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 March 31, 1999 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 April 30, 1999 LNC had 100,169,741 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 20.
Page 1 of
<PAGE>-2-
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31 December 31
(000s omitted) 1999 1998
-------------- ---- ----
ASSETS
<S> <C> <C>
Investments:
Securities available-for-sale, at fair value:
Fixed maturity (cost 1999 -$29,681,366;
1998 - $28,639,558)......................................... $30,577,880 $30,232,892
Equity (cost 1999 - $379,935;
1998 - $436,718)............................................ 480,815 542,843
Mortgage loans on real estate................................... 4,344,590 4,393,082
Real estate..................................................... 471,831 488,722
Policy loans.................................................... 1,842,387 1,839,970
Other investments............................................... 411,939 431,964
---------- -----------
Total Investments............................................. 38,129,442 37,929,473
Investment in unconsolidated affiliates........................... 20,520 18,811
Cash and invested cash............................................ 2,327,046 2,433,350
Property and equipment............................................ 177,992 174,762
Deferred acquisition costs........................................ 2,112,187 1,964,366
Premiums and fees receivable...................................... 241,819 246,203
Accrued investment income......................................... 585,611 528,500
Assets held in separate accounts.................................. 44,339,393 43,408,858
Federal income taxes.............................................. 286,037 204,075
Amounts recoverable from reinsurers............................... 3,124,498 3,127,093
Goodwill.......................................................... 1,404,597 1,484,343
Other intangible assets........................................... 1,845,354 1,848,442
Other assets...................................................... 755,782 467,984
--------- ---------
Total Assets.................................................. $95,350,278 $93,836,260
</TABLE>
See notes to consolidated financial statements on pages 7 - 11.
<PAGE>-3-
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
-CONTINUED-
<TABLE>
<CAPTION>
March 31 December 31
(000s omitted) 1999 1998
-------------- ---- ----
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Insurance and Investment Contract Liabilities:
Insurance policy and claim reserves.................................. $20,244,319 $20,139,982
Contractholder funds................................................. 20,600,875 20,753,064
Liabilities related to separate accounts ........................... 44,339,393 43,408,858
---------- ----------
Total Insurance and Investment Contract Liabilities............... 85,184,587 84,301,904
Short-term debt........................................................ 281,842 314,610
Long-term debt......................................................... 712,146 712,171
Minority interest - preferred securities
of subsidiary companies.............................................. 745,000 745,000
Other liabilities...................................................... 3,319,282 2,374,634
--------- -----------
Total Liabilities................................................. 90,242,857 88,448,319
Shareholders' Equity:
Series A preferred stock-10,000,000 shares authorized
(3/31/99 liquidation value - $2,546).................................. 1,046 1,083
Common stock - 800,000,000 shares authorized........................... 995,907 994,472
Retained earnings...................................................... 3,825,705 3,790,038
Accumulated Other Comprehensive Income:
Foreign currency translation adjustment.............................. 30,123 49,979
Net unrealized gain on securities available-for-sale................... 254,640 552,369
---------- ----------
Total Accumulated Other Comprehensive Income...................... 284,763 602,348
---------- -----------
Total Shareholders' Equity........................................ 5,107,421 5,387,941
---------- ----------
Total Liabilities and Shareholders' Equity ...................... $95,350,278 $93,836,260
</TABLE>
See notes to consolidated financial statements on pages 7 - 11.
<PAGE>-4-
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Three Months Ended
March 31
(000s omitted, except per share amounts) 1999 1998
---------------------------------------- ---- ----
<S> <C> <C>
Revenue:
Insurance premiums ....................................................... $ 439,063 $ 347,589
Insurance fees............................................................ 378,001 299,894
Investment advisory fees ................................................. 58,790 57,879
Net investment income..................................................... 709,538 658,359
Equity in earnings of unconsolidated affiliates........................... 1,606 1,497
Realized gain on investments.............................................. 1,927 23,923
Other revenue and fees ................................................... 86,433 58,878
--------- ---------
Total Revenue.......................................................... 1,675,358 1,448,019
Benefits and Expenses:
Benefits.................................................................. 891,234 784,637
Underwriting, acquisition,
insurance and other expenses ........................................... 546,535 473,601
Interest and debt expense ............................................... 33,104 23,368
---------- ---------
Total Benefits and Expenses .......................................... 1,470,873 1,281,606
--------- ---------
Net Income Before Federal Income Taxes .............................. 204,485 166,413
Federal income taxes ..................................................... 59,423 44,370
-------- ---------
Net Income ........................................................... $ 145,062 $ 122,043
Net Income Per Common Share-Basic........................................... $1.44 $1.22
Net Income Per Common Share-Diluted......................................... $1.42 $1.20
</TABLE>
See notes to consolidated financial statements on pages 7 - 11.
<PAGE>-5-
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Three Months Ended March 31
Number of Shares Amounts
(000s omitted from dollar amounts) 1999 1998 1999 1998
---------------------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Series A Preferred Stock:
Balance at beginning-of-year ................. 32,959 35,091 $ 1,083 $ 1,153
Conversion into common stock ................. (1,128) (815) (37) (27)
------- ------- ---- ------
Balance at March 31...................... 31,831 34,276 1,046 1,126
Common Stock:
Balance at beginning-of-year ................. 101,055,587 100,859,478 994,472 966,461
Conversion of series A preferred stock........ 9,024 6,520 37 27
Issued for benefit plans ................... 176,066 82,491 3,811 2,844
Issued for acquisition of subsidiaries........ 44,535 3,664
Retirement of common stock ................... (617,500) (623,281) (6,077) (5,972)
--------- --------- -------- -------
Balance at March 31 .................... 100,667,712 100,325,208 995,907 963,360
Retained Earnings:
Balance at beginning-of-year.................. 3,790,038 3,533,105
Comprehensive income (loss)................... (172,523) 167,267
Less other comprehensive income (loss):
Foreign currency translation................. (19,856) 6,200
Net unrealized gain (loss) on
securities available-for-sale............... (297,729) 39,024
------- -------
Net Income............................... 145,062 122,043
Retirement of common stock.................... (54,227) (40,899)
Dividends declared:
Series A preferred ($.75 per share)........... (24) (26)
Common stock (1999-$.55; 1998-$.52)........... (55,144) (51,888)
--------- ----------
Balance at March 31...................... 3,825,705 3,562,335
Foreign Currency Translation Adjustment:
Accumulated adjustment at
beginning-of-year........................... 49,979 46,204
Change during the period...................... (19,856) 6,200
--------- -------
Balance at March 31...................... 30,123 52,404
Net Unrealized Gain (Loss) on
Securities Available-for-Sale:
Balance at beginning-of-year.................. 552,369 435,992
Change during the period...................... (297,729) 39,024
--------- -------
Balance at March 31...................... 254,640 475,016
Total Shareholders' Equity
at March 31............................ $5,107,421 $5,054,241
Common Stock at End of Quarter:
Assuming conversion of preferred stock........ 100,922,360 100,599,416
Diluted basis................................. 101,612,510 102,080,882
</TABLE>
See notes to consolidated financial statements on pages 7 - 11.
<PAGE>-6-
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Three Months Ended
March 31
(000s omitted) 1999 1998
-------------- ---- ----
<S> <C> <C>
Cash Flows from Operating Activities:
Net income.............................................................. $ 145,062 $ 122,043
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Deferred acquisition costs.......................................... (81,808) (30,329)
Premiums and fees receivable........................................ 4,385 (9,307)
Accrued investment income........................................... (57,111) (16,263)
Policy liabilities and accruals..................................... 26,238 98,238
Contractholder funds................................................ 194,333 153,325
Amounts recoverable from reinsurers................................. 2,596 59,914
Federal income taxes................................................ 75,138 20,004
Equity in earnings of unconsolidated affiliates..................... (1,606) (1,497)
Provisions for depreciation ...................................... 25,153 13,610
Amortization of goodwill and other intangible assets................ 41,387 39,521
Realized gain on investments........................................ (1,927) (23,923)
Other............................................................... 165,810 (35,201)
------- ------
Net Adjustments................................................... 392,588 268,092
------- -------
Net Cash Provided by Operating Activities......................... 537,650 390,135
Cash Flows from Investing Activities:
Securities-available-for-sale:
Purchases............................................................. (2,589,991) (2,446,959)
Sales................................................................. 1,031,446 2,149,815
Maturities............................................................ 573,102 106,694
Purchase of other investments........................................... (380,397) (259,830)
Sale or maturity of other investments................................... 449,699 448,270
Purchase of affiliates/blocks of business............................... -- (1,426,000)
Increase in cash collateral on loaned securities........................ 802,334 137,238
Other .................................................................. (295,665) (7,653)
--------- -----------
Net Cash Provided by (Used in) Investing Activities............... (409,472) (1,298,425)
Cash Flows from Financing Activities:
Decrease in long-term debt (includes payments and
transfer to short-term debt)........................................... (91) (17)
Issuance of long-term debt.............................................. -- 299,198
Net increase (decrease) in short-term debt.............................. (32,767) 67,688
Universal life and investment contract deposits......................... 528,355 827,287
Universal life and investment contract withdrawals...................... (629,274) (1,342,499)
Common stock issued for benefit plans................................... 3,811 2,844
Retirement of common stock.............................................. (49,180) (46,871)
Dividends paid to shareholders.......................................... (55,336) (52,368)
--------- --------
Net Cash Provided by (Used in) Financing Activities............... (234,482) (244,738)
Net Decrease in Cash.............................................. (106,304) (1,153,028)
Cash and Invested Cash at Beginning-of-Year............................... 2,433,350 3,794,706
---------- ---------
Cash and Invested Cash at March 31................................ $2,327,046 $2,641,678
</TABLE>
See notes to consolidated financial statements on pages 7 - 11.
<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.
The collective group of companies uses "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 audited consolidated financial statements and the
accompanying notes included in LNC's latest annual report on Form 10-K for the
year ended December 31, 1998.
Operating results for the three months ended March 31, 1999 are not necessarily
indicative of the results that may be expected for the full year ending December
31, 1999.
2. Changes in Accounting Principle
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. 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.
On January 1, 1999, LNC implemented the Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use". SOP 98-1 defines internal use software and when the costs
associated with internal use software should be capitalized. The implementation
did not have a material impact on LNC's financial statements.
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 1999 and 1998 resulted
principally from tax-preferred investment income.
4. 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. 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 in October 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
statutory earned surplus is negative and it is necessary for Lincoln Life to
obtain the prior approval of the Indiana Insurance Commissioner before paying
any dividends to LNC until such time as statutory earned surplus is positive.
Statutory earned surplus could 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 or if
dividends are approved or paid at amounts higher than recent history, the
statutory earned surplus may not return to a positive position in a two year
time frame. 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>-8-
Disability Income Claims. The liability for disability income claims net of the
related asset for amounts recoverable from reinsurers at March 31, 1999 and
December 31, 1998 is a net liability of $1.822 billion and $1.813 billion,
respectively, excluding deferred acquisition costs. The liability is based on
the assumption that recent experience will continue in the future. If incidence
levels and/or claim termination rates fluctuate significantly from the
assumptions underlying the reserves, adjustments to reserves could be required
in the future. Accordingly, this liability may prove to be deficient or
excessive. However, it is management's opinion that such future development will
not materially affect the consolidated financial position of LNC. LNC reviews
reserve levels on an on-going basis.
United Kingdom Pension Products. Operations in the UK 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 March 31, 1999 and December 31,
1998, liabilities of $167.9 million and $202.1 million, respectively, were
carried on the books for this issue. The decrease in the level of the reserve
reflects the settlement payouts that have occurred during the three months ended
March 31, 1999. 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 $82.1 million and
$84.9 million at March 31, 1999 and December 31, 1998, respectively. These
liabilities and recoveries are based on various estimates that are subject to
considerable uncertainty. Also, there is further uncertainty from the regulatory
perspective as additional guidelines were issued in December of 1998 that extend
the review to a wider range client population. These guidelines specify actions
expected from the companies that issued such products. 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. In the past, LNC's Reinsurance segment accepted
personal accident reinsurance programs from other insurance companies. Most of
these programs are presented to the Reinsurance segment by independent brokers
who represent the ceding companies. Certain excess of loss personal accident
reinsurance programs created in the London market from 1993 to 1996 have
produced and have potential to produce significant losses. The liabilities
for these programs, net of related assets recoverable from reinsurers were
$177.3 million and $177.4 million at March 31, 1999 and December 31, 1998,
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.
LNC continues to investigate its personal accident reinsurance programs,
including certain workers compensation programs, which may produce losses. At
this time LNC 1) does not have sufficient information to determine whether or
not it is probable that additional losses have been incurred and 2) can not
accurately estimate the ultimate cost or timing of the outcome on these
programs.
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.
<PAGE>-9-
Other Contingency Matters. 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. Two of these lawsuits have been resolved and dismissed. 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.
UK regulatory authorities have completed a review of Lincoln UK selling
practices. This review does not include matters related to the pension product
mis-selling investigations. Management is currently working with the regulators
to address compliance issues that have been raised in the course of this review.
The extent of corrective measures and potential disciplinary actions, if any,
that may result from this review are actively being discussed with the
regulatory authorities. It is not possible to provide a meaningful estimate of
the potential outcome of this matter at the present time. However, it is
management's opinion that the resolution of these matters will not materially
affect the consolidated financial position of LNC.
5. Segment Disclosures
The following tables show financial data by segment:
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31 December 31
(in millions) 1999 1998 1998 1997
------------- ---- ---- ---- ----
Revenue: (Reclassified)(Reclassified) (Reclassified)
<S> <C> <C> <C> <C>
Life Insurance and Annuities............................... $1,031.3 $875.0 $3,640.7 $2,673.7
Lincoln UK................................................. 119.1 103.5 439.8 427.3
Reinsurance................................................ 417.2 352.8 1,576.8 1,381.7
Investment Management...................................... 116.8 118.0 466.7 438.6
Other Operations (includes consolidating adjustments) (9.0) (1.3) (36.9) (22.8)
------- ------- -------- --------
Total.................................................... $1,675.4 $1,448.0 $6,087.1 $4,898.5
Net Income (Loss) before Federal Income Taxes:
Life Insurance and Annuities............................... $162.0 $ 98.9 $520.6 $403.5
Lincoln UK................................................. 26.9 26.8 106.9 (96.8)
Reinsurance................................................ 50.3 44.1 156.7 (210.2)
Investment Management...................................... (2.3) 9.6 38.8 16.9
Other Operations (includes interest expense)............... (32.4) (13.0) (125.6) (78.5)
------ ----- ------ -----
Total.................................................... $204.5 $166.4 $697.4 $ 34.9
Federal Income Taxes (Credits):
Life Insurance and Annuities............................... $42.9 $21.0 $132.8 $97.0
Lincoln UK................................................. 8.9 9.4 35.2 10.0
Reinsurance................................................ 17.8 15.5 54.5 (73.8)
Investment Management...................................... 1.0 4.3 16.8 10.9
Other Operations........................................... (11.2) (5.8) (51.7) (31.4)
----- ---- ----- ----
Total.................................................... $59.4 $44.4 $187.6 $12.7
Net Income (Loss):
Life Insurance and Annuities............................... $119.1 $ 77.9 $387.8 $306.5
Lincoln UK................................................. 18.0 17.4 71.7 (106.8)
Reinsurance................................................ 32.5 28.6 102.2 (136.4)
Investment Management...................................... (3.3) 5.3 22.0 6.0
Other Operations (includes interest expense)............... (21.2) (7.2) (73.9) (47.1)
----- ------ ----- ------
Total Net Income from Continuing Operations.............. 145.1 122.0 509.8 22.2
Discontinued Operations.................................... -- -- -- 911.8
------- ------- -------- -----
Total Net Income......................................... $145.1 $122.0 $509.8 $934.0
</TABLE>
<PAGE>-10-
<TABLE>
<CAPTION>
March 31 December 31 December 31
(in millions) 1999 1998 1997
Assets: (Reclassified) (Reclassified)
<S> <C> <C> <C>
Life Insurance and Annuities............................... $75,292.0 $73,966.1 $57,070.5
Lincoln UK................................................. 8,798.1 8,757.3 7,923.8
Reinsurance................................................ 6,437.3 6,408.0 5,540.2
Investment Management...................................... 1,545.6 1,622.6 1,756.6
Other Operations........................................... 3,277.3 3,082.3 4,883.6
--------- ---------- -------
Total.................................................... $95,350.3 $93,836.3 $77,174.7
</TABLE>
Select data shown above for the Investment Management segment, Life Insurance &
Annuities segment and Other Operations for the three months ended March 31, 1998
and the years ended December 31, 1998 and 1997 has been reclassified due to a
change in the reporting relationship for LNC's internal investment advisor and
401(k) pension unit.
6. Earnings Per Share
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>
Three Months Ended
March 31
1999 1998
---- ----
<S> <C> <C>
Numerator: [in millions]
Net income from continuing operations,
as used in basic calculation........................................ $145.1 $122.0
Dividends on convertible preferred stock............................. * *
-------- ------
Net income from continuing
operations, as used in diluted calculation...................... $145.1 $122.0
* Less than $100,000.
Denominator: [number of shares]
Weighted average shares, as used in basic calculation.................. 100,592,737 100,215,284
Shares to cover conversion of preferred stock.......................... 258,129 277,865
Shares to cover restricted stock....................................... 258,270 186,224
Average stock options outstanding during the period................. 3,021,884 3,435,289
Assumed acquisition of shares with assumed proceeds
and tax benefits from exercising stock options
(at average market price during the period) .......................... (2,315,905) (2,016,142)
------------ ------------
Weighted-average shares, as used in diluted calculation.......... 101,815,115 102,098,520
</TABLE>
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.
7. Comprehensive Income
<TABLE>
<CAPTION>
Three Months Ended
March 31
(in millions) 1999 1998
------------- ---- ----
<S> <C> <C>
Net income............................................................. $ 145.1 $122.0
Foreign currency translation........................................... (19.9) 6.2
Net unrealized gain (loss) on securities.............................. (297.7) 39.1
------ -----
Comprehensive Income (Loss)....................................... $(172.5) $167.3
</TABLE>
<PAGE>-11-
8. Acquisition of Individual Life Insurance and Annuity Business and
Organizational Review
On January 2, 1998, LNC acquired a block of individual life insurance and
annuity business from CIGNA Corporation 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. Funding used to complete this acquisition was from the
proceeds of LNC's sale of the property-casualty business in 1997. 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 an agreement
to sell the administration rights to a variable annuity portfolio that had been
acquired as a part of the block of business acquired January 2, 1998. The sale
closed on October 12, 1998 with an effective date of August 1, 1998. As of March
31, 1999, the application of purchase accounting to this block of business, net
of the administration rights sold, resulted in goodwill and other intangible
assets of $728 million and $434 million, respectively. The goodwill amount shown
includes an adjustment of $58.6 million to the amount shown at December 31,
1998. This adjustment resulted from reaching final agreement with the seller as
to the value of the assets and liabilities transferred to LNC. 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. The pattern of actual expenses for
integrating this block of business have matched the expected expenditures.
On October 1, 1998, LNC acquired the domestic individual life insurance business
from Aetna, Inc. for $1.0 billion. This transaction was accounted for using
purchase accounting and, accordingly, the operating results generated by this
block of business after the closing are included in LNC's consolidated financial
statements. At the time of closing, this block of business had estimated
liabilities, measured on a statutory basis, of $3.3 billion. These liabilities
became LNC's obligations at the time of closing. At closing LNC received assets,
measured on a 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 Aetna block of business. The sale closed on
October 14, 1998 with an effective date of October 1, 1998 at a sales price of
$99.5 million. During 1997, after deducting the sponsored life income statement
amounts, the 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). As of March 31, 1999, the application of purchase accounting to
this block of business net of the sponsored life business resulted in goodwill
and other intangible assets of $214 million and $852 million, respectively. The
additional analysis of this block of business during 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.
During the first quarter of 1999, LNC recorded a charge to its Investment
Management segment of $12.1 million ($16.9 million pre-tax). The charge was for
certain costs of downsizing and consolidation of back office operations at Lynch
& Mayer.
<PAGE>-12-
Item 2 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 for the three months ended
March 31, 1999 compared to the results for the three months ended March 31 1998.
As a result of the purchase of a block of individual life insurance business
from Aetna in October 1998 (see note 8 on page 11) select income statement
accounts increased in 1999 versus 1998. Such increases over comparable 1998
periods are expected to continue through the third quarter of 1999.
Life Insurance and Annuity Premiums
Life insurance and annuity premiums for the first three months of 1999 increased
$79.0. million or 38% compared with the first three months of 1998. These
increases were 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
blocks of business described above.
Health Premiums
Health premiums increased $12.5 million or 9% for the first three months of
1999 compared with the first three months of 1998 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 $78.1 million or 26% compared with the first
three months of 1998. 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 $0.9 million or 2% for the first three
months of 1999 as a result of increased volumes of business.
Net Investment Income
Net investment income increased $51.2 million or 8% when compared with the first
three months of 1998. This increase is the result of a 9% increase in mean
invested assets, partially offset by a decrease in the overall yield on
investments from 7.39% to 7.26% (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 the acquisition of the block of business described
above.
Realized Gain on Investments
The first three months of 1999 and 1998 had realized gains on investments of
$1.9 million and $23.9 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.
<PAGE>-13-
The pre-tax write-downs of securities available-for-sale for the first three
months of 1999 and 1998 were $12.4 million and $14.3 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 three months
of 1999, LNC released $0.2 million in reserves on real estate and mortgage loans
on real estate compared to reserves released of $1.0 million for the first three
months of 1998. Net write-downs and reserve releases for all investments for the
three months ended March 31, 1999 and 1998 were $12.2 million and $13.3 million,
respectively.
Other Revenue and Fees
Other revenue and fees increased $27.6 million when compared to the first three
months of 1998 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 $95.4 million or 15% when compared
with the first three months of 1998. 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 increased $11.2 million or 8% for the first three months of 1999
when compared with the first three months of 1998 as a result of increased
volumes of business.
Underwriting, Acquisition, Insurance and Other Expenses
These expenses increased $72.9 million or 15% for the first three months of 1999
compared with the first three months of 1998. The increase is a result of
increases in business volume in the Life Insurance & Annuities segments and the
acquisition of the block of business described above.
Interest and Debt Expense
Interest and debt expense increased $9.7 million or 42% as compared with the
first three months of 1998. This was the result of higher average debt
outstanding.
Federal Income Taxes
Federal income taxes increased $15.1 million in the first three months of 1999
as compared with the first three months of 1998. The increase in federal income
taxes is a result of an increase in pre-tax earnings.
Summary
Net income for the first three months of 1999 was $145.1 million or $1.42 per
diluted share compared with $122.0 million or $1.20 per diluted share in the
first three months of 1998. Excluding realized gains and losses on investments
and the restructuring charge, LNC earned $155.7 million for the first three
months of 1999 compared with $128.1 million for the first three months of 1998.
This increase was the result of increased earnings from each of the business
segments.
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, cost estimates and remediation
activities.
LNC identified first quarter 1999 expenditures of $14.4 million ($9.4 million
after-tax) to address this issue. This brings the expenditures for 1996 through
first quarter 1999 to $62.9 million ($40.9 million after-tax). LNC's financial
plans for the remainder of 1999 and the year 2000 include expected expenditures
of an additional $31.0 million ($20.2 million after-tax) bringing estimated
overall Year 2000 expenditures to $93.9 million ($61.1 million after-tax).
Because updating systems and procedures is an integral part of LNC's on-going
operations, approximately 50% of the expenditures shown above are expected to
continue after all Year 2000 issues have been resolved. All Year 2000
expenditures are expected to be funded from operating cash flows. The
anticipated cost of addressing Year 2000 issues is 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. LNC's management continues to closely
monitor these costs, but there can be no guarantee that actual costs will not be
higher than these estimated costs. 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 relevant
computer problems and other uncertainties.
<PAGE>-14-
The current scope of the overall Year 2000 program includes the following four
major project areas: 1) addressing the readiness of business applications,
operating systems and hardware on mainframe, personal computer and Local Area
Network platforms (IT); 2) addressing the readiness of embedded chips, end-user
developed spreadsheets and software (non-IT); 3) addressing the readiness of key
business partners and 4) establishing year 2000 contingency plans.
The projects to address IT and non-IT readiness have four major phases. Phase
one involves raising awareness and creating an inventory of all IT and non-IT
assets. The second phase consists of assessing all items inventoried to
initially determine whether they are affected by the Year 2000 issue and
preparing general 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 has completed these four phases for over three-fourths of its high priority
IT systems including those provided by software vendors. As of March 31, 1999
the status of projects addressing readiness of IT assets is: 100% of IT assets
have been inventoried (Phase 1) and assessed (Phase 2); 98% of IT projects have
been through the remediation phase (Phase 3) and 81% of IT projects have
completed the testing phase (Phase 4) with the last project scheduled to finish
testing by the end of June. LNC defines the IT testing phase as comprehensive
testing of Year 2000 systems changes for both Year 2000 functionality and
regression testing to confirm that the Year 2000 changes have not inadvertently
modified existing processing. This IT testing includes simulated future date
unit tests, systems tests and integration tests with LNC affiliates and is
expected to be completed by June 30, as noted above. Environmental and
external agent/vendor testing, which are subject to external factors such as
vendor readiness, will continue through third quarter as planned.
Re-testing of systems as part of the pre-production quality assurance process
("clean management") as well as participation in industry-wide testing will
continue throughout the year.
As of March 31, 1999 the status of projects that address readiness of high
priority non-IT assets is: 100% of non-IT assets have been inventoried (Phase
1); 97% of non-IT assets have been assessed (Phase 2) 91% of non-IT
projects addressing remediation (Phase 3) have been completed and 57% of
non-IT projects have completed the testing phase (Phase 4). LNC expects to have
all phases related to high priority non-IT completed by the end of October 1999.
Concurrent with the IT and non-IT projects, the readiness of key business
partners is being reviewed and Year 2000 contingency plans are being developed.
The most significant categories of key business partners are financial
institutions, software vendors, and utility providers (gas, electric and
telecommunications). Surveys have been mailed to key business partners. Based on
responses received, current levels of readiness are being assessed, follow-up
contacts are underway, alternative strategies are being developed and testing is
being scheduled or is already underway where feasible. Some of LNC's business
partners have indicated that they cannot test with all partners. In those
instances where LNC is not testing with a high priority business partner, LNC
will review test results of clients having similar systems and determine LNC's
comfort level with their testing. This effort is expected to continue well
into the third quarter of 1999. As noted above, software vendor assessments are
considered part of the IT projects and, therefore, would follow the schedule
shown above for such projects.
The complexity of the Year 2000 issue gives rise to numerous uncertainties.
Regardless of best efforts, LNC recognizes the possibility that failures may
occur. LNC is putting significant emphasis on Year 2000 contingency
planning. Year 2000 contingency plans are currently being developed. Testing of
the plans and training will continue throughout the second half of the year.
Contingency plans consider failures due to either internal or external Y2K
events ranging from such things as systems failures to utility outages to
external provider failures. Alternative providers have been identified and in
some cases contacted; year-end staffing plans are being finalized; manual
work arounds are being documented and prioritization processes for problem
resolution are being developed.
While LNC is working to meet the various schedules outlined above, some
uncertainty remains. 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 uncertainties.
<PAGE>-15-
A worst case scenario might include LNC's inability to achieve Year 2000
readiness with respect to one or more of LNC's significant policyholder systems,
resulting 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 might be repaired and returned to production within a
matter of hours with no material impact. Unanticipated failures with a longer
service disruption period might have a more serious impact. For this reason, LNC
is placing significant emphasis on risk management and Year 2000 contingency
planning. As noted above, LNC is in the process of modifying its contingency
plans to address potential Year 2000 issues. Where these efforts identify either
high risks due to unacceptable work around procedures or significant readiness
risks, appropriate risk management techniques are being defined. These
techniques, such as resource shifting or use of alternate providers, will be
employed if needed 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 mitigate identified worst case scenarios.
REVIEW OF CONSOLIDATED FINANCIAL CONDITION
Investments
The total investment portfolio increased $200.0 million in the first three
months of 1999. This is the net result of purchases of investments from cash
flow generated by the business segments being partially offset by the decrease
in the fair value of securities available-for-sale, and by fixed annuity
contractholders opting to transfer funds to variable annuity contracts.
The quality of LNC's fixed maturity securities portfolio as of March 31,1999 was
as follows:
Treasuries and AAA 26.3% BBB 32.0%
AA 7.0% BB 4.4%
A 27.6% Less than BB 2.7%
As of March 31, 1999, $2.2 billion or 7.1% of fixed maturity securities was
invested in below investment grade securities (less than BBB). This represents
5.7% 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 three
months ended March 31, 1999, the aggregate cost of such investments purchased
was $204.4 million. Aggregate proceeds from such investments sold were $215.8
million, resulting in a net realized pre-tax loss at the time of sale of $22.9
million.
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 March 31, 1999, mortgage loans on real estate and real estate represented
11.4% and 1.2% of LNC's total investment portfolio, respectively. As of March
31, 1999, the underlying properties supporting the mortgage loans on real estate
consisted of 26.3% in commercial office buildings, 31.1% in retail stores, 19.1%
in apartments, 12.9% in industrial buildings, 5.0% in hotels/motels and 5.6% in
other. In addition to the dispersion by property type, the mortgage loan
portfolio is geographically diversified throughout the United States.
<PAGE>-16-
The following summarizes key information on mortgage loans:
<TABLE>
<CAPTION>
March 31 December 31
(in millions) 1999 1998
------------- ---- ----
<S> <C> <C>
Total Portfolio (net of reserves)...................................... $4,344.6 $4,393.1
Mortgage loans two or more payments
delinquent (incl. in process of foreclosure).......................... 5.2 2.4
Restructured loans in good standing.................................... 31.5 32.0
Reserve for mortgage loans............................................. 4.7 4.8
</TABLE>
Fixed maturity securities available-for-sale, mortgage loans on real estate and
real estate that were non-income producing for the three months ended March 31,
1999 were not significant.
Cash and Invested Cash
Cash and invested cash decreased by $106.3 million in the first three months of
1999, primarily as a result of the purchase and retirement of 617,500 shares of
common stock at a cost of $60.3 million.
Deferred Acquisition Costs
Deferred acquisition costs increased $147.8 million during the first three
months of 1999 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.
Premiums and Fees Receivable
Premiums and fees receivable decreased $4.4 million in the first three months of
1999 as the result of collection of premium receipts from high fourth quarter
sales in the Life Insurance & Annuities segment.
Assets Held in Separate Accounts
This asset account as well as the corresponding liability account increased by
$930.5 million in the first three months of 1999 reflecting an increase in
annuity funds under management. This increase resulted from new deposits and
market appreciation.
Goodwill and Other Intangible Assets
The decrease in these amounts is the result of the amortization of account
balances for the three months ended March 31, 1999 and the adjustment made to
goodwill resulting from reaching final settlement with the seller as to the
value of assets and liabilities transferred to Lincoln on the business acquired
January 2, 1998 (see note 8 on page 11).
Other Assets
The increase in other assets of $287.8 million is the result of having a higher
receivable related to investment securities sold in the last few days of the
first quarter of 1999 versus the end of 1998.
Total Liabilities
Total liabilities increased by $1.8 billion in the first three months of 1999.
Insurance policy reserves increased $104.3 million. Contractholder funds
decreased $152.2 million which is the net result of new deposits being less than
offset by the withdrawal upon maturity of guaranteed interest contracts.
Liabilities related to separate accounts increased $930.5 million (see
discussion of Assets Held in Separate Accounts above). Total debt decreased
$32.8 million. All other liabilities increased $944.6 million as a result of an
increase in certain investing activities during the first three months of 1999.
LNC's liabilities include some contingency items (see note 4 on page 7).
Shareholders' Equity
Total shareholders' equity decreased $280.5 million in the first three months of
1999. Excluding the decrease of 297.7 million related to a decrease in the
unrealized gains on securities available-for-sale, shareholders' equity
increased $17.2 million. This increase was the net result of increases due to
$145.1 million from net income, $3.8 million from the issuance of common stock
related to benefit plans and $3.7 million from the issuance of common stock
related to the acquisition of subsidiaries and being offset by a decrease of
$19.8 million in the cumulative foreign currency translation adjustment, $60.3
million for the repurchase of common shares and $55.1 million for the
declaration of dividends to shareholders.
<PAGE>-17-
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 $537.7 million during the first three months of
1999. 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. As of March 31, 1999, LNC has a shelf registration with
an unused balance of $825 million that would allow LNC to issue a variety of
securities, including debt, preferred stock, common stock and hybrid securities.
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 purchase and retirement of 617,500 shares of common stock
at a cost of $60.3 million in the first three months of 1999. The common shares
purchased in 1999, along with shares purchased in 1997 and 1998, have reduced
the June 1997 board authorization of $500 million to $97.9 million at March 31,
1999. As of April 30, 1999, additional repurchases have reduced the board
authorization to $46.7 million.
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 4 on page 7, the acquisition of two blocks of business in 1998
placed 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 statutory
earned surplus is negative and it is necessary for Lincoln Life to obtain the
prior approval of the Indiana Insurance Commissioner before paying any dividends
to LNC until such time as statutory earned surplus is positive. Statutory earned
surplus could return to a positive position within two years from the closing of
the Aetna transaction 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 or if dividends are approved or paid at
amounts higher then recent history the statutory earned surplus may not return
to a positive position in a two year time frame. 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.
Item 3 Quantitative and Qualitative Disclosure of Market Risk
In Item 7A of Part II for the year ended December 31, 1998 (see page 28 of LNC's
Form 10-K), LNC provided a discussion of its market risk. During the first
quarter of 1999, there was no substantive change to LNC's market risk. The
following is a discussion of changes to LNC's derivative positions.
Derivatives
<PAGE>-18-
As discussed in note 7 to the consolidated financial statements for the year
ended December 31, 1998 (see page 57 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. During the first three months of 1999, the
more significant changes in LNC's derivative positions are 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
$4.1 billion notional to $3.6 billion notional. The decrease in notional
is a result of expirations and, therefore, no gain or loss has been
recognized.
2. Increased its use of interest rate swap agreements from $258.3 million
notional to $268.0 million notional. During the quarter, $0.6 million
notional expired with no gain or loss recognized. These interest rate
swap agreements are part of a replication strategy which will result in a
higher yield on bonds held by LNC.
3. Decreased its use of foreign currency swaps that are hedging the foreign
currency risk of its portfolio of foreign bonds from $47.2 million
notional to $44.3 million notional. This reduction in notional resulted
in a recognized gain of $0.3 million. These foreign currency swaps 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.
4. Decreased its use of FTSE index call options from $11.1 million notional
to $7.5 million notional. As a result of this termination, a $1.3 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.
5. Increased its use of S&P 500 index options from $79.9 million notional to
$83.2 million notional. New options in the amount of $5.8 million were
entered into during the quarter and $2.4 million were terminated,
resulting in a $0.1 million gain. These call 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.
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.
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) No reports on Form 8-K were filed during the quarter ended March 31, 1999.
<PAGE>-19-
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. VanWyngarden
Donald L. VanWyngarden
Second Vice President and
Controller
Date May 10, 1999
<PAGE>-20-
LINCOLN NATIONAL CORPORATION
Exhibit Index for the Report on Form 10-Q
for the Quarter Ended March 31, 1999
Exhibit Number Description Page Number
12 Historical Ratio of Earnings to
Fixed Charges 21
27 Financial Data Schedule 22
<PAGE>-21-
LINCOLN NATIONAL CORPORATION AND SUBSIDIARIES
EXHIBIT 12 - HISTORICAL RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
Three Months
Ended March 31 Year Ended December 31,
-----------------------
(millions of dollars) 1999 1998 1998 1997(4) 1996 1995 1994
- --------------------- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Net Income before Federal
Income Taxes and
Accounting Change.................. 204.5 166.4 697.4 1427.1 692.7 626.6 376.3
Equity Loss (Earnings) in
Unconsolidated Affiliates.......... (1.6) (1.5) (3.3) (2.1) (1.4) (12.4) (14.6)
Sub-total of Fixed Charges.......... 39.9 28.9 144.1 113.3 108.6 94.4 66.6
----- ----- ----- ------ ------ ---- ----
Sub-total of Adjusted
Net Income...................... 242.8 193.8 838.2 1538.3 799.9 708.6 428.3
Interest on Annuities &
Financial Products................. 359.1 378.6 1446.2 1253.5 1185.6 1147.1 1064.5
----- ----- ------ ------ ------ ------ ------
Adjusted Income Base............ 601.9 572.4 2284.4 2791.8 1985.5 1855.7 1492.8
Rent Expense........................ 20.3 16.5 81.3 62.5 71.6 65.7 51.3
Fixed Charges:
Interest and Debt Expense........... 33.1 23.4 117.1 92.5 84.7 72.5 49.5
Rent (Pro-rated).................... 6.8 5.5 27.0 20.8 23.9 21.9 17.1
---- ---- ----- ------- ---- ---- ----
Sub-total of Fixed Charges....... 39.9 28.9 144.1 113.3 108.6 94.4 66.6
Interest on Annuities &
Financial Products................. 359.1 378.6 1446.2 1253.5 1185.6 1147.1 1064.5
----- ----- ------ ------- ------ ------ ------
Sub-total of Fixed Charges....... 399.0 407.5 1590.3 1366.8 1294.2 1241.5 1131.1
Preferred Dividends (Pre-tax)....... * * .1 .2 .2 13.4 24.2
----- ----- ------ ------ ----- ------ ------
Total Fixed Charges.............. 399.0 407.5 1590.4 1367.0 1294.4 1254.9 1155.3
*Less than $100,000
Ratio of Earnings to Fixed Charges:
Excluding Interest on
Annuities and Financial
Products (1) ..................... 6.09 6.71 5.82 13.57 7.37 7.51 6.43
Including Interest on
Annuities and Financial
Products (2)...................... 1.51 1.40 1.44 2.04 1.53 1.49 1.32
Ratio of Earnings to
Combined Fixed Charges
and Preferred Stock
Dividends (3)..................... 1.51 1.40 1.44 2.04 1.53 1.48 1.29
</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 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.
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
LINCOLN NATIONAL CORPORATION AND SUBSIDIARIES
EXHIBIT 27 - FINANCIAL DATA SCHEDULE
<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> 3-MOS
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-START> Jan-01-1999
<PERIOD-END> Mar-31-1999
<DEBT-HELD-FOR-SALE> 30,577,880,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 480,815,000
<MORTGAGE> 4,344,590,000
<REAL-ESTATE> 471,831,000
<TOTAL-INVEST> 38,129,442,000
<CASH> 2,327,046,000
<RECOVER-REINSURE> 3,124,498,000
<DEFERRED-ACQUISITION> 2,112,187,000
<TOTAL-ASSETS> 95,350,278,000
<POLICY-LOSSES> 20,244,319,000
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 20,600,875,000
<NOTES-PAYABLE> 1,738,988,000
0
1,046,000
<COMMON> 995,907,000
<OTHER-SE> 4,110,468,000
<TOTAL-LIABILITY-AND-EQUITY> 95,350,278,000
817,064,000
<INVESTMENT-INCOME> 709,538,000
<INVESTMENT-GAINS> 1,927,000
<OTHER-INCOME> 146,829,000
<BENEFITS> 891,234,000
<UNDERWRITING-AMORTIZATION> 74,848,000
<UNDERWRITING-OTHER> 471,687,000
<INCOME-PRETAX> 204,485,000
<INCOME-TAX> 59,423,000
<INCOME-CONTINUING> 145,062,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 145,062,000
<EPS-PRIMARY> 1.44
<EPS-DILUTED> 1.42
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
