<PAGE> 1
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, 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.)
1500 MARKET STREET, SUITE 3900,
PHILADELPHIA, PENNSYLVANIA 19102-2112
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER (215) 448-1400
As of October 29, 1999 LNC had 195,472,893 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 25.
<PAGE> 2
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
(000s omitted) 1999 1998
-------------- ---- ----
ASSETS (Unaudited)
<S> <C> <C>
Investments:
Securities available-for-sale, at fair value:
Fixed maturity (cost 1999 - $28,974,353;
1998 - $28,639,558) $28,708,389 $30,232,892
Equity (cost 1999 - $414,049;
1998 - $436,718) 506,615 542,843
Mortgage loans on real estate 4,772,684 4,393,082
Real estate 280,303 488,722
Policy loans 1,863,209 1,839,970
Other investments 401,182 431,964
----------- -----------
Total Investments 36,532,382 37,929,473
Investment in unconsolidated affiliates 23,382 18,811
Cash and invested cash 2,342,946 2,433,350
Property and equipment 191,852 174,762
Deferred acquisition costs 2,614,500 1,964,366
Premiums and fees receivable 296,005 246,203
Accrued investment income 602,874 528,500
Assets held in separate accounts 46,228,846 43,408,858
Federal income taxes 457,268 204,075
Amounts recoverable from reinsurers 3,315,649 3,127,093
Goodwill 1,435,022 1,484,343
Other intangible assets 1,760,639 1,848,442
Other assets 699,308 467,984
----------- -----------
Total Assets $96,500,673 $93,836,260
</TABLE>
See notes to consolidated financial statements on pages 7 - 14.
2
<PAGE> 3
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
-CONTINUED-
<TABLE>
<CAPTION>
September 30, December 31,
(000s omitted) 1999 1998
------------- ---- ----
(Unaudited)
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES:
Insurance and Investment Contract Liabilities:
Insurance policy and claim reserves $ 20,496,898 $ 20,139,982
Contractholder funds 20,555,071 20,753,064
Liabilities related to separate accounts 46,228,846 43,408,858
------------ ------------
Total Insurance and Investment Contract Liabilities 87,280,815 84,301,904
Short-term debt 367,731 314,610
Long-term debt 712,003 712,171
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 745,000 745,000
Other liabilities 2,732,967 2,374,634
------------ ------------
Total Liabilities 91,838,516 88,448,319
SHAREHOLDERS' EQUITY:
Series A preferred stock-10,000,000 shares authorized
(9/30/99 liquidation value - $2,367) 972 1,083
Common stock - 800,000,000 shares authorized 983,707 994,472
Retained earnings 3,741,048 3,790,038
Accumulated Other Comprehensive Income (Loss):
Foreign currency translation adjustment 40,240 49,979
Net unrealized gain (loss) on securities available-for-sale (103,810) 552,369
------------ ------------
Total Accumulated Other Comprehensive Income (Loss) (63,570) 602,348
------------ ------------
Total Shareholders' Equity 4,662,157 5,387,941
------------ ------------
Total Liabilities and Shareholders' Equity $ 96,500,673 $ 93,836,260
</TABLE>
See notes to consolidated financial statements on pages 7 - 14.
3
<PAGE> 4
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, September 30,
(000s omitted, except per share amounts) 1999 1998 1999 1998
---------------------------------------- ---- ---- ---- ----
(Unaudited) (Unaudited)
REVENUE:
<S> <C> <C> <C> <C>
Insurance premiums $ 1,286,781 $ 1,108,096 $ 413,402 $ 386,532
Insurance fees 1,151,336 919,450 392,508 291,148
Investment advisory fees 169,705 169,510 54,605 52,470
Net investment income 2,107,426 1,966,687 697,050 649,608
Equity in earnings (loss)
of unconsolidated affiliates 3,958 800 1,239 (738)
Realized gain (loss) on investments 3,285 22,711 5,407 (26,753)
Other revenue and fees 273,321 185,850 77,915 65,324
----------- ----------- ----------- -----------
Total Revenue 4,995,812 4,373,104 1,642,126 1,417,591
BENEFITS AND EXPENSES:
Benefits 2,683,800 2,349,283 886,341 766,143
Underwriting, acquisition,
insurance and other expenses 1,623,619 1,414,098 539,326 471,824
Interest and debt expense 99,005 83,578 33,269 32,538
----------- ----------- ----------- -----------
Total Benefits and Expenses 4,406,424 3,846,959 1,458,936 1,270,505
----------- ----------- ----------- -----------
Net Income Before Federal Income Taxes 589,388 526,145 183,190 147,086
Federal income taxes 163,659 141,974 50,873 33,637
----------- ----------- ----------- -----------
Net Income $ 425,729 $ 384,171 $ 132,317 $ 113,449
NET INCOME PER COMMON SHARE-BASIC $2.14 $1.91 $ .67 $ .56
NET INCOME PER COMMON SHARE-DILUTED $2.11 $1.89 $ .66 $ .56
</TABLE>
See notes to consolidated financial statements on pages 7 - 14.
4
<PAGE> 5
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Nine Months Ended September 30,
Number of Shares Amounts
(000s omitted from dollar amounts) 1999 1998 1999 1998
---------------------------------- ---- ---- ---- ----
(Unaudited) (Unaudited)
<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 (3,377) (2,025) (111) (67)
------------ ------------ ------------ ------------
Balance at September 30 29,582 33,066 972 1,086
COMMON STOCK:
Balance at beginning-of-year 202,111,174 201,718,956 994,472 966,461
Conversion of series A preferred stock 54,032 32,400 111 67
Issued for benefit plans 843,438 1,558,260 37,222 27,238
Issued for acquisition of subsidiaries 86,228 -- 3,547 --
Retirement of common stock (7,309,100) (1,246,562) (51,645) (5,972)
Certain issuance costs related to
Feline Prides -- -- -- (14,834)
------------ ------------ ------------ ------------
Balance at September 30 195,785,772 202,063,054 983,707 972,960
RETAINED EARNINGS:
Balance at beginning-of-year 3,790,038 3,533,105
Comprehensive income (loss) (240,189) 735,534
Less other comprehensive income (loss):
Foreign currency translation (9,739) 13,623
Net unrealized gain (loss) on
securities available-for-sale (656,179) 337,740
--------- -----------
Net Income 425,729 384,171
Retirement of common stock (311,880) (40,899)
Dividends declared:
Series A preferred ($2.25 per share) (68) (77)
Common stock (1999-$.825; 1998-$.780) (162,771) (156,297)
--------- -----------
Balance at September 30 3,741,048 3,720,003
FOREIGN CURRENCY TRANSLATION ADJUSTMENT:
Accumulated adjustment at
beginning-of-year 49,979 46,204
Change during the period (9,739) 13,623
--------- ------------
Balance at September 30 40,240 59,827
NET UNREALIZED GAIN (LOSS) ON
SECURITIES AVAILABLE-FOR-SALE:
Balance at beginning-of-year 552,369 435,992
Change during the period (656,179) 337,740
---------- ------------
Balance at September 30 (103,810) 773,732
Total Shareholders' Equity at
September 30 $4,662,157 $5,527,608
COMMON STOCK AT END OF QUARTER:
Assuming conversion of preferred stock 196,259,084 202,592,110
Diluted basis 196,913,728 203,915,422
</TABLE>
See notes to consolidated financial statements on pages 7 - 14.
5
<PAGE> 6
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
(000s omitted) 1999 1998
-------------- ---- ----
(Unaudited) (Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 425,729 $ 384,171
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred acquisition costs (216,105) (152,233)
Premiums and fees receivable (49,802) (44,096)
Accrued investment income (74,374) (124,241)
Policy liabilities and accruals 133,764 171,341
Contractholder funds 755,302 592,868
Amounts recoverable from reinsurers (188,556) (103,753)
Federal income taxes 96,796 134,467
Equity in earnings of unconsolidated affiliates (3,958) (800)
Provisions for depreciation 45,753 40,676
Amortization of goodwill and other intangible assets 112,724 89,426
Realized gain on investments (3,285) (22,711)
Other 116,970 (110,981)
----------- -----------
Net Adjustments 725,229 469,963
----------- -----------
Net Cash Provided by Operating Activities 1,150,958 854,134
CASH FLOWS FROM INVESTING ACTIVITIES:
Securities-available-for-sale:
Purchases (4,994,567) (8,927,928)
Sales 2,960,393 7,091,988
Maturities 1,720,835 1,494,166
Purchase of other investments (1,597,035) (948,151)
Sale or maturity of other investments 1,470,135 1,332,759
Purchase of affiliates/blocks of business -- (1,426,000)
Increase in cash collateral on loaned securities 234,731 256,954
Other (313,769) (143,519)
----------- -----------
Net Cash Used in Investing Activities (519,277) (1,269,731)
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in long-term debt (includes payments and
transfer to short-term debt) (369) (99,883)
Issuance of long-term debt -- 300,796
Net increase in short-term debt 53,121 57,231
Issuance of preferred securities of subsidiary companies -- 430,000
Certain issuance costs related to Feline Prides -- (14,834)
Universal life and investment contract deposits 1,497,351 886,049
Universal life and investment contract withdrawals (1,787,981) (2,036,732)
Common stock issued for benefit plans 37,350 27,238
Retirement of common stock (356,722) (46,871)
Dividends paid to shareholders (164,835) (156,748)
----------- -----------
Net Cash Used in Financing Activities (722,085) (653,754)
----------- -----------
Net Decrease in Cash and Invested Cash (90,404) (1,069,351)
Cash and Invested Cash at Beginning-of-Year 2,433,350 3,794,706
----------- -----------
Cash and Invested Cash at September 30 $ 2,342,946 $ 2,725,355
</TABLE>
See notes to consolidated financial statements on pages 7 - 14.
6
<PAGE> 7
LINCOLN NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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
divided into four business segments. The collective group of companies uses
"Lincoln Financial Group" as its marketing identity. Less than majority-owned
entities in which LNC has at least a 20% interest are reported on the equity
basis. These unaudited consolidated financial 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 nine months ended September 30, 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 ("FASB"), issued
Statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("FAS 133"), which may be adopted at the
beginning of any fiscal quarter but no later than the first quarter of 2000. In
July 1999, the FASB issued Statement of Financial Accounting Standard No. 137,
"Accounting for Derivative Instruments and Hedging Activities-Deferral of the
Effective Date of FASB Statement No. 133" ("FAS 137"), which delays the
effective date of FAS 133 one year (i.e., adoption required no later than the
first quarter of 2001). LNC has not completed the analysis necessary to provide
a precise estimate of the effects of the standard or to decide whether to the
adopt the standard prior to 2001.
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 consolidated 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. SUPPLEMENTAL FINANCIAL DATA
Details underlying the income statement caption, "Underwriting, Acquisition,
Insurance and Other Expenses," are as follows:
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, September 30,
(in millions) 1999 1998 1999 1998
------------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C>
Commissions $ 671.7 $ 528.0 $ 234.2 $ 184.2
Other volume related expenses 186.2 100.4 67.5 42.4
Operating and administrative expenses 898.9 816.7 285.9 265.7
Deferred acquisition costs net of
amortization (227.6) (125.8) (75.0) (37.0)
Restructuring charges 21.8 30.8 4.9 --
Other 72.6 64.0 21.8 16.5
---------- ---------- -------- --------
Total $ 1,623.6 $ 1,414.1 $ 539.3 $ 471.8
</TABLE>
7
<PAGE> 8
5. COMMON STOCK SPLIT
On May 13, 1999, LNC's Board of Directors approved a
two-for-one stock split for its common stock. The record date for the stock
split was June 4, 1999 and the additional shares were distributed to
shareholders on June 21, 1999. All shares and per share amounts in the
consolidated financial statements have been adjusted to reflect the effects of
the common stock split for all periods presented. Following this common stock
split, the conversion rate of LNC's preferred stock series A changed from eight
shares of common stock to sixteen shares of common stock for each series A
preferred stock.
6. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES
STATUTORY RESTRICTIONS. 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 Corporation in January 1998 and
the domestic individual life insurance business from Aetna, Inc. in October
1998. These acquisitions were structured as indemnity reinsurance transactions.
Statutory accounting regulations do not allow goodwill to be recognized on
indemnity reinsurance transactions and therefore, the related ceding commission
flows through the statutory statement of operations as an expense resulting in a
reduction of earned surplus. As a result of these acquisitions and dividends
declared, Lincoln Life's statutory earned surplus is negative. 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. The time frame for statutory earned surplus to
return to a positive position is dependent upon future statutory earnings and
dividends paid by Lincoln Life. Although no assurance can be given that
additional dividends to LNC will be approved, during the second quarter 1999,
Lincoln Life received regulatory approval and paid an extraordinary dividend of
$350 million to LNC. In the event such approvals are not obtained in the future,
management believes that LNC can obtain the funds required to satisfy its
obligations from its existing credit facilities and other sources.
DISABILITY INCOME CLAIMS. The liabilities for disability income claims net of
the related assets for amounts recoverable from reinsurers at September 30, 1999
and December 31, 1998 are $1.847 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 developments will not materially affect
the consolidated financial position of LNC. LNC reviews reserve levels on an
on-going basis.
On November 1, 1999, LNC closed its previously announced agreement to transfer
a block of disability income business to MetLife. Under this indemnity
reinsurance agreement, LNC transferred approximately $495.4 million of cash to
MetLife representing the statutory reserves transferred on this business, net
of $18.5 million of purchase price consideration. Although a gain on the sale
is expected, all related calculations have not yet been finalized. Once these
calculations are finalized, the gain will be deferred and recognized in future
periods over the life of the business.
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 must 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, 1999 and December
31, 1998, liabilities of $127.0 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 nine months ended
September 30, 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 $83.2 million and
$84.9 million at September 30, 1999 and December 31, 1998, respectively.
8
<PAGE> 9
Recent actions by regulatory authorities have raised industry-wide concerns with
respect to the ultimate costs of addressing these matters. These actions fall
into three general areas. First, regulators have mandated the use of updated
mortality tables. This will increase the costs of settlements by increasing the
expected period of payments. Second, preliminary regulatory guidance has been
issued indicating that policies which were sold to clients making additional
voluntary pension contributions (Free Standing Additional Voluntary
Contributions - FSAVC) might have to be included in determining whether
individuals received appropriate advice. Definitive guidance on this point is
expected by the end of 1999. Finally, regulators have revised prior guidance
that had indicated that simplified settlement procedures would be allowed. By
eliminating simplified procedures, additional administration and settlement
costs may be incurred.
LNC is continuing to evaluate the potential effects of these developments upon
the previously established liability relating to these matters. LNC is also in
the process of analyzing policyholder responses to mandated correspondence on
these matters. This analysis will continue during the fourth quarter of 1999.
There is significant uncertainty concerning the developing regulatory matters
and in the previous assumptions underlying the reserves that have been
established. Accordingly, it is not possible to provide a meaningful estimate of
the potential increase in reserves that may be required; but the increase could
be significant. However, it is management's opinion that the resolution of these
matters 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 $175.6
million and $177.4 million at September 30, 1999 and December 31, 1998,
respectively. These amounts are based on various estimates that are subject to
considerable uncertainty. Accordingly, the liabilities 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 its investigation into its participation in workers' compensation
carve out (i.e., life and health risks associated with workers' compensation
coverage) programs managed by Unicover Managers, Inc. Two of Unicover's
retrocessionaires have initiated arbitration to attempt to rescind its
reinsurance coverage to the carriers participating in Unicover programs. LNC
denies the validity of these actions. At this time, LNC (1) does not have
sufficient information to determine whether or not it is probable that
additional losses have been incurred in relation to these programs, and (2)
cannot accurately estimate the ultimate cost or timing of the outcome on these
programs.
HMO EXCESS-OF-LOSS REINSURANCE PROGRAMS. During the third quarter of 1999, an
in-depth review was conducted of claims and loss ratios on the HMO
excess-of-loss reinsurance programs written by LNC's Reinsurance segment. As a
result of this review, the reserve level was deemed inadequate to meet future
obligations. Therefore, LNC's Reinsurance segment took a charge of $25 million
after tax ($38.5 million pre-tax) to strengthen reserves for claims on certain
HMO excess-of-loss reinsurance programs. The liability for HMO claims, net of
the related assets for amounts recoverable from reinsurers, was $107.3 million
at September 30, 1999. LNC reviews reserve levels on an ongoing basis. The
liability is based on the assumption that recent experience will continue in the
future. If claims and loss ratios fluctuate significantly from the assumptions
underlying the reserves, adjustments to reserves could be required in the
future. Accordingly, the 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.
In light of the continued volatility of this line of business, LNC discontinued
writing new HMO excess-of-loss reinsurance programs in the third quarter of
1999. Consequently, during the third quarter of 1999, LNC recorded a charge in
the Reinsurance segment of $3.2 million after tax ($4.9 million pre-tax) for
employee severance and other costs related to the discontinuance of the
business.
9
<PAGE> 10
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.
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.
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.
SEGUROS SERFIN LINCOLN. In December 1997, LNC invested $85 million for a 49%
share of Seguros Serfin Lincoln ("SSL"), a Mexican bancassurance company, that
sells life, auto and homeowners insurance to the customers of Banca Serfin.
Grupo Financiero Serfin S.A. ("GFS") owns 51% of SSL and 100% of Banca Serfin.
On July 8, 1999, the private shareholders of GFS declined to contribute
additional capital to Banca Serfin as required by the Mexican Government.
Accordingly, the Bank Savings Protection Institute ("IPAB"), a government
agency, took control of GFS. IPAB has injected capital into Banca Serfin and has
indicated its intent to place GFS up for sale.
Under the terms of the Shareholders Agreement with GFS, LNC now has the right to
put its investment in SSL to GFS for an amount equal to the LNC's initial
investment in SSL plus a 7% annual return. LNC has given GFS notice of its
decision to exercise its put. Given these contractual rights and the status of
ongoing discussions with GFS and IPAB concerning these matters, LNC believes
that it will recover the value of its investment in SSL along with a 7% annual
return on that investment.
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 materially affect the consolidated financial position of LNC.
With the recent filing of a lawsuit alleging fraud in the sale of interest
sensitive universal and whole life insurance policies, Lincoln Life now has
three such actions pending. While they each seek class action status, the court
has not certified a class in any of these cases. Two other similar 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 discovery 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.
10
<PAGE> 11
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) 1999 1998 1999 1998
------------- ---------- ---------- ---------- ----------
REVENUE: (Reclassified) (Reclassified)
<S> <C> <C> <C> <C>
Life Insurance and Annuities $ 3,107.6 $ 2,599.9 $ 1,042.6 $ 825.4
Lincoln UK 342.8 330.5 110.6 102.8
Reinsurance 1,244.2 1,120.8 403.9 391.2
Investment Management 341.6 344.2 110.5 108.2
Other Operations (includes consolidating adjustments) (40.4) (22.3) (25.5) (10.0)
---------- ---------- ---------- ----------
Total $ 4,995.8 $ 4,373.1 $ 1,642.1 $ 1,417.6
NET INCOME (LOSS) BEFORE FEDERAL INCOME TAXES:
Life Insurance and Annuities $ 506.9 $ 368.0 $ 183.8 $ 106.7
Lincoln UK 72.7 80.6 20.5 21.9
Reinsurance 83.8 121.1 (0.6) 41.9
Investment Management 21.6 22.4 12.3 2.3
Other Operations (includes interest expense) (95.6) (66.0) (32.8) (25.7)
---------- ---------- ---------- ----------
Total $ 589.4 $ 526.1 $ 183.2 $ 147.1
FEDERAL INCOME TAXES (CREDITS):
Life Insurance and Annuities $ 140.0 $ 88.7 $ 53.5 $ 23.4
Lincoln UK 18.3 28.1 4.1 4.0
Reinsurance 29.7 42.2 (0.0) 14.4
Investment Management 9.3 11.3 4.1 2.4
Other Operations (33.6) (28.4) (10.8) (10.6)
---------- ---------- ---------- ----------
Total $ 163.7 $ 141.9 $ 50.9 $ 33.6
NET INCOME (LOSS):
Life Insurance and Annuities $ 366.9 $ 279.3 $ 130.3 $ 83.3
Lincoln UK 54.4 52.5 16.4 17.8
Reinsurance 54.1 78.9 (0.6) 27.6
Investment Management 12.3 11.1 8.2 (0.1)
Other Operations (includes interest expense) (62.0) (37.6) (22.0) (15.2)
---------- ---------- ---------- ----------
Total $ 425.7 $ 384.2 $ 132.3 $ 113.4
</TABLE>
<TABLE>
<CAPTION>
September 30, December 31,
(in millions) 1999 1998
------------- ---- ----
ASSETS:
<S> <C> <C>
Life Insurance and Annuities $ 75,733.6 $ 73,966.1
Lincoln UK 9,057.4 8,757.3
Reinsurance 6,526.6 6,408.0
Investment Management 1,500.6 1,622.6
Other Operations 3,682.5 3,082.3
----------- -----------
Total $ 96,500.7 $ 93,836.3
</TABLE>
Select data shown above for the Life Insurance & Annuities segment, Investment
Management segment and Other Operations for the three months and nine months
ended September 30, 1998 has been reclassified due to a change in the reporting
relationship for LNC's internal investment advisor and 401(k) pension unit.
11
<PAGE> 12
8. EARNINGS PER SHARE
Per share amounts for net income 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, after consideration of the June 1999
two-for-one stock split (see Note 5). Reconciliations of the factors used in the
two calculations are as follows:
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, September 30,
Numerator: [in millions] 1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income as used in basic calculation $ 425.7 $ 384.1 $ 132.3 $ 113.4
Dividends on convertible preferred stock * .1 * *
------- --------- -------- --------
Net income as used in diluted calculation $ 425.7 $ 384.2 $ 132.3 $ 113.4
* Less than $100,000
</TABLE>
<TABLE>
DENOMINATOR: [NUMBER OF SHARES]
<S> <C> <C> <C> <C>
Weighted average shares, as used
in basic calculation 198,882,557 200,631,506 196,394,953 200,850,884
Shares to cover conversion of
preferred stock 500,208 546,678 482,822 537,080
Shares to cover non-vested stock 503,848 407,792 490,505 522,980
Average stock options outstanding
during the period 8,129,319 6,434,058 12,498,969 9,638,970
Assumed acquisition of shares
with assumed proceeds and tax
benefits from exercising stock options
(at average market price during the period) (6,482,746) (4,466,066) (10,877,413) (7,685,860)
------------ ------------ ------------ ------------
Weighted-average shares, as
used in diluted calculation 201,533,186 203,553,968 198,989,836 203,864,054
</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 dilutive to LNC's earnings per
share as of September 30, 1999 and will not be dilutive in the future except
during periods when the average market price of LNC's common stock exceeds a
threshold price of $55.725 per share.
9. COMPREHENSIVE INCOME (LOSS)
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, September 30,
(in millions) 1999 1998 1999 1998
------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 425.7 $384.2 $ 132.3 $113.4
Foreign currency translation (9.7) 13.6 19.6 8.0
Net unrealized gain (loss) on securities (656.2) 337.7 (102.7) 304.2
------- ------ ------- ------
Comprehensive Income (Loss) $(240.2) $735.5 $ 49.2 $425.6
</TABLE>
10. ACQUISITIONS AND DIVESTITURES
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.
12
<PAGE> 13
As of September 30, 1999, the application of purchase accounting to this block
of business, net of the administration rights sold and net of amortization,
resulted in goodwill and other intangible assets of $754.9 million and $419.0
million, respectively. The goodwill amount shown includes adjustments to the
amount shown at December 31, 1998. These first quarter 1999 adjustments
resulted from reaching final agreement with the seller as to the value of the
assets and liabilities transferred to LNC.
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 September 30, 1999, the application of purchase accounting to
this block of business, net of the sponsored life business and net of
amortization, resulted in goodwill and other intangible assets of $223.8 million
and $797.4 million, respectively. 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 the third quarter 1998 public securities offerings
from available shelf registrations.
For the 1998 acquisitions noted above, other intangible assets represent the
present value of future profits on the blocks of acquired insurance businesses.
Goodwill is amortized over 40 years and other intangible assets are amortized
over the lives of the businesses acquired.
On September 13, 1999, LNC announced that it had reached an agreement to
purchase Alden Risk Management Services, the employer medical stop-loss business
of the John Alden Life Insurance Company for $41.5 million in cash. The
agreement also includes the purchase of a block of group life and accidental
death and dismemberment business. The purchase closed on November 1, 1999.
11. RESTRUCTURING CHARGES
In 1998, LNC implemented a restructuring plan related to the integration of
existing operations with the new business operations acquired from CIGNA
Corporation, and a second restructuring plan related to downsizing LNC's
corporate center operations. The aggregate charges associated with these two
restructuring plans totaled $34.3 million after-tax ($52.8 million pre-tax).
These aggregate pre-tax costs include $19.6 million for employee severance and
termination benefits, $9.9 million for asset impairments and $23.3 million for
costs relating to exiting business activities. As of September 30, 1999, actual
pre-tax costs of $45.4 million have been expended or written-off under these
restructuring plans and a balance of $7.4 million pre-tax remains in the
restructuring reserves for these 1998 plans. LNC anticipates that the remaining
reserves will be utilized in completing these restructuring plans. Details of
each of these 1998 restructuring plans are provided below.
During the first quarter of 1998, the operations of the Life Insurance and
Annuities segment were restructured to downsize and integrate existing
operations with the new business operations acquired from CIGNA Corporation. LNC
recorded a charge of $30.8 million (pre-tax) related to this restructuring plan.
This charge was included in Underwriting, Acquisition, Insurance and Other
Expenses on the Consolidated Statement of Income for the year ended December 31,
1998. The overall objective of this restructuring plan is to downsize the
existing life insurance operations in Fort Wayne, Indiana and to move the
platform for these operations to Hartford, Connecticut. The restructuring plan
identified $10.7 million (pre-tax) for severance and employee termination costs
related to the elimination of 211 positions and $20.1 million (pre-tax) for
the merging and closing of field offices and for the merging and reduction of
duplicative policyholder administrative systems. These actions were required as
part of this restructuring plan in order to eliminate redundancies in existing
operations resulting from the acquisition of the CIGNA block of business. These
restructuring activities are expected to be complete by the end of 1999. As of
September 30, 1999, $29.6 million (pre-tax) has been expended or written-off
under this restructuring plan. At the present time, LNC anticipates that the
total costs of these activities may slightly exceed the remaining restructuring
reserve balance.
13
<PAGE> 14
During the fourth quarter of 1998, LNC completed an organizational expense
review which centered around the size and make-up of the parent company. LNC
recorded a restructuring charge of $22 million (pre-tax) relating to the
restructuring plan that resulted from this review. This charge was included in
Underwriting, Acquisition, Insurance and Other Expenses on the Consolidated
Statement of Income for the year ended December 31, 1998. The objectives of this
restructuring plan are to realign the activities and functions conducted within
the parent company, in light of the series of acquisitions and divestitures that
LNC executed in recent years, and to reduce overall costs in response to
increasing competitive pressures in the businesses that LNC operates. To achieve
these objectives, the restructuring plan includes reductions in the number of
corporate center employees along with a reduction in the size of LNC's
facilities. The following activities and associated costs are included in this
restructuring plan: (1) $8.9 million for severance and termination benefits
related to the elimination of 143 positions, (2) $9.9 million for the write-off
of leasehold improvements related to abandoned facilities and other impaired
assets, and (3) $3.2 million for rents on abandoned facilities. All expenditures
for severance and termination benefits under the plan are expected to be
complete by the end of 2000. Expenditures for rents on abandoned facilities are
expected to be complete by the end of 2004 consistent with the remaining lease
commitment. As of September 30, 1999, $15.8 million (pre-tax) has been expended
or written-off under this restructuring plan. LNC estimated a reduction in
future expenses of $15 million to $20 million per year after the plan was fully
implemented. The total annualized cost reduction achieved through September 30,
1999 was $19.5 million.
During the first nine months of 1999, LNC implemented one restructuring plan
related to the downsizing and consolidation of the operations of Lynch & Mayer,
Inc. and a second restructuring plan related to the discontinuance of the HMO
excess-of-loss reinsurance programs. The aggregate charges associated with these
two restructuring plans totaled $15.3 million after-tax ($21.8 million pre-tax).
These aggregate pre-tax costs include $4.4 million for employee severance and
termination benefits, $9.8 million for asset impairments and $7.6 million for
costs relating to exiting business activities. As of September 30, 1999, actual
pre-tax costs of $13.1 million pre-tax have been expended or written-off under
these restructuring plans and a balance of $8.7 million pre-tax remains in the
restructuring reserves for these 1999 plans. LNC anticipates that the remaining
reserves will be utilized in completing these restructuring plans. Details of
each of these 1999 restructuring plans are provided below.
During the first quarter of 1999, LNC recorded a restructuring charge in its
Investment Management segment for $16.9 million (pre-tax). The objective of this
restructuring plan is to downsize and consolidate the back office operations of
Lynch & Mayer, Inc. into Delaware Management Holdings, Inc., in order to reduce
ongoing operating costs and eliminate redundant facilities within this business
segment. This charge was included in Underwriting, Acquisition, Insurance and
Other Expenses on the unaudited Consolidated Statement of Income. The
restructuring plan identified the following activities and associated costs to
achieve the objectives of the restructuring plan: (1) severance and termination
benefits of $2.8 million related to the elimination of 34 positions, (2)
write-off of impaired assets of $9.8 million and (3) other costs of $4.3
million. Restructuring activities began in the first quarter of 1999, with all
expenditures under the plan anticipated to be completed by the second quarter of
2000. As of September 30, 1999, $13.1 million (pre-tax) has been expended or
written-off under this restructuring plan.
LNC discontinued writing new HMO excess-of-loss reinsurance programs in the
third quarter of 1999. Consequently, during the third quarter of 1999, LNC
recorded within its Reinsurance segment a charge of $4.9 million pre-tax for
employee severance and termination benefits, and other costs related to the
discontinuance of the business. This charge was included in Underwriting,
Acquisition, Insurance and Other Expenses on the unaudited Consolidated
Statement of Income. Restructuring activities will begin in the fourth quarter
of 1999 and will not be completed until the discontinuance of this business is
complete.
14
<PAGE> 15
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 nine months ended
September 30, 1999 compared to the results for the nine months ended September
30, 1998. The factors affecting the current quarter to prior 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 business from
Aetna in October 1998 (see Note 10 on page 13), select income statement accounts
increased in 1999 versus 1998.
LIFE INSURANCE AND ANNUITY PREMIUMS
Life insurance and annuity premiums for the first nine months of 1999 increased
$184.4 million or 29% when compared with the first nine months of 1998. These
increases were the result of increases in business volume from the Life
Insurance & Annuities and Reinsurance segments. Volume increases in the Life
Insurance and Annuities segment were primarily due to the acquisition of the
block of business described above. Volume increases in the Reinsurance segment
were due to elevated business levels in the Individual Markets line of business.
HEALTH PREMIUMS
Health premiums for the first nine months of 1999 decreased $5.7 million or 1%
due to decreased volumes of business in the Reinsurance segment. This was the
net result of increases in premiums from the group business being more than
offset by decreases from areas where reinsurance is curtailing its writing of
such coverages. Future periods are expected to have approximately $65 million
(annual amount) less in health premiums due to the sale of a block of disability
income business that closed on November 1, 1999 (see Note 6 on page 8). Also, in
the third quarter of 1999, LNC announced that it would discontinue writing HMO
excess-of-loss business which will impact future health premiums (see Note 6 on
page 9).
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 $231.9 million or 25% compared with the first
nine 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 mortality and
administrative fee assessments are based.
INVESTMENT ADVISORY FEES
Investment advisory fees for the first nine months of 1999 were essentially
equal to the comparable 1998 period. This was the net result of an increase in
fees generated by new sales and a market-driven increase in assets under
management offset by decreases in fees due to the withdrawal of funds.
NET INVESTMENT INCOME
Net investment income for the first nine months of 1999 increased $140.7 million
or 7% when compared with the first nine months of 1998. This increase was the
result of a 7% increase in mean invested assets, partially offset by a decrease
in the overall yield on investments from 7.29% to 7.20% (all calculations on a
cost basis). The increase in mean invested assets was the result of increased
volumes of business in the Life Insurance and Annuities segment. A portion of
the increased volume of business was due to the acquisition of the block of
business described above.
15
<PAGE> 16
REALIZED GAIN (LOSS) ON INVESTMENTS
The first nine months of 1999 and 1998 had realized gains on investments of $3.3
million and $22.7 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. The 1999
amount includes gains on the sale of real estate partially offset by losses on
the sale of fixed income securities. The 1998 amount includes gains that
resulted from LNC reducing its position in equity securities. Securities
available-for-sale that were deemed to have declines in fair value that are
other than temporary were written down. Also, LNC records write-downs and
allowances on select mortgage loans on real estate, real estate and other
investments when the underlying value of the property is deemed to be less than
the carrying value.
The pre-tax write-downs of securities available-for-sale for the first nine
months of 1999 and 1998 were $31.4 million and $65.1 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 1999, LNC released $0.5 million in reserves on real estate and mortgage loans
on real estate compared to reserves released of $0.7 million for the first nine
months of 1998. Net write-downs and reserve releases for all investments for the
nine months ended September 30, 1999 and 1998 were $30.9 million and $71.4
million, respectively.
OTHER REVENUE AND FEES
Other revenue and fees for the first nine months of 1999 increased $87.4 million
or 47% when compared to the first nine months of 1998. This increase was due to
increased volumes of fee income from each of the business segments.
LIFE INSURANCE AND ANNUITY BENEFITS
Life insurance and annuity benefits for the first nine months of 1999 increased
$268.5 million or 14% when compared with the first nine months of 1998. This
increase was 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 BENEFITS
Health benefits increased $66.0 million or 15% for the first nine months of 1999
when compared with the first nine months of 1998 due to increased business
volume and higher claim activity within the Reinsurance group markets. As noted
under "Health Premiums" above, a block of disability income business was sold on
November 1, 1999 and the HMO excess-of-loss business was discontinued in the
third quarter of 1999. These events will result in a reduction in health
benefits proportionate to the health premium reductions.
UNDERWRITING, ACQUISITION, INSURANCE AND OTHER EXPENSES
These expenses increased $209.5 million or 15% for the first nine months of 1999
compared with the first nine months of 1998. The increase was a result of
increases in business volume in the Life Insurance & Annuities and Reinsurance
segments and the acquisition of the block of business described above.
RESTRUCTURING CHARGES TAKEN IN 1999
During the first nine months of 1999, LNC implemented a restructuring plan
related to the downsizing and consolidation of the operations of Lynch & Mayer,
Inc. LNC also announced a second restructuring plan related to the
discontinuance of HMO excess-of-loss reinsurance programs. The aggregate charges
associated with these two restructuring plans totaled $15.3 million after-tax
($21.8 million pre-tax). The component elements of these aggregate pre-tax costs
include $4.4 million for employee severance and termination benefits, write-off
of impaired assets of $9.8 million, and other costs of $7.6 million. (See Note
11 on page 14 for details regarding both of these restructuring plans.)
16
<PAGE> 17
INTEREST AND DEBT EXPENSE
Interest and debt expense increased $15.4 million or 19% for the first nine
months of 1999 when compared with the first nine months of 1998. This increase
was due to an increase in the average debt outstanding for the period. LNC
through its subsidiaries issued $200 million of 8.35% Trust Originated Preferred
Securities ("TOPrS") in July 1998 and $230 million of 7.75% FELINE PRIDES
(service mark of Merrill Lynch & Co., Inc.) in August 1998.
FEDERAL INCOME TAXES
Federal income taxes increased $21.7 million or 15% in the first nine months of
1999 as compared with the first nine months of 1998 due to the increase in
pre-tax earnings.
SUMMARY
Net income for the first nine months of 1999 was $425.7 million or $2.11 per
diluted share compared with $384.2 million or $1.89 per diluted share in the
first nine months of 1998. Excluding realized gains and losses on investments,
restructuring charges and the third quarter 1999 special addition to HMO
excess-of-loss reserves ($25 million after-tax), LNC earned $463.9 million for
the first nine months of 1999 compared with $391.0 million for the first nine
months of 1998. This increase was the result of increased earnings from the Life
Insurance & Annuities, Reinsurance and Investment Management segments.
Trends in the United Kingdom for pension and life insurance businesses are
changing rapidly, due in large part to government mandated product design
changes that are expected to be imposed upon the industry within the next year
or two. In anticipation of these marketplace changes, a review of strategic
alternatives for Lincoln UK was initiated earlier this year. From this review,
it was determined that significant changes in Lincoln UK's operations are needed
to enable Lincoln UK to continue its success in the United Kingdom marketplace.
This conclusion resulted in a decision to engage external consultants and to
devote internal resources to a transformation program encompassing Lincoln UK's
products, distribution, investment performance and cost structure. At this stage
in the transformation program, management has not yet determined what
restructuring actions might be taken. Prior to the finalization and approval of
the restructuring plan, it is not possible to provide a meaningful estimate of
restructuring costs. These decisions are expected to be made in the fourth
quarter of 1999.
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 expenditures for the first nine months of 1999 of $41.6 million
($27.0 million after-tax) to address this issue. This brings the expenditures
for 1996 through third quarter 1999 to $90.1 million ($58.6 million after-tax).
LNC's financial plans for the remainder of 1999 and the year 2000 include
expected expenditures of an additional $8.4 million ($5.5 million after-tax)
bringing estimated overall Year 2000 expenditures to $98.4 million ($64.0
million after-tax). Because updating systems and procedures is an integral part
of LNC's on-going operations, approximately 55% of the 1999 expenditures 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.
17
<PAGE> 18
The 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 fourth phase
consists of testing to verify Year 2000 readiness.
LNC has completed these four project phases for all of its high and low priority
IT systems, including those provided by software vendors. 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
included simulated future date unit tests, systems tests and integration tests
with LNC affiliates. Environmental and external agent/vendor testing, which are
subject to external factors such as vendor readiness, continued through the
third quarter of 1999 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 September 30, 1999, 100% of the high priority non-IT assets have been
inventoried (Phase 1), assessed (Phase 2), and remediated (Phase 3); 98% have
completed the testing phase (Phase 4). LNC expects to have all phases for high
priority non-IT assets completed by the end of October 1999. LNC has completed
these four phases for all of its low priority non-IT assets.
Concurrent with the IT and non-IT projects, the readiness of key business
partners has been reviewed and Year 2000 contingency plans have been developed.
The most significant categories of key business partners are financial
institutions, software vendors, and utility providers (gas, electric and
telecommunications). Surveys were mailed to key business partners. Based on
responses received, current levels of readiness have been assessed, follow-up
contacts have been made where necessary, alternative strategies have been
developed and testing has been conducted where feasible. For key business
partners able to test with LNC, those tests have been conducted. Some of LNC's
key business partners have indicated that they would not test with all partners.
In those instances where LNC and the key partner could not test but test results
were available, LNC reviewed the results of tests the partner conducted either
with other, similar firms or as part of industry tests. Where neither testing
nor test results were available, LNC evaluated the partner's Y2K readiness
statements, other information available on the partner's Year 2000 program, the
results of LNC's Year 2000 contingency plan testing and the availability of
alternative partners to determine LNC's comfort level. Testing and monitoring of
the Year 2000 readiness of key business partners will continue during the fourth
quarter.
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.
All planned Year 2000 contingency plans have been developed and tested. Testing
of key contingency plans has been through the use of actual data and processes,
scenario simulation or walk-throughs as appropriate for the test situation.
Testing of the plans and training are continuing throughout the fourth quarter
of 1999. 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 have been documented and prioritization processes for problem
resolution have been 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 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.
18
<PAGE> 19
A worst case scenario might include experiencing 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 has modified
or developed 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 have been 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
scenarios and believes its plans are sufficient to mitigate these worst case
scenario risks.
REVIEW OF CONSOLIDATED FINANCIAL CONDITION
INVESTMENTS
The total investment portfolio decreased $1.4 billion in the first nine months
of 1999. This decrease was due to the decrease in the fair value of securities
available-for-sale partially offset by the purchases of investments from cash
flow generated by the business segments.
The quality of LNC's fixed maturity securities portfolio as of September 30,
1999 was as follows:
<TABLE>
<S> <C> <C> <C>
Treasuries and AAA 24.2% BBB 32.6%
AA 6.9% BB 4.6%
A 28.8% Less than BB 2.9%
</TABLE>
As of September 30, 1999, $2.1 billion or 7.5% of fixed maturity securities was
invested in below investment grade securities (less than BBB). This represents
5.9% 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, 1999, the aggregate cost of such investments
purchased was $450.7 million. Aggregate proceeds from such investments sold were
$431.3 million, resulting in a net realized pre-tax loss at the time of sale of
$25.9 million.
LNC's entire fixed maturity and equity securities portfolio is classified as
"available-for-sale" and is carried at fair value on its balance sheet. Because
the general intent of the "available-for-sale" accounting rules is to reflect
shareholder's equity as if unrealized gains and losses where actually
recognized, it is necessary for LNC to consider all related accounting
adjustments that would occur upon such a hypothetical recognition of unrealized
gains and losses. Such related balance sheet effects include adjustments to the
balances of deferred acquisition costs, policyholder commitments and deferred
income taxes. Adjustments to each of these balances are charged or credited
directly to shareholder's equity as part of LNC's "available-for-sale"
accounting. For instance, deferred acquisition costs are adjusted upon the
recognition of unrealized gains or losses since the amortization of deferred
acquisition costs is based upon an assumed emergence of gross profits on
certain insurance business. In a similar manner, adjustments to the balances of
policyholder reserves or commitments are made because LNC has either a
contractual obligation or has a consistent historical practice of making
allocations of investment gains or losses to policyholders. Deferred income tax
balances are also adjusted, since unrealized gains or losses do not affect
actual taxes currently paid.
As of September 30, 1999, real estate and mortgage loans on real estate
represented 0.8% and 13.1% of LNC's total investment portfolio, respectively. As
of September 30, 1999, the underlying properties supporting the mortgage loans
on real estate consisted of 27.1% in commercial office buildings, 31.2% in
retail stores, 17.8% in apartments, 13.5% in industrial buildings, 5.4% in
hotels/motels and 5.0% in other. In addition to the dispersion by property type,
the mortgage loan portfolio is geographically diversified throughout the United
States.
19
<PAGE> 20
The following summarizes key information on mortgage loans:
<TABLE>
<CAPTION>
September 30, December 31,
(in millions) 1999 1998
------------- ---- ----
<S> <C> <C>
Total Portfolio (net of reserves) $ 4,772.7 $ 4,393.1
Mortgage loans two or more payments
delinquent (including in process of foreclosure) 5.7 2.4
Restructured loans in good standing 3.4 32.0
Reserve for mortgage loans 4.3 4.8
</TABLE>
Fixed maturity securities available-for-sale, real estate and mortgage loans on
real estate that were non-income producing for the nine months ended September
30, 1999 were not significant.
CASH AND INVESTED CASH
Cash and invested cash decreased by $90.4 million in the first nine months of
1999. This decrease was due primarily to the purchase and retirement of common
stock at a cost of $356.7 million offset by the receipt of a Federal tax refund
for 1998 of $106.5 million and cash flows generated from operations.
DEFERRED ACQUISITION COSTS
Deferred acquisition costs increased by $650.1 million during the first nine
months of 1999 due to additions for new business and amounts restored for the
increase in unrealized loss on securities available-for-sale, partially offset
by amortization.
PREMIUMS AND FEES RECEIVABLE
Premiums and fees receivable increased $49.8 million in the first nine months of
1999 as a result of increased volumes of business.
ASSETS HELD IN SEPARATE ACCOUNTS
This asset account as well as the corresponding liability account increased by
$2.8 billion in the first nine months of 1999 reflecting an increase in variable
annuity funds under management. This increase was due to market appreciation
exceeding net outflows during the period.
GOODWILL AND OTHER INTANGIBLE ASSETS
The decrease in these amounts is the result of the amortization of account
balances for the nine months ended September 30, 1999, coupled with the
adjustments made to goodwill and other intangible assets during 1999. During the
first quarter of 1999, an adjustment was made to goodwill as a result of the
final settlement reached with CIGNA Corporation as to the amount of assets and
liabilities transferred to LNC on the business acquired January 2, 1998. Also,
during 1999, adjustments were made to goodwill and other intangibles as a
result of additional analysis of the block of business acquired from Aetna,
Inc. on October 1, 1998 (see Note 10 on page 12).
OTHER ASSETS
The increase in other assets of $231.3 million is the result of having higher
receivables for open security sales as of September 30, 1999 relative to the
balance at December 31, 1998.
TOTAL LIABILITIES
Total liabilities increased by $3.4 billion in the first nine months of 1999.
Insurance policy reserves increased $356.9 million due to increased business
volumes and specific reserve strengthening related to the Reinsurance segment's
HMO excess-of-loss reinsurance programs (see Note 6 on page 9). Contractholder
funds decreased $198.0 million which is the net result of new deposits being
more than offset by the withdrawal upon maturity of guaranteed interest
contracts. Liabilities related to separate accounts increased $2.8 billion (see
discussion of "Assets Held in Separate Accounts" above). Total debt increased
$53.0 million due to an increase in the outstanding balance of commercial paper
issued. Other liabilities increased $358.3 million as a result of higher
payables for open security purchases as of September 30, 1999 relative to
December 31, 1998 and due to increased business volumes. LNC's liabilities
include some contingency items (see Note 6 on page 8).
20
<PAGE> 21
RESTRUCTURING CHARGES TAKEN IN 1998
During 1998, LNC implemented a restructuring plan relating to the integration of
existing life and annuity operations with the new business operations acquired
from CIGNA Corporation. A second restructuring plan relating to the streamlining
of LNC's corporate center operations was also implemented during 1998. The
aggregate charges associated with these two unrelated restructuring plans
totaled $34.3 million after-tax ($52.8 million pre-tax). Both of these
restructuring plans are proceeding on schedule, with actual pre-tax costs
totaling $45.4 million having been expended or written off. The remaining
aggregate reserve balance of $7.4 million is anticipated to be utilized in the
completion of these restructuring plans. (See Note 11 on page 13 for details
regarding both of these restructuring plans.)
SHAREHOLDERS' EQUITY
Total shareholders' equity decreased $725.8 million in the first nine months of
1999. Excluding the decrease of $656.2 million related to a decrease in the
unrealized gains on securities available-for-sale, shareholders' equity
decreased $69.6 million. This decrease was the net result of increases due to
$425.7 million from net income, $37.2 million from the issuance of common stock
related to benefit plans and $3.5 million from the issuance of common stock
related to the acquisition of subsidiaries being offset by a decrease of $9.7
million in the cumulative foreign currency translation adjustment, $363.5
million for the repurchase of common shares and $162.8 million for the
declaration of dividends to shareholders.
Due to increased levels of net unrealized losses on securities
available-for-sale, consolidated deferred taxes are in a net deferred tax asset
position as of September 30, 1999. Realization of the deferred tax asset is
based upon offsetting existing taxable temporary differences, carrybacks to
prior years, and expectations of future taxable income. Existing levels of
pre-tax earnings are sufficient to generate the minimum amount of future taxable
income over the next few years necessary to fully support the realization of the
net deferred tax asset.
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 $1.2 billion during the first nine 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 and
invested 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 September 30, 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 that occurred recently include the purchase and retirement of
shares of common stock at a cost of $356.7 million in the first nine months of
1999. In May 1999, the LNC board authorized $500 million to repurchase shares of
common stock. Since the May 1999 board authorization repurchases of $236.6
million through October 29, 1999 have reduced the board authorization to $263.4
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 6 on page 8, 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 and dividends declared,
Lincoln Life's statutory earned surplus is negative. 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. The time frame for statutory earned surplus to return to a positive
position is dependent upon future statutory earnings and dividends paid by
Lincoln Life. Although no assurance can be given that additional dividends will
be approved, during the second quarter 1999, Lincoln Life received regulatory
approval and paid an extraordinary dividend of $350 million to LNC. In the event
such approvals are not obtained in the future, management believes that LNC can
obtain the funds required to satisfy its obligations from its existing credit
facilities and other sources.
21
<PAGE> 22
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 nine
months 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
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 nine 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 $2.7 billion notional. The decrease in notional
is a result of expirations and, therefore, no gain or loss has been
recognized.
2. Decreased its use of swaptions which are used to hedge various portfolios
of interest rate sensitive assets by $34.3 million notional, resulting in
a remaining balance of $1.87 billion notional. The decrease in notional
of swaptions was a result of expirations and no gain or loss was
recognized.
3. Increased its use of interest rate swap agreements from $258.3 million
notional to $371.3 million notional. During the first nine months of
1999, $6.4 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.
Entered into $363.0 million notional of forward starting interest rate
swaps to hedge the anticipated purchase of assets. Of this amount, $54.0
million notional was terminated during the period resulting in no gain or
loss. These swap agreements are part of a strategy to lengthen the
duration of the portfolio of assets supporting the life insurance block
of business, as well as protect LNC from rising interest rates.
4. Terminated its use of foreign exchange forward contracts that hedge the
foreign currency risk of its portfolio of foreign investments. The
balance as of December 31, 1998 was $1.5 million notional. A $0.1 million
gain was recognized as a result of the terminations.
Entered into foreign exchange forward contracts in the amount of $40.0
million notional. These contracts hedge LNC's exposure to currency
fluctuations associated with its commercial paper program in the United
Kingdom. A total of $30.0 million notional was terminated during the
period resulting in no gain or loss.
5. Decreased its use of foreign currency swap agreements that are hedging
the foreign currency risk of its portfolio of foreign bonds from $47.2
million notional to $44.2 million notional. This reduction in notional
resulted in a recognized gain of $0.4 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.
22
<PAGE> 23
6. Decreased its use of FTSE index call options from $11.1 million notional
to $4.4 million notional. As a result of these terminations, a $1.0
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.
7. Increased its use of S&P 500 index options from $79.9 million notional to
$115.6 million notional. New options in the amount of $38.7 million were
entered into and $3.0 million were terminated during the period,
resulting in a $0.2 million gain. These call options 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.
8. Entered into a gold commodity swap agreement with a notional amount of
$8.1 million. The gold commodity swap was part of a replication strategy
in which LNC owned a bond that made its coupon payments to bondholders in
ounces of gold. The gold buillon was then swapped into U.S. dollars,
replicating a U.S. dollar paying security. During the third quarter of
1999, the $8.1 million notional swap agreement expired resulting in a
$2.9 million gain.
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 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.)
10(a) Lincoln National Corporation Value Sharing Plan
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 September 30,
1999.
23
<PAGE> 24
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/ Casey J. Trumble
----------------------------
Casey J. Trumble
Senior Vice President and
Chief Accounting Officer
Date November 2, 1999
--------------------
24
<PAGE> 25
LINCOLN NATIONAL CORPORATION
Exhibit Index for the Report on Form 10-Q
for the Quarter Ended September 30, 1999
Exhibit Number Description Page Number
- -------------- ----------- -----------
10(a) Lincoln National Corporation Value Sharing Plan 26
12 Historical Ratio of Earnings to Fixed Charges 37
27 Financial Data Schedule 38
25
<PAGE> 1
LINCOLN NATIONAL CORPORATION
DIRECTORS' VALUE SHARING PLAN
(INCLUDING ALL AMENDMENTS THROUGH JULY 2, 1999)
ARTICLE I - PURPOSE OF PLAN
1.1 ESTABLISHMENT OF PLAN. Lincoln National Corporation (the
"Corporation") adopts the Directors' Value Sharing Plan (the "Plan") to provide
the benefits specified in the Plan for members of the Board of Directors of the
Corporation who are not employees of the Corporation or any of its affiliates or
subsidiaries ("Non-Employee Directors").
1.2 PURPOSE OF THE PLAN. The purpose of the Plan is to provide
Non-Employee Directors with an increased economic interest in the Corporation in
order to attract and retain well-qualified individuals to serve as Non-Employee
Directors and to enhance the identity of interests between Non-Employee
Directors and the shareholders of the Corporation.
The Corporation intends that its Non-Employee Directors' Base
Compensation (i.e., retainer and meeting fees) approximate the median of that
for peer companies within the industry. The Plan is designed to provide
additional compensation to Non-Employee Directors linked to overall return to
the Corporation's shareholders.
The Plan increases the Non-Employee Directors' financial interest in
the Corporation through the payment of stock units based on:
1) Performance of the Corporation's stock relative to a group of
peer companies, and
2) Service on the Board.
ARTICLE II - ELIGIBILITY AND PARTICIPATION
All Non-Employee Directors are eligible and shall participate in the
Plan in accordance with the terms and conditions set forth herein.
ARTICLE III - VALUE SHARING AWARD: COMPANY PERFORMANCE
3.1 STOCK UNITS. As soon as practicable after December 31, 2000, the
Corporation shall award each individual who was a Non-Employee Director during
the period beginning on
26
<PAGE> 2
January 1, 1999 and ending on December 31, 2000 a whole number of stock units
(the "Stock Units"), as determined under Section 3.2, in consideration for
services rendered as a Non-Employee Director. Each Stock Unit shall represent an
unfunded, unsecured obligation of the Corporation to pay an amount equal to the
fair market value of a share of common stock of the Corporation ("Stock"),
determined as of any business day by averaging the high and low sales price of
the Stock quoted on the New York Stock Exchange Composite Listing on the
preceding business day on which there were such quotations for the day in
question.
3.2 CALCULATION OF STOCK UNIT AWARD. The number of Stock Units to be
awarded to each Non-Employee Director will be determined in accordance with the
following provisions.
a. Generally. If the arithmetic average of increases in Income from
Operations per Share, diluted and after the exclusion of any
restructuring charges as reported by the Corporation for the years
1998, 1999 and 2000 ("LTIC Average Increase") is equal to or greater
than 17% per year and if the Corporation achieves an average adjusted
return on equity of 13.6% in the years 1998, 1999 and 2000 adjusted
downward for acquisitions ("AROE"), then each Director shall be awarded
a whole number of Stock Units having a value of $82,000 (Level 1
Performance). If the LTIC Average Increase is equal to 15% and an AROE
of 13.6% is achieved, then each Director shall be awarded a whole
number of Stock Units having a value of $41,000 (Level 2 Performance).
If the Corporation's performance falls between Level 1 Performance and
Level 2 Performance as set out above, the value of the Stock Units
awarded shall be based on the interpolation of the value to be awarded
between the relevant referenced points. To the extent that the formula
described in this Section 3.2(a) does not result in a whole number of
Stock Units, the results shall be rounded upward to the next whole
number so that no fractional Stock Units shall be issued under the
Plan. The number of the Stock Units awarded shall be determined by
using the average of the closing price of Stock on the last trading
date of December in the last year of the performance cycle and the
closing prices of Stock on the last days of January and February in the
succeeding year.
27
<PAGE> 3
b. Individual Not Director Throughout Period. Nothwithstanding the
provisions of Subsection 3.2(a), if an individual is a Non-Employee
Director during a portion, but not all, of the period beginning on
January 1, 1999 and ending on December 31, 2000, the number of Stock
Units awarded to the individual shall equal the number of Stock Units
determined in accordance with Subsection 3.2(a), multiplied by the
appropriate factor, determined as follows:
1. If the individual became a Non-Employee Director after January 1,
1999, but is a Non-Employee Director on December 31, 2000, the
appropriate factor shall equal the number of full months that the
individual was a Non-Employee Director as of December 31, 2000 divided
by 24.
2. If the individual ceased to be a Non-Employee Director
before December 31, 2000 (A) after attaining age 70, (B) after
attaining age 65, but with the consent of a majority of the
members of the Board of Directors of the Corporation other than
the individual, (C) as a result of the individual's death, or (D)
as a result of the individual's permanent and total disability
(as defined in section 22(e)(3) of the Internal Revenue Code of
1986, as amended), the appropriate factor shall equal the number
of full months that the individual was a Non-Employee Director
after of December 31, 1998 divided by 24.
3. If the individual ceased to be a Non-Employee Director as a
result of a "change of control" (within the meaning given to that
term under the Corporation's Executives' Severance Benefit Plan
on the date that is six months immediately preceding the "change
of control"), the appropriate factor shall equal the number of
full months that the individual was a Non-Employee Director after
of December 31, 1998 divided by the number of full months in the
period beginning on January 1, 1999 and ending on the date of the
28
<PAGE> 4
change of control.
3. If the individual ceased to be a Non-Employee Director
before December 31, 2000 for any reason not described in
Paragraph 3.2(b)(2) or (3), the appropriate factor shall be zero,
except to the extent decided otherwise by the Board of Directors
of the Corporation.
b. Notwithstanding the foregoing, the Board of Directors may in
its discretion increase or decrease the number of Stock Units
awarded to one or more of its members or former members as it
determines appropriate.
5.2 SPECIAL PAYMENT RULES. Notwithstanding the foregoing:
a. In the event of a change of control, awards of Stock Units
will be made under this Article III to Non-Employee Directors as
if Level 1 Performance were achieved, and cash payments with
respect to those Stock Units will be made as soon as practicable
following the change of control.
b. In the event an individual ceases to be a Non-Employee
Director before December 31, 2000 for any reason other than
change in control, payment with respect to the Stock Units
awarded to the individual pursuant to this Article III will be
made as soon as practicable following December 31, 2000 provided,
however, that if the Non-Employee Director elected installment
payments under Article VII with respect to other Stock Units
awarded under the Plan, payment with respect to the Stock Units
awarded pursuant to this Article III will be made over the number
of installments remaining to be paid to the Non-
29
<PAGE> 5
Employee Director as of the date that payment with respect to
these Stock Units begins.
ARTICLE IV - VALUE SHARING AWARD: BOARD SERVICE
4.1 In addition to the awards based on stock performance described in
Article III, the Corporation shall award Stock Units in lieu of participation in
any pension or other retirement program of the Corporation to each Non-Employee
Director who on or before March 31, 1996, waived any entitlement under (or who
never becomes entitled to benefits under) such a program.
4.2 The number of such Stock Units to be granted each eligible Director
shall be determined by (i) calculating the dollar amount (the "Level Funding")
required to fund in equal quarterly payments over the Calculation Period
(defined below) a notional lump sum amount payable as of age 70 of .185 of the
current annual retainer multiplied by the number of quarters in the Calculation
Period; and then (ii) applying the provisions of 4.3 through 4.9 of this Plan.
The Level Funding shall be calculated assuming such payments were credited at
the end of each calendar quarter commencing on the later of April 1, 1986, or
the beginning of the calendar quarter which includes the date on which the
individual first became a Non-Employee Director and terminating at the end of
the Calculation Period and assuming an effective annual interest rate of 7.5%
during the Calculation Period and during the period from the end of the
Calculation Period to age 70. The Calculation Period shall be a period equal to
the lesser of forty calendar quarters or the number of calendar quarters
commencing with the calendar quarter which includes the date on which the
individual's service as a Non-Employee Director began and ending with the
calendar quarter immediately preceding the calendar quarter during which
attainment of age 70 occurs. (See Exhibit A.)
4.3 An initial grant of stock units shall be made to each Non-Employee
Director who has waived benefits as provided in 4.1 above by calculating (i) the
dollar amount that would have accumulated had such Level Funding outlined in
4.2(i) above taken place during the period beginning the later of April 1, 1986
or the quarter which includes the date the individual became a Non-Employee
Director and ending on March 31, 1996, including interest at 7.5% and dividing
30
<PAGE> 6
this amount by (ii) the value of a share of Stock determined in the manner set
forth in 3.1 above (the "Stock Value") on March 31, 1996.
4.4 For an individual who as of March 31, 1996 has served as a
Non-Employee Director for a period equal to or greater than the Calculation
Period, the initial grant as described in 4.3 above shall constitute the entire
basic Board Service Value Sharing Award and shall be supplemented by additional
Board Service grants only as provided in 4.6 below.
4.5 For a Non-Employee Director who as of March 31, 1996 has not served
as a Non-Employee Director for a period equal to or greater than the Calculation
Period, the Corporation shall continue to make grants of Stock Units at the end
of calendar quarters beginning April 1, 1996, and thereafter equal to the Level
Funding amount calculated under 4.2(i) divided by the Stock Value as of the date
of grant until grants have been made for each of the remaining quarters in the
Calculation Period during which the individual continues to serve as a
Non-Employee Director.
31
<PAGE> 7
4.6 To the extent that the current annual retainer payable to
Non-Employee Directors is increased in any year, each Non-Employee Director
serving for such year shall also receive a grant of Stock Units equal to (i)
.185 of the dollar amount of such increase times the number of quarters (to a
maximum of forty) then served as a Non-Employee Director discounted at 7.5%
interest from the Non-Employee Director's age 70 to the last day of the quarter
during which such increase in retainer occurred, divided by (ii) the Stock Value
as of the last day of the quarter in which such increase in retainer occurred.
4.7 For a Non-Employee Director who, as of the date any increase in
retainer occurs, has not served as a Non-Employee Director for a period equal to
or greater than the Calculation Period, the amount of any quarterly payment made
in quarters following the quarter during which the increase in retainer occurred
will be increased to an amount equal to the then current quarterly payment times
the ratio of the new retainer to the then current retainer.
4.8 The beneficiary of a Non-Employee Director who dies while serving
as a Non-Employee Director and who prior to March 31, 1996, waived his or her
rights under any pension or retirement plan as provided in 4.1 above shall be
entitled to receive an additional amount credited to his or her Account equal to
the amount by which (i) the lump sum death benefit which would have been payable
under the Lincoln National Corporation Directors' Retirement Plan had the
Non-Employee Director continued to participate in that plan until his or her
date of death exceeds (ii) the value as of the date of his or her death of the
Stock Units calculated under the provisions of 4.2 through 4.7 and the Dividend
Equivalent Payments provided by Article VI attributable to such Stock Units. No
additional amount shall be credited under 4.8 if 4.8(ii) exceeds 4.8(i).
4.9 In no event shall grants under this Article IV be increased or
decreased to reflect increases or decreases in Stock Value subsequent to the
date of grant.
ARTICLE V - STOCK UNIT TERMS AND CONDITIONS
Stock Units shall be represented by and recorded in a bookkeeping
account set up in each Non-Employee Director's name (the "Account"). The
following terms and conditions shall apply to Stock Units: (i) a Dividend
Equivalent Payment, as defined in Article VI below, shall be
32
<PAGE> 8
credited to the Account and shall have the same terms and conditions as the
Stock Units; (ii) none of the Stock Units may be sold, transferred, assigned,
pledged, or otherwise encumbered or disposed of; and (iii) the Stock Units and
Dividend Equivalent Payments shall vest on the date the Non-Employee Director
ceases to be a Director of the Corporation.
ARTICLE VI - DIVIDEND EQUIVALENT PAYMENTS
As of each dividend payment date with respect to Stock, each
Non-Employee Director shall be awarded a Dividend Equivalent Payment equal to
the product of (i) the per share cash dividend payable with respect to each
share of Stock on such date; and (ii) the total number of Stock Units and
Dividend Equivalent Payments credited to the Non-Employee Director's Account, as
of the record date corresponding to such dividend payment date, divided by the
fair market value. The Dividend Equivalent Payments are subject to the
restrictions specified in Article V.
ARTICLE VII - PAYMENT OF BENEFITS
As soon as practicable following the date the Non-Employee Director
ceases to be a director of the Corporation (the "Date"), the Corporation shall
pay to the Non-Employee Director (or his or her designated beneficiary) an
amount equal in value to the Stock Units and Dividend Equivalent Payments
credited to his or her Account in a lump sum valued as of the Date. In lieu of a
lump sum, at age 70 or after, a Director who has so elected may receive payments
in annual installments over a 5, 10 or 15 year period.
ARTICLE VIII - ADJUSTMENT UPON CHANGES IN CAPITALIZATION
In the event of a Stock dividend, Stock split or combination,
reclassification, recapitalization or other capital adjustment of shares of
Stock, the number of Stock Units and the amount of Dividend Equivalent Payments
credited to Accounts shall be appropriately adjusted by the Board of Directors
of the Corporation, whose determination shall be final, binding and conclusive.
The award of Stock Units pursuant to this Plan shall not affect in any way the
right or power of the Corporation to issue additional Stock or other securities,
to make adjustments,
33
<PAGE> 9
reclassification, reorganizations or other changes in its corporate, capital or
business structure, to participate in a merger, consolidation or share exchange
or to transfer its assets or dissolve or liquidate.
ARTICLE IX - TERMINATION OR AMENDMENT OF PLAN
9.1 IN GENERAL. The Board of Directors of the Corporation may at any
time terminate, suspend or amend this Plan.
9.2 WRITTEN CONSENTS. No amendment may, without the written consent of
such Non-Employee Director, adversely affect the right of any Non-Employee
Director to receive any Stock Units or any Dividend Equivalent Payments
previously awarded.
ARTICLE X - GOVERNMENT REGULATIONS
The obligations of the Corporation under this Plan shall be subject to
all applicable laws, rules and regulations and the obtaining of all such
approvals by government agencies as may be deemed necessary or appropriate by
the Board of Directors of the Corporation.
ARTICLE XI - MISCELLANEOUS
11.1 UNFUNDED PLAN. The Plan shall at all times be entirely unfunded.
Any Account established and maintained under the Plan is solely for accounting
purposes and shall not require a segregation of any assets of the Corporation. A
Non-Employee Director's right to receive any payment under this Plan shall be no
greater than the rights of an unsecured general creditor of the Corporation.
11.2 ASSIGNMENT; ENCUMBRANCES. Stock Units and Dividend Equivalent
Payments under this Plan are not assignable or transferrable and shall not be
subject to any encumbrances, liens, pledges or charges of the Non-Employee
Director or his or her creditors. Any attempt to assign, transfer or hypothecate
any Stock Units or Dividend Equivalent Payments shall be void and of no force
and effect whatsoever.
34
<PAGE> 10
11.3 APPLICABLE LAW. This Plan shall be governed by the laws of the
State of Indiana to the extent not preempted by Federal law.
11.4 HEADINGS. The headings in this Plan are for reference purposes
only and shall not affect the meaning or interpretation of this Plan.
11.5 PLAN ADMINISTRATION. The Plan shall be administered by a DVSP
Administration Committee (the "Committee"). At any date, the members of the
Committee shall be those members of the Nominating and Governance Committee of
the Board of Directors who are Non-Employee Directors as such term is defined in
Section 16 of the Securities Exchange Act of 1934, as it may be amended from
time to time. The Committee may not exercise its authority at any time there are
less than two (2) members. The Committee shall exercise its authority only by a
majority vote of its members at a meeting or by a writing without meeting.
ARTICLE XII - EFFECTIVE DATE OF PLAN
This Plan shall become effective as of January 1, 1996.
35
<PAGE> 11
EXHIBIT A
DVSP BOARD SERVICE QUARTERLY CONTRIBUTION
CALCULATED FOR $30,000 RETAINER AT 7.5% INTEREST
Calculation
Become Period
Director Quarterly
at Age Contribution
69 5,400
68 5,205
67 5,015
66 4,829
65 4,649
64 4,473
63 4,302
62 4,136
61 3,974
60 3,817
59 3,551
58 3,303
57 3,073
56 2,858
55 2,659
54 2,473
53 2,301
52 2,140
51 1,991
50 1,852
49 1,723
48 1,603
47 1,491
46 1,387
45 1,290
44 1,200
43 1,116
42 1,039
41 966
40 899
39 836
38 778
36
<PAGE> 1
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) 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 589.4 526.1 697.4 1,427.1 692.7 626.6 376.3
Equity (Earnings) in
Unconsolidated Affiliates (4.0) (0.8) (3.3) (2.1) (1.4) (12.4) (14.6)
Sub-total of Fixed Charges 119.4 100.1 144.1 113.3 108.6 94.4 66.6
------- ------- ------- -------- ------- ------- -------
Sub-total of Adjusted
Net Income 704.8 625.4 838.2 1,538.3 799.9 708.6 428.3
Interest on Annuities and
Financial Products 1,121.9 1,065.6 1,446.2 1,253.5 1,185.6 1,147.1 1,064.5
------- ------- ------- -------- ------- ------- -------
Adjusted Income Base 1,826.7 1,691.0 2,284.4 2,791.8 1,985.5 1,855.7 1,492.8
Rent Expense 61.0 49.5 81.3 62.5 71.6 65.7 51.3
FIXED CHARGES:
Interest and Debt Expense 99.0 83.6 117.1 92.5 84.7 72.5 49.5
Rent (Pro-rated) 20.3 16.5 27.0 20.8 23.9 21.9 17.1
------- ------- ------- -------- ------- ------- -------
Sub-total of Fixed Charges 119.3 100.1 144.1 113.3 108.6 94.4 66.6
Interest on Annuities and
Financial Products 1,121.9 1,065.6 1,446.2 1,253.5 1,185.6 1,147.1 1,064.5
------- ------- ------- -------- ------- ------- -------
Sub-total of Fixed Charges 1,241.2 1,165.7 1,590.3 1,366.8 1,294.2 1,241.5 1,131.1
Preferred Dividends (Pre-tax) 0.1 0.1 0.1 0.2 0.2 13.4 24.2
------- ------- ------- -------- ------- ------- -------
Total Fixed Charges 1,241.3 1,165.8 1,590.4 1,367.0 1,294.4 1,254.9 1,155.3
RATIO OF EARNINGS TO FIXED CHARGES:
Excluding Interest on
Annuities and Financial
Products (1) 5.91 6.25 5.82 13.57 7.37 7.51 6.43
Including Interest on
Annuities and Financial
Products (2) 1.47 1.45 1.44 2.04 1.53 1.49 1.32
Ratio of Earnings to
Combined Fixed Charges
and Preferred Stock
Dividends (3) 1.47 1.45 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.
37
<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-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 28,708,389,000
<DEBT-CARRYING-VALUE> 0
<DEBT-MARKET-VALUE> 0
<EQUITIES> 506,615,000
<MORTGAGE> 4,772,684,000
<REAL-ESTATE> 280,303,000
<TOTAL-INVEST> 36,532,382,000
<CASH> 2,342,946,000
<RECOVER-REINSURE> 3,315,649,000
<DEFERRED-ACQUISITION> 2,614,500,000
<TOTAL-ASSETS> 96,500,673,000
<POLICY-LOSSES> 20,496,898,000
<UNEARNED-PREMIUMS> 0
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 20,555,071,000
<NOTES-PAYABLE> 1,824,734,000
0
972,000
<COMMON> 983,707,000
<OTHER-SE> 3,677,478,000
<TOTAL-LIABILITY-AND-EQUITY> 96,500,673,000
2,438,117,000
<INVESTMENT-INCOME> 2,107,426,000
<INVESTMENT-GAINS> 3,285,000
<OTHER-INCOME> 446,984,000
<BENEFITS> 2,683,800,000
<UNDERWRITING-AMORTIZATION> 279,819,000
<UNDERWRITING-OTHER> 1,343,800,000
<INCOME-PRETAX> 589,388,000
<INCOME-TAX> 163,659,000
<INCOME-CONTINUING> 425,729,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 425,729,000
<EPS-BASIC> 2.14
<EPS-DILUTED> 2.11
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
