UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K/A
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report: December 14, 1998
Date of earliest
event reported: October 1, 1998
LINCOLN NATIONAL CORPORATION
(exact name of registrant as specified in its charter)
Indiana 1-6028 35-1140070
(State of incorporation) (Commission File (I.R.S. Employer
Number) Identification No.)
200 East Berry Street, Fort Wayne, Indiana 46802-2706
(Address of principal executive offices)
Registrant's telephone number 219-455-2000
2
Item 2 Acquisition or Disposition of Assets
On October 16, 1998, LNC filed a Form 8-K with the Commission regarding the
announcement and closing of the purchase of the domestic individual life
insurance from Aetna Inc. on October 1, 1998 for $1.0 billion. This filing is a
follow-up to the October 16, 1998 filing to provide audited financial statements
of the acquired business and pro forma financial information as required by Item
2 of the Form 8-K rules. This transaction was completed as a 100% indemnity
reinsurance agreement among two of Aetna's affiliates (Aetna Life Insurance
Company and Aetna Life Insurance and Annuity Company) and two of LNC's life
insurance affiliates (Lincoln National Life Insurance Company and Lincoln Life
and Annuity Company of New York). The price resulted from a negotiation process
with the seller. The source of cash for this purchase was from the proceeds of
two third quarter 1998 financings ($200 million 7.4% Series C Trust Originated
Preferred Securities and $230 million of FELINE PRIDES) plus available cash
remaining from the sale of its property casualty business segment in 1997. This
block of business includes individual life insurance contracts underwritten in
all states in the United States.
Pro Forma Financial Statements are shown in Item 7 of this document as follows:
Pro Forma Condensed Consolidated Balance Sheet as of
September 30, 1998.............................................Page 25
Pro Forma Condensed Consolidated Statements of Income:
Nine Months Ended September 30, 1998...........................Page 26
Year Ended December 31, 1997...................................Page 27
Notes to Pro Forma Financial Information............................Page 28
3
Item 7 Financial Statements and Exhibits
(a) Financial statements of business acquired
The audited financial statements covering the domestic individual life insurance
business being acquired are on pages 4 through 24 of this filing.
(b) Pro forma condensed consolidated financial information (unaudited)
The following pro forma condensed consolidated balance sheet of LNC and its
subsidiaries as of September 30, 1998 and the pro forma condensed consolidated
statements of income for the year ended December 31, 1997 and nine months ended
September 30, 1998 have been prepared based on the historical results of
operations and financial condition of LNC. Pro forma adjustments, which have
been prepared by LNC's management and the assumptions on which they are based
are described in the accompanying notes to pro forma condensed consolidated
financial information. Other acquisition/disposition activities completed by LNC
during 1998 which are not related to the transaction described above have not
been included in the following pro forma condensed consolidated financial
statements since they are not material to LNC's financial position or results of
operations either individually or in the aggregate as defined within the
regulatory guidelines.
The pro forma condensed consolidated balance sheet assumes that LNC's
acquisition of the block of individual life business from Aetna, Inc. had been
consummated as of September 30, 1998. The pro forma condensed consolidated
statements of income assume that LNC's acquisition of the block of individual
life business from Aetna, Inc. had been consummated on January 1, 1997. The
actual acquisition date was October 1, 1998. LNC believes that the following pro
forma income statement may not be indicative of the results that actually would
have occurred if the acquisition described in this document had been in effect
on January 1, 1997 or indicative of the results which may be achieved in the
future.
The pro forma financial information on pages 25 through 28 of this filing should
be read in conjunction with the audited financial statements of LNC.
(c) Exhibit
Exhibit 23 Consent of KMPG Peat Marwick LLP, Independent Auditors.
4
Independent Auditors' Report
The Board of Directors of Aetna Life Insurance and Annuity Company
The Board of Directors of Aetna Life Insurance Company:
We have audited the accompanying historical statements of assets and liabilities
of the Life Insurance Businesses as of September 30, 1998 and December 31, 1997,
and the related historical statements of income and changes in net assets and
cash flows for the nine month period ended September 30, 1998 and for the
twelve month period ended December 31, 1997. These financial statements are the
responsibility of Aetna Life Insurance and Annuity Company's and Aetna Life
Insurance Company's (the "Companies") management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
The accompanying financial statements were prepared to present the historical
assets and liabilities, income, changes in net assets and cash flows of the Life
Insurance Businesses pursuant to the contractual agreements referred to in Note
1, and is not intended to be a complete presentation of the Companies' assets
and liabilities, income, changes in net assets and cash flows.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the historical assets and liabilities of the Life
Insurance Businesses as of September 30, 1998 and December 31, 1997, and the
related historical income, changes in net assets and cash flows for the
nine month period ended September 30, 1998 and twelve month period ended
December 31, 1997 in conformity with generally accepted accounting principles.
/s/KPMG Peat Marwick LLP
Hartford, Connecticut
November 25, 1998
5
Historical Statements of Income and Changes in Net Assets
For the nine month For the twelve
period ended month period ended
September 30, December 31,
(millions) 1998 1997
Statements of Income:
Revenue:
Premiums $ 60.7 $ 93.6
Charges assessed against policyholders 161.5 213.0
Net investment income 180.3 244.5
Net realized capital gains 0.2 7.1
Other income 3.1 3.7
------------ -----------
Total revenue 405.8 561.9
------------ -----------
Benefits and expenses:
Current and future benefits 212.8 323.9
Operating expenses 46.2 66.7
Amortization of deferred policy acquisition costs 38.6 45.2
------------ -----------
Total benefits and expenses 297.6 435.8
Income before income taxes 108.2 126.1
Income taxes 35.3 44.8
------------ -----------
Net income $ 72.9 $ 81.3
============ ===========
Statements of Changes in Net Assets:
Net income $ 72.9 $ 81.3
Amounts transferred out of Life Insurance Businesses (99.8) (76.7)
Change in unrealized gains on investments, net 11.5 8.2
------------ -----------
Net change in net assets (15.4) 12.8
------------ -----------
Net assets, beginning of period 661.0 648.2
============ ===========
Net assets, end of period $ 645.6 $ 661.0
============ ===========
See Notes to Historical Financial Statements.
6
Historical Statements of Assets and Liabilities
September 30, December 31,
(millions) 1998 1997
Assets
Investments:
Debt securities available for sale, at fair value
(amortized cost: $1,343.8 and $2,832.1) $ 1,428.9 $ 2,953.6
Equity securities, available for sale:
Nonredeemable preferred stock (cost: $0.6 and $7.6) 0.6 7.6
Common stock (cost: $20.4 and 26.6) 19.8 28.1
Short-term investments 33.4 22.7
Mortgage loans 53.2 60.8
Real estate 3.4 6.0
Policy loans 372.8 377.6
------------- -------------
Total investments 1,912.1 3,456.4
Cash and cash equivalents 1,573.4 64.5
Short-term investments under securities loan agreement 131.1 -
Accrued investment income 20.9 39.4
Premiums due and other receivables 32.3 26.1
Deferred policy acquisition costs 867.3 836.1
Income taxes receivable 4.0 -
Separate account assets 439.2 355.1
------------- -------------
Total assets $ 4,980.3 $ 4,777.6
============= =============
Liabilities
Liabilities:
Future policy benefits $ 3,256.3 $ 3,270.6
Unpaid claims and claim expenses 31.0 38.8
Policyholders' funds 183.0 186.0
------------- -------------
Total insurance reserve liabilities 3,470.3 3,495.4
Payables under securities loan agreement 131.1 -
Other liabilities 92.0 81.2
Income taxes:
Current - 4.1
Deferred 135.1 113.5
Participating policyholders' interests 68.7 69.9
Separate account liabilities 437.5 352.5
------------- -------------
Total liabilities 4,334.7 4,116.6
------------- -------------
Net Assets 645.6 661.0
------------- -------------
Total liabilities and net assets $ 4,980.3 $ 4,777.6
============= =============
See Notes to Historical Financial Statements.
7
Historical Statements of Cash Flows
For the nine month For the twelve
period ended month period ended
(millions) September 30, December 31,
1998 1997
Cash Flows from Operating Activities:
Net income $ 72.9 $ 81.3
Adjustments to reconcile net income to net cash provided
by operating activities:
Decrease (increase) in accrued investment income 18.5 (1.3)
Increase in premiums due and other receivables (6.3) (1.8)
Decrease (increase) in policy loans 4.8 (3.2)
Increase in deferred policy acquisition costs (31.2) (55.5)
Increase in insurance reserve liabilities 4.8 164.1
Net change in other liabilities and other assets 25.7 (73.1)
Net change in income taxes 15.8 (0.1)
Net accretion of discount on investments (4.9) (8.6)
Net realized capital gains (0.2) (7.1)
------------- -------------
Net cash provided by operating activities 99.9 94.7
------------- -------------
Cash Flows from Investing Activities:
Proceeds from sales of:
Debt securities available for sale 2,325.7 1,857.0
Equity securities 23.6 20.7
Mortgage loans 7.6 125.0
Real estate 2.9 17.2
Investment maturities and collections of:
Debt securities available for sale 232.0 204.8
Short-term investments 63.3 230.6
Cost of investment purchases in:
Debt securities available for sale (1,061.1) (2,224.8)
Equity securities (9.6) (13.8)
Short-term investments (76.4) (247.4)
Mortgage loans - (0.3)
Real estate (0.1) (10.5)
------------- -------------
Net cash provided by (used for) investing activities 1,507.9 (41.5)
------------- -------------
Cash Flows from Financing Activities:
Amounts transferred out of Life Insurance Businesses (99.8) (76.7)
Capital contribution to separate account - (2.6)
Return of capital from separate account 0.9 -
------------- -------------
Net cash used for financing activities (98.9) (79.3)
------------- -------------
Net increase (decrease) in cash and cash equivalents 1,508.9 (26.1)
------------- -------------
Cash and cash equivalents, beginning of period 64.5 90.6
------------- -------------
Cash and cash equivalents, end of period $ 1,573.4 $ 64.5
------------- -------------
Supplemental cash flow information:
Income taxes paid, net $ 19.6 $ 46.2
============= =============
See Notes to Historical Financial Statements.
8
Notes to Historical Financial Statements
1. Summary of Significant Accounting Policies
On October 1, 1998, Aetna Life Insurance and Annuity Company ("ALIAC") and
Aetna Life Insurance Company ("ALIC"), collectively, the "Companies", the
ultimate parent of which is Aetna Inc., ("Aetna"), sold their domestic
individual life insurance businesses, collectively, the "Life Insurance
Businesses", to The Lincoln National Life Insurance Company and Lincoln
Life & Annuity Company of New York, collectively, "Lincoln", for $1 billion
in cash. The transaction is generally in the form of an indemnity
reinsurance arrangement, under which Lincoln contractually assumed from the
Companies certain policyholder liabilities and obligations which were
accounted for in conformity with accounting practices prescribed or
permitted by the State of Connecticut Insurance Department ("statutory"),
although the Companies remain directly obligated to policyholders. On
October 1, 1998, approximately $3 billion of statutory policyholder
liabilities were transferred to Lincoln. Certain invested assets related to
and supporting the liabilities and obligations transferred were sold to
consummate the transaction. The proceeds of the sale of the invested assets
were transferred to Lincoln and the Companies recorded a reinsurance
receivable from Lincoln.
Basis of Presentation
The accompanying historical financial statements of the Life Insurance
Businesses have been prepared in accordance with generally accepted
accounting principles and reflect the historical assets, historical
liabilities and net assets, historical results of operations, historical
changes in net assets and historical cash flows allocated and directly
supporting the Life Insurance Businesses.
These historical financial statements are not intended to present what the
Life Insurance Businesses would look like after the transaction with
Lincoln.
The Life Insurance Businesses include universal life, traditional whole
life, term insurance and participating life insurance.
New Accounting Standards
Statement of Position ("SOP") 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, issued by the American
Institute of Certified Public Accountants ("AICPA") was adopted on January
1, 1998. This statement requires that certain costs incurred in developing
internal-use computer software be capitalized, and provides guidance for
determining whether computer software is considered to be for internal use.
The Companies will amortize these costs over a period of 3 to 5 years.
Previously, the Companies expensed the cost of internal-use computer
software as incurred. The adoption of this statement resulted in an
increase to the Life Insurance Businesses' net income of $1.2 million
(after tax) for the nine-month period ended September 30, 1998.
9
Notes to Historical Financial Statements
1. Summary of Significant Accounting Policies (continued)
New Accounting Standards (continued)
Financial Accounting Standard ("FAS") No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, was
issued in September 1996 and provides accounting and reporting standards
for transfers of financial assets and extinguishments of liabilities. FAS
No. 125 was effective for 1997 financial statements; however, certain
provisions relating to accounting for repurchase agreements and securities
lending were not effective until January 1, 1998. The adoption of those
provisions effective in 1998 did not have a material effect on the Life
Insurance Businesses' financial position or results of operations.
Future Application of Accounting Standards
In October 1998, the AICPA issued SOP 98-7, Deposit Accounting: Accounting
for Insurance and Reinsurance Contracts That Do Not Transfer Insurance
Risk, which provides guidance on how to account for all insurance and
reinsurance contracts that do not transfer insurance risk, except for
long-duration life and health insurance contracts. This statement is
effective for financial statements beginning January 1, 2000, with early
adoption permitted. The impact of the adoption of this statement is not
expected to impact the Life Insurance Businesses.
In June 1998, the Financial Accounting Standards Board issued FAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. This standard
requires companies to record all derivatives on the balance sheet as either
assets or liabilities and measure those instruments at fair value. The
manner in which companies are to record gains or losses resulting from
changes in the values of those derivatives depends on the use of the
derivative and whether it qualifies for hedge accounting. This standard is
effective for financial statements beginning January 1, 2000, with early
adoption permitted. The impact of the adoption of this statement and the
potential effect on the financial position or results of operations of the
Life Insurance Businesses is currently being evaluated.
In December 1997, the AICPA issued Statement of Position 97-3, Accounting
by Insurance and Other Enterprises for Insurance-Related Assessments, which
provides guidance for determining when an insurance or other enterprise
should recognize a liability for guaranty-fund and other insurance related
assessments and guidance for measuring the liability. This statement is
effective for 1999 financial statements with early adoption permitted. The
impact of the adoption of this statement and the potential effect on the
financial position or results of operations of the Life Insurance
Businesses is not expected to be material.
10
Notes to Historical Financial Statements
1. Summary of Significant Accounting Policies (continued)
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates,
including, but not limited to those related to allocations to the Life
Insurance Businesses, and assumptions that affect the amounts reported in
these historical financial statements and accompanying notes. Actual
results could differ from reported results using those estimates. In the
opinion of management all adjustments necessary for a fair statement of
results have been made. All such adjustments are of a normal, recurring
nature.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, money market instruments
and other debt issues with a maturity of 90 days or less when purchased.
Investments
The Companies segment their general account investments in order to match
the assets and liabilities of their respective businesses. Accordingly,
investments included within these historical financial statements have been
specifically identified, as well as allocated, by the Companies to the Life
Insurance Businesses.
Debt and equity securities are classified as available for sale and carried
at fair value. These securities are written down (as realized capital
losses) for other than temporary declines in value. Unrealized capital
gains and losses related to available for sale investments, other than
amounts allocable to experience rated contractholders, are reflected in net
assets, net of related taxes.
Fair values for debt and equity securities are based on quoted market
prices or dealer quotations. Where quoted market prices or dealer
quotations are not available, fair values are measured utilizing quoted
market prices for similar securities or by using discounted cash flow
methods. Cost for mortgage-backed securities is adjusted for unamortized
premiums and discounts, which are amortized using the interest method over
the estimated remaining term of the securities, adjusted for anticipated
prepayments.
The Companies engage in securities lending whereby certain securities from
their portfolios, including the Life Insurance Businesses' portfolios, are
loaned to other institutions for short periods of time. Initial collateral,
primarily cash, is required at a rate of 102% of the market value of a
loaned domestic security and 105% of the market value of a loaned foreign
security. The collateral is deposited by the borrower with a lending agent,
and retained and invested by the lending agent according to the Companies
guidelines to generate additional income. The market value of the loaned
securities is monitored on a daily basis with additional collateral
obtained or refunded as the market value of the loaned securities
fluctuates. At September 30, 1998 and December 31, 1997, the Companies
loaned securities
11
Notes to Historical Financial Statements
1. Summary of Significant Accounting Policies (continued)
Investments (continued)
of the Life Insurance Businesses (which are reflected as invested assets)
with a market value of approximately $131.1 million and 235.1 million,
respectively.
Purchases and sales of debt and equity securities are recorded on the trade
date. Sales of mortgage loans and real estate are recorded on the closing
date.
Mortgage loans and policy loans are carried at unpaid principal balances,
net of impairment reserves. A mortgage loan is considered impaired when it
is probable that amounts due according to the contractual terms of the loan
agreement will be unable to be collected (delays of up to 60 days may not
result in a loan being considered impaired). For impaired loans, a specific
impairment reserve is established for the difference between the recorded
investment in the loan and the estimated fair value of the collateral. This
loan impairment policy is applied individually to all loans in the
portfolio and does not aggregate loans for the purpose of applying such
provisions. Full or partial charge-offs of loans are recorded at the time
an event occurs affecting the legal status of the loan, typically at the
time of foreclosure or upon a loan modification giving rise to forgiveness
of debt. A general reserve is established for losses management believes
are likely to arise from loans in the portfolio, other than for those
losses as to which there has been a specific reserve established. Interest
is not accrued on impaired loans when management believes the collection of
interest is unlikely. Investment real estate intended to be held for the
production of income is carried at depreciated cost, including capital
additions, net of write-downs for other than temporary declines in fair
value. Properties held for sale (primarily acquired through foreclosure)
are carried at the lower of cost or fair value less estimated selling
costs. Adjustments to the carrying value of properties held for sale are
recorded in a valuation reserve when the fair value less estimated selling
costs is below cost. Fair value is generally estimated using a discounted
future cash flow analysis in conjunction with comparable sales information.
Property valuations are reviewed regularly by investment management.
Short-term investments, consisting primarily of money market instruments
and other debt issues purchased with a maturity of 91 days to one year, are
considered available for sale and are carried at fair value, which
approximates amortized cost.
Futures contracts are utilized for other than trading purposes in order to
hedge investment returns and price risk and to align maturities, interest
rates, and funds availability with their obligations. In 1998, U.S.
treasury futures were utilized to hedge interest rate risk from the date
the reinsurance transaction with Lincoln was announced in May 1998 to the
date the investments supporting the Life Insurance Businesses were sold.
12
Notes to Historical Financial Statements
1. Summary of Significant Accounting Policies (continued)
Investments (continued)
Futures contracts are carried at fair value and require daily cash
settlement. Changes in the fair value of futures contracts allocable to
experience rated contracts are deducted from capital gains or losses with
an offsetting amount reported in future policy benefits. Changes in the
fair value of futures contracts allocable to non-experience rated contracts
and that qualify as hedges are deferred and recognized as an adjustment to
the hedged asset or liability. Deferred gains or losses on such futures
contracts are amortized over the life of the acquired asset or liability as
a yield adjustment or through net realized capital gains or losses upon
disposal of an asset. Changes in the fair value of futures contracts that
do not qualify as hedges are recorded in net realized capital gains or
losses. Hedge designation requires specific asset or liability
identification, a probability at inception of high correlation with the
position underlying the hedge, and that high correlation be maintained
throughout the hedge period. If a hedging instrument ceases to be highly
correlated with the position underlying the hedge, hedge accounting ceases
at that date and excess gains or losses on the hedging instrument are
reflected in net realized capital gains or losses.
Deferred Policy Acquisition Costs
Certain costs of acquiring insurance business are deferred. These costs,
all of which vary with and are primarily related to the production of new
and renewal business, consist principally of commissions, certain expenses
of underwriting and issuing contracts, and certain agency expenses.
For fixed ordinary life contracts, such costs are amortized over expected
premium-paying periods (up to 20 years). For universal life contracts, such
costs are amortized in proportion to estimated gross profits and adjusted
to reflect actual gross profits over the life of the contracts (up to 50
years). Deferred policy acquisition costs are written off to the extent
that it is determined that future policy premiums and investment income or
gross profits are not adequate to cover related losses and expenses.
Insurance Reserve Liabilities
Future policy benefits include reserves for universal life and traditional
life insurance contracts. Reserves for universal life contracts are equal
to cumulative deposits less charges and withdrawals plus credited interest
thereon. Reserves for traditional life contracts are computed on the basis
of assumed investment yield, mortality and expenses, including a margin for
adverse deviations. Such assumptions vary by plan, year of issue and policy
duration. Reserve interest rates range from 2.25% to 6.75% for all periods
presented. Investment yield is based on the experience of the Life
Insurance Businesses' portfolios. Mortality and withdrawal rate assumptions
are based on relevant Aetna experience and are periodically reviewed
against both industry standards and experience.
13
Notes to Historical Financial Statements
1. Summary of Significant Accounting Policies (continued)
Insurance Reserve Liabilities (continued)
Policyholders' funds include reserves for dividends on participating
policies left with the Companies and premium and other deposit funds.
Unpaid claims for all lines of insurance include benefits for reported
losses and estimates of benefits for losses incurred but not reported.
Premiums, Charges Assessed Against Policyholders, Benefits and Expenses
For universal life contracts, charges assessed against policyholders' funds
for the cost of insurance, surrender charges, and other charges and fees
are recorded as revenue in charges assessed against policyholders. Other
amounts received for these contracts are reflected as deposits and are not
recorded as revenue. Life insurance premiums, other than premiums for
universal life contracts, are recorded as premium revenue when due. Related
policy benefits are recorded in relation to the associated premiums or
gross profit so that profits are recognized over the expected lives of the
contracts.
Separate Account
Assets held under variable universal life contracts are segregated in a
separate account and are invested, as designated by the contractholder or
participant under a contract, in shares of mutual funds which are managed
by an affiliate of Aetna, or in shares of other selected mutual funds not
managed by an affiliate of Aetna.
Separate account assets and liabilities are carried at fair value.
Separate account assets and liabilities are shown as separate captions in
the historical statements of assets and liabilities. Deposits, investment
income and net realized and unrealized capital gains or losses of the
separate account are not reflected in the historical statements of income
and changes in net assets. The historical statements of cash flows do not
reflect investment activity of the separate account.
Income Taxes
The Companies are included in the consolidated federal income tax return of
Aetna and are taxed at regular corporate rates after adjusting income
reported for financial statement purposes for certain items. Deferred
income tax expenses or benefits result from changes during the year in
cumulative temporary differences between the tax basis and book basis of
assets and liabilities.
14
Notes to Historical Financial Statements
1. Summary of Significant Accounting Policies (continued)
Net Assets
Net assets represent the excess of assets over liabilities. Net assets
include unrealized holding gains and losses on investments.
2. Investments
Debt securities available for sale at September 30, 1998 were as follows:
Gross Gross
(millions) Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. government and government
agencies and authorities $ 65.5 $ 11.7 $ - $ 77.2
States, municipalities and political
subdivisions 2.5 1.2 - 3.7
U.S. corporate securities 756.4 50.3 3.0 803.7
Foreign securities 220.4 13.7 8.6 225.5
Residential mortgage-backed securities 141.7 15.1 .5 156.3
Commercial/Multifamily mortgage-
backed securities 49.3 1.2 .1 50.4
Other asset-backed securities 108.0 4.1 - 112.1
---------- --------- ------ -----------
Total debt securities $ 1,343.8 $ 97.3 $ 12.2 $ 1,428.9
========== ========= ====== ===========
15
Notes to Historical Financial Statements
2. Investments (Continued)
Debt securities available for sale at December 31, 1997 were as follows:
Gross Gross
(millions) Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
U.S. government and government
agencies and authorities $ 290.9 $ 18.8 $ - $ 309.7
States, municipalities and political
subdivisions 2.5 .8 - 3.3
U.S. corporate securities 1,087.7 51.3 1.2 1,137.8
Foreign securities 386.1 24.5 13.2 397.4
Residential mortgage-backed securities 618.4 31.7 .4 649.7
Commercial/Multifamily mortgage-
backed securities 89.7 2.6 - 92.3
Other asset-backed securities 356.8 6.8 .2 363.4
----------- ---------- -------- ---------
Total debt securities $ 2,832.1 $ 136.5 $ 15.0 $ 2,953.6
=========== ========== ======== =========
At September 30, 1998 and December 31, 1997 net unrealized appreciation of
$85.1 million and $121.5 million, respectively, on available-for-sale debt
securities included $43.0 million and $72.8 million, respectively, related
to experience rated contracts, which were not reflected in net assets but
were in future policy benefits.
16
Notes to Historical Financial Statements
2. Investments (Continued)
The amortized cost and fair value of debt securities for the nine-month
period ended September 30, 1998, are shown below by contractual maturity.
Actual maturities may differ from contractual maturities because securities
may be restructured, called, or prepaid.
(millions) Amortized Fair
Cost Value
Due to mature:
One year or less $ 23.8 $ 23.9
After one year through five years 155.0 160.3
After five years through ten years 324.5 333.6
After ten years 541.5 591.9
Mortgage-backed securities 191.0 207.0
Other asset-backed securities 108.0 112.2
------ -----
Total $1,343.8 $1,428.9
======== ========
There were no investments in a single issuer, other than obligations of the
U.S. government, with an amortized cost in excess of 10% of the Life
Insurance Businesses' net assets at September 30, 1998.
Included in debt securities were residential collateralized mortgage
obligations ("CMOs") supporting the following:
September 30, 1998 December 31, 1997
--------------------------- ------------------------
(millions) Amortized Fair Amortized Fair
Cost Value Cost Value
Total residential CMOs (1) $ 76.1 $ 81.5 $ 337.1 $ 352.4
=========== =========== ========= ===========
Percentage of total:
Supporting experience rated products 83.1% 81.2%
Supporting remaining products 16.9 18.8
----------- -----------
100.0% 100.0%
(1) At September 30, 1998 and December 31, 1997, approximately 37% and
71%, respectively, of these residential CMO holdings were backed by
government agencies such as GNMA, FNMA and FHLMC.
17
Notes to Historical Financial Statements
2. Investments (Continued)
There are various categories of CMOs which are subject to different degrees
of risk from changes in interest rates and, for nonagency-backed CMOs,
defaults. The principal risks inherent in holding CMOs are prepayment and
extension risks related to dramatic decreases and increases in interest
rates resulting in the repayment of principal from the underlying mortgages
either earlier or later than originally anticipated. At both September 30,
1998 and December 31, 1997, approximately 1% of the Life Insurance
Businesses' CMO holdings were invested in types of CMOs which are subject
to more prepayment and extension risk than traditional CMOs (such as
interest- or principal-only strips).
3. Financial Instruments
Estimated Fair Value
The carrying value and estimated fair values of certain financial
instruments at September 30, 1998 and December 31, 1997, were as follows:
September 30, 1998 December 31, 1997
-------------------- ------------------------
(millions) Carrying Fair Carrying Fair
Value Value Value Value
Mortgage loans $ 53.2 $ 53.0 $ 60.8 $ 61.4
======= ======== ========= =========
Fair value estimates are made at a specific point in time, based on
available market information and judgments about the financial instrument,
such as estimates of timing and amount of future cash flows. Such estimates
do not reflect any premium or discount that could result from offering for
sale at one time the entire holdings of a particular financial instrument,
nor do they consider the tax impact of the realization of unrealized gains
or losses. In many cases, the fair value estimates cannot be substantiated
by comparison to independent markets, nor can the disclosed value be
realized in immediate settlement of the instrument. In evaluating the
management of interest rate, price and liquidity risks, the fair values of
all assets and liabilities should be taken into consideration, not only
those presented above.
Fair values of mortgage loans are estimated by discounting expected
mortgage loan cash flows at market rates which reflect the rates at which
similar loans would be made to similar borrowers. The rates reflect
management's assessment of the credit quality and the remaining duration of
the loans.
18
Notes to Historical Financial Statements
3. Financial Instruments (continued)
Off-Balance-Sheet and Other Financial Instruments (including Derivative
Instruments)
Off-balance-sheet and other financial instruments are used primarily to
manage portfolio risks, including interest rate, prepayment/call, credit,
price, and liquidity risks. In 1998 and 1997, U.S. treasury futures
contracts were used to manage interest rate risk in the debt securities
portfolio.
Futures Contracts:
Futures contracts represent commitments to either purchase or sell
securities at a specified future date and at a specified price or yield.
Futures contracts trade on organized exchanges and, therefore, have minimal
credit risk. Cash settlements are made daily based on changes in the prices
of the underlying assets. The notional amounts, carrying values and
estimated fair values of the open U.S. treasury futures at September 30,
1998 were $786.2 million, ($6.3) million, and ($6.3) million, respectively.
These open U.S. treasury futures were related to hedging the interest rate
risk on the assets supporting the Life Insurance Businesses sold to
Lincoln. There were no open U.S. treasury futures at December 31, 1997.
Debt Instruments with Derivative Characteristics:
Debt securities also include investments in certain debt instruments with
derivative characteristics, including those whose market value is at least
partially determined by, among other things, levels of or changes in
domestic and/or foreign interest rates (short or long term), exchange
rates, prepayment rates, equity markets or credit ratings/spreads. The
amortized cost and fair value of these securities, included in the debt
securities portfolio, at September 30, 1998, was as follows:
(millions) Amortized Fair
Cost Value
Residential collateralized mortgage obligations $ 76.1 $ 81.5
Principal-only strips (included above) .7 1.7
Interest-only strips (included above) .1 .1
Other structured securities with derivative
characteristics (1) 5.4 4.1
(1) Represents non-leveraged instruments whose fair values and credit
risk are based on underlying securities, including fixed income
securities and interest rate swap agreements.
19
Notes to Historical Financial Statements
4. Net Investment Income
Sources of net investment income were as follows:
(millions) For the nine month For the twelve month
period ended period ended
September 30, 1998 December 31, 1997
Debt securities $ 153.9 $ 210.5
Nonredeemable preferred stock 1.0 .8
Mortgage loans 4.2 9.2
Real estate .4 1.1
Policy loans 14.0 19.6
Cash equivalents 9.2 5.7
Other .2 2.5
------- ------
Gross investment income 182.9 249.4
Less investment expenses 2.6 4.9
------- ------
Net investment income $ 180.3 $ 244.5
======= =======
Net investment income includes amounts allocable to experience rated
contractholders of $113.9 million and $152.2 million for the nine month
period ended September 30, 1998 and the twelve month period ended December
31, 1997, respectively. Interest credited to contractholders is included in
current and future benefits.
5. Capital Gains and Losses on Investment Operations
Realized capital gains or losses are the difference between the carrying
value and sale proceeds of specific investments sold.
Realized capital gains (losses) on investments were as follows:
(millions) For the For the
nine month period twelve month period
ended ended
September 30, 1998 December 31, 1997
Debt securities $ 5.5 $ 2.5
Equity securities 0.7 1.4
Mortgage loans (0.1) 2.1
Real estate 1.2 0.5
Futures (7.0) -
Other (0.1) 0.6
--------- ------
Pretax net realized capital gains $ 0.2 $ 7.1
========= ======
After tax net realized capital gains $ 0.1 $ 4.6
========= ======
20
Notes to Historical Financial Statements
5. Capital Gains and Losses on Investment Operations (continued)
Net realized capital losses of $49.4 million for the nine month period
ended September 30,1998 and net realized capital gains of $12.4 million for
the twelve month period ended December 31, 1997 allocable to experience
rated contracts, were deducted from net realized capital gains for both
periods and an offsetting amount was reflected in future policy benefits.
Proceeds from the sale of available-for-sale debt securities and the
related gross gains and losses were as follows:
(millions) For the nine month For the twelve month
period ended period ended
September 30, 1998 December 31, 1997
Proceeds on Sales $ 2,325.7 $ 1,857.0
Gross Gains 7.6 3.4
Gross Losses 2.1 .9
6. Severance and Facilities Charges
In the third quarter of 1996, the Life Insurance Businesses were allocated
a $9.2 million after tax severance and facilities charge from the Companies
to reflect actions taken or expected to be taken to improve their cost
structure relative to their competitors. The severance portion of the
charge was based on a plan to eliminate certain customer service, sales and
information technology support staff positions. The facilities portion of
the charge is based on a plan to consolidate sales/services field offices.
As of the nine month period ended September 30, 1998 and the twelve month
period ended December 31, 1997, $1.7 million after tax and $3.6 million
after tax, respectively, remained.
7. Income Taxes
The Companies are included in the consolidated federal income tax return,
and the Unitary Illinois, the combined Connecticut and the combined New
York state income tax returns of Aetna. Aetna allocates to each member an
amount approximating the tax it would have incurred were it not a member of
the consolidated group, and credits the member for the use of its tax
saving attributes in the consolidated income tax returns.
21
Notes to Historical Financial Statements
7. Income Taxes (continued)
Income taxes consist of:
For the nine For the twelve
month period month period
ended ended
September 30, December 31,
1998 1997
Current taxes:
Income taxes:
Federal income tax $ 31.1 $39.8
State income tax .8 .1
Net realized capital (losses) gains (20.5) 5.2
--------- ---
Total current 11.4 45.1
--------- ----
Deferred taxes (benefits):
Income taxes:
Federal income tax 3.3 2.4
Net realized capital gains (losses) 20.6 (2.7)
--------- ----
Total deferred 23.9 (.3)
--------- ---
Total $ 35.3 $44.8
========= ======
Income taxes were different from the amount computed by applying the
federal income tax rate to income before income taxes for the following
reasons:
(millions) For the nine For the twelve
month period month period
ended ended
September 30 December 31,
1998 1997
Income before income taxes $ 108.2 $ 126.1
Tax rate 35% 35%
------- -------
Application of the tax rate 37.9 44.2
------- -------
Tax effect of:
State income tax, net of federal benefit .5 .1
Participating policyholders' interest (2.2) 1.7
Other, net (.9) (1.2)
-------- --------
Income taxes $ 35.3 $ 44.8
========= =========
22
Notes to Historical Financial Statements
7. Income Taxes (Continued)
The tax effects of temporary differences that give rise to deferred tax
assets and deferred tax liabilities are presented below:
(millions) For the nine For the twelve
month period month period
ended ended
September 30, December 31,
1998 1997
Deferred tax assets:
Insurance reserves $ 104.3 $ 116.9
Unrealized gains allocable to experience
rated contracts 15.1 25.5
Investment (losses) gains (.9) 2.0
Postretirement benefits other than pensions
9.0 9.1
Deferred compensation 9.1 6.8
Other 3.0 6.9
--------- --------
Total gross assets 139.6 167.2
Deferred tax liabilities:
Deferred policy acquisition costs 243.5 236.8
Market discount 1.4 1.4
Net unrealized capital gains 29.8 42.5
---- ----
Total gross liabilities 274.7 280.7
--------- ---------
Net deferred tax liability $ 135.1 $ 113.5
========== ===========
Net unrealized capital gains and losses are presented in net assets, net of
deferred taxes.
The Internal Revenue Service (the "Service") has completed examinations of
the consolidated federal income tax returns of Aetna through 1990.
Discussions are being held with the Service with respect to proposed
adjustments. Management believes there are adequate defenses against, or
sufficient reserves to provide for, any such adjustments. The Service has
commenced its examinations for the years 1991 through 1994.
8. Benefit Plans
The Life Insurance Businesses utilize employees of Aetna and its
affiliates. The benefit plan charges allocated to the Life Insurance
Businesses for the nine month period ended September 30, 1998 and the
twelve month period ended December 31, 1997 were immaterial.
23
Notes to Historical Financial Statements
9. Related Party Transactions
The Companies are compensated by the Separate Account for bearing mortality
and expense risks pertaining to variable life contracts. Under the
insurance contracts, the Separate Account pays the Companies a daily fee
which, on an annual basis, ranges, depending on the product, from .65% to
1.00% of their average daily net assets. The Companies also receive fees
from the underlying mutual funds for providing investment advice (on funds
where the Companies act as the investment advisor) and distribution and
service fees (on other mutual funds). The amount of compensation and fees
received from the Separate Account and mutual funds included in charges
assessed against policyholders, amounted to $3.6 million for the nine month
period ended September 30, 1998 and $3.7 million for the twelve month
period ended December 31, 1997. The Companies may waive advisory fees at
their discretion.
Substantially all of the administrative and support functions of the Life
Insurance Businesses are provided by the Companies and their affiliates.
Operating expenses represent allocated charges for these services based
upon measures appropriate for the type and nature of service provided.
10. Reinsurance
The Companies utilize indemnity reinsurance agreements to reduce their
exposure to large losses in all aspects of the Life Insurance Businesses.
Such reinsurance permits recovery of a portion of losses from reinsurers,
although it does not discharge the primary liability of the Companies as
direct insurers of the risks reinsured. The Companies evaluate the
financial strength of potential reinsurers and continually monitor the
financial condition of reinsurers. Only those reinsurance recoverables
deemed probable of recovery are reflected as assets on the Historical
Statements of Assets and Liabilities.
Effective January 1, 1998, 90% of the mortality risk on substantially all
individual universal life product business written from June 1, 1991
through October 31, 1997 was reinsured externally. Beginning November 1,
1997, 90% of mortality risk on new business written on these products was
reinsured.
The following table includes all premium amounts ceded/assumed to/from
unaffiliated companies.
Ceded to Assumed
(millions) Direct Other from Other Net
Amount Companies Companies Amount
September 30, 1998
Premiums: $ 62.0 $ 1.4 $ .1 $ 60.7
Deposits: 380.3 18.9 - 361.4
December 31, 1997
Premiums: 95.0 1.5 .1 93.6
Deposits: 491.2 6.3 - 484.9
24
Notes to Historical Financial Statements
11. Contingent Liabilities
Litigation
The Companies are involved in a number of lawsuits arising, for the most
part, in the ordinary course of their business operations. While the
ultimate outcome of litigation cannot be determined at this time, such
litigation, net of reserves and giving effect to reinsurance probable of
recovery, is not expected to result in liability for amounts material to
the financial condition, although it may adversely affect results of
operations in future periods.
12. Participating Policyholders' Interests
Under participating life insurance contracts issued by the Companies,
the policyholder is entitled to share in the earnings of such
contracts. Premiums, assets and liabilities allocable to the
participating policyholders were as follows:
(millions) September 30, December 31,
1998 1997
Premiums $ 33.5 $ 52.3
Assets 612.5 608.4
Liabilities 612.5 608.4
25
LINCOLN NATIONAL CORPORATION
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED)
September 30, 1998
(in millions)
Pro Forma
--------------------------------------------------
As Acquisition of
Previously Individual Life
Reported Business(a) Adjustments Consolidated
ASSETS:
Investments............................... $35,763.9 $ 845.3 $ $36,609.2
Cash and invested cash.................... 2,725.4 2,461.0 (1,000.0)(b) 4,186.4
Goodwill and other intangibles............ 2,394.8 1,130.8 3,525.6
Other..................................... 43,722.1 101.5 43,823.6
-------- ------- ------------- ---------
Total Assets............................ $84,606.2 $ 4,538.6 $ (1,000.0) $88,144.8
LIABILITIES AND
SHAREHOLDERS' EQUITY:
Insurance and investment
contract liabilities.................... $74,355.0 $ 3,529.0 $ $77,884.0
Short and long-term debt.................. 1,066.9 1,066.9
Minority interest-preferred securities
of subsidiary companies................. 745.0 745.0
Other liabilities......................... 2,911.7 9.6 2,921.3
-------- --------- ------------ ---------
Total Liabilities....................... 79,078.6 3,538.6 82,617.2
Preferred stock........................... 1.1 1.1
Common stock.............................. 973.0 973.0
Retained earnings......................... 3,720.0 1,000.0 (1,000.0)(b) 3,720.0
Net unrealized gain (loss) on
securities available-for-sale........... 773.7 773.7
Other shareholders' equity................ 59.8 59.8
--------- --------- ------------ ---------
Total Shareholders' Equity.............. 5,527.6 1,000.0 (1,000.0) 5,527.6
--------- --------- ------------ ---------
Total Liabilities and
Shareholders' Equity................... $84,606.2 $ 4,538.6 $ (1,000.0) $88,144.8
See notes to unaudited pro forma condensed consolidated financial information.
26
LINCOLN NATIONAL CORPORATION
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)
Nine Months Ended September 30, 1998
(in millions, except per share amounts)
Pro Forma
---------------------------------------------------
As Acquisition of
Previously Individual Life
Reported Business (c) Adjustments Consolidated
REVENUE:
Premiums and other
considerations........................... $2,383.7 $ 225.3 $ $ 2,609.0
Net investment income..................... 1,966.7 180.3 (23.5)(d) 2,123.5
Realized gain on investments.............. 22.7 .2 22.9
-------- ------- ------- ----------
Total Revenue........................... 4,373.1 405.8 (23.5) 4,755.4
BENEFITS AND EXPENSES:
Benefits ................................. 2,349.3 212.8 2,562.1
Underwriting, acquisition,
insurance and other expenses............ 1,414.1 89.4 1,503.5
Interest expense.......................... 83.5 21.7(e) 105.2
--------- ------- ------ ----------
Total Benefits and Expenses............. 3,846.9 302.2 21.7 4,170.8
------- ------- ------ ----------
Net Income before Federal
Income Taxes........................... 526.2 103.6 (45.2) 584.6
Federal Income Taxes ....................... 142.0 35.3 (14.4)(f) 162.9
-------- ----- ------ ----------
Net Income ............................. $ 384.2 $ 68.3 $(30.8) $ 421.7
Net Income Per Diluted Share............ $3.77 $4.14
See notes to unaudited pro forma condensed consolidated financial information.
27
LINCOLN NATIONAL CORPORATION
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME (UNAUDITED)
Year Ended December 31, 1997
(in millions, except per share amounts)
Pro Forma
---------------------------------------------------
As Acquisition of
Previously Individual Life
Reported Business (c) Adjustments Consolidated
REVENUE:
Premiums and other
considerations........................... $2,525.1 $ 310.3 $ $2,835.4
Net investment income..................... 2,250.8 244.5 (31.4)(d) 2,463.9
Realized gain on investments.............. 122.6 7.1 129.7
-------- -------- ------- --------
Total Revenue........................... 4,898.5 561.9 (31.4) 5,429.0
BENEFITS AND EXPENSES:
Benefits ................................. 3,191.7 323.9 3,515.6
Underwriting, acquisition,
insurance and other expenses............ 1,579.4 118.0 1,697.4
Interest expense.......................... 92.5 32.6(e) 125.1
------- -------- ------- --------
Total Benefits and Expenses............. 4,863.6 441.9 32.6 5,338.1
------- -------- ------- --------
Net Income before Federal
Income Taxes........................... 34.9 120.0 (64.0) 90.9
Federal Income Taxes ....................... 12.7 44.8 (20.5)(f) 37.0
------- -------- ------- --------
Net Income from Continuing
Operations............................ 22.2 75.2 $(43.5) 53.9
Discontinued Operations..................... 911.8 911.8
-------- -------- ------- --------
Net Income.............................. $ 934.0 $ 75.2 $(43.5) $ 965.7
Net Income from Continuing
Operations Per Diluted Share.......... $ .21 $ .58
Net Income Per Diluted Share............ $8.98 $9.28
See notes to unaudited pro forma condensed consolidated financial information
28
LINCOLN NATIONAL CORPORATION
NOTES TO PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
Balance Sheet Items:
(a) The data shown in this "Acquisition of Individual Life Business" column
is after the preliminary application of purchase accounting. The
additional analysis of the business acquired that will occur into 1999
may result in changes in the amounts or the shifting between goodwill
and other intangible assets.
(b) Pro forma adjustment to cash and invested cash reflects the $1.0 billion
paid to acquire the block of individual life insurance business. These
funds were from 1) funds raised during the third quarter of 1998 from
the issuance of debt and the sale of portfolio investments and 2) funds
from the sale of its property-casualty business in 1997. Pro forma
adjustment to retained earnings reflects consolidating adjustments
related to the block of individual life business acquired.
Income Statement Items:
(c) The data shown in the "Acquisition of Individual Life Business" is as
shown in the accompanying audited financial statements less the impact
of the amortization of goodwill. An underlying assumption was made that
the amortization of deferred acquisition costs included in the audited
financial statements is equal to the amortization of the present value
of future profits that would have been recorded after the completion of
the acquisition.
(d) Pro forma adjustments to reflect the reduction in net investment income
resulting from the sale of select investments to fund the purchase of
the individual life insurance business. Investments were assumed to be
producing a pre-tax return of 5.5%.
(e) Pro forma adjustments to reflect the increase in interest expense due to
the issuance of $200 million Trust Originated Preferred Securities
("TOPrS") and $230 million of 7.75% FELINE PRIDES (service mark of
Merrill Lynch & Co. Inc).
(f) Pro forma adjustments to reflect the tax expense (credit) related to the
income resulting from the reduction in net investment income and
increase in interest expense [see ("c") and ("d") above]. The tax effect
is less than the 35% prevailing Corporate federal tax rate because the
interest on state and municipal bonds that were sold was exempt from
federal taxes.
Other:
(g) The amounts shown within the balance sheet and income statements include
100% of the individual life insurance business acquired. Subsequent to
the October 1, 1998 acquisition of this individual life insurance
business, LNC reached an agreement to sell the sponsored life portion of
the business acquired. The disposition of this business for a sales
price of $99.5 million occurred on October 14, 1998 with an effective
date of October 1, 1998 and resulted in no gain or loss. The disposition
was completed through the use of a 100% indemnity reinsurance agreement.
During 1997, the business sold produced $48.8 million of premiums and
fees and $12.0 million of net income (on the basis of generally accepted
accounting principles, prior to adjustments required by purchase
accounting).
29
SIGNATURE PAGE
LINCOLN NATIONAL CORPORATION
Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Lincoln National Corporation
By /s/ Richard C. Vaughan
Richard C. Vaughan
Executive Vice President and
Chief Financial Officer
By /s/ Donald L. Van Wyngarden
Donald L. Van Wyngarden
Second Vice President and
Controller
Date December 14, 1998