UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended March 31,June 30, 2005.
¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to .
Commission File Number 1-6028
LINCOLN NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
Indiana | 35-1140070 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
1500 Market Street, Suite 3900, Philadelphia, Pennsylvania | 19102-2112 | |
(Address of principal executive offices) | (Zip Code) |
(215) 448-1400
Registrant’s telephone number, including area code
Not Applicable
Former name, former address and former fiscal year, if changed since last report
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
As of April 30,July 29, 2005, 173,701,482172,488,893 shares of common stock of the registrant were outstanding.
Item 1. Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
March 31, 2005 | December 31, 2004 | June 30, 2005 | December 31, 2004 | |||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
(000s omitted) | (000s omitted) | |||||||||||||||
ASSETS | ||||||||||||||||
Investments: | ||||||||||||||||
Securities available-for-sale, at fair value: | ||||||||||||||||
Fixed maturity (cost: 2005—$32,945,804; 2004—$32,815,424) | $ | 34,224,858 | $ | 34,700,604 | ||||||||||||
Equity (cost: 2005—$142,598; 2004—$145,809) | 154,786 | 161,127 | ||||||||||||||
Fixed maturity (cost: 2005—$33,036,420; 2004—$32,815,424) | $ | 34,975,085 | $ | 34,700,604 | ||||||||||||
Equity (cost: 2005—$141,654; 2004—$145,809) | 154,515 | 161,127 | ||||||||||||||
Trading securities | 3,206,513 | 3,237,377 | 3,345,060 | 3,237,377 | ||||||||||||
Mortgage loans on real estate | 3,805,700 | 3,856,908 | 3,750,607 | 3,856,908 | ||||||||||||
Real estate | 213,376 | 191,364 | 209,788 | 191,364 | ||||||||||||
Policy loans | 1,860,464 | 1,870,593 | 1,866,938 | 1,870,593 | ||||||||||||
Derivative investments | 104,600 | 102,456 | 156,552 | 102,456 | ||||||||||||
Other investments | 411,888 | 386,830 | 404,786 | 386,830 | ||||||||||||
Total Investments | 43,982,185 | 44,507,259 | 44,863,331 | 44,507,259 | ||||||||||||
Cash and invested cash | 1,499,072 | 1,661,686 | 1,658,851 | 1,661,686 | ||||||||||||
Property and equipment | 203,941 | 207,118 | 187,919 | 207,118 | ||||||||||||
Deferred acquisition costs | 3,712,723 | 3,444,965 | 3,554,542 | 3,444,965 | ||||||||||||
Premiums and fees receivable | 299,323 | 232,942 | 222,763 | 232,942 | ||||||||||||
Accrued investment income | 557,576 | 525,137 | 537,519 | 525,137 | ||||||||||||
Assets held in separate accounts | 55,387,234 | 55,204,595 | 57,239,953 | 55,204,595 | ||||||||||||
Federal income taxes | 4,987 | — | ||||||||||||||
Amounts recoverable from reinsurers | 7,336,504 | 7,067,549 | 7,241,619 | 7,067,549 | ||||||||||||
Goodwill | 1,195,672 | 1,195,861 | 1,194,809 | 1,195,861 | ||||||||||||
Other intangible assets | 1,092,030 | 1,116,120 | 1,059,534 | 1,116,120 | ||||||||||||
Other assets | 1,080,934 | 1,056,033 | 1,192,601 | 1,056,033 | ||||||||||||
Total Assets | $ | 116,352,181 | $ | 116,219,265 | $ | 118,953,441 | $ | 116,219,265 | ||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||||||||||
Liabilities: | ||||||||||||||||
Insurance and Investment Contract Liabilities: | ||||||||||||||||
Insurance policy and claim reserves | $ | 24,666,209 | $ | 24,328,125 | $ | 24,671,767 | $ | 24,328,125 | ||||||||
Contractholder funds | 22,870,166 | 23,074,398 | 22,939,749 | 23,074,398 | ||||||||||||
Liabilities related to separate accounts | 55,387,234 | 55,204,595 | 57,239,953 | 55,204,595 | ||||||||||||
Total Insurance and Investment Contract Liabilities | 102,923,609 | 102,607,118 | 104,851,469 | 102,607,118 | ||||||||||||
Short-term debt | 193,972 | 214,415 | 222,530 | 214,415 | ||||||||||||
Long-term debt | 1,046,572 | 1,048,636 | 1,000,615 | 1,048,636 | ||||||||||||
Junior subordinated debentures issued to affiliated trusts | 336,564 | 339,800 | 338,672 | 339,800 | ||||||||||||
Reinsurance related derivative liability | 313,489 | 375,342 | 420,295 | 375,342 | ||||||||||||
Funds withheld reinsurance liabilities | 1,929,234 | 1,895,092 | 1,964,581 | 1,895,092 | ||||||||||||
Federal income taxes payable | — | 77,624 | 160,813 | 77,624 | ||||||||||||
Other liabilities | 2,672,090 | 2,572,669 | 2,756,510 | 2,572,669 | ||||||||||||
Deferred gain on indemnity reinsurance | 893,723 | 912,980 | 874,467 | 912,980 | ||||||||||||
Total Liabilities | 110,309,253 | 110,043,676 | 112,589,952 | 110,043,676 | ||||||||||||
Shareholders’ Equity: | ||||||||||||||||
Series A preferred stock—10,000,000 shares authorized (2005 liquidation value—$1,304) | 550 | 566 | ||||||||||||||
Series A preferred stock—10,000,000 shares authorized (2005 liquidation value—$1,300) | 548 | 566 | ||||||||||||||
Common stock—800,000,000 shares authorized | 1,688,000 | 1,654,785 | 1,690,196 | 1,654,785 | ||||||||||||
Retained earnings | 3,677,292 | 3,589,533 | 3,757,617 | 3,589,533 | ||||||||||||
Accumulated Other Comprehensive Income: | ||||||||||||||||
Net unrealized gain on securities available-for-sale | 582,867 | 822,851 | 851,236 | 822,851 | ||||||||||||
Net unrealized gain on derivative instruments | 7,708 | 14,032 | 11,863 | 14,032 | ||||||||||||
Foreign currency translation adjustment | 146,475 | 154,301 | 109,354 | 154,301 | ||||||||||||
Minimum pension liability adjustment | (59,964 | ) | (60,479 | ) | (57,325 | ) | (60,479 | ) | ||||||||
Total Accumulated Other Comprehensive Income | 677,086 | 930,705 | 915,128 | 930,705 | ||||||||||||
Total Shareholders’ Equity | 6,042,928 | 6,175,589 | 6,363,489 | 6,175,589 | ||||||||||||
Total Liabilities and Shareholders’ Equity | $ | 116,352,181 | $ | 116,219,265 | $ | 118,953,441 | $ | 116,219,265 | ||||||||
See accompanying Notes to the Consolidated Financial Statements.
2
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31, | |||||||||||||||||||||
2005 | 2004 | Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||
(Unaudited) | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||
(000s omitted) | (Unaudited) (000s omitted) | (Unaudited) (000s omitted) | |||||||||||||||||||
Revenue: | |||||||||||||||||||||
Insurance premiums | $ | 70,368 | $ | 75,563 | $ | 72,585 | $ | 74,025 | $ | 142,953 | $ | 149,588 | |||||||||
Insurance fees | 419,032 | 383,674 | 426,752 | 390,220 | 845,783 | 773,893 | |||||||||||||||
Investment advisory fees | 59,373 | 62,722 | 66,932 | 66,435 | 126,305 | 129,157 | |||||||||||||||
Net investment income | 659,811 | 677,542 | 703,553 | 683,105 | 1,363,364 | 1,360,647 | |||||||||||||||
Realized gain (loss) on investments | 11,383 | (20,102 | ) | (9,120 | ) | 13,728 | 2,263 | (6,374 | ) | ||||||||||||
Amortization of deferred gain on indemnity reinsurance | 19,257 | 18,207 | 19,257 | 18,256 | 38,513 | 36,463 | |||||||||||||||
Other revenue and fees | 74,015 | 61,424 | 93,217 | 112,950 | 167,235 | 174,376 | |||||||||||||||
Total Revenue | 1,313,239 | 1,259,030 | 1,373,176 | 1,358,719 | 2,686,416 | 2,617,750 | |||||||||||||||
Benefits and Expenses: | |||||||||||||||||||||
Benefits | 572,645 | 583,326 | 593,262 | 583,294 | 1,165,908 | 1,166,620 | |||||||||||||||
Underwriting, acquisition, insurance and other expenses | 480,358 | 444,263 | 519,825 | 491,188 | 1,000,184 | 935,453 | |||||||||||||||
Interest and debt expense | 22,433 | 22,812 | 22,089 | 24,662 | 44,521 | 47,473 | |||||||||||||||
Total Benefits and Expenses | 1,075,436 | 1,050,401 | 1,135,176 | 1,099,144 | 2,210,613 | 2,149,546 | |||||||||||||||
Income before Federal Income Taxes and Cumulative Effect of Accounting Changes | 237,803 | 208,629 | 238,000 | 259,575 | 475,803 | 468,204 | |||||||||||||||
Federal income taxes | 58,867 | 53,670 | 40,138 | 72,572 | 99,005 | 126,242 | |||||||||||||||
Income before Cumulative Effect of Accounting Changes | 178,936 | 154,959 | 197,862 | 187,003 | 376,798 | 341,962 | |||||||||||||||
Cumulative Effect of Accounting Changes (net of Federal Income Taxes) | — | (24,502 | ) | — | — | — | (24,502 | ) | |||||||||||||
Net Income | $ | 178,936 | $ | 130,457 | $ | 197,862 | $ | 187,003 | $ | 376,798 | $ | 317,460 | |||||||||
Earnings Per Common Share-Basic | |||||||||||||||||||||
Income before Cumulative Effect of Accounting Changes | $ | 1.03 | $ | 0.87 | $ | 1.15 | $ | 1.05 | $ | 2.18 | $ | 1.92 | |||||||||
Cumulative Effect of Accounting Changes (net of Federal Income Taxes) | — | (0.14 | ) | — | — | — | (0.13 | ) | |||||||||||||
Net Income | $ | 1.03 | $ | 0.73 | $ | 1.15 | $ | 1.05 | $ | 2.18 | $ | 1.79 | |||||||||
Earnings Per Common Share-Diluted: | |||||||||||||||||||||
Income before Cumulative Effect of Accounting Changes | $ | 1.01 | $ | 0.86 | $ | 1.13 | $ | 1.04 | $ | 2.14 | $ | 1.89 | |||||||||
Cumulative Effect of Accounting Changes (net of Federal Income Taxes) | — | (0.14 | ) | — | — | — | (0.14 | ) | |||||||||||||
Net Income | $ | 1.01 | $ | 0.72 | $ | 1.13 | $ | 1.04 | $ | 2.14 | $ | 1.75 | |||||||||
See accompanying Notes to the Consolidated Financial Statements.
3
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Three Months Ended March 31, | Six Months Ended June 30, | |||||||||||||||||||||||||||
Number of Shares | Amounts | Number of Shares | Amounts | |||||||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||
(Unaudited) | (Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||||||||||||||
(000s omitted, except for share amounts) | (000s omitted, except for share amounts) | |||||||||||||||||||||||||||
Series A Preferred Stock: | ||||||||||||||||||||||||||||
Balance at beginning-of-year | 16,912 | 17,746 | $ | 566 | $ | 593 | 16,912 | 17,746 | $ | 566 | $ | 593 | ||||||||||||||||
Conversion into common stock | (616 | ) | (37 | ) | (16 | ) | (1 | ) | (656 | ) | (69 | ) | (18 | ) | (2 | ) | ||||||||||||
Balance at March 31 | 16,296 | 17,709 | 550 | 592 | ||||||||||||||||||||||||
Balance at June 30 | 16,256 | 17,677 | 548 | 591 | ||||||||||||||||||||||||
Common Stock: | ||||||||||||||||||||||||||||
Balance at beginning-of-year | 173,557,730 | 178,212,455 | 1,654,785 | 1,528,701 | 173,557,730 | 178,212,455 | 1,654,785 | 1,528,701 | ||||||||||||||||||||
Conversion of series A preferred stock | 9,856 | 592 | 16 | 1 | 10,496 | 1,104 | 18 | 2 | ||||||||||||||||||||
Stock compensation/issued for benefit plans | 822,165 | 1,660,713 | 38,405 | 58,464 | 1,067,931 | 2,290,141 | 55,371 | 101,574 | ||||||||||||||||||||
Deferred compensation payable in stock | 48,192 | — | 1,993 | — | 51,079 | — | 2,247 | — | ||||||||||||||||||||
Retirement of common stock | (755,000 | ) | (1,369,446 | ) | (7,199 | ) | (11,747 | ) | (2,331,000 | ) | (4,595,745 | ) | (22,225 | ) | (40,560 | ) | ||||||||||||
Balance at March 31 | 173,682,943 | 178,504,314 | 1,688,000 | 1,575,419 | ||||||||||||||||||||||||
Balance at June 30 | 172,356,236 | 175,907,955 | 1,690,196 | 1,589,717 | ||||||||||||||||||||||||
Retained Earnings: | ||||||||||||||||||||||||||||
Balance at beginning-of-year | 3,589,533 | 3,413,302 | 3,589,533 | 3,413,302 | ||||||||||||||||||||||||
Comprehensive income (loss) | (74,683 | ) | 400,696 | 361,221 | (56,314 | ) | ||||||||||||||||||||||
Less other comprehensive income (loss) (net of federal income tax): | ||||||||||||||||||||||||||||
Net unrealized gain (loss) on securities available-for-sale, net of reclassification adjustment | (239,984 | ) | 244,947 | 28,385 | (381,069 | ) | ||||||||||||||||||||||
Net unrealized gain (loss) on derivative instruments | (6,324 | ) | 6,875 | (2,169 | ) | (3,596 | ) | |||||||||||||||||||||
Foreign currency translation adjustment | (7,826 | ) | 19,901 | (44,947 | ) | 11,751 | ||||||||||||||||||||||
Minimum pension liability adjustment | 515 | (1,484 | ) | 3,154 | (860 | ) | ||||||||||||||||||||||
Net Income | 178,936 | 130,457 | 376,798 | 317,460 | ||||||||||||||||||||||||
Retirement of common stock | (27,415 | ) | (53,010 | ) | (81,367 | ) | (172,504 | ) | ||||||||||||||||||||
Dividends declared: | ||||||||||||||||||||||||||||
Series A preferred ($0.75 per share) | (12 | ) | (13 | ) | ||||||||||||||||||||||||
Common (2005-$0.365; 2004-$0.35) | (63,750 | ) | (62,478 | ) | ||||||||||||||||||||||||
Series A preferred ($1.50 per share) | (24 | ) | (27 | ) | ||||||||||||||||||||||||
Common (2005-$0.73; 2004-$0.70) | (127,323 | ) | (124,909 | ) | ||||||||||||||||||||||||
Balance at March 31 | $ | 3,677,292 | $ | 3,428,258 | ||||||||||||||||||||||||
Balance at June 30 | $ | 3,757,617 | $ | 3,433,322 | ||||||||||||||||||||||||
See accompanying Notes to the Consolidated Financial Statements.
4
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Continued)
Three Months Ended March 31, | Six Months Ended June 30, | |||||||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
(000s omitted, except for share amounts) | (000s omitted, except for share amounts) | |||||||||||||||
Net Unrealized Gain on Securities Available-for-Sale: | ||||||||||||||||
Balance at beginning-of-year | $ | 822,851 | $ | 793,054 | $ | 822,851 | $ | 793,054 | ||||||||
Change during the period | (239,984 | ) | 244,947 | 28,385 | (381,069 | ) | ||||||||||
Balance at March 31 | 582,867 | 1,038,001 | ||||||||||||||
Balance at June 30 | 851,236 | 411,985 | ||||||||||||||
Net Unrealized Gain on Derivative Instruments: | ||||||||||||||||
Balance at beginning-of-year | 14,032 | 22,094 | 14,032 | 22,094 | ||||||||||||
Change during the period | (6,324 | ) | 6,875 | (2,169 | ) | (3,596 | ) | |||||||||
Balance at March 31 | 7,708 | 28,969 | ||||||||||||||
Balance at June 30 | 11,863 | 18,498 | ||||||||||||||
Foreign Currency Translation Adjustment: | ||||||||||||||||
Accumulated adjustment at beginning-of-year | 154,301 | 108,993 | 154,301 | 108,993 | ||||||||||||
Change during the period | (7,826 | ) | 19,901 | (44,947 | ) | 11,751 | ||||||||||
Balance at March 31 | 146,475 | 128,894 | ||||||||||||||
Balance at June 30 | 109,354 | 120,744 | ||||||||||||||
Minimum Pension Liability Adjustment: | ||||||||||||||||
Balance at beginning-of-year | (60,479 | ) | (55,112 | ) | (60,479 | ) | (55,112 | ) | ||||||||
Change during the period | 515 | (1,484 | ) | 3,154 | (860 | ) | ||||||||||
Balance at March 31 | (59,964 | ) | (56,596 | ) | ||||||||||||
Balance at June 30 | (57,325 | ) | (55,972 | ) | ||||||||||||
Total Shareholders’ Equity at March 31 | $ | 6,042,928 | $ | 6,143,537 | ||||||||||||
Total Shareholders’ Equity at June 30 | $ | 6,363,489 | $ | 5,518,885 | ||||||||||||
Common Stock at End of Quarter: | ||||||||||||||||
Assuming conversion of preferred stock | 173,943,679 | 178,787,658 | 172,616,332 | 176,190,787 | ||||||||||||
Diluted basis | 176,544,131 | 181,439,353 | 174,843,027 | 178,802,376 |
See accompanying Notes to the Consolidated Financial Statements.
5
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, | ||||||||||||||||
2005 | 2004 | Six Months Ended June 30, | ||||||||||||||
(Unaudited) | 2005 | 2004 | ||||||||||||||
(000s omitted) | (Unaudited) (000s omitted) | |||||||||||||||
Cash Flows from Operating Activities: | ||||||||||||||||
Net income | $ | 178,936 | $ | 130,457 | $ | 376,798 | $ | 317,460 | ||||||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | ||||||||||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||||||
Deferred acquisition costs | (70,679 | ) | (89,895 | ) | (162,951 | ) | (183,757 | ) | ||||||||
Premiums and fees receivable | (66,381 | ) | 14,611 | 10,180 | 86,927 | |||||||||||
Accrued investment income | (32,439 | ) | (25,174 | ) | (12,382 | ) | (21,017 | ) | ||||||||
Policy liabilities and accruals | 340,691 | (42,629 | ) | 194,041 | (176,124 | ) | ||||||||||
Net trading securities purchases, sales and maturities | (21,536 | ) | 13,683 | (74,007 | ) | (59,141 | ) | |||||||||
(Gain) loss on reinsurance embedded derivative/trading securities | (4,381 | ) | 4,246 | 722 | (6,061 | ) | ||||||||||
Cumulative effect of accounting change | — | 37,695 | — | 37,695 | ||||||||||||
Contractholder funds | (105,381 | ) | 216,488 | 85,989 | 424,534 | |||||||||||
Amounts recoverable from reinsurers | (268,955 | ) | (26,514 | ) | (174,071 | ) | (19,213 | ) | ||||||||
Federal income taxes | 52,141 | 33,202 | 65,671 | 54,094 | ||||||||||||
Stock-based compensation expense | 11,781 | 14,210 | 26,829 | 27,187 | ||||||||||||
Provisions for depreciation | 12,131 | 18,671 | 46,413 | 35,126 | ||||||||||||
Amortization of other intangible assets | 20,829 | 17,782 | 39,260 | 49,290 | ||||||||||||
Gain on sale of subsidiaries/business | (14,231 | ) | — | (14,231 | ) | (24,059 | ) | |||||||||
Realized loss on investments and derivative instruments | 7,229 | 15,856 | 11,247 | 36,494 | ||||||||||||
Amortization of deferred gain | (19,257 | ) | (18,207 | ) | (38,513 | ) | (36,463 | ) | ||||||||
Other | 170,682 | (140,214 | ) | (3,591 | ) | (114,454 | ) | |||||||||
Net Adjustments | 12,244 | 43,811 | 606 | 111,058 | ||||||||||||
Net Cash Provided by Operating Activities | 191,180 | 174,268 | 377,404 | 428,518 | ||||||||||||
Cash Flows from Investing Activities: | ||||||||||||||||
Securities-available-for-sale: | ||||||||||||||||
Purchases | (1,484,719 | ) | (2,540,250 | ) | (2,968,063 | ) | (4,896,470 | ) | ||||||||
Sales | 886,797 | 1,732,927 | 1,596,296 | 2,796,907 | ||||||||||||
Maturities | 508,122 | 555,044 | 1,161,978 | 1,277,208 | ||||||||||||
Purchase of other investments | (233,446 | ) | (193,093 | ) | (400,529 | ) | (370,950 | ) | ||||||||
Sale or maturity of other investments | 242,095 | 442,300 | 464,371 | 749,496 | ||||||||||||
Increase in cash collateral on loaned securities | 123,023 | 220,998 | 97,732 | 174,017 | ||||||||||||
Proceeds from sale of subsidiaries/business | 14,231 | — | 14,231 | 10,775 | ||||||||||||
Other | 52,786 | (54,096 | ) | 260,005 | 111,592 | |||||||||||
Net Cash Provided by Investing Activities | 108,889 | 163,830 | ||||||||||||||
Net Cash Provided by (Used in) Investing Activities | 226,021 | (147,425 | ) | |||||||||||||
Cash Flows from Financing Activities: | ||||||||||||||||
Issuance of long-term debt | — | 197,294 | — | 197,294 | ||||||||||||
Payment of long-term debt | (240,936 | ) | — | |||||||||||||
Net decrease in short-term debt | (20,443 | ) | (5,976 | ) | 201,030 | (13,976 | ) | |||||||||
Universal life and investment contract deposits | 1,098,868 | 1,212,739 | 2,516,003 | 2,391,536 | ||||||||||||
Universal life and investment contract withdrawals | (1,163,632 | ) | (750,867 | ) | (2,296,418 | ) | (1,440,089 | ) | ||||||||
Investment contract transfers | (346,750 | ) | (399,329 | ) | (658,306 | ) | (679,118 | ) | ||||||||
Increase in funds withheld liability | 34,142 | 31,124 | 69,488 | 32,267 | ||||||||||||
Common stock issued for benefit plans | 27,899 | 40,381 | 34,271 | 65,154 | ||||||||||||
Retirement of common stock | (29,017 | ) | (56,818 | ) | (103,591 | ) | (206,076 | ) | ||||||||
Dividends paid to shareholders | (63,750 | ) | (62,323 | ) | (127,801 | ) | (125,568 | ) | ||||||||
Net Cash Provided by (Used in) Financing Activities | (462,683 | ) | 206,225 | (606,260 | ) | 221,424 | ||||||||||
Net Increase (Decrease) in Cash and Invested Cash | (162,614 | ) | 544,323 | (2,835 | ) | 502,517 | ||||||||||
Cash and Invested Cash at Beginning-of-Year | 1,661,686 | 1,711,196 | 1,661,686 | 1,711,196 | ||||||||||||
Cash and Invested Cash at March 31 | $ | 1,499,072 | $ | 2,255,519 | ||||||||||||
Cash and Invested Cash at June 30 | $ | 1,658,851 | $ | 2,213,713 | ||||||||||||
See accompanying Notes to the Consolidated Financial Statements.
6
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.subsidiaries (“LNC” or the “Company” which also may be referred to as “we” or “us”). Through subsidiary companies, LNC operateswe operate multiple insurance and investment management businesses divided into four business segments (see Note 7). The collective group of companies uses “Lincoln Financial Group” as its marketing identity. Less than majority-owned entities in which LNC haswe have at least a 20% interest are reported on the equity basis. These unaudited Consolidated Financial 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(“GAAP”). 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 incorporated by reference into LNC’sour latest annual report on Form 10-K for the year ended December 31, 2004.2004 (“2004 Form 10-K”).
Operating results for the three and six months ended March 31,June 30, 2005 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2005. Certain amounts reported in prior years’ Consolidated Financial Statements have been reclassified to conform withto the presentation adopted in 2005.2005 presentation. These reclassifications have no effect on net income or shareholders’ equity of the prior years.
2. Changes in Accounting Principles and Changes in Estimates
SFAS No. 123(r) - Accounting for Share-Based Payment. In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS 123(r)”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS 123(r) requires recognition in the income statement of all share-based payments to employees based on their fair values. We had previously adopted the retroactive restatement method under SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” and restated all periods presented to reflect stock-based employee compensation cost under the fair value accounting method for all employee awards granted, modified or settled in fiscal years beginning after December 15, 1994.
We currently use the Black-Scholes formula to estimate the value of stock options granted to employees. We are evaluating the use of other acceptable option valuation models upon the required adoption of SFAS 123(r). SFAS 123(r) also requires the reporting of the benefits of tax deductions in excess of recognized compensation as financing cash flow, rather than as an operating cash flow. In April 2005, the Securities and Exchange Commission (“SEC”) deferred required implementation to January 1, 2006. We do not expect adoption of SFAS 123(r) to have a material effect on our results of operations, operating cash flows or financial position.
EITF 03-1—The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. In March 2004, the FASB’s Emerging Issues Task Force (“EITF”) reached a final consensus on Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 established impairment models for determining whether to record impairment losses associated with investments in certain equity and debt securities. It also required the accrual of income on a level-yield basis following an impairment of debt securities, where reasonable estimates of the timing and amount of future cash flows can be made. The application of EITF 03-1 was to be effective for reporting periods beginning after June 15, 2004.
In September 2004, the FASB directed the FASB staff to issue further guidance on this topic in FASB Staff Position (“FSP”) EITF No. 03-1-a, “Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1” (“FSP EITF 03-1-a”). On September 30, 2004, the FASB delayed the effective date of the accounting and measurement provisions of EITF 03-1 in order to consider the further guidance included in FSP EITF 03-1-a. However, the disclosure requirements and the definition of other-than-temporary impairment (“OTTI”) included in EITF 03-1 were not delayed, and accordingly we made the appropriate disclosures and utilized the definition of OTTI to evaluate all securities within the scope of EITF 03-1.
In June 2005, the FASB directed the FASB staff to issue proposed FSP EITF 03-1-a, but retitled as FSP FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP FAS 115-1”). The FASB expects to issue FSP FAS 115-1 in August 2005 at which time we will evaluate its potential effects, if any, on our consolidated financial condition or results of operations.
Statement of Position 03-1. In July 2003,Effective January 1, 2004, we implemented the Accounting Standards Executive Committee (“AcSEC”)provisions of the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (“the SOP”). LNC implemented the provisions of the SOP as of January 1, 2004. Adjustments arising from implementation, as discussed below, have beenwere recorded in net income as a cumulative effect of accounting change.
The SOP provides guidance related to the reporting and disclosure of certain insurance contracts and separate accounts, including guidance for computing reserves for products with guaranteed benefits, such as guaranteed minimum death benefit (“GMDB”), and for products with annuitization benefits such as guaranteed minimum income benefits. In addition, the SOP addresses the presentation and reporting of separate accounts, the capitalization and amortization of sales inducements, and secondary guarantees on universal-life type contracts.
GMDBGuaranteed Minimum Death Benefit Reserves. Although there was no method prescribed under generally accepted accounting principlesGAAP for GMDBguaranteed minimum death benefit (“GMDB”) reserving until the issuance of the SOP, LNC’sour Retirement segment hashad been recording a reserve for GMDBs.
At December 31, 2003, LNC’sour GMDB reserve was $46.4 million. Based upon a comparison of the requirements of the SOP to LNC’s established practice of reserving for GMDB, the adoptionAdoption of the GMDB reserving methodology under the SOP resulted in a decrease to reserves of $9.7 million pre-tax at the time of adoption.pre-tax. GMDB reserves were $24.7$24.4 million and $18.2 million at March 31,June 30, 2005 and December 31, 2004, respectively.
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Application of the SOP impacts estimated gross profits (“EGPs”) used to calculate the amortization of deferred acquisition costs (“DAC”), the present value of acquired blocks of in-force policies (“PVIF”), deferred sales inducements (“DSI”), and the liability for deferred front-end loads (“DFEL”). The benefit ratio approach under the SOP results in the accrual of a portion of future GMDB fees being accrued as a liability for future GMDB reserves. As a result, the EGPs used in LNC’sour determination of DAC amortization are lower under the SOP. Therefore, upon adoption of the SOP in the first quarter of 2004, LNCwe reported an unfavorable DAC/PVIF/DSI/DFEL unlocking as a negative cumulative effect adjustment of $43.2 million pre-tax.
The combined effects of the GMDB reserve requirements and related unlocking adjustments from implementation of the SOP resulted in a charge to net income for the cumulative effect of accounting change of $33.5 million pre-tax ($21.8 million after-tax) in the first quarter of 2004.
Sales Inducements. LNC’sOur Retirement segment variable annuity product offerings include contracts that offer a bonus credit, typically ranging from 2% to 5% of each deposit. LNCWe also offersoffer enhanced interest rates to variable annuity contracts that are under dollar cost averaging (“DCA”) funding arrangements. Bonus credits and excess DCA interest are considered sales inducements under the SOP and, as such, are to be deferred as a sales inducement asset and amortized as a benefit expense over the expected life of the contract. Amortization is computed using the same methodology and assumptions used in amortizing DAC.
LNCWe previously deferred bonus credits as part of the DAC asset and reported the amortization of bonus credits as part of DAC amortization. Upon implementation of the SOP, LNCwe reclassified bonus credits of $45.2 million from DAC to DSI, which are reported in other assets on the Consolidated Balance Sheets. Amortization of the DSI asset is reported as part of benefit expense.
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Universal Life Contracts. LNC’sOur Life Insurance segment offers an array of individual and survivor-life universal life insurance products that contain features for which the SOP might apply. A review of the products and their features for possible SOP implications concluded that no additional reserves would be necessary with the exception of the MoneyGuardSMproduct. MoneyGuardSM is a universal life insurance product with an acceleration of death benefit feature that provides convalescent care benefit payments when the insured becomes chronically ill. There is an optional extension of benefit rider available that will provide continuation of the convalescent care benefit payments once the total benefits from the base policy have been exhausted. The optional extended benefit payments can be for 2 years, 4 years, or the remaining life of the insured. Charges for the extension rider are deducted from the base policy account value and vary by the length of extension period selected. The adoption of the SOP in the first quarter of 2004 resulted in a charge recorded as a cumulative effect of accounting change of $4.2 million pre-tax ($2.7 million after-tax) for the extension of benefit feature in MoneyGuardSM.
FASB Staff Position No. FAS 97-1—Situations in Which Paragraphs of FASB Statement No. 97 Permit or Require Accrual of an Unearned Revenue Liability. In June of 2004, the Financial Accounting Standards Board (“FASB”) issued Financial Staff Position FAS 97-1 (“FSP 97-1”), which was effective for the third quarter 2004. FSP 97-1 clarifies that the SOP did not restrict the recording of a liability for unearned revenue as defined in accordance with paragraphs 17(b) and 20 of Statement of Accounting Standards No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” to only those situations where profits are followed by expected losses. LNC implemented the requirements of FSP 97-1, and they did not have any effect on LNC’s results of operations.
FASB Statement of Financial Accounting Standards No. 123(r) - Accounting for Share-Based Payment. In December 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment (“FAS 123(r)”), which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation.” FAS 123(r) requires all share-based payments to employees to be recognized in the income statement based on their fair values. LNC had previously adopted the retroactive restatement method under Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure” and restated all periods presented to reflect stock-based employee compensation cost under the fair value accounting method in FAS 123 for all employee awards granted, modified or settled in fiscal years beginning after December 15, 1994.
LNC currently uses the Black-Scholes formula to estimate the value of stock options granted to employees and expects to continue to use this acceptable option valuation model upon the required adoption of FAS 123(r). FAS 123(r) also requires that the benefits of tax deductions in excess of recognized compensation cost be reported as financing cash flow, rather than as an operating cash flow as currently required. In April 2005 the Securities and Exchange Commission deferred required implementation to January 1, 2006. LNC does not anticipate that adoption for FAS 123(r) will have a material effect on results of operations, operating cash flows or its financial position.
FASB Financial Staff Position No. FAS-106-1-Medicare Prescription Drug Improvement and Modernization Act of 2003 and FASB Staff Position No. FAS-106-2-Accounting and Disclosure Requirements Related to the Medicare Prescription Drug Improvement and Modernization Act of 2003. In December 2003, the Medicare Prescription Drug Improvement and Modernization Act of 2003 (“the Medicare Act”) became law. Beginning in 2006, the Medicare Act provides various alternatives that could result in an offset to some portion of the costs of prescription drug benefits provided to retirees. In January 2004, the staff of the FASB issued Financial Staff Position No. FAS 106-1 (“FSP 106-1”), which permitted a sponsor of a post-retirement health care plan that provides retiree prescription drug benefits to make a one-time election to defer accounting for the effects of the Medicare Act. In May 2004, the staff of the FASB issued Financial Staff Position No. FAS 106-2 (“FSP 106-2”), which required sponsors of a post-retirement health care plan that provides retiree prescription drug benefits to reflect the provisions of the Medicare Act in determining post-retirement benefit cost for the first annual or interim period starting after June 15, 2004. In January 2005, administrative rules related to the Medicare Act were published.
There are several uncertainties that exist as to the eventual effects of the Medicare Act on the cost of the prescription drug benefits currently included in LNC’s retiree medical benefit plan. These uncertainties include the potential for significant legislative changes to the Medicare Act prior to its implementation in 2006, and the interrelated effects that the existence of various cost containment measures currently included within LNC’s retiree medical benefit plans may have under the new legislation.
LNC completed its analysis and incorporated the provisions of the Medicare Act in determining other post-retirement benefit costs and the accumulated post-retirement benefit obligation in third quarter of 2004. The implementation did not have a material effect on LNC’s results of operations.
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Due to uncertainties about how participants in LNC’s post-retirement plan will elect to participate in the Medicare Act’s benefits, LNC’s assessment of the effects of the provisions of the Medicare Act could change. Any change would be included in the financial statements in the period the change occurs. Any change is not expected to have a material effect on LNC.
EITF 03-1—The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. In March 2004, the FASB’s Emerging Issues Task Force (“EITF”) reached a final consensus on Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”). EITF 03-1 established impairment models for determining whether to record impairment losses associated with investments in certain equity and debt securities. It also required income to be accrued on a level-yield basis following an impairment of debt securities, where reasonable estimates of the timing and amount of future cash flows can be made. EITF 03-1 indicated that, although not presumptive, a pattern of selling investments prior to the forecasted recovery may call into question an investor’s intent to hold the security until it recovers in value. The application of EITF 03-1 was to be effective for reporting periods beginning after June 15, 2004. However, in September 2004, the FASB directed the FASB staff to develop a staff position (“FSP”) providing further guidance on this topic. On September 30, 2004, the FASB issued FSP EITF 03-1-1 delaying the effective date of the accounting and measurement provisions of EITF 03-1 until further guidance is finalized, and it is not known what the effective date of the final FSP will be. Although the accounting and measurement provisions have been delayed, the disclosure requirements and the actual definition of impairment that are within EITF 03-1 have not been delayed. LNC has made the appropriate disclosures related to EITF 03-1 and utilized the definition of impairment to evaluate all securities, including those that we might not have previously evaluated in this manner, that meet the scope of EITF 03-1. LNC will continue to monitor developments concerning EITF 03-1 and is currently unable to estimate the potential effects of implementing EITF 03-1 on its consolidated financial condition or results of operations.
3. Federal Income Taxes
The effective tax rate on net income is lower than the prevailing corporate Federal income tax rate principally from tax-preferred investment income. LNC earnsWe earn tax-preferred investment income that does not change proportionately with the overall change in earnings or losses before Federal income taxes.
TheOur Federal income tax liability at December 31, 2004 includesincluded a valuation allowance of $46.8 million attributable to the net operating losses of LNC’sour foreign life reinsurance subsidiary domiciled in Barbados. This valuation allowance washas been reduced to $41.0$17.5 million as of March 31,June 30, 2005, including a reduction of $23.5 million in the three months ended June 30, 2005. The net operating lossesloss carryforwards of this subsidiary are subject to Federal income tax limitations that only allow the net operating losses to be used to offset future taxable income of the subsidiary. LNC believesWe believe that it is more likely than not that all of the tax benefits associated with this subsidiary’s net operating losses will not be realized. The release of the remaining valuation allowance will be apportioned to the remaining quarters of 2005 through an adjustment to the annual effective tax rate.
The American Jobs Creation Act of 2004 provides for an election for either 2004 or 2005 of a special one-time tax deduction of 85 percent of certain foreign earnings that are repatriated. LNC is currently evaluating the effects of the repatriation provision and expects that the evaluation will be completed by the end of the third quarter. Until such evaluation is complete, a range of income tax effects of such repatriation cannot be reasonably estimated.
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4. Supplemental Financial Data
A roll forwardrollforward of the balance sheet account “Deferreddeferred acquisition costs”costs on the Consolidated Balance Sheets is as follows:
Three Months Ended March 31, | Six Months Ended June 30, | |||||||||||||||
(in millions) | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Balance at beginning-of-year | $ | 3,445.0 | $ | 3,147.1 | $ | 3,445.0 | $ | 3,147.1 | ||||||||
Deferral | 203.5 | 198.7 | 419.9 | 400.6 | ||||||||||||
Amortization | (132.8 | ) | (108.8 | ) | (256.9 | ) | (216.8 | ) | ||||||||
Adjustment related to realized gains on securities available-for-sale | (11.7 | ) | (17.6 | ) | (26.0 | ) | (23.7 | ) | ||||||||
Adjustment related to unrealized (gains) losses on securities available-for-sale | 215.7 | (201.1 | ) | |||||||||||||
Adjustment related to unrealized gains on securities available-for-sale | 10.9 | 241.7 | ||||||||||||||
Foreign currency translation adjustment | (7.0 | ) | 19.9 | (38.4 | ) | 11.7 | ||||||||||
Cumulative effect of accounting change | — | (39.2 | ) | — | (39.2 | ) | ||||||||||
Balance at end-of-period | $ | 3,712.7 | $ | 2,999.0 | $ | 3,554.5 | $ | 3,521.4 | ||||||||
Realized gains and losses on investments and derivative instruments on the Consolidated Statements of Income for the threesix months ended March 31,June 30, 2005 and 2004 are net of amounts amortized against deferred acquisition costs of $11.7$26.0 million and $17.6$23.7 million, respectively. In addition, realized gains and losses for the threesix months ended March 31,June 30, 2005 and 2004 are net of adjustments made to policyholder reserves of $(1.8)$(1.5) million and $(2.1)$0.9 million, respectively. LNC hasWe have either a contractual obligation or hashave a consistent historical practice of making allocations of investment gains or losses to certain policyholders and to certain reinsurance arrangements.
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Details underlying the income statement caption “Underwriting,underwriting, acquisition, insurance and other expenses”expenses on the Consolidated Statements of Income are as follows:
Three Months Ended March 31, | ||||||||
(in millions) | 2005 | 2004 | ||||||
Commissions | $ | 174.7 | $ | 169.1 | ||||
Other volume-related expenses | 109.0 | 109.9 | ||||||
Operating and administrative expenses | 212.4 | 187.5 | ||||||
Deferred acquisition costs net of amortization | (70.7 | ) | (89.9 | ) | ||||
Other intangibles amortization | 20.8 | 26.8 | ||||||
Taxes, licenses and fees | 32.3 | 29.4 | ||||||
Restructuring charges | 1.9 | 11.5 | ||||||
Total | $ | 480.4 | $ | 444.3 | ||||
The carrying amount of goodwill by reportable segment as of March 31, 2005 and December 31, 2004 was as follows:
(in millions) | March 31, 2005 | December 31, 2004 | ||||
Life Insurance Segment | $ | 855.1 | $ | 855.1 | ||
Investment Management Segment | 260.8 | 260.8 | ||||
Lincoln Retirement Segment | 64.1 | 64.1 | ||||
Lincoln UK Segment * | 15.7 | 15.9 | ||||
Total | $ | 1,195.7 | $ | 1,195.9 | ||
* See * below. |
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
(in millions) | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Commissions | $ | 195.2 | $ | 170.7 | $ | 369.9 | $ | 339.8 | ||||||||
Other volume-related expenses | 115.7 | 107.0 | 224.6 | 216.9 | ||||||||||||
Operating and administrative expenses | 235.2 | 252.3 | 447.7 | 439.7 | ||||||||||||
Deferred acquisition costs net of amortization | (92.2 | ) | (93.9 | ) | (163.0 | ) | (183.8 | ) | ||||||||
Other intangibles amortization | 18.4 | 22.5 | 39.3 | 49.3 | ||||||||||||
Taxes, licenses and fees | 24.3 | 27.3 | 56.6 | 56.8 | ||||||||||||
Restructuring charges | 23.2 | 5.3 | 25.1 | 16.8 | ||||||||||||
Total | $ | 519.8 | $ | 491.2 | $ | 1,000.2 | $ | 935.5 | ||||||||
For intangible assets subject to amortization, the total gross carrying amount and accumulated amortization in total and for each major intangible asset class by segment are as follows:
As of March 31, 2005 | As of December 31, 2004 | |||||||||||
(in millions) | Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | ||||||||
Amortized Intangible Assets: | ||||||||||||
Present value of in-force | ||||||||||||
Lincoln Retirement Segment | $ | 225.0 | $ | 134.7 | $ | 225.0 | $ | 132.4 | ||||
Life Insurance Segment | 1,254.2 | 543.3 | 1,254.2 | 527.7 | ||||||||
Lincoln UK Segment* | 405.3 | 133.4 | 410.2 | 134.1 | ||||||||
Client lists | ||||||||||||
Investment Management Segment | 91.4 | 72.5 | 91.4 | 70.5 | ||||||||
Total | $ | 1,975.9 | $ | 883.9 | $ | 1,980.8 | $ | 864.7 | ||||
* The gross carrying amount and accumulated amortization of the goodwill and present value of in-force for the Lincoln UK segment changed from December 31, 2004 to March 31, 2005 due to the translation of the balances from British pounds to U.S. dollars based on the prevailing exchange rate as of the balance sheet dates. |
As of June 30, 2005 | As of December 31, 2004 | |||||||||||
(in millions) | Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | ||||||||
Present value of in-force | ||||||||||||
Lincoln Retirement | $ | 225.0 | $ | 137.1 | $ | 225.0 | $ | 132.4 | ||||
Life Insurance | 1,254.2 | 555.7 | 1,254.2 | 527.7 | ||||||||
Lincoln UK * | 383.1 | 127.8 | 410.2 | 134.1 | ||||||||
Subtotal | 1,862.3 | 820.6 | 1,889.4 | 794.2 | ||||||||
Client lists | ||||||||||||
Investment Management | 92.2 | 74.4 | 91.4 | 70.5 | ||||||||
Total | $ | 1,954.5 | $ | 895.0 | $ | 1,980.8 | $ | 864.7 | ||||
* | The gross carrying amount and accumulated amortization of the present value of in-force for the Lincoln UK segment changed from December 31, 2004 to June 30, 2005 primarily due to the translation of the balances from British pounds to U.S. dollars based on the prevailing exchange rate as of the respective balance sheet dates. |
The aggregateAggregate amortization expense for other intangible assets for the three and six months ended March 31,June 30, 2005 and 2004 was $20.8$18.4 million and $26.8$39.3 million, respectively, compared to $22.5 million and $49.3 million for the three and six months ended June 30, 2004, respectively.
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Future estimated amortization of other intangible assets is as follows (in millions):
Remainder 2005 - | 2006 - | 2007 - | ||
2008 - | 2009 - | Thereafter |
The amount shown above for 2005 is the amortization expected for the remainder of 2005 from March 31, 2005.
A reconciliationrollforward of the present value of insurance business acquired included in other intangible assets is as follows:
(in millions) | March 31, 2005 | December 31, 2004 | June 30, 2005 | December 31, 2004 | ||||||||||||
Balance at beginning of year | $ | 1,095.2 | $ | 1,196.5 | $ | 1,095.2 | $ | 1,196.5 | ||||||||
Interest accrued on unamortized balance | 16.0 | 69.2 | ||||||||||||||
(Interest rates range from 5% to 7%) | ||||||||||||||||
Interest accrued on unamortized balance (Interest rates range from 5% to 7%) | 31.6 | 69.2 | ||||||||||||||
Amortization | (34.9 | ) | (190.0 | ) | (67.0 | ) | (190.0 | ) | ||||||||
Foreign exchange adjustment | (3.2 | ) | 19.5 | (18.1 | ) | 19.5 | ||||||||||
Balance at end-of-period | 1,073.1 | 1,095.2 | 1,041.7 | 1,095.2 | ||||||||||||
Other intangible assets (non-insurance) | 18.9 | 20.9 | 17.8 | 20.9 | ||||||||||||
Total other intangible assets at end-of-period | $ | 1,092.0 | $ | 1,116.1 | $ | 1,059.5 | $ | 1,116.1 | ||||||||
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Details underlying contractholder funds on the balance sheet caption, “Contractholder funds,”Consolidated Balance Sheets are as follows:
(in millions) | March 31, 2005 | December 31, 2004 | June 30, 2005 | December 31, 2004 | ||||||||
Premium deposit funds | $ | 22,026.0 | $ | 22,215.1 | $ | 22,075.8 | $ | 22,215.1 | ||||
Undistributed earnings on participating business | 128.1 | 145.3 | 146.3 | 145.3 | ||||||||
Other | 716.1 | 714.0 | 717.6 | 714.0 | ||||||||
Total | $ | 22,870.2 | $ | 23,074.4 | $ | 22,939.7 | $ | 23,074.4 | ||||
5. Insurance Benefit Reserves
LNC issuesWe issue variable contracts through itsour separate accounts for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contractholder (traditional variable annuities). LNCWe also issuesissue variable annuity and life contracts through separate accounts that include various types of GMDB features and a guaranteed minimum withdrawal benefit (“GMWB”). The GMDB features generally include those where LNCwe contractually guaranteesguarantee that the contractholder receives (a) a return of no less than total deposits made to the contract less any partial withdrawals, (b) total deposits made to the contract less any partial withdrawals plus a minimum return, or (c) the highest contract value on any contract anniversary date through age 80 minus any payments or withdrawals following such contract anniversary.
The following table provides information on the GMDB features outstanding at March 31,June 30, 2005 and December 31, 2004. (Note that LNC’sour variable contracts with guarantees may offer more than one type of guarantee in each contract; therefore, the amounts listed are not mutually exclusive.) The net amount at risk is defined as the current guaranteed minimum death benefit in excess of the current account balance at the respective balance sheet date.dates.
In the Event of Death | In the Event of Death | |||||||||||||||
(dollars in billions) | March 31, 2005 | December 31, 2004 | June 30, 2005 | December 31, 2004 | ||||||||||||
Return of net deposit | ||||||||||||||||
Account value | $ | 28.3 | $ | 28.4 | $ | 29.2 | $ | 28.4 | ||||||||
Net amount at risk | 0.2 | 0.2 | 0.2 | 0.2 | ||||||||||||
Average attained age of contractholders | 52 | 52 | 53 | 52 | ||||||||||||
Return of net deposits plus a minimum return | ||||||||||||||||
Account value | $ | 0.3 | $ | 0.3 | $ | 0.3 | $ | 0.3 | ||||||||
Net amount at risk | — | — | — | — | ||||||||||||
Average attained age of contractholders | 65 | 65 | 65 | 65 | ||||||||||||
Guaranteed minimum return | 5 | % | 5 | % | 5 | % | 5 | % | ||||||||
Highest specified anniversary account value minus withdrawals post anniversary | ||||||||||||||||
Account value | $ | 15.8 | $ | 15.6 | $ | 16.7 | $ | 15.6 | ||||||||
Net amount at risk | 0.7 | 0.6 | 0.6 | 0.6 | ||||||||||||
Average attained age of contractholders | 62 | 62 | 63 | 62 |
Approximately $4.7$5.7 billion and $4.2 billion of separate account values at March 31,June 30, 2005 and December 31, 2004 were attributable to variable annuities with a GMWB feature. This GMWB feature offers the contractholder a guarantee equal to the initial deposit adjusted for any subsequent purchase payments or withdrawals. There are one-year and five-year step-up options, which allow the contractholder to step up the guarantee. GMWB features are considered to be derivatives under Statement of Financial Accounting StandardsSFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” resulting in the guarantees being recognized at fair value, with changes in fair value being reported in net income.
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Separate account balances attributable to variable annuity contracts with guarantees are as follows:
(in billions) | March 31, 2005 | December 31, 2004 | June 30, 2005 | December 31, 2004 | ||||||||||||
Asset Type | ||||||||||||||||
Domestic equity | $ | 27.6 | $ | 27.6 | $ | 28.7 | $ | 27.6 | ||||||||
International equity | 3.3 | 3.2 | 3.5 | 3.2 | ||||||||||||
Bonds | 4.3 | 4.2 | 4.6 | 4.2 | ||||||||||||
Total | 35.2 | 35.0 | 36.8 | 35.0 | ||||||||||||
Money market | 3.4 | 3.3 | 3.6 | 3.3 | ||||||||||||
Total | $ | 38.6 | $ | 38.3 | $ | 40.4 | $ | 38.3 | ||||||||
Percent of total variable annuity separate account values | 88.3 | % | 88.7 | % | 95 | % | 95 | % | ||||||||
(1) | Excluding Alliance mutual fund account values because they are not included in the separate accounts reported on our Consolidated Balance Sheets. |
The following table summarizes the liabilities for GMDB:GMDB liabilities:
GMDB | GMDB | |||||||||||||||
(in millions) | March 31, 2005 | March 31, 2004 | June 30, 2005 | June 30, 2004 | ||||||||||||
Balance at beginning of year | $ | 18.2 | $ | 46.4 | $ | 18.2 | $ | 46.4 | ||||||||
Cumulative effect of implementation of SOP 03-1 | — | (9.7 | ) | — | (9.7 | ) | ||||||||||
Changes in reserves | 8.8 | 6.9 | 11.8 | 14.3 | ||||||||||||
Benefits paid | (2.3 | ) | (4.7 | ) | (5.6 | ) | (9.1 | ) | ||||||||
Balance at end-of-period | $ | 24.7 | $ | 38.9 | $ | 24.4 | $ | 41.9 | ||||||||
The changes to the benefit reserves amounts above are reflected in benefits in the Consolidated Statements of Income. Also included in benefits are the results of the hedging program, which included gains (losses) of $3.7$(2.1) million and $(0.4)$1.6 million for GMDB for the three and six months ended March 31,June 30, 2005, respectively, and $(0.6) million and $(1.0) million for the three and six months ended June 30, 2004, respectively.
6. Restrictions and Contingencies
Statutory Restrictions
LNC’sOur 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. In general, a dividend is not subject to prior approval from the Indiana Insurance Commissioner (“Commissioner”) provided The Lincoln National Life Insurance Company’s (“LNL”) statutory earned surplus is positive and the proposed dividend, plus all other dividends made within the twelve consecutive months prior to the date of the proposed dividend, does not exceed the standard limitation of the greater of 10% of the insurer’s policyholders’ surplus, as shown on its last annual statement on file with the Commissioner, or the insurer’s statutory net gain for the previous calendar year. Based upon anticipated on-going positive statutory earnings and favorable credit markets, LNL expects it could continue to pay dividends of up to $293 million in 2005 without prior approval from the Commissioner.
LNL 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, it is also subject to the regulatory requirements that the state of New York imposes upon authorized insurers. These regulations include reserve requirements, which differ from Indiana’s requirements. The New York regulations require LNL to report more reserves to the state of New York. As a result, the level of statutory surplus that LNL reports to New York is less than the statutory surplus reported to Indiana and the National Association of Insurance Commissioners. If New York requires us to maintain a higher level of capital to remain an authorized insurer in New York, LNL’s ability to pay dividends to LNCus could be constrained. However, we do not expect the recent amendments to constrain LNL’s ability to pay dividends during 2005.
Lincoln UK’s operations consist primarily of unit-linked life and pension products, which are similar to U.S. produced variable life and annuity products. Lincoln UK’s insurance subsidiaries are regulated by the UK Financial Services Authority (“FSA”) and are subject to capital requirements as defined by the UK Capital Resources Requirement (formerly the Required Minimum Solvency Margin.Margin). Lincoln UK maintains approximately 1.5 to 2.0 times the required capital as prescribed by the regulatory margin.resource requirement. In addition, the FSA has imposed certain minimum capital requirements for the combined U.K. subsidiaries. As is the case with regulated insurance companies in the U.S., changes to regulatory capital requirements can impact the dividend capacity of the UK insurance subsidiaries and cash flow to LNC.
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Reinsurance
LNC’sOur amounts recoverable from reinsurers represents receivables from and reserves ceded to reinsurers. LNC obtainsWe obtain reinsurance from a diverse group of reinsurers and monitorsmonitor concentration as well as financial strength ratings of LNC’sour principal reinsurers. LNC’sOur principal reinsurers are strongly rated companies, with Swiss Re representing the largest exposure. LNCWe sold itsour reinsurance business to Swiss Re primarily through an indemnity reinsurance arrangementarrangements in 2001. Because LNC iswe are not relieved of itsour liability to the ceding companies for this business, the liabilities and obligations associated with the reinsured contracts remain on theour Consolidated Balance Sheet of LNCSheets with a corresponding reinsurance receivable from the business sold to Swiss Re, which totaled $4.5$4.4 billion at March 31,June 30, 2005, and is included in amounts recoverable from reinsurers. During 2004, Swiss Re funded a trust for $2.0 billion to support this business. In addition to various remedies that LNCwe would have in the event of a default by Swiss Re, LNC continueswe continue to hold assets in support of certain of the transferred reserves. These assets consist of those reported as trading securities and certain mortgage loans. LNC’sOur funds withheld and embedded derivative liabilities at March 31,June 30, 2005 included $1.9$2.0 billion and $0.3 billion, respectively, related to the business reinsured by Swiss Re.
In 2001, LNC sold its reinsurance operation to Swiss Re. The transaction involved a series of indemnity reinsurance transactions combined withWe recorded the sale of certain stock companies that comprised our reinsurance operation. The gain related to the indemnity reinsurance transactions was recordedon the business sold to Swiss Re as deferred gain in the liability section of LNC’sour Consolidated Balance Sheet in accordance with the requirements of Statement of Financial Accounting StandardsSFAS No. 113, “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts” (“FAS 113”). The deferred gain is being amortized into income at the rate that earnings on the reinsured business are expected to emerge, over a period of 15 years. In addition, because LNC has not been relieved of its legal liabilities
Because the reserves related to the underlying ceding companies with respect to the portion of the business indemnity reinsured by Swiss Re, under FAS 113 the reserves for the underlying reinsurance contracts as well as a corresponding reinsurance recoverable from Swiss Re will continue to be carried on the Consolidated Balance Sheet during the run-off period of the underlying reinsurance business. This is particularly relevant in the case of the exited personal accident reinsurance lines of business where the underlying reserves are based upon various estimates that are subject to considerable uncertainty.
Because of ongoing uncertainty, related to personal accident business, the reserves related to these exited business lines carried on the Consolidated Balance Sheet at December 31, 2004June 30, 2005 may ultimately prove to be either excessive or deficient. For instance, in the event that future developments indicate that these reserves should be increased, under FAS 113, we would record a current period non-cash charge to record the increase in reserves. Because Swiss Re is responsible for paying the underlying claims to the ceding companies, LNCwe would record a corresponding increase in reinsurance recoverable from Swiss Re. However, FAS 113 does not permit LNCus to take the full benefit in earnings for the recording of the increase in the reinsurance recoverable in the period of the change. Rather, LNCwe would increase the deferred gain recognized upon the closing of the indemnity reinsurance transaction with Swiss Re and would report a cumulative amortization “catch-up” adjustment to the deferred gain balance as increased earnings recognized in the period of change. Any amount of additional increase to the deferred gain above the cumulative amortization “catch-up” adjustment must continue to be deferred and will be amortized into income in future periods over the remaining period of expected run-off of the underlying business. No cash would be transferred between Swiss Re and LNCus as a result of these developments.
United Kingdom Selling Practices
Various selling practices of the Lincoln UK operations have come under scrutiny by the U.K. regulators. These include the sale and administration of individual pension products, mortgage endowments and the selling practices of City Financial Partners Limited, a subsidiary company purchased in December 1997. Regarding 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 alleged inappropriate advice, an extensive investigation has been or is being carried out and the individual put in a position similar to what would have been attained if the individual had remained in an employer-sponsored plan.
At March 31,June 30, 2005 and December 31, 2004, the aggregate liability associated with Lincoln UK selling practices was $23.9$15.9 million and $27.4 million, respectively. On an ongoing basis, Lincoln UK evaluates various assumptions underlying these estimated liabilities, including the expected levels of future complaints and the potential implications with respect to the adequacy of the aggregate liability associated with UK selling practice matters. Any further changes in the regulatory position on time limits for making a complaint regarding the sale of mortgage endowment contracts, or higher than expected levels of complaints may result in Lincoln UK revising its estimate of the required level of these liabilities. The reserves for these issues are based on various estimates that are subject to considerable uncertainty. Accordingly, the reserves may prove to be deficient or excessive. However, it is management’s opinion that future developments regarding Lincoln UK selling practices will not have a material effect on theour results of operations or theour consolidated financial position of LNC.position.
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In addition, LNC and itsour United Kingdom subsidiaries have successfully pursued claims with some of their liability carriers for reimbursement of certain costs incurred in connection with certain United Kingdom selling practices. LNC and itsour United Kingdom subsidiaries are continuing to pursue claims with liability carriers.
Marketing and Compliance Issues
There continues to be a significant amount of federal and state regulatory activity in the industry relating to numerous issues including, but not limited to, market timing and late trading of mutual fund and variable insurance products and broker-dealer access arrangements. Like others in the industry, LNC haswe have received inquiries including requests for information and/or subpoenas from various authorities including the Securities and Exchange Commission,SEC, the National Association of Securities Dealers (“NASD”) and the New York Attorney General. LNC isGeneral, as well as notices of potential proceedings from the SEC and NASD. We are in the process of responding to these inquiries and continuesnotices and continue to cooperate fully with such authorities.
Regulators also continue to focus on replacement and exchange issues. Under certain circumstances companies have been held responsible for replacing existing policies with policies that were less advantageous to the policyholder. LNC’sOur management continues to monitor compliance procedures to minimize any potential liability. Due to the uncertainty surrounding all of these matters, it is not possible to provide a meaningful estimate of the range of potential outcomes; however it is management’s opinion that future developments will not materially affect theour consolidated financial position of LNC.position.
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Other Contingency Matters
LNC and itsour subsidiaries are involved in various pending or threatened legal proceedings, including purported class actions, arising from the conduct of business. In some instances, these proceedings include claims for unspecified or substantial 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 these proceedings ultimately will be resolved without materially affecting theour consolidated financial position of LNC.position.
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 hasWe have accrued for expected assessments net of estimated future premium tax deductions.
Guarantees
LNC hasWe have guarantees with off-balance-sheet risks whose contractual amounts represent credit exposure. Guarantees with off-balance sheet risks having contractual values outstanding of $4.4$4.2 million and $4.6 million were outstanding at March 31,June 30, 2005 and December 31, 2004, respectively.
Certain subsidiaries of LNC had invested in real estate partnerships that used industrial revenue bonds to finance their projects. These guarantees expired in the fourth quarter of 2004 and no losses were incurred.
In addition, certainour subsidiaries of LNC have sold commercial mortgage loans through grantor trusts, which issued pass-through certificates. These subsidiaries have agreed to repurchase any mortgage loans which remain delinquent for 90 days at a repurchase price substantially equal to the outstanding principal balance plus accrued interest thereon to the date of repurchase. In case of default by the partnerships, LNC haswe have recourse to the underlying real estate. It is management’s opinion that the value of the properties underlying these commitments is sufficient that in the event of default, the impact would not be material to LNC.us. These guarantees expire in 2009.
Derivative Instruments
LNC maintainsWe maintain an overall risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate risk, foreign currency risk, equity risk, and credit risk. LNC assessesWe assess these risks by continually identifying and monitoring changes in interest rate exposure, foreign currency exposure, equity market exposure, and credit exposure that may adversely impact expected future cash flows and by evaluating hedging opportunities. Derivative instruments that are currently used as part of LNC’sour interest rate risk management strategy include interest rate swaps, interest rate futures and interest rate caps. Derivative instruments that are used as part of LNC’sour foreign currency risk management strategy include foreign currency swaps and foreign exchange forwards. Call options on LNCour stock, total return swaps, put options and equity futures are used as part of LNC’sour equity market risk management strategy. LNCWe also usesuse credit default swaps as part of itsour credit risk management strategy.
By using derivative instruments, LNC iswe are exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair value gain in the derivative. When the fair value of a derivative contract is positive, this generally indicates that the counterparty owes LNCus and, therefore, creates a payment risk for LNC.us. When the fair value of a
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derivative contract is negative, LNC oweswe owe the counterparty and therefore LNC haswe have no payment risk. LNC minimizesWe minimize the credit (or payment) risk in derivative instruments by entering into transactions with high quality counterparties that are reviewed regularly by LNC. LNCwe review regularly. We also maintainsmaintain a policy of requiring that all derivative contracts be governed by an International Swaps and Derivatives Association (“ISDA”) Master Agreement.
LNCLNL and LNLwe are required to maintain minimum ratings as a matter of routine practice in negotiating ISDA agreements. Under the majority of ISDA agreements and as a matter of policy, LNL has agreed to maintain financial strength or claims-paying ratings above S&P BBB and Moody’s Baa2. A downgrade below these levels would result in termination of the derivatives contract at which time any amounts payable by LNCus would be dependent on the market value of the underlying derivative contract. In certain transactions, LNCthe counterparty and the counterpartyLNL have entered into a collateral support agreement requiring LNCus to post collateral upon significant downgrade. LNC isWe are required to maintain long-term senior debt ratings of S&P BBB- and Moody’s Baa3. LNCWe also requiresrequire for itsour own protection minimum rating standards for counterparty credit protection. LNL is required to maintain financial strength or claims-paying ratings above S&P A- and Moody’s A3 under certain ISDA agreements, which collectively do not represent material notional exposure. LNC doesWe do not believe the inclusion of termination or collateralization events pose any material threat to itsour liquidity position.
Market risk is the adverse effect that a change in interest rates, currency rates, implied volatility rates, or a change in certain equity indexes or instruments has on the value of a financial instrument. LNC managesWe manage the market risk by establishing and monitoring limits as to the types and degree of risk that may be undertaken.
LNC’sOur derivative instruments are monitored by itsour risk management committee as part of that committee’s oversight of LNC’sour derivative activities. LNC’sOur derivative instruments committee is responsible for implementing various hedging strategies that are developed through its analysis of financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into LNC’sour overall risk management strategies.
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7. Segment Information
LNC hasWe have four business segments: Lincoln Retirement, Life Insurance, Investment Management and Lincoln UK. Segment operating revenue and income from operations are internal financial performance measures used by our management and Board of Directors to evaluate and assess the results of our segments. Operating revenue excludes realized gains and losses on investments and derivative instruments, gains and losses on reinsurance embedded derivative/trading securities, gains and losses on sale of subsidiaries/businesses and amortization of deferred gain arising from reserve development. Income (loss) from operations is net income (loss) excluding net realized investment gains and losses, losses on early retirement of debt, restructuring charges, reserve development net of related amortization on business sold through reinsurance and cumulative effect of accounting changes is the financial performance.changes. Our management and Board of Directors believe that income (loss) from operations explains the results of our ongoing businesses in a manner that allows for a better understanding of the underlying trends in our current businesses because net realized investment gains and losses, losses on early retirement of debt, restructuring charges, reserve development net of related amortization on business sold through reinsurance and cumulative effect of accounting changes are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments, and in many instances, decisions regarding these items do not necessarily relate to the operations of the individual segments.
The following tables showtable shows financial data by segment:
Three Months Ended March 31, | Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
(in millions) | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | ||||||||||||||||||
Revenue: | ||||||||||||||||||||||||
Segment Operating Revenue: | ||||||||||||||||||||||||
Lincoln Retirement | $ | 538.5 | $ | 528.0 | $ | 573.0 | $ | 534.4 | $ | 1,111.6 | $ | 1,062.4 | ||||||||||||
Life Insurance | 484.2 | 483.4 | 497.3 | 484.8 | 981.5 | 968.1 | ||||||||||||||||||
Investment Management (1) | 130.4 | 135.2 | 138.0 | 139.0 | 268.3 | 274.2 | ||||||||||||||||||
Lincoln UK | 74.6 | 76.1 | 78.4 | 81.0 | 153.1 | 157.1 | ||||||||||||||||||
Segment Operating Revenue | 1,227.7 | 1,222.7 | ||||||||||||||||||||||
Other Operations | 243.8 | 203.7 | 248.2 | 204.9 | 491.8 | 408.6 | ||||||||||||||||||
Consolidating adjustments | (170.0 | ) | (147.6 | ) | (152.9 | ) | (99.4 | ) | (322.9 | ) | (247.0 | ) | ||||||||||||
Net realized investment results (2) | 11.4 | (20.1 | ) | (9.1 | ) | 13.7 | 2.3 | (6.4 | ) | |||||||||||||||
Other (3) | 0.3 | 0.3 | ||||||||||||||||||||||
Reserve development net of related amortization on business sold through reinsurance | 0.3 | 0.3 | 0.7 | 0.7 | ||||||||||||||||||||
Total | $ | 1,313.2 | $ | 1,259.0 | $ | 1,373.2 | $ | 1,358.7 | $ | 2,686.4 | $ | 2,617.7 | ||||||||||||
Net Income: | ||||||||||||||||||||||||
Segment Income from Operations: | ||||||||||||||||||||||||
Lincoln Retirement | $ | 98.6 | $ | 102.2 | $ | 119.4 | $ | 101.8 | $ | 218.1 | $ | 204.0 | ||||||||||||
Life Insurance | 67.7 | 74.8 | 75.8 | 76.2 | 143.6 | 150.9 | ||||||||||||||||||
Investment Management | 7.4 | 12.5 | 3.9 | 13.4 | 11.2 | 25.9 | ||||||||||||||||||
Lincoln UK | 10.0 | 6.2 | 10.3 | 10.7 | 20.4 | 16.9 | ||||||||||||||||||
Segment Income from Operations | 183.7 | 195.7 | ||||||||||||||||||||||
Other Operations | (11.2 | ) | (20.4 | ) | 9.3 | (20.7 | ) | (2.1 | ) | (41.0 | ) | |||||||||||||
Other Items (4) | (1.3 | ) | (7.5 | ) | ||||||||||||||||||||
Net realized investment results (5) | 7.5 | (13.0 | ) | |||||||||||||||||||||
Other Items (3) | (15.0 | ) | (3.5 | ) | (16.3 | ) | (10.9 | ) | ||||||||||||||||
Net realized investment results (4) | (6.0 | ) | 8.9 | 1.5 | (4.2 | ) | ||||||||||||||||||
Reserve development net of related amortization on business sold through reinsurance | 0.2 | 0.2 | 0.2 | 0.2 | 0.4 | 0.4 | ||||||||||||||||||
Income before cumulative effect of accounting change | 178.9 | 155.0 | 197.9 | 187.0 | 376.8 | 342.0 | ||||||||||||||||||
Cumulative effect of accounting change | — | (24.5 | ) | — | — | — | (24.5 | ) | ||||||||||||||||
Net Income | $ | 178.9 | $ | 130.5 | $ | 197.9 | $ | 187.0 | $ | 376.8 | $ | 317.5 | ||||||||||||
(in millions) | March 31, 2005 | December 31, 2004 | ||||||||||||||||||||||
Assets: | ||||||||||||||||||||||||
Lincoln Retirement | $ | 68,256.2 | $ | 68,552.7 | ||||||||||||||||||||
Life Insurance | 22,862.0 | 22,805.0 | ||||||||||||||||||||||
Investment Management | 6,418.8 | 6,391.5 | ||||||||||||||||||||||
Lincoln UK | 9,603.2 | 9,583.9 | ||||||||||||||||||||||
Other Operations | 15,040.2 | 14,572.9 | ||||||||||||||||||||||
Consolidating adjustments | (5,828.2 | ) | (5,686.7 | ) | ||||||||||||||||||||
Total | $ | 116,352.2 | $ | 116,219.3 | ||||||||||||||||||||
(1) | Revenues for the Investment Management segment include inter-segment revenues for asset management services provided to |
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(2) | Includes realized losses on investments and derivatives of |
(3) |
Represents restructuring charges. |
Includes realized losses on investments and derivatives of |
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$15.6 million for the three months ended June 30, 2004. Includes realized losses on investments and derivatives of $7.3 million and $23.7 million for the six months ended June 30, 2005 and 2004, respectively; gain (loss) on reinsurance embedded derivative/trading securities of $(0.5) million and $3.9 million for the six months ended June 30, 2005 and 2004, respectively; and gain on sale of subsidiaries/businesses of $9.3 million and $15.6 million for the six months ended June 30, 2005 and 2004, respectively.
8. Earnings Per Share
Per share amounts forA reconciliation of the components of the calculations of basic and diluted net income and income before cumulative effect of accounting change and net income from continuing operations are shown on the income statement using 1) an earnings per common share basic calculation and 2) an earnings per common share-assuming dilution calculation. A reconciliation of the factors used in the two calculations areis as follows:
Three Months Ended March 31, | Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
2005 | 2004 | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||
Numerator: [millions] | ||||||||||||||||||||||||
Net income before cumulative effect of accounting changes as used in basic calculation | $ | 178.9 | $ | 155.0 | ||||||||||||||||||||
Cumulative effect of accounting changes as used in basic calculation | — | (24.5 | ) | |||||||||||||||||||||
178.9 | 130.5 | |||||||||||||||||||||||
Income before cumulative effect of accounting changes as used in basic calculation | $ | 197.9 | $ | 187.0 | $ | 376.8 | $ | 342.0 | ||||||||||||||||
Dividends on convertible preferred stock and adjustments for minority interests | — | (0.2 | ) | — | (0.2 | ) | (0.1 | ) | (0.3 | ) | ||||||||||||||
Income before cumulative effect of accounting changes as used in diluted calculation | $ | 197.9 | $ | 186.8 | $ | 376.7 | $ | 341.7 | ||||||||||||||||
Net income as used in basic calculation | $ | 197.9 | $ | 187.0 | $ | 376.8 | $ | 317.5 | ||||||||||||||||
Dividends on convertible preferred stock and adjustments for minority interests | — | (0.2 | ) | (0.1 | ) | (0.3 | ) | |||||||||||||||||
Net income as used in diluted calculation | $ | 197.9 | $ | 186.8 | $ | 376.7 | $ | 317.2 | ||||||||||||||||
$ | 178.9 | $ | 130.3 | |||||||||||||||||||||
Denominator: [number of shares] | ||||||||||||||||||||||||
Weighted-average shares, as used in basic calculation | 173,695,598 | 178,274,958 | 172,758,060 | 177,354,689 | 173,224,239 | 177,815,095 | ||||||||||||||||||
Shares to cover conversion of preferred stock | 268,895 | 283,831 | ||||||||||||||||||||||
Shares to cover non-vested stock | 1,159,248 | 155,782 | ||||||||||||||||||||||
Conversion of preferred stock | 260,096 | 282,950 | 264,471 | 283,388 | ||||||||||||||||||||
Non-vested stock | 837,829 | 198,947 | 841,289 | 177,506 | ||||||||||||||||||||
Average stock options outstanding during the period | 6,959,159 | 10,145,799 | 4,798,166 | 10,328,759 | 5,836,051 | 10,237,279 | ||||||||||||||||||
Assumed acquisition of shares with assumed proceeds and benefits from exercising stock options (at average market price during the period). | (6,065,796 | ) | (8,284,767 | ) | ||||||||||||||||||||
Assumed acquisition of shares with assumed proceeds and benefits from exercising stock options | (4,180,042 | ) | (8,740,403 | ) | (5,104,262 | ) | (8,515,078 | ) | ||||||||||||||||
Shares repurchaseable from measured but unrecognized stock option expense | (620,946 | ) | (356,400 | ) | (383,813 | ) | (148,921 | ) | (498,273 | ) | (252,660 | ) | ||||||||||||
Average deferred compensation shares | 1,232,732 | 995,192 | 1,262,731 | 1,025,408 | 1,247,731 | 1,010,300 | ||||||||||||||||||
Weighted-average shares, as used in diluted calculation | 176,628,890 | 181,214,395 | 175,353,027 | 180,301,429 | 175,811,246 | 180,755,830 | ||||||||||||||||||
LNC hasWe have stock options outstanding, which were issued at prices that are above the current average market price of LNCour common stock. In the event the average market price of LNC’sour common stock exceeds the issue price of stock options, such options would be dilutive to LNC’sour earnings per share and will be shown in the table above. Participants in LNC’sour deferred compensation plans that select LNCour stock for measuring the investment return attributable to their deferral amounts will be paid out in LNCour stock. These deferred compensation plan obligations are dilutive and are shown in the table above.
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9. Benefit Plans
Components of Net Periodic Pension Cost—U.S.and Post-retirement Plans
The components of net periodic benefit expense for our U.S. defined benefit pension plan and post-retirement benefit plan expenseplans are as follows:
Pension Benefits | Other Postretirement Benefits | Pension Benefits | Other Post-retirement Benefits | ||||||||||||||||||||||||||
Three months ended March 31, | Three months ended March 31, | ||||||||||||||||||||||||||||
(in millions) | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||
For the three months ended June 30 (in millions) | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||
Service cost | $ | 5.0 | $ | 4.7 | $ | 0.5 | $ | 0.5 | $ | 5.0 | $ | 4.7 | $ | 0.5 | $ | 0.5 | |||||||||||||
Interest cost | 8.4 | 8.2 | 1.5 | 1.5 | 8.5 | 8.2 | 1.4 | 1.5 | |||||||||||||||||||||
Expected return on plan assets | (11.2 | ) | (10.5 | ) | — | — | (11.1 | ) | (10.1 | ) | — | — | |||||||||||||||||
Amortization of prior service cost | (0.4 | ) | (0.6 | ) | — | — | (0.3 | ) | (0.6 | ) | — | — | |||||||||||||||||
Recognized net actuarial losses | 0.7 | 0.2 | 0.1 | — | |||||||||||||||||||||||||
Recognized net actuarial gains (losses) | (0.1 | ) | — | 0.3 | (0.1 | ) | |||||||||||||||||||||||
Net periodic benefit expense | $ | 2.5 | $ | 2.0 | $ | 2.1 | $ | 2.0 | $ | 2.0 | $ | 2.2 | $ | 2.2 | $ | 1.9 | |||||||||||||
Pension Benefits | Other Post-retirement Benefits | ||||||||||||||
For the six months ended June 30 (in millions) | 2005 | 2004 | 2005 | 2004 | |||||||||||
Service cost | $ | 10.0 | $ | 9.4 | $ | 1.0 | $ | 1.0 | |||||||
Interest cost | 16.9 | 16.4 | 2.9 | 3.0 | |||||||||||
Expected return on plan assets | (22.3 | ) | (20.6 | ) | — | — | |||||||||
Amortization of prior service cost | (0.7 | ) | (1.1 | ) | — | (0.1 | ) | ||||||||
Recognized net actuarial losses | 0.6 | 0.2 | 0.4 | — | |||||||||||
Net periodic benefit expense | $ | 4.5 | $ | 4.3 | $ | 4.3 | $ | 3.9 | |||||||
As discussedWe expect to contribute between $0 and $20 million to our qualified U.S. defined benefit pension plans and between $75 million and $85 million for our non-U.S. defined benefit pension plan in Note 2, the amounts above for other post-retirement benefits reflect the Medicare Act.2005.
Deferred Compensation Plans
As discussed in Note 7 to the audited financial statements in LNC’s annual report on Form 10-K for the year ended December 31, 2004, LNC sponsors deferred compensation plans for certain U.S. employees and agents.
10. Stock-Based Incentive Compensation Plans
Refer to Note 7 to the audited financial statementsConsolidated Financial Statements in LNC’s annual report onour 2004 Form 10-K for the year ended December 31, 2004, for a detailed discussion of Stockstock and Incentive Compensation.incentive compensation.
LNC Stock-Based Incentive Plans
LNC hasWe have various incentive plans for our employees, agents and directors of LNC and itsour subsidiaries that provide for the issuance of stock options, stock incentive awards, stock appreciation rights (“SAR”), restricted stock awards, restricted stock units (“performance shares”), and deferred stock units. Delaware Investments U.S., Inc. (“DIUS”) has a separate stock option incentive plan.
Information with respect to stock option and performance share awards granted under these plans is provided in the table below. The first quarter 2005 performance share unit awards are subject to approval by shareholders of an amendment to the Incentive Compensation Plan at the May 2005 Annual Meeting of Shareholders.below:
March 31, 2005 | March 31, 2004 | June 30, 2005 | June 30, 2004 | |||||
Awards | ||||||||
10-year LNC stock options | 370,646 | 414,798 | 370,646 | 414,798 | ||||
Performance share units | 432,561 | 552,906 | 435,827 | 552,906 | ||||
Outstanding at March 31 | ||||||||
Outstanding at June 30 | ||||||||
10-year LNC stock options | 988,787 | 615,810 | 988,797 | 615,810 | ||||
Performance share units | 1,647,076 | 1,247,463 | 1,594,026 | 1,248,521 |
Performance measures for determining the actual amount of stock options and performance share units are established at the beginning of each three-year performance period. Depending on the performance, the actual amount of stock options and performance share units could range from zero to 200% of the granted amount.
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Total pre-tax compensation expense for performance vesting awards for the three months ended March 31, 2005 was $0.7 million relating to stock options, $5.8 million relating to shares, and $1.0 million relating to cash awards. Total compensation expense for LNC performance vesting awards for the three months ended March 31, 2004 was $0.4 million relating to stock options, $3.6 million relating to shares, and $0.4 million relating to cash awards. The amount of stock option expense for the performance vesting awards is included in the total LNC stock option expense as discussed below.follows:
(in millions) | Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||
2005 | 2004 | 2005 | 2004 | |||||||||
Stock options | $ | 1.1 | $ | 0.5 | $ | 1.8 | $ | 0.9 | ||||
Shares | 6.2 | 5.2 | 12.0 | 8.8 | ||||||||
Cash awards | 0.8 | 0.7 | 1.8 | 1.1 |
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Information with respect to the LNCour incentive plans involving stock options is as follows:
Options Outstanding | Options Exercisable | Options Outstanding | Options Exercisable | |||||||||||||||||||
Shares | Weighted- Average Exercise Price | Shares | Weighted- Average Exercise Price | Shares | Weighted- Average Exercise Price | Shares | Weighted- Average Exercise Price | |||||||||||||||
Balance at December 31, 2004 | 11,903,200 | $ | 42.37 | 9,981,911 | $ | 41.84 | 11,903,200 | $ | 42.37 | 9,981,911 | $ | 41.84 | ||||||||||
Granted-original | 372,173 | 46.77 | 370,646 | 46.77 | ||||||||||||||||||
Granted-reloads | 22,241 | 47.11 | 25,436 | 46.89 | ||||||||||||||||||
Exercised (includes shares tendered) | (859,528 | ) | 31.43 | (1,051,586 | ) | 31.59 | ||||||||||||||||
Forfeited | (303,131 | ) | 39.28 | (755,339 | ) | 46.30 | ||||||||||||||||
Balance at March 31, 2005 | 11,134,955 | $ | 43.45 | 9,551,881 | $ | 43.28 | ||||||||||||||||
Balance at June 30, 2005 | 10,492,357 | $ | 43.53 | 9,046,860 | $ | 43.35 | ||||||||||||||||
Total compensation expense for LNCour incentive plans involving stock options, including the DIUS stock option incentive plan discussed below, was $9.0 million and $14.9 million for the three and six months ended March 31,June 30, 2005, respectively, and 2004 was $6.0$7.7 million and $9.4$17.5 million for the three and six months ended June 30, 2004, respectively.
Delaware Stock Option Incentive Plan
At March 31,June 30, 2005, DIUS had 10,084,70510,052,761 shares of common stock outstanding. Information with respect to the DIUS incentive plan involving stock options is as follows:
Options Outstanding | Options Exercisable | Options Outstanding | Options Exercisable | |||||||||||||||||||
Shares | Weighted- Average | Shares | Weighted- Average Exercise Price | Shares | Weighted- Average | Shares | Weighted- Average Exercise Price | |||||||||||||||
Balance at December 31, 2004 | 1,326,691 | $ | 108.42 | 552,259 | $ | 103.63 | 1,326,691 | $ | 121.73 | 552,259 | $ | 116.94 | ||||||||||
Granted – original | 444,100 | 142.57 | ||||||||||||||||||||
Exercised (includes shares tendered) | (31,487 | ) | 103.50 | (42,881 | ) | 116.51 | ||||||||||||||||
Forfeited | (175,281 | ) | 106.34 | (175,281 | ) | 119.65 | ||||||||||||||||
Balance at March 31, 2005 | 1,119,923 | $ | 108.89 | 528,951 | $ | 103.36 | ||||||||||||||||
Balance at June 30, 2005 | 1,522,629 | $ | 128.07 | 597,346 | $ | 119.32 | ||||||||||||||||
In the second quarter of 2005, the DIUS granted 2005 awards of 444,100 shares with anStock Option Plan was amended to increase the exercise price for all outstanding options by $13.31 to reflect the impact to the DIUS Stock Option Plan of $142.57the DIAL sale. As a result, the average exercise prices have been restated for all periods in April 2005.the table above.
Stock Appreciation Rights Incentive Plan
LNC recognizesWe recognize compensation expense for the stock appreciation rights (“SAR”)SAR program based on the fair value method using an option-pricing model. Compensation expense and the related liability are recognized on a straight-line basis over the vesting period of the SARs. The SAR liability is marked-to-market through net income. This accounting treatmentincome, which causes volatility in net income as a result of changes in the market value of LNCour stock. LNC hedgesWe hedge this volatility by purchasing call options on LNC stock. Call options hedging vested SARsour stock, which are also marked-to-market through net income. Total compensation expense (income) recognized for the SAR program was $0.9 million and $0.2 million for the three and six months ended March 31,June 30, 2005, and 2004 was $(0.7)respectively, compared to $0.8 million and $4.1$4.9 million, respectively.respectively, for the three and six months ended June 30, 2004. The mark-to-market gain (loss) recognized through net income on the call options on LNCour stock was $0.3 million and $(1.3) million for the three and six months ended March 31,June 30, 2005, and 2004 was $(1.6)respectively, compared to ($0.2) million and $2.9$2.7 million for the three and six months ended June 30, 2004, respectively. The SAR liability at March 31,June 30, 2005 and December 31, 2004 was $4.9$5.6 million and $9.4 million, respectively.
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Information with respect to the LNCour incentive plan involving SARs is as follows:
SARs Outstanding | SARs Exercisable | SARs Outstanding | SARs Exercisable | |||||||||||||||||||
Shares | Weighted- Average Exercise Price | Shares | Weighted- Average | Shares | Weighted- Average Exercise Price | Shares | Weighted- Average | |||||||||||||||
Balance at December 31, 2004 | 1,291,500 | $ | 40.90 | 629,991 | $ | 40.34 | 1,291,500 | $ | 40.90 | 629,991 | $ | 40.34 | ||||||||||
Granted-original | 230,750 | 46.76 | 230,600 | 46.72 | ||||||||||||||||||
Exercised (includes shares tendered) | (198,926 | ) | 28.26 | (221,031 | ) | 28.95 | ||||||||||||||||
Forfeited | (13,512 | ) | 40.23 | (20,028 | ) | 42.06 | ||||||||||||||||
Balance at March 31, 2005 | 1,309,812 | $ | 43.82 | 725,895 | $ | 44.52 | ||||||||||||||||
Balance at June 30, 2005 | 1,281,041 | $ | 43.96 | 701,757 | $ | 44.78 | ||||||||||||||||
10.11. Restructuring Charges
Included in the discussion below are restructuring plans that were implemented during the years 1999 through 20032005 that were not yet completed as of December 31, 2004.June 30, 2005. Any restructuring plans that were implemented during the years 1999
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through 2002 that were completed as of December 31, 2004June 30, 2005 are not included in the discussion below. For a discussion of these completed plans, see Note 13 to the audited Consolidated Financial Statements in LNC’s annual report onour 2004 Form 10-K for the year ended December 31, 2004.10-K. The aggregate charges associated with the restructuring plans were included in underwriting, acquisition, insurance and other expenses on the Consolidated Statements of Income in the period incurred.
2005 Restructuring Plan
During May 2005, LFA implemented a restructuring plan, to realign its field management and financial planning support areas. Total pre-tax restructuring charges incurred during the first six months of 2005 were $4.4 million. These charges, which are included in Other Operations, included employee severance and termination benefits charges of $3.5 million and rent on abandoned office space charges of $0.9 million. The remaining reserves totaled $3.0 million at June 30, 2005. The plan is expected to be completed by the third quarter of 2006, except for lease payments on vacated space which run through 2008.
2003 Restructuring Plan
In January 2003, the Life Insurance segment announced that it was realigning its operations in Hartford, Connecticut and Schaumburg, Illinois to enhance productivity, efficiency and scalability while positioning the segment for future growth. In February 2003, Lincoln Retirement announced plans to consolidate its fixed annuity operations in Schaumburg, Illinois into Fort Wayne, Indiana. In June 2003, LNCwe announced that it waswe were combining itsour retirement and life insurance businesses into a single operating unit focused on providing wealth accumulation and protection, income distribution and wealth transfer products. The realigned organization has significantly reduced operating expenses while positioning LNCus for future growth. In August 2003, LNCwe announced additional realignment activities, which impact all of LNC’sour domestic operations.
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The following table provides information about the 2003 restructuring plans.plans:
(in millions) | Life Insurance Realignment Jan 2003 | Fixed Annuity Consolidation Feb 2003 | Realignment June/August 2003 | Total | Life Insurance Realignment Jan 2003 | Fixed Annuity Consolidation Feb 2003 | Realignment June/August 2003 | Total | ||||||||||||||||
Total expected charges | $ | 25.7 | $ | 4.8 | $ | 102.1 | $ | 132.6 | $ | 25.7 | $ | 4.8 | $ | 100.5 | $ | 131.0 | ||||||||
Amounts incurred through 2004 | ||||||||||||||||||||||||
Incurred through 2004 | ||||||||||||||||||||||||
Employee severance and termination benefits | 7.0 | 1.9 | 38.2 | 47.1 | 7.0 | 1.9 | 38.2 | 47.1 | ||||||||||||||||
Write-off of impaired assets | 1.9 | — | 4.9 | 6.8 | 1.9 | — | 4.9 | 6.8 | ||||||||||||||||
Other Costs: | ||||||||||||||||||||||||
Rent on abandoned office space | 6.1 | 2.2 | 5.0 | 13.3 | 6.1 | 2.2 | 5.0 | 13.3 | ||||||||||||||||
Other | 7.4 | 0.2 | 2.1 | 9.7 | 7.4 | 0.2 | 2.1 | 9.7 | ||||||||||||||||
Total Restructuring Charges (pre-tax) through 2004 | 22.4 | 4.3 | 50.2 | 76.9 | 22.4 | 4.3 | 50.2 | 76.9 | ||||||||||||||||
Amounts expended through 2004 | 21.6 | 3.9 | 45.0 | 70.5 | ||||||||||||||||||||
Amounts reversed through 2004 | — | — | 1.7 | 1.7 | ||||||||||||||||||||
Expended through 2004 | 21.6 | 3.9 | 45.0 | 70.5 | ||||||||||||||||||||
Reversed through 2004 | — | — | 1.7 | 1.7 | ||||||||||||||||||||
Restructuring reserve at December 31, 2004 | 0.8 | 0.4 | 3.5 | 4.7 | 0.8 | 0.4 | 3.5 | 4.7 | ||||||||||||||||
Amounts incurred in the first three months of 2005 | ||||||||||||||||||||||||
Incurred in the first six months of 2005 | ||||||||||||||||||||||||
Employee severance and termination benefits | — | — | 0.6 | 0.6 | — | — | 0.8 | 0.8 | ||||||||||||||||
Other Costs: | ||||||||||||||||||||||||
Write-off of impaired assets | — | — | 16.5 | 16.5 | ||||||||||||||||||||
Rent on abandoned office space | — | — | 0.5 | 0.5 | — | — | 0.6 | 0.6 | ||||||||||||||||
Other | 0.8 | — | — | 0.8 | 1.3 | — | 1.5 | 2.8 | ||||||||||||||||
Total Restructuring Charges (pre-tax) in the first three months of 2005 | 0.8 | — | 1.1 | 1.9 | ||||||||||||||||||||
Amounts expended in the first three months of 2005 | 0.9 | — | 2.5 | 3.4 | ||||||||||||||||||||
Total Restructuring Charges (pre-tax) in the first six months of 2005 | 1.3 | — | 19.4 | 20.7 | ||||||||||||||||||||
Expended in the first six months of 2005 | 1.4 | — | 21.8 | 23.2 | ||||||||||||||||||||
Reversed in the first six months of 2005 | — | — | 0.2 | 0.2 | ||||||||||||||||||||
Restructuring reserve at March 31, 2005 | $ | 0.7 | $ | 0.4 | $ | 2.1 | $ | 3.2 | ||||||||||||||||
Restructuring reserve at June 30, 2005 | $ | 0.7 | $ | 0.4 | $ | 0.9 | $ | 2.0 | ||||||||||||||||
Additional amounts expended that do not qualify as restructuring charges: | ||||||||||||||||||||||||
Year ended December 31, 2004 | $ | 2.0 | $ | 0.5 | $ | 22.8 | $ | 25.3 | $ | 2.0 | $ | 0.5 | $ | 22.8 | $ | 25.3 | ||||||||
Three months ended March 31, 2005 | — | — | 2.0 | 2.0 | ||||||||||||||||||||
Six months ended June 30, 2005 | — | — | 3.9 | 3.9 | ||||||||||||||||||||
Expense savings realized in 2004 (pre-tax) | 20.0 | 6.4 | 73.6 | 100.0 | 20.0 | 6.4 | 73.6 | 100.0 | ||||||||||||||||
Total expected annual expense savings (pre-tax) | 20.0 | 6.4 | 104.0 | 130.4 | 20.0 | 6.4 | 104.0 | 130.4 | ||||||||||||||||
Expected completion date | | 2nd Quarter 2006 | | 2nd Quarter 2006 | | 1st Quarter 2006 | | 2nd Quarter 2006 | | 2nd Quarter 2006 | | 2nd Quarter 2006 |
Pre-tax restructuring charges for the June/August realignment activities for the threesix months ended March 31,June 30, 2005 occurred in the following segments: Retirement ($0.616.0 million), Life Insurance ($0.13.3 million), and Other Operations ($0.40.1 million).
Pre-tax restructuring charges for the June/August realignment activities for the threesix months ended March 31,June 30, 2004 occurred in the following segments: Retirement ($1.73.5 million), Life Insurance ($0.40.6 million), Investment Management ($1.5 million), and Other Operations ($5.58.5 million).
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1999 and 2000 Restructuring Plans
During 1999 and 2000, LNCwe implemented restructuring plans relating to the Lincoln UK’s operations. In addition to various other activities, these plans involved vacating leased facilities. All other plan activities have been completed and the remaining reserves relate to future lease payments on exited properties, which expirerun through 2016. The remaining reserves for these plans totaled $8.0$7.2 million at March 31,June 30, 2005.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is a discussion of the financial condition of Lincoln National Corporation and its consolidated subsidiaries (“LNC” or the “Company” which also may be referred to as “we” or “us”) as of March 31,June 30, 2005, compared with December 31, 2004, and the results of operations of LNC for the three and six months ended March 31,June 30, 2005, compared with the same periodperiods last year. The balance sheet information presented below is as of March 31,June 30, 2005 and December 31, 2004. The statement of operations information is for the three and six months ended March 31,June 30, 2005 and 2004.
This discussion and analysis should be read in conjunction with our Consolidated Financial Statements and Notes thereto presented in Item 1 (“Consolidated Financial Statements”) and Management’s Discussion and Analysis (“MD&A”) in LNC’sour latest annual report on Form 10-K for the year ended December 31, 2004.2004 (“2004 Form 10-K”). You should also read our discussion below of “Critical Accounting Policies”Estimates” for an explanation of those accounting estimates that we believe are most important to the portrayal of our financial condition and results of operations and that require our most difficult, subjective and complex judgments. Financial information in the tables that follow is presented in conformity with accounting principles generally accepted in the United States of America (“GAAP”), unless otherwise indicated. Certain reclassifications have been made to prior periods’ financial information to conform to the 2005 presentation.
Forward-Looking Statements—Cautionary Language
Certain statements made in this report and in other written or oral statements made by LNC or on LNC’s behalf are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”). A forward-looking statement is a statement that is not a historical fact and, without limitation, includes 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. LNC claims the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the results contained in the forward-looking statements. Risks and uncertainties that may cause actual results to vary materially, some of which are described within the forward-looking statements include, among others:
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The risks included here are not exhaustive. Other sections of this report and LNC’s annual reports on Form 10-K, current reports on Form 8-K and other documents filed with the Securities and Exchange Commission include additional factors which could 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.
EXECUTIVE SUMMARY
We are a holding company whichthat operates multiple insurance and investment management businesses through subsidiary companies. Through our business segments, we sell a wide range of wealth protection, accumulation and accumulation products.retirement income products and solutions. These products include institutional and/or retail fixed annuities, variable annuities, universal life insurance, variable universal life insurance, term life insurance, other individual insurance coverages, retail mutual funds, “529” college savings plans and managed accounts.
We have four business segments: 1) Lincoln Retirement, 2) Life Insurance, 3) Investment Management and 4) Lincoln UK. We also have an “Other Operations” category that includes the financial data for the operations of LFA and LFD, our retail and wholesale distributors, and for operations that are not directly related to the business segments, unallocated corporate items (such as, corporate investment income and interest expense on short-term and long-term borrowings), and the historical results of the former Reinsurance segment, which was sold to Swiss Re in the fourth quarter of 2001, along with the ongoing amortization of deferred gain on the indemnity reinsurance portion of the transaction with Swiss Re.
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Lincoln’s business model is based upon a strategic intent to be the partner of choice for accumulating, protecting and enjoying wealth. We view our business similarmaintain a philosophy that certain elements are necessary to achieve these objectives, and we visually depict these elements in the form of a columned structure. The basefirst layer of the buildingfoundation of the structure is made up of our employees. Building up from that is financial and risk management, which is the cornerstone ofalso underlies our management and business philosophy. GoodTalented employees and strong financial and risk management provide the foundation from which we operate and grow our company. With that as a base, there are three pillars that we focus on — product excellence, power of the branddistribution reach and distribution reach.a powerful brand.
Product excellence is one of the pillarsfirst pillar of our business. It is important that we continually develop and provide products to the marketplace that not only meet the needs of our customers and compete effectively, but also satisfy our risk profile and meet our profitability standards. These products must be well supported with service after the sale.
In the Life Insurance segment, competitive pressures continue to depress its overall revenues. However, we remain committed to maintaining our pricing discipline. Within the Retirement segment, deposits and net flows have been strong in 2005 within both the individual and employer-sponsored marketplace due to the acceptance of our varied product offering, especially our variable annuities with guaranteed minimum withdrawal benefits andi4LIFE®, our income for life rider. In our Investment Management segment, we have also experienced increased net flows as we continue to have strong investment performance. In addition, during 2005, we have decided notcontinued to participateenhance some of our investment classes through the addition of talented managers in certain aspects of the life settlement insurance business, referred to as investor-owned life insurance (“IOLI”). Generally, the insured purchases an IOLI policy with the intent to later sell that policy to an investor or group of investors, who then become the ownerslarge asset classes like fixed income, value, growth, and beneficiaries of the policy. These investors will usually loan to the insured an amount equal to or greater than the amount required to fund the policy during the period between original purchase and planned sale to the investors. The decision not to participate in this market may further constrain the Life Insurance segment’s revenues.international.
Our second essential pillar is distribution reach. Because our products are complex and are generally purchased through broker-dealers and financial advisors, being ablethe ability to distribute to these marketing channels is one key to success in our industry. During the first quartersix months of 2005, LFD, our wholesaling distribution arm, increased account penetration and its number of wholesalers. LFA, our retail distribution arm, implemented its new planner affiliation model in the first quarter of 2005. The new model is designed to bring consistency to compensation and expense charges for all LFA planners. Although we continue to believe that the new structure will be beneficial to us, our policyholders and planners, during 2005 we expect to incur costs associated with the transition to the new affiliation model andremainder of 2005 we believe that the loss of planners remains a risk.
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We continue to expect our major challenges infor the remainder of 2005 to include:
CRITICAL ACCOUNTING POLICIESESTIMATES
The MD&A includedpreparation of financial statements in our annual report on Form 10-K forconformity with GAAP requires management to make estimates and assumptions that affect the year ended December 31, 2004 contains areported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expense during the reporting period. Actual results could differ from those estimates.
The following information updates the detailed discussion of our critical accounting policies. The following information updates the critical accounting policies providedestimates included in the MD&A in our 2004 annual report on Form 10-K.
Intangible Assets
Accounting for intangible assets requires numerous assumptions, such as estimates of expected future profitability for our operations and our ability to retain existing blocks of life and annuity business in force. Our accounting policies for the intangible assets DAC, present value of acquired blocks of in-force policies (“PVIF”), deferred sales inducements (“DSI”) and the liability for deferred front-end loads (“DFEL”) impact all four business segments: Lincoln Retirement, Life Insurance, Investment Management and Lincoln UK. DAC, PVIF, DSI and DFEL will be referred to hereinafter collectively as DAC.
Deferred Acquisition Costs, Present Value of In-Force, Deferred Sales Inducements and Deferred Front-End Loads
Statement of Financial Accounting StandardStandards (“SFAS”) No. 97, “Accounting by Insurance Companies for Certain Long-Duration Contracts and Realized Gains and Losses on Investment Sales” requires that acquisition costs for variable annuity contracts, universal and variable universal life insurance policies be amortized over the lives of the contracts in relation to the incidence of estimated gross profits (“EGPs”) derived from the contracts. Acquisition costs are those costs that vary with and are
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primarily related to new or renewal business. These costs include commissions and other expenses that vary with new business volume. The costs that we defer are recorded as an asset on our balance sheet as DAC for products sold by us or PVIF for books of business acquired by us. In addition, we defer costs associated with DSI and revenues associated with DFEL. DFEL is a balance sheet liability, and when amortized, increases income. On an annual basis, in the third quarter, we perform our normal review and adjust as necessary our assumptions for prospective amortization of DAC, PVIF, DSI and DFEL. The table below presents the balances by business segment as of March 31,June 30, 2005.
March 31, 2005 (in millions) | Lincoln Retirement | Life Insurance | Investment Management | Lincoln UK | Other Operations | Total | ||||||||||||||||||||||||||||||
June 30, 2005 (in millions) | Lincoln Retirement | Life Insurance | Investment Management | Lincoln UK | Other Operations | Total | ||||||||||||||||||||||||||||||
DAC | $ | 1,214.0 | $ | 1,786.7 | $ | 133.8 | $ | 576.9 | $ | 1.3 | $ | 3,712.7 | $ | 1,174.8 | $ | 1,714.8 | $ | 126.7 | $ | 537.0 | $ | 1.2 | $ | 3,554.5 | ||||||||||||
PVIF | 90.3 | 710.9 | — | 271.9 | — | 1,073.1 | 87.9 | 698.5 | — | 255.3 | — | 1,041.7 | ||||||||||||||||||||||||
DSI | 94.9 | — | — | — | — | 94.9 | 106.6 | — | — | — | — | 106.6 | ||||||||||||||||||||||||
Total DAC, PVIF and DSI | 1,399.2 | 2,497.6 | 133.8 | 848.8 | 1.3 | 4,880.7 | 1,369.3 | 2,413.3 | 126.7 | 792.3 | 1.2 | 4,702.8 | ||||||||||||||||||||||||
DFEL | — | 328.0 | — | 428.3 | — ` | 756.3 | — | 331.5 | — | 399.8 | — | 731.3 | ||||||||||||||||||||||||
Net DAC, PVIF, DSI and DFEL | $ | 1,399.2 | $ | 2,169.6 | $ | 133.8 | $ | 420.5 | $ | 1.3 | $ | 4,124.4 | $ | 1,369.3 | $ | 2,081.8 | $ | 126.7 | $ | 392.5 | $ | 1.2 | $ | 3,971.5 | ||||||||||||
Note: | The above table also includes DAC and PVIF amortized in accordance with |
As more fully discussed in our 2004 annual report on Form 10-K, beginning in the fourth quarter of 2004, we enhanced our “reversion to the mean” (“RTM”) process, the process we use to compute our best estimate long-term gross growth rate assumption, to evaluate the carrying value of DAC for our variable annuity, annuity-based 401(k) and unit-linked product blocks of business. We changed our RTM process because we do not believe that random and insignificant short-term fluctuations in equity market returns are reflective of the best estimate of future EGPs, and that it is larger fluctuations or sustained trends in the equity markets that should change our best estimate of future EGPs for these products. Prior to the change to the enhanced RTM process, we reviewed actual and estimates of future gross profits underlying the DAC amortization model on a quarterly basis, and recorded a positive or negative retrospective adjustment to the amount expensed (i.e., unlock DAC, PVIF and DSI), or earned (i.e., unlock DFEL). Under our enhanced RTM process, on each valuation date, future EGPs are projected using stochastic modeling of a large number of future equity market scenarios in conjunction with best estimates of lapse rates, interest margins and mortality to develop a statistical distribution of the present value of future EGPs for each of the blocks of business. The statistical distribution is designed to identify when the equity market return deviations from expected returns have become significant enough to warrant a change of the future equity return EGP assumption.
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The stochastic modeling performed for our variable annuity blocks of business is used to develop a range of reasonably possible future EGPs. We compare the range of the present value of the future EGPs from the stochastic modeling to that used in the DAC amortization model. A set of intervals around the mean of these scenarios is utilized to calculate two separate statistical ranges of reasonably possible EGPs. These intervals are compared to the present value of the EGPs used in the DAC amortization model. If the present value of EGP assumptions utilized in the DAC amortization model were to exceed the margin of the reasonable range of statistically calculated EGPs, a revision of the EGPs used to calculate DAC amortization would occur. If a revision is deemed necessary, future EGPs would be re-projected using the current account values at the end of the period during which the revision occurred along with a revised long-term annual equity market gross return assumption such that the re-projected EGPs would be our best estimate of EGPs.
Given where our best estimate of EGPs for the Retirement segment was positioned in the range at March 31,June 30, 2005, if we were to assume a 9% long-term gross equity market growth assumption from March 31,June 30, 2005 forward in determining the revised EGPs, we estimate that it would result in a cumulative decrease to DAC amortization (positive DAC unlocking) of approximately $69.7$80 million pre-tax ($45.352 million after-tax). To further illustrate the position in the range of our best estimate of EGPs for the Retirement segment at March 31,June 30, 2005, a one-quarter equity market movement of positive 20%10% would bring us to the first of the two statistical ranges while a one quarterone-quarter equity market movement of positive 35%30% would bring us to the second of the two ranges for the Retirement segment. Subsequent equity market performance that would keep us at or move us beyond the first statistical range would likely result in positive unlocking. We estimate that a one-quarter equity market movement of negative 35% would bring us to the first of the two statistical ranges, while a one-quarter equity market movement of negative 40% would bring us to the second of the two ranges for the Retirement segment.
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For a more detailed discussion of the enhanced RTM process, refer to the discussion in Critical Accounting Policies – Intangible Assets, included in our annual report on2004 Form 10-K for the year ended December 31, 2004.10-K.
Guaranteed Minimum Benefits
During 2003 and 2004, the Lincoln Retirement segment implemented and expanded a hedging strategy designed to mitigate the risk and income statement volatility caused by changes in the equity markets, interest rates, and volatility associated with the Lincoln Smart Securitysm Advantage guaranteed minimum withdrawal benefit (“GMWB”) and our various guaranteed minimum death benefit (“GMDB”) features. The hedging strategy is designed such that changes in the value of the hedge contracts move in the opposite direction of changes in the value of the embedded derivative of the GMWB or changes in the reserve for GMDB contracts subject to the hedging strategy. Account balances covered in this hedging program combined with account balances for which there is no death benefit represent approximately 95% of total variable annuity account balances.balances, which excludes the Alliance mutual fund business.
The reserves related to the GMDB are based on the application of a benefit ratio to total assessments related to the variable annuity. The level and direction of the change in reserves will vary over time based on the emergence of the benefit ratio (which is based on both historical and projected future level of benefits) and the level of assessments (both historical and projected) associated with the variable annuity. We utilize a delta hedging strategy for variable annuity products with a GMDB feature, which uses futures on U.S.-based equity market indices to hedge against movements in equity markets. Because the GMDB reserves are based upon projected long-term equity market return assumptions, and since the value of the hedging contracts will reflect current capital market conditions, the quarterly changes in values for the GMDB reserves and the hedging contracts may not offset each other on an exact basis. Despite these short-term fluctuations in values, we intend to continue to hedge our long-term GMDB exposure in order to mitigate the risk associated with falling equity markets. During the third quarter of 2004, we expanded our hedging program to cover substantially all exposures for these policies.
We utilize a dynamic hedging strategy for variable annuity products with a GMWB feature, which uses futures on U.S.-based equity indices to hedge against movements in the equity markets, as well as interest rate and equity derivative securities to hedge against changes in reservesthe embedded derivative associated with changes in interest rates and market implied volatilities. As of March 31,June 30, 2005, the notional amounts of the underlying hedge instruments are such that the magnitude of the change in the value of the hedge instruments due to changes in equity markets, interest rates, and implied volatilities is designed to offset the magnitude of the change in the fair value of the GMWB guarantee caused by those same factors. At March 31,June 30, 2005, the embedded derivative for GMWB was an asseta liability valued at $12.3$20.5 million. Prior to the fourth quarter of 2004, we only hedged against movements in the equity markets, but asmarkets. As a result of strong flows and current and possible future product enhancements, we expanded our hedging program in the fourth quarter of 2004 to cover movements in interest rates and implied volatilities.
2523
RESULTS OF CONSOLIDATED OPERATIONS
All amounts stated in this MD&A are on an after-tax basis except where specifically noted as pre-tax.
Consolidated Results
Three Months Ended March 31, (in millions) | 2005 | 2004 | Increase Prior Period | ||||||||||||||||||||||||||||||
Three Months | Increase Prior Period | Six Months | Increase Prior Period | ||||||||||||||||||||||||||||||
(in millions) | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||||
Insurance premiums | $ | 70.4 | $ | 75.6 | (7 | )% | $ | 72.6 | $ | 74.0 | (2 | )% | $ | 143.0 | $ | 149.6 | (4 | )% | |||||||||||||||
Insurance fees | 419.0 | 383.7 | 9 | % | 426.8 | 390.2 | 9 | % | 845.8 | 773.9 | 9 | % | |||||||||||||||||||||
Investment advisory fees | 59.4 | 62.7 | (5 | )% | 66.9 | 66.4 | 1 | % | 126.3 | 129.2 | (2 | )% | |||||||||||||||||||||
Net investment income | 659.8 | 677.5 | (3 | )% | 703.5 | 683.1 | 3 | % | 1,363.4 | 1,360.6 | 0 | % | |||||||||||||||||||||
Amortization of deferred gain | 19.2 | 18.2 | 5 | % | 19.3 | 18.3 | 5 | % | 38.5 | 36.5 | 5 | % | |||||||||||||||||||||
Other revenues and fees | 74.0 | 61.4 | 21 | % | 93.2 | 113.0 | (18 | )% | 167.2 | 174.4 | (4 | )% | |||||||||||||||||||||
Realized loss on investments | (2.8 | ) | (20.1 | ) | (86 | )% | |||||||||||||||||||||||||||
Net realized investment losses | (9.1 | ) | (10.4 | ) | (13 | )% | (12.0 | ) | (30.5 | ) | (61 | )% | |||||||||||||||||||||
Gain on sale of subsidiaries | 14.2 | — | NM | — | 24.1 | (100 | )% | 14.2 | 24.1 | (41 | )% | ||||||||||||||||||||||
Total Revenue | 1,313.2 | 1,259.0 | 4 | % | 1,373.2 | 1,358.7 | 1 | % | 2,686.4 | 2,617.8 | 3 | % | |||||||||||||||||||||
Insurance benefits | 572.6 | 583.3 | (2 | )% | 593.3 | 583.3 | 2 | % | 1,165.9 | 1,166.6 | 0 | % | |||||||||||||||||||||
Underwriting, acquisition, insurance and other expenses | 480.4 | 444.3 | 8 | % | 519.8 | 491.2 | 6 | % | 1,000.2 | 935.5 | 7 | % | |||||||||||||||||||||
Interest and debt expenses | 22.4 | 22.8 | (2 | )% | 22.1 | 24.6 | (10 | )% | 44.5 | 47.5 | (6 | )% | |||||||||||||||||||||
Total Benefits and Expenses | 1,075.4 | 1,050.4 | 2 | % | 1,135.2 | 1,099.1 | 3 | % | 2,210.6 | 2,149.6 | 3 | % | |||||||||||||||||||||
Income before federal income taxes | 237.8 | 208.6 | 14 | % | 238.0 | 259.6 | (8 | )% | 475.8 | 468.2 | 1 | % | |||||||||||||||||||||
Federal income taxes | 58.9 | 53.6 | 10 | % | 40.1 | 72.6 | (45 | )% | 99.0 | 126.2 | (23 | )% | |||||||||||||||||||||
Income before cumulative effect of accounting changes | 178.9 | 155.0 | 15 | % | 197.9 | 187.0 | (6 | )% | 376.8 | 342.0 | 10 | % | |||||||||||||||||||||
Cumulative effect of accounting changes | — | (24.5 | ) | NM | — | — | NM | — | (24.5 | ) | 100 | % | |||||||||||||||||||||
Net Income | $ | 178.9 | $ | 130.5 | 37 | % | $ | 197.9 | $ | 187.0 | (6 | )% | $ | 376.8 | $ | 317.5 | 19 | % | |||||||||||||||
Items Included in Net Income (after-tax): | |||||||||||||||||||||||||||||||||
Realized loss on investments and derivative instruments | $ | (4.6 | ) | $ | (10.3 | ) | $ | (2.7 | ) | $ | (13.4 | ) | $ | (7.3 | ) | $ | (23.7 | ) | |||||||||||||||
Gain on sale of subsidiaries | 9.3 | — | — | 15.7 | 9.3 | 15.7 | |||||||||||||||||||||||||||
Restructuring charges | (1.3 | ) | (7.5 | ) | (15.0 | ) | (3.5 | ) | (16.3 | ) | (10.9 | ) | |||||||||||||||||||||
Net gain (loss) on reinsurance embedded derivative/trading securities | 2.8 | (2.7 | ) | (3.3 | ) | 6.7 | (0.5 | ) | 4.0 | ||||||||||||||||||||||||
FAS 113 reserve development, net of related amortization on business sold through indemnity reinsurance | 0.2 | 0.2 | |||||||||||||||||||||||||||||||
Reserve development, net of related amortization on business sold through indemnity reinsurance | 0.2 | 0.2 | 0.4 | 0.4 | |||||||||||||||||||||||||||||
Cumulative effect of accounting changes | — | (24.5 | ) | — | — | — | (24.5 | ) |
NM - Not Meaningful
The table below provides a detailed comparison of items included within realized gain (loss) on investments and derivatives.
Three Months Ended March 31, (in millions) | 2005 | 2004 | Increase (Decrease) Over Prior Period | ||||||||||||||||||||||||||||||
Three Months | Increase | Six Months | Increase | ||||||||||||||||||||||||||||||
Periods ended June 30, (in millions) | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||||
Realized gains on investments | $ | 27.6 | $ | 38.5 | (28 | )% | $ | 33.8 | $ | 28.6 | 18 | % | $ | 60.5 | $ | 67.1 | (10 | )% | |||||||||||||||
Realized losses on investments | (20.6 | ) | (27.0 | ) | (24 | )% | (16.9 | ) | (39.9 | ) | (58 | )% | (36.7 | ) | (66.9 | ) | (45 | )% | |||||||||||||||
Realized gains (losses) on derivative instruments | 1.6 | (5.0 | ) | NM | |||||||||||||||||||||||||||||
Realized losses on derivative instruments | (4.4 | ) | (3.8 | ) | 16 | % | (2.8 | ) | (8.8 | ) | (68 | )% | |||||||||||||||||||||
Amounts amortized to balance sheet accounts | (13.5 | ) | (19.7 | ) | (31 | )% | (14.1 | ) | (3.1 | ) | 355 | % | (27.5 | ) | (22.8 | ) | 21 | % | |||||||||||||||
Market adjustment reinsurance embedded derivative/trading securities | 4.4 | (4.2 | ) | NM | (5.1 | ) | 10.2 | NM | (0.7 | ) | 6.0 | NM | |||||||||||||||||||||
Investment expenses | (2.3 | ) | (2.7 | ) | (15 | )% | (2.4 | ) | (2.4 | ) | (4 | )% | (4.8 | ) | (5.1 | ) | (6 | )% | |||||||||||||||
Net loss on investments and derivative instruments | $ | (2.8 | ) | $ | (20.1 | ) | (86 | )% | $ | (9.1 | ) | $ | (10.4 | ) | (13 | )% | $ | (12.0 | ) | $ | (30.5 | ) | (61 | )% | |||||||||
Write-downs for other-than-temporary impairments included in realized losses on investments above | $ | (9.2 | ) | $ | (9.4 | ) | (2 | )% | $ | (2.4 | ) | $ | (18.6 | ) | (87 | )% | $ | (11.6 | ) | $ | (28.1 | ) | (59 | )% | |||||||||
2624
Three Months Ended March 31, (in billions) | 2005 | 2004 | Increase (Decrease) Over Prior Period | ||||||||
Deposits(1): | |||||||||||
Lincoln Retirement Segment | $ | 2.639 | $ | 2.223 | 19 | % | |||||
Life Insurance Segment | 0.512 | 0.501 | 2 | % | |||||||
Investment Management Segment (including both retail and institutional deposits)(2) | |||||||||||
Domestic | 5.168 | 3.655 | 41 | % | |||||||
London-based International Investment Unit | — | 1.419 | NM | ||||||||
Consolidating Adjustments(3) | (0.298 | ) | (0.289 | ) | 3 | % | |||||
Total Deposits | $ | 8.021 | $ | 7.509 | 7 | % | |||||
Net Flows(1): | |||||||||||
Lincoln Retirement Segment | $ | 0.776 | $ | 0.712 | 9 | % | |||||
Life Insurance Segment | 0.260 | 0.248 | 5 | % | |||||||
Investment Management Segment (including both retail and institutional net flows)(2) | |||||||||||
Domestic | 2.796 | 1.540 | 82 | % | |||||||
London-based International Investment Unit | — | 1.089 | NM | ||||||||
Consolidating Adjustments(3) | 0.019 | (0.059 | ) | NM | |||||||
Total Net Flows | $ | 3.851 | $ | 3.530 | 9 | % | |||||
As of March 31, (in billions) | |||||||||||
Assets Under Management by Advisor(4) | |||||||||||
Investment Management Segment(2): | |||||||||||
External Assets | $ | 58.0 | $ | 67.1 | (14 | )% | |||||
Insurance-related Assets | 44.2 | 44.0 | 1 | % | |||||||
Lincoln UK | 8.6 | 7.8 | 10 | % | |||||||
Within Business Units (Policy Loans) | 1.9 | 1.9 | — | % | |||||||
By Non-LNC Entities | 32.8 | 28.5 | 15 | % | |||||||
Total Assets Under Management | $ | 145.5 | $ | 149.3 | (3 | )% | |||||
Following are deposits and net flows by business segment. For additional detail of deposit and net flow information, see the discussion in “Results of Operations by Segment” below:
Three Months | Six Months | |||||||||||||||||||||
Periods Ended June 30, (in billions) | 2005 | 2004 | Increase (Decrease) Over Prior Period | 2005 | 2004 | Increase (Decrease) Over Prior Period | ||||||||||||||||
Deposits: | ||||||||||||||||||||||
Lincoln Retirement | $ | 2.529 | $ | 2.203 | 15 | % | $ | 5.167 | $ | 4.426 | 17 | % | ||||||||||
Life Insurance | 0.527 | 0.507 | 4 | % | 1.039 | 1.009 | 3 | % | ||||||||||||||
Investment Management (including both retail and institutional deposits)(1) | ||||||||||||||||||||||
Domestic | 9.885 | 3.488 | 183 | % | 15.053 | 7.143 | 111 | % | ||||||||||||||
London-based International Investment Unit(2) | — | 1.960 | (100 | )% | — | 3.379 | (100 | )% | ||||||||||||||
Consolidating Adjustments(3) | (0.264 | ) | (0.213 | ) | 24 | % | (0.561 | ) | (0.504 | ) | 11 | % | ||||||||||
Total Deposits | �� | $ | 12.677 | $ | 7.945 | 60 | % | $ | 20.698 | $ | 15.453 | 34 | % | |||||||||
Net Flows: | ||||||||||||||||||||||
Lincoln Retirement | $ | 0.857 | $ | 0.700 | 22 | % | $ | 1.632 | $ | 1.412 | 16 | % | ||||||||||
Life Insurance | 0.309 | 0.291 | 6 | % | 0.569 | 0.539 | 6 | % | ||||||||||||||
Investment Management (including both retail and institutional net flows)(1) | ||||||||||||||||||||||
Domestic | 6.439 | 1.003 | 542 | % | 9.235 | 2.543 | 263 | % | ||||||||||||||
London-based International Investment Unit(2) | — | 1.657 | (100 | )% | — | 2.745 | (100 | )% | ||||||||||||||
Consolidating Adjustments(3) | 0.014 | 0.059 | (76 | )% | 0.034 | 0.002 | 1,600 | % | ||||||||||||||
Total Net Flows | $ | 7.619 | $ | 3.710 | 105 | % | $ | 11.470 | $ | 7.241 | 58 | % | ||||||||||
As of June 30, | As of December 31, 2004 | Increase | Increase | ||||||||||||
(in billions) | 2005 | 2004 | |||||||||||||
Assets Under Management by Advisor(4) | |||||||||||||||
Investment Management(1): | |||||||||||||||
External Assets | $ | 66.0 | $ | 69.7 | $ | 56.0 | (5 | )% | 18 | % | |||||
Insurance-related Assets | 45.2 | 42.5 | 44.0 | 6 | % | 3 | % | ||||||||
Lincoln UK | 8.3 | 7.8 | 8.6 | 6 | % | (3 | )% | ||||||||
Within Business Units (Policy Loans) | 1.9 | 1.9 | 1.9 | — | % | — | % | ||||||||
By Non-LNC Entities | 34.6 | 29.4 | 33.8 | 18 | % | 2 | % | ||||||||
$ | 156.0 | $ | 151.3 | $ | 144.3 | 3 | % | 8 | % | ||||||
(1) | For additional detail of deposit and net flow information see the discussion in “Results of Operations by Segment” below. |
(2) | In September 2004, we completed the sale of our London-based international investment management unit (“DIAL”), which had assets under management of $22.1 billion at the date of sale that were transferred to the acquirer. For additional information see “Results of Operations by Segment—Investment Management” segment discussion. Assets under management include assets sub-advised for us by unaffiliated parties, including DIAL’s acquirer. As a result of the sale of DIAL, the amount of total sub-advised assets |
(3) | Consolidating adjustments represent the elimination of deposits and net flows on products affecting more than one segment. |
(4) | Assets under management by advisor provide a breakdown of assets that we manage or administer either directly or through unaffiliated third parties. These assets represent our investments, assets held in separate accounts and assets that we manage or administer for individuals or other companies. We earn insurance fees, investment advisory fees or investment income on these assets. |
25
Comparison of Three and Six Months Ended March 31,June 30, 2005 to 2004
Revenues
The increase in insurance fees and investment advisory fees in the second quarter and first quartersix months of 2005 primarily reflects growth in deposits and assets under management, and to a lesser extent, the effects of favorable equity market performance. Assets under management increased 11.9% excludingExcluding the effects of the DIAL sale, assets under management increased 20% as a result of positive net flows throughout 2004 and the first quartersix months of 2005. The average level of the equity markets was higher in 2005, compared to 2004, resulting in higher fee income for the Lincoln Retirement segment. Excluding the impact of dividends, the S&P 500 index increased 4.8%4.4% and the average daily S&P index increased 5.3%5.2% in the first quartersix months of 2005, compared to the same 2004 period.
27
Net realized losses on investments for the second quarter and first quartersix months of 2005 declined $17.3$1.3 million and $18.5 million from the same periodperiods last year. Favorable credit markets resulted in lower losses from sales of available-for-sale securities, and rising interest rates resulted in gains in the first quartersix months of 2005 on the reinsurance-related derivative instrument, compared to losses in the same 2004 period. Additional details on our investment performance are provided in the “Consolidated Investments” section below.
Revenues fromfor the six months ended June 30, 2005 include a gain on sale of subsidiaries/businesses include a pre-tax gainsubsidiaries of $14.2 million pre-tax from an agreement to settle in full the residual contingent payments resulting from the arrangement to outsource Lincoln UK’s back-office operations to Capita Life and Pension Services Limited, a subsidiary of Capita Group Plc, (“Capita”) the outsourcing firm for Lincoln UK’s customer and policy administration functions. The gain on the sale of subsidiaries included in the second quarter of 2004 reflects a $10.2 million pre-tax gain on the exercise of a put option arising from the Capita arrangement (see Note 7 to the Consolidated Financial Statements in our 2004 Form 10-K for additional information) and $13.8 million from the sale of LFA’s employee benefits marketing business.
The decreaseincrease in net investment income infor the firstsecond quarter of 2005, compared to the same period in 2004, primarily reflects fees received from standby real estate equity commitments of $26 million and favorable partnership earnings in the second quarter of 2005 as well as the favorable effect of asset growth from net flows. Offsetting the favorable effects of these items for the first six months of 2005, compared to the same 2004 period, was the first quarter 2004 receipt of approximately $21.9 million pre-tax, of contingent interest on mortgage loans on real estate previously owned by us. Decliningus and declining portfolio yields partially offset by the favorable effect of asset growth from net flows, also contributed to the decrease.yields.
Expenses
Consolidated expenses increased $19.9 million, or 2%, and $45.0 million, or 2%, for the second quarter and first threesix months of 2005, compared to the same periodperiods in 2004 increased $25.0 million, pre-tax, or 2%.2004. Expenses were higher in the Lincoln Retirement, Life Insurance and Investment Management business segments. See “Results of Operations by Segment” below for further discussion by segment. The increase resulted from growth in our business partially offset by the effect of spread management through lower crediting rates on interest-sensitive business, movements from fixed to variable annuity products, and a reduction in the level of GMDB benefits. In addition, expenses were higher from the amortization of DAC, PVIF, DSI and DFELDSI on a consolidated basis. The impact varied by segment. See “Results of Operations by Segment” below for further discussion by segment.
Restructuring charges of $1.3were $15.0 million and $7.5$16.3 million infor the first quarters ofthree and six months ended June 30, 2005, compared to $3.5 million and 2004, respectively, were$10.9 million for the result ofsame periods last year, resulting from expense initiatives undertaken by us during 2003 to improve operational efficiencies. Forefficiencies and costs associated with LFA’s 2005 plan to realign its field management and financial planning support areas. See Note 11 to our Consolidated Financial Statements for additional information on restructuring charges see Note 10 to the Consolidated Financial Statements of this Form 10-Q.charges.
Federal income tax expense included reductions of $23.5 million for the second quarter and $29.3 million for the first quartersix months of 2005 included a $5.8 million reduction related to a partial releasereleases of a deferred tax valuation allowance in our Barbados insurance company. This reduction is included in Other Operations. We believe that it is more likely than not that the remaining tax benefits of $17.5 million associated with the net operating losses of the Barbados insurance subsidiary will be realized. Future adjustments to the remaining valuation allowance will be dependent uponapportioned to the amount and timingremaining quarters of taxable income of2005 through an adjustment to the Barbados company.annual effective tax rate
RESULTS OF OPERATIONS BY SEGMENT
In this MD&A, in addition to providing consolidated revenues and net income (loss), we also provide segment operating revenue and income (loss) from operations because we believe they are meaningful measures of revenues and the profit or loss generated by our operating segments. Operating revenue is GAAP revenue excluding realized gains and losses on investments and derivative instruments, gains and losses on reinsurance embedded derivative/trading securities, gains and losses on sale of subsidiaries/businesses and amortization of deferred gain arising from reserve development. Income (loss) from operations, which is GAAP net income (loss) excluding net realized investment gains and losses, losses on early retirement of debt, restructuring charges, reserve development net of related amortization on business sold through reinsurance and cumulative effect of accounting changes. Operating revenue and income (loss) from operations are the financial performance measures used by our management and Board of Directors to evaluate and assess the results of our segments. Accordingly, we report income (loss) from operations by segment in Note 7 to theour Consolidated Financial Statements as required by Statement of Financial Accounting StandardsSFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.” Our management and Board of Directors believe that income (loss) from operations explains the results of our ongoing businesses in a manner that allows for a better understanding of the underlying trends in our current businesses because net realized investment gains and losses, restructuring charges, reserve development net of related amortization on business sold through reinsurance and cumulative effect of accounting changes are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments, and in many instances, decisions regarding these items do not necessarily relate to the operations of the individual segments. Income (loss) from operations does not replace net income (loss) as the GAAP measure of our consolidated results of operations.
2826
Below is a reconciliation of our segment revenue and income from operations to our consolidated revenue and net income:
Three Months Ended March 31, | Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
(in millions) | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | ||||||||||||||||||
Revenue: | ||||||||||||||||||||||||
Segment Operating Revenue: | ||||||||||||||||||||||||
Lincoln Retirement | $ | 538.5 | $ | 528.0 | $ | 573.0 | $ | 534.4 | $ | 1,111.6 | $ | 1,062.4 | ||||||||||||
Life Insurance | 484.2 | 483.4 | 497.3 | 484.8 | 981.5 | 968.1 | ||||||||||||||||||
Investment Management (1) | 130.4 | 135.2 | 138.0 | 139.0 | 268.3 | 274.2 | ||||||||||||||||||
Lincoln UK | 74.6 | 76.1 | 78.4 | 81.0 | 153.1 | 157.1 | ||||||||||||||||||
Segment Operating Revenue | 1,227.7 | 1,222.7 | ||||||||||||||||||||||
Other Operations | 243.8 | 203.7 | 248.2 | 204.9 | 491.8 | 408.6 | ||||||||||||||||||
Consolidating adjustments | (170.0 | ) | (147.6 | ) | (152.9 | ) | (99.4 | ) | (322.9 | ) | (247.0 | ) | ||||||||||||
Net realized investment results (2) | 11.4 | (20.1 | ) | (9.1 | ) | 13.7 | 2.3 | (6.4 | ) | |||||||||||||||
Other (3) | 0.3 | 0.3 | ||||||||||||||||||||||
Reserve development net of related amortization on business sold through reinsurance | 0.3 | 0.3 | 0.7 | 0.7 | ||||||||||||||||||||
Total | $ | 1,313.2 | $ | 1,259.0 | $ | 1,373.2 | $ | 1,358.7 | $ | 2,686.4 | $ | 2,617.7 | ||||||||||||
Net Income: | ||||||||||||||||||||||||
Segment Income from Operations: | ||||||||||||||||||||||||
Lincoln Retirement | $ | 98.6 | $ | 102.2 | $ | 119.4 | $ | 101.8 | $ | 218.1 | $ | 204.0 | ||||||||||||
Life Insurance | 67.7 | 74.8 | 75.8 | 76.2 | 143.6 | 150.9 | ||||||||||||||||||
Investment Management | 7.4 | 12.5 | 3.9 | 13.4 | 11.2 | 25.9 | ||||||||||||||||||
Lincoln UK | 10.0 | 6.2 | 10.3 | 10.7 | 20.4 | 16.9 | ||||||||||||||||||
Segment Income from Operations | 183.7 | 195.7 | ||||||||||||||||||||||
Other Operations | (11.2 | ) | (20.4 | ) | 9.3 | (20.7 | ) | (2.1 | ) | (41.0 | ) | |||||||||||||
Other Items (4) | (1.3 | ) | (7.5 | ) | ||||||||||||||||||||
Net realized investment results (5) | 7.5 | (13.0 | ) | |||||||||||||||||||||
Other Items (3) | (15.0 | ) | (3.5 | ) | (16.3 | ) | (10.9 | ) | ||||||||||||||||
Net realized investment results (4) | (6.0 | ) | 8.9 | 1.5 | (4.2 | ) | ||||||||||||||||||
Reserve development net of related amortization on business sold through reinsurance | 0.2 | 0.2 | 0.2 | 0.2 | 0.4 | 0.4 | ||||||||||||||||||
Income before cumulative effect of accounting change | 178.9 | 155.0 | 197.9 | 187.0 | 376.8 | 342.0 | ||||||||||||||||||
Cumulative effect of accounting change | — | (24.5 | ) | — | — | — | (24.5 | ) | ||||||||||||||||
Net Income | $ | 178.9 | $ | 130.5 | $ | 197.9 | $ | 187.0 | $ | 376.8 | $ | 317.5 | ||||||||||||
(in millions) | March 31, 2005 | December 31, 2004 | ||||||||||||||||||||||
Assets: | ||||||||||||||||||||||||
Lincoln Retirement | $ | 68,256.2 | $ | 68,552.7 | ||||||||||||||||||||
Life Insurance | 22,862.0 | 22,805.0 | ||||||||||||||||||||||
Investment Management | 6,418.8 | 6,391.5 | ||||||||||||||||||||||
Lincoln UK | 9,603.2 | 9,583.9 | ||||||||||||||||||||||
Other Operations | 15,040.2 | 14,572.9 | ||||||||||||||||||||||
Consolidating adjustments | (5,828.2 | ) | (5,686.7 | ) | ||||||||||||||||||||
Total | $ | 116,352.2 | $ | 116,219.3 | ||||||||||||||||||||
(1) | Revenues for the Investment Management segment include inter-segment revenues for asset management services provided to |
(2) | Includes realized losses on investments and derivatives of |
(3) |
Represents restructuring charges. |
Includes realized losses on investments and derivatives of |
2927
Lincoln Retirement
Operating Summary for the Three Months Ended March 31, (in millions) | 2005 | 2004 | Increase (Decrease) Over Prior Period | ||||||||||||||||||||||||||||||
Three Months | Increase | Six Months | Increase | ||||||||||||||||||||||||||||||
Operating Summary for the Periods Ended June 30, (in millions) | 2005 | 2004 | 2005 | 2004 | |||||||||||||||||||||||||||||
Operating Revenues: | |||||||||||||||||||||||||||||||||
Insurance premiums | $ | 10.5 | $ | 6.5 | 62 | % | $ | 7.8 | $ | 7.4 | 5 | % | $ | 18.3 | $ | 13.9 | 32 | % | |||||||||||||||
Insurance fees | 172.0 | 143.2 | 20 | % | 180.0 | 146.9 | 23 | % | 352.0 | 290.1 | 21 | % | |||||||||||||||||||||
Net investment income | 357.4 | 379.0 | (6 | )% | 386.8 | 382.4 | 1 | % | 744.2 | 761.4 | (2 | )% | |||||||||||||||||||||
Other revenues and fees | (1.4 | ) | (0.7 | ) | 100 | % | (1.6 | ) | (2.3 | ) | (30 | )% | (2.9 | ) | (3.0 | ) | (3 | )% | |||||||||||||||
Total Operating Revenues | 538.5 | 528.0 | 2 | % | 573.0 | 534.4 | 7 | % | 1,111.6 | 1,062.4 | 5 | % | |||||||||||||||||||||
Operating Expenses: | |||||||||||||||||||||||||||||||||
Insurance benefits | 247.8 | 252.8 | (2 | )% | 256.2 | 250.2 | 2 | % | 504.0 | 503.0 | 0 | % | |||||||||||||||||||||
Underwriting, acquisition, insurance and other expenses | 163.3 | 141.6 | 15 | % | 158.2 | 150.4 | 5 | % | 321.6 | 292.0 | 10 | % | |||||||||||||||||||||
Total Operating Expenses | 411.1 | 394.4 | 4 | % | 414.4 | 400.6 | 3 | % | 825.6 | 795.0 | 4 | % | |||||||||||||||||||||
Income before taxes | 127.4 | 133.6 | (5 | )% | |||||||||||||||||||||||||||||
Income from operations before taxes | 158.6 | 133.8 | 19 | % | 286.0 | 267.4 | 7 | % | |||||||||||||||||||||||||
Federal income taxes | 28.8 | 31.4 | (8 | )% | 39.2 | 32.0 | 23 | % | 67.9 | 63.4 | 7 | % | |||||||||||||||||||||
Income from Operations | $ | 98.6 | $ | 102.2 | (4 | )% | $ | 119.4 | $ | 101.8 | 17 | % | $ | 218.1 | $ | 204.0 | 7 | % | |||||||||||||||
March 31, (in billions) | 2005 | 2004 | Increase (Decrease) Over Prior Period | ||||||||||||||||||||||||||||||
Account Values | |||||||||||||||||||||||||||||||||
Variable Annuities—including fixed portion of variable | $ | 43.7 | $ | 37.6 | 16 | % | |||||||||||||||||||||||||||
Fixed Annuities | 21.4 | 21.3 | 1 | % | |||||||||||||||||||||||||||||
Reinsurance Ceded | (2.3 | ) | (2.4 | ) | (4 | )% | |||||||||||||||||||||||||||
Total Fixed Annuities | 19.1 | 18.9 | 1 | % | |||||||||||||||||||||||||||||
Total Account Values | $ | 62.8 | $ | 56.5 | 11 | % | |||||||||||||||||||||||||||
Average Daily Variable Account Values | $ | 43.4 | $ | 37.2 | 17 | % | |||||||||||||||||||||||||||
Fixed Portion of Variable | 9.7 | 9.6 | 1 | % |
June 30, (in billions) | 2005 | 2004 | Increase Over Prior Period | ||||||||
Account Values | |||||||||||
Variable Annuities | $ | 42.3 | $ | 36.1 | 17 | % | |||||
Fixed Annuities | 21.5 | 21.4 | — | % | |||||||
Reinsurance Ceded | (2.3 | ) | (2.3 | ) | — | % | |||||
Total Fixed Annuities | 19.2 | 19.1 | — | % | |||||||
Total Annuity Account Values | 61.5 | 55.2 | 11 | % | |||||||
Alliance Mutual Funds | 3.4 | 2.3 | 48 | % | |||||||
Total Annuities and Alliance Account Values | $ | 64.9 | $ | 57.5 | 13 | % | |||||
Fixed Portion of Variable | 9.7 | 9.7 | — | % |
Three Months | Six Months | |||||||||||||||||
June 30, (in billions) | 2005 | 2004 | Increase (Decrease) over Prior Period | 2005 | 2004 | Increase Over Prior Period | ||||||||||||
Average Daily Variable Account Values | $ | 41.0 | $ | 35.4 | 16 | % | $ | 40.7 | $ | 35.2 | 16 | % | ||||||
Average Daily Alliance Mutual Fund Account Values | $ | 3.3 | $ | 3.2 | 50 | % | $ | 3.2 | $ | 2.2 | 45 | % |
28
Income from Operations Variances—Increase (Decrease)
in the Period From Prior Year Period
Three Months Ended March 31, (in millions, after-tax, after DAC) | 2005 to 2004 | |||
Decrease in Income from Operations | $ | (3.6 | ) | |
Significant Changes in Segment Income from Operations: | ||||
Effects of Equity Markets – Fee income | 1.2 | |||
Increase in fee income from variable annuity net flows (net of DAC) | 5.7 | |||
Investment margins (including earnings on investment partnerships) (net of DAC) | (9.6 | ) |
Period Ended June 30, 2005 | ||||||||
(in millions, after-tax, after DAC) | Three Months | Six Months | ||||||
Increase in Income from Operations | $ | 17.6 | $ | 14.1 | ||||
Significant Changes in Segment Income from Operations: | ||||||||
Effects of Equity Markets – Fee income | 3.1 | 5.8 | ||||||
Increase in fee income from variable annuity and Alliance Mutual fund net flows (net of DAC) | 6.8 | 12.8 | ||||||
Investment margins (including earnings on investment partnerships) (net of DAC) | (3.9 | ) | (6.3 | ) | ||||
Standby real estate equity commitments | 12.5 | 12.5 | ||||||
Contingent interest (net of DAC) | — | (6.5 | ) | |||||
Deferred sales inducements | (2.2 | ) | (3.3 | ) |
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Net Flows
Three Months Ended March 31, (in billions) | 2005 | 2004 | Improvement (Decline) Over Prior Period | ||||||||||||||||||||||||||||||
Three Months | Six Months | ||||||||||||||||||||||||||||||||
Periods ended June 30, (in billions) | 2005 | 2004 | Improvement (Decline) Over Prior Period | 2005 | 2004 | Improvement (Decline) Over Prior Period | |||||||||||||||||||||||||||
Variable Portion of Annuity Deposits | $ | 1.899 | $ | 1.407 | 35 | % | $ | 1.513 | $ | 1.237 | 22 | % | $ | 2.991 | $ | 2.393 | 25 | % | |||||||||||||||
Variable Portion of Annuity Withdrawals | (1.085 | ) | (0.942 | ) | (15 | )% | (1.018 | ) | (0.973 | ) | (5 | )% | (2.030 | ) | (1.903 | ) | (7 | )% | |||||||||||||||
Variable Portion of Annuity Net Flows | 0.814 | 0.465 | 75 | % | 0.495 | 0.264 | 88 | % | 0.961 | 0.490 | 96 | % | |||||||||||||||||||||
Fixed Portion of Variable Annuity Deposits | 0.542 | 0.452 | 20 | % | 0.613 | 0.530 | 16 | % | 1.155 | 0.982 | 18 | % | |||||||||||||||||||||
Fixed Portion of Variable Annuity Withdrawals | (0.324 | ) | (0.301 | ) | (8 | )% | (0.328 | ) | (0.253 | ) | (30 | )% | (0.653 | ) | (0.555 | ) | (18 | )% | |||||||||||||||
Fixed Portion of Variable Annuity Net Flows | 0.218 | 0.151 | 44 | % | 0.285 | 0.277 | 3 | % | 0.502 | 0.427 | 18 | % | |||||||||||||||||||||
Total Variable Annuity Deposits | 2.441 | 1.859 | 31 | % | 2.126 | 1.767 | 20 | % | 4.146 | 3.375 | 23 | % | |||||||||||||||||||||
Total Variable Annuity Withdrawals | (1.409 | ) | (1.243 | ) | (13 | )% | (1.346 | ) | (1.226 | ) | (10 | )% | (2.683 | ) | (2.458 | ) | (9 | )% | |||||||||||||||
Total Variable Annuity Net Flows | 1.032 | 0.616 | 68 | % | 0.780 | 0.541 | 44 | % | 1.463 | 0.917 | 60 | % | |||||||||||||||||||||
Fixed Annuity Deposits | 0.198 | 0.364 | (46 | )% | 0.181 | 0.249 | (27 | )% | 0.378 | 0.613 | (38 | )% | |||||||||||||||||||||
Fixed Annuity Withdrawals | (0.454 | ) | (0.268 | ) | (69 | )% | (0.304 | ) | (0.262 | ) | (16 | )% | (0.757 | ) | (0.530 | ) | (43 | )% | |||||||||||||||
Fixed Annuity Net Flows | (0.256 | ) | 0.096 | (367 | )% | (0.123 | ) | (0.013 | ) | NM | (0.379 | ) | 0.083 | NM | |||||||||||||||||||
Total Annuity Deposits | 2.639 | 2.223 | 19 | % | 2.307 | 2.016 | 14 | % | 4.524 | 3.988 | 13 | % | |||||||||||||||||||||
Total Annuity Withdrawals | (1.863 | ) | (1.511 | ) | (23 | )% | (1.650 | ) | (1.488 | ) | (11 | )% | (3.440 | ) | (2.988 | ) | (15 | )% | |||||||||||||||
Total Annuity Net Flows | $ | 0.776 | $ | 0.712 | 9 | % | 0.657 | 0.528 | 24 | % | 1.084 | 1.000 | 8 | % | |||||||||||||||||||
Incremental Deposits (1) | $ | 2.582 | $ | 2.165 | 19 | % | |||||||||||||||||||||||||||
Total Alliance Mutual Fund Deposits | 0.222 | 0.187 | 19 | % | 0.643 | 0.438 | 47 | % | |||||||||||||||||||||||||
Total Alliance Mutual Fund Withdrawals | (0.022 | ) | (0.015 | ) | (47 | )% | (0.095 | ) | (0.026 | ) | NM | ||||||||||||||||||||||
Total Alliance Mutual Fund Net Flows | 0.200 | 0.172 | 16 | % | 0.548 | 0.412 | 33 | % | |||||||||||||||||||||||||
Total Annuity and Alliance Deposits | 2.529 | 2.203 | 15 | % | 5.167 | 4.426 | 17 | % | |||||||||||||||||||||||||
Total Annuity and Alliance Withdrawals | (1.672 | ) | (1.503 | ) | (11 | )% | (3.535 | ) | (3.014 | ) | (17 | )% | |||||||||||||||||||||
Total Annuity and Alliance Net Flows | $ | 0.857 | $ | 0.700 | 22 | % | $ | 1.632 | $ | 1.412 | 16 | % | |||||||||||||||||||||
Annuities Incremental Deposits | $ | 2.256 | $ | 1.961 | 15 | % | $ | 4.417 | $ | 3.875 | 14 | % | |||||||||||||||||||||
Alliance Mutual Fund Incremental Deposits | 0.222 | 0.187 | 19 | % | 0.643 | 0.438 | 47 | % | |||||||||||||||||||||||||
Total Annuities and Alliance Incremental Deposits (1) | $ | 2.478 | $ | 2.148 | 15 | % | $ | 5.060 | $ | 4.313 | 17 | % | |||||||||||||||||||||
(1) | Incremental Deposits represent gross deposits reduced by transfers from other Lincoln |
29
New Deposits
Three Months Ended March 31, (in billions) | 2005 | 2004 | Improvement (Decline) Over Prior Period | ||||||||||||||||||||||||
Three Months | Six Months | ||||||||||||||||||||||||||
Periods Ended June 30, (in billions) | 2005 | 2004 | Improvement (Decline) Over Prior Period | 2005 | 2004 | Improvement (Decline) Over Prior Period | |||||||||||||||||||||
Individual Annuities | |||||||||||||||||||||||||||
Variable | $ | 1.730 | $ | 1.319 | 31 | % | $ | 1.837 | $ | 1.482 | 24 | % | $ | 3.567 | $ | 2.800 | 27 | % | |||||||||
Fixed | 0.053 | 0.192 | (72 | )% | 0.041 | 0.122 | (66 | )% | 0.093 | 0.316 | (71 | )% | |||||||||||||||
Total Individual Annuities | 1.783 | 1.511 | 18 | % | 1.878 | 1.604 | 17 | % | 3.660 | 3.116 | 17 | % | |||||||||||||||
Employer-Sponsored Annuities | |||||||||||||||||||||||||||
Employer-Sponsored Products | |||||||||||||||||||||||||||
Variable | 0.711 | 0.540 | 32 | % | 0.289 | 0.285 | 1 | % | 0.579 | 0.575 | 1 | % | |||||||||||||||
Fixed | 0.145 | 0.172 | (16 | )% | 0.026 | 0.031 | (16 | )% | 0.046 | 0.062 | (26 | )% | |||||||||||||||
Total Employer-Sponsored Annuities – excluding Alliance | 0.315 | 0.316 | — | % | 0.625 | 0.637 | (2 | )% | |||||||||||||||||||
Fixed – Alliance | 0.114 | 0.096 | 19 | % | 0.239 | 0.235 | 2 | % | |||||||||||||||||||
Total Employer-Sponsored Annuities | 0.856 | 0.712 | 20 | % | 0.429 | 0.412 | 4 | % | 0.864 | 0.872 | (1 | )% | |||||||||||||||
Total Annuity Deposits | |||||||||||||||||||||||||||
Alliance Mutual Funds | 0.222 | 0.187 | 19 | % | 0.643 | 0.438 | 47 | % | |||||||||||||||||||
Total Employer-Sponsored Products | 0.651 | 0.599 | 9 | % | 1.507 | 1.310 | 15 | % | |||||||||||||||||||
Total Annuity and Alliance Deposits | |||||||||||||||||||||||||||
Variable | 2.441 | 1.859 | 31 | % | 2.348 | 1.954 | 20 | % | 4.789 | 3.813 | 26 | % | |||||||||||||||
Fixed | 0.198 | 0.364 | (46 | )% | 0.181 | 0.249 | (27 | )% | 0.378 | 0.613 | (38 | )% | |||||||||||||||
Total Annuities | $ | 2.639 | $ | 2.223 | 19 | % | |||||||||||||||||||||
Total Annuities and Alliance | $ | 2.529 | $ | 2.203 | 15 | % | $ | 5.167 | $ | 4.426 | 17 | % | |||||||||||||||
Total Alliance Program Deposits | $ | 0.336 | $ | 0.283 | 19 | % | $ | 0.882 | $ | 0.673 | 31 | % | |||||||||||||||
Average Fixed Annuity Account Values | $ | 20.5 | $ | 20.3 | $ | 20.5 | $ | 20.3 | |||||||||||||||||||
31
Interest Rate Margins
Three Months Ended March 31, | 2005 | 2004 | Change in Rate Over Prior Period (basis points) | ||||||||||||||||||||||||||||||
Three Months | Six Months | ||||||||||||||||||||||||||||||||
Periods Ended June 30, | 2005 | 2004 | Change in Rate (basis points) | 2005 | 2004 | Change in Rate (basis points) | |||||||||||||||||||||||||||
Net investment income yield | 6.05 | % | 6.43 | % | (38 | ) | 6.06 | % | 6.34 | % | (28 | ) | 6.05 | % | 6.38 | % | (33 | ) | |||||||||||||||
Interest rate credited to policyholders | 3.82 | % | 3.97 | % | (15 | ) | 3.81 | % | 3.93 | % | (12 | ) | 3.82 | % | 3.95 | % | (14 | ) | |||||||||||||||
Interest rate margin | 2.23 | % | 2.46 | % | (23 | ) | 2.25 | % | 2.41 | % | (16 | ) | 2.23 | % | 2.43 | % | (19 | ) | |||||||||||||||
Effect on yield and interest rate margin | |||||||||||||||||||||||||||||||||
Commercial mortgage loan prepayment and bond makewhole premiums | 0.08 | % | 0.07 | % | 0.09 | % | 0.38 | % | 0.09 | % | 0.22 | % | |||||||||||||||||||||
Contingent interest | — | % | 0.27 | % | — | % | — | % | — | % | 0.13 | % | |||||||||||||||||||||
Interest rate margin adjusted for above items | 2.15 | % | 2.12 | % | 2.16 | % | 2.03 | % | 2.14 | % | 2.08 | % | |||||||||||||||||||||
Average Fixed Annuity Account Values (in billions) | $ | 20.5 | $ | 20.2 | |||||||||||||||||||||||||||||
Effect on income from operations (after-tax, after DAC) (in millions) | |||||||||||||||||||||||||||||||||
Commercial mortgage loan prepayment and bond makewhole premiums | $ | 1.9 | $ | 1.6 | $ | 1.6 | $ | 8.7 | $ | 3.5 | $ | 10.2 | |||||||||||||||||||||
Contingent interest | — | 6.5 | — | — | — | 6.5 | |||||||||||||||||||||||||||
Effect on income from operations | $ | 1.9 | $ | 8.1 | $ | 1.6 | $ | 8.7 | $ | 3.5 | $ | 16.7 | |||||||||||||||||||||
Comparison of Three and Six Months Ended March 31,June 30, 2005 to 2004
Revenues
Insurance fees increased in the second quarter and first quartersix months of 2005 compared to the first quarter ofsame periods in 2004 as a result of increases in average daily variable annuity account values. The increase in account values reflects cumulative positive net flows and improvement in the equity markets between periods. The average S&P 500 Index was 5% higher for the second quarter and first six months of 2005, compared to the same periods in 2004. Variable product sales were up 31% in20% for the second quarter and 23% for the first threesix months of 2005 over the same 2004 periodperiods while fixed product sales were down from the same periodperiods in the previous year. Through the first quarter of 2005, the Retirement segment has experienced 15 consecutive quarters of positive net flows.
30
New deposits are an important component of our effort to grow the annuity business. In the past several years, we have concentrated our efforts on both product and distribution breadth. Annuity deposits increased significantly infor the second quarter and first quartersix months of 2005 compared to the same 2004 period,periods, with growth in both the individual variable annuity business and variable products within the employer-sponsored business.
The growth in individual variable annuity deposits was a result of continued strong sales of the Lincoln Smart Securitysm Advantage benefit introduced in June of 2003, and expansion of the wholesaling force in LFD. Lincoln ChoicePlussm and American Legacy variable annuity gross deposits were up 33%29% for the first quartersix months of 2005 to $1.7$3.5 billion, compared to $1.3$2.7 billion for the first quartersix months of 2004.
Individual fixed annuity deposits experienced a decline infor the second quarter and first quartersix months of 2005 compared to the same 2004 period. The declineperiods in fixed annuity deposits is2004, primarily due to the continued low interest rate environment. We approached the fixed annuity marketplace on an opportunistic basis throughout 2004 and into 2005, generally offering rates that are consistent with our required spreads. In the current interest rate environment, we expect this trend of lower fixed annuity deposits to continue.
Significant deposit growth in the employer-sponsored business has come through our Alliance program. The Alliance program bundles our traditional annuity products with mutual funds, along with recordkeeping and employee education components. We earn fees for the services we provide to mutual fund accounts and investment margins on fixed annuities of Alliance program accounts. Alliance program deposits were $545.8$336 million ($420.8and $882 million in mutual funds; $125.0 million in(including Alliance program fixed annuities)annuity deposits) in the second quarter and first quartersix months of 2005, an increaseincreases of 40%19% and 31% from deposits of $389.5 million ($250.7 million in mutual funds; $138.8 million in fixed annuities) in the first quarter of 2004. Net flows and account values forsame 2004 periods. These amounts associated with the Alliance program attributable to mutual funds in the tables above were $347.3 million and $3.2 billion, respectively, for the first quarter of 2005, and $239.7 million and $2.2 billion, respectively, for the first quarter of 2004. These amountsfund program are not included in the separate accounts reported in our Consolidated Balance Sheets. Our traditional annuity products in the employer-sponsored business show a modest decrease of 3%2% over the same period infirst six months of the previous year.
The other component of net flows is retention of the business. One of the key assumptions in pricing a product is the account persistency, often referred to as the lapse rate. The lapse rate compares the amount of withdrawals to the retained account values. One way to measure a company’s success in retaining assets is to look at the overall level of withdrawals from period to period. However, this alone does not tell the whole story. By comparing actual lapse rates to the rates assumed
32
in designing the annuity product, it is possible to gauge the impact of persistency on profitability. Overall lapse rates were 8.9% and 9.5% for the first quarters ofthree and six months ended June 30, 2005, compared to 8.5% and 2004 were 10.1% and 9.2%, respectively. In both8.9% for the same periods overallin 2004. Overall lapse rates have been more favorable than the level of persistency assumed in product pricing. The increase in the first quartersix months of 2005 is due to three large employer-sponsored case withdrawals aggregating $121 million.million in the first quarter of 2005. In addition, as described above, we experienced an increase in the second quarter and first quartersix months of 2005 in deposits within the employer-sponsored business’ Alliance program, offered withincompared to the employer-sponsored marketplace.same periods last year. The persistency of the employer-sponsored business tends to be higher than in the individual annuity marketplace as employer-sponsored products involve systematic deposits and are part of an overall employee benefit plan which are generally not subject to the level of exchange activity typically experienced in the individual marketplace.
Insurance premiumsNet investment income increased $4.0$4.5 million or 61.5% inand decreased $17.2 million for the second quarter and first quartersix months of 2005, compared to the first quarter of 2004. The increase is primarily driven by increases in annuities in the payout phase. There was a corresponding increase in the insurance benefit line from the resulting increase in reserves.
same periods last year. Net investment income decreased $21.6 million, or 5.7% for the first three monthssecond quarter of 2005 compared with the same 2004 period.includes $19.3 million of fees for standby real estate equity commitments and $13.4 million higher income for partnerships. Although fixed annuity account values increased during the first three months of 2005 from net flows and investment income, lower investment portfolio rates in the first quarter of 2005 and $13.0 million pre-tax of contingent interest income received in the first quartersix months of 2004 were the drivers ofcontributed to the decrease in investment income for the 2005 six month period. Net investment income for the segment included $4.1 million pre-tax,and $8.3 million from commercial mortgage loan prepayment and bond makewhole premiums, for the second quarter and first quartersix months of 2005, respectively, compared to $3.6$19.5 million and $23.1 million of prepayment premiums for the same 2004 period.periods in 2004.
When analyzing the impact of net investment income, on the results of the segment, it is important to understand that a portion of the investment income earned is credited to the policyholders of our fixed annuity products. The interest credited to policyholders is included in the segment’s expenses. Annuity product interest rate margins represent the excess of the yield on earning assets over the average crediting rate. The yield on earning assets is calculated as net investment income on fixed product investment portfolios divided by average earning assets. The average crediting rate is calculated using interest credited on annuity products less bonus credits and excess interest on policies with the dollar cost averaging feature, divided by the average fixed account values net of coinsured account values. Fixed account values reinsured under modified coinsurance agreements are included in account values for this calculation. As a result of crediting rate actions we took in 2003 through the firstsecond quarter of 2005, interest credited to policyholder balances decreased for the first three and six months ofended June 30, 2005, compared to the same 2004 period.periods.
The interest rate margin table above summarizes the effect of changes in the portfolio yield, credited rate to policyholders, as well as the impact of contingent interest and prepayment premiums on the segment’s results on an after-DAC, after-tax basis. Although the net investment income yield declined year over year, we were able to reduce crediting rates to substantially offset this decrease. The interest rate margin decreased to 2.25% for the second quarter and 2.23% for the first quartersix months of 2005 from 2.46%2.41% and 2.43%, respectively, for the first quarter of 2004.same periods last year. After removing the effects of the contingent interest received in the first quarter of 2004 and prepayment premiums, in the first quarter of 2005 and 2004, the interest rate margin improved modestly to 2.15%2.16% for the second quarter and 2.14% for the first quartersix months of 2005, compared to 2.12%2.03% and 2.08% for the first quarter of 2004.same periods last year. We expect a reduction of 4 to 5 basis points (pre-DAC and pre-tax) per quarter in interest rate margins in 2005. This decrease2005, which is expected to reduce the segment’s income by approximately $0.5 million, after-tax after DAC, in the remaining quarters of 2005. This assumes a 50 basis point annual improvement in new money investment rates that there are no significant changes in net flows in or out of our fixed accounts or other changes which may cause interest rate margins to differ from our expectation. For information on interest rate margins and the interest rate risk due to falling interest rates, see “Item 3.3 - Quantitative and Qualitative Disclosures About Market Risk” of this Form 10-Q.
31
Expenses
Insurance benefits include interest credited to policyholders of $204.7$206.4 million and $207.8$411.1 million in the second quarter and first quartersix months of 2005, compared to $208.0 million and 2004, respectively.$415.8 million for the same periods in 2004. The reductionreductions in 2005 waswere a result of actions taken by the segment to lower crediting rates commensurate with the reduction in the overall investment yield. Refer to the table above for the interest rate credited to policyholders.
Equity market performance, as measured by the S&P 500 index, without dividends, was a decline of 2.6%Also included in the first quarter of 2005, compared to an increase of 1.3% for first quarter of 2004, which are both below our long-term equity market growth assumption of 9%. As a result of the enhanced reversion to the mean methodology implemented during the fourth quarter of 2004 and discussed in “Critical Accounting Policies” above, the first quarter 2005 equity market performance did not result in DAC unlocking during the quarter.
Included in the segment’s insurance benefits are the costs associated with guaranteed benefits included within variable annuities with the GMDB or GMWB riders. The effect of modest increases in net reserve and benefit payments during the second quarter and first quartersix months of 2005 attributable to these productsguaranteed benefits was more thanpartially offset by the favorable results of the expanded hedge program implemented during the third quarter of 2004.2004 such that the period over period variances on an after-DAC and after-tax basis were not significant.
33
At March 31,June 30, 2005, Lincoln Retirement’s net amount at risk (“NAR”) was $0.9 billion and the$0.8 billion. The GAAP and statutory reserves related to contracts with a GMDB feature were $24.7$24.4 million and $51.6$50.1 million, respectively. The comparable amounts at January 1, 2005,December 31, 2004 were a NAR of $0.8 billion, GAAP reserves of $18.2 million and statutory reserves of $46.4 million. At any point in time, the NAR is the difference between the potential death benefit payable and the total account value, with a floor of zero (when account values exceed the potential death benefit there is no amount at risk). Accordingly, the NAR represents the maximum amount Lincoln Retirement would have to pay if all policyholders died. In evaluating the GMDB exposures that exist within our variable annuity business relative to industry peers, it is important to distinguish between the various types of GMDB features, and other factors such as average account values, average amounts of NAR, and the age of contractholders. The following table and discussion provides this information for our variable annuity business as of March 31,June 30, 2005:
Type of GMDB Feature | Type of GMDB Feature | |||||||||||||||||||||||||||||||||||||||
Return of Premium | High Water Mark | Roll-up | No GMDB | Total | Return of Premium | High Water Mark | Roll-up | No GMDB | Total | |||||||||||||||||||||||||||||||
Variable Annuity Account Value (billions) | $ | 28.3 | $ | 15.8 | $ | 0.3 | $ | 8.9 | $ | 53.3 | $ | 29.2 | $ | 16.7 | $ | 0.3 | $ | 5.9 | $ | 52.1 | ||||||||||||||||||||
% of Total Annuity Account Value | 53.1 | % | 29.6 | % | 0.6 | % | 16.7 | % | 100.0 | % | 56.0 | % | 32.0 | % | 0.6 | % | 11.4 | % | 100.0 | % | ||||||||||||||||||||
Average Account Value (thousands) | $ | 40.5 | $ | 82.7 | $ | 112.6 | $ | 56.4 | $ | 53.8 | $ | 41.9 | $ | 85.4 | $ | 114.6 | $ | 58.6 | $ | 52.5 | ||||||||||||||||||||
Average NAR (thousands) | $ | 2.7 | $ | 7.8 | $ | 11.3 | N/A | $ | 5.3 | $ | 2.9 | $ | 9.1 | $ | 13.2 | N/A | $ | 5.9 | ||||||||||||||||||||||
NAR (billions) | $ | 0.2 | $ | 0.7 | $ | — | N/A | $ | 0.9 | $ | 0.2 | $ | 0.6 | $ | — | N/A | $ | 0.8 | ||||||||||||||||||||||
Average Age of Contract Holder | 52 | 62 | 65 | 60 | 55 | 53 | 63 | 65 | 61 | 56 | ||||||||||||||||||||||||||||||
% of Contract Holders > 70 Years of Age | 11.4 | % | 28.5 | % | 34.9 | % | 25.3 | % | 16.7 | % | 11.8 | % | 28.7 | % | 36.0 | % | 26.3 | % | 17.2 | % |
We have variable annuity contracts containing GMDBs that have a dollar for dollar withdrawal feature. Under such a feature, withdrawals reduce both current account value and the GMDB amount on a dollar for dollar basis. For contracts containing this dollar for dollar feature, the account holder could withdraw a substantial portion of their account value resulting in a GMDB that is multiples of the current account value. Our exposure to this dollar for dollar risk is somewhat mitigated by the fact that we do not allow for partial 1035 exchanges on non-qualified contracts. To take advantage of the dollar for dollar feature, the contractholder must take constructive receipt of the withdrawal and pay any applicable surrender charges. We report the appropriate amount of the withdrawal that is taxable to the Internal Revenue Service, as well as indicating whether or not tax penalties apply under the premature distribution tax rules. We closely monitor the dollar for dollar withdrawal GMDB exposure and work with key broker dealers that distribute our variable annuity products. The GMDB feature offered on new sales is a pro-rata GMDB feature whereby each dollar of withdrawal reduces the GMDB benefit in proportion to the current GMDB to account value ratio. As of March 31,June 30, 2005, there were 728770 contracts for which the death benefit to account value ratio was greater than ten to one. The NAR on these contracts was $49.3$51.5 million.
32
Life Insurance
Operating Summary for the Three Months Ended March 31, (in millions) | 2005 | 2004 | Increase Prior Period | ||||||||||||||||||||||||
Three Months | Six Months | ||||||||||||||||||||||||||
Operating Summary for the Periods Ended June 30, (in millions) | 2005 | 2004 | Increase Prior Period | 2005 | 2004 | Increase Prior Period | |||||||||||||||||||||
Operating Revenues: | |||||||||||||||||||||||||||
Insurance premiums | $ | 45.6 | $ | 47.9 | (5 | )% | $ | 47.9 | $ | 48.3 | (1 | )% | $ | 93.5 | $ | 96.1 | (3 | )% | |||||||||
Insurance fees | 194.1 | 192.1 | 1 | % | 192.0 | 193.4 | (1 | )% | 386.2 | 385.5 | 0 | % | |||||||||||||||
Net investment income | 236.3 | 235.7 | — | % | 249.2 | 234.8 | 6 | % | 485.4 | 470.5 | 3 | % | |||||||||||||||
Other revenues and fees | 8.2 | 7.7 | 6 | % | 8.2 | 8.3 | (1 | )% | 16.4 | 16.0 | 3 | % | |||||||||||||||
Total Operating Revenues | 484.2 | 483.4 | — | % | 497.3 | 484.8 | 3 | % | 981.5 | 968.1 | 1 | % | |||||||||||||||
Operating Expenses: | |||||||||||||||||||||||||||
Insurance benefits | 261.6 | 260.7 | — | % | 268.6 | 267.0 | 1 | % | 530.2 | 527.7 | 0 | % | |||||||||||||||
Underwriting, acquisition, insurance and other expenses | 122.9 | 112.4 | 9 | % | 116.7 | 105.4 | 7 | % | 239.6 | 217.7 | 10 | % | |||||||||||||||
Total Operating Expenses | 384.5 | 373.1 | 3 | % | 385.3 | 372.4 | 3 | % | 769.8 | 745.4 | 3 | % | |||||||||||||||
Income before taxes | 99.7 | 110.3 | (10 | )% | |||||||||||||||||||||||
Income from operations before taxes | 112.0 | 112.4 | 0 | % | 211.7 | 222.7 | (5 | )% | |||||||||||||||||||
Federal income taxes | 32.0 | 35.5 | (10 | )% | 36.2 | 36.2 | 0 | % | 68.1 | 71.8 | (5 | )% | |||||||||||||||
Income from Operations | $ | 67.7 | $ | 74.8 | (9 | )% | $ | 75.8 | $ | 76.2 | (1 | )% | $ | 143.6 | $ | 150.9 | (5 | )% | |||||||||
34
Income from Operations Variances—Increase (Decrease)
in the Period From Prior Year Period
Three Months Ended March 31, (in millions, after-tax) | 2005 to 2004 | |||
Decrease in Income from Operations | $ | (7.1 | ) | |
Significant Changes in Segment Income from Operations: | ||||
DAC/PVIF/DFEL | ||||
Effects of equity markets | (0.4 | ) | ||
Retrospective unlocking | (1.9 | ) | ||
Amortization | (2.2 | ) | ||
Mortality | (1.8 | ) | ||
Investment margins (including earnings on investment partnerships) | (0.8 | ) |
Three Months Ended March 31, | 2005 | 2004 | Increase (Decrease) Over Prior Period | ||||||||
First Year Premiums—by Product (in millions) | |||||||||||
Universal Life (“UL”) | |||||||||||
Excluding MoneyGuardsm | $ | 87.1 | $ | 95.6 | (9 | )% | |||||
MoneyGuardsm | 49.3 | 56.3 | (12 | )% | |||||||
Total Universal Life | 136.4 | 151.9 | (10 | )% | |||||||
Variable Universal Life (“VUL”) | 25.9 | 22.5 | 15 | % | |||||||
Whole Life | 7.8 | 10.8 | (28 | )% | |||||||
Term | 9.2 | 10.5 | (12 | )% | |||||||
Total Retail | 179.3 | 195.7 | (8 | )% | |||||||
Corporate Owned Life Insurance (“COLI”) | 24.8 | 14.2 | 75 | % | |||||||
Total First Year Premiums | $ | 204.1 | $ | 209.9 | (3 | )% | |||||
Net Flows (in billions) | |||||||||||
Deposits | $ | 0.512 | $ | 0.502 | 2 | % | |||||
Withdrawals & Deaths | (0.252 | ) | (0.254 | ) | 1 | % | |||||
Net Flows | $ | 0.260 | $ | 0.248 | 5 | % | |||||
Policyholder Assessments | $ | (0.287 | ) | $ | (0.267 | ) | (7 | )% | |||
March 31, (in billions) | 2005 | 2004 | Increase (Decrease) | ||||||||
Account Values | |||||||||||
Universal Life | $ | 9.8 | $ | 9.2 | 7 | % | |||||
Variable Universal Life | 2.5 | 2.2 | 14 | % | |||||||
Interest-Sensitive Whole Life (“ISWL”) | 2.2 | 2.2 | — | % | |||||||
Total Life Insurance Account Values | $ | 14.5 | $ | 13.6 | 7 | % | |||||
In Force—Face Amount | |||||||||||
Universal Life and Other* | $ | 132.4 | $ | 129.7 | 2 | % | |||||
Term Insurance | 176.6 | 157.3 | 12 | % | |||||||
Total In-Force | $ | 309.0 | $ | 287.0 | 8 | % | |||||
Net Amount at Risk | |||||||||||
Universal Life and Other | $ | 115.6 | $ | 113.7 | 2 | % | |||||
Term Insurance | 175.7 | 156.6 | 12 | % | |||||||
Total Net Amount at Risk | $ | 291.3 | $ | 270.3 | 8 | % | |||||
Periods Ended June 30, 2005 | ||||||||
(in millions, after-tax) | Three Months | Six Months | ||||||
Decrease in Income from Operations | $ | (0.4 | ) | $ | (7.3 | ) | ||
Significant Changes in Segment Income from Operations: | ||||||||
DAC/PVIF/DFEL | ||||||||
Retrospective unlocking | (1.0 | ) | (3.3 | ) | ||||
Amortization | (3.1 | ) | (5.3 | ) | ||||
Mortality (net of DAC) | (0.2 | ) | (1.2 | ) | ||||
Investment margins (including earnings on investment partnerships) | 2.8 | 5.7 | ||||||
Standby real estate equity commitments | 3.7 | 3.7 | ||||||
Contingent interest | — | (3.7 | ) | |||||
Operating and administrative expenses | (2.6 | ) | (3.0 | ) |
33
Three Months | Six Months | |||||||||||||||||||||
Periods Ended June 30, | 2005 | 2004 | Increase (Decrease) Over Prior Period | 2005 | 2004 | Increase (Decrease) Over Prior Period | ||||||||||||||||
First Year Premiums—by Product (in millions) | ||||||||||||||||||||||
Universal Life (“UL”) | ||||||||||||||||||||||
Excluding MoneyGuardsm | $ | 104.1 | $ | 100.7 | 3 | % | $ | 191.2 | $ | 196.4 | (3 | )% | ||||||||||
MoneyGuardsm | 53.4 | 61.1 | (13 | )% | 102.7 | 117.2 | (12 | )% | ||||||||||||||
Total Universal Life | 157.5 | 161.8 | (3 | )% | 293.9 | 313.6 | (6 | )% | ||||||||||||||
Variable Universal Life (“VUL”) | 23.8 | 17.7 | 34 | % | 49.7 | 40.2 | 24 | % | ||||||||||||||
Whole Life | 8.3 | 7.6 | 9 | % | 16.1 | 18.4 | (13 | )% | ||||||||||||||
Term | 8.6 | 10.7 | (20 | )% | 17.8 | 21.1 | (16 | )% | ||||||||||||||
Total Retail | 198.2 | 197.8 | — | % | 377.5 | 393.3 | (4 | )% | ||||||||||||||
Corporate Owned Life Insurance (“COLI”) | 10.2 | 9.8 | 4 | % | 35.0 | 24.1 | 45 | % | ||||||||||||||
Total First Year Premiums | $ | 208.4 | $ | 207.6 | — | % | $ | 412.5 | $ | 417.4 | (1 | )% | ||||||||||
Net Flows (in billions) | ||||||||||||||||||||||
Deposits | $ | 0.527 | $ | 0.507 | 4 | % | $ | 1.039 | $ | 1.009 | 3 | % | ||||||||||
Withdrawals & Deaths | (0.218 | ) | (0.216 | ) | 1 | % | (0.470 | ) | (0.470 | ) | — | % | ||||||||||
Net Flows | $ | 0.309 | $ | 0.291 | 6 | % | $ | 0.569 | $ | 0.539 | 6 | % | ||||||||||
Policyholder Assessments | $ | (0.290 | ) | $ | (0.271 | ) | 7 | % | $ | (0.577 | ) | $ | (0.537 | ) | 7 | % | ||||||
June 30, (in billions) | 2005 | 2004 | Increase (Decrease) | ||||||
Account Values | |||||||||
Universal Life | $ | 9.9 | $ | 9.3 | 6 | % | |||
Variable Universal Life | 2.6 | 2.3 | 13 | % | |||||
Interest-Sensitive Whole Life (“ISWL”) | 2.2 | 2.2 | — | % | |||||
Total Life Insurance Account Values | $ | 14.7 | $ | 13.8 | 7 | % | |||
In Force—Face Amount | |||||||||
Universal Life and Other* | $ | 133.3 | $ | 130.3 | 2 | % | |||
Term Insurance | 180.7 | 162.9 | 11 | % | |||||
Total In-Force | $ | 314.0 | $ | 293.2 | 7 | % | |||
Net Amount at Risk | |||||||||
Universal Life and Other | $ | 116.3 | $ | 114.2 | 2 | % | |||
Term Insurance | 179.8 | 162.2 | 11 | % | |||||
Total Net Amount at Risk | $ | 296.1 | $ | 276.4 | 7 | % | |||
* | Includes COLI of |
3534
Interest Rate Margins
Three Months Ended March 31, | 2005 | 2004 | Change in Rate Over Prior Period Increase (Decrease) | ||||||||||||||||||||||||||||||
Three Months | Six Months | ||||||||||||||||||||||||||||||||
Periods Ended June 30, | 2005 | 2004 | Change in Rate Over Prior Period Increase (Decrease) | 2005 | 2004 | Change in Rate Over Prior Period Increase (Decrease) | |||||||||||||||||||||||||||
Basis points | Basis points | Basis points | |||||||||||||||||||||||||||||||
Interest Sensitive Products | |||||||||||||||||||||||||||||||||
Net investment income yield | 6.32 | % | 6.84 | % | (52 | ) | 6.35 | % | 6.70 | % | (35 | ) | 6.34 | % | 6.78 | % | (44 | ) | |||||||||||||||
Interest rate credited to policyholders | 4.75 | % | 4.97 | % | (22 | ) | 4.64 | % | 4.89 | % | (25 | ) | 4.70 | % | 4.93 | % | (23 | ) | |||||||||||||||
Interest rate margin | 1.57 | % | 1.87 | % | (30 | ) | 1.71 | % | 1.81 | % | (10 | ) | 1.64 | % | 1.85 | % | (21 | ) | |||||||||||||||
Effect on Yield and Interest Rate Margin | |||||||||||||||||||||||||||||||||
Commercial mortgage loan prepayment and bond makewhole premiums | — | % | 0.07 | % | (7 | ) | 0.12 | % | 0.32 | % | (20 | ) | 0.06 | % | 0.20 | % | (14 | ) | |||||||||||||||
Contingent interest | — | % | 0.25 | % | (25 | ) | — | % | — | % | — | — | % | 0.13 | % | (13 | ) | ||||||||||||||||
Interest rate margin, excluding the above items | 1.57 | % | 1.55 | % | 2 | 1.59 | % | 1.49 | % | 10 | 1.58 | % | 1.52 | % | 6 | ||||||||||||||||||
Effect on Income from Operations (After-tax, after DAC) (in millions) | |||||||||||||||||||||||||||||||||
Commercial mortgage loan prepayment and bond makewhole premiums | $ | — | $ | 0.6 | $ | 1.2 | $ | 3.0 | $ | 1.2 | $ | 3.6 | |||||||||||||||||||||
Contingent interest | — | 2.1 | — | — | — | 2.1 | |||||||||||||||||||||||||||
Effect on income from operations | $ | — | $ | 2.7 | $ | 1.2 | $ | 3.0 | $ | 1.2 | $ | 5.7 | |||||||||||||||||||||
Traditional Products | |||||||||||||||||||||||||||||||||
Net investment income yield | 6.43 | % | 7.33 | % | (90 | ) | 6.50 | % | 6.61 | % | (11 | ) | 6.46 | % | 6.96 | % | (50 | ) | |||||||||||||||
Effect on Yield | |||||||||||||||||||||||||||||||||
Commercial mortgage loan prepayment and bond makewhole premiums | 0.05 | % | — | % | 5 | 0.12 | % | 0.05 | % | 7 | 0.08 | % | 0.03 | % | 5 | ||||||||||||||||||
Contingent interest | — | % | 0.72 | % | (72 | ) | — | % | — | % | — | — | % | 0.36 | % | (36 | ) | ||||||||||||||||
Net investment income yield after adjusted for above items | 6.38 | % | 6.61 | % | (23 | ) | 6.38 | % | 6.56 | % | (18 | ) | 6.38 | % | 6.57 | % | (19 | ) | |||||||||||||||
Effect on Income from Operations (After-tax) (in millions) | |||||||||||||||||||||||||||||||||
Commercial mortgage loan prepayment and bond makewhole premiums | $ | 0.1 | $ | — | $ | 0.3 | $ | 0.1 | $ | 0.4 | $ | 0.1 | |||||||||||||||||||||
Contingent interest | — | 1.6 | — | — | — | 1.6 | |||||||||||||||||||||||||||
Effect on income from operations | $ | 0.1 | $ | 1.6 | $ | 0.3 | $ | 0.1 | $ | 0.4 | $ | 1.7 | |||||||||||||||||||||
Comparison of Three and Six Months Ended March 31,June 30, 2005 to 2004
Revenues, First Year Premium, In-force and Net Amount at Risk
Overall revenues for the second quarter and first quartersix months of 2005 were level withincreased modestly from the same 2004 period. First quarter 2004 netperiods. Net investment income, included $10.8 million, pre-tax, of contingent interest and commercial mortgage loan prepayment and bond makewhole premiums, which is explained below.below, was the primary driver of the increases. Insurance fees include surrender charges, mortality assessments and expense assessments. Revenues from insurance fees were up onlydeclined 1%. for the second quarter and increased modestly for the first six months of 2005, compared to the same 2004 periods, primarily reflecting lower surrender charge revenue partially offset by higher mortality assessments. The decline in surrender charge revenue was due to more favorable persistency resulting in higher business in force, which should favorably affect future revenues. Mortality assessments increased $3.1 million and $7.9 million for the second quarter and first six months of 2005, or 3% for each period, compared to the same 2004 periods. This increase in insurance feesgrowth is in line with the lack of growth in UL and Other face amount in-force, and NAR (Other includes VUL, whole life, ISWL and COLI; UL and Other products are referred to as permanent products). Insurance fees include mortalityMortality assessments which are comprised of cost of insurance assessments (“COI”) and are charged to policyholders in relation to the NAR less the cost of reinsurance premiums that we pay for reinsurance coverage. In recent years, we have reinsured a larger percentage of the mortality risk on our business than in the past. As older business with a lower percentage of reinsurance has run off, this has had the effect of reducingslowing the amountgrowth of revenues from net mortality assessments.
The increase in life insurance in-force and NAR has been driven primarily by the growth in term life insurance. It is important to view the in-force and NAR growth separately for term products versus UL and other permanent products, as term products by design have a lower profitability to face amount relationship than do permanent life insurance products. Insurance premium revenue relates to whole life and term life insurance products. Although insuranceInsurance premiums were down 5%1% for the second quarter
35
and 3% for the first quartersix months of 2005 compared to the first quarter of 2004,same periods in 2004. Insurance premiums for term insurance was up 10%increased 8% and 9% for the second quarter and first six months of 2005 compared to the same periods in 2004, while insurance premiums for whole life was down 11%decreased 5% and 8% for the comparable periods, as this block of business is declining. These premiums included those received from policyholders and are net of premiums we pay for reinsurance coverage. Term and whole life insurance products have insurance fees and COIs generated from the NAR. These are components of the change in policy reserves on these products, and are reflected in insurance benefits.
Total first year premiums for the firstsecond quarter of 2005 declinedwere level with the second quarter of 2004 and decreased 1% for the first six months of 2005 from the first quartercomparable 2004 period. First year premiums are not part of 2004.revenues but are indicative of future profitability. Due to the equity market turnaround and the fourth quarter 2004 introduction of a new product, first year premiums for VUL were up $3.4$6.1 million, or 15%34%, in the second quarter of 2005, and $9.5 million, or 24%, in the first quartersix months of 2005, compared to the same 2004 period.periods last year. COLI sales were also favorable, with first year premiumpremiums up $10.6$0.4 million or 75% from4% for the firstsecond quarter of 2004.2005 and $10.9 million or 45% for the year-to-date periods.
36
The declinedeclines in first year premiums for UL in the first quarter of 2005 waswere due to increased competition. The segment introduced a new UL product during the third quarter of 2004, which generated sales of approximately $26$37 million for the second quarter and $63 million for the first quarter 2005 sales.six months of 2005. Overall, we expect first year premiums and related revenues in 2005 to equal or modestly exceed 2004 results..results.
Net investment income for the Life Insurance segment for thesecond quarter and first quartersix months of 20042005 included $1.9$0.9 million and $5.2 million pre-tax from commercial mortgage loan prepayment and bond makewhole premiums, and alsothe second quarter 2005 receipt of fees from the standby real estate equity commitments of $5.7 million pre-tax. Net investment income for the second quarter and first six months of 2004 included $9.1 million and $11.0 million pre-tax, respectively, from commercial mortgage loan prepayment and bond makewhole premiums, and for the first six months, $8.9 million pre-tax ($6.5 million in the interest sensitive lines and $2.5 million for traditional non-par lines) of contingent interest income. Absent these items, interest rate margins for the Life Insurance segment improved in the second quarter and first quartersix months of 2005, compared to the same 2004 period. periods in 2004.
Interest sensitive products include UL and ISWL and provide for interest to be credited to policyholder accounts. The difference between what we credit to policyholder accounts and interest income we earn on interest sensitive assets is interest rate margin. Traditional non-dividend participating (“Non-par”) products include term and whole life insurance with interest income used to build the policy reserves. At March 31,June 30, 2005 and 2004, interest-sensitive products represented approximately 88% of total interest sensitive and traditional Non-par earning assets. At March 31,June 30, 2005, 36%35% of the interest sensitive account values have crediting rates at contract guaranteed levels, and 56% have crediting rates within 50 basis points of contractual guarantees. We expect a reduction of 1 to 2 basis points (pre-DAC and pre-tax) per quarter in interest rate margins in 2005 for the Life Insurance segment. This decrease is expected to reduce the segment’s income by approximately $0.2 million, after-tax after DAC, in the remaining quarters of 2005. This assumes a 50 basis point annual improvement in new money investment rates and no significant changes in net flows in or out of our fixed accounts or other changes whichthat may cause interest rate margins to differ from our expectation. For information on interest rate margins and the interest rate risk due to falling interest rates, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk” in this Form 10-Q.
Expenses
Insurance benefits include interest credited to policyholders of $145.8$145.2 million and $144.8$291.1 million in the second quarter and first quartersix months of 2005, respectively, compared to $143.9 million and 2004, respectively.$288.8 million for the same periods in 2004. Actions taken by the segment to lower crediting rates commensurate with the reduction in the overall investment yield in 2004 and 2005 offset the effects of growth in the book of business. Refer to the table above for the interest rate credited to policyholders.
During 2004, we undertook our annual comprehensive review of the assumptions underlying the amortization of DAC, PVIF and DFEL. The Life Insurance segment reviewed the various assumptions including investment rate margins and retention. This comprehensive review resulted in an increase in the on-going amortization expense of approximately $3.0 million, pre-tax, ($2.0 million after-tax) per quarter beginning in the fourth quarter of 2004.
The segment also experienced negative retrospective DAC unlocking in the first quarter of 2005 of $3.4 million pre-tax ($2.2 million after-tax). The negative unlocking resulted in the first quarter of 2005 and $3.5 million pre-tax ($2.3 million after-tax) in the first six months of 2005, resulting primarily from unfavorable mortality, results reflecting a first death on a large survivorship policy, and COLI surrenders and unfavorable equity markets during the period.periods.
37In July 2005, a committee of the NAIC adopted a change to Actuarial Guideline 38 (also known as “AXXX”), the statutory reserve requirements for UL products with secondary guarantees, such as Lincoln National Life’s lapse protection rider (“LPR”). This proposal is expected to be formally adopted by the NAIC in September 2005 with an effective date of July 1, 2005.
The proposal does not affect business written prior to the effective date of July 1, 2005. However, based on early analysis and normalized sales of UL products sold with secondary guarantees, we expect Actuarial Guideline 38 could result in up to $100 million of additional statutory reserves for 2005. We continue to evaluate potential modifications to our universal life products with secondary guarantees that may be made in response to the revised regulation. Although the impact of this proposal on future sales of guaranteed no-lapse UL cannot be predicted, it may result in a price increase for such products.
36
Investment Management
Operating Summary for the Three Months Ended March 31, (in millions) | 2005 | 2004 | Increase (Decrease) Over Prior Period | ||||||||||||||||||||||||
Three Months | Six Months | ||||||||||||||||||||||||||
Operating Summary for the Periods Ended June 30, (in millions) | 2005 | 2004 | Increase (Decrease) Over Prior Period | 2005 | 2004 | Increase (Decrease) Over Prior Period | |||||||||||||||||||||
Operating Revenues: | |||||||||||||||||||||||||||
Investment advisory fees - retail/institutional | $ | 59.4 | $ | 62.7 | (5 | )% | $ | 66.9 | $ | 66.4 | 1 | % | $ | 126.3 | $ | 129.2 | (2 | )% | |||||||||
Investment advisory fees - insurance-related | 24.8 | 26.5 | (6 | )% | 24.6 | 26.1 | (6 | )% | 49.4 | 52.6 | (6 | )% | |||||||||||||||
Insurance fees | 17.3 | 14.6 | 18 | % | 17.4 | 15.2 | 14 | % | 34.6 | 29.8 | 16 | % | |||||||||||||||
Net investment income | 12.9 | 12.2 | 6 | % | 14.2 | 14.6 | (3 | )% | 27.0 | 26.8 | 1 | % | |||||||||||||||
Other revenues and fees | 16.0 | 19.2 | (17 | )% | 14.9 | 16.7 | (11 | )% | 31.0 | 35.8 | (13 | )% | |||||||||||||||
Total Operating Revenues | 130.4 | 135.2 | (4 | )% | 138.0 | 139.0 | (1 | )% | 268.3 | 274.2 | (2 | )% | |||||||||||||||
Operating Expenses: | |||||||||||||||||||||||||||
Insurance benefits | 6.8 | 6.6 | 3 | % | 7.0 | 6.6 | 6 | % | 13.8 | 13.2 | 5 | % | |||||||||||||||
Underwriting, acquisition, insurance and other expenses | 112.8 | 110.4 | 2 | % | 126.0 | 112.3 | �� | 12 | % | 238.8 | 222.8 | 7 | % | ||||||||||||||
Total Operating Expenses | 119.6 | 117.0 | 2 | % | 133.0 | 118.9 | 12 | % | 252.6 | 236.0 | 7 | % | |||||||||||||||
Income before taxes | 10.8 | 18.2 | (41 | )% | |||||||||||||||||||||||
Income from operations before taxes | 5.0 | 20.1 | (75 | )% | 15.7 | 38.2 | (59 | )% | |||||||||||||||||||
Federal income taxes | 3.4 | 5.7 | (40 | )% | 1.1 | 6.7 | (84 | )% | 4.5 | 12.3 | (63 | )% | |||||||||||||||
Income from Operations | $ | 7.4 | $ | 12.5 | (41 | )% | $ | 3.9 | $ | 13.4 | (71 | )% | $ | 11.2 | $ | 25.9 | (57 | )% | |||||||||
Income from Operations Variances—Increase (Decrease)
in the Period From Prior Year Period
Three Months Ended March 31, (in millions after-tax) | 2005 to 2004 | |||
Decrease in Income from Operations | $ | (5.1 | ) | |
Significant Changes in Segment Income from Operations: | ||||
Effects of financial markets/net flows, variable expenses and other | 2.8 | |||
Changes in earnings from seed capital | (2.0 | ) | ||
Income from operations of DIAL in 2004 | (3.5 | ) | ||
Asset management fees related to LNC’s general account | (0.8 | ) | ||
Severance | (1.4 | ) |
March 31, (in billions) | 2005 | 2004 | Increase (Decrease) Over Prior Period | |||||||
Assets Under Management: | ||||||||||
Retail-Equity | $ | 27.0 | $ | 22.6 | 19 | % | ||||
Retail-Fixed | 8.5 | 8.3 | 2 | % | ||||||
Total Retail | 35.5 | 30.9 | 15 | % | ||||||
Institutional-Equity | 11.5 | 27.2 | (58 | )% | ||||||
Institutional-Fixed | 11.0 | 9.0 | 22 | % | ||||||
Total Institutional | 22.5 | 36.2 | (38 | )% | ||||||
Insurance-related Assets | 44.2 | 44.0 | 1 | % | ||||||
Total Assets Under Management | $ | 102.2 | $ | 111.1 | * | (8 | )% | |||
Total Sub-advised Assets, included in above amounts | ||||||||||
Retail | $ | 12.2 | $ | 4.0 | 205 | % | ||||
Institutional | 3.9 | — | NM | |||||||
Total Sub-advised Assets at the End of the Period | $ | 16.1 | $ | 4.0 | 303 | % | ||||
Periods Ended June 30, 2005 | ||||||||
(in millions after-tax) | Three Months | Six Months | ||||||
Decrease in Income from Operations | $ | (9.5 | ) | $ | (14.7 | ) | ||
Significant Changes in Segment Income from Operations: | ||||||||
Effects of financial markets/net flows, variable expenses and other | 2.7 | 5.1 | ||||||
Changes in earnings from seed capital | 0.9 | (1.1 | ) | |||||
Income from operations of DIAL in 2004 | (4.1 | ) | (7.6 | ) | ||||
Reduction in asset management fees related to LNC’s general account | (0.8 | ) | (1.5 | ) | ||||
Portfolio management alignment | (5.6 | ) | (7.2 | ) |
June 30, (in billions) | 2005 | 2004 | Increase (Decrease) Over Prior Period | |||||||
Assets Under Management: | ||||||||||
Retail-Equity | $ | 29.9 | $ | 23.2 | 29 | % | ||||
Retail-Fixed | 8.8 | 8.2 | 7 | % | ||||||
Total Retail | 38.7 | 31.4 | 23 | % | ||||||
Institutional-Equity | 15.5 | 28.4 | (45 | )% | ||||||
Institutional-Fixed | 11.8 | 9.9 | 19 | % | ||||||
Total Institutional | 27.3 | 38.3 | (29 | )% | ||||||
Insurance-related Assets | 45.2 | 42.5 | 6 | % | ||||||
Total Assets Under Management | $ | 111.2 | $ | 112.2 | * | (1 | )% | |||
Total Sub-advised Assets, included in above amounts | ||||||||||
Retail | $ | 13.7 | $ | 4.3 | 219 | % | ||||
Institutional | 4.2 | — | NM | |||||||
Total Sub-advised Assets at the End of the Period | $ | 17.9 | $ | 4.3 | 316 | % | ||||
* | Includes DIAL Assets Under Management of |
3837
Three Months Ended March 31, (in billions) | 2005 | 2004 | Increase Prior Year | ||||||||||||||||||||||||||||||
Three Months | Six Months | ||||||||||||||||||||||||||||||||
Periods Ended June 30, (in billions) | 2005 | 2004 | Increase Prior Year | 2005 | 2004 | Increase Prior Year | |||||||||||||||||||||||||||
Retail: | |||||||||||||||||||||||||||||||||
Equity: | |||||||||||||||||||||||||||||||||
Fund deposits | $ | 2.773 | $ | 1.938 | 43 | % | $ | 3.421 | $ | 1.666 | 105 | % | $ | 6.194 | $ | 3.603 | 72 | % | |||||||||||||||
Redemptions and transfers | (1.508 | ) | (0.994 | ) | (52 | )% | (1.255 | ) | (1.032 | ) | (22 | )% | (2.763 | ) | (2.025 | ) | (36 | )% | |||||||||||||||
Net flows—Equity | 1.265 | 0.944 | 34 | % | 2.166 | 0.634 | 242 | % | 3.431 | 1.578 | 117 | % | |||||||||||||||||||||
Fixed Income: | |||||||||||||||||||||||||||||||||
Fund deposits | 0.608 | 0.513 | 19 | % | 0.612 | 0.452 | 35 | % | 1.221 | 0.965 | 27 | % | |||||||||||||||||||||
Redemptions and transfers | (0.295 | ) | (0.488 | ) | 40 | % | (0.447 | ) | (0.469 | ) | 5 | % | (0.742 | ) | (0.958 | ) | 23 | % | |||||||||||||||
Net flows—Fixed Income | 0.313 | 0.025 | 1,152 | % | 0.165 | (0.017 | ) | NM | 0.479 | 0.007 | 6,743 | % | |||||||||||||||||||||
Total Retail: | |||||||||||||||||||||||||||||||||
Fund deposits | 3.381 | 2.451 | 38 | % | 4.033 | 2.118 | 90 | % | 7.415 | 4.568 | 62 | % | |||||||||||||||||||||
Redemptions and transfers | (1.803 | ) | (1.482 | ) | (22 | )% | (1.702 | ) | (1.501 | ) | (13 | )% | (3.505 | ) | (2.983 | ) | (17 | )% | |||||||||||||||
Net flows—Total Retail | 1.578 | 0.969 | 63 | % | 2.331 | 0.617 | 278 | % | 3.910 | 1.585 | 147 | % | |||||||||||||||||||||
Institutional: | |||||||||||||||||||||||||||||||||
Equity: | |||||||||||||||||||||||||||||||||
Inflows/deposits | 0.576 | 1.817 | (68 | )% | 4.563 | 2.049 | 123 | % | 5.138 | 3.867 | 33 | % | |||||||||||||||||||||
Withdrawals and transfers | (0.440 | ) | (0.749 | ) | 41 | % | (1.003 | ) | (1.154 | ) | 13 | % | (1.442 | ) | (1.905 | ) | 24 | % | |||||||||||||||
Net flows—Equity | 0.136 | 1.068 | (87 | )% | 3.560 | 0.895 | 298 | % | 3.696 | 1.962 | 88 | % | |||||||||||||||||||||
Fixed Income: | |||||||||||||||||||||||||||||||||
Inflows/deposits | 1.211 | 0.806 | 50 | % | 1.289 | 1.281 | 1 | % | 2.500 | 2.087 | 20 | % | |||||||||||||||||||||
Withdrawals and transfers | (0.129 | ) | (0.214 | ) | 40 | % | (0.741 | ) | (0.133 | ) | (457 | )% | (0.871 | ) | (0.346 | ) | (152 | )% | |||||||||||||||
Net flows—Fixed Income | 1.082 | 0.592 | 83 | % | 0.548 | 1.148 | (52 | )% | 1.629 | 1.741 | (6 | )% | |||||||||||||||||||||
Total Institutional: | |||||||||||||||||||||||||||||||||
Inflows/deposits | 1.787 | 2.623 | (32 | )% | 5.852 | 3.330 | 76 | % | 7.638 | 5.954 | 28 | % | |||||||||||||||||||||
Withdrawals and transfers | (0.569 | ) | (0.963 | ) | 41 | % | (1.744 | ) | (1.287 | ) | (36 | )% | (2.313 | ) | (2.251 | ) | (3 | )% | |||||||||||||||
Net flows—Total Institutional | 1.218 | 1.660 | (27 | )% | 4.108 | 2.043 | 101 | % | 5.325 | 3.703 | 44 | % | |||||||||||||||||||||
Combined Retail and Institutional: | |||||||||||||||||||||||||||||||||
Deposits/inflows | 5.168 | 5.074 | 2 | % | 9.885 | 5.448 | 81 | % | 15.053 | 10.522 | 43 | % | |||||||||||||||||||||
Redemptions, withdrawals and transfers | (2.372 | ) | (2.445 | ) | 3 | % | (3.446 | ) | (2.788 | ) | (24 | )% | (5.818 | ) | (5.234 | ) | (11 | )% | |||||||||||||||
Net flows—Combined Retail and Institutional | $ | 2.796 | $ | 2.629 | 6 | % | $ | 6.439 | $ | 2.660 | 142 | % | $ | 9.235 | $ | 5.288 | 75 | % | |||||||||||||||
Note: | The term deposits in the above table and in the following discussion represents purchases of mutual funds and managed accounts, deposits in variable annuity funds, and inflows in advisory |
The following table presents the segment’s net flows with and without DIAL.
Three Months Ended March 31, (in billions) | 2005 | 2004 | Increase (Decrease) | ||||||||||||||||||||||||
Three Months | Six Months | ||||||||||||||||||||||||||
Periods Ended June 30, (in billions) | 2005 | 2004 | Increase (Decrease) | 2005 | 2004 | Increase (Decrease) | |||||||||||||||||||||
Net Flows | |||||||||||||||||||||||||||
As reported above | $ | 2.796 | $ | 2.629 | 6 | % | $ | 6.439 | $ | 2.660 | 142 | % | $ | 9.235 | $ | 5.288 | 75 | % | |||||||||
DIAL | — | 1.089 | NM | — | 1.657 | NM | — | 2.745 | NM | ||||||||||||||||||
Net Flows—Excluding DIAL | $ | 2.796 | $ | 1.540 | 82 | % | $ | 6.439 | $ | 1.003 | 542 | % | $ | 9.235 | $ | 2.543 | 263 | % | |||||||||
38
Comparison of Three and Six Months Ended March 31,June 30, 2005 to 2004
Revenues, Deposits and Net Flows
The decline in investmentInvestment advisory fees—retail/institutional increased 1% for the second quarter, but declined 2% for the first six months of 2005 compared with the same periods last year. The decline for the six-month period was due to the third quarter 2004 sale of DIAL, which resulted in lower investment advisory fees and lower levellevels of assets under management. Excluding this,DIAL, investment advisory fees-retail/institutional increased 7.5%, pre-tax,33% and 29% for the second quarter and first six months of 2005, compared to the same periods last year, due to a higher average levellevels of assets under management. The higher average levellevels of assets under management resulted from changes in the equity markets and positive net flows. We believe
39
that the positiveThe level of net flows arein the second quarter of 2005 was significantly higher than previous periods for the institutional business, and to a resultlesser degree the retail business. Net flows for the segment in the second quarter of 2005 were 130% higher than the first quarter of 2005. The increase in net flows is attributable to several factors, including: changes in the management of certain asset category offerings, the recognition in the marketplace of theimproving investment performance, for both institutional products, as well as retail funds managed by the segment, and the expanded wholesaling of the segment’s products by LFD. The investmentlevel of net flows may vary considerably from period to period and net flows in one quarter may not be indicative of net flows in subsequent quarters. While it is difficult to predict the level of net flows in any given quarter, we do not expect net flows in the third quarter to repeat the level achieved in the second quarter of 2005. Investment advisory fees include amounts that are ultimately paid to sub-advisors for managing the sub-advised assets. The amounts paid to sub-advisors are included in the expenses of the segment. In addition, included in the investment advisory fees—retail/institutional are fees earned from managing funds included within our variable annuity and life insurance products.
Investment advisory fees – insurance related is made up of fees for asset management services this segment provides for our general account assets supporting our fixed products and surplus, including those of the Lincoln Retirement and Life Insurance segments. As a result of analysis performed in the latter half of 2004, we reduced the inter-segment fees paid to the Investment Management segment by approximately 2 basis points, or 12.4%12%, effective January 1, 2005. This resulted in a negative impact net of expense reductions of $0.8$1.4 million after-tax in the second quarter of 2005 and $2.8 million for the first quartersix months of 2005. This was offset by a corresponding net positive impactimpacts within the Lincoln Retirement and Life Insurance segments.
The increase in insurance fees from the annuity-based 401(k) Lincoln DirectorSM business (“Director”) primarily relates to higher assets under management from equity market performance and positive net flows of $0.5$0.4 billion in the twelve months ended March 31,June 30, 2005. Assets under management for this business were $5.7$5.9 billion and $4.9$5.1 billion at March 31,June 30, 2005 and 2004, respectively.
Other revenue includes changes in the value of seed capital, as well as shareholder servicing and accounting fees for services provided to mutual funds and variable annuity products that we sponsor. Seed capital represents the amount of capital invested to start a new fund or product. Seed capital investments are accounted for in a manner consistent with the accounting for trading securities, with changes in fair market value reported as a component of revenue.revenues. The primary driver of the reduction in other revenuerevenues in the firstsecond quarter of 2005, compared to the same 2004 period, was related to the seed capital component. Revenues for the second quarter and first quartersix months of 2005 included losses related to seed capital, compared to gains in the same 2004 period.periods. These results were driven by equity market performance in the respective periods. In addition, there was a lower level of seed capital in 2005. The amount of seed capital was reduced during 2004 and 2005 as certain funds reached an appropriate size to return seed capital to the holding company.
The decline in assets under management from March 31,June 30, 2004 to 2005 is primarily the result of the sale of DIAL. Assets managed by DIAL were $19.3 million$21.2 billion at March 31, 2005.June 30, 2004. This decline was partially offset by market value gains and positive net flows. Excluding the DIAL assets, market value gains for the twelve months ended March 31,June 30, 2005 were $2.2$3.3 billion in retail and $0.8$1.6 billion in institutional. Net flows were $3.8$5.5 billion in retail and $4.5$8.3 billion in institutional for the same period.
As a result of the sale of DIAL, certain retail assets are now sub-advised by the acquirer. This change resulted in the increase in sub-advised assets, presented in the table above. Sub-advised assetswhich represent approximately 16% of the segment’s assets under management at March 31,June 30, 2005 compared to approximately 4% at March 31,June 30, 2004. As stated above, the segment pays fees to the sub-advisor for managing the assets. Also, in 2004, the segment outsourced its mutual fund based 401(k) record-keeping business. As a result, approximately $1.0 billion of the retirement accounts were transferred to third parties during 2004.
Expenses
Underwriting, acquisition, insurance and other expenses increased 2%12% in the firstsecond quarter of 2005 and 7% for the first six months, compared to the first quarter ofsame periods in 2004, primarily from expenses that vary with revenues or levels of assets under management. These expenses include the fees we pay to third party sub-advisors. Payments to LFD for wholesaling services increased 17% or $1.8 million, pre-taxor 38%, in the second quarter and $3.1 million, or 30%, in the first six months, compared to the same periods last year as a result of the strong retail deposits in the first quarter of 2005. In the asset management business, we are not able to capitalize the acquisition costs of new business unlike the capitalization of acquisition costs with insurance products. Operating expenses for the first quartersix months of 2005 also include approximately $2.2$2.5 million pre-tax of severance. LowerIn addition, expenses resulting fromwere higher as the DIAL sale partially offsetresult of the 2005 first quarter increaseaddition in expenses.
In April 2005 of several growth equity managers and certain other investment personnel joined Delaware to form a new large cap equity growth team. Although we expect to see a positive economic impact fromFor the addition of the team, net incremental expenses are expected to depress after-tax income from operations for the Investment Management segment by approximately $3.5 million to $4.5 million in the second quarterremainder of 2005, and $2we anticipate additional net expenses related to investment professional talent acquisitions of $1 million in the second half of 2005. However, these estimates could vary based upon timing of flows and market performance.after-tax per quarter.
4039
Lincoln UK
Operating Summary for the Three Months Ended March 31, (in millions) | 2005 | 2004 | Increase (Decrease) Over | ||||||||||||||||||||||||
Three Months | Six Months | ||||||||||||||||||||||||||
Operating Summary for the Periods Ended June 30, (in millions) | 2005 | 2004 | Increase (Decrease) Over | 2005 | 2004 | Increase (Decrease) Over | |||||||||||||||||||||
Operating Revenues: | |||||||||||||||||||||||||||
Insurance premiums | $ | 14.6 | $ | 18.1 | (19 | )% | $ | 16.4 | $ | 19.6 | (16 | )% | $ | 31.0 | $ | 37.7 | (18 | )% | |||||||||
Insurance fees | 35.6 | 33.8 | 5 | % | 37.3 | 34.8 | 7 | % | 72.9 | 68.6 | 6 | % | |||||||||||||||
Net investment income | 20.3 | 18.5 | 10 | % | 19.6 | 18.3 | 7 | % | 39.9 | 36.7 | 9 | % | |||||||||||||||
Other revenues and fees | 4.1 | 5.7 | (28 | )% | 5.1 | 8.3 | (39 | )% | 9.3 | 14.1 | (34 | )% | |||||||||||||||
Total Operating Revenues | 74.6 | 76.1 | (2 | )% | 78.4 | 81.0 | (3 | )% | 153.1 | 157.1 | (3 | )% | |||||||||||||||
Operating Expenses: | |||||||||||||||||||||||||||
Insurance benefits | 25.1 | 29.0 | (13 | )% | 27.9 | 28.8 | (3 | )% | 53.0 | 57.8 | (8 | )% | |||||||||||||||
Underwriting, acquisition, insurance and other expenses | 34.1 | 37.6 | (9 | )% | 34.6 | 35.7 | (3 | )% | 68.7 | 73.3 | (6 | )% | |||||||||||||||
Total Operating Expenses | 59.2 | 66.6 | (11 | )% | 62.5 | 64.5 | (3 | )% | 121.7 | 131.1 | (7 | )% | |||||||||||||||
Income before taxes | 15.4 | 9.5 | 62 | % | 15.9 | 16.5 | (4 | )% | 31.4 | 26.0 | 21 | % | |||||||||||||||
Federal income taxes | 5.4 | 3.3 | 64 | % | 5.6 | 5.8 | (3 | )% | 11.0 | 9.1 | 21 | % | |||||||||||||||
Income from Operations | $ | 10.0 | $ | 6.2 | 61 | % | $ | 10.3 | $ | 10.7 | (4 | )% | $ | 20.4 | $ | 16.9 | 21 | % | |||||||||
March 31, (in billions) | 2005 | 2004 | Increase (Decrease) | ||||||||||||||||||||||||
Unit-Linked Assets | $ | 7.2 | $ | 6.5 | 11 | % | |||||||||||||||||||||
Individual Life Insurance In-Force | 19.8 | 20.5 | (3 | )% | |||||||||||||||||||||||
Exchange Rate Ratio—U.S. Dollars to Pounds Sterling: | |||||||||||||||||||||||||||
Average for the Period | 1.904 | 1.836 | 4 | % | |||||||||||||||||||||||
End of Period | 1.896 | 1.844 | 3 | % |
June 30, (in billions) | 2005 | 2004 | Increase (Decrease) | ||||||
Unit-Linked Assets | $ | 6.9 | $ | 6.5 | 6 | % | |||
Individual Life Insurance In-Force | 18.5 | 19.8 | (7 | )% | |||||
Exchange Rate Ratio—U.S. Dollars to Pounds Sterling: | |||||||||
Average for the Period | 1.855 | 1.814 | 4 | % | |||||
End of Period | 1.792 | 1.819 | (1 | )% |
Income from Operations Variances—Increase (Decrease)
in the Period From Prior Year Period
Three Months Ended March 31, (in millions, after-tax) | 2005 to 2004 | ||
Increase in Income from Operations | $ | 3.8 | |
Significant Changes in Income from Operations: | |||
Effects of Equity Markets | |||
Fee income from equity-linked assets | 0.9 | ||
DAC/PVIF/DFEL | 1.3 | ||
Foreign currency exchange rates | 0.4 |
Periods Ended June 30, 2005 | |||||||
(in millions, after-tax) | Three Months | Six Months | |||||
Increase (decrease) in Income from Operations | $ | (0.4 | ) | $ | 3.5 | ||
Significant Changes in Income from Operations: | |||||||
Effects of Equity Markets | |||||||
Fee income from equity-linked assets | — | 1.4 | |||||
DAC/PVIF/DFEL | — | 1.8 |
Note: | The segment has its balance sheets and income statements translated at the current spot exchange rate as of the end of the period and average spot exchange rate for the period, respectively. |
Comparison of Three and Six Months Ended March 31,June 30, 2005 to 2004
Revenues
Insurance premiums were down approximately 19%16% for the second quarter and 18% for the first quartersix months of 2005 compared to the first quartersame periods of 2004. This decrease is a result2004, resulting from the continuing decline of the in-force block continuing to decline.block. Policy lapse rates for the three months ended March 31, 2005, were 6.8%, an improvement over the 7.2% rate for the six months ended June 30, 2005 was 7% comparable to that experienced in 2004, period as measured by the number of policies in-force. Insurance fees benefited from higher average equity-linked account values resulting largely from the increase in the U.K. equity markets. As illustrated by the performance of the FTSE 100 index, U.K. equity markets had increased 11.6%14.5% at March 31,June 30, 2005 from March 31,June 30, 2004; the daily average basis FTSE 100 for the firstsecond quarter of 2005 was up 10.6%10.5% from the firstsecond quarter of 2004.
Other revenues decreased $1.6 million, or 28%,39% and 34% in the second quarter and first quartersix months of 2005, compared to the same periods last year. Equity markets declined between 2003 and June 2004, period. This decreaseresulting in positive retrospective unlocking of DFEL and negative retrospective unlocking of DAC and PVIF. Although the equity markets increased during 2005, there was primarilyno corresponding unlocking due to the impact of equity markets and the positive first quarter 2004 unlocking of DFEL included in other revenue. The performance of the equity markets in the first quarter 2004 was belowenhancement to our long-term growth assumption of 9%, which resulted in positive DFEL unlocking. As a result of the enhanced reversion to the mean processes implementedprocess. The unlocking of DFEL in the third quarter of 2004 no unlocking occurredresulted in the first quarter of 2005.
41
Expenses
Expenses wereother revenue being lower in the first quarter of 2005, compared to the first quarter of 2004 due to the net negative first quarter 2004 unlocking of assumptions for DAC and PVIF related to the same items as noted above for DFEL.2004. The absence of effects of the net unlocking activitiesactivity for the second quarter and first quartersix months of 2005 for DAC/PVIF and DFEL resulted in an increase in income of $2.0$0.8 million and $2.8 million pre-tax ($1.30.5 million after-tax).and $1.8 million after-tax, respectively), compared to 2004. The impact of the unlocking of DAC and PVIF is included in expenses.
Insurance benefits decreased $3.9 million or 13% for40
Expenses
Expenses were lower in the second quarter and first quartersix months of 2005 compared to the same 2004 period.periods, due to the net negative retrospective unlocking of assumptions for DAC and PVIF that occurred in the second quarter and first six months of 2004 as noted above.
Insurance benefits decreased 3% for the second quarter and 8% for the first six months of 2005, compared to the same 2004 periods. Excluding the effects of the exchange rate, insurance benefits decreased approximately $5 million. The decrease is$1.5 million for the second quarter and $6 million for the first six months, compared to the same 2004 periods, due to a continuing decline in the overall book of business.
The services provided to the segment under the Capita agreement are currently deemed to be exempt from value added tax (“VAT”), which is levied at the rate of 17.5%. In a recent ruling by the European Court of Justice regarding a similar arrangement involving a Dutch insurer, it was deemed that VAT should be applied to such an arrangement. The U.K. authorities are required to take note of this ruling in determining U.K. legislation. If the U.K. authoritieslegislation and have on July 8, 2005 issued a consultation paper outlining their intention to amend U.K. legislation so that VAT applies to contracts, such as our arrangement with Capita, weCapita. We estimate that, we could haveafter allowing for the estimated recovery of a percentage of these VAT costs as provided under the Capita agreement, such a change would result in negative DAC unlocking of approximately $16$12 million pre-tax ($107.8 million after-tax) as future EGPs would be lower from the increased expense. In addition, the segment’s income from operations would be reduced by approximately $4$3 million pre-tax ($2 million after-tax) on an annual basis.
Other Operations
Operating Summary for the Three Months Ended March 31, (in millions) | 2005 | 2004 | Increase (Decrease) | ||||||||
Income (Loss) from Operations by Source: | |||||||||||
LFA | $ | (7.6 | ) | $ | (8.7 | ) | (13 | )% | |||
LFD | (6.0 | ) | (4.6 | ) | 30 | % | |||||
Financing costs | (14.6 | ) | (14.6 | ) | — | % | |||||
Other Corporate | 4.7 | (4.1 | ) | NM | |||||||
Amortization of deferred gain on indemnity reinsurance | 12.3 | 11.6 | 6 | % | |||||||
Loss from Operations | $ | (11.2 | ) | $ | (20.4 | ) | (45 | )% | |||
Three Months | Six Months | |||||||||||||||||||||
Operating Summary for the Periods Ended June 30, (in millions) | 2005 | 2004 | Increase (Decrease) | 2005 | 2004 | Increase (Decrease) | ||||||||||||||||
Income (Loss) from Operations by Source: | ||||||||||||||||||||||
LFA | $ | (4.4 | ) | $ | (5.3 | ) | (17 | )% | $ | (12.0 | ) | $ | (14.0 | ) | (14 | )% | ||||||
LFD | (5.4 | ) | (6.4 | ) | (16 | )% | (11.4 | ) | (11.1 | ) | 3 | % | ||||||||||
Financing costs | (14.5 | ) | (15.7 | ) | (8 | )% | (29.1 | ) | (30.3 | ) | (4 | )% | ||||||||||
Other Corporate | 21.2 | (5.0 | ) | NM | 25.8 | (8.9 | ) | NM | ||||||||||||||
Amortization of deferred gain on indemnity reinsurance | 12.4 | 11.7 | 5 | % | 24.6 | 23.3 | 6 | % | ||||||||||||||
Income (Loss) from Operations | $ | 9.3 | $ | (20.7 | ) | (144 | )% | $ | (2.1 | ) | $ | (41.0 | ) | (95 | )% | |||||||
Comparison of Three Months and Six Ended March 31,June 30, 2005 to 2004
LFA
LFA’s operating lossresults for the second quarter and first quartersix months of 2005 improved by $1.1$0.9 million and $2.0 million, respectively, compared to the same 2004 period. This improvement isperiods. The improvements are due to expense management resulting from realignment activities initiated in 2003. Improvements from the realignment activities were constrainedpartially offset in the second quarter and first quartersix months of 2005 as a result ofby lower sales of our Life Insurance segment’sand Retirement segments’ products and non-proprietary products. Sales of life insurance products are the primary driver of LFA’s results. and services.
LFA’s net revenues were $52.8$54.5 million and $59.1$106.1 million for the three and six months ended March 31,June 30, 2005, respectively, compared to $59.1 million and 2004, respectively, a decline of 11%.$118.2 million for the same periods last year. Net revenues are revenues received, primarily in compensation for the sale of a product or service, reduced by commissions owed to agents or brokers responsible for the sale or provision of service. Proprietary first year life insurance premiums distributed through LFA decreased 10%5% and 8% in the second quarter and first quartersix months of 2005, respectively, compared to the first quarter of 2004,same periods in 2004. These declines were driven by an $11.3decreases of $4.6 million, or 27%12%, decreaseand $16.0 million, or 20%, for the second quarter and first six months of 2005, respectively, in universal life, whole life and term life insurance products, partially offset by a $6.4 million, or 97%,an increase infor variable life insurance products.products of $2.2 million, or 26%, for the second quarter and $8.4 million, or 58%, for the first six months of 2005. Lower deposits for proprietary individual annuity products of 10%7% and proprietary mutual funds9% for the second quarter and first six months of 3%2005, respectively, compared to the same 2004 periods, also contributed to the decline in net revenues. Deposits into Delaware’s mutual funds through LFA were $59.3$66.0 million and $61.3$125.3 million for the second quarter and first six months of 2005, respectively, compared to $50.2 million and $111.5 million for the same periods in 2004. Because of increased levels of deposits into non-commissionable mutual funds in 2005, LFA net revenues associated with Delaware mutual fund deposits for the second quarter and first six months of 2005 were level with the same 2004 periods. LFA net revenues from non-proprietary products, including managed accounts, financial planning and other product revenues, are approximately 5% below the prior year’s second quarter level and are down approximately 13% for the six-month period.
41
LFA implemented a restructuring plan in the second quarter of 2005 to realign field management and 2004, respectively. Deposits into Delaware mutual funds through LFA represent approximately 12% of LFA’s total mutual fund depositsfinancial planning support areas, which is expected to result in reduced operating expenses. See Note 11 to the first quarter of 2005, approximately a 2% increase over first quarter 2004.Consolidated Financial Statements for additional discussion.
LFD
LFD’s operating lossresults improved $1.0 million for the second quarter and declined $0.3 million for the first quartersix months of 2005, increased $1.4 million fromcompared to the first quarter of 2004. Whilesame periods last year, reflecting strong sales growth was strong quarter over quarter,and changes in product mix and wholesaling allowances. Changes in product mix and wholesaling allowances resulted infavorably affected margins for the second quarter of 2005 compared to the second quarter of 2004. Results for the first six months of 2005, compared to the same 2004 period, are due primarily to less favorable margins. margins in the first quarter of 2005 due to these changes. LFD also had higher expenses for the second quarter and first six months of 2005, compared to the same periods last year, primarily associated with the continuing expansion of the wholesaling force.
LFD’s revenues represent wholesaling allowances paid by our operating segments to LFD for wholesaling our products. Sales growth was primarily a result of strong deposits in investment products and individual variable annuities, partially offset by lower first year premiums in retail life insurance. Deposits into mutual funds, managed accounts and 401(k) products for which LFD provided wholesaling services were $2.9$2.6 billion and $5.5 billion in the second quarter and first quartersix months of 2005, an increaseincreases of 45%49% and 47% over the first quarter of 2004.same periods last year. Deposits into variable annuities were $1.7$1.8 billion an increasefor the second quarter and $3.5 billion for the first six months of 34%2005, increases of 24% and 28%, respectively, over first quarter 2004.the same periods last year. Deposits in the American
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Legacy Variable Annuity product were the key contributor to the variable annuity deposit growth in the first quarter of 2005. First year premiums of retail life insurance products through LFD were $140.9$158.3 million and $299.3 million for the second quarter and first six months of 2005, an increase of 1% and a decrease of 8%4%, respectively, from the first quarter ofsame periods in 2004. First year premiums of COLI life insurance products were $24.8$10.2 million in the firstsecond quarter of 2005 an increaseand $35.0 million for the first six months, increases of 74% from4% and 45%, respectively, compared to the same 2004 period. Higher expenses, primarily associated with the continuing expansion of the wholesaling force, also contributed to the increased loss.periods last year.
Financing Costs
Interest expense on our debt for the second quarter and first quartersix months of 2005 is level withdeclined 10% and 6%, respectively, compared to the first quartersame periods in 2004. These decreases were the result of 2004.the maturity in May 2005 of 7.25% senior notes for $193 million, partially offset by increased rates on floating rate debt and higher commercial paper borrowings. The favorable effects of the 2004 refinancing of certain fixed rate debt at lower rates was offset by increased rates on floating rate debt.also contributed to the improvement. For additional information on our financing activities, see “Review of Consolidated Financial Condition—Liquidity and Cash Flow—Sources of Liquidity and Cash Flow—Financing Activities.”
Amortization of Deferred Gain on Indemnity Reinsurance
Income from the amortization of the deferred gain includes an increase of 5% and 6% for the second quarter and first six months of 2005, compared to the same 2004 periods, resulting from ana third quarter 2004 adjustment to the deferred gain in the third quarter of 2004 on the reinsurance business sold in 2001.
Other Corporate
Other Corporate reportedhad operating income of $4.7$21.2 million and $25.8 million for the second quarter and first quartersix months of 2005, compared to an operating losslosses of $4.1$5.0 million and $8.9 million for the first quarter ofsame periods in 2004. Included in operating income for the second quarter and first quartersix months of 2005 is a $5.8are reductions of $23.5 million reductionand $29.3 million, respectively, in Federal income tax expense related to a partial releasereleases of a deferred tax valuation allowance in our Barbados insurance company. See Note 3 of the Consolidated Financial Statements for additional discussion. Lower litigation and other expenses also contributed to the first quarter 2005 improvement.improvements.
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CONSOLIDATED INVESTMENTS
The following table presents consolidated invested assets, net investment income and investment yield.
(in billions) | March 31, 2005 | December 31, 2004 | March 31, 2004 | ||||||||
Total Consolidated Investments (at Fair Value) | $ | 44.0 | $ | 44.5 | $ | 43.5 | |||||
Average Invested Assets (at Amortized Cost) | 43.9 | 43.2 | 42.6 | ||||||||
Three Months Ended March 31, (in millions) | 2005 | 2004 | |||||||||
Adjusted Net Investment Income(1) | $ | 659.8 | $ | 677.5 | |||||||
Investment Yield (ratio of net investment income to average invested assets) | 6.03 | % | 6.38 | % | |||||||
Items Included in Net Investment Income: | |||||||||||
Limited partnership investment income | $ | 9.0 | $ | 6.5 | |||||||
Prepayment and makewhole premiums | 2.6 | 3.3 | |||||||||
Contingent interest | — | 21.9 |
(in billions) | June 30, 2005 | December 31, 2004 | June 30, 2004 | ||||||
Total Consolidated Investments (at Fair Value) | $ | 44.9 | $ | 44.5 | $ | 42.4 | |||
Average Invested Assets (at Amortized Cost) | 43.8 | 43.2 | 42.5 |
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
(in millions) | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Adjusted Net Investment Income(1) | $ | 705.2 | $ | 684.8 | $ | 1,366.6 | $ | 1,364.0 | ||||||||
Investment Yield (ratio of net investment income to average invested assets) | 6.44 | % | 6.37 | % | 6.24 | % | 6.41 | % | ||||||||
Items Included in Net Investment Income: | ||||||||||||||||
Limited partnership investment income | $ | 21.1 | $ | 17.1 | $ | 30.0 | $ | 23.6 | ||||||||
Prepayment and makewhole premiums | 3.6 | 14.1 | 6.2 | 17.4 | ||||||||||||
Contingent interest | — | — | — | 21.9 | ||||||||||||
Standby real estate equity commitments | 26.0 | — | 26.0 | — |
(1) | Includes tax-exempt income on a tax equivalent basis. |
The decreaseincrease in our investment portfolio for the first quartersix months of 2005 resulted from a decline in the fair value of securities available-for-sale, partially offset by purchases of investments as a result of cash flow generated by the business segments.segments and an increase in the fair value of securities available-for-sale.
Our insurance assets are invested primarily in high quality fixed maturity securities that are expected to generate cash flows that will enable us to meet the liability funding requirements of our life insurance and annuity businesses. The dominant investments held are fixed maturity securities available-for-sale, which represent approximately 78% of the investment portfolio. Trading securities, which are primarily fixed maturity securities, represent approximately 7.3%7.5% of the investment portfolio.
We have the ability to maintain our investment holdings throughout credit cycles because of our capital position, the long-term nature of our liabilities and the matching of our portfolios of investment assets with the liabilities of our various products.
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The quality of our available-for-sale fixed maturity securities portfolio, as measured at fair value and by the percentage of fixed maturity securities invested in various ratings categories relative to the entire available-for-sale fixed maturity security portfolio, as of March 31,June 30, 2005 werewas as follows:
(in millions) | ||||||||||||||||||||||
NAIC Designation | Rating Agency Equivalent Designation | Amortized Cost | Estimated Fair Value | % of Total | ||||||||||||||||||
(in millions) NAIC Designation | Rating Agency Equivalent Designation | Amortized Cost | Estimated Fair Value | % of Total | ||||||||||||||||||
1 | AAA / AA / A | $ | 20,613.8 | $ | 21,352.0 | 62.4 | % | AAA / AA / A | $ | 20,802.6 | $ | 22,006.4 | 62.9 | % | ||||||||
2 | BBB | 10,346.8 | 10,820.7 | 31.6 | % | BBB | 10,081.1 | 10,724.5 | 30.7 | % | ||||||||||||
3 | BB | 1,261.8 | 1,283.2 | 3.8 | % | BB | 1,373.6 | 1,424.3 | 4.1 | % | ||||||||||||
4 | B | 479.5 | 495.9 | 1.4 | % | B | 565.0 | 587.0 | 1.7 | % | ||||||||||||
5 | CCC and lower | 182.8 | 177.1 | 0.5 | % | CCC and lower | 167.1 | 160.6 | 0.4 | % | ||||||||||||
6 | In or near default | 61.1 | 96.0 | 0.3 | % | In or near default | 47.0 | 72.3 | 0.2 | % | ||||||||||||
$ | 32,945.8 | $ | 34,224.9 | 100.0 | % | $ | 33,036.4 | $ | 34,975.1 | 100.0 | % | |||||||||||
The National Association of Insurance Commissioners (“NAIC”) assigns securities quality ratings and uniform valuations called “NAIC Designations” which are used by insurers when preparing their annual statements. The NAIC assigns designations to publicly traded as well as privately placed securities. The designations assigned by the NAIC range from class 1 to class 6, with designations in classes 1 and 2 generally considered investment grade.
As of March 31, 2005 and December 31, 2004, $2.1 billion, or 6.0%, and $2.2 billion, or 6.2%, respectively, of all fixedFixed maturity securities available-for-sale were invested in below investment grade securities (NAIC designations 3 thru 6). were $2.2 billion, or 6.4% and 6.2%, of all fixed maturity securities available-for-sale, as of June 30, 2005 and December 31, 2004, respectively. This represents 4.8%4.9% of the total investment portfolio at both March 31,June 30, 2005, andcompared to 4.8% at December 31, 2004. When viewed on aOn an amortized cost basis, below investment grade securities heldrepresented 6.5% and 6.2% of available-for-sale fixed maturity securities at March 31,June 30, 2005 and December 31, 2004, represented 6.0% and 6.2%, respectively, of fixed maturity securities.respectively.
Fixed Maturity and Equity Securities Portfolios: Fixed maturity securities and equity securities consist of portfolios classified as available-for-sale and trading. Mortgage-backed and private securities are included in both available-for-sale and trading portfolios.
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Available-for-Sale: Securities that are classified as “available-for-sale” make up 92%91% of our fixed maturity and equity securities portfolio. These securities are carried at fair value on our Consolidated Balance Sheets. 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. ChangesDecreases in fair value that are other than temporary are recorded as realized losses in the Consolidated Statements of Income.
Trading Securities: Investment results for these portfolios, including gains and losses from sales, are passed directly to the reinsurers through the contractual terms of the reinsurance arrangements. Trading securities are carried at fair value and changes in fair value are recorded in net income as they occur. Offsetting these amounts are corresponding changes in the fair value of the embedded derivative liability associated with the underlying reinsurance arrangement.
Mortgage-Backed Securities:Our fixed maturity securities include residential and commercial mortgage-backed securities. The mortgage-backed securities included in our investment portfolio are subject to risks associated with variable prepayments. This may result in these securities having a different actual cash flow and maturity than expected at the time of purchase. We limit the extent of our risk on mortgage-backed securities by prudently limiting exposure to the asset class, by generally avoiding the purchase of securities with a cost that significantly exceeds par, by purchasing securities backed by stable collateral, and by concentrating on securities with enhanced priority in their trust structure. Such securities with reduced risk typically have a lower yield (but higher liquidity) than higher-risk mortgage-backed securities. At selected times, higher-risk securities may be purchased if they do not compromise the safety of the general portfolio. Our investments in residential mortgage-backed securities at March 31,June 30, 2005 and December 31, 2004 totaled $3.8$4.1 billion and $3.6 billion, respectively. At March 31,June 30, 2005, our investments in commercial mortgage backed securities totaled $2.6 billion.
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Mortgage Loans on Real Estate and Real Estate:
The following summarizes key information on mortgage loans:
(in millions) | March 31, 2005 | December 31, 2004 | June 30, 2005 | December 31, 2004 | ||||||||||||
Total Portfolio (net of reserves) | $ | 3,805.7 | $ | 3,856.9 | $ | 3,750.6 | $ | 3,856.9 | ||||||||
Percentage of total investment portfolio | 8.7 | % | 8.7 | % | 8.4 | % | 8.7 | % | ||||||||
Percentage of investment by property type | ||||||||||||||||
Commercial office buildings | 39.3 | % | 39.2 | % | 39.1 | % | 39.2 | % | ||||||||
Retail stores | 20.4 | % | 20.2 | % | 20.3 | % | 20.2 | % | ||||||||
Industrial buildings | 17.4 | % | 17.9 | % | 17.4 | % | 17.9 | % | ||||||||
Apartments | 12.1 | % | 11.6 | % | 12.3 | % | 11.6 | % | ||||||||
Hotels/motels | 6.8 | % | 7.1 | % | 6.8 | % | 7.1 | % | ||||||||
Other | 4.0 | % | 4.0 | % | 4.1 | % | 4.0 | % | ||||||||
Impaired mortgage loans | $ | 80.2 | $ | 84.0 | $ | 71.8 | $ | 84.0 | ||||||||
Impaired mortgage loans as a percentage of total mortgage loans | 2.1 | % | 2.2 | % | 1.9 | % | 2.2 | % | ||||||||
Restructured loans in good standing | $ | 74.1 | $ | 69.5 | $ | 70.7 | $ | 69.5 | ||||||||
Reserve for mortgage loans | $ | 13.8 | $ | 15.5 | $ | 11.1 | $ | 15.5 |
In addition to the dispersion by property type, the mortgage loan portfolio is geographically diversified throughout the United States.
All mortgage loans that are impaired have an established allowance for credit loss. Changing economic conditions impact our valuation of mortgage loans. IncreasingChanging vacancies and declining rents are incorporated into the discounted cash flow analysis that we perform for monitored loans and may contribute to the establishment of (or an increase in) an allowancechanges in allowances for credit losses. In addition, we continue to monitor the entire commercial mortgage loan portfolio to identify risk. Areas of current emphasis are the hotel, mortgage loan portfolio and retail, office and industrial properties that have deteriorating credits or have experienced debt coverage reduction. Where warranted, we have established or increased loss reserves based upon this analysis. Impaired mortgage loans as a percentagewere 1.9% and 2.2% of total mortgage loans was 2.1% and 2.2% as of March 31,June 30, 2005 and December 31, 2004, respectively. As of March 31,June 30, 2005 and December 31, 2004, all commercial mortgage loans were current as to principleprincipal and interest payments.
Limited Partnership Investments: As of March 31,June 30, 2005 and December 31, 2004, there were $300.1$288.2 million and $270.6 million, respectively, of limited partnership investments included in consolidated investments. These include investments in approximately 5450 different partnerships that allow us to gain exposure to a broadly diversified portfolio of asset classes such as venture capital, hedge funds, and oil and gas. Limited partnership investments are accounted for using the equity method of accounting and the majority of these investments are included in other investments in the Consolidated Balance Sheets.
Net Investment Income:Net investment income decreased 2.6%increased 3% in the second quarter and was essentially level for the first threesix months of 2005, when compared withto the first three months ofsame periods in 2004. Excluding contingent interest, and commercial mortgage loan prepayment and bond makewhole premiums, partnership income and fees received from the contingent acquisition financing program, the favorable effect of asset growth from net flows was more than offset by a declining portfolio yield.yields. The decline in yields was due to lower interest rates on new securities purchased to replace matured securities and new securities purchased from net product deposits into the portfolio.
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Fixed maturity securities, mortgage loans on real estate and real estate that were non-income producing for the three months ended March 31,June 30, 2005 were not significant. As of March 31,June 30, 2005 and December 31, 2004, the carrying value of non-income producing securities was $134.4$108.8 million and $147.4 million, respectively.
The following discussion addresses our invested assets excluding trading account securities. As discussed above, investment results attributable to the trading securities are passed directly to the reinsurers under the terms of the reinsurance arrangements. For additional information regarding our investments seeSee the discussion in our 2004 annual report on Form 10-K under “Consolidated Investments.”Investments” for additional information regarding our investments.
Realized Gains and Losses on Investments and Derivative Instruments: We had net pre-tax realized losses on investments and derivatives of $7.2$4.0 million and $15.9$20.6 million for the three months ended March 31,June 30, 2005 and 2004, respectively, and $11.3 million and $36.5 million for the six months ended June 30, 2005 and 2004, respectively. Prior to the amortization of acquisition costs, provision for policyholder commitments and investment expenses, pre-taxnet realized investment gains net of losses(losses) were $8.6$12.5 million and $6.5$(15.1) million for the three months ended March 31,June 30, 2005 and 2004, respectively, and $21.0 million and $(8.6) million for the six months ended June 30, 2005 and 2004, respectively.
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The grossGross realized gains on fixed maturity and equity securities were $26.7$32.2 million and $37.6$58.9 million for the three and six months ended March 31,June 30, 2005, respectively, compared to $28.5 million and 2004, respectively.$66.1 million for the same periods in 2004. Gross realized losses on fixed maturity and equity securities were $20.6$12.7 million and $22.7$33.3 million for the three and six months ended March 31,June 30, 2005, respectively, compared to $40.6 million and 2004, respectively.$63.3 million for the same periods in 2004. Included withinin the gross realized losses for fixed maturities and equity securities are write-downs for impairments of $9.2$2.4 million and $9.4$11.6 million for the three and six months ended March 31,June 30, 2005, respectively, compared to $18.6 million and 2004, respectively.$28.1 million for the same periods in 2004.
For additional information regarding our process for determining whether declines in fair value of securities available-for-sale are other than temporary, see the discussion in our 2004 annual report on Form 10-K under “Critical Accounting Policies – Write-Downs for Other-Than Temporary Impairments and Allowance for Losses.”Losses” in our 2004 Form 10-K.
Unrealized Gains and Losses—Available-for-Sale Securities:When considering unrealized gain and loss information, it is important to realize that the information relates to the status of securities at a particular point in time, and may not be indicative of the status of our investment portfolios subsequent to the balance sheet date. Further, since the timing of the recognition of realized investment gains and losses through the selection of which securities are sold is largely at management’s discretion, it is important to consider the information provided below within the context of the overall unrealized gain or loss position of our investment portfolios. These are important considerations that should be included in any evaluation of the potential impact of unrealized loss securities on our future earnings. We had an overall net unrealized gain (after the amortization of acquisition costs, provision for policyholder commitments, investment expenses and taxes) on securities available-for-sale under Statement of Financial Accounting StandardsSFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” of $582.9$851.2 million and $822.9 million at March 31,June 30, 2005 and December 31, 2004, respectively.
At March 31,June 30, 2005 and December 31, 2004, gross unrealized gains on securities available-for-sale were $1,566.8$2,106.2 million and $2,035.8 million, respectively, and gross unrealized losses on securities available-for-sale were $275.6$154.7 million and $135.3 million, respectively. At March 31,June 30, 2005, gross unrealized gains and losses on fixed maturity securities available-for-sale were $1,553.6$2,092.2 million and $274.5$153.5 million, respectively, and gross unrealized gains and losses on equity securities available-for-sale were $13.2$14.0 million and $1.1$1.2 million, respectively. At December 31, 2004, gross unrealized gains and losses on fixed maturity securities available-for-sale were $2,020.0 million and $134.8 million, respectively, and gross unrealized gains and losses on equity securities available-for-sale were $15.8 million and $0.5 million, respectively. Changes in unrealized gains and losses can be attributed to changes in interest rates and credit spreads, which have created temporary price fluctuations.
For total publicly traded and private securities that we held at March 31, 2005 that were in unrealized loss status, theThe fair value, amortized cost, unrealized loss and total time period that the security has been in an unrealized loss position for total publicly traded and private securities that we held at June 30, 2005 that were in an unrealized loss position are presented in the table below.
(in millions) | Fair Value | % Fair Value | Amortized Cost | % Amortized Cost | Unrealized Loss | % Unrealized Loss | Fair Value | % Fair Value | Amortized Cost | % Amortized Cost | Unrealized Loss | % Unrealized Loss | ||||||||||||||||||||||||||
£ 90 days | $ | 6,281.9 | 64.4 | % | $ | 6,377.2 | 63.6 | % | $ | (95.3 | ) | 34.6 | % | $ | 903.5 | 19.0 | % | $ | 914.0 | 18.6 | % | $ | (10.5 | ) | 6.8 | % | ||||||||||||
> 90 days but£ 180 days | 1,256.9 | 12.9 | % | 1,287.1 | 12.8 | % | (30.2 | ) | 11.0 | % | 1,175.5 | 24.8 | % | 1,192.0 | 24.3 | % | (16.5 | ) | 10.7 | % | ||||||||||||||||||
> 180 days but£ 270 days | 237.9 | 2.5 | % | 246.9 | 2.5 | % | (9.0 | ) | 3.2 | % | 804.2 | 16.9 | % | 816.3 | 16.7 | % | (12.1 | ) | 7.8 | % | ||||||||||||||||||
> 270 days but£ 1 year | 881.0 | 9.0 | % | 930.8 | 9.3 | % | (49.8 | ) | 18.1 | % | 294.9 | 6.2 | % | 315.4 | 6.4 | % | (20.5 | ) | 13.3 | % | ||||||||||||||||||
> 1 year | 1,091.6 | 11.2 | % | 1,182.9 | 11.8 | % | (91.3 | ) | 33.1 | % | 1,570.2 | 33.1 | % | 1,665.3 | 34.0 | % | (95.1 | ) | 61.4 | % | ||||||||||||||||||
Total | $ | 9,749.3 | 100.0 | % | $ | 10,024.9 | 100.0 | % | $ | (275.6 | ) | 100.0 | % | $ | 4,748.3 | 100.0 | % | $ | 4,903.0 | 100.0 | % | $ | (154.7 | ) | 100.0 | % | ||||||||||||
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The composition by industry categories of all securities that we held at June 30, 2005 in an unrealized loss status which we held at March 31, 2005position is presented in the table below.below:
(in millions) | Fair Value | % Fair Value | Amortized Cost | % Amortized Cost | Unrealized Loss | % Unrealized Loss | Fair Value | % Fair Value | Amortized Cost | % Amortized Cost | Unrealized Loss | % Unrealized Loss | ||||||||||||||||||||||||||
Automotive | $ | 205.1 | 4.3 | % | $ | 236.5 | 4.8 | % | $ | (31.4 | ) | 20.3 | % | |||||||||||||||||||||||||
Banking | $ | 940.2 | 9.6 | % | $ | 965.8 | 9.6 | % | $ | (25.6 | ) | 9.3 | % | 597.1 | 12.6 | % | 617.5 | 12.6 | % | (20.4 | ) | 13.2 | % | |||||||||||||||
Automotive | 206.4 | 2.1 | % | 231.6 | 2.3 | % | (25.2 | ) | 9.1 | % | ||||||||||||||||||||||||||||
Airlines | 106.2 | 2.2 | % | 120.6 | 2.5 | % | (14.4 | ) | 9.4 | % | ||||||||||||||||||||||||||||
Media—Non-cable | 132.0 | 2.8 | % | 144.3 | 2.9 | % | (12.3 | ) | 8.0 | % | ||||||||||||||||||||||||||||
Collateralized mortgage obligations (“CMO”) | 410.1 | 8.6 | % | 416.3 | 8.5 | % | (6.2 | ) | 4.0 | % | ||||||||||||||||||||||||||||
Asset-backed securities (“ABS”) | 254.9 | 5.4 | % | 260.9 | 5.3 | % | (6.0 | ) | 3.9 | % | ||||||||||||||||||||||||||||
Chemicals | 92.4 | 1.9 | % | 98.2 | 2.0 | % | (5.8 | ) | 3.8 | % | ||||||||||||||||||||||||||||
Electric Power | 665.2 | 6.8 | % | 683.4 | 6.8 | % | (18.2 | ) | 6.6 | % | 323.4 | 6.8 | % | 329.1 | 6.7 | % | (5.7 | ) | 3.7 | % | ||||||||||||||||||
Collateralized mortgage obligations (“CMO”) | 1,140.1 | 11.7 | % | 1,157.2 | 11.5 | % | (17.1 | ) | 6.2 | % | ||||||||||||||||||||||||||||
Media—Cable | 34.4 | 0.7 | % | 38.8 | 0.8 | % | (4.4 | ) | 2.8 | % | ||||||||||||||||||||||||||||
Commercial mortgage-backed securities (“CMBS”) | 731.8 | 7.5 | % | 745.7 | 7.4 | % | (13.9 | ) | 5.0 | % | 240.8 | 5.1 | % | 245.1 | 5.0 | % | (4.3 | ) | 2.8 | % | ||||||||||||||||||
Airlines | 114.5 | 1.2 | % | 126.8 | 1.3 | % | (12.3 | ) | 4.5 | % | ||||||||||||||||||||||||||||
Retailers | 153.8 | 1.6 | % | 166.1 | 1.7 | % | (12.3 | ) | 4.5 | % | 102.7 | 2.2 | % | 106.7 | 2.2 | % | (4.0 | ) | 2.6 | % | ||||||||||||||||||
Asset-backed securities (“ABS”) | 477.3 | 4.9 | % | 488.9 | 4.9 | % | (11.6 | ) | 4.2 | % | ||||||||||||||||||||||||||||
Technology | 93.3 | 2.0 | % | 96.5 | 2.0 | % | (3.2 | ) | 2.1 | % | ||||||||||||||||||||||||||||
Wirelines | 129.5 | 2.7 | % | 132.5 | 2.7 | % | (3.0 | ) | 1.9 | % | ||||||||||||||||||||||||||||
Consumer Products | 97.1 | 2.0 | % | 99.7 | 2.0 | % | (2.6 | ) | 1.7 | % | ||||||||||||||||||||||||||||
Brokerage | 65.8 | 1.4 | % | 68.2 | 1.4 | % | (2.4 | ) | 1.6 | % | ||||||||||||||||||||||||||||
Paper | 44.9 | 0.9 | % | 47.3 | 1.0 | % | (2.4 | ) | 1.5 | % | ||||||||||||||||||||||||||||
Food and Beverage | 169.4 | 3.6 | % | 171.3 | 3.5 | % | (1.9 | ) | 1.2 | % | ||||||||||||||||||||||||||||
Foreign Local Governments | 36.0 | 0.8 | % | 37.6 | 0.8 | % | (1.6 | ) | 1.0 | % | ||||||||||||||||||||||||||||
Non-Captive Diversified | 107.0 | 2.3 | % | 108.6 | 2.2 | % | (1.6 | ) | 1.0 | % | ||||||||||||||||||||||||||||
Property & Casualty insurers (“P&C”) | 84.0 | 1.8 | % | 85.4 | 1.7 | % | (1.4 | ) | 0.9 | % | ||||||||||||||||||||||||||||
Entertainment | 263.2 | 2.7 | % | 274.2 | 2.7 | % | (11.0 | ) | 4.0 | % | 29.9 | 0.6 | % | 31.3 | 0.6 | % | (1.4 | ) | 0.8 | % | ||||||||||||||||||
Media—Non-cable | 143.2 | 1.5 | % | 153.6 | 1.5 | % | (10.4 | ) | 3.8 | % | ||||||||||||||||||||||||||||
Sovereigns | 398.5 | 4.1 | % | 408.8 | 4.1 | % | (10.3 | ) | 3.7 | % | ||||||||||||||||||||||||||||
Chemicals | 128.8 | 1.3 | % | 136.2 | 1.4 | % | (7.4 | ) | 2.7 | % | ||||||||||||||||||||||||||||
Wirelines | 231.0 | 2.4 | % | 238.1 | 2.4 | % | (7.1 | ) | 2.6 | % | ||||||||||||||||||||||||||||
Food and Beverage | 223.9 | 2.3 | % | 230.0 | 2.3 | % | (6.1 | ) | 2.2 | % | ||||||||||||||||||||||||||||
Technology | 130.4 | 1.3 | % | 135.4 | 1.4 | % | (5.0 | ) | 1.8 | % | ||||||||||||||||||||||||||||
Consumer Products | 115.6 | 1.2 | % | 119.9 | 1.2 | % | (4.3 | ) | 1.6 | % | ||||||||||||||||||||||||||||
Media—Cable | 19.1 | 0.2 | % | 22.8 | 0.2 | % | (3.7 | ) | 1.3 | % | ||||||||||||||||||||||||||||
30YR Mortgage | 430.6 | 4.4 | % | 434.3 | 4.3 | % | (3.7 | ) | 1.3 | % | ||||||||||||||||||||||||||||
Pipelines | 71.6 | 1.5 | % | 72.8 | 1.5 | % | (1.2 | ) | 0.8 | % | ||||||||||||||||||||||||||||
Government | 130.4 | 1.3 | % | 134.1 | 1.3 | % | (3.7 | ) | 1.3 | % | 25.9 | 0.5 | % | 26.9 | 0.5 | % | (1.0 | ) | 0.6 | % | ||||||||||||||||||
Distributors | 120.9 | 1.2 | % | 124.2 | 1.2 | % | (3.3 | ) | 1.2 | % | ||||||||||||||||||||||||||||
Property & Casualty insurers (“P&C”) | 236.3 | 2.4 | % | 239.6 | 2.4 | % | (3.3 | ) | 1.2 | % | ||||||||||||||||||||||||||||
Non-Captive Diversified | 172.4 | 1.8 | % | 175.7 | 1.8 | % | (3.3 | ) | 1.2 | % | ||||||||||||||||||||||||||||
Pipelines | 116.5 | 1.2 | % | 119.7 | 1.2 | % | (3.2 | ) | 1.2 | % | ||||||||||||||||||||||||||||
Federal Home Loan MTG Corp | 181.9 | 1.9 | % | 184.9 | 1.8 | % | (3.0 | ) | 1.1 | % | ||||||||||||||||||||||||||||
Diversified Manufacturing | 48.6 | 0.5 | % | 51.5 | 0.5 | % | (2.9 | ) | 1.1 | % | ||||||||||||||||||||||||||||
Paper | 116.0 | 1.2 | % | 118.7 | 1.2 | % | (2.7 | ) | 1.0 | % | ||||||||||||||||||||||||||||
Municipal | 112.6 | 1.2 | % | 115.3 | 1.2 | % | (2.7 | ) | 1.0 | % | ||||||||||||||||||||||||||||
Brokerage | 107.0 | 1.1 | % | 109.7 | 1.1 | % | (2.7 | ) | 1.0 | % | ||||||||||||||||||||||||||||
Foreign Local Governments | 90.6 | 0.9 | % | 93.2 | 0.9 | % | (2.6 | ) | 0.9 | % | ||||||||||||||||||||||||||||
Federal National MTG Assn. | 165.5 | 1.7 | % | 167.9 | 1.7 | % | (2.4 | ) | 0.9 | % | ||||||||||||||||||||||||||||
Financial Other | 122.2 | 1.3 | % | 124.4 | 1.2 | % | (2.2 | ) | 0.8 | % | ||||||||||||||||||||||||||||
Metals and Mining | 141.8 | 1.5 | % | 144.0 | 1.4 | % | (2.2 | ) | 0.8 | % | ||||||||||||||||||||||||||||
Transportation Services | 49.6 | 0.5 | % | 51.6 | 0.5 | % | (2.0 | ) | 0.7 | % | ||||||||||||||||||||||||||||
Non-Captive Consumer | 107.6 | 1.1 | % | 109.5 | 1.1 | % | (1.9 | ) | 0.7 | % | ||||||||||||||||||||||||||||
Industrial—Other | 58.1 | 0.6 | % | 60.0 | 0.6 | % | (1.9 | ) | 0.7 | % | ||||||||||||||||||||||||||||
Captive | 18.1 | 0.2 | % | 19.9 | 0.2 | % | (1.8 | ) | 0.7 | % | ||||||||||||||||||||||||||||
Real estate investment trusts (“REITS”) | 72.3 | 0.7 | % | 74.1 | 0.7 | % | (1.8 | ) | 0.7 | % | ||||||||||||||||||||||||||||
Home Construction | 47.0 | 0.5 | % | 48.5 | 0.5 | % | (1.5 | ) | 0.5 | % | ||||||||||||||||||||||||||||
Consumer Services | 34.9 | 0.4 | % | 36.3 | 0.4 | % | (1.4 | ) | 0.5 | % | ||||||||||||||||||||||||||||
Transportation | 23.8 | 0.2 | % | 25.2 | 0.3 | % | (1.4 | ) | 0.5 | % | ||||||||||||||||||||||||||||
Mortgage | 77.8 | 0.8 | % | 79.1 | 0.8 | % | (1.3 | ) | 0.5 | % | ||||||||||||||||||||||||||||
15YR Mortgage | 62.6 | 0.6 | % | 63.8 | 0.6 | % | (1.2 | ) | 0.4 | % | ||||||||||||||||||||||||||||
Oil Field Services | 68.2 | 0.7 | % | 69.2 | 0.7 | % | (1.0 | ) | 0.4 | % | ||||||||||||||||||||||||||||
Industries with U/R Losses < $1MM | 753.0 | 7.7 | % | 766.0 | 7.7 | % | (13.0 | ) | 4.6 | % | 1,294.8 | 27.3 | % | 1,310.9 | 26.8 | % | (16.1 | ) | 10.4 | % | ||||||||||||||||||
Total | $ | 9,749.3 | 100.0 | % | $ | 10,024.9 | 100.0 | % | $ | (275.6 | ) | 100.0 | % | $ | 4,748.3 | 100.0 | % | $ | 4,903.0 | 100.0 | % | $ | (154.7 | ) | 100.0 | % | ||||||||||||
Unrealized losses on available-for-sale securities subject to enhanced analysis were $12.7$15.1 million at March 31,June 30, 2005, compared with $16.4 million at December 31, 2004.
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Unrealized Loss on All Below-Investment-Grade Available-for-Sale Fixed Maturity Securities: Gross unrealized losses on all available-for-sale below-investment-grade securities were $63.0$55.6 million at March 31,June 30, 2005, representing 22.9%36% of total gross unrealized losses on all available-for-sale securities. Generally, below-investment-grade fixed maturity securities are more likely than investment-grade securities to develop credit concerns. The remaining $212.6$99.1 million, or 77.1%64%, of the gross unrealized losses relate to investment grade available-for-sale securities. The ratios of fair value to amortized cost reflected in the table below are not necessarily indicative of the fair value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of these ratios subsequent to March 31,June 30, 2005.
For fixed maturity securities that we held at March 31,June 30, 2005 that are below-investment-grade and in an unrealized loss position, the fair value, amortized cost, unrealized loss and the ratios of market value to amortized cost are presented in the table below.below:
Aging Category (in millions) | Ratio of Amortized Cost to Fair Value | Fair Value | Amortized Cost | Unrealized Loss | Ratio of Amortized | Fair Value | Amortized Cost | Unrealized Loss | ||||||||||||||||
<=90 days | 70% to 100% | $ | 479.0 | $ | 491.9 | $ | (12.9 | ) | 70% to 100% | $ | 161.7 | $ | 162.7 | $ | (1.0 | ) | ||||||||
>90 days but <=180 days | 70% to 100% | 30.6 | 31.7 | (1.1 | ) | 70% to 100% | 155.1 | 161.2 | (6.1 | ) | ||||||||||||||
>180 days but <=270 days | 70% to 100% | 22.0 | 24.9 | (2.9 | ) | 70% to 100% | 23.9 | 24.6 | (0.7 | ) | ||||||||||||||
>270 days but <=1 year | 70% to 100% | 91.6 | 103.0 | (11.4 | ) | 70% to 100% | 59.2 | 63.8 | (4.6 | ) | ||||||||||||||
<=1 year Total | 623.2 | 651.5 | (28.3 | ) | ||||||||||||||||||||
>1 year | 70% to 100% | 186.4 | 212.7 | (26.3 | ) | 70% to 100% | 311.2 | 354.4 | (43.2 | ) | ||||||||||||||
40% to 70% | 15.4 | 23.8 | (8.4 | ) | ||||||||||||||||||||
>1 year Total | 201.8 | 236.5 | (34.7 | ) | ||||||||||||||||||||
Total Below-Investment-Grade | $ | 825.0 | $ | 888.0 | $ | (63.0 | ) | $ | 711.1 | $ | 766.7 | $ | (55.6 | ) | ||||||||||
At March 31,June 30, 2005, and December 31, 2004, less than 5.9% and 5.8%, respectively,the range of thematurity dates for these publicly traded and private securities held that were subject to enhanced analysis and monitoring for potential changes in unrealized loss status were rated as investment grade. At March 31, 2005, the range of maturity dates for these securities varies, with about 36.1%22% of these securities maturing between 5 and 10 years, about 18.0%22% maturing in greater than 10 years and the remaining securities maturing in less than 5 years. At December 31, 2004, the range of maturity dates for these securities varies, with about 19.4%19% maturing between 5 and 10 years, 43.3%43% maturing after 10 years and the remaining securities maturing in less than 5 years. At June 30, 2005 and December 31, 2004 5% of these securities were rated as investment grade.
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Unrealized Loss on Fixed Maturity Securities Available-for-Sale in Excess of $10 million: At March 31,June 30, 2005, we had fixed maturity available-for-sale securities with gross unrealized losses greater than $10 million. At March 31, 2005, there were no non-investment grade available-for-sale fixed maturity securities with unrealized losses in excess of $10 million. TheAt June 30, 2005 we had fixed maturity securities available-for-sale with a gross unrealized loss oflosses greater than $10 million were related to a large U.S. automobile manufacturer. The securities, which had a fair value of $28.1 million and an amortized cost of $40.4 million, had been in an unrealized loss position for more than 270 days, but less than one year and had a fair value of $24.9 million, amortized cost of $35.2 million and an unrealized loss of $10.3 million.year. At March 31,June 30, 2005, our total available-for-sale holdings in this company werecompany’s securities had a fair value of $47.8$51.1 million and an amortized cost of $57.8$62.9 million. In addition, at March 31,June 30, 2005, we held fixed maturity securities available-for-sale securities of another large U.S. automobile manufacturer with fair value of $63.7$73.1 million and amortized cost of $63.9$72.0 million. Our total gross unrealized loss on available-for-sale securities for these two companies was $12.9$15.7 million.
The information presented above is subject to rapidly changing conditions. As such, we expect that the level of securities with overall unrealized losses will fluctuate, as will the level of unrealized loss securities that are subject to enhanced analysis and monitoring.
REINSURANCE
Our insurance companies cede insurance to other companies. The portion of risks exceeding each company’s retention limit is reinsured with other insurers. We seek reinsurance coverage within the businesses that sell life insurance to limit our exposure to mortality losses and enhance our capital management. Prior to 2003, our retention policy was to retain no more than $10 million on a single insured life. Beginning in 2003, the retention policy was changed to limit retention on new sales to $5 million on a single insured life issued on fixed and variable universal life insurance contracts. Additionally, the retention per single insured life for term life insurance and for COLI is $1 million and $2 million, respectively. Portions of our deferred annuity business have been reinsured on a Modco basis with other companies to limit our exposure to interest rate risks. At March 31,June 30, 2005, the reserves associated with these reinsurance arrangements totaled $2.3$2.4 billion. To cover products other than life insurance, we acquire other insurance coverages with retentions and limits that management believes
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are appropriate for the circumstances. The accompanying financial statements reflect premiums, benefits and deferred acquisition costs, net of insurance ceded. See “Part I—Item 1—Risk Factors” and “Forward-looking Statements—Cautionary Language” and Note 5 to the Consolidated Financial Statements in our 2004 annual report on Form 10-K for further information. Our insurance companies remain liable if their reinsurers are unable to meet contractual obligations under applicable reinsurance agreements.
Our Consolidated Balance Sheets include an asset for amounts recoverable from reinsurers which represents receivables from and reserves ceded to reinsurers. At March 31, 2005 and December 31, 2004, the amounts recoverable from reinsurers were $7.3 billion and $7.1 billion, respectively. We obtain reinsurance from a diverse group of reinsurers and we monitor concentration as well as financial strength ratings of our principal reinsurers. Our principal reinsurers are strongly rated companies, with Swiss Re representing the largest exposure. We sold our reinsurance segmentbusiness to Swiss Re primarily through an indemnity reinsurance arrangementarrangements in 2001. Because we are not relieved of our liability to the ceding companies for this business, the liabilities and obligations associated with the reinsured contracts remain on our Consolidated Balance Sheets with a corresponding reinsurance receivable from the business sold to Swiss Re, which totaled $4.5 billion and $4.4 billion at March 31,June 30, 2005, and December 31, 2004, respectively.is included in amounts recoverable from reinsurers. During 2004, Swiss Re funded a trust for $2.0 billion to support this business. In addition to various remedies that we would have in the event of a default by Swiss Re, we continue to hold assets in support of certain of the transferred reserves. These assets primarily consist of those reported as trading securities and certain mortgage loans. Our funds withheld and embedded derivative liabilities at June 30, 2005 included $1.9$2.0 billion and $0.3 billion, respectively, at March 31, 2005 and December 31, 2004, related to the business reinsured by Swiss Re.
REVIEW OF CONSOLIDATED FINANCIAL CONDITION
Liquidity 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. Our principal sources of cash flow from operating activities are insurance and investment advisory fees and investment income, while investing cash flows originate from maturities and sales of invested assets. We use cash to pay policy claims and benefits, operating expenses, commissions, and taxes, to purchase new investments, to pay dividends to our shareholders and to repurchase our stock. The Consolidated Statements of Cash Flows in the unaudited Consolidated Financial Statements indicate thatOur operating activities provided cash of $191.2$377.4 million during the first threesix months of 2005. This statement also classifies the other sources and uses of cash by investing activities and financing activities and discloses the amount of cash available at the end of the year to meet our obligations.
When considering our liquidity and cash flow it is important to distinguish between the needs of our insurance subsidiaries, including The Lincoln National Life Insurance Company (“LNL”), our principal insurance subsidiary, and the needs of the holding company, LNC. As a holding company with no operations of its own, LNC derives itswe derive our cash primarily from itsour operating subsidiaries.
The liquidity resources of the holding company are principally comprised of dividends and interest payments from subsidiaries augmented by holding company short-term investments, bank lines of credit, a commercial paper program, and the ongoing availability of long-term financing under an SEC shelf registration. These sources of liquidity and cash flow support the general corporate needs of the holding company including its common stock dividends, interest and debt service, funding of callable securities, securities repurchases, and acquisitions.
Sources of Liquidity and Cash Flow
The following table summarizes the primary sources of holding company cash flow. The table focuses on significant and recurring cash flow items and excludes the effects of certain financing activities, namely the periodic issuance and retirement of
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debt and cash flows related to our intercompany cash management account. Taxes have been eliminated from the analysis due to a tax sharing agreement among our primary subsidiaries resulting in a modest impact on net cash flows at the holding company. Also excluded from this analysis is the modest amount of investment income on short-term investments of the holding company.
Three Months Ended March 31, | Year Ended 2004 | Three Months Ended June 30, | Six Months Ended June 30, | Year Ended 2004 | ||||||||||||||||||||
(in millions) | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | ||||||||||||||||||
Dividends from Subsidiaries | ||||||||||||||||||||||||
LNL | $ | 100.0 | $ | 50.0 | $ | 150.0 | $ | — | $ | 50.0 | $ | 100.0 | $ | 100.0 | $ | 150.0 | ||||||||
Delaware Investments | 10.5 | — | 59.0 | 10.5 | 23.6 | 21.0 | 23.6 | 59.0 | ||||||||||||||||
Lincoln UK | — | — | 28.9 | — | — | — | — | 28.9 | ||||||||||||||||
Other | — | — | 1.0 | — | 1.0 | — | 1.0 | 1.0 | ||||||||||||||||
Subsidiary Loan Repayments & Interest | ||||||||||||||||||||||||
LNL Interest on Surplus Notes (1) | 19.5 | 19.5 | 78.0 | 19.5 | 19.5 | 39.0 | 39.0 | 78.0 | ||||||||||||||||
Lincoln UK | — | 19.3 | 39.3 | — | 20.0 | — | 39.3 | 39.3 | ||||||||||||||||
$ | 130.0 | $ | 88.8 | $ | 356.2 | $ | 30.0 | $ | 114.1 | $ | 160.0 | $ | 202.9 | $ | 356.2 | |||||||||
Other Cash Flow and Liquidity Items | ||||||||||||||||||||||||
Dividend of proceeds from sale of DIAL | $ | — | $ | — | $ | 141.5 | $ | — | $ | — | $ | — | $ | — | $ | 141.5 | ||||||||
Variable annuity contract withdrawal | — | — | 65.4 | — | 65.4 | — | 65.4 | 65.4 | ||||||||||||||||
Return of seed capital | — | 9.6 | 33.4 | 15.2 | 7.0 | 15.2 | 16.6 | 33.4 | ||||||||||||||||
Net capital received from stock option exercises | 25.5 | 36.3 | 77.5 | 5.0 | 24.3 | 30.5 | 60.6 | 77.5 | ||||||||||||||||
$ | 25.5 | $ | 45.9 | $ | 317.8 | $ | 20.2 | $ | 96.7 | $ | 45.7 | $ | 142.6 | $ | 317.8 | |||||||||
(1) | Represents interest on the holding company’s $1.25 billion in surplus note investments in LNL. |
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Subsidiaries
It is important to note that, regardless of the particular state regulations, we take into account the overall health of the business, capital quality, and business and environmental risk in determining statutory dividend strategy.
2005 LNL Dividend Capacity:Dividends: Provided that earned surplus is positive (after giving effect for the dividend request), the cumulative total of all dividends paid in the past 12 months cannot exceed the greater of 10% of the insurer’s policyholders’ surplus, as shown on its last annual statement on file with the Indiana Insurance Commissioner (“Commissioner”) surplus (LNL’s policyholder surplus was approximately $3.0 billion at December 31, 2004) or the insurer’s statutory net gain for the previous calendar year (2004 statutory net gain was $181.3 million for LNL). LNL had positive earned surplus of $230.0 million at December 31, 2004. Based upon anticipated on-going positive statutory net gain and stable credit markets, LNL expects to be able tocould pay up to $293 million in dividends to LNCus in 2005 without prior approval from the Commissioner. This represents 10% of LNL’s policyholder surplus at December 31, 2004. LNL continues to qualify for the “ordinary dividend” process with the Indiana Department of Insurance requiring only notification of dividend payments and not requiring formal approval for the dividend.
2005 LNL Dividends: Statutory earned surplus was positive at December 31, 2004, and LNL paid adividends of $100 million dividend in the first quartersix months of 2005, which did not require prior approval.approval of the Commissioner.
2004 LNL Dividends: Statutory earned surplus was positive at December 31, 2003, and LNL’s 2004LNL paid dividends of $150$50 million and $100 million for the second quarter and first six months of 2004, respectively, which did not require prior approval.approval of the Commissioner.
Our UL LPR products and certain other products are subject to Actuarial Guideline 38 (also known as “AXXX”) and XXX reserving requirements. GAAP reserves are not subject to AXXX and XXX statutory reserving requirements. As stated previously, in July 2005, a Committee of the NAIC adopted a change to AXXX, which is expected to be formally adopted by the NAIC in September 2005 with an effective date of July 1, 2005. The proposal does not affect business written prior to the effective date of July 1, 2005. However, based on early analysis and normalized sales, we expect that it could result in up to $100 million of additional statutory reserves on UL products sold with secondary guarantees beginning with sales on July 1, 2005. Although this will not have a material impact on cash flows to LNC, LNL is employing strategies to lessen the burden of increased statutory reserves associated with these statutory reserving requirements. Strategies include a mix of letters of credit (“LOC”), reinsurance and capital markets solutions that provide for risk transfer and associated reserve and surplus relief. Currently, the majority of LPR business is reinsured with a wholly owned non-U.S. domiciled subsidiary of LNC.
Under prior Federal income tax law, one-half of the excess of a life insurance company’s income from operations over its taxable investment income was not taxed, but was set aside in a special tax account designated as “Policyholders’ Surplus.” At December 31, 2004, LNCwe had approximately $200.7 million of untaxed “Policyholders’ Surplus” on which no payment of Federal income taxes will be required unless it is distributed as a dividend, or under other specified conditions. On October 23, 2004, President Bush signed into law the “American Jobs Creation Act of 2004.” Beginning January 1, 2005 through December 31, 2006, the additional tax imposed on distributions from the special tax account, “Policyholders’ Surplus,” is suspended. In addition, the statute provides that distributions made during the two-year suspension period will first reduce the “Policyholders’ Surplus” account
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balance. Based on dividend activity in the first quarterhalf of 2005, the untaxed “Policyholders’ Surplus” account was reduced to $95.9 million at March 31,June 30, 2005, and no income taxes were required. We believe that our dividend activity will be sufficient to eliminate the account balance during the suspension period.
Lincoln UK’s operations consist primarily of unit-linked life and pension products, which are similar to U.S. produced variable life and annuity products. Lincoln UK’s insurance subsidiaries are regulated by the U.K. Financial Services Authority (“FSA”) and are subject to capital requirements as defined by the U.K. Capital Resources Requirement (formerly the Required Minimum Solvency Margin.Margin). Lincoln UK targets maintaining approximately 1.5 to 2.0 times the required capital as prescribed by the regulatory margin.resource requirement. Effective January 1, 2005, all insurance companies operating in the U.K have to complete a risk-based capital assessment to demonstrate to the FSA that they hold sufficient capital to cover their risks. Risk-based capital requirements in the U.K. are different than the NAIC risk-based capital (“RBC”). In addition, the FSA has imposed certain minimum capital requirements for the combined U.K. subsidiaries that will restrict Lincoln UK’s ability to pay dividends in 2005. As a result, we expect distributions from Lincoln UK in 2005 will be in the range of $40 million to $50 million. This estimate takes into consideration an expected contribution of $75 million to $85 million into Lincoln UK’s defined benefit pension plan. As is the case with regulated insurance companies in the U.S., future changes to regulatory capital requirements could impact the dividend capacity of our U.K. insurance subsidiaries and cash flow to the holding company.
Financing Activities
Although our subsidiaries generate adequate cash flow to meet the needs of our normal operations, periodically we may issue debt or equity securities to fund internal growth, acquisitions, and the retirement of our debt and equity. Our current shelf registration has $600 million of remaining authorization to issue various securities, including debt securities, preferred stock, common stock, warrants, stock purchase contracts and stock purchase units of LNC and trust preferred securities of
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four subsidiary trusts. The net proceeds from the sale of the securities offered by this shelf registration are expected to be used for general corporate purposes, including repurchases of outstanding common stock, repayment or redemption of outstanding debt or preferred stock, the possible acquisition of financial services businesses or assets thereof, and working capital needs. Cash funds are also available from our revolving credit agreements and through our commercial paper program.
We also have a commercial paper program. As discussed above, we have the flexibility in the future to issue new long-term securities under our shelf registration to retire the commercial paper outstanding, or reduce the commercial paper outstanding from other available liquidity resources.
At March 31,June 30, 2005, we maintained two revolving credit agreements with a group of domestic and foreign banks totaling $519 million:banks: a $500 million five-year revolving credit facility maturing in December 2009, which was amended December 2004, and a U.K. facility, which was renewed in February 2005 for $1910 million pounds sterling ($18 million at June 30, 2005) maturing in February 2006. At March 31,June 30, 2005, we did not have any amounts outstanding under any of the bank lines.
Effective December 2004, we amended our existing letter of credit facility. Under the letter of credit facility, we (or our subsidiaries) may issue up to $900 million in standby letters of credit (“LOC”).LOC’s. The term of the LOC facility is five years. At March 31,June 30, 2005, there were approximately $552 million in outstanding LOCs. These LOCs support intercompany reinsurance transactions and specific treaties associated with our reinsurance segment, which was acquired by Swiss Re in 2001. LOCs are used to satisfy the U.S. state regulatory requirements of domestic insurance companies who have contracted with our non-U.S. domiciled insurance subsidiaries.
Under the credit agreements, we must maintain a minimum consolidated net worth level and if LNC’sour senior, unsecured long-term debt rating is not at least A- from Standard and Poor’s or A3 from Moody’s then it also must maintain a defined maximum debt to total capitalization ratio. In addition, the agreements contain covenants restricting our ability to incur liens, merge or consolidate with another entity where we are not the surviving entity and dispose of all or substantially all of our assets. At March 31,June 30, 2005, we were in compliance with all such covenants.
If current debt ratings and claims paying ratings were downgraded in the future, certain covenants of various contractual obligations may be triggered which could negatively impact overall liquidity. In addition, contractual selling agreements with intermediaries could be negatively impacted which could have an adverse impact on overall sales of annuities, life insurance and investment products. At March 31,June 30, 2005, we maintained adequate current financial strength and senior debt ratings and do not anticipate any ratings-based impact to future liquidity.
As discussed above, LNL is employing strategies to lessen the burden of increased AXXX and XXX statutory reserves associated with our UL lapse protection rider (“LPR”)LPR product and other products subject to these statutory reserving requirements. GAAP reserves are not subject to AXXX and XXX statutory reserving requirements. Strategies include both reinsurance and capital markets solutions that provide for risk transfer and associated reserve and surplus relief. Currently, the majority of LPR business is reinsured with a wholly owned non-U.S. domiciled subsidiary of LNC. At March 31,June 30, 2005, there were approximately $252.4 million in outstanding LOCs under the LOC facility supporting the reinsurance obligations of our non-U.S. domiciled subsidiary to LNL on this LPR business. Recognizing that LOCs are generally one to five years in duration, it is likely LNL will apply a mix of LOCs, reinsurance, and capital market strategies in addressing long-term AXXX and XXX needs. The changes in statutory reserving requirements for LPR products sold after July 1, 2005 may result in an increase in our outstanding LOCs at the end of 2005. LOCs and related capital market alternatives lower the RBC impact of the LPR product. An inability to obtain the necessary LOC capacity or other capital market alternatives could impact our returns on the LPR product.
Alternative Sources of Liquidity
In order to maximize the use of available cash, the holding company maintains an intercompany cash management account where subsidiaries can borrow from the holding company to meet their short-term needs and can invest their short-term funds with
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the holding company. Depending on the overall cash availability or need, the holding company invests excess cash in short-term investments or borrows funds in the financial markets. LNL, by virtue of its general account fixed income investment holdings, can access liquidity through securities lending programs and repurchase agreements. At March 31,June 30, 2005, LNL had $1.0 billion carrying value of securities out on loan under the securities lending program.
Uses of Capital
Return of Capital to Shareholders
One of the holding company’s principal uses of cash is to provide a return to our shareholders. Through dividends and stock repurchases, we have an established record of providing significant cash returns to our shareholders. We have increased our dividend in each of the last 20 years. In determining our dividend payout, we balance the desire to increase the dividend against capital needs, rating agency considerations and requirements for financial flexibility. The following table summarizes this activity for 2005 and 2004.
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Three Months Ended March 31, | Year Ended 2004 | Three Months Ended June 30, | Six Months Ended June 30, | Year Ended 2004 | ||||||||||||||||||||
(in millions) | 2005 | 2004 | ||||||||||||||||||||||
(in millions, except per share data) | 2005 | 2004 | 2005 | 2004 | Year Ended 2004 | |||||||||||||||||||
Dividends to shareholders | $ | 63.8 | $ | 62.5 | $ | 250.1 | $ | 63.5 | $ | 62.4 | $ | 127.3 | $ | 124.9 | ||||||||||
Repurchase of common stock | 34.6 | 64.8 | 350.2 | 69.0 | 148.3 | 103.6 | 213.1 | 350.2 | ||||||||||||||||
Total Cash Returned to Shareholders | $ | 98.4 | $ | 127.3 | $ | 600.3 | $ | 132.5 | $ | 210.7 | $ | 230.9 | $ | 338.0 | $ | 600.3 | ||||||||
Number of shares repurchased | 0.755 | 1.369 | 7.612 | 1.576 | 3.226 | 2.331 | 4.596 | 7.612 | ||||||||||||||||
Average Price Per Share | $ | 45.84 | $ | 47.26 | $ | 46.01 | $ | 43.78 | $ | 45.97 | $ | 44.44 | $ | 46.36 | $ | 46.01 |
The remaining amount of share repurchases authorized by theour Board of Directors was $290.5$221.6 million at March 31,June 30, 2005. We expect to continue our share repurchases in 2005 with the amount and timing dependent on trends in key capital ratios, rating agency expectations, the generation of free cash flow, and the relative attractiveness of alternative uses for the capital.
OurWe repaid our 7.25% senior notes forof $193 million are dueat their maturity date May 15, 2005. We expectutilized cash flow from our commercial paper program to fund the maturity of this note from cash flow from current operations and by utilizing our existing commercial paper program. Our commercial paper is issued in reliance on the exemption from registration provided under Section 4(2) of the Securities Act of 1933. As discussed above, we have the flexibility in the future to issue a new long-term security under our shelf registration to retire the commercial paper outstanding, or reduce the commercial paper outstanding from other available liquidity resources.repayment.
The following table summarizes the primary uses of holding company cash flow. The table focuses on significant and recurring cash flow items and excludes the effects of certain financing activities, namely the periodic retirement of debt and cash flows related to our intercompany cash management account. Taxes have been eliminated from the analysis due to a tax sharing agreement among our primary subsidiaries resulting in a modest impact on net cash flows at the holding company.
Three Months Ended March 31, | Year Ended 2004 | Three Months Ended June 30, | Six Months Ended June 30, | Year Ended 2004 | ||||||||||||||||||||
(in millions) | 2005 | 2004 | 2005 | 2004 | 2005 | 2004 | ||||||||||||||||||
Debt Service (Interest Paid) | $ | 19.3 | $ | 13.0 | $ | 93.0 | $ | 27.0 | $ | 30.6 | $ | 46.3 | $ | 43.3 | $ | 93.0 | ||||||||
Capital Contribution to LNL | — | — | 100.0 | — | — | — | — | 100.0 | ||||||||||||||||
Capital Contribution to Delaware Investments | 10.0 | — | — | 4.0 | — | 14.0 | — | — | ||||||||||||||||
Common Dividends | 63.8 | 62.3 | 250.1 | 64.0 | 63.3 | 127.8 | 125.6 | 250.1 | ||||||||||||||||
Common Stock Repurchase | 29.0 | 56.8 | 350.2 | 74.6 | 149.3 | 103.6 | 206.1 | 350.2 | ||||||||||||||||
Total | $ | 122.1 | $ | 132.1 | $ | 793.3 | $ | 169.6 | $ | 243.2 | $ | 291.7 | $ | 375.0 | $ | 793.3 | ||||||||
At the end of 2004, we made a $100 million capital contribution to LNL as presented in the table above. This contribution was made as we were in a strong capital position at year-end 2004 and our preference is to hold capital at LNL.
Contingencies and Off-Balance Sheet Arrangements
We have outstanding guarantees with off-balance sheet risks of $4.2 million and $4.6 million at June 30, 2005 and December 31, 2004, whose contractual amounts represent credit exposure. Outstanding guarantees with off-balance sheet risks had contractual values of $4.4 million and $4.6 million at March 31, 2005 and December 31, 2004.
Certain subsidiaries of LNC had invested in real estate partnerships that used industrial revenue bonds to finance their projects. These guarantees expired in the fourth quarter of 2004 and no losses were incurred.
In addition, someSome of our subsidiaries have sold commercial mortgage loans through grantor trusts, which issued pass-through certificates. These subsidiaries have agreed to repurchase any mortgage loans which remain delinquent for 90 days at a repurchase price substantially equal to the outstanding principal balance plus accrued interest thereon to the date of repurchase. In case of default on the mortgage loans, we have recourse to the underlying real estate. It is management’s opinion that the value of the properties underlying these commitments is sufficient that in the event of default, the impact would not be material to us. These guarantees expire in 2009.
Shareholders’ Equity
Total shareholders’ equity decreased $132.7increased $187.9 million during the three-month periodsix months ended March 31, 2005. The table below provides a reconciliation of shareholders’ equity from December 31, 2004June 30, 2005, primarily due to March 31, 2005 (in millions).
Balance at December 31, 2004 | $ | 6,175.6 | ||
Changes to Accumulated Other Comprehensive Income | ||||
Unrealized losses on securities available-for-sale and derivative instruments | (246.3 | ) | ||
Foreign Currency Translation Adjustment | (7.8 | ) | ||
Minimum Pension Liability Adjustments | 0.5 | |||
Total Changes to Accumulated Other Comprehensive Income | (253.6 | ) | ||
Net Income | 178.9 | |||
Issuance of Common Stock Related to Stock Compensation and Benefit Plans | 38.4 | |||
Deferred Compensation Payable in Stock | 2.0 | |||
Dividends Declared to Shareholders | (63.8 | ) | ||
Repurchase of Common Stock | (34.6 | ) | ||
Total Changes to Shareholders’ Equity | (132.7 | ) | ||
Balance at March 31, 2005 | $ | 6,042.9 | ||
net income, partially offset by dividends to shareholders and share repurchases.
5250
OTHER MATTERS
Other Factors Affecting Our Business
In general, our businesses are subject to a changing social, economic, legal, legislative and regulatory environment. Some of the changes include initiatives to require more reserves to be carried by our insurance subsidiaries, to make permanent recent reductions in individual tax rates, to permanently repeal the estate tax and to increase regulation of our annuity and investment management businesses. Although the eventual effect on us of the changing environment in which we operate remains uncertain, these factors and others could have a material effect on our results of operations, liquidity and capital resources.
Recent Accounting Pronouncements
For a discussion of accounting pronouncements that have been implemented during the periods presented or that have been issued and are to be implemented in the future, see Note 2 to theour Consolidated Financial Statements.
Restructuring Activities
See Note 1011 to theour Consolidated Financial Statements for the detail of our restructuring activities
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We provided a discussion of our market risk in Item 7A of our 2004 annual report on Form 10-K for the year ended December 31, 2004.10-K. During the first threesix months of 2005, there was no substantive change in our market risk except for the items noted below:
Interest Rate Risk—Falling Rates. As discussed in the Quantitative and Qualitative Disclosures About Market Risk section of our 2004 annual report on Form 10-K, spreads on our fixed annuity and interest-sensitive whole life, universal life and fixed portion of variable universal life insurance policies, are at risk if interest rates decline and remain low for a period of time. The following table provides detail on the difference between interest crediting rates and minimum guaranteed rates as of March 31,June 30, 2005. For example, at March 31,June 30, 2005, there are $269$261 million of combined Retirement and Life Insurance account values where the excess of the crediting rate over contract minimums is between 1.01% and 1.50%. The analysis presented below ignores any non-guaranteed elements within the life insurance products such as cost of insurance or expense loads, which for many products may be redetermined in the event that interest margins deteriorate below the level that would cause the credited rate to equal the minimum guaranteed rate.
Excess of Crediting Rates over Contract Minimums As of March 31, 2005 | Retirement Segment Account Values | Life Segment Account Values | Total Account Values | Percent of Total Account Values | ||||||||||||||||||||
Excess of Crediting Rates over Contract Minimums As of June 30, 2005 | Retirement Segment Account Values | Life Segment Account Values | Total Account Values | Percent of Total Account Values | ||||||||||||||||||||
(in millions) | (in millions) | |||||||||||||||||||||||
CD and On-Benefit type annuities | $ | 5,899 | $ | — | $ | 5,899 | 17.69 | % | $ | 5,992 | $ | — | $ | 5,992 | 17.88 | % | ||||||||
Discretionary rate setting products* | ||||||||||||||||||||||||
No difference | 12,771 | 4,250 | 17,021 | 51.05 | % | 12,771 | 4,246 | 17,017 | 50.77 | % | ||||||||||||||
up to .1% | 100 | 1,302 | 1,402 | 4.21 | % | 100 | 1,287 | 1,387 | 4.14 | % | ||||||||||||||
.11% to .20% | 117 | 59 | 176 | 0.53 | % | 131 | 93 | 224 | 0.67 | % | ||||||||||||||
.21% to .30% | 187 | 198 | 385 | 1.15 | % | 167 | 197 | 364 | 1.09 | % | ||||||||||||||
.31% to .40% | 204 | 2,845 | 3,049 | 9.15 | % | 215 | 2,872 | 3,087 | 9.21 | % | ||||||||||||||
.41% to .50% | 827 | 2,244 | 3,071 | 9.21 | % | 874 | 2,350 | 3,224 | 9.62 | % | ||||||||||||||
.51% to .60% | 746 | 233 | 979 | 2.94 | % | 719 | 176 | 895 | 2.67 | % | ||||||||||||||
.61% to .70% | 53 | 21 | 74 | 0.22 | % | 35 | 117 | 152 | 0.45 | % | ||||||||||||||
.71% to .80% | 60 | 281 | 341 | 1.02 | % | 58 | 205 | 263 | 0.78 | % | ||||||||||||||
.81% to .90% | 9 | 256 | 265 | 0.79 | % | 7 | 276 | 283 | 0.84 | % | ||||||||||||||
.91% to 1.0% | 155 | 55 | 210 | 0.63 | % | 120 | 59 | 179 | 0.53 | % | ||||||||||||||
1.01% to 1.50% | 57 | 212 | 269 | 0.81 | % | 44 | 217 | 261 | 0.78 | % | ||||||||||||||
1.51% to 2.00% | 31 | 9 | 40 | 0.12 | % | 38 | 9 | 47 | 0.14 | % | ||||||||||||||
2.01% to 2.50% | 96 | — | 96 | 0.29 | % | 97 | — | 97 | 0.29 | % | ||||||||||||||
2.51% to 3.00% | 25 | — | 25 | 0.08 | % | 25 | — | 25 | 0.07 | % | ||||||||||||||
3.01% and above | 38 | — | 38 | 0.11 | % | 24 | — | 24 | 0.07 | % | ||||||||||||||
Total Discretionary rate setting products | 15,476 | 11,965 | 27,441 | 82.31 | % | 15,425 | 12,104 | 27,529 | 82.12 | % | ||||||||||||||
Grand Total—Account Values | $ | 21,375 | $ | 11,965 | $ | 33,340 | 100.00 | % | $ | 21,417 | $ | 12,104 | $ | 33,521 | 100.00 | % | ||||||||
* | For purposes of this table, contracts currently within new money rate bands are grouped according to the corresponding portfolio rate band in which they will fall upon their first anniversary. |
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We expect interest spreads to decrease by 4 to 5 basis points for the Retirement segment and 1 to 2 basis points for the Life Insurance segment during the remainder of 2005 relative to the first quarter ofJune 30, 2005. Refer toSee Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations by Segment for the effects of interest rate environments.
Derivatives.As indicated in Note 8 ofto the Consolidated Financial Statements in our 2004 annual report on Form 10-K, for the year ended December 31, 2004, we have entered into derivative transactions to reduce our exposure to rapid risesfluctuations in interest rates, the risk of changes in liabilities indexed to equity markets, credit risk, foreign exchange risk and to increase our exposure to certain investments in exchange for a premium. In addition, we are subject to risks associated with changes in the value of our derivatives; however, such changes in value are generally offset by changes in the value of the items being hedged by such contracts. Modifications to our derivative strategy are initiated periodically upon review of our overall risk assessment. During the first threesix months of 2005, the more significant changes in our derivative positions are as follows:
1. | Entered into |
2. | Entered into |
3. | Entered into 0.2 million call options on an equal number of shares of LNC stock, resulting in a total of 1.3 million call options on an equal number of shares of LNC stock. A total of 0.2 million call options were terminated, resulting in a gain of $1.4 million. These call options are hedging the increase in liabilities arising from stock appreciation rights granted on LNC stock. Additional stock appreciation rights were granted to LNC agents during the first quarter of 2005. |
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4. | Entered into financial future contracts in the amount of |
5. | Entered into |
6. | Decreased our use of credit default swaps hedging against a drop in bond prices from $8.0 million notional to no remaining notional. The decrease in notional is a result of terminations and resulted in a loss of $0.1 million. We used credit default swaps to hedge against a drop in bond prices due to credit concerns of certain bond issuers. |
7. | Entered into |
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We are exposed to credit loss in the event of non-performance by counterparties on various derivative contracts. However, we do 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.
Item 4. Controls and Procedures
(a) Conclusions Regarding Disclosure Controls and Procedures
We maintain disclosure controls and procedures, which are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. As of March 31,June 30, 2005, we, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us and our consolidated subsidiaries required to be disclosed in our periodic reports under the Exchange Act.
(b) Changes in Internal Control Over Financial Reporting
During our last fiscal quarter, there was no change in our internal control over financial reporting that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
A control system, no matter how well designed and operated, can provide only reasonable assurance that the control system’s objectives will be met. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the company have been detected. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
5553
PART II – OTHER INFORMATION
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
(c) | The following tables summarizes purchases of equity securities by the issuer during the quarter ended |
Period | (a) Total Number Purchased(1) | (b) Average Price Paid per Share (or Unit) | (c) Total Number of Shares Part of Publicly Announced Plans or Programs(2) | (d) Approximate Dollar Value Purchased Under the Plans or Programs (in millions)(3) | ||||||
1/1/05 – 1/31/05 | 3,247 | $ | 24.72 | — | $ | 325.1 | ||||
2/1/05 – 2/28/05 | 23,043 | 29.06 | — | 325.1 | ||||||
3/1/05 – 3/31/05 | 767,401 | 45.84 | 755,000 | 290.5 |
Period | (a) Total Number Purchased(1) | (b) Average Price Paid per Share (or Unit) | (c) Total Number of Shares Part of Publicly Announced Plans or Programs(2) | (d) Approximate Dollar Value Purchased Under the Plans or Programs (in millions)(3) | ||||||
4/1/05 – 4/30/05 | — | $ | — | — | $ | 290.5 | ||||
5/1/05 – 5/31/05 | 1,406,054 | 43.57 | 1,404,000 | 229.3 | ||||||
6/1/05 – 6/30/05 | 173,141 | 44.80 | 172,000 | 221.6 |
(1) | Total number of shares include those purchased as part of publicly announced plans or programs as well as shares received for the purchase price on the exercise of stock options and shares withheld for taxes on the vesting of restricted stock. |
(2) | In August 2002, the Board of Directors of LNC approved |
(3) | As of the last day of the applicable month. |
Item 4. Submission of Matters to a Vote of Security Holders
(a) | The 2005 annual meeting of shareholders of Lincoln National Corporation (LNC) was held on May 12, 2005. |
(b) | Proxies were solicited pursuant to Regulation 14 under the Securities Exchange Act of 1934 and there was no solicitation in opposition to the management nominees. All three nominees named in LNC’s proxy statement were elected to serve as directors for a three-year term expiring in 2008. |
(c) | The matters voted upon at the meeting and the votes cast with respect to such matters are as follows: |
Election of Directors
Nominee | Votes Cast For | Votes Withheld | ||
Marcia J. Avedon | 147,250,416 | 3,275,979 | ||
J. Patrick Barrett | 144,109,782 | 6,416,613 | ||
Michael F. Mee | 146,576,034 | 3,950,361 |
Proposal: To ratify the appointment of Ernst & Young LLP, as independent registered public accounting firm for 2005.
For | Against | Abstain | Broker Non-Votes | |||
146,136,093 | 3,156,300 | 1,234,002 | — |
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Proposal: To approve the Lincoln National Corporation Amended and Restated Incentive Compensation Plan.
For | Against | Abstain | Broker Non-Votes | |||
130,748,344 | 17,904,124 | 1,869,169 | 4,758 |
Item 5.Other Information
Our business faces significant risks. The risks described below update the risk factors described in our 2004 Form 10-K and should be read in conjunction with those risk factors. The risk factors described in this Form 10-Q and the 2004 Form 10-K may not be the only risks we face. Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations. If any of the following risks actually occur, our business, financial condition, results of operations or prospects could be affected materially.
Our businesses are heavily regulated and changes in regulation may reduce our profitability.
Our insurance subsidiaries are subject to extensive supervision and regulation in the states in which we do business. The supervision and regulation relate to numerous aspects of our business and financial condition. The primary purpose of the supervision and regulation is the protection of our insurance policyholders, and not our investors. The extent of regulation varies, but generally is governed by state statutes. These statutes delegate regulatory, supervisory and administrative authority to state insurance departments. This system of supervision and regulation covers, among other things:
The regulations of the state insurance departments may affect the cost or demand for our products and may impede us from taking actions we might wish to take to increase our profitability. For example, on December 29, 2004, the New York State Insurance Department promulgated, as an emergency measure, amendments to its regulations governing the valuation of life insurance reserves for New York authorized insurers issuing certain life insurance policies. Specifically, the amendments apply to life insurance policies providing secondary guarantees, such as policies with our LPR (as discussed above), that allow those policies to remain in force at the original schedule of benefits, even if the policy’s cash value is depleted, as long as the contractual requirements to maintain the secondary guarantee are satisfied. The amendments apply retroactively to policies issued on or after January 1, 2003. We do not currently expect these changes to affect LNL’s ability to continue as an accredited reinsurer in New York. However, although we continue to examine various alternatives to mitigate the impact of New York’s statutory reserve requirements, they may constrain LNL’s ability to pay dividends to LNC and may result in an increase in the cost of LPR products.
In July 2005, a committee of the NAIC adopted a change to Actuarial Guideline 38 (also known as “AXXX”), the statutory reserve requirements for UL products with secondary guarantees, such as Lincoln National Life’s lapse protection rider (“LPR”). This proposal is expected to be formally adopted by the NAIC in September 2005 with an effective date of July 1, 2005. It is unclear at this time how the NAIC’s action will affect New York’s adoption of emergency amendments as mentioned above.
The proposal does not affect business written prior to the effective date of July 1, 2005. However, based on early analysis and normalized sales of UL products sold with secondary guarantees, we expect Actuarial Guideline 38 could result in up to $100 million of additional statutory reserves for 2005. We continue to evaluate potential modifications to our universal life products with secondary guarantees that may be made in response to the revised regulation. Although the impact of this proposal on future sales of guaranteed no-lapse UL cannot be predicted, it may result in a price increase for such products, and therefore, may lower sales of such products.
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Further, we may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations, which may change from time to time. Also, regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or impose substantial fines. Further, insurance regulatory authorities have relatively broad discretion to issue orders of supervision, which permit such authorities to supervise the business and operations of an insurance company. As of December 31, 2004, no state insurance regulatory authority had imposed on us any substantial fines or revoked or suspended any of our licenses to conduct insurance business in any state or issued an order of supervision with respect to our insurance subsidiaries, which would have a material adverse effect on our results of operations or financial condition.
In addition, LFA and LFD as well as our variable annuities and variable life insurance products are subject to regulation and supervision by the SEC and the NASD. Our Investment Management segment, like other investment management groups, is subject to regulation and supervision by the SEC, NASD, MSRB, the Pennsylvania Department of Banking and jurisdictions of the states, territories and foreign countries in which they are licensed to do business. Lincoln U.K. is subject to regulation by the Financial Services Authority (“FSA”) in the U.K. These laws and regulations generally grant supervisory agencies and self-regulatory organizations broad administrative powers, including the power to limit or restrict the subsidiaries from carrying on their businesses in the event that they fail to comply with such laws and regulations.
Many of the foregoing regulatory or governmental bodies have the authority to review our products and business practices and those of our agents and employees. In recent years, there has been increased scrutiny of our businesses by these bodies, which has included more extensive examinations, regular “sweep” inquiries and more detailed review of disclosure documents. These regulatory or governmental bodies may bring regulatory or other legal actions against us if, in their view, our practices, or those of our agents or employees, are improper. These actions can result in substantial fines, penalties or prohibitions or restrictions on our business activities and could have a material adverse effect on our business, results of operations or financial condition.
Legal and regulatory actions are inherent in our businesses and could result in financial losses or harm our businesses.
There continues to be a significant amount of federal and state regulatory activity in the industry relating to numerous issues including market timing and late trading of mutual funds and variable annuity products and broker-dealer access agreements. Like others in the industry, we have received related inquiries including requests for information and/or subpoenas from various authorities including the SEC, NASD, the New York Attorney General and other authorities as well as notices of potential proceedings from the SEC and NASD. We are in the process of responding to these inquiries and notices and continue to cooperate fully with such authorities. In addition, we are, and in the future may be, subject to legal actions in the ordinary course of our insurance and investment management operations, both domestically and internationally. Pending legal actions include proceedings relating to aspects of our businesses and operations that are specific to us, and proceedings that are typical of the businesses in which we operate. Some of these proceedings have been brought on behalf of various alleged classes of complainants. In certain of these matters, the plaintiffs are seeking large and/or indeterminate amounts, including punitive or exemplary damages. For example, in late April 2005, a lawsuit was filed against certain Delaware Investments entities and other defendants in connection with Delaware’s having hired certain portfolio managers; this suit seeks, among other things, compensatory, punitive and exemplary damages. Although we believe that these proceedings ultimately will be resolved without materially affecting our consolidated financial position, substantial legal liability in these or future legal or regulatory actions could have a material financial effect or cause significant harm to our reputation, which in turn could materially harm our business prospects.
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Item 6. Exhibits
The following Exhibits of the Registrant are included in this report.report:
Note: The number preceding the exhibit corresponds to the specific exhibit number within Item 601 of Regulation S-K.
(a) | |||
(b) | |||
10 | (c) | LNC’s Executives’ Severance Benefit Plan (As effective January 1, 2005) | |
10 | (d) | Amendment No. 1 to | |
10 | (e) | First Amendment To Lease dated December 1999 with respect to Delaware Management Holdings, Inc., offices located at Commerce Square, Philadelphia, Pennsylvania. | |
10 | (f) | LNC’s Amended and Restated Incentive Compensation Plan | |
12 | Ratio of Earnings to Fixed Charges. | ||
(a) | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
(b) | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
(a) | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
(b) | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
5657
SIGNATURES
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/ FREDERICK J. CRAWFORD | |||
Frederick J. Crawford Senior Vice President and Chief Financial Officer | ||||
By: | /S/ DOUGLAS N. MILLER | |||
Douglas N. Miller Vice President, Controller and Chief Accounting Officer | ||||
|
Date: August 4, 2005
5758
LINCOLN NATIONAL CORPORATION
Exhibit Index for the Report on Form 10-Q
For the Quarter Ended March 31,June 30, 2005
10 | (a) |
| |
(b) | |||
(c) | |||
(d) | |||
10 | (e) | First Amendment To Lease dated December 1999 with respect to | |
10 | (f) | LNC’s Amended and Restated Incentive Compensation Plan is incorporated by reference to Exhibit 8 of LNC’s Proxy Statement in connection with its May 12, 2005 Annual Meeting of Shareholders. | |
12 | Ratio of Earnings to Fixed Charges. | ||
(a) | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
(b) | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
(a) | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
(b) | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
E-1