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, 2000 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 20, 2000 LNC had 191,584,225 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 30.
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30 December 31
(000s omitted) 2000 1999
-------------- ---- -----
ASSETS (Unaudited)
<S> <C> <C> <C>
Investments:
Securities available-for-sale, at fair value:
Fixed maturity (cost 2000 - $27,727,224;
1999 - $28,357,057) $27,264,230 $27,688,613
Equity (cost 2000 - $450,235;
1999 - $481,531) 570,166 603,954
Mortgage loans on real estate 4,767,266 4,735,397
Real estate 297,562 256,202
Policy loans 1,935,614 1,892,392
Other investments 470,537 401,826
------------ ------------
Total Investments 35,305,375 35,578,384
Investment in unconsolidated affiliates 5,803 25,825
Cash and invested cash 1,435,877 1,895,883
Property and equipment 213,821 203,753
Deferred acquisition costs 3,048,022 2,800,290
Premiums and fees receivable 240,828 259,630
Accrued investment income 569,207 533,183
Assets held in separate accounts 54,410,896 53,654,223
Federal income taxes 267,268 345,010
Amounts recoverable from reinsurers 3,774,685 3,954,345
Goodwill 1,296,587 1,423,039
Other intangible assets 1,598,359 1,746,499
Other assets 1,076,352 675,669
------------ ------------
Total Assets $103,243,080 $103,095,733
See notes to consolidated financial statements on pages 7 - 14.
<CAPTION>
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
-CONTINUED-
September 30 December 31
(000s omitted) 2000 1999
-------------- ---- -----
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C> <C>
Liabilities:
Insurance and Investment Contract Liabilities:
Insurance policy and claim reserves $21,274,947 $20,924,768
Contractholder funds 18,708,160 20,228,753
Liabilities related to separate accounts 54,410,896 53,654,223
------------ ------------
Total Insurance and Investment Contract Liabilities 94,394,003 94,807,744
Short-term debt 330,349 460,153
Long-term debt 712,164 711,963
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 745,000 745,000
Other liabilities 2,522,947 2,107,005
------------ ------------
Total Liabilities 98,704,463 98,831,865
Shareholders' Equity:
Series A preferred stock-10,000,000 shares authorized
(9/30/00 liquidation value - $2,106) 868 948
Common stock - 800,000,000 shares authorized 989,619 1,007,099
Retained earnings 3,865,955 3,691,470
Accumulated Other Comprehensive Income (Loss):
Foreign currency translation adjustment 19,893 30,049
Net unrealized loss on securities available-for-sale (337,718) (465,698)
------------ ------------
Total Accumulated Other Comprehensive Loss (317,825) (435,649)
------------ ------------
Total Shareholders' Equity 4,538,617 4,263,868
------------ ------------
Total Liabilities and Shareholders' Equity $103,243,080 $103,095,733
See notes to consolidated financial statements on pages 7 - 14.
</TABLE>
<TABLE>
<CAPTION>
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended Three Months Ended
September 30 September 30
(000s omitted, except per share amounts) 2000 1999 2000 1999
--------------------------------------- ---- ---- ---- ----
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenue:
Insurance premiums $ 1,327,566 $ 1,286,781 $ 456,869 $ 413,402
Insurance fees 1,244,354 1,151,336 425,150 392,508
Investment advisory fees 159,484 169,705 53,349 54,605
Net investment income 2,074,986 2,107,426 690,019 697,050
Equity in earnings (loss) of
unconsolidated affiliates (977) 3,958 1,626 1,239
Realized gain (loss) on investments (28,324) 3,285 (16,965) 5,407
Other revenue and fees 300,896 273,321 106,049 77,915
------------ ------------ ------------ ------------
Total Revenue 5,077,985 4,995,812 1,716,097 1,642,126
Benefits and Expenses:
Benefits 2,636,443 2,663,016 893,459 874,546
Underwriting, acquisition,
insurance and other expenses 1,687,441 1,644,403 597,871 551,121
Interest and debt expense 106,129 99,005 34,409 33,269
------------ ------------ ------------ ------------
Total Benefits and Expenses 4,430,013 4,406,424 1,525,739 1,458,936
------------ ------------ ------------ ------------
Net Income Before Federal Income Taxes 647,972 589,388 190,358 183,190
Federal income taxes 175,530 163,659 51,754 50,873
------------ ------------ ------------ ------------
Net Income Before Minority Interest In
Consolidated Subsidiary 472,442 425,729 138,604 132,317
Minority interest in consolidated
subsidiary (9) -- (20) --
------------ ------------ ------------ ------------
Net Income $ 472,451 $ 425,729 $ 138,624 $ 132,317
Net Income Per Common Share-Basic $2.47 $2.14 $0.73 $0.67
Net Income Per Common Share-Diluted $2.42 $2.11 $0.71 $0.66
See notes to consolidated financial statements on pages 7 - 14.
</TABLE>
<TABLE>
<CAPTION>
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Nine Months Ended September 30
Number of Shares Amounts
(000s omitted from dollar amounts) 2000 1999 2000 1999
---------------------------------- ---- ---- ---- ----
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Series A Preferred Stock:
Balance at beginning-of-year 28,857 32,959 $948 $1,083
Conversion into common stock (2,537) (3,377) (80) (111)
------------ ------------ ------------ ------------
Balance at September 30 26,320 29,582 868 972
Common Stock:
Balance at beginning-of-year 195,494,898 202,111,174 1,007,099 994,472
Conversion of series A preferred stock 40,592 54,032 80 111
Issued for benefit plans 900,307 843,438 7,291 37,222
Issued for acquisition of subsidiaries 34,688 86,228 1,392 3,547
Retirement of common stock (5,109,081) (7,309,100) (26,243) (51,645)
------------ ------------ ------------ ------------
Balance at September 30 191,361,404 195,785,772 989,619 983,707
Retained Earnings:
Balance at beginning-of-year 3,691,470 3,790,038
Comprehensive income (loss) 590,275 (240,189)
Less other comprehensive gain (loss):
Foreign currency translation loss (10,156) (9,739)
Net unrealized gain (loss) on
securities available-for-sale 127,980 (656,179)
------------ ------------
Net Income 472,451 425,729
Retirement of common stock (132,042) (311,880)
Dividends declared:
Series A preferred ($2.25 per share) (61) (68)
Common stock (2000-$0.87; 1999-$0.825) (165,863) (162,771)
------------ ------------
Balance at September 30 3,865,955 3,741,048
Foreign Currency Translation Adjustment:
Accumulated adjustment at
beginning-of-year 30,049 49,979
Change during the period (10,156) (9,739)
------------ ------------
Balance at September 30 19,893 40,240
Net Unrealized Gain (Loss) on
Securities Available-for-Sale:
Balance at beginning-of-year (465,698) 552,369
Change during the period 127,980 (656,179)
------------ ------------
Balance at September 30 (337,718) (103,810)
------------ ------------
Total Shareholders' Equity
at September 30 $ 4,538,617 $ 4,662,157
Common Stock at End of Quarter:
Assuming conversion of preferred stock 191,782,524 196,259,084
Diluted basis 196,172,505 196,913,728
See notes to consolidated financial statements on pages 7 - 14.
</TABLE>
<TABLE>
<CAPTION>
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30
(000s omitted) 2000 1999
-------------- ---- -----
Cash Flows from Operating Activities: (Unaudited)
<S> <C> <C> <C>
Net income $472,451 $425,729
Adjustments to reconcile net income to net cash
provided by operating activities:
Deferred acquisition costs (288,239) (227,632)
Premiums and fees receivable 18,803 (49,802)
Accrued investment income (36,024) (74,374)
Policy liabilities and accruals 426,572 318,091
Contractholder funds (301,403) 1,135,361
Amounts recoverable from reinsurers 179,660 (188,556)
Federal income taxes 84,962 96,796
Equity in earnings of unconsolidated affiliates (977) (3,958)
Minority interest in consolidated subsidiary (9) --
Provisions for depreciation 19,092 45,753
Amortization of goodwill and other intangible assets 146,730 113,700
Realized (gain) loss on investments 28,324 (3,285)
Other 67,969 116,969
------------ ------------
Net Adjustments 345,460 1,279,063
------------ ------------
Net Cash Provided by Operating Activities 817,911 1,704,792
Cash Flows from Investing Activities:
Securities-available-for-sale:
Purchases (2,904,842) (4,994,567)
Sales 2,206,512 2,960,393
Maturities 1,293,947 1,720,835
Purchase of other investments (1,405,809) (1,597,035)
Sale or maturity of other investments 1,140,620 1,481,662
Sale of unconsolidated affiliates 85,000 --
Increase in cash collateral on loaned securities 291,216 234,731
Other (216,619) (314,745)
------------ ------------
Net Cash Provided by (Used in) Investing Activities 490,025 (508,726)
Cash Flows from Financing Activities:
Decrease in long-term debt (includes payments and
transfer to short-term debt) (477) (369)
Net increase (decrease) in short-term debt (129,327) 53,121
Universal life and investment contract deposits 2,646,493 2,932,158
Universal life and investment contract withdrawals (2,831,294) (3,290,173)
Investment contract transfers (1,135,000) (497,000)
Common stock issued for benefit plans 7,291 37,350
Retirement of common stock (158,285) (356,722)
Dividends paid to shareholders (167,343) (164,835)
------------ ------------
Net Cash Used in Financing Activities (1,767,942) (1,286,470)
------------ ------------
Net Decrease in Cash and Invested Cash (460,006) (90,404)
Cash and Invested Cash at Beginning-of-Year 1,895,883 2,433,350
------------ ------------
Cash and Invested Cash at September 30 $ 1,435,877 $ 2,342,946
See notes to consolidated financial statements on pages 7 - 14.
</TABLE>
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. The collective group of companies
uses "Lincoln Financial Group" as its marketing identity. Operations
are divided into five business segments. Less than majority-owned
entities in which LNC has at least a 20% interest are reported on the
equity basis. These unaudited consolidated statements have been
prepared in conformity with accounting principles generally accepted in
the United States, 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, 1999.
Operating results for the nine months ended September 30, 2000 are not
necessarily indicative of the results that may be expected for the full
year ending December 31, 2000.
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"). 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 delayed the effective date of FAS 133 one year (i.e.,
adoption required no later than the first quarter of 2001). In June
2000, the FASB issued Statement of Financial Accounting Standard No.
138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities" ("FAS 138"), which addresses a limited number of
implementation issues arising from FAS 133.
LNC plans to adopt FAS 133 on January 1, 2001. On adoption, the
provisions of FAS 133 must be applied prospectively. The financial
statement impact resulting from the adoption of FAS 133 will depend upon
actual market conditions and other relevant information as of January 1,
2001. However, as one indication of the potential effect that adopting
FAS 133 could have upon its consolidated financial statements, LNC
computed the transitional adjustments that would have been recorded
assuming a hypothetical adoption of FAS 133 using market conditions and
other relevant information available as of September 30, 2000. Under
these assumptions, the hypothetical results that LNC would have reported
had FAS 133 been adopted as of September 30, 2000 would have been a net
loss of $9.0 million recorded in net income as a component of realized
gains and losses on investments, and a net gain of $29.7 million
recorded in equity.
The estimates provided above reflect information available at September
30, 2000. The financial statement impact could change significantly by
January 1, 2001, the adoption date of FAS 133. Management will use
information available at January 1, 2001 to record the actual financial
statement impact from implementing FAS 133.
In addition to the net transition adjustments that will be recorded at
January 1, 2001 relating to the adoption of FAS 133, LNC also expects
that FAS 133 will result in increased volatility in ongoing reported net
income. Because certain derivative instruments, such as interest rate
caps and swaptions, that are regularly used by LNC to manage risks
associated with fluctuating interest rates, do not appear to meet the
requirements of FAS 133 for hedge accounting treatment, LNC may be
required to record changes in the fair market value of some derivatives
in net income. Assuming that further analysis to be completed prior to
the actual adoption of FAS 133 does not change these preliminary
conclusions, LNC would expect to include the impact of the change in
fair value of certain derivatives in net income as a component of gains
and losses on investments.
Currently, management is continuing its implementation efforts,
including reviewing investments and other financial instruments for
potential embedded derivatives, developing models for assessing hedge
effectiveness, analyzing existing accounting processes in anticipation
of required ongoing changes, and finalizing the actual impact of
adopting FAS 133 as of January 1, 2001.
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 2000 and
1999 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) 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Commissions $684.5 $671.7 $238.5 $234.2
Other volume related expenses 174.3 186.2 65.2 67.5
Operating and administrative expenses 831.9 807.7 268.1 253.1
Deferred acquisition costs net of
amortization (288.2) (227.6) (107.0) (75.0)
Restructuring charges 57.7 21.8 53.5 4.9
Other 227.2 184.6 79.6 66.4
-------- -------- -------- --------
Total $1,687.4 $1,644.4 $597.9 $551.1
</TABLE>
5. Restrictions, Commitments and Contingencies
Statutory Restriction. 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 a block of individual life insurance 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 statutory ceding commission flows through the
statement of operations as an expense resulting in a reduction of
statutory earned surplus. As a result of these acquisitions, 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
nine months ended September 30, 2000 and during the year ended December
31, 1999, Lincoln Life received regulatory approval and paid
extraordinary dividends totaling $315 million and $530 million,
respectively, 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.
Lincoln Life is recognized as an accredited reinsurer in the state of
New York, which effectively enables it to conduct reinsurance business
with unrelated insurance companies that are domiciled within the state
of New York. As a result, in addition to regulatory restrictions
imposed by the state of Indiana, Lincoln Life is also subject to the
regulatory requirements that the State of New York imposes upon
accredited reinsurers.
Disability Income Claims. The liabilities for disability income claims
net of the related assets for amounts recoverable from reinsurers at
September 30, 2000 and December 31, 1999 were $1.324 billion and $1.316
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.
United Kingdom Pension Products. Operations in the United Kingdom
("UK") have included the sale and administration of pension products to
individuals. Regulatory agencies have raised questions as to what
constitutes appropriate advice to individuals who bought pension
products as an alternative to participation in an employer sponsored
plan. In cases of inappropriate advice, an extensive investigation may
have to be done and the individual put in a position similar to what
would have been attained if the individual had remained in the
employer-sponsored plan. At September 30, 2000 and December 31, 1999,
liabilities of $321.0 million and $294.4 million, respectively, were
carried on the books for this issue. The liability at December 31, 1999
was net of expected recoveries of $99.7 million from previous owners of
companies acquired in past years as specified in the indemnification
clauses of the purchase agreements. In the third quarter of 2000,
settlements with the previous owners were reached which resulted in the
receipt by LNC of amounts that were in line with the expected
recoverables. The increase in the level of the reserve from the balance
on December 31, 1999 reflects the receipt of these recoveries,
partially offset by settlement payouts to policyholders, that have
occurred during the nine months ended September 30, 2000. These
liabilities are based on various estimates that are subject to
considerable uncertainty. Accordingly, these liabilities may prove to be
deficient or excessive. However, it is management's opinion that such
future developments will not materially affect the consolidated
financial position of LNC.
United Kingdom Restructuring.
On September 28, 2000, LNC reached a definitive agreement to transfer
Lincoln UK's sales force, numbering in total over 1,000 members, to
Inter-Alliance Group PLC ("Inter-Alliance"), one of the UK's largest
independent financial advisory groups. The terms of the transfer
provides various persistency protections on Lincoln UK's current block
of business. Inter-Alliance will employ a number of the transferred
sale force members and assume the leases on several Lincoln UK sales
offices, the exact numbers of which will be determined during the fourth
quarter of 2000.
In addition, concurrent with the announcement of the transfer agreement,
LNC announced that a party with which it had been negotiating for months
on the sale of Lincoln UK advised LNC that it would not proceed with the
transaction. In light of this development, and in conjunction with the
transfer of the Lincoln UK sales force, LNC also decided to cease
writing new business in the UK. LNC will continue to investigate
financial and reinsurance strategies to maximize shareholder value and
to limit its exposure to trends in the UK pensions and life insurance
businesses.
As a result of the decisions detailed above, LNC is expecting to record
restructuring charges of up to $93 million after-tax. Of this total,
$40.5 million was recorded in the third quarter of 2000 as a
restructuring charge and $3.4 million was recorded as an operating
expense. Up to another $39 million after-tax is expected to be recorded
in the fourth quarter of 2000 as a restructuring charge. In addition,
up to $10 million after-tax is expected to be recorded in the fourth
quarter of 2000, or in future quarters, the timing of which will depend
upon the dates of decisions and employee termination notifications,
relating to the expected consolidation of Lincoln UK home offices and
operations. (See further discussion of the Lincoln UK restructuring
charge in Note 10.)
Personal Accident Programs. In the past, LNC's Reinsurance segment
accepted personal accident reinsurance programs from other insurance
companies. Most of these programs were presented to the Reinsurance
segment by independent brokers who represented 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 $169.6 million and
$174.7 million at September 30, 2000 and December 31, 1999,
respectively.
Settlement activities relating to LNC's participation in workers'
compensation carve-out (i.e., life and health risks associated with
workers' compensation coverage) programs managed by Unicover Managers,
Inc. have allowed LNC to evaluate the possibility of settlements and to
estimate its potential costs to settle Unicover-related exposures. As of
December 31, 1999, a liability of $62.2 million was established for the
settlement of LNC's exposure to the Unicover programs. On March 30,
2000, LNC reached settlement with regard to one portion of the Unicover
programs. The costs of this settlement were in line with earlier
estimated costs to settle this portion of LNC's participation in these
programs.
The liabilities for both the personal accident reinsurance programs and
the worker's compensation carve-out programs managed by Unicover
Managers, Inc. 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.
HMO Excess-of-Loss and Group Carrier Medical Reinsurance Programs. The
liabilities for HMO excess-of-loss and group carrier medical claims, net
of the related assets for amounts recoverable from reinsurers, were
$93.6 million and $132.6 million at September 30, 2000 and December 31,
1999, respectively. LNC reviews reserve levels on an ongoing basis. The
liabilities are 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
liabilities 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.
Marketing and Compliance Issues. Regulators continue to focus on market
conduct and compliance issues. Under certain circumstances, companies
operating in the insurance and financial services markets have been held
responsible for providing incomplete or misleading sales materials and
for replacing existing policies with policies that were less
advantageous to the policyholder. LNC's management continues to monitor
the company's sales materials and compliance procedures and is making an
extensive effort to minimize any potential liability. Due to the
uncertainty surrounding such matters, it is not possible to provide a
meaningful estimate of the range of potential outcomes at this time;
however, it is management's opinion that such future developments will
not materially affect the consolidated financial position of LNC.
UK regulators continue to focus on industry-wide marketing and
compliance issues. Under certain circumstances, companies operating in
the insurance and financial services markets may be held responsible for
providing incomplete or misleading sales materials and information. As
a consequence of low interest and inflation rates, the projected
maturity values of mortgage endowment policies are, in many cases,
expected to fall short of the original illustrations.
UK regulators have required companies to review the assumptions used in
calculating future investment growth on certain endowment policies and
inform existing clients of the progress of their policies. For LNC, the
additional costs associated with this administrative process have been
immaterial because LNC's policyholders have been receiving regular
updates on the progress of their policies. No further action by LNC has
been required by the regulators to date. On October 3, 2000 UK
regulators issued a press release reaffirming their view that an
industry-wide review of all past mortgage endowment sales practices is
not justified. However, regulators have carried out a number of
targeted visits to endowment product providers and have indicated that
such visits will continue. UK regulators have also confirmed that formal
investigations are under way into the mortgage endowment selling
practices of a number of firms. While LNC has not been under such an
investigation, and has not been notified of any targeted visits by
regulators, the possibility of additional administrative or remedial
action remains. Due to the continued uncertainty of the situation, 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 this matter will not materially affect
the consolidated financial position of LNC.
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. In some instances, these proceedings include claims for
compensatory and punitive damages and similar types of relief in
addition to amounts for alleged contractual liability or requests for
equitable relief. After consultation with legal counsel and a review of
available facts, it is management's opinion that the ultimate liability,
if any, under these suits will not have a material adverse effect on the
consolidated financial position of LNC.
Lincoln Life now has two lawsuits against it alleging fraud in the sale
of interest-sensitive universal and whole life insurance policies.
While each of these lawsuits seeks class action status, the court has
not certified a class in any of them. In each of these lawsuits,
plaintiffs seek unspecified damages and penalties for themselves and on
behalf of the putative class. While the relief sought in these lawsuits
is substantial, they are in the discovery stages of litigation, and it
is premature to make assessments about potential loss, if any. In a
third lawsuit, a settlement has been preliminarily approved by the court
and a class has been conditionally certified for settlement purposes. A
fairness hearing originally scheduled in June of 2000 has been postponed
and has not yet been rescheduled. The court has not ruled on several
issues, and negotiations with several objectors have begun. Three
similar lawsuits were previously resolved and dismissed. A fourth such
lawsuit will proceed as an individual action after plaintiff's counsel
agreed to have class action allegations stricken from his complaint. In
addition, a lawsuit has been filed against Lincoln Life by an annuity
contractholder. In that case, plaintiff seeks class certification on
behalf of all contractholders who have acquired a variable annuity from
Lincoln Life to fund a tax-deferred qualified retirement plan.
Plaintiff claims that marketing variable annuities for use in such plans
is inappropriate. Management intends to defend these lawsuits
vigorously. The amount of liability, if any, which may arise as a result
of these lawsuits cannot be reasonably estimated at this time.
State guaranty funds assess insurance companies to cover losses to
policyholders of insolvent or rehabilitated companies. Mandatory
assessments may be partially recovered through a reduction in future
premium taxes in some states. LNC has accrued for expected assessments
net of estimated future premium tax deductions.
In October 2000, LNC conditionally agreed to modify certain terms relating
to a prior acquistion. In exchange for a payment of $43 million to LNC,
certain terms under the acquisition agreement would be modified. This
modification and the payment to LNC are subject to contingencies that are
expected to be resolved sometime during the fourth quarter of 2000. If these
contingencies are resolved, LNC would anticipate recording $43 million in
net income upon its receipt of the payment. Other than the receipt of this
cash payment, LNC does not expect that this potential modification to the
prior acquisition agreement would affect its ongoing financial results.
6. Segment Disclosures
In December 1999, management initiated a plan to change the structure of
LNC's internal organization in a manner that caused the composition of
its reportable segments to change beginning in 2000. During the first
quarter of 2000, execution of the planned changes was finalized so that
beginning with the quarter ending March 31, 2000, decisions about
resource allocation and performance assessment were made separately for
an Annuities segment and a Life Insurance segment. As of, and for the
nine months and quarter ended September 30, 2000, financial reporting
for the two separate segments is presented and the corresponding
information for earlier periods is presented on a basis consistent with
the new segment reporting structure. Most of the lines of business
previously included in the Life Insurance and Annuities segment are now
reported within either the Annuities segment or the Life Insurance
segment based on how the lines of business are being managed.
As a result of current management structures, the life and annuity
results for First Penn-Pacific are now reported in the Life Insurance
segment, Legacy Life results are now reported in the Annuities segment
and results for Lincoln Financial Advisors are now reported in "Other
Operations". Also, net investment income and related unrealized and
realized gain/loss on surplus investments and certain unallocated
expenses previously reported in the Life Insurance and Annuities segment
are now allocated to the Annuities, Life Insurance, Reinsurance and
Investment Management segments and Other Operations based on various
methodologies.
<TABLE>
<CAPTION>
The following tables show financial data by segment:
Nine Months Three Months
Ended September 30 Ended September 30
(in millions) 2000 1999 2000 1999
------------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenue:
Annuities $1,499.0 $1,457.5 $494.2 $479.5
Life Insurance 1,471.3 1,428.6 496.8 487.1
Lincoln UK 333.9 342.8 112.8 110.6
Reinsurance 1,308.3 1,254.2 454.4 405.5
Investment Management 343.6 342.9 115.9 110.7
Other Operations (includes consolidating adjustments) 121.9 169.8 42.0 48.7
-------- -------- -------- --------
Total $5,078.0 $4,995.8 $1,716.1 $1,642.1
Net Income (Loss) before Federal Income Taxes:
Annuities $316.0 $260.2 $104.6 $82.0
Life Insurance 317.8 267.9 113.9 96.2
Lincoln UK 7.0 72.7 (39.0) 20.5
Reinsurance 123.6 93.6 39.2 0.9
Investment Management 12.8 20.2 5.1 11.6
Other Operations (includes interest expense) (129.2) (125.2) (33.4) (28.0)
-------- -------- -------- --------
Total $648.0 $589.4 $190.4 $183.2
Federal Income Taxes (Credits):
Annuities $57.5 $49.9 $14.7 $17.7
Life Insurance 115.7 97.1 41.3 34.3
Lincoln UK 2.3 18.3 (9.1) 4.1
Reinsurance 37.9 33.2 12.7 0.5
Investment Management 5.2 8.8 2.4 3.9
Other Operations (43.1) (43.6) (10.2) (9.6)
-------- -------- -------- --------
Total $175.5 $163.7 $51.8 $50.9
Net Income (Loss):
Annuities $258.5 $210.3 $89.9 $64.3
Life Insurance 202.1 170.8 72.6 61.9
Lincoln UK 4.7 54.4 (29.9) 16.4
Reinsurance 85.7 60.4 26.5 0.4
Investment Management 7.6 11.4 2.7 7.7
Other Operations (includes interest expense) (86.1) (81.6) (23.2) (18.4)
-------- -------- -------- --------
Net Income $472.5 $425.7 $138.6 $132.3
<CAPTION>
September 30 December 31
(in millions) 2000 1999
------------- ---- ----
<S> <C> <C> <C>
Assets:
Annuities $ 60,526.5 $60,414.0
Life Insurance 20,709.1 19,941.3
Lincoln UK 8,866.6 9,712.8
Reinsurance 6,802.1 6,757.7
Investment Management 1,443.6 1,483.1
Other Operations 4,895.2 4,786.8
---------- ----------
Total $103,243.1 $103,095.7
</TABLE>
7. 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. Reconciliations of the
factors used in the two calculations are as follows:
<TABLE>
<CAPTION>
Nine Months Three Months
Ended September 30 Ended September 30
Numerator: [in millions] 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income as used in basic calculation $472.5 $425.7 $138.6 $132.3
Dividends on convertible preferred stock * * * *
------ ------ ------ ------
Net income as used in diluted calculation $472.5 $425.7 $138.6 $132.3
* Less than $100,000.
Denominator: [number of shares]
Weighted average shares, as used
in basic calculation 191,543,213 198,882,557 190,172,062 196,394,953
Shares to cover conversion of
preferred stock 444,945 500,208 429,097 482,822
Shares to cover non-vested stock (1,722) 503,848 27,183 490,505
Average stock options outstanding
during the period 11,903,461 8,129,319 17,726,610 12,498,969
Assumed acquisition of shares
with assumed proceeds and tax
benefits from exercising stock options
(at average market price during the period) (9,669,200) (6,482,746) (13,452,338) (10,877,413)
Average deferred compensation shares 645,581 -- 716,650 --
---------- ---------- ---------- ----------
Weighted-average shares, as
used in diluted calculation 194,866,278 201,533,186 195,619,264 198,989,836
</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. During 1999,
LNC changed its deferred compensation plans so that participants
selecting LNC stock for measuring the investment return attributable to
their deferral amounts will be paid out in LNC stock. The obligation to
satisfy these deferred compensation plan liabilities is dilutive and is
shown in the table above. Also, LNC has purchase contracts outstanding
which require the holder to purchase LNC common stock by August 16,
2001. These purchase contracts were issued in conjunction with the
FELINE PRIDES financing. The common shares involved are not currently
dilutive to LNC's earnings per share and will not be dilutive in the
future except during periods when the average market price of LNC's
common stock exceeds a stated threshold price of $55.725 per share.
8. Comprehensive Income
<TABLE>
<CAPTION>
Nine Months Three Months
Ended September 30 Ended September 30
(in millions) 2000 1999 2000 1999
------------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net income $472.5 $425.7 $138.6 $132.3
Foreign currency translation loss (10.2) (9.7) (2.0) 19.6
Net unrealized gain (loss) on securities 128.0 (656.2) 218.9 (102.7)
------ ------ ------ ------
Comprehensive Income (Loss) $590.3 $(240.2) $355.5 $49.2
</TABLE>
9. Divestiture
On March 30, 2000, LNC transferred its 49% share of Seguros Serfin
Lincoln to its partner, Grupo Financiero Serfin S.A., for $100.5
million. The proceeds included the recovery of LNC's investment which
freed up approximately $90.0 million of capital and included interest of
$14.1 million ($9.2 million after-tax).
10. Restructuring Charges
During 1998, LNC implemented a restructuring plan related to the
integration of existing life and annuity operations with the new
business operations acquired from CIGNA, and a second restructuring plan
related to downsizing LNC's corporate center operations. The aggregate
charges associated with these two unrelated restructuring plans totaled
$34.3 million after-tax ($52.8 million pre-tax). The aggregate pre-tax
costs include $19.6 million for employee severance and termination
benefits related to the elimination of 211 positions and 143 positions
for the two plans, respectively, $9.9 million for asset impairments and
$23.3 million for costs relating to exiting business activities. As of
September 30, 2000, actual pre-tax costs of $54.3 million have been
expended or written-off and 313 positions have been eliminated under
these restructuring plans. All expenditures under the restructuring
plan related to the integration of the existing life and annuity
operations with the new business operations acquired from CIGNA were
completed by the first quarter of 2000. As of September 30, 2000, a
balance of $2.5 million pre-tax related to the downsizing of LNC's
corporate center operations remains in the restructuring reserve for
this 1998 plan.
In 1999, LNC implemented three different restructuring plans related to
1) the downsizing and consolidation of the operations of Lynch & Mayer,
Inc. ("Lynch & Mayer"), 2) the discontinuance of HMO excess-of-loss
reinsurance programs and 3) the streamlining of Lincoln UK's operations.
The aggregate charges associated with these three unrelated
restructuring plans totaled $21.8 million after-tax ($31.8 million
pre-tax). These aggregate pre-tax costs include $8.3 million for
employee severance and termination benefits related to the elimination
of 34, 71 and 119 positions for the three plans, respectively, $9.8
million for asset impairments and $13.7 million for costs relating to
exiting business activities. As of September 30, 2000, actual pre-tax
costs of $22.0 million have been expended or written-off and 170
positions have been eliminated under these restructuring plans. During
the fourth quarter of 1999, LNC determined that part of rent expense
related to abandoned office space included in the costs related to
downsizing and consolidation of operations for Lynch & Mayer would not
be incurred due to the landlord allowing Lynch & Mayer to surrender the
lease rather than to sublease the space. As a result, the original
estimate was reduced by $3.0 million pre-tax. This reduction was
recorded in the fourth quarter of 1999 as a reversal to the
restructuring charge and related reserve. In addition, during the fourth
quarter of 1999, $1.5 million pre-tax associated with lease terminations
was released into income. As of September 30, 2000, a balance of $6.8
million pre-tax remains in the restructuring reserves for these 1999
plans.
During the second quarter of 2000, LNC recorded a restructuring charge
in its Investment Management segment of $2.7 million after-tax ($4.1
million pre-tax). The objective of this restructuring plan is to
combine the structured products team of Delaware Management Holdings,
Inc. ("Delaware") and Vantage Global Advisors, Inc. ("Vantage") in
Philadelphia and consolidate the back office operations of Vantage into
Delaware, 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 Consolidated Statement of Income. The restructuring plan identified
the following activities and associated pre-tax costs to achieve the
objectives of the restructuring plan: (1) severance and termination
benefits of $2.3 million related to the elimination of 15 positions, (2)
write-off of impaired assets of $1.4 million and (3) other costs of $0.4
million. Write-offs under the restructuring plan began in the second
quarter of 2000. All remaining expenditures under this restructuring
plan are expected to be complete by the end of 2000. As of September
30, 2000, $0.6 million (pre-tax) has been expended or written-off under
this restructuring plan. All affected employees have been given notice
of termination; however, the payment of termination benefits will begin
on October 1, 2000. As of September 30, 2000, a balance of $3.5 million
pre-tax remains in the restructuring reserve for this plan.
On September 28, 2000, LNC announced the transfer of the Lincoln UK
sales force to Inter-Alliance and the decision to cease writing new
business in the UK. As a result, LNC entered into an exit plan
("restructuring plan") in the third quarter of 2000. Where all
commitment date and liability recognition criteria were met, charges for
this restructuring plan were recorded in the third quarter of 2000. The
remaining charges are expected to be recorded in the fourth quarter of
2000, when certain decisions under the contract with Inter-Alliance
relating to personnel and facilities will be finalized and all
requirements related to certain involuntary termination benefits will
also be met. The objective of this restructuring plan is to exit all
sales and sales support operations. Total expected restructuring costs
will include: the involuntary termination of affected members of the
sales force and employees, leasing costs of closed sales offices, the
write-off of impaired goodwill which was specific to a previously
acquired sales force operation, costs associated with the closing of a
home office operation that will no longer be required under this exit
plan, write-off of impaired fixed assets related to sales and sales
support functions and other costs to exit.
The charge recorded in the third quarter of 2000 related to this
restructuring plan was $40.5 million after-tax ($53.5 million pre-tax).
This charge was included in Underwriting, Acquisition, Insurance and
Other Expenses on the Consolidated Statement of Income. The part of the
restructuring plan related specifically to the third quarter
restructuring charge of $53.5 million pre-tax identified the following
activities and associated costs to achieve the objectives of the
restructuring plan: (1) severance and termination benefits of $11.5
million related to the elimination of 1,065 members of the sales force,
(2) write-off of impaired assets of $36.8 million and (3) other costs to
exit of $5.2 million. The additional charge to be recorded in the
fourth quarter of 2000 is expected to not exceed $39 million
after-tax. Depending upon decisions relating to the closure of a home
office operation, further charges of up to an additional $10 million
after-tax could also be recorded in future periods. All expenditures
under this restructuring plan are expected to be complete by the end of
2001. Given the close proximity of the announcement of this
restructuring plan to the end of the third quarter, while members of the
sales force have received notification, none of the sales force or
employee termination benefits have yet been paid out, nor have other
exit costs yet been paid out. Therefore, at September 30, 2000, of the
total third quarter charge of $53.5 pre-tax, $36.8 million of assets
have been written down and a balance of $16.7 million remains in the
restructuring reserves.
Item 2 Management's Discussion and Analysis of Financial Information
Forward Looking Statements - Cautionary Language
The pages that follow review the results of operations of LNC
consolidated, LNC's five business segments and "Other Operations"; LNC's
consolidated investments; and consolidated financial condition including
liquidity, cash flow and capital resources. Historical financial
information is presented and analyzed. Where appropriate, factors that
may affect future financial performance are identified and discussed.
Certain statements made in this report are "forward-looking statements"
within the meaning of the Securities Litigation Reform Act of 1995 (the
"Act"). Forward-looking statements include, without limitation, any
statement that may predict, forecast, indicate or imply future results,
performance or achievements, and may contain words like: "believe",
"anticipate", "expect", "estimate", "project", "will", "shall" and other
words or phrases with similar meaning. Forward-looking statements
involve risks and uncertainties which may cause actual results to differ
materially from the forward-looking statements. These risks and
uncertainties include, among others: 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), accounting principles generally accepted in the
United States, regulations (e.g., insurance and securities regulations),
litigation (e.g., adverse decisions in extracontractual damage cases,
new appellate decisions which change the law, unexpected trial court
rulings, unavailability of witnesses and newly discovered evidence),
debt and claims paying ratings issued by nationally recognized rating
organizations, acts of God (e.g., hurricanes, earthquakes and storms),
stability of foreign governments in countries that LNC does business,
other insurance risks (e.g., policyholder mortality and morbidity) and
competition.
The risks included here are not exhaustive. Other sections of this
report may include additional factors which could adversely impact LNC's
business and financial performance. Moreover, LNC operates in a rapidly
changing and competitive environment. New risk factors emerge from time
to time and it is not possible for management to predict all such risk
factors. Further, it is not possible to assess the impact of all risk
factors on LNC's business or the extent to which any factor or
combination of factors, may cause actual results to differ materially
from those contained in any forward-looking statements. Given these
risks and uncertainties, investors should not place undo reliance on
forward-looking statements as a prediction of actual results. In
addition, LNC disclaims any obligation to update any forward-looking
statements to reflect events or circumstances that occur after the date
of this report.
The discussion that follows focuses on the results of operations for the
nine months ended September 30, 2000 compared to the results for the
nine months ended September 30, 1999. The factors affecting the current
quarter to prior year quarter comparisons are essentially the same as
the year-to-date factors except as noted.
Within the discussion of the results of operations, reference is made to
"Income from Operations". This alternative measure of earnings is
defined as "Net income less realized gain (loss) on sale of investments,
gain (loss) on sale of subsidiaries and restructuring charges, all net
of taxes".
<TABLE>
<CAPTION>
RESULTS OF CONSOLIDATED OPERATIONS
Summary Financial Results
Nine Months Three Months
Ended September 30 Ended September 30
(in millions) 2000 1999 2000 1999
------------- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Operating Revenue (1) $5,106.3 $4,992.5 $1,733.1 $1,636.7
Expenses (including taxes) (2) 4,571.9 4,553.6 1,542.4 1,505.3
-------- -------- -------- --------
Income from Operations (2) 534.4 438.9 190.7 131.4
Realized Gain (Loss) on Investments (after-tax) (18.7) 2.1 (11.6) 4.1
Restructuring Charge (after-tax) (43.2) (15.3) (40.5) (3.2)
-------- -------- -------- --------
Net Income $ 472.5 $ 425.7 $ 138.6 $ 132.3
(1) Operating revenue excludes realized gain/(loss) on investments.
(2) Expenses exclude restructuring charges.
</TABLE>
LNC has the following business segments: Annuities, Life Insurance,
Lincoln UK, Reinsurance and Investment Management. LNC reports
operations not directly related to the business segments and unallocated
corporate items in "Other Operations". Included in "Other Operations"
are corporate investment income, interest expense on corporate debt,
unallocated overhead expenses and the operations of Lincoln Financial
Advisors Corporation ("LFA"). See "Reorganization of Reporting Segments"
below for further discussion of LNC's segment reporting structure.
Net income and income from operations for the first nine months of 2000
increased 11% and 22%, respectively, compared to the same period in
1999. Net income and income from operations for the third quarter of
2000 increased 5% and 45%, respectively, compared to the same quarter in
1999. The increases in net income and income from operations for the
nine months and quarter were primarily the result of increased earnings
in the Annuities and Life Insurance segments. Also, a $25.0 million
after-tax reserve increase was recorded in the third quarter of 1999
related to the HMO excess-of-loss business.
Consolidated operating revenues increased slightly (2% for the first
nine months of 2000 compared to the same period in 1999) due primarily
to increased fee income in the Annuities and Life Insurance segments,
increased individual life premiums in the Reinsurance segment, increased
other revenue in the Investment Management segment and increased
investment partnership income in the Life Insurance segment. These
increases were partially offset by decreased business volume in the
Reinsurance segment related to exited businesses, decreased investment
advisory fees in the Investment Management segment and decreased net
investment income in the Annuities segment. All of the explanations
noted above for the change in operating revenues for this nine month
comparison also apply to the comparison of the third quarter of 2000 to
the third quarter of 1999.
Operating expenses including taxes increased slightly (0.4% for the
first nine months of 2000 compared to the same period of 1999).
However, expenses excluding taxes were $4,372.4 million for the nine
months ended September 30, 2000 and $4,384.6 million for the nine months
ended September 30, 1999, a slight decrease of 0.3% between periods.
This decrease was due primarily to lower Year 2000 information
technology costs across all segments and expense management initiatives
by LFA included in Other Operations and decreased health benefit
expenses in the Reinsurance segment. These decreases were partially
offset by increases in volume related expenses, increased individual
life benefit expenses in the Reinsurance segment related to business
growth and fluctuations in mortality and increased staffing costs in the
Investment Management segment related to the initiatives to improve
relative performance. Operating expenses were $1,472.2 million for the
third quarter of 2000 and $1,454.1 million for the third quarter of
1999, a slight increase of 1% between periods. In this comparison, the
volume related increases outweighed any cost savings related to lower
Year 2000 information technology costs and expense management
initiatives. For further discussion of the results of operations, see
the discussion of the results of operations by segment.
Reorganization of Reporting Segments
In December 1999, management initiated a plan to change the structure of
LNC's internal organization in a manner that caused the composition of
its reportable segments to change beginning in 2000. During the first
quarter of 2000, execution of the planned changes was finalized so that
beginning with the quarter ending March 31, 2000, decisions about
resource allocation and performance assessment were made separately for
an Annuities segment and a Life Insurance segment. As of and for the
nine months and quarter ended September 30, 2000, financial reporting
for the two separate segments is presented and the corresponding
information for earlier periods is presented on a basis consistent with
the new segment reporting structure. Most of the lines of business
previously included in the Life Insurance and Annuities segment are now
reported within either the Annuities segment or the Life Insurance
segment based on how the lines of business are being managed.
As a result of current management structures, the life and annuity
results for First Penn-Pacific are now reported in the Life Insurance
segment, Legacy Life results are now reported in the Annuities segment
and results for LFA are now reported in "Other Operations". Also, net
investment income and related unrealized and realized gain/loss on
surplus investments and certain unallocated expenses previously reported
in the Life Insurance and Annuities segment are now allocated to the
Annuities, Life Insurance, Reinsurance and Investment Management
segments and Other Operations based on various methodologies.
Lincoln UK Restructuring
On September 28, 2000, LNC reached a definitive agreement to transfer
Lincoln UK's sales force, numbering in total over 1,000 members, to
Inter-Alliance, one of the UK's largest independent financial
advisory groups. The terms of the transfer provides various persistency
protections on Lincoln UK's current block of business. Also,
Inter-Alliance will employ a number of the transferred sale force
members and assume the leases on several Lincoln UK sales offices, the
exact numbers of which will be determined during the fourth quarter of
2000.
In addition, concurrent with the announcement of the transfer agreement,
LNC announced that a party with which it had been negotiating for months
on the sale of Lincoln UK advised LNC that it would not proceed with the
transaction. In light of this development, and in conjunction with the
transfer of the Lincoln UK sales force, LNC also decided to cease
writing new business in the UK. LNC will continue to investigate
financial and reinsurance strategies to maximize shareholder value and
to limit its exposure to trends in the UK pensions and life insurance
businesses.
As a result of the transfer of the Lincoln UK sales force and the
decision to cease writing new business in the UK, LNC is expecting to
record restructuring charges of up to $93 million after-tax. Of this
total, $40.5 million was recorded in the third quarter of 2000 as a
restructuring charge and $3.4 million was recorded as an operating
expense. Up to another $39 million after-tax is expected to be recorded
in the fourth quarter of 2000 as a restructuring charge. In addition,
up to $10 million after-tax is expected to be recorded in the fourth
quarter of 2000, or in future quarters, the timing of which will depend
upon the dates of decisions and employee termination notifications,
relating to the expected consolidation of Lincoln UK home offices and
operations. (See further discussion of the Lincoln UK restructuring
charge under the results of operations for the Lincoln UK segment.)
Previously Announced Restructuring Plans
During the second quarter of 2000, LNC implemented a restructuring plan
related to the downsizing and consolidation of the operations of Vantage
Global Advisors, Inc. ("Vantage"). The charge associated with this
restructuring plan was $2.7 million after-tax ($4.1 million pre-tax).
The components of the pre-tax costs include employee severance and
termination benefits of $2.3 million, write-off of impaired assets of
$1.4 million, and other costs of $0.4 million. (See Note 10 to the
consolidated financial statements for further details regarding this
restructuring plan.)
For an update on the status of restructuring plans implemented in 1998
and 1999 refer to Note 10 to the consolidated financial statements.
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS BY SEGMENT
Annuities
Results of Operations (1) Six Months Ended Three Months Ended
September 30 September 30
(in millions) 2000 1999 2000 1999
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income from Operations $263.9 $214.6 $98.5 $71.1
Net Income 258.5 210.3 89.9 64.3
<CAPTION>
September 30 (in billions) 2000 1999
-----------------------------------------------------------------------------------------------------------
Account Values
Variable Annuities $42.7 $35.6
Fixed Annuities 13.8 14.9
Variable Life Insurance 0.2 0.1
-------- --------
Total Account Values $56.7 $50.6
</TABLE>
(1) The 1999 data was restated from the prior year due to the
reorganization of the Life Insurance and Annuities segment into two
separate segments: an Annuities segment and a Life Insurance segment.
The Annuities segment reported an increase in net income of $48.2
million or 23% for the first nine months of 2000 compared to the same
period in 1999 and an increase of $25.6 million or 40% for the third
quarter of 2000 compared to the same quarter in 1999. Income from
operations for the first nine months of 2000 increased $49.3 million or
23% compared to the same period in 1999 and increased $27.4 million or
39% for the third quarter of 2000 compared to the same quarter in 1999.
The increase in net income and income from operations was driven
primarily by growth in fee income from variable annuity accounts ($38.4
million for the year-to-date and $11.7 million for the third quarter of
2000) and other items discussed below. These increases were partially
offset by increased expenses of approximately $6.0 million for the
year-to-date and $4.4 million for the quarter. Variable annuity account
values increased by $7.1 billion or 20% from September 30, 1999 to
September 30, 2000. The growth in the variable annuity account values
was driven by stock market appreciation partially offset by net cash
outflow. The increase in general and administrative expenses was due
primarily to increased staffing expenses, consulting fees and costs
associated with the reorganization of the profit center which resulted
from the segment reorganization. These increased expenses were
partially offset by lower Year 2000 information technology costs.
Other items that were included in income from operations for the third
quarter of 2000 were investment partnership income of $5.9 million,
changes in various assumptions relating to a block of annuity business
acquired from CIGNA in 1998 which resulted in $6.1 million of income, a
$4.8 million reduction in the effective tax rate for the Annuities
segment that resulted from refinements in the dividend received
deduction from separate account business and a $0.6 million reduction in
defined benefit expenses.
During the first nine months of 2000 and the third quarter of 2000, the
Annuities segment experienced a continuation of the trend of net cash
outflow that was noted in the 1999 Form 10-K. For the first nine months
of 2000, annuity deposits were $3.7 billion and withdrawals were $5.5
billion, resulting in net cash outflow of $1.8 billion. For the first
nine months of 1999, annuity deposits were $3.5 billion and withdrawals
were $3.9 billion, resulting in net cash outflow of $0.4 billion. The
growth rate of annuity deposits of 5% between periods was attributable
to variable annuity deposits which grew 21% between periods. Fixed
annuity deposits decreased by 10% between periods as result of lower
deposits in the second and third quarters of 2000 compared to the same
quarters in 1999.
The amount of net cash outflow for variable annuities deteriorated in
the third quarter of 2000 to $0.5 billion, a 72% increase over the same
quarter in 1999 and a 40% increase over the second quarter of 2000.
Although the first two months of the third quarter of 2000 reflected the
highest level of net cash outflow for the year, September cash flows
showed improvement. As expected, the third quarter launch of several new
products occurred too late in the quarter to have much of an impact upon
that period's cash flows. However, variable annuity average daily gross
deposits in the first three weeks of the fourth quarter of 2000, have
been strong when compared to the first nine months of the year. It
appears that deposits may be starting to trend upward due to recent
product line expansion initiatives. In addition to new product launches
aimed at increasing sales, LNC is also continuing to implement several
programs aimed at the retention of current accounts.
<TABLE>
<CAPTION>
Life Insurance
Results of Operations (1) Nine Months Three Months
Ended September 30 Ended September 30
(in millions) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income from Operations $208.3 $174.0 $72.2 $60.6
Net Income 202.1 170.8 72.6 61.9
First Year Premiums (by Product) (in millions)
Universal Life $205 $226 $71 $74
Variable Universal Life 136 77 52 27
Whole Life 14 16 6 6
Term 38 38 10 12
Corporate Owned Life Insurance ("COLI") 38 11 6 2
---- ---- ---- ----
Total First Year Premiums $431 $368 $145 $121
<CAPTION>
September 30 (in billions) 2000 1999
---------------------------------------------------------------------------------------------------------------
Account Values
<S> <C> <C>
Universal Life $6.9 $6.5
Variable Universal Life 1.8 1.3
Interest-Sensitive Whole Life 2.0 1.9
---- ----
Total Life Insurance 10.7 9.7
Annuities 3.1 3.5
Reinsurance Ceded on Annuities (1.2) (1.5)
---- ----
Total Annuities 1.9 2.0
Total Account Values $12.6 $11.7
In-Force - Face Amount of Coverage
Universal Life and Oth $112.9 $106.9
Term Insurance 98.4 82.0
</TABLE>
(1) The 1999 data was restated from the prior year due to the
reorganization of the Life Insurance and Annuities segment into two
separate segments: an Annuities segment and a Life Insurance segment.
The Life Insurance segment reported an increase in net income of $31.3
million or 18% for the first nine months of 2000 compared to the same
period in 1999 and an increase of $10.7 million or 17% for the third
quarter of 2000 compared to the same quarter in 1999. Income from
operations for the first nine months of 2000 increased $34.3 million or
20% compared to the same period in 1999 and increased $11.6 million or
19% for the second quarter of 2000 compared to the same quarter in 1999.
The increase in net income and income from operations for the first nine
months of 2000 as compared to the first nine months of 1999 was
attributable to strong sales growth, favorable investment income and
expense savings. Despite the growth in in-force, expenses decreased in
the first nine months of 2000 due primarily to lower Year 2000
information technology costs. Also, in the third quarter of 2000, there
was a $0.6 million reduction in defined benefit plan expenses.
First year premiums increased $66.0 million or 18% for the first nine
months of 2000 compared to the same period in 1999 and increased $24.0
million or 20% for the third quarter of 2000 compared to the same
quarter in 1999. Account values of universal life, variable universal
life and interest-sensitive life insurance products increased $1.0
billion or 10% from September 30, 1999 to September 30, 2000. In-force
increased $22.4 billion or 12% year-over-year. The growth in in-force
resulting from sales growth and market appreciation contributed to an
increase in income of $25.7 million for the first nine months of 2000
compared to the same period in 1999. The sales growth was fueled by
variable universal life ("VUL") products which had a 77% increase in
sales for the first nine months of 2000 over the comparable period in
1999. Lincoln Life introduced two new single life VUL products in 1999
and a new survivorship VUL in May 2000 which have been significant
drivers of this growth. Also, corporate owned life insurance, bolstered
by a new corporate VUL product launched at the end of 1999, had an
increase in first year premiums of $27 million over the first nine
months of 1999. This growth was partially offset by decreased sales of
First-Penn Pacific's fixed universal life products.
Investment income increased $3.7 million for the first nine months of
2000 over the comparable period in 1999 due primarily to increased
income from investment partnerships.
<TABLE>
<CAPTION>
Lincoln UK
Results of Operations (1) Nine Months Three Months
Ended September 30 Ended September 30
(in millions) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income from Operations $45.5 $53.3 $10.6 $16.2
Realized Gain (Loss) on Investments (0.3) 1.1 -- 0.2
Restructuring Charge (40.5) -- (40.5) --
---- ---- ---- ----
Net Income (Loss) 4.7 54.4 (29.9) 16.4
September 30 (in billions) 2000 1999
---------------------------------------------------------------------------------------------------------------
Unit-Linked Assets $6.5 $6.6
Individual Life Insurance In-Force $24.5 $26.2
</TABLE>
The UK segment reported a decrease in net income of $49.7 million or 91%
for the first nine months of 2000 compared to the same period in 1999
and a decrease of $46.3 million or 282% for the third quarter of 2000
compared to the same quarter in 1999. Income from operations for the
first nine months of 2000 decreased $7.8 million or 15% compared to the
same period in 1999 and decreased $5.6 million or 35% for the third
quarter of 2000 compared to the same quarter in 1999. The decrease in
net income and income from operations for the first nine months of 2000
compared to the same period in 1999 was primarily attributable to
reduced sales volumes and increased expenses. In addition, the decrease
in net income was significantly impacted by the recording of a $40.5
million after-tax restructuring charge which resulted from the decision
to cease writing new business in the UK and the transfer of the Lincoln
UK sales force (see below for further explanation). Expenses increased
due to reserve strengthening of $4.0 million for policies carrying
guaranteed annuity options and the recording of $3.4 million in expenses
related to the strategic review of Lincoln UK. Also, there was an
increase in the amortization of deferred acquisition costs of $3.5
million in the third quarter of 2000 related to changing persistency
assumptions resulting from the decision to cease writing new business.
These increases in expenses were partially offset by decreases in
operating expenses resulting from the implementation of cost management
initiatives.
On September 28, 2000, LNC announced the transfer of the Lincoln UK
sales force to Inter-Alliance and the decision to cease writing new
business in the UK. As a result, LNC entered into an exit plan
("restructuring plan") in the third quarter of 2000. Where all
commitment date and liability recognition criteria were met, charges for
this restructuring plan were recorded in the third quarter of 2000. The
remaining charges are expected to be recorded in the fourth quarter of
2000, when certain decisions under the contract relating to personnel
and facilities with Inter-Alliance will be finalized and all
regulations related to certain involuntary termination benefits will
also be met. The charge recorded in the third quarter of 2000 related to
this restructuring plan was $40.5 million after-tax ($53.5 million
pre-tax). The components of the pre-tax costs include employee
severance and termination benefits of $11.5 million, write-off of
impaired assets of $36.8 million and other costs to exit of $5.2
million. (See Note 10 to the consolidated financial statements for
further details regarding this restructuring plan.)
The agreement with Inter-Alliance contains incentives designed to
retain the existing business on Lincoln UK's books. As noted above, LNC
management changed persistency assumptions in the third quarter of 2000
resulting in increased expense of $3.5 million. These new assumptions
are based upon current expectations that significant numbers of Lincoln
UK's sale force will become affiliated with Inter-Alliance.
Decisions by Inter-Alliance and Lincoln UK's sales force members will be
finalized in the fourth quarter of 2000; the result of these decisions
will be a factor that LNC will consider in its fourth quarter review of
the expected persistency of Lincoln UK's business.
<TABLE>
<CAPTION>
Reinsurance
Results of Operations (1) Nine Months Three Months
Ended September 30 Ended September 30
(in millions) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Results by Source
Individual Markets $62.3 $71.6 $20.5 $24.9
Group Markets 3.7 -- 1.5 (1.3)
Financial Reinsurance 15.7 16.2 4.5 4.2
Other (2.5) (0.7) (0.5) --
---- ---- ---- ----
Income from Operations, excluding Exited Businesses 79.2 87.1 26.0 27.8
Exited Businesses 8.6 (24.8) 2.7 (24.5)
---- ---- ---- ----
Income from Operations 87.8 62.3 28.7 3.3
Realized Gain (Loss) on Investments (2.1) 1.3 (2.2) 0.3
Restructuring Charge -- (3.2) -- (3.2)
---- ---- ---- ----
Net Income $85.7 $60.4 $26.5 $0.4
Individual Life Sales - Face Amount (in billions) $104.4 $67.3 $37.2 $28.8
September 30 (in billions) 2000 1999
---------------------------------------------------------------------------------------------------------------
Individual and Group Life Insurance In-Force
Face Amount $412.6 $297.1
</TABLE>
(1) The 1999 data was restated from the prior year due to the reallocation
of net investment income on surplus investments from"Other" in the former
Life Insurance and Annuities segment to all segments that have business in
Lincoln National Life Insurance Company.
The Reinsurance segment ("Lincoln Re") reported an increase in net
income of $25.3 million or 42% for the first nine months of 2000
compared to the same period in 1999 and an increase of $26.1 million for
the third quarter of 2000 compared to the same quarter in 1999. Income
from operations for the first nine months of 2000 increased by $25.5
million or 41% compared to the same period in 1999 and increased $25.4
million for the third quarter of 2000 compared to the same quarter in
1999. The primary reason for these increases was a $25.0 million
after-tax charge taken in the third quarter of 1999 for reserve
strengthening related to the HMO excess-of-loss business (included in
Exited Businesses). In addition, in the third quarter of 1999, the
decision was made to discontinue writing new HMO excess-of-loss
business. As a result, a restructuring charge of $3.2 million after-tax
was taken in the third quarter of 1999 for employee severance and other
costs related to the discontinuance of the business. After considering
these third quarter 1999 items, there was a slight increase in the
results for the first nine months and third quarter of 2000 from the
comparable periods in 1999. These increases were the result of
offsetting results by business source.
In Individual markets, earnings were bolstered by the growth in the
individual life business, as the strong sales experienced over the last
12 months continued through the third quarter of 2000. Part of the
growth in sales in the first part of 2000 was due to the surge in term
life insurance policies written by direct life insurance companies prior
to January 1, 2000 when the Valuation of Life Insurance Model Regulation
("Regulation XXX") became effective. Regulation XXX requires companies
to increase reserves related to certain term life insurance policies
resulting in an increase in premium to the policyholder. The individual
life insurance in-force face amount grew to $381.4 billion at the end of
the third quarter of 2000; a $119.9 billion or 46% increase from the end
of the third quarter of 1999. However, fluctuations in mortality more
than offset the positive effects of the growth in business, which
explains why individual markets' earnings were down relative to the
first nine months of 1999. The actual to expected loss ratio
deteriorated in the third quarter of 2000 to 101.2% from 96.9% in the
second quarter of 2000. For the first nine months of 2000, the loss
ratio remained slightly above long-term pricing expectations at 99.3%.
The comparable loss ratio for the first nine months of 1999 was 85.5%.
Group markets earnings increased due to growth in the employer stop-loss
business. Finally, while Exited businesses (excluding the $25.0 million
charge in the third quarter of 1999) benefited from $9.2 million
(after-tax) of interest received upon the transfer of LNC's investment
in Seguros Serfin Lincoln in the first quarter of 2000 and increased
earnings on investment partnerships held in the surplus investment
portfolio in the third quarter of 2000, earnings without these items
were down slightly. This was due to increased reserves for the group
carrier medical reinsurance and HMO excess-of-loss reinsurance programs.
<TABLE>
<CAPTION>
Investment Management
Results of Operations (1) Nine Months Three Months
Ended September 30 Ended September 30
(in millions) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total Investment Advisory Fees $207.6 $214.9 $69.3 $69.3
Income from Operations 12.6 24.0 3.0 8.1
Realized Loss on Investments (after-tax) (2.3) (0.5) (0.3) (0.4)
Restructuring Charge (after-tax) (2.7) (12.1) -- --
---- ---- ---- ----
Net Income $7.6 $11.4 $2.7 $7.7
<CAPTION>
September 30 (in billions) 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets under Management
Regular Operations:
Retail $30.2 $28.6
Institutional 25.3 30.3
---- ----
55.5 58.9
At Cost Operations 35.0 36.8
---- ----
Total Assets Under Management $90.5 $95.7
</TABLE>
(1) The 1999 data was restated from the prior year due to the
reallocation of net investment income on surplus investments and
expenses from "Other" in the former Life Insurance and Annuities segment
to all segments that have business in Lincoln National Life Insurance
Company. Within this segment, the reallocation relates to the 401(k)
operations.
The Investment Management segment reported a decrease in net income of
$3.8 million or 33% for the first nine months of 2000 compared to the
same period in 1999 and a decrease of $5.0 million or 65% for the third
quarter of 2000 compared to the same quarter in 1999. Net income
exclusive of restructuring charges was $10.3 million and $23.5 million
for the first nine months of 2000 and 1999, respectively, a 56% decrease
between periods. Income from operations for the first nine months of
2000 decreased $11.4 million or 48% compared to the same period in 1999
and decreased $5.1 million or 63% for the third quarter of 2000 compared
to the same quarter in 1999. The decrease in both net income excluding
the restructuring charge and income from operations for the first nine
months of 2000 as compared to the first nine months of 1999 was
attributable to decreased investment advisory fees and increased
expenses, which were partially offset by an increase in other revenue.
Expenses increased primarily due to an increase in compensation expense
primarily resulting from an increase in headcount of investment
professionals and space costs. The increase in headcount of investment
professionals was a result of the decision made in the fourth quarter of
1999 to invest in the business to ultimately improve investment
performance. In the third quarter of 2000, 19 additional fixed income
investment professionals were hired. These expense increases were
partially offset by lower Year 2000 information technology costs. Other
revenue increased due to an increase in fees resulting from an increase
in the number and value of accounts being serviced in the 401(k) and
investment accounting groups.
Investment advisory fees relating to assets under management of regular
operations (i.e. external assets under management) for the first nine
months of 2000 decreased $13.4 million or 7% compared to the same period
in 1999 due to a decrease in institutional assets under management
partially offset by an increase in retail assets under management.
Institutional assets under management were $25.3 billion at the end of
the third quarter of 2000 as compared to $30.3 billion at the end of the
third quarter of 1999. Retail assets under management were $30.2 billion
at the end of the third quarter of 2000 as compared to $28.6 billion at
the end of the third quarter of 1999. The decrease in institutional
assets under management was due to net cash outflows partially offset by
market appreciation. The increase in retail assets under management was
due to market appreciation partially offset by net cash outflows.
The net cash outflows of $4.7 billion experienced by the institutional
accounts and to a lesser extent by the retail accounts ($1.6 billion)
during the first nine months of 2000 were due to performance issues. Net
cash outflows have continued for both institutional and retail accounts,
but the third quarter of 2000 showed improvement over the levels
experienced in the first two quarters of 2000. While its growth funds
have continued to perform strongly, LNC has initiated various actions to
improve relative performance across all asset classes. Once
demonstrable improvement in performance track records occurs, LNC
eventually expects positive fund flows leading to higher revenues and
ultimately a return to higher earnings levels for this segment. This
process will take time; however, early indications of performance
enhancement are appearing in certain asset classes. One important
measure of improvement is that for the six months ending September 30,
2000, the Investment Management segment's large cap value performance
has exceeded its relevant indices.
<TABLE>
<CAPTION>
Other Operations
Results of Operations (1) Nine Months Three Months
Ended September 30 Ended September 30
(in millions) 2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Results by Source
LNC Financing $(65.5) $(62.3) $(21.9) $(19.8)
LFA (13.4) (23.4) (3.1) (5.3)
Other Corporate (2) (4.8) (3.6) 2.7 (2.8)
---- ---- ---- ----
Loss from Operations (83.7) (89.3) (22.3) (27.9)
Net Loss $(86.1) $(81.6) $(23.2) $(18.4)
</TABLE>
(1) The 1999 data was restated from the prior year due to the
reorganization of the Life Insurance and Annuities segment into two
separate segments: an Annuities segment and a Life Insurance segment.
Results for LFA and certain unallocated expenses previously reported in
the Life Insurance and Annuities segment are now reported in "Other
Operations".
(2) Other Corporate was restated from the prior year to include the
financial results of AnnuityNet. In May 2000, LNC adopted the equity
method of accounting for AnnuityNet. This change was due to the
reduction of LNC's ownership interest in AnnuityNet to 44.9% resulting
from second round funding by an unaffiliated investor group.
Other Operations reported a decrease in the net loss of $4.5 million or
6% for the first nine months of 2000 compared to the same period in 1999
and a decrease in the net loss of $4.8 million or 26% for the second
quarter of 2000 compared to the same quarter in 1999. Loss from
operations for the first nine months of 2000 decreased by $5.6 million
or 6% compared to the same period in 1999 and decreased $5.6 million or
20% for the third quarter of 2000 compared to the same quarter in 1999.
The change in net loss and loss from operations for the first nine
months of 2000 compared to the same period in 1999 was due to offsetting
results by business source. The decrease in the loss from LFA was due
to increased sales volumes and reduced field office costs resulting from
expense management initiatives. The increase in the loss in the LNC
Financing line was due primarily to increased short-term debt costs. The
increase in the loss in the Other Corporate line for the first nine
months of 2000 as compared to the same period in 1999 is attributable to
a variety of items including $2.6 million (after-tax) of offsetting
litigation matters recorded in the first quarter of 2000 and $2.5
million relating to interest on tax refunds received in the second
quarter of 1999 and timing differences between periods on various
intercompany expense allocations.
The decrease in the loss in the Other Corporate line for the third
quarter of 2000 compared to the same quarter in 1999 was due primarily
to greater allocation of expenses to the business units in the third
quarter of 2000. The third quarter of 1999 included expenses related to
the corporate office relocation that were not allocated to the business
units.
<TABLE>
<CAPTION>
CONSOLIDATED INVESTMENTS
September 30 (in billions) 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Total Assets Managed $136.3 $133.2
<CAPTION>
Nine Months Ended Three Months Ended
September 30 September 30
2000 1999 2000 1999
---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Mean Invested Assets (cost basis) (in billions) $37.60 $39.22 $37.25 $39.11
Adjusted Net Investment Income (1) (in millions) $2,080.2 $2,112.8 $691.5 $698.7
Investment Yield (ratio of net investment
income to mean invested assets) 7.38% 7.18% 7.43% 7.15%
</TABLE>
(1) Includes tax-exempt income.
The total investment portfolio decreased $273 million in the first nine
months of 2000. This is the net result of the decrease in the fair
value of securities available-for-sale and fixed annuity contractholders
opting to transfer funds to variable annuity contracts partially offset
by purchases of investments from cash flow generated by the business
segments.
The quality of LNC's fixed maturity securities portfolio as of September
30, 2000 was as follows:
Treasuries and AAA 22.3% BBB 32.9%
AA 7.1% BB 3.6%
A 30.8% Less than BB 3.3%
As of September 30, 2000, $1.9 billion or 6.9% of fixed maturity
securities was invested in below investment grade securities (less than
BBB). This represents 5.3% 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, 2000, the aggregate cost of such investments purchased was
$70.8 million. Aggregate proceeds from such investments sold were
$111.5 million, resulting in a net realized pre-tax loss at the time of
sale of $38.5 million.
LNC's entire fixed maturity and equity securities portfolio is
classified as "available-for-sale" and is carried at fair value.
Changes in fair value, net of related deferred acquisition costs,
amounts required to satisfy policyholder commitments and taxes, are
charged or credited directly to shareholders' equity.
As of September 30, 2000, mortgage loans on real estate and real estate
represented 13.5% and 0.8% of LNC's total investment portfolio,
respectively. As of September 30, 2000, the underlying properties
supporting the mortgage loans on real estate consisted of 31.0% in
commercial office buildings, 29.4% in retail stores, 16.2% in
apartments, 13.5% in industrial buildings, 5.4% in hotels/motels and
4.5% in other. In addition to the dispersion by property type, the
mortgage loan portfolio is geographically diversified throughout the
United States.
The following summarizes key information on mortgage loans:
<TABLE>
<CAPTION>
September 30 December 31
(in millions) 2000 1999
-------------- ---- -----
<S> <C> <C>
Total Portfolio (net of reserves) $4,767.3 $4,735.4
Mortgage loans two or more payments
delinquent (including in process of foreclosure) 7.6 5.1
Restructured loans in good standing 4.2 3.3
Reserve for mortgage loans 5.0 4.7
</TABLE>
Fixed maturity securities available-for-sale, mortgage loans on real
estate and real estate that were non-income producing for the nine
months ended September 30, 2000 were not significant.
Net Investment Income
Net investment income decreased $32.4 million or 1.5% when compared with
the first nine months of 1999. This decrease was the result of a 4%
decrease in mean invested assets partially offset by an increase in the
overall yield on investments from 7.18% to 7.33% (exclusive of $14.1
million of interest income on the transfer of Seguros Serfin Lincoln
recognized in the first quarter of 2000).
Realized Gain on Investments
The first nine months of 2000 and 1999 had realized gains (losses) on
investments of $(28.3) million and $3.3 million, respectively. The
losses and slight gains for 2000 and 1999, respectively, which are net
of related deferred acquisition costs and expenses, were the result of
rising interest rates. Securities available-for-sale that were deemed
to have declines in fair value that are other than temporary were
written down. Also, when the underlying value of the property is deemed
to be less than the carrying value, LNC records write-downs and
allowances on mortgage loans on real estate, real estate and other
investments.
The pre-tax write-downs of securities available-for-sale for the first
nine months of 2000 and 1999 were $32.6 million and $31.4 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 2000, LNC released $1.4
million in reserves on real estate and mortgage loans on real estate
compared to reserves released of $0.5 million for the first nine months
of 1999. Net write-downs and reserve releases for all investments for
the nine months ended September 30, 2000 and 1999 were $31.2 million and
$30.9 million, respectively.
REVIEW OF CONSOLIDATED FINANCIAL CONDITION
Liquidity, Cash Flow and Capital Resources
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 statement of cash flows on page 6, indicates that
operating activities provided cash of $817.9 million during the first
nine months of 2000. This statement also classifies the other sources
and uses of cash by investing activities and financing activities and
discloses the total amount of cash available to meet LNC's obligations.
Although LNC generates adequate cash flow to meet the needs of its
normal operations, periodically LNC may issue debt or equity securities
to fund internal expansion, acquisitions, investment opportunities and
the retirement of LNC's debt and equity. As of September 30, 2000, LNC
has a shelf registration with an unused balance of $825 million that
would allow LNC to issue a variety of securities, including debt,
preferred stock, common stock and hybrid securities. Finally, cash
funds are available from LNC's revolving credit agreement which provides
for borrowing up to $750 million.
Transactions such as those described in the preceding paragraph that
have occurred in the first six months of 2000 include the purchase and
retirement of 5,109,081 shares of common stock at a cost of $158.3
million. At September 30, 2000, the remaining amount under the May 1999
board authorization to repurchase $500 million of common stock was
$105.1 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. Generally, these restrictions pose no
short-term liquidity concerns for the holding company. However, as
discussed in detail within Note 5 to the consolidated financial
statements, 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 its 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 first nine months of 2000 and during the year
ended December 31, 1999, Lincoln Life received regulatory approval and
paid extraordinary dividends totaling $315 million and $530 million,
respectively, to LNC. In the event such approvals are not obtained,
management believes that LNC can obtain the funds required to satisfy
its obligations from its existing credit facilities and other sources.
Total shareholders' equity increased $274.7 million in the first nine
months of 2000. Excluding the increase of $128.0 million related to a
decrease in the unrealized loss on securities available-for-sale,
shareholders' equity increased $146.7 million. This increase was the
net result of increases due to $472.5 million from net income, $7.2
million from the issuance of common stock related to benefit plans and
$1.4 million from the issuance of common stock related to the
acquisition of subsidiaries offset by decreases of $10.2 million for the
cumulative foreign currency translation adjustment, $158.3 million for
the repurchase of common shares and $165.9 million for the declaration
of dividends to shareholders.
As of September 30, 2000, LNC's senior debt ratings included Moody's at
A2 ("Upper Medium Grade"), Standard and Poor's at A- ("Strong"), Fitch
at A+ ("Strong") and A.M. Best at a ("Strong"), and LNC's commercial
paper ratings included Moody's at P-1 ("Superior"), Standard and Poor's
at A-2 ("Satisfactory") and Fitch at F-1 ("Very Strong"). In October of
2000, Moody's downgraded LNC's senior debt from A2 ("Upper Medium
Grade") to A3 ("Upper Medium Grade") and LNC's commercial paper from P-1
("Superior") to P-2 ("Strong"). Although there are less investors for
A-2/P-2 commercial paper and the short-term borrowing rate on the
issuance of commercial paper will increase approximately 0.20% per annum
as a result of the downgrade by Moody's, management believes that
liquidity will not be adversely impacted.
As of September 30, 2000, Lincoln National (UK) PLC's commercial paper
ratings included Standard and Poor's at A-2 ("Satisfactory") and
Moody's at P-1 ("Superior"). In October of 2000, Moody's also downgraded
Lincoln National (UK) PLC from P-1 ("Superior") to P-2 ("Strong"). When
Standard and Poor's lowered its rating of Lincoln National (UK) PLC's
commercial paper in November of 1999, the market treated Lincoln UK like
a A-2/P-2 issuer rather than one with a split rating and its borrowing
rate went up at that time by approximately 0.20% per annum. Management
does not expect any incremental costs as a result of the latest
downgrade by Moody's and does not believe that liquidity will be
adversely impacted.
Contingencies
See Note 5 to the consolidated financial statements for information
regarding claims for disability income coverages, liabilities and
recoveries related to inappropriate selling of products in the UK,
liabilities for personal accident reinsurance programs, liabilities for
HMO excess-of-loss and group carrier medical reinsurance programs,
liabilities for marketing and compliance issues, the reserve for the
run-off of group pension annuities and other contingency matters.
Item 3 Quantitative and Qualitative Disclosure of Market Risk
In Item 7A, Part II of LNC's Form 10-K for the year ended December 31,
1999 (see page 29 of LNC's 1999 Form 10-K), LNC provided a discussion of
its market risk. During the first nine months of 2000, 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, 1999 (see page 65 of LNC's 1999 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, credit risk, foreign
exchange risk 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 2000, 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 $2.5 billion notional to $1.6 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 by $85.5 million notional, resulting
in a remaining balance of $1.8 billion notional. The decrease in
notional of the swaptions is a result of expirations and no gain or loss
has been recognized. LNC uses swaptions to hedge various portfolios of
interest rate sensitive assets.
3. Increased its use of interest rate swaps hedging variable rate bonds
from $370.9 million notional to $398.3 million notional. New interest
rate swaps in the amount of $39.7 million notional were entered into
during the first nine months. A total of $12.3 million notional
expired. No gain or loss was recognized as a result of the expirations.
These interest rate swap agreements convert floating rate bond coupon
payments into a fixed rate of return. LNC also increased its use of
forward starting interest rate swaps to hedge the anticipated purchase
of assets from $260.0 million notional to $405.5 million notional. New
forward starting interest rate swaps in the amount of $584.0 million
notional were entered into during the first nine months. In addition,
$438.5 million notional was terminated resulting in a $4.5 million loss.
A total of $3.9 million loss was used to adjust the basis of purchased
assets and a $0.6 million loss was recognized. These swap agreements
protect LNC from falling interest rates.
4. Decreased its use of foreign currency swaps from $44.2 million
notional to $37.5 million notional. A total of $0.6 million notional
expired with no gain or loss recognized, and a total of $6.1 million
notional was terminated resulting in a $0.2 million gain. These foreign
currency swap agreements are part of a replication strategy. LNC owns
various foreign issue securities. Interest payments from these
securities are received in a foreign currency and then swapped into U.S.
dollars, replicating a foreign issue, U.S. dollar paying security.
5. Entered into $766.8 million notional of foreign exchange forward
contracts. These foreign exchange forward contracts were hedging the
foreign currency risk of LNC's net investment in Lincoln UK. The entire
$766.8 million notional was terminated resulting in a $26.6 million gain
reported in other comprehensive income. In addition, LNC entered into
foreign exchange forward contracts in the amount of $960.4 million
notional to hedge LNC's exposure to currency fluctuation associated with
its issuance of non-Sterling commercial paper in Europe. A total of
$848.4 million notional was terminated resulting in no gain or loss.
6. Increased its use of S&P 500 index call options from $129.6 million
notional to $173.5 million notional. New options in the amount of $77.0
million were entered into during the first nine months. A total of
$33.1 million notional was terminated, resulting in a $0.04 million
loss. These call options continue to offset LNC's increased liabilities
resulting from certain reinsurance agreements which guarantee payment
for a specified portion of the appreciation of the S&P 500 index on
certain underlying annuity products.
7. Decreased its use of FTSE index call options from $4.3 million
notional to $2.0 million notional. As a result of the terminations, a
$2.2 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.
8. Entered into 0.6 million call options on an equal number of shares of
LNC stock. These call options are hedging the expected increase in
liabilities arising from stock appreciation rights granted on LNC stock.
The stock appreciation rights were granted to LNC agents during the
first quarter 2000.
9. Entered into $100.0 million notional of spread lock agreements.
These spread lock agreements protect a portion of fixed maturity
securities and mortgage loans against widening spreads. The entire
$100.0 million notional was terminated resulting in a $2.4 million loss
used to adjust the basis of purchased assets.
10. Decreased its use of put option agreements from $21.3 million
notional to zero. These put option agreements are part of a replication
strategy that establishes a fixed maturity date for various perpetual
bonds owned by LNC. The entire gain of $3.4 million was used to adjust
the basis of the perpetual bonds.
LNC is exposed to credit loss in the event of non-performance by
counterparties on various derivative contracts. However, LNC does not
anticipate non-performance by any of the counterparties. The credit
risk associated with such agreements is minimized by purchasing such
agreements from financial institutions with long-standing superior
performance records.
PART II - OTHER INFORMATION AND EXHIBITS
Items 1, 2, 3, 4 and 5 of this Part II are either inapplicable or are
answered in the negative and are omitted pursuant to the instructions to
Part II.
Item 6 Exhibits and Reports on Form 8-K
(a) The following Exhibits of the Registrant are included in this
report.
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, 2000.
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 October 27, 2000
LINCOLN NATIONAL CORPORATION
Exhibit Index for the Report on Form 10-Q
for the Quarter Ended September 30, 2000
Exhibit Number Description Page Number
-------------- ----------- -----------
12 Historical Ratio of Earnings to
Fixed Charges 31
27 Financial Data Schedule 32
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) 2000 1999 1999 1998 1997(4) 1996 1995
-------------------- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Net Income before Federal
Income Taxes $648.0 $589.4 $570.0 $697.4 $1,427.1 $692.7 $626.6
Equity Loss (Earnings) in
Unconsolidated Affiliates 1.0 (4.0) (5.8) (3.3) (2.1) (1.4) (12.4)
Sub-total of Fixed Charges 126.5 119.4 160.9 144.1 113.3 108.6 94.4
-------- -------- -------- -------- -------- -------- --------
Sub-total of Adjusted
Net Income 775.5 704.8 725.1 838.2 1,538.3 799.9 708.6
Interest on Annuities &
Financial Products 1,102.7 1,121.9 1,510.4 1,446.2 1,253.5 1,185.6 1,147.1
-------- -------- -------- -------- -------- -------- --------
Adjusted Income Base 1,878.2 1,826.7 2,235.5 2,284.4 2,791.8 1,985.5 1,855.7
Rent Expense 61.1 61.0 81.5 81.3 62.5 71.6 65.6
Fixed Charges:
Interest and Debt Expense 106.1 99.0 133.7 117.1 92.5 84.7 72.5
Rent (Pro-rated) 20.4 20.3 27.2 27.0 20.8 23.9 21.9
-------- -------- -------- -------- -------- -------- --------
Sub-total of Fixed Charges 126.5 119.3 160.9 144.1 113.3 108.6 94.4
Interest on Annuities &
Financial Products 1,102.7 1,121.9 1,510.4 1,446.2 1,253.5 1,185.6 1,147.1
-------- -------- -------- -------- -------- -------- --------
Sub-total of Fixed Charges 1,229.2 $1,241.2 1,671.3 1,590.3 1,366.8 1,294.2 1,241.5
Preferred Dividends (Pre-tax) 0.1 0.1 0.1 0.1 0.2 0.2 13.4
-------- -------- -------- -------- -------- -------- --------
Total Fixed Charges $1,229.3 $1,241.3 $1,671.4 $1,590.4 $1,367.0 $1,294.4 $1,254.9
*Less than $100,000
Ratio of Earnings to Fixed Charges:
Excluding Interest on
Annuities and Financial
Products (1) 6.13 5.91 4.51 5.82 13.57 7.37 7.51
Including Interest on
Annuities and Financial
Products (2) 1.53 1.47 1.34 1.44 2.04 1.53 1.49
Ratio of Earnings to
Combined Fixed Charges
and Preferred Stock
Dividends (3) 1.53 1.47 1.34 1.44 2.04 1.53 1.48
</TABLE>
(1) For purposes of determining this ratio, earnings consist of income
before federal income taxes 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.
