
<PAGE>
8
TOPrS. In July 1998, LNC's wholly-owned subsidiary (Lincoln National Capital
III) issued 8,000,000 shares or $200 million of 7.40% Series C Trust Originated
Preferred Securities ("Series C TOPrS") which mature on September 30, 2028.
FELINE PRIDES. In August 1998, LNC through its wholly-owned subsidiary (Lincoln
National Capital IV) issued $230 million of FELINE PRIDES (service mark of
Merrill Lynch & Co. Inc.). This issue includes 9,200,000 FELINE PRIDES
(8,200,000 Income Prides and 1,000,000 Growth Prides) and 1,000,000 separately
offered and separately traded preferred securities of Lincoln National Capital
IV which mature on August 15, 2003. Holders of both Income Prides and Growth
Prides will receive stock purchase contracts that require them to purchase LNC
common stock by August 16, 2001 at a price ranging between the minimum reference
price of $92.875 per share (approximately 2.5 million shares) and the threshold
appreciation maximum price of $111.45 per share (approximately 2.1 million
shares). The holders of Income Prides also receive an equivalent number of
preferred securities of Lincoln National Capital IV which are pledged as
collateral to secure their obligations in respect to the common stock purchase
contracts and are entitled to a distribution rate on the Income Prides of 7.75%
per annum. The preferred securities holders are entitled to a distribution rate
of 6.40% per annum of their $25 stated liquidation value. The holders of Growth
Prides receive a 1/40th beneficial interest in a zero-coupon U.S. Treasury
security maturing August 15, 2001 which is pledged as collateral to secure their
obligations in respect to the common stock purchase contracts and are entitled
to a distribution rate on the Growth Prides of 1.85% per annum.
Lincoln National Capital IV utilized the proceeds from the issuance of the
FELINE PRIDES and preferred securities to purchase an equivalent principal
amount of LNC's 6.40% subordinated debentures. The distribution rate on the
preferred securities will be reset, subject to certain limitations, effective
August 13, 2001. A portion of the issuance costs associated with this offering
($6.1 million) along with the present value of the payments associated with the
stock purchase contracts ($8.8 million) were charged to the common stock line
within shareholders' equity.
5. Change in Estimate for Disability Income Reserve
During the second quarter of 1997, LNC completed an in-depth review of
experience on its disability income business. As a result of this study, 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 by $130 million or
$1.25 per diluted share ($200 million pre-tax).
6. Restrictions, Commitments and Contingencies
Statutory Restriction. LNC's insurance subsidiaries are subject to certain
insurance department regulatory restrictions as to the transfer of funds and
payments of dividends to LNC. Based upon these regulations, and without giving
effect to the 1998 acquisitions (see note 11 on page 12), LNC's insurance
subsidiaries would have been able to pay dividends to LNC in 1998 of
approximately $396.2 million without obtaining specific approval from the
insurance commissioners. LNC's primary insurance subsidiary, Lincoln National
Life Insurance Company ("Lincoln Life") acquired a block of individual life
insurance and annuity business from CIGNA in January 1998 and the domestic
individual life insurance business from Aetna on October 1, 1998. These
acquisitions were structured as indemnity reinsurance transactions. The
statutory accounting regulations do not allow goodwill to be recognized on
indemnity reinsurance transactions and therefore, the related statutory ceding
commission flows through the statement of operations as an expense resulting in
a reduction of earned surplus. As a result of these acquisitions, Lincoln Life's
earned surplus will be negative and it will be necessary for Lincoln Life to
obtain the prior approval of the Indiana Insurance Commissioner before paying
any dividends to LNC until such time as earned surplus is positive. It is
expected that earned surplus will return to a positive position within two years
from the closing of the Aetna transaction described above assuming a level of
statutory earnings coinciding with recent earnings patterns. If statutory
earnings are less than recent patterns due, for example, to adverse operating
conditions or further indemnity reinsurance transactions of this nature, the
earned surplus may not return to a positive position as soon as expected.
Although no assurance can be given, management believes that the approvals for
the payment of dividends in amounts consistent with those paid in the past can
be obtained. In the event such approvals are not obtained, management believes
that LNC can obtain the funds required to satisfy its obligations from its
existing credit facilities and other sources.
<PAGE>
9
Disability Income Claims. The liability for disability income claims net of the
related asset for amounts recoverable from reinsurers at September 30, 1998 and
December 31, 1997 is a net liability of $1.803 billion and $1.654 billion,
respectively, excluding deferred acquisition costs. Both net liability amounts
include the impact of the special addition in the second quarter of 1997 (see
note 5 above). 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. LNC reviews reserve levels on an on-going basis.
United Kingdom Pension Products. Operations in the U.K. include the sale of
pension products to individuals. Regulatory agencies have raised questions as to
what constitutes appropriate advice to individuals who bought pension products
as an alternative to participation in an employer sponsored plan. In cases of
inappropriate advice, an extensive investigation may have to be done and the
individuals put in a position similar to what would have been attained if they
had remained in the employer sponsored plan. At September 30, 1998 and December
31, 1997 liabilities of $217.7 million and $291.0 million, respectively, had
been established for this issue. The decrease in the level of the reserve
reflects the settlement payouts that have occurred during the nine months ended
September 30, 1998. These liabilities, which are net of expected recoveries,
have been established for the estimated cost of this issue following regulatory
guidance as to activities to be undertaken. The expected recoveries from
previous owners of companies acquired over the last few years as specified in
the indemnification clauses of the purchase agreements were $114.1 million and
$113.0 million at September 30, 1998 and December 31, 1997, respectively. These
liabilities and recoveries are based on various estimates that are subject to
considerable uncertainty. Accordingly, these liabilities 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.
Personal Accident Programs. LNC's Reinsurance segment accepts personal accident
reinsurance programs from other insurance companies. Certain excess of loss
personal accident reinsurance programs created in the London market during
1993-1996 are producing much higher claims than expected at the time the
programs were written. The loss reserves for these programs net of related
assets recoverable from reinsurers at September 30, 1998 and December 31, 1997
were $179.9 million and $186.3 million, respectively. This liability is based on
various estimates that are subject to considerable uncertainty. Accordingly,
this liability may prove to be deficient or excessive. However, it is
management's opinion that future developments in these programs will not
materially affect the consolidated financial position of LNC.
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 future developments related to
marketing and compliance issues will not materially affect the consolidated
financial position of LNC.
Group Pension Annuities. The liabilities for guaranteed interest and group
pension annuity contracts are supported by a single portfolio of assets that
attempts to match the duration of these liabilities. Due to the long-term nature
of group pension annuities and the resulting inability to exactly match cash
flows, a risk exists that future cash flows from investments will not be
reinvested at rates as high as currently earned by the portfolio. Accordingly,
these liabilities may prove to be deficient or excessive. However, it is
management's opinion that the future development in this business will not
materially affect the consolidated financial position of LNC.
Euro Conversion. LNC owns operating companies in Europe and conducts business
with companies located within Europe. LNC has initiated an internal analysis of
its systems, financial activities and currency risk exposure that may be
impacted by the European Union's pending conversion to a new common currency
(the euro). While LNC has not completed the analysis necessary to provide a
precise estimate of the effect of this conversion, based on the size of the
operations and the analysis completed to date, it is management's opinion that
the January 1, 1999 euro conversion will not materially affect the consolidated
financial condition of LNC.
<PAGE>
10
Legal Proceedings. LNC and its subsidiaries are involved in various pending or
threatened legal proceedings arising from the conduct of business. Most of this
litigation is routine in the ordinary course of business. LNC maintains
professional liability insurance coverage for claims in excess of $5 million.
The degree of applicability of this coverage will depend on the specific facts
of each proceeding. In some instances, these proceedings include claims for
compensatory and punitive damages and similar types of relief in addition to
amounts for alleged contractual liability or requests for equitable relief.
After consultation with legal counsel and a review of available facts, it is
management's opinion that the ultimate liability, if any, under these suits will
not have a material adverse effect on the consolidated financial condition of
LNC.
Four lawsuits involving alleged fraud in the sale of interest sensitive
universal and whole life insurance policies have been filed as class actions
against Lincoln Life, although the court has not certified a class in any of
these cases. One of these suits was dismissed, three remain outstanding.
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.
7. Segment Disclosures
The following tables show financial data by segment:
<TABLE>
<CAPTION>
Nine Months Three Months
Ended September 30 Ended September 30
(in millions) 1998 1997 1998 1997
------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue:
Life Insurance and Annuities................................. $2,682.2 $2,064.6 $ 851.8 $ 704.4
Lincoln UK................................................... 330.5 314.8 102.8 112.6
Reinsurance.................................................. 1,120.8 1,024.4 391.2 375.1
Investment Management........................................ 221.2 199.2 68.2 81.7
Other Operations (includes consolidating adjustments)........ 18.4 (9.8) 3.6 (6.7)
------- -------- -------- ---------
Total...................................................... $4,373.1 $3,593.2 $1,417.6 $ 1,267.1
Net Income (Loss) from Continuing
Operations before Federal Income Taxes:
Life Insurance and Annuities................................. $ 367.3 $ 279.6 $ 106.3 $ 113.1
Lincoln UK................................................... 80.6 75.1 21.9 26.7
Reinsurance.................................................. 121.1 (84.7) 41.9 48.5
Investment Management........................................ 22.4 15.8 3.1 10.8
Other Operations (includes interest expense)................. (65.3) (88.0) (26.1) (25.8)
----- ----- ----- -----
Total...................................................... $ 526.1 $ 197.8 $ 147.1 $ 173.3
Federal Income Taxes (Credits):
Life Insurance and Annuities.................................. $ 88.4 $ 69.4 $ 23.6 $ 26.1
Lincoln UK.................................................... 28.1 24.4 4.0 10.3
Reinsurance................................................... 42.2 (29.6) 14.4 17.4
Investment Management......................................... 11.4 9.9 2.3 5.5
Other Operations.............................................. (28.2) (36.2) (10.7) (10.8)
----- ----- ---- -----
Total....................................................... $ 141.9 $ 37.9 $ 33.6 $ (48.5)
Net Income (Loss) from Continuing Operations:
Life Insurance and Annuities.................................. $ 278.9 $ 210.2 $ 82.7 $ 87.0
Lincoln UK.................................................... 52.5 50.7 17.8 16.4
Reinsurance................................................... 78.9 (55.1) 27.6 31.1
Investment Management......................................... 11.0 5.9 0.7 5.3
Other Operations (includes interest expense).................. (37.1) (51.8) (15.4) (15.0)
----- ----- ---- -----
Total Net Income (Loss) from Continuing Operations.......... 384.2 159.9 113.4 124.8
Discontinued Operations....................................... -- 134.9 -- 46.4
-------- ----- ------- -----
Total Net Income (Loss)..................................... $ 384.2 $ 294.8 $ 113.4 $ 171.2
</TABLE>
<PAGE>
11
<TABLE>
<CAPTION>
September 30 December 31
(in millions) 1998 1997
------------- ---- ----
<S> <C> <C>
Assets:
Life Insurance and Annuities........................................... $69,210.0 $60,604.4
Lincoln UK............................................................. 8,152.7 7,923.8
Reinsurance............................................................ 6,183.2 5,540.2
Investment Management.................................................. 686.4 697.4
Other Operations....................................................... 373.9 2,408.9
--------- ---------
Total................................................................ $84,606.2 $77,174.7
</TABLE>
Reinsurance's net income for the nine months ended September 30, 1997 includes a
$130.0 million after-tax ($200.0 million pre-tax) reserve strengthening for its
disability income business. Life Insurance and Annuities' revenue, net income
and assets increased in the 1998 periods compared to 1997 due to the addition of
a block of individual life insurance and annuity business (see note 11 on page
12).
8. Earnings Per Share
Financial Accounting Standard No. 128 entitled "Earnings per Share" was adopted
in the fourth quarter of 1997. All prior period earnings per share amounts have
been restated to conform to the provisions of this standard. Per share amounts
for net income from continuing operations are shown in the income statement
using 1) an earnings per common share basic calculation and 2) an earnings per
common share-assuming dilution calculation. Reconciliations of the factors used
in the two calculations are as follows:
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30 September 30
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Numerator: [in millions]
Net income from continuing operations,
as used in basic calculation........................ $384.1 $159.9 $113.4 $124.9
Dividends on convertible preferred stock............. .1 .1 * *
------- --------- -------- ------
Net income from continuing
operations, as used in diluted calculation...... $384.2 $160.0 $113.4 $124.9
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30 September 30
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Denominator: [number of shares]
Weighted average shares,
as used in basic calculation...................... 100,315,753 102,987,208 100,425,442 102,092,881
Shares to cover conversion of preferred stock...... 273,339 288,918 268,540 284,020
Shares to cover restricted stock................... 203,896 204,133 261,490 201,953
Average stock options outstanding
during the period................................. 3,217,029 2,876,189 4,819,485 3,511,954
Assumed acquisition of shares with assumed
proceeds and tax benefits from exercising
stock options (at average market price
during the period) ............................... (2,233,033) (1,905,434) (3,842,930) (2,251,199)
--------- --------- --------- ---------
Weighted-average shares, as
used in diluted calculation................ 101,776,984 104,451,014 101,932,027 103,839,609
* Less than $100,000.
</TABLE>
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. 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 $111.45 per share.
<PAGE>
12
9. Comprehensive Income
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
(in millions) September 30 September 30
-------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income........................................... $384.2 $294.8 $113.4 $171.2
Foreign currency translation......................... 13.6 (32.4) 8.0 (12.9)
Net unrealized gain on securities.................... 337.7 181.8 304.2 169.7
----- ----- ----- -----
Comprehensive Income............................ $735.5 $444.2 $425.6 $328.0
</TABLE>
10. Discontinued Operations
On June 9, 1997, LNC announced that it agreed to sell its 83.3% ownership in
American States Financial Corporation for $2.65 billion. As this sale resulted
in an exit from the property-casualty business (previously a business segment),
the financial data for periods prior to the closing date related to the units
being sold is shown as discontinued operations in the accompanying consolidated
financial statements. June 9, 1997 is the measurement date for purposes of
reporting the units sold as discontinued operations. The gain on sale of $1.225
billion ($776.9 million after-tax) resulting from the October 1, 1997 closing
was reported with discontinued operations in the fourth quarter of 1997. LNC
used most of the proceeds from this sale to expand its other businesses (see
note 11 below) and repurchased $341.8 million of its own common stock as
authorized by the Board of Directors in June of 1997.
11. Acquisition of Individual Life Insurance and Annuity Business
On January 2, 1998, LNC acquired a block of individual life insurance and
annuity business for $1.414 billion. Additional funds of $228.5 million were
required to cover expenses associated with the purchase and to provide
additional capital for the Life Insurance and Annuities segment to support this
business. This transaction was accounted for using purchase accounting and,
accordingly, 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 approximately $5.5 billion that became LNC's obligations. LNC also
received assets, measured on a historical statutory basis, equal to the
liabilities. Subsequent to this acquisition, LNC announced that it had reached
agreement to sell a variable annuity portfolio administered by AIM Advisors,
Inc. (through a reinsurance arrangement) that had been acquired as a part of the
block of business acquired January 2, 1998. The application of purchase
accounting to this block of business, net of the AIM business being retroceded,
indicates that goodwill and other intangible assets will be approximately $725
million and $585 million, respectively. The additional analysis of this block of
business during the remainder of 1998 may result in a change in the amounts or
the shifting of amounts between goodwill and other intangible assets.
During the first quarter of 1998, in connection with this acquisition, LNC
recorded a charge to its Life Insurance and Annuities segment of $20.0 million
($30.8 million pre-tax). This charge was for certain costs of integrating the
new block of business with existing operations.
On October 1, 1998, LNC acquired the domestic individual life insurance business
from Aetna, Inc. for $1.0 billion. This transaction will be accounted for using
purchase accounting and, accordingly, the operating results generated by this
block of business after the closing will be included in LNC's consolidated
financial statements from the closing date. As of September 30, 1998, this block
of business had estimated liabilities, measured on a statutory basis, of $3.3
billion. These liabilities became LNC's obligation at the time of closing. At
closing LNC received assets, measured on a historic 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 block of
business from Aetna. The sale price on this business was $99.5 million. This
transaction closed on October 14, 1998 with an effective date of October 1,
1998. During 1997, after deducting the sponsored life income statement amounts,
the block of business being purchased 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).
The statutory liabilities associated with the business being sold are
approximately $346 million. The preliminary application of purchase accounting
to the block of business being acquired, less the block of business being sold,
indicates that goodwill and other intangible assets will be approximately $210
million and $795 million, respectively.
<PAGE>
13
The additional analysis of this block of business during the remainder of 1998
and into 1999 could result in a change in the amounts or the shifting of amounts
between goodwill and other intangible assets. Approximately one-half of the
funding for this acquisition came from available funds within the consolidated
group. The other half was from the proceeds of third quarter public securities
offerings from available shelf registrations (see note 4 on page 7).
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION
The pages to follow review LNC's results of consolidated operations and
financial condition. Historical financial information is presented and analyzed.
Where appropriate, factors that may affect future financial performance are
identified and discussed. Actual results could differ materially from those
indicated in forward-looking statements due to, among other specific changes
currently not known, subsequent significant changes in: the company (e.g.,
acquisitions and divestitures), financial markets (e.g., interest rates and
securities markets), legislation (e.g., taxes and product taxation), regulations
(e.g., insurance and securities regulations), acts of God (e.g., hurricanes,
earthquakes and storms), other insurance risks (e.g., policyholder mortality and
morbidity) and competition.
REVIEW OF CONSOLIDATED OPERATIONS
The discussion that follows focuses on net income from continuing operations for
the nine months ended September 30, 1998 compared to the results for the nine
months ended September 30, 1997. The factors affecting the current quarter to
prior year quarter comparisons are essentially the same as the year-to-date
factors except as noted. As a result of the purchase of a block of individual
life insurance and annuity business (see note 11 on page 12) select income
statement accounts increased in 1998 versus 1997. Increases over comparable 1997
periods are expected to continue for the remainder of 1998.
Life Insurance and Annuity Premiums
Life insurance and annuity premiums for the first nine months of 1998 increased
$94.7 million or 17% compared with the first nine months of 1997. This increase
is the result of increases in business volume from the Life Insurance &
Annuities and Reinsurance segments. A portion of the increase from the Life
Insurance and Annuities segment is the result of the acquisition of the block of
business described above.
Health Premiums
Health premiums increased $29.9 million or 7% for the first nine months of 1998
compared with the first nine months of 1997 as a result of increased volumes of
business in the Reinsurance segment.
Insurance Fees
Insurance fees in the Life Insurance & Annuities and Lincoln UK segments from
universal life, other interest-sensitive life insurance contracts and variable
life insurance contracts increased $307.7 million or 50% compared with the first
nine months of 1997. This increase was the result of increases in the volume of
business (including the block of business purchased) and a market-driven
increase in the value of existing customer accounts upon which some of the fees
are based.
Investment Advisory Fees
Investment advisory fees increased by $17.2 million or 11% for the first nine
months of 1998 as a result of increased volumes of business and the increase in
the market value of assets managed.
Net Investment Income
Net investment income increased $301.0 million or 18% when compared with the
first nine months of 1997. This increase is the net result of a 22% increase in
mean invested assets and a decrease in the overall yield on investments from
7.48% to 7.29% (all calculations on a cost basis). The increase in mean invested
assets is the result of increased volumes of business in all the business
segments and funds held in Corporate and Other that were applied to the purchase
of an additional block of business on October 1, 1998 (see note 11 on page 12).
The increase in the Life Insurance and Annuities segment includes the
acquisition of the block of business on January 2, 1998 as described above.
<PAGE>
14
Realized Gain on Investments
The first nine months of 1998 and 1997 had realized gains on investments of
$22.7 million and $71.6 million, respectively. These gains, which are net of
related deferred acquisition costs and expenses, were the result of net gains on
sales of investments, less write-downs and provisions for losses. Securities
available-for-sale that were deemed to have declines in fair value that are
other than temporary were written down. Also, when the underlying value of the
property is deemed to be less than the carrying value, LNC records write-downs
and allowances on select mortgage loans on real estate, real estate and other
investments.
The pre-tax write-downs of securities available-for-sale for the first nine
months of 1998 and 1997 were $65.1 million and $22.0 million, respectively. The
fixed maturity securities to which write-downs apply were generally of
investment grade quality at the time of purchase, but were classified as "below
investment grade" at the time of the write-downs. During the first nine months
of 1998, LNC released $.7 million in reserves on real estate and mortgage loans
on real estate net of $1.0 million of additions compared to reserves released of
$7.0 million net of $2.4 million of additions for the first nine months of 1997.
During the nine months ended September 30, 1998 other investments were written
down by $7.0 million. Net write-downs and reserves for all investments for the
nine months ended September 30, 1998 and 1997 were $71.4 million and $15.0
million, respectively.
Net investment income of $2.5 million ($1.6 million after-tax) recorded in the
third quarter of 1998 and realized loss on investments of $20.0 million ($13.0
million after-tax) recorded in the second quarter of 1998 may be reversed in a
future period if regulators initiate rule changes currently being discussed (see
note 2 on page 7).
Other Revenue and Fees
Other revenue and fees increased $79.1 million when compared to the first nine
months of 1997 as the result of increased volumes of fee income from each of the
business segments.
Life Insurance and Annuity Benefits
Life insurance and annuity benefits increased $306.7 million or 19% when
compared with the first nine months of 1997. This increase is the result of
increases in business volume from the Life Insurance & Annuities, Lincoln UK and
Reinsurance segments. A portion of the increase from the Life Insurance and
Annuities segment is the result of the acquisition of the block of business
described above.
Health Benefits
Health benefits decreased $107.0 million for the first nine months of 1998 when
compared with the first nine months of 1997 as a net result of increased volumes
of business and the absence of a special addition to the reserve (see note 5 on
page 7) in the Reinsurance segment.
Underwriting, Acquisition, Insurance and Other Expenses
These expenses increased $238.3 million or 20% for the first nine months of 1998
compared with the first nine months of 1997. The primary cause of this increase
was the additional expenses associated with the acquisition of the block of
business (see note 11 on page 12).
Because of the on-going and increasing competitive pressures within the
businesses LNC operates in, the decision was made to initiate an organizational/
expense review. This review, which is expected to be completed in the fourth
quarter of 1998, will result in a one-time charge to earnings. The amount
of the charge and the on-going impact of reductions in staff counts and
expense levels in 1999 and beyond has not yet been determined as the analysis to
determine the specific actions to be taken has not been finalized.
Interest and Debt Expense
Interest and debt expense increased $13.6 million or 19% as compared with the
first nine months of 1997. This was the result of higher average debt
outstanding and changes in composition of debt outstanding.
Federal Income Taxes
Federal income taxes increased $104.1 million in the first nine months of 1998
as compared with the first nine months of 1997. The increase in federal income
taxes is a result of an increase in pre-tax earnings. The increase in pre-tax
earnings relates to the absence of a special addition to the health reserve in
1998.
<PAGE>
15
Summary
Net income for the first nine months of 1998 was $384.2 million or $3.77 per
diluted share compared with $294.8 million or $2.82 per diluted share in the
first nine months of 1997. Excluding realized gains and losses on investments
and restructuring charges, LNC earned $391.0 million for the first nine months
of 1998 compared with $226.0 million for the first nine months of 1997. This
increase was the result of increased earnings from each of the business segments
and the absence of a special addition to the disability income reserve (see note
5 on page 7).
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. LNC and its operating subsidiaries have been redirecting a large
portion of internal Information Technology ("IT") efforts and contracting with
outside consultants to update systems to address Year 2000 issues. Experts have
been engaged to assist in developing work plans and cost estimates and to
complete remediation activities. External consultants with expertise in
reviewing companies' project management and oversight activities for Year 2000
remediation plans were engaged to conduct a review of LNC's overall Year 2000
readiness plans.
As indicated in LNC's Form 10-K for the year ended December 31, 1997, during
1996 and 1997, LNC identified expenditures of approximately $11 million ($7
million after-tax) that it had spent to address this issue. LNC's financial
plans for 1998-2000 include expected expenditures of an additional $63.2 million
($41.1 million after-tax) on this issue. These expected expenditures do not
include amounts for a block of business acquired on October 1, 1998 (see note 11
on page 12). The preliminary estimate of expenditures to make the systems and
procedures for this block compliant is $9.6 million ($6.3 million after-tax).
From January through September 30, 1998, LNC has incurred and expensed $20
million ($13 million after-tax). The amounts quantified represent expenditures
and expected expenditures as defined within applicable regulations. Because
updating systems and procedures is an integral part of LNC's on-going
operations, approximately 50% of such expenditures are expected to continue
after all Year 2000 issues have been resolved. Actual Year 2000 expenditures
through September 30, 1998 and expected Year 2000 expenditures in the future are
expected to be funded from operating cash flow. The cost of addressing Year 2000
issues and the timeliness of completion will be closely monitored by management
and are based on management's current best estimates which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain resources, third party modification plans and other
factors. Nevertheless, there can be no guarantee that these estimated costs will
be achieved and actual results could differ significantly from those
anticipated. Specific factors that might cause such differences include, but are
not limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer problems and other
uncertainties.
The current scope of the Year 2000 project includes: ensuring the readiness of
business applications, operating systems and hardware on mainframe, personal
computer and Local Area Network platforms; addressing issues related to non-IT
embedded software and equipment; addressing the readiness of key business
partners and updating business continuity plans for Year 2000 readiness issues.
The project has four major phases. Phase one involves raising awareness and
creating an inventory of all IT assets, non-IT assets, and external agent and
vendor relationships. The second phase consists of assessing all items
inventoried to initially determine whether they are affected by the Year 2000
issue and preparing high level plans and strategies. The third phase entails the
detailed planning and remediation of affected systems and equipment. The last
phase consists of testing to verify Year 2000 readiness.
LNC expects to complete the above phases for nearly all IT systems designated
high priority by December 31, 1998. However, phases three and four for a small
number of high priority systems will continue through the end of the second
quarter 1999. The current status of projects addressing readiness of IT assets
is: 100% of IT assets have been inventoried (Phase 1) and assessed (Phase 2);
90% of IT projects have been through the remediation phase (Phase 3) with the
last project scheduled for completion by the end of March 1999; and 47% of IT
projects have completed the testing phase (Phase 4) with the last project
scheduled to finish testing by the end of June 1999.
The current status of projects that address readiness of non-IT assets is: 100%
of non-IT assets have been inventoried (Phase 1) and assessed (Phase 2); 74% of
non-IT projects addressing remediation (Phase 3) have been completed and 6% of
non-IT projects have completed the testing phase (Phase 4). LNC expects to have
all phases related to non-IT completed by the end of October 1999.
<PAGE>
16
The most significant categories of key business partners are financial
institutions, software vendors, and utility providers (gas, electric and
telecommunications). The assessment phase of key business partners is in the
preliminary stages. Surveys have been mailed, follow-up contacts are underway
and strategies are being developed. This effort is expected to continue well
into 1999. Software vendor assessments are considered part of the IT projects
and, therefore, would follow the schedule shown above for such projects.
Although LNC expects remediation of its high priority systems to be
substantially completed by the end of 1998, there is no guarantee that these
results will be achieved. Specific factors that give rise to this uncertainty
include a possible loss of technical resources to perform the work, failure to
identify all susceptible systems, non-compliance by third parties whose systems
and operations impact LNC and other similar uncertainties.
A worst case scenario might include one or more of LNC's significant
policyholder systems being non-compliant. Such an event could result in a
material disruption to LNC's operations. Specifically, LNC could experience an
interruption in its ability to collect and process premiums or deposits, process
claim payments, accurately maintain policyholder information, accurately
maintain accounting records, and/or perform adequate customer service. Should
the worst case scenario occur, it could, depending on its duration, have a
material impact on LNC's results of operations and financial position. Simple
failures can be repaired and returned to production within a matter of hours
with no material impact. Unanticipated failures with a longer service disruption
period would have a more serious impact. For this reason, LNC is placing
significant emphasis on risk management and Year 2000 business continuity
planning. LNC is in the process of modifying its business continuity plans to
address potential year 2000 issues. These efforts will identify where acceptable
work around procedures exist. Where risks are high due to unacceptable work
arounds, resource shifting, consideration of alternative providers and other
risk management techniques will be employed to provide stronger assurances of
readiness. LNC has gone through exercises to identify worst case scenario
failures. At this time, LNC believes its plans are sufficient to avoid
identified worst case scenarios. If LNC continues to manage to plan, none of
these scenarios are "reasonably likely" to occur. LNC will continue to monitor
its reasonably likely worst case scenario on a quarterly basis.
REVIEW OF CONSOLIDATED FINANCIAL CONDITION
As the result of the purchase of a block of individual life insurance and
annuity business (see note 11 on page 12) select balance sheet accounts
increased from December 31, 1997 to September 30, 1998.
Investments
The total investment portfolio increased $5.9 billion in the first nine months
of 1998. This is the net result of increases from the addition of the $4.8
billion in invested assets related to the block of business acquired on January
2, 1998; purchases of investments from cash flow generated by the business
segments and the increase in the fair value of securities available-for-sale,
being partially offset by fixed annuity contractholders opting to transfer funds
to variable annuity contracts.
The quality of LNC's fixed maturity securities portfolio as of September 30,
1998 was as follows:
Treasuries and AAA 26.1% BBB 32.1%
AA 7.2% BB 3.5%
A 28.3% Less than BB 2.8%
As of September 30, 1998, $1.8 billion or 6.3% of fixed maturity securities was
invested in below investment grade securities (less than BBB). This represents
5.0% of the total investment portfolio. The interest rates available on these
below investment grade securities are significantly higher than are 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 nine
months ended September 30, 1998, the aggregate cost of such investments
purchased was $1.2 billion. Aggregate proceeds from such investments sold were
$995.9 million, resulting in a net realized pre-tax loss at the time of sale of
$35.0 million.
<PAGE>
17
LNC's entire fixed maturity and equity securities portfolio is classified as
"available-for-sale" and is 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 September 30, 1998, mortgage loans on real estate and real estate
represented 12.1% and 1.3% of LNC's total investment portfolio. As of September
30, 1998, the underlying properties supporting the mortgage loans on real estate
consisted of 22.9% in commercial office buildings, 36.6% in retail stores, 19.0%
in apartments, 11.3% in industrial buildings, 4.1% in hotels/motels and 6.1% in
other. In addition to the dispersion by property type, the mortgage loan
portfolio is geographically diversified throughout the United States.
Impaired loans along with the related allowance for losses are as follows:
September 30 December 31
in millions) 1998 1997
Impaired loans with allowance for losses........ $38.4 $41.2
Allowance for losses............................ (5.2) (5.0)
Impaired loans with no allowance for losses..... 2.2 --
----- -----
Net Impaired Loans............................ $35.4 $36.2
Impaired loans with no allowance for losses are a result of 1) direct
write-downs or 2) collateral dependent loans where the fair value of the
collateral is greater than the recorded investment in the loan.
A reconciliation of the mortgage loan allowance for losses for these impaired
mortgage loans is as follows:
Nine Months
Ended September 30
(in millions) 1998 1997
------------- ---- ----
Balance at beginning of year......................... $5.0 $12.4
Increase (decrease) in provisions for losses......... .8 2.2
Releases due to sales................................ (.6) (4.8)
Releases due to foreclosures......................... -- (3.4)
---- ----
Balance at End of Period........................... $5.2 $ 6.4
The average recorded investment in impaired loans and the interest income
recognized on impaired loans were as follows:
Nine Months
Ended September 30
(in millions) 1998 1997
------------ ---- ----
Average recorded investment in impaired loans......... $34.6 $86.1
Interest income recognized on impaired loans.......... 2.6 6.1
All interest income on impaired loans was recognized on the cash basis of income
recognition.
As of September 30, 1998 and 1997, LNC had restructured loans of $31.7 million
and $38.9 million, respectively. LNC recorded $2.4 million and $2.8 million of
interest income on these restructured loans for the nine months ended September
30, 1998 and 1997, respectively, as compared to interest income of $2.4 million
and $3.9 million that would have been recorded according to their original
terms.
Fixed maturity securities available-for-sale, mortgage loans on real estate and
real estate that were non-income producing for the nine months ended September
30, 1998 were not significant.
Cash and Invested Cash
Cash and invested cash decreased by $1.1 billion in the first nine months of
1998. This decrease is the result of paying out funds accumulated in the fourth
quarter of 1997 to purchase a block of individual life and annuity business on
January 2, 1998 (see note 11 on page 12).
Deferred Acquisition Costs
Deferred acquisition costs increased $224.1 million during the first nine months
of 1998 as the net result of increases in new business being partially offset by
reductions related to the increase in unrealized gain on securities
available-for-sale.
<PAGE>
18
Premiums and Fees Receivable
Premiums and fees receivable increased $44.1 million in the first nine months of
1998 as the net result of increased volumes of business in the Life Insurance &
Annuities and Reinsurance segments.
Assets Held in Separate Accounts
Through six months of 1998, this asset account, as well as the corresponding
liability account had increased $5.1 billion, reflecting an increase in annuity
funds under management. This increase resulted from new deposits, market
appreciation and the continuation of fixed annuity contractholders opting to
transfer funds to variable annuity contracts. Because of the decline in the
financial markets during the third quarter, this asset and corresponding
liability decreased during the third quarter of 1998, leaving an increase of
$420.2 million for the first nine months of 1998.
Goodwill and Other Intangible Assets
The increase in these amounts is the net result of the additions associated with
the block of individual life insurance and annuity business (see note 11 on page
12) being more than the amortization for the nine months ended September 30,
1998.
Other Assets
The increase in other assets of $308.8 million is the result of having a higher
receivable related to investment securities sold in the last few days of the
third quarter of 1998 versus the end of 1997.
Total Liabilities
Total liabilities increased by $6.9 billion in the first nine months of 1998.
The primary item underlying this increase is the addition of the block of
individual life insurance and annuity business described above. Insurance policy
reserves increased $5.0 billion as a result of the new block of business and
increased levels of business in the Life Insurance and Annuities segment.
Contractholder funds increased $468.9 million which is the net result of new
deposits and the acquisition of business being partially offset by the
withdrawal upon maturity of guaranteed interest contracts. Liabilities related
to separate accounts increased $420.2 million (see discussion of Assets Held in
Separate Accounts above). Total debt increased $688.1 million as the result of
issuing new debt in the first and third quarters of 1998 (see note 4 on page 7).
All other liabilities increased $312.1 million as the net result of a 1998
payment of Federal taxes related to the sale of the property-casualty business
(see note 10 on page 12) and the addition of liabilities related to the
acquisition of the block of individual life insurance business (see note 11 on
page 12). LNC's liabilities include some contingency items (see note 6 on page
8).
Shareholders' Equity
Total shareholders' equity increased $544.7 million in the first nine months of
1998. Excluding the increase of $337.7 million related to an increase in the
unrealized gains on securities available-for-sale, shareholders' equity
increased $207.0 million. This increase was the net result of increases due to
$384.2 million from net income, $26.4 million from the issuance of common stock
related to benefit plans and an increase of $13.6 million in the cumulative
foreign currency translation adjustment, being offset by the repurchase of
common shares ($46.9 million), certain expenses associated with the FELINE
PRIDES offering ($14.0 million ) and the declaration of dividends to
shareholders ($156.3 million).
Derivatives
As discussed in note 7 to the consolidated financial statements for the year
ended December 31, 1997 (see page 56 of LNC's Form 10-K), LNC has entered into
derivative transactions to reduce its exposure to fluctuations in interest
rates, the widening of bond yield spreads over comparable maturity U.S.
Government obligations, increased liabilities associated with certain
reinsurance agreements, foreign exchange risks and fluctuations in the FTSE and
S&P indexes. In addition, LNC is subject to risks associated with changes in the
value of its derivatives; however, such changes in value are generally offset by
changes in the value of the items being hedged by such contracts. Modifications
to LNC's derivative strategy are initiated periodically upon review of the
company's overall risk assessment. Select increases in LNC's derivative
positions noted below are the result of derivatives received in conjunction with
the acquisition of a block of individual life insurance and annuity business
(see note 11 on page 12). During the first nine months of 1998, LNC's derivative
positions have changed as follows:
1. Decreased its use of interest rate cap agreements that are used to hedge
its annuity business from the effect of fluctuating interest rates from
$4.9 billion notional to $4.3 billion notional. The decrease in notional
is a result of expirations and, therefore, no gain or loss has been
recognized.
<PAGE>
19
2. Added $218.3 million in notional amount of swaptions. In addition, $36.8
million notional amount of swaptions expired, resulting in a remaining
balance of $1.9 billion in notional amount of swaptions hedging various
portfolios of interest rate sensitive assets.
3. Increased its use of interest rate swap agreements from $10.0 million
notional to $213.9 million notional. These interest rate swap agreements
are part of a replication strategy which will result in a higher yield on
bonds held by LNC. In the second quarter of 1998, LNC also entered into
$1.8 billion notional of interest rate swaps to hedge the anticipated
purchase of an individual life insurance block of business. During the
third quarter of 1998, $936.5 million notional of these interest rate
swaps were terminated, resulting in a gain of $13.9 million, which has
been deferred against securities purchased.
4. Entered into put option agreements with a notional amount of $21.3
million. These put option agreements are part of a replication strategy
which establishes a fixed maturity date for various perpetual bonds owned
by LNC.
5. Decreased its use of foreign exchange forward contracts that are hedging
the foreign currency risk of its portfolio of foreign bonds from $163.1
million notional to $31.8 million notional. As a result of the U.S.
dollar strengthening against the foreign currencies hedged LNC decided to
terminate a portion of its foreign exchange forward contracts.
6. Entered into foreign currency swap agreements with a notional amount of
$39.2 million, of which $7.1 million has been terminated resulting in a
recognized gain of $.8 million. These foreign currency swap agreements
are part of a replication strategy. LNC owns various foreign issue
securities. Interest payments from these securities are received in a
foreign currency and then swapped into U.S. dollars, replicating a
foreign issue, U.S. dollar paying security.
7. Entered into gold commodity swap agreements with a notional amount of
$8.1 million. This gold commodity swap is part of a replication strategy.
LNC owns a foreign issue bond that makes its coupon payments to its bond
holders in ounces of gold. The gold bullion is then swapped into U.S.
dollars, replicating a foreign issue, U.S. dollar paying security.
8. Decreased its use of FTSE index call options from $14.1 million notional
to $11.8 million notional. As a result of this termination, a $3.4
million gain was recognized. The purpose of LNC's FTSE index call option
program is to offset the cost of increases in the liabilities of certain
single premium investment contracts which are tied to the appreciation of
the FTSE index.
9. Increased its use of S&P 500 index options from $5.3 million notional to
$73.6 million notional. These options continue to offset LNC's increased
liabilities resulting from certain reinsurance agreements which guarantee
payment for a specified portion of the appreciation of the S&P 500 index
on certain underlying annuity products.
The following is additional information regarding two new hedging strategies LNC
entered into since year-end 1997:
Put Options. LNC uses put options, combined with various perpetual fixed income
securities, to replicate a fixed income, fixed maturity investment. The put
options give LNC the right, but not the obligation, to sell to the counterparty
of the agreement the specified securities on a specified date at a fixed price.
Commodity Swap. A commodity swap is a contractual agreement to exchange a
certain amount of a particular commodity for a known amount of cash. LNC owns a
fixed income security that meets its coupon payment obligations in gold bullion.
LNC is obligated to pay to the counterparty the gold bullion, and in return,
receives from the counterparty a stream of fixed income payments. The fixed
income payments are the product of the swap notional multiplied by the fixed
rate stated in the swap agreement. The net receipts/payments from commodity
swaps are recorded in net investment income.
LNC is exposed to credit loss in the event of non-performance by counterparties
on interest rate cap agreements, swaptions, spread-lock agreements, interest
rate swaps, put options, foreign exchange forward contracts, foreign currency
options, foreign currency swaps, commodity swaps and call options. However, LNC
does not anticipate non-performance 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.
<PAGE>
20
Liquidity and Cash Flow
Liquidity refers to the ability of an enterprise to generate adequate amounts of
cash from its normal operations to meet cash requirements with a prudent margin
of safety. Because of the interval of time from receipt of a deposit or premium
until payment of benefits or claims, LNC and other insurers employ investment
portfolios as an integral element of operations. By segmenting its investment
portfolios along product lines, LNC enhances the focus and discipline it can
apply to managing the liquidity as well as the interest rate and credit risk of
each portfolio commensurate with the profile of the liabilities. For example,
portfolios backing products with less certain cash flows and/or withdrawal
provisions are kept more liquid than portfolios backing products with more
predictable cash flows.
The consolidated statements of cash flows on page 6, indicates that operating
activities provided cash of $854.1 million during the first nine months of 1998.
This statement also classifies the other sources and uses of cash by investing
activities and financing activities and discloses the total amount of cash
available to meet LNC's obligations.
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. In April 1998, LNC filed a shelf registration for $1.3
billion. The $1.3 billion included an aggregate of $300 million that had not
been utilized from a previously filed shelf registration. The registration
statement included the right to offer and sell a variety of securities including
debt, preferred stock, common stock and hybrid securities. After deducting the
impact of the securities issued during the first nine months of 1998 (see note 4
on page 7), and combining the unused portion of a shelf registration filed in
May 1996, LNC may offer and sell an additional $825 million of securities under
its existing shelf registration. Finally, cash funds are available from LNC's
revolving credit agreement which provides for borrowing up to $750 million.
Transactions such as those described in the preceding paragraph that occurred
recently include the issuance of securities as shown in note 4 (page 7) and the
purchase and retirement of 623,281 shares of common stock at a cost of $46.9
million in the first five months of 1998. The shares purchased in 1998, along
with shares purchased in 1997, have reduced the June 1997 board authorization of
$500 million to $158.2 million at September 30, 1998. Within the May 1998
announcement concerning the expected purchase of a block of business (see note
11 on page 12), LNC indicated it would curtail further share repurchases for the
near-term.
LNC's insurance subsidiaries are subject to certain insurance department
regulatory restrictions, as to the transfer of funds and payment of dividends to
the holding company (LNC). Generally, these restrictions pose no short-term
liquidity concerns for the holding company. However, as discussed in detail
within note 6 on page 8, the acquisition of two blocks of business in 1998 will
place further restrictions on the ability of LNC's primary insurance subsidiary,
Lincoln National Life Insurance Company ("Lincoln Life"), to declare and pay
dividends. As a result of these acquisitions, Lincoln Life earned surplus will
be negative and it will be necessary for Lincoln Life to obtain the prior
approval of the Indiana Insurance Commissioner before paying any dividends to
LNC until such time as earned surplus is positive. It is expected that earned
surplus will return to a positive position within two years from the closing of
the Aetna transaction assuming the level of statutory earnings coinciding with
recent earnings patterns. If statutory earnings are less than recent patterns
due, for example, to adverse operating conditions or further indemnity
reinsurance transactions of this nature, the earned surplus may not return to a
positive position as soon as expected. Although no assurance can be given,
management believes that the approvals for the payment of dividends in amounts
consistent with those paid in the past can be obtained. In the event such
approvals are not obtained, management believes that LNC can obtain the funds
required to satisfy its obligations from its existing credit facilities and
other sources.
<PAGE>
21
PART II - OTHER INFORMATION AND EXHIBITS
Items 1, 2, 3, 4 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 6. Exhibits and Reports on Form 8-K
(a) The following Exhibits of the Registrant are included in this report.
(Note: The number preceding the exhibit corresponds to the specific
number within Item 601 of Regulation S-K.)
12 Historical Ratio of Earnings to Fixed Charges
27 Financial Data Schedule
(b) During the quarter ended September 30, 1998, Form 8-K's were filed with
the Commission as follows:
1) LNC's press release announcing its second quarter 1998 earnings
(filing date of July 23, 1998). This filing was made in conjunction
with an offering of Trust Originated Preferred Securities, Series C.
2) LNC's offering of Trust Originated Preferred Securities (filing date
of July 30, 1998).
3) LNC's press release announcing the expected sale of a portion of the
block of business being acquired from Aetna (filing date of
August 7, 1998).
<PAGE>
22
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,
Executive Vice President and
Chief Financial Officer
By /S/ Donald L. Van Wyngarden
Donald L. Van Wyngarden,
Second Vice President and Controller
Date November 5, 1998
<PAGE>
23
LINCOLN NATIONAL CORPORATION
Exhibit Index for the Report on Form 10-Q
for the Quarter Ended September 30, 1998
Exhibit Number Description Page Number
12 Historical Ratio of Earnings to
Fixed Charges 24
27 Financial Data Schedule 25
<PAGE>
24
LINCOLN NATIONAL CORPORATION AND SUBSIDIARIES
EXHIBIT 12 - HISTORICAL RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
Nine Months
Ended September 30 Year Ended December 31,
-----------------------
(millions of dollars) 1998 1997(4) 1997(4) 1996 1995 1994 1993
- --------------------- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Net Income before Federal
Income Taxes and
Accounting Change.................. 526.1 372.8 1427.1 692.7 626.6 376.3 587.8
Equity Loss (Earnings) in
Unconsolidated Affiliates.......... (.8) (1.6) (2.1) (1.4) (12.4) (14.6) --
Sub-total of Fixed Charges.......... 100.1 88.0 113.4 108.6 94.4 66.6 62.9
----- ----- ------ ------ ---- ---- ----
Sub-total of Adjusted
Net Income...................... 625.4 459.2 1538.4 799.9 708.6 428.3 650.7
Interest on Annuities &
Financial Products................. 1215.6 1136.0 1478.5 1435.6 1400.0 1359.0 1315.8
------- ------ -------- ------- ------- ------- ------
Adjusted Income Base............ 1841.0 1595.2 3016.9 2235.5 2108.6 1787.3 1966.5
Rent Expense........................ 49.5 54.0 62.7 71.6 65.7 51.3 55.8
Fixed Charges:
Interest and Debt Expense........... 83.6 70.0 92.5 84.7 72.5 49.5 44.3
Rent (Pro-rated).................... 16.5 18.0 20.9 23.9 21.9 17.1 18.6
----- ---- ------- ---- ---- ---- ----
Sub-total of Fixed Charges....... 100.1 88.0 113.4 108.6 94.4 66.6 62.9
Interest on Annuities &
Financial Products................. 1215.6 1136.0 1478.5 1435.6 1400.0 1359.0 1315.8
------ ------ ------- ------ ------ ------ ------
Sub-total of Fixed Charges....... 1315.7 1224.0 1591.9 1544.2 1494.4 1425.6 1378.7
Preferred Dividends (Pre-tax)....... .1 .1 .2 .2 13.4 24.2 24.2
------ ------ ------ ------ ------ ------ ------
Total Fixed Charges.............. 1315.8 1224.1 1592.1 1544.4 1507.8 1449.8 1402.9
Ratio of Earnings to Fixed Charges:
Excluding Interest on
Annuities and Financial
Products (1) ..................... 6.25 5.22 13.57 7.37 7.51 6.43 10.35
Including Interest on
Annuities and Financial
Products (2)...................... 1.40 1.30 1.90 1.45 1.41 1.25 1.43
Ratio of Earnings to
Combined Fixed Charges
and Preferred Stock
Dividends (3)..................... 1.40 1.30 1.89 1.45 1.40 1.23 1.40
</TABLE>
(1) For purposes of determining this ratio, earnings consist of income before
federal income taxes and cumulative effect of accounting change adjusted
for the difference between income or losses from unconsolidated equity
investments and cash distributions from such investments, plus fixed
charges. Fixed charges consist of 1) interest and debt expense on short
and long-term debt and distributions to minority interest-preferred
securities of subsidiary companies and 2) the portion of operating leases
that are representative of the interest factor.
(2) Same as the ratio of earnings to fixed charges, excluding interest on
annuities and financial products, except fixed charges and earnings
include interest on annuities and financial products.
(3) Same as the ratio of earnings to fixed charges, including interest on
annuities and financial products, except that fixed charges include the
pre-tax earnings required to cover preferred stock dividend requirements.
(4) The coverage ratios for the nine months ended September 30, 1997 are
lower than the other periods shown due to the reduction in net income
caused by the reserve strengthening in LNC's disability income business.
The coverage ratios for the year 1997 are higher than the other periods
shown due to the inclusion of the gain on sale of a major subsidiary in
net income.
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
condensed consolidated financial statements of Lincoln National Corporation and
is qualified in its entirety by reference to such condensed consolidated
financial statements. </LEGEND>
<CIK> 0000059558
<NAME> Lincoln National Corporation
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> Dec-31-1998
<PERIOD-START> Jan-01-1998
<PERIOD-END> Sep-30-1998
<DEBT-HELD-FOR-SALE> 28,553,977,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 504,899,000
<MORTGAGE> 4,329,293,000
<REAL-ESTATE> 459,551,000
<TOTAL-INVEST> 35,763,889,000
<CASH> 2,725,355,000
<RECOVER-REINSURE> 2,454,518,000
<DEFERRED-ACQUISITION> 1,847,952,000
<TOTAL-ASSETS> 84,606,194,000
<POLICY-LOSSES> 16,263,694,000
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 20,532,311,000
<NOTES-PAYABLE> 1,811,388,000
0
1,086,000
<COMMON> 972,960,000
<OTHER-SE> 4,553,562,000
<TOTAL-LIABILITY-AND-EQUITY> 84,606,194,000
2,027,546,000
<INVESTMENT-INCOME> 1,966,687,000
<INVESTMENT-GAINS> 22,711,000
<OTHER-INCOME> 356,160,000
<BENEFITS> 2,349,283,000
<UNDERWRITING-AMORTIZATION> 276,687,000
<UNDERWRITING-OTHER> 1,137,411,000
<INCOME-PRETAX> 526,145,000
<INCOME-TAX> 141,974,000
<INCOME-CONTINUING> 384,171,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 384,171,000
<EPS-PRIMARY> 3.83
<EPS-DILUTED> 3.77
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
