Exhibit 13 Portions of LNC's 2000 Annual Report to Shareholders
Selected Quarterly Financial Data
(in millions, except per share data)
Operating Results by Quarter 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
- ------------------------------------------------------------------------------------------------------------------
2000 Data
Premiums and other considerations $959.1 $1,029.2 $1,043.0 $1,101.4
Net investment income 711.1 673.8 690.0 672.1
Realized gain (loss) on investments (1.0) (10.4) (17.0) 0.1
Net income(1) $170.2 $163.6 $138.6 $148.9
Net income per diluted share $0.87 $0.84 $0.71 $0.76
1999 Data
Premiums and other considerations $963.9 $981.5 $939.7 $1,108.1
Net investment income 709.5 700.8 697.1 700.1
Realized gain (loss) on investments 1.9 (4.0) 5.4 (0.3)
Net income $145.1 $148.4 $132.3 $34.6
Net income per diluted share $0.71 $0.73 $0.66 $0.18
==================================================================================================================
(1) Net income for the third and fourth quarters of 1999 includes special charges for changes in estimates of reserves
and the fourth quarter includes a charge for estimated settlement costs for participation in workers' compensation
carve-out business and a tax benefit related to the release of a tax valuation allowance.
Selected Annual Financial Data
Year Ended December 31 2000 1999 1998 1997 1996
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Total revenue $6,851.5 $6,803.7 $6,087.1 $4,898.5 $4,733.6
Net income from continuing operations(1) 621.4 460.4 509.8 22.2 356.4
Net income from discontinued operations -- -- -- 134.9 157.2
Gain on sale of discontinued operations -- -- -- 776.9 --
- ------------------------------------------------------------------------------------------------------------------
Net income(1) $621.4 $460.4 $509.8 $934.0 $513.6
Per Share Data:(2)
Net income from continuing operations $3.19 $2.30 $2.51 $0.11 $1.69
Net income from discontinued operations -- -- -- 0.65 0.75
Gain on sale of discontinued operations -- -- -- 3.73 --
- ------------------------------------------------------------------------------------------------------------------
Net Income-Diluted $3.19 $2.30 $2.51 $4.49 $2.44
Net Income-Basic $3.25 $2.33 $2.54 $4.56 $2.47
Common stock dividends $1.175 $1.115 $1.055 $0.995 $0.935
(millions of dollars, except per share data)
Year Ended December 31 2000 1999 1998 1997 1996
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Assets $99,844.1 $103,095.7 $93,836.3 $77,174.7 $71,713.4
Long-term debt 712.2 712.0 712.2 511.0 626.3
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts holding
solely junior subordinated debentures 745.0 745.0 745.0 315.0 315.0
Shareholders' equity $4,954.1 4,263.9 5,387.9 4,982.9 4,470.0
Per Share Data:(2)
Shareholders' equity (Securities at market) $25.92 $21.76 $26.59 $24.63 $21.50
Shareholders' equity (Securities at cost) 25.85 24.14 23.86 22.48 19.51
Market value of common stock $47.31 $40.00 $40.91 $39.07 $26.25
==================================================================================================================
(1) Factors affecting the comparability of income from continuing operations and net income from continuing operations
for the 1996-2000 period are shown on page 36 (see "Supplemental Data"). Other factors affecting comparability
are shown within the results of operations by segment (see pages 41 through 57).
(2) Per share amounts were affected by the issuance of 2,796,224 shares of common stock in 1997 and the retirement of
6,222,581, 7,675,000; 1,246,562; 9,897,800 and 1,238,164 shares of common stock in 2000, 1999, 1998, 1997 and
1996, respectively.
Supplemental Data
The following table presents a reconciliation of "Income (Loss) from Continuing Operations" to "Net Income
from Continuing Operations" determined in accordance with generally accepted accounting principles. Income
(Loss) from Continuing Operations is LNC's alternative measure of operating performance which excludes the
after-tax realized gain (loss) on investments and associated items, gain (loss) on sale of subsidiaries
(if applicable) and restructuring charges.
Year Ended December 31 (in millions) 2000 1999 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations(1) $719.1 $475.5 $530.4 $(50.7) $298.8
Realized gain (loss) on investments, net of associated
amortization of deferred policy acquisition costs,
provision for policyholder commitments, investment
expenses and income taxes (17.5) 3.8 13.7 72.9 57.6
Restructuring charges, net of income taxes (80.2) (18.9) (34.3) -- --
- ---------------------------------------------------------------------------------------------------------------
Net Income from Continuing Operations $621.4 $460.4 $509.8 $22.2 $356.4
===============================================================================================================
(1) Income (loss) from continuing operations for 1999 includes changes in estimates of reserves for 1) Lincoln UK' s
pension business of $126.1 million, after-tax and 2) Reinsurance's HMO excess-of-loss reinsurance programs of
$25.0 million, after-tax and workers' compensation carve-out business underwritten by Unicover Managers, Inc.
of $40.4 million, after-tax; and includes a tax benefit of $42.1 million related to the decision to explore
exiting the UK insurance market. Also, 1997 includes the impact of changes in estimates of reserves needed for
1) LNC's disability income business of $130.0 million, after-tax 2) Lincoln UK's pension business of $174.9
million, after-tax and 3) Reinsurance's personal accident programs of $113.7 million, after-tax.
Management's Discussion and Analysis
Introduction
Lincoln National Corporation ("LNC") is a holding company. Through
subsidiary companies, LNC operates multiple insurance and investment
management businesses. The collective group of companies uses "Lincoln
Financial Group" as its marketing identity. LNC is the 33rd largest
(based on assets) United States corporation (1999 Fortune 500 Largest
U.S. Corporations, April 2000). Operations are divided into five
business segments: 1) Annuities, 2) Life Insurance, 3) Reinsurance, 4)
Investment Management and 5) Lincoln UK. Total employment of LNC at
December 31, 2000 on a consolidated basis was 7,820.
Forward-Looking Statements -- Cautionary Language
The pages that follow review LNC's results of operations and financial
condition including liquidity and cash flows, and capital resources.
Historical financial information is presented and analyzed. Where
appropriate, factors that may affect future financial performance are
identified and discussed. Certain statements made in this report are
"forward-looking statements" within the meaning of the Securities
Litigation Reform Act of 1995 (the "Act"). Forward-looking statements
include, without limitation, any statement that may predict, forecast,
indicate or imply future results, performance or achievements, and may
contain words like: "believe", "anticipate", "expect", "estimate",
"project", "will", "shall" and other words or phrases with similar
meaning. Forward-looking statements involve risks and uncertainties
which may cause actual results to differ materially from the results
contained in the forward-looking statements. These risks and
uncertainties include, among others: subsequent significant changes in
the company (e.g., acquisitions and divestitures), financial markets
(e.g., interest rates and securities markets), legislation (e.g.,
corporate, individual, estate and product taxation), accounting
principles generally accepted in the United States, regulations (e.g.,
insurance and securities regulations), receipt of regulatory approvals,
litigation (e.g., adverse decisions in extracontractual and class action
damage cases, new appellate decisions which change the law, unexpected
trial court rulings, unavailability of witnesses and newly discovered
evidence), debt and claims paying ratings issued by nationally
recognized statistical rating organizations, acts of God (e.g.,
hurricanes, earthquakes and storms), stability of foreign governments in
countries that LNC does business, other insurance risks (e.g.,
policyholder mortality and morbidity) and competition.
The risks included here are not exhaustive. Other sections of this
report may include additional factors which could adversely impact LNC's
business and financial performance. Moreover, LNC operates in a rapidly
changing and competitive environment. New risk factors emerge from time
to time and it is not possible for management to predict all such risk
factors. Further, it is not possible to assess the impact of all risk
factors on LNC's business or the extent to which any factor or
combination of factors, may cause actual results to differ materially
from those contained in any forward-looking statements. Given these
risks and uncertainties, investors should not place undo reliance on
forward-looking statements as a prediction of actual results. In
addition, LNC disclaims any obligation to update any forward-looking
statements to reflect events or circumstances that occur after the date
of this report.
On pages 37 through 57, the results of operations of LNC consolidated,
LNC's five business segments and "Other Operations" are presented and
discussed. Within these discussions of the results of operations,
reference is made to "Income from Operations". This alternative measure
of earnings is defined as "Net income less realized gain (loss) on sale
of investments and associated items, gain (loss) on sale of subsidiaries
and restructuring charges, all net of taxes." Pages 57 through 60
discuss LNC's consolidated investments. Pages 60 through 62 discuss
LNC's consolidated financial condition including liquidity and cash
flow, and capital resources. Pages 62 through 69 provide LNC's
quantitative and qualitative disclosures about market risk. Please note
that all amounts stated in this "Management's Discussion and Analysis"
are on an after-tax basis except where specifically identified as
pre-tax.
This "Management's Discussion and Analysis" should be read in
conjunction with the audited consolidated financial statements and
accompanying notes presented on pages 70 through 114.
Overview: Results Of Consolidated Operations
Summary Information Increase
(Decrease)
--------------------
Year Ended December 31 (in millions) 2000 1999 1998 2000 1999
- ---------------------------------------------------------------------------------------------------------------
Life insurance and annuity premiums $1,403.3 $1,183.0 $985.6 19% 20%
Health insurance premiums 409.8 698.5 635.1 (41%) 10%
Insurance fees 1,661.4 1,537.6 1,274.6 8% 21%
Investment advisory fees 213.2 223.8 227.1 (5%) (1%)
Net investment income 2,747.1 2,807.5 2,681.4 (2%) 5%
Equity in earnings (losses) of
unconsolidated affiliates (0.4) 5.8 3.3
Realized gain (loss) on investments (28.3) 3.0 19.0
Other revenue and fees 445.4 344.5 261.0 29% 32%
Life insurance and annuity benefits 3,108.2 3,145.3 2,762.0 (1%) 14%
Health insurance benefits 449.0 659.7 566.9 (32%) 16%
Underwriting, acquisition, insurance and
other expenses 2,318.5 2,295.0 1,943.7 1% 18%
Interest and debt expenses 139.5 133.7 117.1 4% 14%
Federal income taxes 214.9 109.6 187.6
- ---------------------------------------------------------------------------------------------------------------
Net Income $621.4 $460.4 $509.8
===============================================================================================================
Summary
Net income for 2000 was $621.4 million compared to $460.4 million for
1999, a $161.0 million or 35% increase. Net income for 1999 included the
following special items which decreased earnings by $149.4 million:
additions to HMO excess-of-loss and UK pension reserves of $25.0 million
and $126.1 million, respectively, a charge for estimated settlement
costs for participation in workers' compensation carve-out business of
$40.4 million and a tax benefit of $42.1 million related to the decision
in 1999 to explore exiting the UK insurance market. In addition,
restructuring charges net of reversals included in net income in 2000
and 1999 were $80.2 million and $18.9 million, respectively. (Refer to
page 39 in the MD&A for further discussion of restructuring charges.)
Income from operations was $719.1 million in 2000 compared to $624.9
million in 1999, exclusive of the special items noted above. The
increase in 2000 was $94.2 million or 15%. The increases in net income
and income from operations excluding special charges recorded in 1999
were primarily the result of increased earnings from the Annuities,
Life Insurance and Reinsurance segments.
Management's Discussion and Analysis
Operating revenue (total revenue excluding realized gains and losses on
investments) increased slightly (1%) in 2000 reflecting increased
insurance fees in the Annuities and Life Insurance segments primarily
due to increased variable account values during the early part of 2000,
increased individual life insurance premiums in the Reinsurance segment
resulting from business volume growth and increased other revenue in the
Reinsurance and Investment Management segments. Also, the Life Insurance
and Reinsurance segments had increased investment income due primarily
to increased investments resulting from business volume growth. These
increases were partially offset by decreased health premiums in the
Reinsurance segment resulting from business volume decreases within
exited businesses, decreased investment advisory fees in the Investment
Management segment due to a decrease in assets under management and
decreased investment income in the Annuities segment resulting from
fixed annuity lapses and transfers.
Total expenses, exclusive of federal income taxes, decreased 3.5% in
2000 due to decreased annuity benefits in the Annuities segment
resulting from a decline in fixed annuity account values and decreased
life insurance benefits in the Lincoln UK segment. In 1999, Lincoln UK
recorded a charge of $194.0 million pre-tax to strengthen reserves for
pension mis-selling. In addition, health benefits decreased in the
Reinsurance segment due to business volume decreases within exited
businesses. Underwriting, acquisition, insurance and other expenses
exclusive of the pre-tax restructuring charges of $104.9 million and
$27.3 million in 2000 and 1999, respectively, decreased due primarily to
lower operating expenses in the Life Insurance and Reinsurance segments
resulting from lower year 2000 information technology costs. These
decreases were partially offset by increased volume-related expenses in
all segments except for the Lincoln UK segment. In addition, operating
expenses increased in the Investment Management segment due primarily to
the implementation of initiatives to improve the investment management
process.
Net income for 1999 was $460.4 million compared with $509.8 million for
1998. Restructuring charges (after-tax) included in net income in 1999
and 1998 were $18.9 million and $34.3 million, respectively. Excluding
after-tax realized gain on investments, restructuring charges, and the
1999 special items described above, LNC earned $624.9 million for 1999
compared to $530.4 million for 1998. This increase was the result of
increased earnings in the Annuities, Life Insurance, Reinsurance and
Investment Management segments. For further discussion of the results of
operations, see the discussion of the results of operations by segment
starting on page 41.
Accounting for Derivative Instruments and Hedging Activities
LNC adopted Statement of Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("FAS
133") on January 1, 2001. Upon adoption, the provisions of FAS 133 were
applied prospectively. The financial statement impacts resulting from
the adoption of FAS 133 were computed using actual market conditions and
other relevant information as of January 1, 2001. The pre-tax transition
adjustments that LNC recorded upon adoption of FAS 133 on January 1,
2001 resulted in a net loss of $11.5 million (pre-tax) recorded in net
income as a component of realized gains and losses on investments, and a
net gain of $45.4 million (pre-tax) recorded in equity as a component of
Other Comprehensive Income. These transition adjustments will be
reported in LNC's first quarter 2001 financial statements as the effects
of a change in accounting principle.
In addition to the net transition adjustments that were recorded as of
January 1, 2001 relating to the adoption of FAS 133, LNC also expects
that FAS 133 will result in increased volatility in ongoing reported net
income. Certain derivative instruments, such as interest rate caps and
swaptions, that are regularly used by LNC to manage risks associated
with fluctuating interest rates, do not meet the requirements of the new
rules of FAS 133 for hedge accounting treatment. In these instances, LNC
expects to record changes in the fair market value of such derivatives
as a component of gains and losses on investments in net income.
Reorganization of Reporting Segments
In December 1999, management initiated a plan to change the structure of
LNC's internal organization in a manner that caused the composition of
its reportable segments to change beginning in 2000. During the first
quarter of 2000, the implementation of these changes were finished so
that beginning with the quarter ending March 31, 2000, decisions about
resource allocation and performance assessment were made separately for
an Annuities segment and a Life Insurance segment. As of and for the
year ended December 31, 2000, financial reporting for the two separate
segments is presented and the corresponding information for earlier
periods is presented on a basis consistent with the new segment
reporting structure. Most of the lines of business previously included
in the Life Insurance and Annuities segment are now reported within
either the Annuities segment or the Life Insurance segment based on how
the lines of business are being managed.
Consistent with the current management structures, the life and annuity
results for First Penn-Pacific are now reported in the Life Insurance
segment, Legacy Life results are now reported in the Annuities segment
and results for Lincoln Financial Advisors ("LFA") are now reported in
"Other Operations." Also, net investment income and related unrealized
and realized gain/loss on surplus investments and certain unallocated
expenses previously reported in the Life Insurance and Annuities segment
are now allocated to the Annuities, Life Insurance, Reinsurance and
Investment Management segments and Other Operations.
During 2000, management initiated a plan to change the operational and
management reporting structure of LNC's wholesale distribution
organization, such that beginning in 2001, Lincoln Financial
Distributors ("LFD"), the wholesaling arm of LNC's distribution network,
will be reported within Other Operations. Earlier periods will be
restated to aid comparability of segment reporting between periods. LFD,
comprised of approximately 250 wholesalers, is responsible for the sale
of various internally manufactured life insurance products, annuities,
mutual funds and wrap accounts through multiple distribution channels.
Previously, LNC's wholesaling efforts were conducted separately within
the Annuities, Life Insurance and Investment Management segments. The
purpose of the distribution reorganization is to improve client service,
reduce redundancies, increase efficiencies and effectiveness and achieve
economies of scale.
Also, in the fourth quarter of 2000, a decision was made to change the
management reporting and operational responsibilities for First
Penn-Pacific's ("First Penn") annuities business. This decision will
result in the consolidation of the management of all annuities products.
The financial reporting for the annuities portion of First Penn will be
moved from the Life Insurance segment where it had previously been
reported. Beginning with the quarter ending March 31, 2001, the
financial reporting for First Penn's annuities business will be included
in the Annuities segment. Earlier periods will be restated to aid the
comparability of segment reporting between periods.
Changes Related to Inter-segment Transactions
Prior to 2001, primarily all of the management of general account
investments performed by Lincoln Investment Management for LNC's U.S.
based insurance operations was generally priced on an "at cost" basis.
Effective January 1, 2001, substantially all of these internal
investment management services will be priced on an arms-length "profit"
basis. To reflect this new internal pricing standard, Lincoln Investment
Management will receive approximately 18.5 basis points on certain
assets under management. Lincoln Investment Management is reported
within the Investment Management segment and, subsequent to December 31,
2000, its operations were combined into Delaware Management Holdings,
Inc. The change in pricing of internal investment management services
will impact segment reporting results for the Annuities, Life Insurance,
Reinsurance and Investment Management segments, along with Other
Operations. Beginning with the quarter ending March 31, 2001, earlier
periods will be restated to aid the comparability of segment reporting
between periods.
Lincoln UK Restructuring
On September 28, 2000, LNC reached a definitive agreement to transfer
Lincoln UK's sales force, numbering in total over 1,000 members, to
Inter-Alliance Group PLC ("Inter-Alliance"), one of the UK's largest
independent financial advisory groups. The terms of the transfer provide
various persistency protections on Lincoln UK's current block of
business. As provided under the transfer agreement, Inter-Alliance hired
563 of Lincoln UK's sales force members and will assume the leases on 11
Lincoln UK sales offices.
Concurrent with the announcement of the Inter-Alliance transfer
agreement, LNC announced that a party with which it had been negotiating
the sale of Lincoln UK had advised LNC that it would not proceed with
the transaction. In light of this development, and in conjunction with
the transfer of the Lincoln UK sales force, LNC ceased writing new
business in the UK through direct sales distribution. Lincoln UK will
continue to manage, administer and accept new deposits on its current
block of business, and as required by UK regulation, accept new business
for certain products.
To implement these decisions, LNC entered into an exit plan
("restructuring plan") in the third quarter of 2000. The objective of
this restructuring plan is to exit all direct sales and sales support
operations and consolidate the Uxbridge home office with the Barnwood
home office. Where all commitment date and liability recognition
criteria were met in the third quarter of 2000, charges for this
restructuring plan were recorded in the third quarter of 2000. The
charges associated with this restructuring plan that were recorded in
the fourth quarter of 2000 occurred as final decisions under the
contract with Inter-Alliance related to personnel and facilities were
made, as regulatory requirements related to certain employee involuntary
termination benefits were met, and as the decision to consolidate the
Uxbridge home office with the Barnwood home office was completed.
Management's Discussion and Analysis
Accordingly, LNC recorded charges totaling $81.4 million after-tax
during 2000. Of this total, $40.5 million was recorded in the third
quarter of 2000 as a restructuring charge and $3.4 million was recorded
as an operating expense. Another $36.1 million was recorded in the
fourth quarter of 2000 as a restructuring charge and an additional $1.4
million was recorded as an operating expense. These actual charges were
less than the estimated total 2000 after-tax charges of $93 million that
LNC disclosed in the third quarter of 2000, primarily due to increased
UK tax benefits relative to the initial estimate. LNC had also disclosed
in the third quarter that up to an additional $10 million after-tax
might be recorded in either the fourth quarter of 2000 or the first
quarter of 2001 relating to the consolidation of Lincoln UK home office
operations. Because all decisions and employee notifications relating to
the closure of the Uxbridge home office occurred within the fourth
quarter of 2000, these costs are included within the $36.1 million
after-tax fourth quarter charge. (See Note 12 to the consolidated
financial statements for further details regarding this restructuring
plan.)
Other Restructuring Charges
During 1998, LNC implemented a restructuring plan relating to the
integration of existing life and annuity operations with the new
business operations acquired from CIGNA Corporation ("CIGNA"). A second
restructuring plan relating to the streamlining of LNC's corporate
center operations was also implemented during 1998. The aggregate
charges associated with these two unrelated restructuring plans totaled
$34.3 million after-tax ($52.8 million pre-tax). The restructuring plan
relating to the integration of existing life and annuity operations with
the new business operations acquired from CIGNA was completed in the
first quarter of 2000 and the restructuring plan relating to the
streamlining of LNC's corporate center was completed in the fourth
quarter of 2000 except for the on-going payments of rents on abandoned
facilities which are expected to continue until the end of 2004. During
the fourth quarter of 2000, $0.5 million (pre-tax) of the original
charge was reversed as a reduction in restructuring costs, due primarily
to changes in severance and outplacement costs. More employees whose
positions were eliminated under the restructuring plan found employment
in other areas of LNC than had been originally anticipated; therefore,
actual severance and outplacement costs were less than previously
estimated. Actual pre-tax costs totaling $55.1 million have been
expended or written off for both plans through December 31, 2000. The
remaining aggregate reserve balance of $1.3 million for the
restructuring plan relating to LNC's corporate center is anticipated to
be utilized in the completion of this restructuring plan. (See Note 12
to the consolidated financial statements for details regarding both of
these restructuring plans.)
During 1999, LNC implemented restructuring plans relating to 1) the
downsizing and consolidation of the operations of Lynch & Mayer, Inc.
("Lynch & Mayer"), 2) the discontinuance of HMO excess-of-loss
reinsurance programs and 3) the streamlining of Lincoln UK's operations.
The aggregate charges associated with these three unrelated
restructuring plans totaled $21.8 million after-tax ($31.8 million
pre-tax). During the fourth quarter of 1999, $3.0 million (pre-tax) of
the original charge recorded for the Lynch & Mayer restructuring plan
was reversed as a reduction of restructuring costs due primarily to a
change in estimate for costs associated with abandoned leased office
space. In addition, during the fourth quarter of 1999, $1.5 million
(pre-tax) associated with lease terminations was released into income.
During the fourth quarter of 2000, the Lynch & Mayer restructuring plan
was completed and $0.3 million (pre-tax) of the original charge recorded
was reversed as Lynch & Mayer was able to successfully exit certain
contracts without any further obligations or penalties. Also, during the
fourth quarter of 2000, $1.0 million (pre-tax) of the original charge
for the discontinuance of HMO excess-of-loss reinsurance programs was
reversed due primarily to changes in severance and outplacement costs.
More employees whose positions were eliminated under the restructuring
plan found employment in other areas of LNC than had been originally
anticipated; therefore, actual severance and outplacement costs were
less than previously estimated. Actual pre-tax costs totaling $21.8
million have been expended or written-off for all three plans through
December 31, 2000. Details of each of these three restructuring plans
are discussed in Note 12 to the consolidated financial statements.
During 2000, LNC implemented restructuring plans relating to 1) the
downsizing and consolidation of the operations of Vantage Global
Advisors, Inc. ("Vantage"), 2) the exit of all direct sales and sales
support operations of Lincoln UK and the consolidation of its Uxbridge
home office with its Barnwood home office, and 3) the downsizing and
consolidation of the investment management operations of Lincoln
Investment Management. The Vantage restructuring charge was recorded in
the second quarter, the Lincoln UK restructuring was recorded in the
third and fourth quarters, and the Lincoln Investment Management
restructuring charge was recorded in the fourth quarter of 2000. The
aggregate charges associated with all restructuring plans entered into
during 2000 totaled $81.8 million after-tax ($107.4 million pre-tax).
The component elements of these aggregate pre-tax costs include employee
severance and termination benefits of $33.8 million, write-off of
impaired assets of $40.9 million and other exit costs of $32.7 million.
During the fourth quarter of 2000, $0.6 million (pre-tax) of the
original charge recorded for the Vantage restructuring plan was reversed
as a reduction of restructuring costs due primarily to changes in
estimates associated with severance and abandoned leased office space
costs. Actual pre-tax costs totaling $64.3 million have been expended or
written off for these plans through December 31, 2000. Details of each
of these restructuring plans are discussed in the results of operations
for the Investment Management and Lincoln UK segments, respectively, and
in Note 12 to the consolidated financial statements.
Results Of Operations By Segment
Annuities
The Annuities segment, headquartered in Fort Wayne, Indiana, provides
tax-deferred investment growth and lifetime income opportunities for its
clients through the manufacture and sale of fixed and variable
annuities. Through a broad-based distribution network, the Annuities
segment provides an array of annuity products to individuals and
employer-sponsored groups in all 50 states of the United States. The
Annuities segment distributes some of its products through LNC's
wholesaling unit, Lincoln Financial Distributors ("LFD"), as well as
LNC's retail unit, Lincoln Financial Advisors ("LFA"). In addition, the
Annuities segment has alliances with a variety of unrelated companies
where LNC provides the manufacturing platform for annuity products and
the alliance company provides marketing and distribution.
Results of Operations(1): The Annuities segment's financial results and account values were as follows:
Year Ended December 31 (in millions) 2000 1999 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------
Financial Results:
Income from Operations $344.9 $285.8 $243.8 $200.7 $155.8
Realized Gain (Loss) on Investments (2.5) (7.4) 11.8 33.3 23.8
- ----------------------------------------------------------------------------------------------------------------
Net Income $342.4 $278.4 $255.6 $234.0 $179.6
================================================================================================================
December 31 (in billions) 2000 1999 1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------
Annuity Account Values:
Variable Annuities $39.4 $41.5 $33.4 $27.3 $20.4
Fixed Annuities 13.6 14.8 14.4 13.4 13.5
- ----------------------------------------------------------------------------------------------------------------
Total Annuity Account Values $53.0 $56.3 $47.8 $40.7 $33.9
================================================================================================================
(1) The 1996-1999 data was restated from the prior year due to the
reorganization of the Life Insurance and Annuities segment into two
separate segments: An Annuities segment and a Life Insurance segment.
The Annuities segment reported record net income of $342.4 million in
2000, $278.4 million in 1999 and $255.6 million in 1998. The Annuities
segment reported record income from operations of $344.9 million in
2000, $285.8 million in 1999 and $243.8 million in 1998.
Comparison of 2000 to 1999
The $59.1 million or 21% increase in income from operations in 2000 was
primarily driven by growth in fee income from variable annuities.
Average variable annuity account values for 2000 as compared to 1999
were $5.8 billion greater which contributed $40.4 million of additional
earnings. In addition, the mix of variable annuity accounts changed in
2000 toward higher fee products, which contributed $5.6 million of
income. The Annuities segment also reported additional earnings of $20.7
million due to increased dividend received deductions flowing from
variable annuity business. The Annuities segment also had an increase in
earnings of $7.4 million due to increased income on surplus investments.
Finally in 2000, changes in various assumptions relating to a block of
annuity business acquired from CIGNA in 1998 resulted in $6.1 million of
income.
The noted increases in earnings for 2000 were partially offset by a
$19.0 million decrease in earnings resulting from lower investment
margins on fixed annuities. This was attributed to a $684.0 million
decrease in average fixed annuity values coupled with an increase in
crediting rates in 2000 as compared to 1999. Also, changes in
assumptions underlying the amortization of deferred acquisition costs
and present value of in-force resulted in additional expense of $8.2
million. The amortization of the affected balances varies with the
profitability of the underlying business; thus, the downturn in the
equity markets and increase in net cash outflows resulted in lowered
estimates of future gross profits and increased current amortization
expense.
Management's Discussion and Analysis
In reviewing the results of fixed annuities, investment spread is a key
performance measure. LNC defines investment spread as the difference
between the average net investment income earned on the underlying
investment portfolio and the average crediting rates paid on the fixed
annuity contracts. Net investment income includes investment management
expenses and portfolio risk management expenses. The investment spreads
on fixed annuities were 1.49% and 1.62% in 2000 and 1999, respectively,
a decrease of 13 basis points between years. This decrease resulted from
a change in mix of crediting rates on fixed annuities and the accelerated
recognition of amortization of premium on certain securities in accordance
with accounting guidelines.
Comparison of 1999 to 1998
The Annuities segment's results for 1999 were primarily driven by growth
in fee income from variable annuities, along with improved investment
spreads on fixed annuity accounts. The year-end variable annuity account
values grew $8.1 billion or 24% over the prior year-end and fixed annuity
account values were relatively flat with only $0.3 billion or 2% growth
between years. The growth in variable annuity account values was due
primarily to stock market appreciation partially offset by net withdrawals.
Also, investment spreads on fixed annuities were 1.62% and 1.54% in 1999
and 1998, an increase of eight basis points between years.
Cash Flows
The Annuities segment's product cash flows were as follows:
Year Ended December 31 (in billions) 2000 1999 1998 1997 1996
- --------------------------------------------------------------------------------------------------
Net Flows:
Variable Annuities Deposits $3.2 $2.6 $2.8 $2.7 $2.7
Variable Annuities Withdrawals (4.9) (3.8) (3.0) (2.0) (1.4)
- --------------------------------------------------------------------------------------------------
Variable Annuities Net Flows (1.7) (1.2) (0.2) 0.7 1.3
Fixed Annuities Deposits 1.9 2.3 1.3 1.6 1.7
Fixed Annuities Withdrawals (2.5) (1.9) (1.9) (1.7) (1.5)
- --------------------------------------------------------------------------------------------------
Fixed Annuities Net Flows (0.6) 0.4 (0.6) (0.1) 0.2
Total Annuities Net Flows $(2.3) $(0.8) $(0.8) $0.6 $1.5
Incremental Deposits(1) $4.4 $4.4 $3.7 $3.9 $3.9
==================================================================================================
(1) Incremental Deposits represent gross deposits reduced by transfers from other Lincoln
Annuity products.
Key to sustaining profitable future earnings growth for both fixed and
variable annuity products is the ability to attract new deposits and to
retain existing accounts. For 2000, total annuity deposits were $5.1
billion and withdrawals were $7.4 billion, resulting in net cash outflow
of $2.3 billion. For 1999, total annuity deposits were $4.9 billion and
withdrawals were $5.7 billion, resulting in net cash outflow of $0.8
billion. In 1998, annuity deposits totaled $4.1 billion and withdrawals
were $4.9 billion, for a net cash outflow of $0.8 billion. Total
incremental deposits were $4.4 billion in 2000, $4.4 billion in 1999 and
$3.7 billion in 1998. Incremental deposits represent gross deposits
reduced by transfers from other Lincoln annuity products.
The growth rate of gross deposits in 2000 was 4%, while incremental
deposits were flat between years. The growth rates of gross deposits and
incremental deposits in 1999 were 20% and 19%, respectively. Although
LNC's gross deposits growth rate decreased from 1999 to 2000 and
incremental deposits did not grow in 2000, the deposit trend did improve
in the last quarter of 2000 after LNC introduced many new variable
annuity products in the third quarter of 2000. (See below for additional
discussion of LNC's new product introductions.)
Total account withdrawals have grown steadily over the last three years;
the growth rate in 2000 was $1.7 billion or 30% from $0.8 billion or 16%
in 1999. In looking at this trend of annuity withdrawals and the overall
profitability of the business, it is important to look beyond the mere
total dollar amount of withdrawals and assess how total withdrawals
compare to total retained account values. These measures of account
persistency are referred to as lapse rates, which are key elements to
assessing underlying profitability. By comparing actual lapse rates to
the rates assumed in designing the annuity product, it is possible to
gauge whether performance is better or worse than pricing. In the
aggregate, the lapse rates for 2000, 1999 and 1998 have been more
favorable than expected in pricing assumptions. This has been a
contributing factor in the strong earnings growth for these years.
Another important aspect of analyzing the impact of net cash flows is to
review the underlying number of new accounts compared to the number of
accounts leaving. Because a typical account leaving LNC has grown over
time, due to the strong performance of the financial markets, the trend
in the number of annuity accounts cannot be measured by just looking at
net cash flows. Here again, LNC's experience has been favorable, with
the number of new annuity accounts established in 2000, 1999 and 1998
significantly exceeding the number of accounts exiting.
Despite the fact that persistency has been favorable relative to product
pricing and that the total number of accounts is increasing, LNC is
concerned about the continued trend of net withdrawals experienced over
the last three years and the effects that such a trend will have on
future profitability of the Annuities segment. LNC is continuing to
address its annuity cash flow issue using a two-pronged effort:
retention of assets and growth of new deposits.
Retention of Assets
LNC has built a significant and seasoned book of business with many
annuity accounts out of the surrender charge period, which is the period
during which a policyholder must pay a surrender charge to terminate the
account. To illustrate this, LNC's variable annuity assets were the
third highest in the industry as of December 31, 2000 (VARDS -- Top 25
Variable Annuity Assets by Issuer 2000 Year-end). This large and
seasoned block of business has been more vulnerable to competitors
offering products with financial incentives designed to increase market
share. LNC is attacking this persistency issue on the individual annuity
side of the business on the following fronts: 1) refining renewal notice
letters on fixed annuity contracts, 2) conducting a grass roots effort
with broker/dealers on retention management with a focus on key
distributors and 3) filing for exemptive relief with the SEC in order to
provide more options for seasoned contractholders.
With regards to exemptive relief, in December of 2000, LNC filed with
the SEC seven options for its American Legacy I and II products. The
options include a bonus on current account value, an enhanced guaranteed
death benefit rider or an estate enhancement death benefit rider. In
exchange for these favorable benefits to the contractholder, a new
surrender charge period applicable to the entire account would be
imposed. The surrender charge period would be for at least the same term
and of the same magnitude as the original surrender charge period. Given
that LNC's exemptive relief filings are similar to previously approved
filings, LNC is expecting approval during the first half of 2001.
LNC has a cross-functional team in place to champion quick execution of
this exemptive relief plan. LNC believes that the options and benefits
that exemptive relief will provide its more seasoned American Legacy
contractholders, coupled with the superior, long-term strength of the
underlying investment options of the product, American Funds Insurance
Series[SERVICE MARK], will collectively help stem the flow of exchanges
to competitors' bonus products.
There have also been significant efforts on the employer-sponsored side
of the business to address the problem of redemptions in group
contracts. These efforts have included the development of a new direct
sales team with broadened market segment focus, creation of the Fringe
Benefits Division within LFA (which has 250 dedicated retirement
consultants around the United States) and product enhancements. The
product portfolio of this division includes the Multi-Fund(registered
trademark) Variable Annuity (group and individual), Group Variable
Annuity, fixed annuities and most recently the Alliance Program. The
account values of these products represent approximately one-third of
total annuity account values as of December 31, 2000.
The Multi-Fund(registered trademark) product was ranked 23rd in variable
annuity sales for 2000 (VARDS -- Top 25 Variable Annuity Contract Sales
- - 2000 Year-end) and has been the flagship product of the
employer-sponsored business over the past several years. However,
preferences of the marketplace are changing and the Alliance Program is
quickly becoming the product of choice for new programs and has become
an essential part of the strategy to retain old business as well. Begun
in 1998, the Alliance Program combines plan expertise with the
flexibility and performance of mutual funds and a fixed annuity. It
offers over 200 mutual fund families representing over 2000 mutual
funds. As a result of the efforts to retain and grow new business, the
employer-sponsored market's incremental deposits grew 10% in 2000.
Management's Discussion and Analysis
Growth of New Deposits
LNC's efforts to grow new deposits have focused on both product and
distribution breadth. Also, the marketing and sales areas are promoting
a sales drive with producers to increase new deposits. LNC introduced
more new annuity products in the year 2000 than it had in the last five
years. These product introductions, which were concentrated in the third
quarter of 2000, included American Legacy C-share and bonus credit
products and Lincoln ChoicePlus[SERVICE MARK] C-share and bonus credit
products. New York versions of C-share products were introduced in
early 2001. Bonus annuities, which have recently been the fastest-selling
annuities in the industry, offer buyers of new contracts a "credit" of
anywhere from 2% to 5% on their initial deposit. The credit increases
the amount of money at work in the annuity. C-share annuities carry no
surrender charges and offer 100% liquidity, which is the ability to
convert an investment into cash quickly with little or no loss in value.
Another innovative product feature that will be offered by LNC on most
of its manufactured individual variable annuities beginning in the first
quarter of 2001, is the Income4Life solution. Income4Life provides a new
value proposition in which a customer investing with LNC, gains an
account balance that is also a death benefit plus an income stream.
There will be daily values which are accessible via the internet,
customer statements and voice response. The investor not only has a
monthly income benefit, but can change investment options.
LNC is building upon its successful partnership with American Funds
Distributors ("AFD"). To further strengthen the AFD alliance, LNC is
putting together a support team of 18 dedicated American Legacy
insurance consultants by the end of 2001, who will work with the AFD
wholesalers. LNC is also partnering with SEI Investments ("SEI"), and
introduced a new variable annuity product designed for SEI in August of
2000. This variable annuity is manufactured by LNC and is distributed by
SEI, a leader in the largest and fastest growing distribution channel
for annuities, the independent financial planner channel. Also, LFD,
LNC's newly organized wholesaling distribution arm and an internal
partner of the Annuities segment, is providing a dedicated wholesaling
unit for the distribution of the Lincoln ChoicePlus variable annuity.
Finally, LNC is currently working on other alliances that will provide
increased access for LNC annuity products to the financial institutions'
distribution channel.
LNC experienced improved results from its new product offerings and
strategic partnerships in the fourth quarter of 2000. Total variable
annuity gross deposits increased to $846 million in the fourth quarter
of 2000, a $212 million or 33% increase from the same quarter in 1999.
Lincoln ChoicePlus gross deposits in the fourth quarter of 2000 doubled
versus the same quarter of 1999; $244 million compared to $122 million.
Over 40% of the Lincoln ChoicePlus sales were for the new C-share and
bonus annuity products. American Legacy gross deposits were relatively
flat between quarters; $545 million in the fourth quarter of 2000 and
$540 million in the same quarter of 1999. Also, sales of the SEI
variable annuity were minimal in its first full quarter of operation due
to a slower than expected launch. Sales are expected to increase in the
first quarter of 2001 as more sales agreements are put in place.
Outlook
LNC is aggressively pursuing ways to continue to grow deposits and
retain existing assets, with the objective of returning to positive net
cash flows by the end of 2001. At the same time, LNC is focusing on
effective expense management as a means to maintaining profitability in
an increasingly challenging market.
Life Insurance
The Life Insurance segment, headquartered in Hartford, Connecticut,
focuses on the creation and protection of wealth for its clients through
the manufacture and sale of life insurance products throughout the
United States. The Life Insurance segment offers, through its Hartford
operations, universal life, variable universal life, interest-sensitive
whole life and corporate owned life insurance. Additional offerings
through its First Penn-Pacific operations include universal life and
term life insurance along with deferred fixed annuities. All of the Life
Insurance segment's products are distributed through LFD and LFA.
Results of Operations(1): The Life Insurance segment's financial results, first year premiums by product,
account values and in-force amounts were as follows:
Year Ended December 31 (in millions) 2000 1999 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
Financial Results:
Income from Operations $285.9 $236.6 $180.4 $67.7 $69.7
Realized Gain (Loss) on Investments (11.6) (1.0) (2.3) 6.2 16.4
Restructuring Charge -- -- (20.0) -- --
- ---------------------------------------------------------------------------------------------------------
Net Income $274.3 $235.6 $158.1 $73.9 $86.1
First Year Premiums (by Product):
Universal Life $283.7 $338.5 $233.0 $114.4 $132.0
Variable Universal Life 208.6 128.7 86.0 52.9 54.2
Whole Life 22.4 24.0 19.5 4.5 6.5
Term 47.5 50.4 48.8 33.5 23.6
Corporate Owned Life Insurance ("COLI") 87.0 14.6 4.0 -- --
- ---------------------------------------------------------------------------------------------------------
Total First Year Premiums $649.2 $556.2 $391.3 $205.3 $216.3
- ---------------------------------------------------------------------------------------------------------
December 31 (in billions) 2000 1999 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
Account Values:
Universal Life $6.9 $6.6 $6.3 $2.6 $2.5
Variable Universal Life 1.8 1.6 1.2 0.5 0.4
Interest-Sensitive Whole Life 2.1 2.0 1.8 -- --
- ---------------------------------------------------------------------------------------------------------
Total Life Insurance 10.8 10.2 9.3 3.1 2.9
Annuities 3.1 3.4 3.6 3.9 4.1
Reinsurance Ceded on Annuities (1.2) (1.4) (1.6) (1.8) (1.8)
- ---------------------------------------------------------------------------------------------------------
Total Annuities 1.9 2.0 2.0 2.1 2.3
Total Account Values $12.7 $12.2 $11.3 $5.2 $5.2
In-Force -- Face Amount:
Universal Life and Other $115.9 $109.3 $105.8 $32.8 $32.9
Term Insurance 100.1 85.7 67.1 30.3 16.3
- ---------------------------------------------------------------------------------------------------------
Total In-Force $216.0 $195.0 $172.9 $63.1 $49.2
=========================================================================================================
(1) The 1996-1999 data was restated from the prior year due to the
reorganization of the Life Insurance and Annuities segment into two
separate segments: An Annuities segment and a Life Insurance segment.
The Life Insurance segment reported record net income of $274.3 million
in 2000, $235.6 million in 1999 and $158.1 million in 1998. The Life
Insurance segment reported record income from operations of $285.9
million in 2000, $236.6 million in 1999 and $180.4 million in 1998.
Comparison of 2000 to 1999
The $38.7 million or 16% increase in net income and the $49.3 million or
21% increase in income from operations in 2000 were primarily
attributable to strong sales growth. Also contributing to the increased
earnings were favorable investment income and effective expense
management. Non-volume related expenses decreased in 2000 due primarily
to lower year 2000 information technology costs and lower general and
administrative expenses.
First year premiums increased by $93 million or 17% in 2000. Account
values of universal life, variable universal life and interest-sensitive
life insurance products increased $0.6 billion or 6% from the end of
1999 to the end of 2000. In-force increased $21 billion or 11%
year-over-year. Policy lapses in 2000 were in line with pricing
assumptions for the year. The sales growth was fueled by variable
universal life ("VUL") and corporate owned life insurance ("COLI")
products which had increased sales between years of $79.9 million or 62%
and $72.4 million or 496%, respectively.
Management's Discussion and Analysis
The Life Insurance segment introduced two new single life VUL products
in 1999 and a survivorship VUL product in May 2000, which have been
significant drivers of this growth. Also, COLI sales were bolstered by a
new corporate VUL product which was launched at the end of 1999. The
increase in account values was due to the growth in business.
Comparison of 1999 to 1998
The $77.5 million or 49% increase in net income and the $56.2 million or
31% increase in income from operations in 1999 were driven by strong
sales growth, increased investment margins and fee income attributable
to increased in-force and account values. The increased sales growth
(premiums and deposits) was a result of expanded distribution channels
along with new product introductions. Distribution capacity was
bolstered by the business acquired from CIGNA and Aetna, Inc. on January
2, 1998 and October 1, 1998, respectively.
First year premiums increased by $163.4 million or 40% over 1998 and
deposits in the universal life, variable life and interest-sensitive
life insurance products were $1.7 billion in 1999, a 42% increase over
the 1998 deposits of $1.2 billion. Investment margins and fee income
increase proportionately with the increase in in-force and account
values for universal life, variable life and interest-sensitive life
products. Account values for these insurance products increased $1.2
billion or 13% over 1998 due to net deposits of $247 million and
investment growth.
Product Development
Over the past several years, individuals have increasingly used VUL as a
source of insurance protection and as a means to participate in strong
financial markets for potential wealth accumulation. The Life Insurance
segment has benefited from this market trend over the last two years and
has experienced significant sales growth of its VUL products. In 1999,
two new VUL products were introduced that targeted different segments of
the affluent market. The first, Lincoln Variable Universal Life ("LVUL"),
targets the younger, middle-aged, emerging affluent customer whose goal is
wealth accumulation. This product offers 30 mutual funds from 12 well-known
fund managers and an interest bearing account. The Lincoln VULdb was the
second product launched and was designed for older individuals seeking
low premiums and a high death benefit. VUL sales were bolstered by these
additions in 1999 with almost half of total annual 1999 VUL sales
occurring in the fourth quarter, subsequent to the launch of LVUL and
VULdb. These products also contributed greatly to 2000 sales, accounting
for 21% of total first year premiums.
More recently, there has been a rise in couples using Joint-life VUL or
Survivorship VUL to help preserve wealth through estate planning. In
fact, according to a sales survey conducted by Life Insurance Marketing
Resource Association ("LIMRA"), annualized premiums for Joint-Life or
Survivorship VUL were up 35% in 2000. Lincoln Life was ranked as the
third largest provider of survivorship life insurance according to the
2000 LIMRA U.S. Survivorship Life Insurance Sales Survey. With the
introduction of the Lincoln SVUL-II product in May 2000, Lincoln Life
has continued to capitalize on this growing trend. The Lincoln SVUL-II
has a range of features designed to make it a cost-effective estate
planning tool. It features a joint life policy that insures two lives
and is designed to provide death benefits at the second death, which is
generally when the bulk of an estate's assets transfer to the next
generation. This product offers 36 mutual funds from 13 well-known fund
families. Other features include the ability to split the policy into
two single life policies, favorable charge structures and the ability to
fund the policy at a level that will prevent lapse regardless of market
performance. Sales of the new SVUL-II were very strong in 2000 with
first year premiums of $35.9 million, accounting for 6% of total first
year premiums.
Proposed Estate Tax Reform
One proposed federal measure, which could affect the Life Insurance
segment, is estate tax reform. It is not currently clear what level of
reform or repeal will ultimately occur. Thus, it is not possible to
determine the magnitude of any effect on the sales or in-force of
survivorship life insurance in the industry or LNC by itself. However,
LNC's total first year premiums in 2000 included $67.3 million of
survivorship universal life, $64.3 million of survivorship VUL and $16.7
million of survivorship whole life. Sales of these three products
accounted for 23% of total first year premiums in 2000.
LNC has been closely monitoring estate tax proposals, discussion and
bills over the last few years and has been developing product and sales
strategies that can capitalize on the opportunity that the various
scenarios of change may bring. LNC's industry leading ability to develop
competitive, innovative products that are delivered with leading edge
speed is viewed as a great strength that will assist in a quick and
effective response to new opportunities. In addition, the Life
Insurance segment's product offerings including survivorship life
insurance address other segments of the affluent market that are
unaffected by estate tax reform, including other wealth transfer
markets, (i.e., business succession planning, charitable giving and
estate liquidity), and wealth accumulation markets. Finally, tax reform
could provide savings and wealth accumulation opportunities that LNC's
other business segments could capitalize on with their multitude of
investment products.
Outlook
The Life Insurance segment is positioned to build upon its strengths:
the breadth and quality of its product portfolio along with its
commitment to exceptional customer service, its extensive distribution
network and the growth opportunity offered by its target market, the
affluent. The optimization of these strengths through flawless execution
is key to the achievement of LNC's goal to place its life insurance
operations among the top five in the industry based on annualized
premium. LNC expects the Life Insurance segment to generate revenues in
future years in excess of revenues produced for the year ended December
31, 2000.
Reinsurance
The Reinsurance segment ("Lincoln Re") manufactures and sells
reinsurance products and services to insurance companies, self-funded
employers and other primary risk accepting organizations in the United
States and economically attractive international markets. Lincoln Re
utilizes a customization process to meet the needs of its clients and it
also relies on alliance partners to reach and service its clients.
Results of Operations(1): Lincoln Re's financial results, sales and in-force were as follows:
Year Ended December 31 (in millions) 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------
Financial Results by Source:
Individual Markets $90.6 $91.9 $83.5 $71.9 $49.8
Group Markets 7.5 (1.6) 1.6 3.3 10.2
Financial Reinsurance 20.3 21.7 17.1 15.5 17.5
Other (5.2) (1.5) (0.9) (0.2) (0.2)
- ------------------------------------------------------------------------------------------------------------
Income from Operations, excluding
Exited Businesses 113.2 110.5 101.3 90.5 77.3
Exited Businesses(2) 11.7 (67.0) 6.0 (238.9) (0.8)
- ------------------------------------------------------------------------------------------------------------
Income (Loss) from Operations(2) 124.9 43.5 107.3 (148.4) 76.5
Realized Gain (Loss) on Investments (0.7) 3.8 (2.6) 16.3 12.0
Restructuring Charge 0.7 (3.2) -- -- --
- ------------------------------------------------------------------------------------------------------------
Net Income (Loss)(2) $124.9 $44.1 $104.7 $(132.1) $88.5
Individual Life Sales --
Face Amount (in billions) $139.5 $116.8 $78.1 $39.5 $26.6
December 31 (in billions) 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------
Individual and Group Life
Insurance In-Force Face Amount $436.7 $340.8 $250.3 $183.5 $160.9
============================================================================================================
(1) The 1996-1999 data was restated from prior year due to the reallocation of net investment income on surplus
investments from "Other" in the former Life Insurance and Annuities segment to all segments that have
business in Lincoln National Life Insurance Company.
(2) Exited businesses, income (loss) from operations and net income (loss) for 1999 include the impact of changes
in estimates of reserves for HMO excess-of-loss reinsurance programs of $25.0 million, after-tax and workers'
compensation carve-out business underwritten by Unicover Managers, Inc. of $40.4 million, after-tax. Also,
exited businesses, income (loss) from operations and net income (loss) for 1997 include the impact of changes
in estimates of reserves needed for 1) LNC's disability income business of $130.0 million, after-tax and for 2)
personal accident programs of $113.7 million, after-tax.
Lincoln Re reported record net income of $124.9 million in 2000 and net
income of $44.1 million in 1999 and $104.7 million in 1998. Lincoln Re
reported record income from operations of $124.9 million in 2000. In
1999, Lincoln Re reported income from operations of $108.9 million
exclusive of special charges totaling $65.4 million (after-tax) reported
in exited businesses for reserve strengthening for the HMO excess-of-loss
programs and settlement costs associated with the workers' compensation
carve-out business underwritten by Unicover Managers, Inc. This compares
with $107.3 million in 1998.
Management's Discussion and Analysis
Comparison of 2000 to 1999
The increase in income from operations (exclusive of special charges
recorded in 1999) of $16.0 million or 15% in 2000 was a result of
offsetting results by business source. Individual markets experienced a
slight decrease in its earnings of $1.3 million or 1% between years.
Individual markets continued to experience significant growth in
individual life sales (face amount) of $22.7 billion or 19% and
individual life insurance in-force of $100.8 billion or 33% between
years. Part of the growth in sales and in-force in 2000 was due to a
surge in business during the first half of the year related to term life
policies written by direct life insurance companies prior to January 1,
2000 when the Valuation of Life Insurance Model Regulation ("Regulation
XXX") became effective. Regulation XXX requires companies to increase
reserves related to certain term life insurance policies; the resulting
surplus strain created for direct writing companies provided increased
sales opportunities for Lincoln Re.
The individual markets earnings growth rate did not keep pace with the
growth in sales volume due to higher mortality. The actual to expected
loss ratio was 97.8% for 2000 as compared to 88.9% for 1999. This
deterioration in mortality can be attributed to more competitive pricing
on newer business deals, which are performing closer to expected
long-term pricing levels of 100% loss ratios, and to below pricing
performance on two large in-force blocks. While the newer blocks of
business are priced to achieve a return on equity of over 15%, and are
performing near expectations, the performance on in-force block deals
continues to be an area of focused attention for individual markets.
Group markets experienced an increase in earnings of $9.1 million in
2000 primarily as a result of better pricing in the employer stop-loss
business. During 2000, employer stop-loss earnings were also bolstered
by the successful integration and retention of clients that were
acquired as a part of Alden Risk Management Services in November 1999.
Financial reinsurance had a decrease in earnings of $1.4 million or 6%
in 2000 primarily due to reduced fee income from two large clients
during 2000. Other had an increase in the loss between years of $3.7
million as a result of higher expenses associated with Lincoln Re's
international activities, along with less investment income on surplus
investments.
Exited businesses had income (loss) from operations of $11.7 million
in 2000 and $(1.6) million in 1999 (exclusive of special charges).
The $13.3 million increase in earnings between years was due
primarily to $9.2 million interest received upon the transfer of
LNC's investment in Seguros Serfin Lincoln in the first quarter of
2000. In addition, there were offsetting impacts in the disability
income and HMO excess-of-loss/group carrier medical lines of
business. The disability income line had increased earnings of
approximately $8 million primarily due to amortization of the
deferred gain from the 1999 transfer of a block of direct disability
income business to MetLife and a reduction in the expenses associated
with the administration of the business. The HMO excess-of-loss/group
carrier medical lines had claims losses in 2000 related to the 1999
underwriting year that decreased earnings by approximately $8 million.
Comparison of 1999 to 1998
The increase in income from operations (exclusive of special charges) of
$1.6 million or 1.5% in 1999 was the result of increased sales volumes
in the individual markets and financial reinsurance businesses offset by
losses in the group markets business and exited businesses. Individual
markets had an increase in pre-tax revenues of $180.5 million or 28%
from 1998 as a result of record sales in 1999, but increases in benefits
payments and operating expenses resulting from the addition of $90.5
billion of in-force (face amount) business resulted in only an $8.4
million or 10% increase in income from operations for the individual
markets business. Financial reinsurance revenues increased $65.2 million
pre-tax or 23% from 1998 and income from operations kept pace by
increasing $4.6 million or 27% from 1998. Group markets had an increased
loss of $3.2 million over 1998 and exited businesses had an increased
loss of $7.6 million (exclusive of special charges) over 1998 due to
higher benefit expenses and operating expenses in 1999. Other had an
increased loss of $0.6 million due to higher expenses in Lincoln Re's
international operations.
Exited Businesses
Exited businesses include lines in which new agreements are not being
entered into, but Lincoln Re must continue to manage and accept premiums
for a limited time according to contract terms under agreements in
force. These businesses include group carrier medical reinsurance, HMO
excess-of-loss reinsurance, personal accident which also includes
Unicover workers' compensation programs, reinsurance disability income
business and through the first quarter of 2000, Seguros Serfin Lincoln.
Significant developments with respect to these exited businesses are
discussed below.
HMO Excess-of-Loss Reinsurance Programs: During the third quarter of
1999, reported claims experience for certain HMO excess-of-loss
reinsurance programs deteriorated causing loss ratios to significantly
exceed pricing assumptions. The unfavorable loss ratio development
related primarily to business written in 1998 and 1997. Time lags in the
reporting of claims experience to Lincoln Re by clients and larger than
anticipated costs for prescription drugs were significant factors that
led to losses exceeding pricing assumptions. As a result of these
developments, the reserve level for these programs was deemed inadequate
to meet future obligations. Consequently, Lincoln Re took a charge in
the third quarter of 1999 of $25.0 million or $0.12 per share ($38.5
million pre-tax) to strengthen reserves for claims on the HMO
excess-of-loss reinsurance programs. The run-off of this line of
business is expected to be virtually complete by the end of 2001.
HMO Excess-of-Loss Restructuring Charge: As a result of the decision to
exit the HMO excess-of-loss business, in the third quarter of 1999, LNC
recorded a charge in the Reinsurance segment of $3.2 million
($4.9 million pre-tax) for employee severance and other costs related to
the discontinuance of this business. During the fourth quarter of 2000,
$0.7 million ($1.0 million pre-tax) of the original restructuring charge
for the discontinuance of HMO excess-of-loss reinsurance programs was
reversed due primarily to a change in estimate for severance and
outplacement costs. More employees whose positions were eliminated under
the restructuring plan found employment in other areas of LNC than had
been originally anticipated; therefore, actual severance and
outplacement costs were less than previously estimated. (See Note 12 to
the consolidated financial statements for further details regarding this
restructuring plan.)
Personal Accident Programs: During the fourth quarter of 1999, LNC
conducted an in-depth review of its exposure related to its
participation in workers' compensation carve-out (i.e., life and health
risks associated with workers' compensation coverage) programs managed
by Unicover Managers, Inc. As a result of this review as well as
settlement proceedings conducted to resolve this issue, LNC took a net
charge of $40.4 million or $0.20 per share ($62.2 million pre-tax) in
the fourth quarter of 1999. During the first quarter of 2000, LNC
reached a settlement with regard to one portion of the Unicover
programs. The costs of this settlement were in line with earlier
estimated costs to settle this portion of LNC's participation in these
programs.
Disability Income: Lincoln Life discontinued writing disability income
insurance in early 1996. The block of business was subsequently
transferred to Lincoln Re where it has been managed along with a block
of reinsurance disability income business. In May 1999, LNC announced an
agreement to transfer a block of direct individual disability income
business to MetLife. Lincoln Re transferred to MetLife cash of $490.4
million equal to statutory reserves, net of purchase price
consideration. A gain on sale of $56.7 million was deferred and will be
recognized in future periods over the premium-paying period of the
business. During 2000, Lincoln Re recognized in exited businesses
approximately $4 million ($6.2 million pre-tax) of the deferred gain
that resulted from the transfer to MetLife.
Seguros Serfin Lincoln: On March 30, 2000, LNC transferred its 49% share
of Seguros Serfin Lincoln to its partner, Grupo Financiero Serfin S.A.,
for $100.5 million. The proceeds included the recovery of LNC's
investment which freed up approximately $90.0 million of capital and
included interest of $14.1 million pre-tax ($9.2 million after-tax).
Product Development and Marketing
Lincoln Re has always focused its product development and marketing
efforts on providing customized solutions for its clients by utilizing
its core strengths of knowledge management and more specifically,
mortality management. Lincoln Re's core business, domestic individual
life reinsurance, has benefited over the last several years from this
industry leading knowledge-based model. Individual life reinsurance in
the United States, however, is not a high growth business. Therefore,
Lincoln Re has sought to find and capitalize on new opportunities for
growth. To this end, Lincoln Re has established its platform for growth
which includes: partnering with new entrants into the marketplace,
expanding its international efforts and meeting and exceeding the
web-based needs of the marketplace.
Lincoln Re has had success in capitalizing on its knowledge-based tools
such as its industry leading proprietary system, Lincoln Mortality
System[TM] ("LMS"). Of all new business written in 2000, almost 50%
originated from clients who use LMS. In 2000, Lincoln Re began expanding
the reach of LMS by exporting the system into international markets,
starting with Mexico and other Latin American countries. Lincoln Re is
bringing its overall mortality knowledge into these countries, but is
tailoring the information for the region. This is the model for future
growth into Japan and Europe. Japan continues to present reinsurance
opportunities for Lincoln Re. Lincoln Re's international efforts also
include a commitment to creating a joint venture in China that will sell
reinsurance products and services.
Management's Discussion and Analysis
Lincoln Re was rated the 4th best financial services company and No. 1
reinsurer in a 2000 survey conducted by Flaspohler/Reyes which asked
the question, "What companies come to mind when thinking about companies
that are especially successful or advanced in e-commerce?" Lincoln Re
has web-enabled sales and marketing, knowledge and administration for
its e-commerce customers. Lincoln Re's customer friendly e-commerce
tools include an electronic underwriting manual and the LincStar system
which is a web-based administrative system that gives the client and
Lincoln Re the ability to interact with each other.
Outlook
By leveraging scale, brand and an expert talent pool, Lincoln Re
continues to enhance its reputation as a leading life-health and
financial strategies reinsurer. It is positioned for growth both
domestically and internationally through its proven competency of
mortality risk management. E-commerce, enhanced research and
development, client product innovation and the use of patented risk
management technology abroad are strong foundations for individual life
reinsurance growth. The employer stop-loss business anticipates
additional growth by leveraging its morbidity management knowledge
within the group markets line of business.
Investment Management
The Investment Management segment offers a variety of asset management
services to retail and institutional clients located throughout the
United States and certain foreign countries. Its product offerings
include mutual funds and separate account wrap products. It also
provides investment management and account administration services
for variable annuity products, and 401(k), pension, endowment and
trust accounts. The primary operating companies within this segment
are the subsidiaries of Delaware Management Holdings, Inc. ("Delaware").
Retail products are distributed through both LFD and LFA. Institutional
products, including large case 401(k) plans, are marketed by a separate
sales force in conjunction with pension consultants. Until December 31,
2000, this segment also included Lincoln Investment Management, LNC's
internal investment advisor. Subsequent to December 31, 2000, the
investment management operations of Lincoln Investment Management
were combined into Delaware as discussed below under Restructuring Charges.
Diversity of investment styles, as well as diversity of clients served,
are prudent ways to diversify risk in varying market environments.
Delaware, historically known for a conservative, "value" equity
investment style has now evolved into an investment manager with strong
and diversified offerings across all asset classes including value and
growth equity investment styles; high-grade, high-yield and municipal
fixed income investment styles; balanced and quantitative investment
styles; and the international and global equity and fixed income
investment styles.
Results of Operations(1): The Investment Management segment's financial
results and assets under management were as follows:
Year Ended December 31 (in millions) 2000 1999 1998 1997 1996
- ----------------------------------------------------------------------------------------------------
Financial Results:
Revenues:
Investment Advisory Fees $231.6 $248.6 $249.0 $229.9 $199.8
Investment Advisory Fees At Cost(2) 46.1 37.7 47.9 46.2 43.7
Other Revenue and Fees 124.7 117.0 102.6 78.9 60.1
Income:
Income (Loss) from Operations $14.0 $32.9 $20.7 $(0.3) $2.8
Realized Gain (Loss) on Investments (2.5) (0.1) 0.5 7.0 6.4
Restructuring Charges (4.6) (9.2) -- -- --
- ----------------------------------------------------------------------------------------------------
Net Income $6.9 $23.6 $21.2 $6.7 $9.2
Income from Operations-Excluding
Amortization of Intangibles $40.8 $60.7 $49.4 $26.8 $26.8
- ----------------------------------------------------------------------------------------------------
December 31 (in billions) 2000 1999 1998 1997 1996
- ----------------------------------------------------------------------------------------------------
Assets Under Management
Regular Operations:
Retail - Equity $21.2 $23.4 $22.1 $17.8 $13.1
Retail - Fixed 6.5 7.4 8.2 8.1 5.9
- ----------------------------------------------------------------------------------------------------
Total Retail 27.7 30.8 30.3 25.9 19.0
Institutional - Equity $19.1 $23.6 $24.2 $24.9 $22.9
Institutional - Fixed 6.1 7.0 7.0 5.7 3.6
- ----------------------------------------------------------------------------------------------------
Total Institutional 25.2 30.6 31.2 30.6 26.5
Total Retail and Institutional 52.9 61.4 61.5 56.5 45.5
At Cost Operations 35.7 35.9 39.4 35.6 37.4
- ----------------------------------------------------------------------------------------------------
Total Assets Under Management $88.6 $97.3 $100.9 $92.1 $82.9
====================================================================================================
(1) The 1996-1999 data was restated from the prior year due to the reallocation of net investment income
on surplus investments and expenses from "Other" in the former Life Insurance and Annuities segment
to all segments that have business in Lincoln National Life Insurance Company. Within this segment,
the reallocation relates to the 401(k) operations.
(2) Fees "at cost" are calculated on an expense-sharing basis and do not include a profit margin.
The Investment Management segment reported net income of $6.9 million in
2000, $23.6 million in 1999 and $21.2 million in 1998. Income (loss)
from operations was $14.0 million, $32.9 million for 1999 and $20.7
million for 1998.
Comparison of 2000 to 1999
The decrease in income from operations of $18.9 million or 57% in 2000
was attributable to decreased investment advisory fees on retail and
institutional assets under management and increased expenses, which were
partially offset by an increase in other revenue. The decrease in
investment advisory fees was due to an overall decrease in external
assets under management between years of $8.5 billion, composed of a
$3.1 billion decrease in retail assets and a $5.4 billion decrease in
institutional assets. The decline in assets under management during 2000
caused earnings to decrease by $11.1 million. The primary cause of the
decrease in assets under management was net cash outflows of $7.2
billion (see below for further discussion of net cash flows) and to a
lesser extent market depreciation of $1.3 billion.
Overall, expenses increased $19.0 million primarily as a result of an
increase in headcount of investment professionals, higher severance
costs related to turnover of investment professionals and higher
commission expense resulting from sales growth. These expense increases
were partially offset by cost savings achieved from consolidating both
Lynch & Mayer and Vantage into Delaware, as well as lower costs achieved
from the reorganization and decentralization of shared services within
the 401(k) line of business and lower year 2000 information technology
costs. Other revenue increased by $5.0 million primarily due to higher
fees on the 401(k) line of business resulting from higher average
balances and higher average annual rates. In addition, distribution
income increased as a result of higher retail sales, and accounting and
record-keeping fees increased as result of more activity and more
accounts being serviced in 2000.
Comparison of 1999 to 1998
The growth in income from operations of $12.2 million or 59% in 1999 was
primarily attributable to cost savings related to the downsizing of
Lynch & Mayer and the integration of the Lincoln Life 401(k) business
into Delaware and an increase in other revenue and fees. Other revenue
and fees increased due to an increase in Delaware's accounting and
record-keeping fees resulting from an increase in accounts being
serviced and an increase in distribution income resulting from higher
retail sales by Delaware over 1998.
Investment advisory fees for the segment were relatively flat from 1998
because of a slight overall decrease in external assets under management
(retail and institutional). External assets under management were $61.4
billion at December 31, 1999 and $61.5 billion at December 31, 1998. The
change in assets under management of $(0.1) billion from 1998 was
attributed to net cash outflows of $4.5 billion partially offset by $4.4
billion in market appreciation. The net cash outflows for the segment were
primarily due to investment performance issues in the institutional
accounts and domestic mutual funds. The primary investment performance
issues centered around all of Lynch & Mayer's portfolios and Delaware's
value portfolios, which under performed the S&P 500 and Russell 1000 Value
indices, respectively, in 1999.
Management's Discussion and Analysis
Although the overall net cash flows were negative, the international
business had net inflows of $2.8 billion. The international net inflows
were the result of an industry-wide trend toward the globalization of
pension investments. In addition, Delaware's domestic retail growth
funds and institutional growth accounts experienced significant asset
growth during 1999. Delaware's retail growth assets under management
increased $2.2 billion or 129% to $3.9 billion at December 31, 1999 from
$1.7 billion at December 31, 1998 and its institutional growth assets
grew 103% to $0.9 billion. These increases in the growth assets were the
result of positive cash flows and strong investment performance
experienced in this area.
Net Cash Flows: The Investment Management segment's net cash flows were
as follows:
Year Ended December 31 (in billions) 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------
Net Cash Flows:
Retail:
Equity Sales $4.0 $3.3 $3.6 $3.0 $2.2
Equity Redemptions and Transfers (4.5) (5.1) (1.7) (1.7) (0.9)
- ------------------------------------------------------------------------------------------------
Net Flows (0.5) (1.8) 1.9 1.2 1.3
Fixed Sales 0.7 1.0 1.1 1.0 0.8
Fixed Redemptions and Transfers (1.7) (1.4) (1.2) (1.6) (1.2)
- ------------------------------------------------------------------------------------------------
Net Flows (1.0) (0.4) (0.1) (0.6) (0.4)
- ------------------------------------------------------------------------------------------------
Total Retail Net Flows (1.5) (2.2) 1.8 0.6 0.9
Institutional:
Equity Inflows 2.7 5.2 3.8 2.5 2.0
Equity Withdrawals and Transfers (7.2) (7.8) (7.4) (6.5) (4.8)
- ------------------------------------------------------------------------------------------------
Net Flows (4.5) (2.6) (3.6) (4.0) (2.8)
Fixed Inflows 0.8 2.0 2.2 2.5 1.5
Fixed Withdrawals and Transfers (2.0) (1.7) (1.3) (0.8) (1.1)
- ------------------------------------------------------------------------------------------------
Net Flows (1.2) 0.3 0.9 1.7 0.4
- ------------------------------------------------------------------------------------------------
Total Institutional Net Flows (5.7) (2.3) (2.7) (2.3) (2.4)
- ------------------------------------------------------------------------------------------------
Total Retail and Institutional Net Flows $(7.2) $(4.5) $(0.9) $(1.7) $(1.5)
================================================================================================
The Investment Management segment's trend of net cash outflows continued
in 2000 with net cash outflows totaling $5.7 billion for institutional
accounts and $1.5 billion for retail accounts. These results were
primarily due to investment performance issues. Retail accounts,
however, reversed the trend in the fourth quarter of 2000, with positive
net flows of $58 million. This improvement represented the best quarter
for redemptions in both retail equity and fixed accounts since the third
quarter of 1998. In total, institutional net cash flows did not improve
during 2000; however, the last three quarters of the year showed
significant improvement over the first quarter net cash outflows of $2.6
billion.
Although total retail and institutional net flows for the fourth quarter
were negative, overall net flows have improved over the previous four
quarters. During 2000, growth accounts have contributed positively to new
flows. Retail growth assets under management increased $1.4 billion or 36%
to $5.3 billion at December 31, 2000 from $3.9 billion at December 31, 1999
and institutional growth assets under management grew $1.6 billion or 178%
to $2.5 billion at December 31, 2000 from $0.9 billion at December 31,
1999. These increases in the growth assets were the result of positive cash
flows and strong investment performance experienced in this area.
In the first quarter of 2000, LNC initiated actions to fix the
investment performance problems that have been the root of the negative
cash flows that have plagued the Investment Management segment over the
last several quarters. LNC believes that once investment performance is
measurably improved, increased asset retention and new asset flows
should follow. Higher assets under management translate into higher fees
and ultimately to higher earnings for the Investment Management segment.
These management actions have focused on two critical components
necessary to improving investment performance across all asset classes:
people and process. Specifically, these actions included hiring a new
chief executive officer for the Investment Management segment with
substantial industry experience, overhauling the investment process in
the large cap value investment management area, recruiting a team of 20
new fixed-income investment professionals, creating a separate portfolio
management group for the retail area, adding to in-house research
resources across all asset classes and enhancing sub-advisory
relationships.
At the beginning of this process, management estimated that at least one
full year of good performance relative to peers and relevant benchmarks
would precede measurable improvement in retail flows. Management also
estimated that the turnaround on improved institutional cash flows would
be more protracted and take up to three years of good performance before
consultants would accept marked improvement and begin recommending
Delaware.
During 2000, investment performance improved for both retail and
institutional asset classes. On the retail side, 16 of the largest 25
mutual funds offered by Delaware finished in the top half of their
respective Lipper universes during the last nine months of 2000.
Likewise, all 13 institutional asset classes managed by Delaware
finished ahead of their benchmarks for the year ended December 31, 2000.
These results are an improvement over 1999's performance when 11 of
Delaware's 25 largest mutual funds were in the top half of their
respective Lipper classifications and 10 institutional asset classes
outperformed their benchmarks for the year.
LNC is encouraged by these results and believes that progress has been
achieved towards the goals of 1) upgrading talent and improving
investment process, 2) achieving good, consistent performance in all
asset classes, and 3) retaining and increasing assets under management.
Restructuring Charges
During the second quarter of 2000, LNC recorded a restructuring charge
in its Investment Management segment of $2.7 million after-tax ($4.1
million pre-tax). The objective of this restructuring plan is to combine
the structured products team of Delaware and Vantage in Philadelphia and
consolidate the back office operations of Vantage into Delaware, to
reduce ongoing operating costs and eliminate redundant facilities within
this business segment. This charge was included in Underwriting,
Acquisition, Insurance and Other Expenses on the Consolidated Statement
of Income. The restructuring plan identified the following activities
and associated pre-tax costs to achieve the objectives of the
restructuring plan: (1) severance and termination benefits of $2.3
million related to the elimination of 15 positions, (2) write-off of
impaired assets of $1.4 million and (3) other costs of $0.4 million.
Write-offs under the restructuring plan began in the second quarter of
2000. During the fourth quarter of 2000, LNC determined that part of
rent expense related to abandoned office space included in (3) above
would not be incurred due to the landlord allowing LNC to surrender the
lease earlier than expected. In addition, Vantage determined that some
of the termination benefit payments included in (1) above would not be
required to be made. As a result, $0.6 million (pre-tax) of the original
charge was reversed. All expenditures under this restructuring plan are
expected to be completed by the third quarter of 2001. As of December
31, 2000, $2.8 million (pre-tax) has been expended or written-off under
this restructuring plan and all 15 positions have been eliminated. As of
December 31, 2000, a balance of $0.7 million remains in the
restructuring reserve for this plan.
During the fourth quarter of 2000, LNC recorded a restructuring charge
in its Investment Management segment of $2.5 million after-tax ($3.9
million pre-tax). The objective of this restructuring plan is to combine
the investment management operations of Lincoln Investment Management
and Delaware in Philadelphia, in order to reduce ongoing operating costs
and eliminate redundant facilities within this business segment. This
charge was included in Underwriting, Acquisition, Insurance and Other
Expenses on the Consolidated Statement of Income. The restructuring plan
identified the following activities and associated pre-tax costs to
achieve the objectives of the restructuring plan: (1) severance and
termination benefits of $1.7 million related to the elimination of 19
positions, (2) write-off of impaired assets of $0.3 million and (3)
other costs of $1.9 million (primarily lease payments on abandoned
office space). Expenditures and write-offs under the restructuring plan
began in the fourth quarter of 2000. All remaining expenditures under
this restructuring plan are expected to be completed by the end of the
first quarter of 2002, except for lease payments on abandoned office
space which will continue until the end of the lease term in November
2014. As of December 31, 2000, $0.1 million (pre-tax) has been expended
or written-off under this restructuring plan and 12 positions have
been eliminated. As of December 31, 2000, a balance of $3.8 million
remains in the restructuring reserve for this plan.
Outlook
LNC initiated significant changes in the Investment Management segment
during 2000. These changes, centered on improving investment
performance, have yielded short-term improvement in investment
performance and net cash flows. LNC believes a strong foundation now
exists in the Investment Management segment for future growth and
improved investment performance in 2001. However, the magnitude of any
positive net cash flows is subject to the continuation of good
investment performance and to the uncertainties associated with the
securities markets.
Management's Discussion and Analysis
Lincoln UK
During 2000, LNC announced the transfer of the Lincoln UK sales force to
Inter-Alliance and the decision to cease writing new business in the UK
through direct sales distribution. Managing the retention of the
existing blocks of business, completing the relocation of the home
office operations, and effectively managing expenses are significant
on-going operational objectives for the Lincoln UK segment.
Results of Operations: Lincoln UK's financial results, net initial
commission value, account values, in-force and exchange rates were as
follows:
Year Ended December 31 (in millions) 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
Financial Results:
Income (Loss) from Operations(1) $61.0 $(13.9) $70.9 $(108.3) $66.1
Realized Gain (Loss) on Investments 2.3 2.2 0.8 1.5 (0.1)
Restructuring Charge (76.5) (6.5) -- -- --
- ------------------------------------------------------------------------------------------------------------------
Net Income (Loss)(1) $(13.2) $(18.2) $71.7 $(106.8) $66.0
Net Initial Commission Value(2) $32.6 $51.4 $54.9 $55.4 $47.2
December 31 (in billions) 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------
Unit-Linked Assets $6.4 $7.2 $6.3 $ 5.6 $5.1
Individual Life Insurance In-Force $24.3 $25.7 $25.0 $25.0 $23.8
Exchange Rate Ratio - U.S. Dollars to Pounds Sterling
Average for the Year 1.518 1.617 1.658 1.644 1.567
End of Year 1.493 1.615 1.660 1.651 1.713
==================================================================================================================
(1) Income (loss) from operations and net income (loss) for 1999 and
1997 include charges of $126.1 million ($194.0 million pre-tax) and
$174.9 million ($199.4 million pre-tax) for changes in estimate of the
cost of settling pension mis-selling liabilities and 1999 includes a tax
benefit of $42.1 million relating to the decision to explore exiting the
UK insurance market (see below for discussion of these special items in
1999).
(2) Net Initial Commission Value was a measure used by Lincoln UK to
measure sales progress and future profitability.
The Lincoln UK segment reported net income (loss) of $(13.2) million in
2000, $(18.2) million in 1999 and $71.7 million in 1998. Income (loss)
from operations was $61.0 million in 2000, $(13.9) million in 1999 and
$70.9 million in 1998. Income from operations excluding special charges
in 1999 for changes in estimate of the cost of settling pension
mis-selling liabilities and the 1999 tax benefit relating to the
decision to explore exiting the UK insurance market was $70.1 million.
Comparison of 2000 to 1999
The $9.1 million or 13% decrease in income from operations excluding the
1999 special items totaling $84.0 million ($126.1 million pension
mis-selling costs less $42.1 million tax benefit) in 2000 was due primarily
to reduced sales volumes and increased expenses. Net income in 2000 was
also negatively impacted by the recording of restructuring charges in the
third and fourth quarters of 2000 totaling $76.5 million after-tax. Sales
volumes were down during 2000 as a result of the transfer of the sales
force in the third quarter and sales force productivity suffered earlier in
the year due to uncertainty around the UK strategic review. Expenses
increased in 2000 as a result of one-time items related to operational
initiatives started in the fourth quarter of 1999 and reserve strengthening
of $4.0 million for policies carrying guaranteed annuity options. Also,
there was $3.4 million in additional expenses related to the strategic
review of Lincoln UK and $1.4 million of expenses associated with the UK
restructuring plan that did not qualify for inclusion in the restructuring
charge. In addition, a change in assumptions governing the amortization of
deferred acquisition costs caused an increase in expenses (see Lincoln UK
Restructuring below for further discussion). Partially offsetting these
increased expenses were lower volume-related expenses.
Comparison of 1999 to 1998
The $0.8 million decrease in income from operations excluding the 1999
special items totaling $84.0 million ($126.1 million pension mis-selling
costs less $42.1 million tax benefit) in 1999 was due primarily to
relatively flat operating revenues and increased expenses. Operating
revenues increased $5.0 million or 1% in 1999 due primarily to an increase
in revenues generated by the increase in unit-linked assets of $0.9 billion
or 14% between years. This was partially offset by a decrease in life
insurance and annuity premiums on non-linked business caused by an
industry-wide decrease in demand for pension products and product
repricing. The increase in the unit-linked assets was mainly due to market
appreciation. The industry-wide decrease in demand for pension products was
due to the advent of the Stakeholder Pension to be launched in 2001.
Benefits expense excluding the reserve strengthening noted above was flat
between years. Underwriting, acquisition, insurance and other expenses
increased by $23.1 million or 13% due primarily to the costs related to the
strategic review process initiated in 1999.
Lincoln UK Restructuring
During 2000, Lincoln UK entered into a restructuring plan. (See discussion
in the MD&A Overview: Results of Consolidated Operations and in Note 12 to
the consolidated financial statements.) As a result of this restructuring,
retaining the existing business on Lincoln UK's books for as long as
possible is important to future profitability. The agreement with
Inter-Alliance contains incentives designed to help Lincoln UK retain the
existing business. Despite these protections, the significant changes in
Lincoln UK's business will require management to continue to update
persistency assumptions. In the third quarter of 2000 an initial assessment
of likely changes in persistency resulted in increased operating expense of
$3.5 million. As decisions relating to the final number of Lincoln UK sales
associates that would become affiliated with Inter-Alliance were finalized
during the fourth quarter, Lincoln UK updated persistency assumptions
again. This update resulted in increased operating expense of $2.9 million
in the fourth quarter of 2000. As the status of the existing business on
Lincoln UK's books continues to develop in the future, LNC management will
continue to consider whether further changes in persistency assumptions are
necessary.
Mortgage Endowments
On November 30, 2000 UK regulators issued a paper containing draft
guidelines explaining how mortgage endowment holders would be
compensated in instances were it is determined that mis-selling
occurred. This release also indicated that an extensive analysis is
underway of mortgage endowment products offered by insurance companies
in the UK marketplace since 1988. Where the results of this analysis
indicate that products are designed in a way that could lead to
potential mis-selling, UK regulators are contacting companies to
review sales practices.
Lincoln UK received a letter from UK regulators on February 8, 2001,
raising concerns with certain mortgage endowment products sold by
British National Life Assurance Company ("BNLA"). The specific policies
at issue were sold between the period of July 1988 through March 1994.
Lincoln UK acquired BNLA from Citibank in August of 1993. Less than
6,000 of these BNLA policies remain in force.
UK regulators are contending that BNLA's sales literature was written in
a manner that provides a contractual warranty that, if certain
assumptions were achieved, the mortgage endowment would grow to a
balance sufficient to repay the contractholder's mortgage. LNC strongly
disagrees that any contractual warranties were made in the sale of these
mortgage endowment policies. LNC is prepared to proceed with all
available means of resolution, including pursuing regulatory,
administrative and legal means of concluding this matter.
While the ultimate outcome of these matters is uncertain, LNC believes
that it will prevail on the merits of its argument that no contractual
warranties were provided in the sale of BNLA's mortgage endowment
contracts. If LNC does not prevail, and is consequently required to
incur compensatory remedies under the UK regulator's breach of warranty
theory, LNC has estimated that it could incur costs of up to $20
million.
United Kingdom Pension Product Mis-selling
During the fourth quarter of 1999, LNC took a charge of $126.1 million
or $0.64 per share ($194.0 million pre-tax) to further strengthen
its reserve for pension mis-selling in the UK. This additional reserve
strengthening was made following: 1) the mandate issued by the Financial
Services Authority, the UK regulating body, for the use of more up to date
mortality rates in determining redress and reduced interest rate
assumptions to be used in calculating redress, thereby causing the amount
of redress to increase, 2) the change to guidance that would have
allowed a simplified process for the calculation and payment of redress for
certain policy groups and 3) the inclusion of redress relating to
additional voluntary contributions made to pension plans by individuals,
retroactive to 1988. (See Note 7 to the consolidated financial statements
for an update on the reserve for United Kingdom Pension Products.)
Tax Benefit Relating to Decision to Explore Exit of UK Insurance Market
When LNC decided to explore exiting the UK insurance market in 1999, LNC
was required to change its method of accounting for Lincoln UK's taxes.
In the fourth quarter of 1999, LNC recorded a $42.1 million tax benefit
relating to this matter.
Management's Discussion and Analysis
Exchange Rates
LNC's subsidiary in the UK, as with subsidiaries in other countries, has
its balance sheets and income statements translated at the current spot
exchange rate as of the year end and average spot exchange rate for the
year, respectively.
Outlook
During 2001, Lincoln UK will work to retain and manage its current block
of business while maximizing earnings through expense management
initiatives.
Other Operations
Activity which is not included in the major business segments is shown
as "Other Operations." "Other Operations" includes operations not
directly related to the business segments, unallocated corporate items
(i.e., corporate investment income, interest expense on corporate debt
and unallocated overhead expenses) and LFA. Starting in 1999, 100% of
LNC's corporate overhead expenses was allocated to the business
segments.
Results of Operations(1): Other Operations' financial results were
as follows:
Year Ended December 31(1) (in millions) 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------
Financial Results by Source:
LNC Financing $(85.5) $(83.6) $(52.5) $(31.9) $(49.7)
LFA (11.7) (20.8) (23.7) (5.3) (10.2)
Other Corporate (14.5) (5.1) (16.4) (24.9) (12.2)
- ------------------------------------------------------------------------------------------------------
Loss from Operations (111.7) (109.5) (92.6) (62.1) (72.1)
Realized Gain (Loss) on Investments (2.5) 6.4 5.3 8.6 (1.0)
Restructuring Charge 0.3 -- (14.3) -- --
- ------------------------------------------------------------------------------------------------------
Net Income (Loss) $(113.9) $(103.1) $(101.6) $(53.5) $(73.1)
======================================================================================================
(1) The 1996-1999 data was restated from the prior year due to the
reorganization of the Life Insurance and Annuities segment into two
separate segments: an Annuities segment and a Life Insurance segment.
Results for LFA and certain unallocated expenses previously reported in the
Life Insurance and Annuities segment are now reported in "Other
Operations."
Other Operations reported a net loss of $113.9 million in 2000, $103.1
million in 1999 and $101.6 million in 1998. Other Operations reported
loss from operations of $111.7 million in 2000, $109.5 million in 1999
and $92.6 million in 1998. The restructuring charge of $14.3 million
included in net income in 1998 resulted from an organizational/expense
review and represents severance pay and space abandonment charges
related to staff reductions in the parent company and reduction in the
size of LNC's facilities. The reversal of the restructuring charge of
$0.3 million recorded in 2000 was related to a change in estimate of
severance costs included in the original 1998 plan. Some employees, who
held positions that were identified for termination, found employment in
other areas of the company. (See Note 12 to the consolidated financial
statements for discussion of these restructuring activities.)
Comparison of 2000 to 1999
The slight increase in the loss from operations of $2.2 million or 2% in
2000 was due to offsetting items. First, the loss in Financing increased
by $1.9 million due primarily to an increase in short-term borrowing
costs caused by both an increase in the average outstanding commercial
paper balance and an increase in interest rates. LFA had a decrease in
its loss between years of $9.1 million or 44% as a result of increased
sales volumes and decreased general and administrative expenses. Other
Corporate had an increase in its loss between years of $9.4 million or
184% due primarily to an increase in incentive compensation in 2000
resulting from the achievement of the three-year long-term incentive
compensation goals. This expense was not allocated to the business
segments. In addition, offsetting litigation settlements contributed to
the increased loss between years (see Litigation below for further
discussion).
Comparison of 1999 to 1998
The increase in loss from operations of $16.9 million or 18% in 1999 was
also due to offsetting items. First, the loss in Financing increased by
$31.1 million or 59% due to higher average debt outstanding. Included in
1999 was a full year of interest related to long-term debt that was
issued in March and August of 1998. The debt proceeds were used to
finance the purchase of a block of business from Aetna Inc. in October
1998. The results for LFA were slightly improved over the prior year due
primarily to increased sales volumes. Other Corporate had a decrease in
its loss of $11.3 million or 69% due primarily to the 1999 change in
allocation methodology in which 100% of LNC's corporate overhead
expenses was allocated to the business segments. The loss that was
recorded in 1999 was related to LNC's investment in AnnuityNet.
Litigation
During the first quarter of 2000, the appellate court upheld LNC's
position in litigation relating to the 1992 sale of the Employee
Life-Health Benefit business segment. As a result of this favorable
decision, LNC's earnings increased by approximately $11.2 million ($17.2
million pre-tax).
During the fourth quarter of 2000, Lincoln National Life Insurance
Company ("LNL") reached an agreement in principle to settle all class
action lawsuits alleging fraud in the sale of non-variable universal
life and participating whole life insurance policies. The agreement is
subject to court approval and is expected to become final in 2001. It
requires that LNL provide benefits and a claim process to policyholders
who purchased non-variable universal life and participating whole life
policies between January 1, 1981 and December 31, 1998. The settlement
covers approximately 431,000 policies.
Total charges recorded during 2000 for this preliminary settlement
aggregated $42.1 million ($64.7 million pre-tax). A charge of $13.8
million ($21.2 million pre-tax) was recorded in the first quarter of
2000 relating to the preliminary settlement of one such class action
lawsuit against LNL. A charge of $28.3 million ($43.5 million pre-tax)
was recorded in the fourth quarter of 2000 related to this preliminary
settlement.
In December 2000, LNC received a $43 million (pre-tax) cash payment in
exchange for agreeing to modify certain non-compete terms included in an
acquisition completed by LNC prior to 1999. In LNC's purchase accounting
for this acquisition, the non-compete terms of the acquisition agreement
were believed to have only negligible value and there was no reasonable
basis for estimating the additional business and profits, if any, that
might result from these non-compete terms. Under these facts and
circumstances, LNC concluded that no separately identifiable intangible
asset should be recorded for the non-compete terms. However, events in 2000
resulted in a substantial increase in the value of these non-compete terms,
culminating with the receipt of the $43 million payment. LNC does not
believe that the forefeiture of its remaining non-compete rights and
benefits, which would have otherwise expired in 2001, diminishes the value
of goodwill recorded in the acquisition. As a result, LNC recorded the
$28.0 million ($43 million pre-tax) payment in fourth quarter 2000 net
income.
Consolidated Investments
The consolidated investments on the balance sheet classified by
investment advisor, mean invested assets, net investment income and
investment yield are as follows:
December 31 (in billions) 2000 1999 1998 1997 1996
- ------------------------------------------------------------------------------------------------------
Assets Managed by Advisor:
Investment Management Segment(1):
External Assets $52.9 $61.4 $61.5 $56.5 $45.5
Internal Assets 35.7 35.9 39.4 35.6 37.4
Lincoln UK 7.9 8.6 7.6 6.8 6.1
Within Business Units (Policy Loans) 1.9 1.9 1.8 0.8 0.8
Non-LNC Affiliates 32.9 32.7 23.5 19.4 15.3
- ------------------------------------------------------------------------------------------------------
Total Assets Managed $131.3 $140.5 $133.8 $119.1 $105.1
Mean Invested Assets $37.47 $39.03 $36.50 $30.34 $27.91
Adjusted Net Investment Income(2) $2.75 $2.82 $2.69 $2.26 $2.10
Investment Yield (ratio of net investment
income to mean invested assets) 7.35% 7.21% 7.36% 7.46% 7.52%
======================================================================================================
(1) See Investment Management segment data starting on page 50 for additional detail.
(2) Includes tax-exempt income.
Management's Discussion and Analysis
Investment Objective: Invested assets are an integral part of the
Annuities, Life Insurance, Lincoln UK and Reinsurance segments'
operations. For discussion of external assets under management, i.e.
retail and institutional assets, see the Investment Management segment
discussion starting on page 50. LNC follows a balanced approach of
investing for both current income and prudent risk management, with an
emphasis on generating sufficient current income to meet LNC's
obligations. This approach requires the evaluation of risk and expected
return of each asset class utilized, while still meeting the income
objectives of LNC. This approach also permits LNC to be more effective
in its asset-liability management, since decisions can be made based
upon both the economic and current investment income considerations
affecting assets and liabilities.
Investment Portfolio Composition and Diversification: Fundamental to
LNC's investment policy is diversification across asset classes. LNC's
investment portfolio, excluding cash and invested cash, is composed of
fixed maturity securities; mortgage loans on real estate; real estate
either wholly owned or in joint ventures and other long-term
investments. LNC purchases investments for its segmented portfolios that
have yield, duration and other characteristics that take into account
the liabilities of the products being supported. The dominant
investments held are fixed maturity securities, which represent
approximately 78% of the investment portfolio. The total investment
portfolio decreased $0.2 billion in 2000 and $2.4 billion in 1999. The
decrease in 2000 was due primarily to the continuation of net cash
outflows for fixed annuity portfolios. This decline was partially offset
by new purchases of investments from cash flow generated by the business
units and market appreciation of fixed maturity securities due to the
decline in interest rates during 2000. The decrease in 1999 was due to
the decrease in fair value of fixed maturity securities
available-for-sale due to a rising interest rate environment in 1999 and
the continuation of the transfer of funds by fixed annuity
contractholders to variable annuity contracts partially offset by the
new purchases of investments from cash flow generated by the business
units.
Fixed Maturity Security Ratings: LNC maintains a high-quality fixed
maturity securities portfolio. As of December 31, 2000, $8.0 billion or
29.1% of its fixed maturity securities portfolio had ratings of AA or
better. Fixed maturity securities with below-investment-grade ratings (BB
or less) were $1.9 billion or 6.9% of the total fixed maturity securities
portfolio (see Note 3 to the consolidated financial statements). The
below-investment-grade fixed maturity securities represent 5.3% of LNC's
total investment portfolio. The interest rates available on these
below-investment-grade securities are significantly higher than are
available on other corporate debt securities. Also, the risk of loss due to
default by the borrower is significantly greater with respect to such below
investment grade securities because these securities are generally
unsecured, often subordinated to other creditors of the issuer and issued
by companies that usually have high levels of indebtedness. LNC attempts to
minimize the risks associated with these below investment grade securities
by limiting the exposure to any one issuer and by closely monitoring the
credit worthiness of such issuers. For the year ended December 31, 2000,
the aggregate cost of below investment grade securities purchased was
$162.3 million. Aggregate proceeds from such investments sold were $176.9
million, resulting in a realized pre-tax loss at the time of sale of $46.7
million.
Securities Available-for-Sale: LNC's entire fixed maturity and equity
securities portfolio is classified as "available-for-sale" and is
carried at fair value on its balance sheet. Because the general intent
of the "available-for-sale" accounting rules is to reflect shareholders'
equity as if unrealized gains and losses were actually recognized, it is
necessary for LNC to consider all related accounting adjustments that
would occur upon such a hypothetical recognition of unrealized gains and
losses. Such related balance sheet effects include adjustments to the
balances of deferred acquisition costs, policyholder commitments and
deferred income taxes. Adjustments to each of these balances are charged
or credited directly to shareholders' equity as part of LNC's
"available-for-sale" accounting. For instance, deferred acquisition
costs are adjusted upon the recognition of unrealized gains or losses
since the amortization of deferred acquisition costs is based upon an
assumed emergence of gross profits on certain insurance business. In a
similar manner, adjustments to the balances of policyholder reserves or
commitments are made because LNC has either a contractual obligation or
has a consistent historical practice of making allocations of investment
gains or losses to certain policyholders. Deferred income tax balances
are also adjusted, since unrealized gains or losses do not affect actual
taxes currently paid. See Note 3 to the consolidated financial
statements for details of the gross unrealized gains and losses as of
December 31, 2000.
Mortgage-Backed Securities: LNC's fixed maturity securities
available-for-sale include mortgage-backed securities. The
mortgage-backed securities included in LNC's 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. Securities that have an amortized
cost greater than par and are backed by mortgages that prepay faster
than expected will incur a reduction in yield or a loss. Those
securities with an amortized cost lower than par that prepay faster than
expected will generate an increase in yield or a gain. In addition, LNC
may incur reinvestment risks if market yields are lower than the book
yields earned on the securities. Prepayments occurring slower than
expected have the opposite impact. LNC may incur disinvestment risks if
market yields are higher than the book yields earned on the securities
and LNC is forced to sell the securities. The degree to which a security
is susceptible to either gains or losses is influenced by 1) the
difference between its amortized cost and par, 2) the relative
sensitivity of the underlying mortgages backing the assets to prepayment
in a changing interest rate environment and 3) the repayment priority of
the securities in the overall securitization structure.
LNC limits the extent of its 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. At
December 31, 2000, LNC did not have a significant amount of higher-risk
mortgage-backed securities. There are negligible default risks in the
mortgage-backed securities portfolio as a whole as the vast majority of
the assets are either guaranteed by U.S. government-sponsored entities
or are supported in the securitization structure by junior securities
enabling the assets to achieve high investment grade status. See Note 3
to the consolidated financial statements for additional detail about the
underlying collateral.
Mortgage Loans on Real Estate and Real Estate: As of December 31, 2000,
mortgage loans on real estate and investments in real estate represented
13.2% and 0.8% of the total investment portfolio. As of December 31,
2000, the underlying properties supporting the mortgage loans on real
estate consisted of 29.9% in retail stores, 32.5% in commercial office
buildings, 13.5% in apartments, 13.9% in industrial buildings, 6.0% in
hotels/motels and 4.2% in other. In addition to the dispersion by type
of property, the mortgage loan portfolio is geographically diversified
throughout the United States.
Fixed Maturity Performance: In 2000, the performance of LNC's fixed
maturity portfolio, managed by the Investment Management segment, was
measured against investment income and risk management measures. The
portfolios have exceeded the investment income benchmark by $47.1
million. The investment income measure is a forecasted investment income
target based upon the assets at the beginning of the year, expected new
investment spreads, and adjusted for interest rate movements during the
year. The portfolios' performance exceeded the risk management measure
by 105 basis points in 2000. The risk management measure is a weighted
composite benchmark, constructed from eighteen asset class indices. The
indices are related to each of the major asset classes utilized by
Lincoln Investment Management. The performance relative to the income
measure exceeded the benchmark due to a number of factors, primarily
asset allocation strategies, credit spread widening and interest rate
increases. While the risk management measure did not exceed the
benchmark in all asset sectors, the aggregate benchmark was exceeded.
This out-performance in aggregate is the result of a continuing
commitment to portfolio diversification and to strong underwriting
guidelines in asset selection.
Net Investment Income: Net investment income decreased $60.4 million or
2% in 2000 due to a 4% decrease in mean invested assets partially offset
by an increase in the yield on investments from 7.21% to 7.35% (all
calculations on a cost basis). The decrease in mean invested assets in
2000 was due primarily to net cash outflows from fixed annuities in the
Annuities segment. Net investment income increased $126.1 million or
4.7% in 1999 due to a 6.9% increase in mean invested assets partially
offset by a decrease in the yield on investments from 7.36% to 7.21%
(all calculations on a cost basis). The increase in mean invested assets
was the result of increased business volumes of traditional life
insurance business in the Life Insurance segment. The increase in the
Life Insurance segment includes the impact of the acquisition of the
blocks of business in 1998 (see Note 11 to the consolidated financial
statements).
Realized Gain on Investments: The pre-tax realized gain (loss) on
investments, net of associated amortization of deferred acquisition
costs and expenses, was $(28.3) million, $3.0 million and $19.0 million
in 2000, 1999 and 1998, respectively. The after-tax gain (loss) in 2000,
1999 and 1998 was $(17.5) million, $3.8 million and $13.7 million,
respectively. The loss in 2000 was primarily the result of the sale of
investments, and to a lesser extent due to the write-down and provision
for losses on investments. Gains in 1999 and 1998 were primarily the
result of the sale of investments. Write-downs and provisions for losses
offset a portion of the realized gains.
Management's Discussion and Analysis
Write-Downs and Allowance for Losses: Securities available-for-sale,
mortgage loans on real estate and real estate that were deemed to have
declines in fair value that were other than temporary were written down.
The fixed maturity securities to which these write-downs apply were
generally of investment grade quality at the time of purchase, but were
classified as "below-investment-grade" at the time of the write-downs.
Also, write-downs and allowances for losses on select mortgage loans on
real estate, real estate and other investments were established when the
underlying value of the property was deemed to be less than the carrying
value. These write-downs and provisions for losses are disclosed within
the notes to the accompanying consolidated financial statements (see
Note 3 to the consolidated financial statements).
Use of Derivatives: The primary use of derivatives at LNC is to hedge
interest rate risk that is embedded in either life insurance and annuity
product liabilities or investment portfolios. To a lesser extent,
derivatives are also used to hedge exposures to foreign currency and
equity market risks.
Review Of Consolidated Financial Condition
Liquidity and Cash Flow
Liquidity refers to the ability of an enterprise to generate adequate
amounts of cash from its normal operations to meet cash requirements
with a prudent margin of safety. Because of the interval of time from
receipt of a deposit or premium until payment of benefits or claims, LNC
and other insurers employ investment portfolios as an integral element
of operations. By segmenting its investment portfolios along product
lines, LNC enhances the focus and discipline it can apply to managing
the liquidity as well as the interest rate and credit risk of each
portfolio commensurate with the profile of the liabilities. For example,
portfolios backing products with less certain cash flows and/or
withdrawal provisions are kept more liquid than portfolios backing
products with more predictable cash flows.
The consolidated statements of cash flows on page 75 indicate that
operating activities provided cash of $2.0 billion, $2.3 billion and
$2.2 billion in 2000, 1999 and 1998, respectively. 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 LNC's obligations.
Although LNC generates adequate cash flow to meet the needs of its
normal operations, periodically LNC may issue debt or equity securities
to fund internal expansion, acquisitions, investment opportunities and
the retirement of LNC's debt and equity. LNC had an unused balance as of
December 31, 2000 of $825 million on its existing shelf registration
filed in April, 1998, that would allow LNC to issue various securities.
The hybrid securities utilize six subsidiaries (Lincoln National Capital
I, II, III, IV, V and VI) which were formed for the specific purpose of
issuing such securities. All of these subsidiaries' common securities
are owned by LNC. Cash funds are also available from LNC's revolving
credit agreements, which provide for borrowing up to $700 million (see
Note 5 to the consolidated financial statements).
In 1998, LNC issued $300 million of long-term debt, $200 million of
Series C Trust Originated Preferred Securities and $230 million of
FELINE PRIDES. LNC purchased and retired 6,222,581, 7,675,000 and
1,246,562 shares of common stock at a cost of $210.0 million, $377.7
million and $46.9 million in 2000, 1999 and 1998, respectively. In May
1999, the LNC board authorized $500 million to repurchase shares of
common stock. The shares repurchased in 1999 included 4,875,600 shares
at a cost of $236.6 million that were purchased under the May 1999 board
authorization. In November 2000, the LNC board authorized an additional
$500 million to repurchase shares of common stock. At the time of this
authorization, there was $99.7 million remaining under the May 1999
share repurchase authorization. All of the shares repurchased in 2000
came under the May 1999 share repurchase authorization. This leaves a
Board authorization to repurchase an additional $553.4 million of LNC's
common stock as of December 31, 2000.
On March 5, 2001, LNC announced that it has agreed to purchase 2.75
million shares of its common stock held by the Dai-ichi Mutual Life
Insurance Company. This transaction is expected to close March 12, 2001.
This transaction completes the May 1999 authorization to repurchase $500
million of LNC stock and initiates usage under the November 2000 $500
million board authorization. After completion of the Dai-ichi
transaction, $423.7 million remains available in the current repurchase
program.
In order to maximize the use of available cash, the holding company
(LNC) maintains a facility where subsidiaries can borrow from the
holding company to meet their short-term needs and can invest their
short-term funds with 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. In
addition to facilitating the management of cash, the holding company
receives dividends from its subsidiaries, invests in operating
companies, maintains an investment portfolio and pays shareholder
dividends and certain corporate expenses.
LNC's insurance subsidiaries are subject to certain insurance department
regulatory restrictions as to the transfer of funds and payment of
dividends to the holding company. Generally, these restrictions pose no
short-term liquidity concerns for the holding company. However, as
discussed in detail within Note 7 to the consolidated financial
statements, the acquisition of two blocks of business in 1998 placed
further restrictions on the ability of LNC's primary insurance
subsidiary, LNL, to declare and pay dividends. As a result of these
acquisitions and dividends declared, LNL's statutory earned surplus is
negative. It is necessary for LNL to obtain the prior approval of the
Indiana Insurance Commissioner before paying any dividends to LNC until
such time its statutory earned surplus is positive. The time frame for
statutory earned surplus to return to a positive position is dependent
upon future statutory earnings and dividends paid by LNL. Although no
assurance can be given that additional dividends will be approved,
during 2000, LNL received regulatory approval and paid extraordinary
dividends totaling $420 million to LNC. In the event such approvals are
not obtained, management believes that LNC can obtain the funds required
to satisfy its obligations from its existing credit facilities and other
sources.
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, in addition to regulatory restrictions imposed by the
state of Indiana, LNL is also subject to the regulatory requirements
that the State of New York imposes upon accredited reinsurers.
As of December 31, 2000, LNC's senior debt ratings were Moody's at A3
("Upper Medium Grade"), Standard and Poor's at A- ("Strong"), Fitch at
A+ ("Strong") and A.M. Best at a ("Strong"), and LNC's commercial paper
ratings included Moody's at P-2 ("Strong"), Standard and Poor's at A-2
("Satisfactory") and Fitch at F-1 ("Very Strong"). In October of 2000,
Moody's downgraded LNC's senior debt from A2 ("Upper Medium Grade") to
A3 ("Upper Medium Grade") and LNC's commercial paper from P-1
("Superior") to P-2 ("Strong"). Although there are less investors for
A-2/P-2 commercial paper, management believes that liquidity will not be
adversely impacted. LNC can draw upon alternative short-term borrowing
facilities such as revolving lines of bank credit.
Management expects the short-term borrowing rate on the issuance of
commercial paper (based on historical trends) to increase approximately
0.20% per annum as a result of the downgrade by Moody's. Since late
December 2000, however, LNC has experienced greater volatility in
commercial paper borrowing rates as an A-2/P-2 issuer with the spread
above A-1/P-1 rates ranging from 0.25% to 0.50%.
As of December 31, 2000, Lincoln National (UK) PLC's commercial paper
ratings were Standard and Poor's at A-2 ("Satisfactory") and Moody's at
P-2 ("Strong"). In October of 2000, Moody's also downgraded Lincoln
National (UK) PLC from P-1 ("Superior") to P-2 ("Strong"). When Standard
and Poor's lowered its rating of Lincoln National (UK) PLC's commercial
paper in November of 1999, the market treated Lincoln UK like a A-2/P-2
issuer rather than one with a split rating and its borrowing rate went
up at that time by approximately 0.20% per annum. Management did not
expect any incremental costs as a result of the latest downgrade by
Moody's, but in January 2001, conditions changed in the A-2/P-2
commercial paper market making it more difficult for Lincoln UK as well
as all other A-2/P-2 issuers to issue commercial paper. As a result,
when Lincoln UK has been able to issue commercial paper, it has
experienced up to a 0.10% per annum increase in its borrowing rate.
Until conditions improve, Lincoln UK can draw upon alternative
short-term borrowing facilities in the form of bank loans which will
cause an increase in the borrowing rate of approximately 0.20% per
annum.
Effect of Inflation
LNC's insurance affiliates, as well as other companies in the insurance
industry, attempt to minimize the effect of inflation on their revenues
and expenses by anticipating inflationary trends in the pricing of their
products. Inflation, except for changes in interest rates, does not have
a significant effect on LNC's balance sheet due to the minimal amount of
dollars invested in property, plant and equipment and the absence of
inventories.
Management's Discussion and Analysis
Capital Resources
Total shareholders' equity increased $690.2 million during the year
ended December 31, 2000. Excluding the increase of $477.7 million
related to the decrease in the unrealized loss on securities
available-for-sale, shareholders' equity increased $212.5 million. This
increase in shareholders' equity was the net result of increases due to
$621.4 million of net income, $33.6 million from the issuance of common
stock related to benefit plans and $0.9 million from the issuance of
common stock related to purchase of subsidiary companies partially
offset by $8.1 million related to a decrease in the accumulated foreign
exchange gain, $224.4 million related to the declaration of dividends to
shareholders, $210.0 million for the retirement of common stock and $0.9
million for shares forefeited under benefit plans.
During May 1999, LNC's Board of Directors approved a two-for-one stock
split for its common stock. The record date for the stock split was June
4, 1999 and the additional shares were distributed to shareholders on
June 21, 1999.
Capital adequacy is a primary measure used by insurance regulators to
determine the financial stability of an insurance company. In the U.S.,
risk-based capital guidelines are used by the National Association of
Insurance Commissioners to determine the amount of capital that
represents minimum acceptable operating amounts related to insurance and
investment risks. Regulatory action is triggered when an insurer's
statutory-basis capital falls below the formula-produced capital level.
At December 31, 2000, statutory-basis capital for each of LNC's U.S.
insurance subsidiaries was in excess of regulatory action levels of
risk-based capital required by the jurisdiction of domicile.
The National Association of Insurance Commissioners revised the
Accounting Practices and Procedures Manual in a process referred to as
Codification. The revised manual is effective January 1, 2001. The
domiciliary states of LNC's U.S. insurance subsidiaries have adopted the
provisions of the revised manual. The revised manual has changed, to
some extent, prescribed statutory accounting practices and will result
in changes to the accounting practices that LNC's U.S. insurance
subsidiaries use to prepare their statutory-basis financial statements.
Management believes the impact of these changes to LNC and its U.S.
insurance subsidiaries' statutory-based capital and surplus as of
January 1, 2001 will not be significant.
As noted above, shareholders' equity includes net unrealized gain (loss)
on securities available-for-sale. At December 31, 2000, the book value
of $25.92 per share included $0.07 of unrealized gains on securities and
at December 31, 1999, the book value of $21.76 per share included $2.38
of unrealized losses on securities.
Contingencies
See Note 7 to the consolidated financial statements for information
regarding contingencies.
Legislation
The Financial Services Modernization Act was passed in November 1999 and
repeals the Glass-Steagall Act of 1933 and expands the Bank Holding
Company Act of 1956. This act allows, among other things,
cross-ownership by banks, securities firms and insurance companies. In
2000, there were some cross-ownership activities in the financial
services industry, however, there was minimal impact on LNC's
operations.
Tax legislation could reduce tax-advantages for some of LNC's life and
annuity products. LNC continues to support reductions in the tax burden
imposed on its businesses, employees and policyholders.
Quantitative and Qualitative Disclosures About Market Risk
Market Risk Exposures of Financial Instruments
LNC analyzes and manages the risks arising from market exposures of
financial instruments, as well as other risks, in an integrated
asset-liability management process that takes diversification into
account. By aggregating the potential effect of market and other risks
of the entire enterprise, LNC estimates, reviews and in some cases
manages the risk to its earnings and shareholder value. LNC has
exposures to several market risks including interest rate, default risk,
foreign currency exchange and equity price risks.
The exposures of financial instruments to market risks, and the related
risk management processes, are most important in the Annuities and Life
Insurance segments. It is within these segments where most of the
invested assets support accumulation and investment oriented insurance
products. As an important element of its integrated asset-liability
management process, LNC uses derivatives to minimize the effects of
changes in interest rate levels and the shape of the yield curve. In
this context, derivatives are designated as a hedge and serve to reduce
interest rate risk by mitigating the effect of significant increases in
interest rates on LNC's earnings. Additional market exposures exist in
LNC's other general account insurance products and in its debt structure
and derivatives positions. The primary sources of market risk are: 1)
substantial, relatively rapid and sustained increases or decreases in
interest rates, 2) fluctuations in currency exchange rates or 3) a sharp
drop in equity market values. Each of these market risks are discussed
in detail in the following pages.
1) Interest Rate Risk
Accumulation and Investment Oriented Insurance Products. General account
assets supporting accumulation and investment oriented insurance
products total $23.1 billion or 65% and $24.2 billion or 68% of total
invested assets at December 31, 2000 and 1999, respectively.
With respect to these products, LNC seeks to earn a stable and
profitable spread between investment income and interest credited to
account values. If LNC has adverse experience on investments that cannot
be passed onto customers, its spreads are reduced. Alternatively, LNC
may seek to maintain spreads and this may result in crediting rates that
are not competitive in the market place. This strategy could result in
adverse surrender experience on policies and could force LNC to
liquidate a portion of its portfolio to fund cash surrender value
benefits.
LNC does not view the near term risk to spreads over the next twelve
months to be material. The combination of a probable range of interest
rate changes over the next twelve months, asset-liability management
strategies, flexibility in adjusting policy crediting rate levels and
protection afforded by policy surrender charges and other switching
costs all work together to minimize this risk. The interest rate
scenarios of concern are those in which there is a substantial,
relatively rapid increase or decrease in interest rates that is then
sustained over a long period.
Fixed Deferred Annuities. Assets of $15.5 billion and $16.8 billion at
December 31, 2000 and 1999, respectively, support the largest category
of accumulation and investment oriented insurance products, fixed
deferred annuities. For these products, LNC may adjust renewal crediting
rates monthly or quarterly, subject to guaranteed minimums ranging from
3% to 5%. The higher minimums apply to in-force blocks of older products
that no longer are sold. Annuity insurance customers have the right to
surrender their policies at account value less a surrender charge that
grades to zero over periods ranging from 5 to 10 years from policy issue
date or, in some cases, the date of each premium received. In some
cases, a market value adjustment may also apply. Due to LNC's ability to
change crediting rates to reflect investment experience on the majority
of its traditional annuity products, the underlying assets are assumed
to be a good proxy for the interest rate risk inherent in these
liabilities. This assumption is appropriate for probable movements in
interest rates over the next 12 months. This assumption may not be
appropriate for a substantial, relatively rapid increase or decrease in
interest rates that is then sustained over a long period.
Universal Life. LNC had $5.8 billion and $5.4 billion in assets at
December 31, 2000 and 1999, respectively, supporting universal life
insurance on which it has the right to adjust renewal crediting rates
subject to guaranteed minimums ranging from 4% to 6% at December 31,
2000. Similar to annuities, universal life insurance customers have the
right to surrender their policies at account value less a surrender
charge that grades to zero over periods ranging from 10 to 20 years from
policy issue date or, in some cases, the date of each premium received.
Guaranteed Interest Contracts and Group Pension Annuities. LNC had
assets totaling $1.8 billion and $2.0 billion at December 31, 2000 and
1999, respectively, that support guaranteed interest contracts, group
pension annuities and immediate annuities. Generally, the cash flows
expected on these liabilities do not vary with fluctuations in market
interest rates and are not adjustable by LNC. Accordingly, if experience
on the assets supporting these products is more adverse than the
assumptions used in pricing the products, spreads will tend to be below
expectations. LNC limits exposure to interest rate risk by managing the
duration and maturity structure of each investment portfolio in relation
to the liabilities it supports.
Management's Discussion and Analysis
Other General Account Insurance Products. LNC had $12.3 billion and
$11.4 billion of assets at December 31, 2000 and 1999, respectively,
supporting general account products, including disability income and
term life insurance. For these products, the liability cash flows may
have actuarial uncertainty. However, their amounts and timing do not
vary significantly with interest rates. LNC limits interest rate risk by
analyzing the duration of the projected cash flows and structuring
investment portfolios with similar durations.
Interest Rate Risk -- Falling Rates. Interest rates fell in 1995, rose
again in 1996, declined in 1997 and 1998, rose again in 1999 and
declined again in 2000. For example, the five-year Treasury yield
decreased from 7.8% in 1994 to 5.4% at the end of 1995, increased to
6.2% by the end of 1996, decreased to 5.7% by the end of 1997, decreased
to 4.5% by the end of 1998, increased to 6.3% by the end of 1999 and
declined to 5.0% by the end of 2000. Under scenarios in which interest
rates fall and remain at levels significantly lower than those
prevailing at December 31, 2000, minimum guarantees on annuity and
universal life insurance policies (generally 3% to 5% or an average of
approximately 4%) could cause the spread between the yield on the
portfolio and the interest rate credited to policyholders to
deteriorate. Select contracts that specify these minimum guarantees can
be amended periodically to reflect current interest rate conditions. The
earned rate on the annuity and universal life insurance portfolios both
averaged 7.7% for the year ended December 31, 2000, providing a cushion
for a decline before the earned rates would be insufficient to cover
minimum guaranteed rates plus the target spread. The maturity structure
and call provisions of the related portfolios are structured to afford
protection against erosion of this cushion for a period of time.
However, spreads would be at risk if interest rates continued to fall
and remained lower for a long period. LNC devotes extensive effort to
evaluating these risks by simulating asset and liability cash flows for
a wide range of interest rate scenarios. LNC manages these exposures by
maintaining a suitable maturity structure and by limiting its exposure
to call risk in each respective investment portfolio.
LNC believes that the portfolios supporting its accumulation and
investment oriented insurance products have a prudent degree of call
protection individually and on a consolidated basis. As of December 31,
2000, the mortgage-backed securities ("MBS") and asset-backed securities
("ABS") portion of the portfolio represented a total of $4.2 billion or
18% of the $23.1 billion of general account assets supporting such
products. Of this portfolio, 12% of general account assets or $2.8
billion is subject to residential prepayment risk from investments made
in Collateralized Mortgage Obligations ("CMOs"), mortgage pass-throughs,
manufactured housing and home equity loans. As of December 31, 1999, the
MBS and ABS portion of the portfolio represented a total of $4.4 billion
or 18% of the $24.2 billion of general account assets supporting such
products. LNC's MBS portfolio has equal to or slightly less prepayment
risk than the MBS pass-through market in general primarily due to
holding more seasoned securities in the portfolio.
Interest Rate Risk -- Rising Rates. For both annuities and universal
life insurance, a rapid and sustained rise in interest rates poses risks
of deteriorating spreads and high surrenders. The portfolios supporting
these products have fixed-rate assets laddered over maturities generally
ranging from one to ten years or more. Accordingly, the earned rate on
each portfolio lags behind changes in market yields. As rates rise, the
lag may be increased by slowing MBS prepayments. The greater and faster
the rise in interest rates, the more the earned rate will tend to lag
behind market rates. If LNC sets renewal crediting rates to earn the
desired spread, the gap between its renewal crediting rates and
competitors' new money rates may be wide enough to cause increased
surrenders. If LNC credits more competitive renewal rates to limit
surrenders, its spreads will narrow. LNC devotes extensive effort to
evaluating these risks by simulating asset and liability cash flows for
a wide range of interest rate scenarios. Such analysis has led to
adjustments in the target maturity structure and to hedging the risk of
rising rates by buying out-of-the-money interest rate cap agreements and
swaptions (see discussion below). With these instruments in place, the
potential adverse impact of a rapid and sustained rise in rates is kept
within corporate risk tolerances.
Debt. As of December 31, 2000, LNC had short-term debt, long-term debt
and company-obligated mandatorily redeemable preferred securities of
subsidiary trusts holding solely junior subordinated debentures totaling
$1.77 billion ($1.46 billion with fixed rates and $0.31 billion with
floating rates). As of December 31, 1999, LNC had short-term debt,
long-term debt and minority interest-preferred securities of subsidiary
companies totaling $1.92 billion ($1.46 billion with fixed rates and
$0.46 billion with floating rates). LNC manages the timing of maturities
and the mixture of fixed-rate and floating-rate debt as part of the
process of integrated management of interest rate risk for the entire
enterprise.
Derivatives. As indicated in Note 7 to the consolidated financial
statements, LNC has entered into derivative transactions to reduce its
exposure to rapid rises in interest rates. The four programs discussed
below are used to help LNC achieve more stable margins while providing
competitive crediting rates to policyholders during periods when
interest rates are rising. Failure to maintain competitive crediting
rates could cause policyholders to withdraw their funds and place them
in more competitive products.
LNC uses interest rate cap agreements to hedge against the negative
impact of a significant and sustained rise in interest rates. Interest
rate caps are contracts that require counterparties to pay LNC at
specified future dates the amount, if any, by which a specified market
interest rate exceeds the cap rate stated in the agreements, applied to
a notional amount. As of December 31, 2000 and 1999, LNC had agreements
with notional amounts of $1.6 billion and $2.5 billion, respectively. At
December 31, 2000, the agreements had cap rates ranging from 250 to 650
basis points above prevailing interest rates. The cap rates in some
contracts increase over time. These agreements expire in 2001 through
2006.
LNC also uses swaptions to hedge against the negative impact of a
significant and sustained rise in interest rates. Swaptions are options
to enter into a swap at a specified future date. If the option is
exercised at expiration, the option is either settled in cash or
exercised into a swap agreement. LNC purchases swaptions to be settled
in cash. At expiration, the counterparty is required to pay LNC the
amount, if any, of the present value of the difference between the fixed
rate on a market rate swap and the strike rate stated in the agreement,
applied to a notional amount. As of December 31, 2000 and 1999, LNC had
agreements with notional amounts of $1.8 billion. At December 31, 2000,
the agreements had strike rates ranging from 350 to 450 basis points
above prevailing interest rates. These agreements expire in 2002 through
2003.
Notional for interest rate caps decreased by $0.9 billion as a result
of expirations. Interest rate caps and swaptions were not purchased
during the year, reflecting declining fixed annuity sales and
declining fixed annuity account values.
For future periods, the fair value of LNC's interest rate caps and
swaptions depends on the levels of future U.S. Treasury and U.S. dollar
swap interest rates. The table below shows estimates of fair value
levels for the cap and swaption portfolio at December 31, 2000 for
future time periods and selected potential future interest rate levels.
Year Ended December 31, 2000 (in millions) 2000 2001 2002 2003 2004 2005
- ---------------------------------------------------------------------------------------------------------------------
No change 1.3 0.3 0.1 -- -- --
Up 2% 18.3 7.1 1.7 0.7 0.2 --
Up 4% 88.0 52.7 24.0 7.3 3.0 1.1
Up 6% 197.9 137.0 79.3 38.6 19.7 10.5
=====================================================================================================================
LNC uses exchange-traded financial futures contracts to hedge against
interest rate risks on a portion of its fixed maturity securities.
Financial futures contracts obligate LNC to buy or sell a financial
instrument at a specified future date for a specified price. They may be
settled in cash or through delivery of the financial instrument. Cash
settlements on the change in market values of financial futures
contracts are made daily. As of December 31, 2000, LNC did not have any
open futures.
LNC uses interest rate swap agreements to hedge its exposure to floating
rate bond coupon payments, replicating a fixed rate bond. An interest
rate swap is a contractual agreement to exchange payments at one or more
times based on the actual or expected price level, performance or value
of one or more underlying interest rates. LNC is required to pay the
counterparty the stream of variable interest payments based on the
coupon payments from the hedged bonds, and in turn, receives a fixed
payment from the counterparty, at a predetermined interest rate. LNC
also uses interest rate swap agreements to hedge its exposure to
interest rate fluctuations related to the forecasted purchase of assets
to support newly acquired blocks of business or certain other portfolios
of assets. As of December 31, 2000 and 1999, LNC had swap agreements
with a notional amount of $708.2 million and $630.9 million,
respectively. The agreements expire in 2001 through 2011. Notional for
interest rate swaps increased $77.3 million during 2000 primarily as a
result of purchasing interest rate swaps to hedge the exposure to
interest rate fluctuations related to the forecasted purchase of assets.
In addition to continuing existing programs, LNC may use derivative
products in other strategies to limit risk and enhance returns,
particularly in the management of investment spread businesses. LNC has
established policies, guidelines and internal control procedures for the
use of derivatives as tools to enhance management of the overall
portfolio of risks assumed in LNC's operations.
Management's Discussion and Analysis
Table of Significant Exposures. The table below provides a general
measure of LNC's significant interest rate risk (principal amounts are
shown by year of maturity and include amortization of premiums and
discounts; notional amounts for interest rate caps and swaptions are
shown by amount outstanding at the year-end given) as of December 31,
2000.
There- Fair
(in millions) 2001 2002 2003 2004 2005 after Total Value
- -----------------------------------------------------------------------------------------------------------------------------
Rate Sensitive Assets:
Fixed interest rate securities $932.8 $1,247.4 $1,512.4 $1,379.3 $1,948.9 $21,516.0 $28,536.8 $26,430.8
Average interest rate 7.42% 7.35% 7.32% 7.52% 7.70% 7.72% 7.66%
Variable interest rate securities $43.8 $62.5 $3.0 $3.1 $99.3 $1,733.5 $1,945.2 $1,019.0
Average interest rate 6.99% 18.64% 7.40% 8.20% 10.99% 9.32% 10.01%
Mortgage loans $133.9 $503.4 $240.2 $596.6 $273.6 $2,915.9 $4,663.6 $4,702.5
Average interest rate 8.40% 8.31% 8.16% 7.76% 8.58% 7.95% 8.02%
Rate Sensitive Liabilities:
Guaranteed Interest Contracts:
Interest paid at maturity $41.0 $2.0 $19.0 $29.0 $19.0 $-- $110.0 $121.0
Average interest rate 8.15% 6.18% 10.67% 10.71% 10.72% 9.69%
Investment type insurance
contracts, excluding
guaranteed interest
contracts(1) $816.6 $1,068.2 $1,040.1 $1,053.2 $1,019.4 $13,776.0 $18,773.5 $17,318.3
Average interest rate 7.39% 7.65% 7.37% 7.48% 7.81% 8.03% 7.90%
Debt(2) $542.9 $100.0 $-- $-- $193.0 $935.3 $1,771.2 $1,743.0
Average interest rate 7.21% 7.63% 7.25% 7.85% 7.58%
Rate Sensitive Derivative
Financial Instruments:
Interest Rate and Foreign
Currency Swaps:
Pay variable/receive fixed 49.6 26.2 47.0 5.0 67.2 550.7 745.7 40.6
Average pay rate 6.9% 7.9% 6.7% 6.8% 7.3% 6.5% 6.7%
Average receive rate 6.0% 7.0% 5.3% 5.9% 7.0% 7.1% 6.9%
Interest Rate Caps and
Swaptions:(3)
Outstanding notional 3,232.2 2,542.3 659.3 250.0 250.0 113.7 1.3
Average strike rate(4) 9.0% 8.9% 8.9% 8.4% 8.4% 8.4%
Forward CMT curve(5) 5.0% 5.2% 5.2% 5.2% 5.3% 5.4%
=============================================================================================================================
The table shows the principal amounts and fair values of assets,
liabilities and derivatives having significant interest rate risks as of
December 31, 1999.
Principal
(in millions) Amount Fair Value
- -------------------------------------------------------------------------
Fixed interest rate securities $29,982.8 $26,876.2
Variable interest rate securities 1,520.3 812.6
Mortgage loans 4,729.8 4,615.5
Guaranteed interest contracts 284.0 294.0
Investment type insurance contracts(1) 21,095.1 19,065.2
Debt(2) 1,918.4 1,806.5
Interest rate and foreign currency swaps -- (20.0)
Interest rate caps and swaptions(3) -- 14.0
=========================================================================
(1) The information shown is for the fixed maturity securities and
mortgage loans that support these insurance contracts.
(2) Includes minority interest preferred securities of subsidiary
companies.
(3) Swaptions notional is shown converted to cap equivalent.
(4) The indexes are a mixture of five-year and ten-year Constant
Maturity Treasury ("CMT") and Constant Maturity Swap ("CMS").
(5) The CMT curve is the five-year constant maturity treasury forward
curve.
2) Foreign Currency Risk
Foreign Currency Denominated Investments. LNC invests in foreign
currency securities for incremental return and risk diversification
relative to United States Dollar-Denominated ("USD") securities. The
fair value of foreign securities totaled $128.4 million as of December
31, 2000. LNC periodically uses foreign exchange forward contracts and
foreign currency swaps to hedge some of the foreign exchange risk
related to its investments in securities denominated in foreign
currencies. The currency risk is hedged using foreign currency
derivatives of the same currency as the bonds. The table below shows
LNC's exposure to foreign currency securities. Also included is the
relevant information relating to the foreign currency derivatives that
are hedging the currency risk of these securities. The table below
presents the principal or notional amount in U.S. dollar equivalents by
expected maturity for LNC's foreign currency denominated investments and
foreign currency swaps as of December 31, 2000.
There- Fair
(in millions) 2001 2002 2003 2004 2005 after Total Value
- ---------------------------------------------------------------------------------------------------------------------
Currencies:
Canadian Dollar $9.7 $10.9 $10.0 $8.0 $3.9 $38.9 $81.4 $83.8
Interest Rate 8.30% 7.68% 7.15% 5.61% 7.90% 5.65% 6.52%
British Pound 5.8 -- -- -- 14.1 19.9 22.0
Interest Rate 4.88% 10.07% 8.53%
Argentine Peso -- 10.0 -- -- 7.0 17.0 15.2
Interest Rate 11.54% 11.70% 11.61%
All Other Currencies 2.2 1.2 0.6 -- 3.7 7.7 7.4
Interest Rate 12.75% 12.29% 13.80% 10.37% 11.74%
Total Currencies 17.7 22.1 10.6 8.0 3.9 63.7 126.0 128.4
Derivatives:
Foreign Currency Swaps 9.6 8.3 -- -- 15.0 4.6 37.5 2.5
=====================================================================================================================
Management's Discussion and Analysis
The table below presents the principal or notional amount in U.S. dollar
equivalents of LNC's foreign currency denominated investments and
foreign currency swaps as of December 31, 1999.
Principal/
Notional
(in millions) Amount Fair Value
- ------------------------------------------------------
Currencies:
Canadian Dollar $94.8 $95.3
British Pound 21.4 23.1
Argentine Peso 17.0 15.1
All other currencies 8.3 7.8
- ------------------------------------------------------
Total Currencies $141.5 $141.3
- ------------------------------------------------------
Derivatives:
Foreign Currency Swaps 44.2 (0.4)
======================================================
Foreign Currency Forward Contracts. LNC uses foreign currency forward
contracts to hedge some of the foreign exchange risk related to its
investments in fixed maturity securities denominated in foreign
currencies. LNC typically engages in short-term currency forward
contracts of less than six months and actively monitors currency markets
in determining those currencies to hedge, the duration of the hedge and
the nominal amount to hedge. A foreign currency forward contract
obligates LNC to deliver a specified amount of currency at a future date
at a specified exchange rate. The value of the foreign exchange forward
contracts at any given point fluctuates according to the underlying
level of exchange rate and interest rate differentials.
Foreign Currency Swaps. A foreign currency swap is a contractual
agreement to exchange the currencies of two different countries at a
specified rate of exchange in the future. LNC uses foreign currency
swaps to convert the cash flow of foreign currency securities to U.S.
dollars.
3) Equity Market Exposures
LNC's revenues, assets, liabilities and derivatives are exposed to
equity market risk.
Fee Revenues. The fee revenues of LNC's Investment Management segment
and fees earned from variable annuities and variable life insurance
products are exposed to the risk of a decline in equity market values.
These fees are generally a fixed percentage of the market value of
assets under management. In a severe equity market decline, fee income
could be reduced by not only reduced market valuations but also by
customer withdrawals and redemptions. Such withdrawals and redemptions
from equity funds and accounts might be partially offset by transfers to
LNC's fixed-income accounts and the transfer of funds to LNC by its
competitors' customers.
Assets. While LNC invests in equity assets with the expectation of
achieving higher returns than would be available in its core
fixed-income investments, the returns on, and values of, these equity
investments are subject to somewhat greater market risk than its fixed
income investments. These investments, however, add diversification
benefits to LNC's fixed income investments. The table below shows the
sensitivity of price changes to LNC's equity assets owned.
December 31, 2000 December 31, 1999
-------------------------------------------- --------------------
10% Fair 10% Fair
Carrying Fair Value Value Carrying Fair
(in millions) Value Value Increase Decrease Value Value
- ----------------------------------------------------------------------------------------------------
U.S. Equities $200.1 $200.1 $220.1 $180.1 $189.4 $189.4
Foreign Equities 337.1 337.1 370.8 303.4 401.6 401.6
Emerging Market Equities 12.5 12.5 13.8 11.2 13.0 13.0
- ----------------------------------------------------------------------------------------------------
Subtotal 549.7 549.7 604.7 494.7 604.0 604.0
Real Estate 282.0 323.0 355.3 290.7 256.2 291.0
S&P 500 Index Call Options 19.3 19.3 22.2 17.8 24.8 24.8
Other Equity Interests 388.3 399.3 439.2 359.4 329.4 359.4
- ----------------------------------------------------------------------------------------------------
Total $1,293.3 $1,291.3 $1,421.4 $1,162.6 $1,214.4 $1,279.2
====================================================================================================
Liabilities. LNC has an exposure to U.S. equity markets through
reinsurance contracts that reinsure equity-indexed annuities. The
aggregate amount of account value of these annuities is $19.3 million
and $24.8 million at December 31, 2000 and 1999, respectively. LNC also
has exposure to U.S. equity markets through stock appreciation rights
("SARs") issued in 2000. The aggregate value for vested and non-vested
SARs was $3.1 million and $13.9 million at December 31, 2000,
respectively. The risks for both of these programs are being hedged with
equity derivatives as discussed below.
Derivatives Hedging Equity Risks. LNC hedges equity market risk in
annuities that contain equity features and equity market risk in stock
appreciation rights on LNC stock with the following two programs.
LNC uses OTC equity call options on the S&P 500 index to hedge against
the increase in its liabilities resulting from certain reinsurance
agreements which guarantee payment of the appreciation of the S&P 500
index on certain underlying annuity products. These call options require
the counterparty to pay LNC at specified future expiration dates the
amount, if any, of the percentage increase in the S&P 500 index over the
strike price defined in the contract, applied to the notional amount.
The reinsurance agreement then requires LNC to pay any appreciation on
the S&P 500 index to the reinsurance client. LNC had agreements with
notional amounts of $183.3 million and $129.6 million for December 31,
2000 and 1999, respectively. The call option expirations are matched to
the liabilities and expire in 2001 through 2007. Notional for the call
options increased by $53.7 million during 2000 as a result of purchasing
additional options to support additional business assumed under the
reinsurance agreement.
LNC began using OTC equity call options on LNC stock to hedge against
the increase in its liabilities arising from stock appreciation rights
granted on LNC stock in 2000. These call options require the
counterparty to pay LNC at specified future expiration dates the amount,
if any, of the increase in LNC's stock price over the strike price of
the option, applied to the number of contracts. LNC had 0.6 million call
options on an equal number of shares of LNC stock at December 31, 2000.
The call options expirations are matched to the liabilities and expire
in 2005.
Default Risk. LNC's portfolio of invested assets was $35.4 billion as of
December 31, 2000. Of this total, $21.2 billion consists of corporate
bonds and $4.7 billion consists of commercial mortgages. LNC manages the
risk of adverse default experience on these investments by applying
disciplined credit evaluation and underwriting standards, prudently
limiting allocations to lower-quality, higher-yielding investments, and
diversifying exposures by issuer, industry, region and property type.
For each counterparty or borrowing entity and its affiliates, LNC's
exposures from all transactions are aggregated and managed in relation
to formal limits set by rating quality and industry group. LNC remains
exposed to occasional adverse cyclical economic downturns during which
default rates may be significantly higher than the long-term historical
average used in pricing. As of December 31, 1999, LNC had a portfolio of
invested assets of $35.6 billion.
LNC is depending on the ability of derivative product dealers and their
guarantors to honor their obligations to pay the contract amounts under
various derivatives agreements. In order to minimize the risk of default
losses, LNC diversifies its exposures among several dealers and limits
the amount of exposure to each in accordance with the credit rating of
each dealer or its guarantor. LNC generally limits its selection of
counterparties that are obligated under these derivative contracts to
those with an A credit rating or above.
Credit-Related Derivatives. LNC periodically uses spread-lock agreements
to hedge a portion of the value of its fixed maturity investments
against the risk of widening in the spreads between their yields and the
yields of comparable maturity U.S. or other Government obligations. As
of December 31, 2000, LNC did not have any open spread-lock agreements.
LNC uses put options, combined with various perpetual fixed-income
securities and interest rate swaps to replicate fixed-income,
fixed-maturity investments. The risk being hedged is a drop in bond
prices due to credit concerns with the international bond issuers. The
put options allow LNC to put the bonds back to the counterparties at
original par. As of December 31, 2000, LNC did not have any open put
options.
LNC began using credit default swaps to hedge against a drop in bond
prices due to credit concerns of certain bond issuers. A credit swap
allows LNC to put the bond back to the counterparty at par upon a credit
event by the bond issuer. A credit event is defined as bankruptcy,
failure to pay, or obligation acceleration. As of December 31, 2000, LNC
had credit swaps with a notional amount of $29.0 million that expire in
2002 through 2006.
Consolidated Financial Statements
The consolidated financial statements and notes to consolidated
financial statements of Lincoln National Corporation and Subsidiaries
follow on pages 70 through 114.
Consolidated Statements of Income
Year Ended December 31
(000s omitted except for per share amounts) 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------
Revenue:
Insurance premiums $1,813,111 $1,881,515 $1,620,629
Insurance fees 1,661,442 1,537,605 1,274,569
Investment advisory fees 213,065 223,803 227,059
Net investment income 2,747,118 2,807,512 2,681,406
Equity in earnings (losses) of unconsolidated affiliates (379) 5,797 3,336
Realized gain (loss) on investments (28,295) 2,955 19,034
Other revenue and fees 445,445 344,513 261,030
- -------------------------------------------------------------------------------------------------------------
Total Revenue 6,851,507 6,803,700 6,087,063
Benefits and Expenses:
Benefits 3,557,160 3,805,024 3,328,865
Underwriting, acquisition,
insurance and other expenses 2,318,518 2,295,015 1,943,749
Interest and debt expense 139,538 133,697 117,051
- -------------------------------------------------------------------------------------------------------------
Total Benefits and Expenses 6,015,216 6,233,736 5,389,665
- -------------------------------------------------------------------------------------------------------------
Net Income Before Federal Income Taxes 836,291 569,964 697,398
Federal Income Taxes 214,898 109,610 187,623
- -------------------------------------------------------------------------------------------------------------
Net Income $621,393 $460,354 $509,775
Earnings Per Common Share-Basic:
Net Income $3.25 $2.33 $2.54
Earnings Per Common Share-Diluted:
Net Income $3.19 $2.30 $2.51
=============================================================================================================
See notes to the consolidated financial statements on pages 76 through 114.
Consolidated Balance Sheets
December 31
(000s omitted) 2000 1999
- ----------------------------------------------------------------------------------------------
Assets
Investments:
Securities available-for-sale, at fair value:
Fixed maturity (cost: 2000 - $27,377,065; 1999 - $28,357,057) $27,449,773 $27,688,613
Equity (cost: 2000 - $462,813; 1999 - $481,531) 549,709 603,954
Mortgage loans on real estate 4,662,983 4,735,397
Real estate 282,014 256,202
Policy loans 1,960,899 1,892,392
Other investments 463,270 401,826
- ----------------------------------------------------------------------------------------------
Total Investments 35,368,648 35,578,384
Investment in unconsolidated affiliates 6,401 25,825
Cash and invested cash 1,927,393 1,895,883
Property and equipment 228,211 203,753
Deferred acquisition costs 3,070,507 2,800,290
Premiums and fees receivable 296,705 259,630
Accrued investment income 546,393 533,183
Assets held in separate accounts 50,579,915 53,654,223
Federal income taxes 207,548 345,010
Amounts recoverable from reinsurers 3,747,734 3,954,345
Goodwill 1,285,993 1,423,039
Other intangible assets 1,556,975 1,746,499
Other assets 1,021,636 675,669
- ----------------------------------------------------------------------------------------------
Total Assets $99,844,059 $103,095,733
==============================================================================================
See notes to the consolidated financial statements on pages 76 through 114.
Consolidate Balance Sheets
December 31
(000s omitted) 2000 1999
- ----------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Liabilities:
Insurance and Investment Contract Liabilities:
Insurance policy and claim reserves $21,728,098 $20,924,768
Contractholder funds 18,377,061 20,228,753
Liabilities related to separate accounts 50,579,915 53,654,223
- ----------------------------------------------------------------------------------------------
Total Insurance and Investment Contract Liabilities 90,685,074 94,807,744
Short-term debt 312,927 460,153
Long-term debt 712,231 711,963
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 745,000 745,000
Other liabilities 2,434,743 2,107,005
- ----------------------------------------------------------------------------------------------
Total Liabilities 94,889,975 98,831,865
Shareholders' Equity:
Series A preferred stock - 10,000,000 shares authorized
(2000 liquidation value - $2,078) 857 948
Common stock - 800,000,000 shares authorized 1,003,651 1,007,099
Retained earnings 3,915,598 3,691,470
Accumulated Other Comprehensive Income (Loss):
Foreign currency translation adjustment 21,930 30,049
Net unrealized gain (loss) on securities available-for-sale 12,048 (465,698)
- ----------------------------------------------------------------------------------------------
Total Accumulated Other Comprehensive Income (Loss) 33,978 (435,649)
- ----------------------------------------------------------------------------------------------
Total Shareholders' Equity 4,954,084 4,263,868
- ----------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $99,844,059 $103,095,733
==============================================================================================
See notes to the consolidated financial statements on pages 76 through 114.
Consolidated Statements of Shareholders' Equity
Year Ended December 31
(000s omitted except for per share amounts) 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------
Series A Preferred Stock:
Balance at beginning-of-year $948 $1,083 $1,153
Conversion into common stock (91) (135) (70)
- -------------------------------------------------------------------------------------------------------------
Balance at End-of-Year 857 948 1,083
Common Stock:
Balance at beginning-of-year 1,007,099 994,472 966,461
Conversion of series A preferred stock 91 135 70
Issued for benefit plans 33,609 51,288 50,666
Shares forfeited under benefit plans (868) (3,274) (1,919)
Issued for acquisition of subsidiaries 893 2,793 --
Retirement of common stock (37,173) (38,315) (5,972)
Issuance costs related to FELINE PRIDES -- -- (14,834)
- -------------------------------------------------------------------------------------------------------------
Balance at End-of-Year 1,003,651 1,007,099 994,472
Retained Earnings:
Balance at beginning-of-year 3,691,470 3,790,038 3,533,105
Comprehensive income (loss) 1,091,020 (577,643) 629,927
Less other comprehensive income (loss):
Foreign currency translation gain (loss) (8,119) (19,930) 3,775
Net unrealized gain (loss) on securities available-for-sale 477,746 (1,018,067) 116,377
- -------------------------------------------------------------------------------------------------------------
Net Income 621,393 460,354 509,775
Retirement of common stock (172,848) (339,404) (40,919)
Dividends declared:
Series A preferred ($3.00 per share) (78) (89) (100)
Common (2000 - $1.175; 1999 - $1.115; 1998 - $1.055) (224,339) (219,429) (211,823)
- -------------------------------------------------------------------------------------------------------------
Balance at End-of-Year 3,915,598 3,691,470 3,790,038
Foreign Currency Translation Adjustment:
Accumulated adjustment at beginning-of-year 30,049 49,979 46,204
Change during the year (8,119) (19,930) 3,775
- -------------------------------------------------------------------------------------------------------------
Balance at End-of-Year 21,930 30,049 49,979
Net Unrealized Gain (Loss) on Securities Available-for-Sale:
Balance at beginning-of-year (465,698) 552,369 435,992
Change during the year 477,746 (1,018,067) 116,377
- -------------------------------------------------------------------------------------------------------------
Balance at End-of-Year 12,048 (465,698) 552,369
- -------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity at End-of-Year $4,954,084 $4,263,868 $5,387,941
=============================================================================================================
See notes to the consolidated financial statements on pages 76 through 114.
Consolidated Statements of Shareholders' Equity
Year Ended December 31
(000s omitted except for per share amounts) 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------
Series A Preferred Stock:
Balance at beginning-of-year 28,857 32,959 35,091
Conversion into common stock (2,877) (4,102) (2,132)
- -------------------------------------------------------------------------------------------------------------
Balance at End-of-Year 25,980 28,857 32,959
Common Stock:
Balance at beginning-of-year 195,494,898 202,111,174 201,718,956
Conversion of series A preferred stock 46,032 65,632 34,112
Issued for benefit plans 1,435,015 1,026,130 1,651,554
Shares forfeited under benefit plans (29,698) (100,933) (46,886)
Issued for purchase of subsidiaries 24,384 67,895 --
Retirement of common stock (6,222,581) (7,675,000) (1,246,562)
- -------------------------------------------------------------------------------------------------------------
Balance Issued and Outstanding at End-of-Year 190,748,050 195,494,898 202,111,174
Common Stock at End-of-Year:
Assuming conversion of preferred stock 191,163,730 195,956,610 202,638,518
Diluted basis 195,230,153 197,003,999 203,395,433
=============================================================================================================
See notes to the consolidated financial statements on pages 76 through 114.
Consolidated Statements of Cash Flows
Year Ended December 31
(000s omitted) 2000 1999 1998
- -------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net income $621,393 $460,354 $509,775
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Deferred acquisition costs (423,087) (314,607) (208,150)
Premiums and fees receivable (37,075) (14,817) 3,151
Accrued investment income (13,210) (4,683) (101,555)
Policy liabilities and accruals 120,480 622,766 1,389,006
Contractholder funds 1,020,756 1,446,336 1,473,554
Amounts recoverable from reinsurers 206,611 (316,982) (775,064)
Federal income taxes 225,553 31,072 (213,458)
Provisions for depreciation 41,552 57,169 58,070
Amortization of goodwill and other intangible assets 195,460 167,173 137,508
Realized (gain) loss on investments 28,295 (2,955) (19,034)
Other (1,140) 201,787 (6,293)
- -------------------------------------------------------------------------------------------------------------
Net Adjustments 1,364,195 1,872,259 1,737,735
- -------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 1,985,588 2,332,613 2,247,510
Cash Flows from Investing Activities:
Securities available-for-sale:
Purchases (4,926,319) (6,255,493) (11,780,821)
Sales 4,005,859 4,210,498 9,278,969
Maturities 1,866,911 2,279,680 1,987,506
Purchase of other investments (1,902,639) (1,948,818) (2,922,984)
Sale or maturity of other investments 1,743,972 1,812,079 1,865,874
Sale of subsidiary/discontinued operations/blocks of business 85,000 (490,381) --
Purchase of affiliates/business -- 11,086 (2,285,081)
Cash acquired from purchase of affiliates/business -- -- 2,323,220
Increase (decrease) in cash collateral on loaned securities 236,811 (485,792) 274,426
Other (202,760) (271,992) (434,889)
- -------------------------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) Investing Activities 906,835 (1,139,133) (1,693,780)
Cash Flows from Financing Activities:
Decrease in long-term debt (includes payments and
transfers to short-term debt) -- (476) (99,977)
Issuance of long-term debt -- -- 299,198
Net increase (decrease) in short-term debt (147,226) 145,543 17,402
Issuance of preferred securities of subsidiary companies -- -- 430,000
Issuance costs related to FELINE PRIDES -- -- (14,834)
Universal life and investment contract deposits 3,543,763 4,139,492 2,660,784
Universal life and investment contract withdrawals (4,524,371) (4,683,705) (4,652,777)
Investment contract transfers (1,347,000) (793,000) (356,001)
Common stock issued for benefit plans 32,741 48,014 48,747
Nonqualified employee stock option exercise tax benefit 13,862 9,338 8,259
Retirement of common stock (210,021) (377,719) (46,871)
Dividends paid to shareholders (222,661) (218,434) (209,016)
- -------------------------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (2,860,913) (1,730,947) (1,915,086)
- -------------------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Invested Cash 31,510 (537,467) (1,361,356)
Cash and Invested Cash at Beginning-of-Year 1,895,883 2,433,350 3,794,706
- -------------------------------------------------------------------------------------------------------------
Cash and Invested Cash at End-of-Year $1,927,393 $1,895,883 $2,433,350
=============================================================================================================
See notes to the consolidated financial statements on pages 76 through 114.
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Basis of Presentation. The accompanying consolidated financial
statements include Lincoln National Corporation ("LNC") and its
majority-owned subsidiaries. Through subsidiary companies, LNC operates
multiple insurance and investment management businesses divided into
five business segments (see Note 9). The collective group of companies
uses "Lincoln Financial Group" as its marketing identity. Less than
majority-owned entities in which LNC has at least a 20% interest are
reported on the equity basis. These consolidated financial statements
have been prepared in conformity with accounting principles generally
accepted in the United States.
Use of Estimates. The nature of the insurance and investment management
businesses requires management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and
accompanying notes. Actual results could differ from those estimates.
Investments. LNC classifies its fixed maturity and equity securities as
available-for-sale and, accordingly, such securities are carried at fair
value. The cost of fixed maturity securities is adjusted for amortization
of premiums and discounts. The cost of fixed maturity and equity securities
is reduced to fair value with a corresponding charge to realized loss on
investments for declines in value that are other than temporary.
For the mortgage-backed securities portion of the fixed maturity
securities portfolio, LNC recognizes income using a constant effective
yield based on anticipated prepayments and the estimated economic life
of the securities. When estimates of prepayments change, the effective
yield is recalculated to reflect actual payments to date and anticipated
future payments. The net investment in the securities is adjusted to the
amount that would have existed had the new effective yield been applied
at the time of acquisition. This adjustment is reflected in net
investment income.
Mortgage loans on real estate are carried at the outstanding principal
balances less unamortized discounts. Investment real estate is carried
at cost less accumulated depreciation. The cost for both mortgage loans
on real estate and investment real estate is adjusted for declines in
value that are other than temporary. Also, allowances for losses are
established, as appropriate, for real estate holdings that are in the
process of being sold. Real estate acquired through foreclosure
proceedings is recorded at fair value on the settlement date which
establishes a new cost basis. If a subsequent periodic review of a
foreclosed property indicates the fair value, less estimated costs to
sell, is lower than the carrying value at the settlement date, the
carrying value is adjusted to the lower amount. Any changes to the
reserves for mortgage loans on real estate and real estate are reported
as realized gain (loss) on investments.
Policy loans are carried at aggregate unpaid balances.
Cash and invested cash are carried at cost and include all highly liquid
debt instruments purchased with a maturity of three months or less.
Realized gain (loss) on investments is recognized in net income, net of
associated amortization of deferred acquisition costs and investment
expenses, using the specific identification method. Changes in the fair
values of securities carried at fair value are reflected directly in
shareholders' equity, after deductions for related adjustments for
deferred acquisition costs and amounts required to satisfy policyholder
commitments that would have been recorded had these securities been sold
at their fair value, and after deferred taxes or credits to the extent
deemed recoverable.
Realized gain (loss) on sale of subsidiaries, net of taxes, is
recognized in net income. Realized gain (loss) on sale of minority
interests in subsidiaries is reflected directly in shareholders' equity
net of deferred taxes, if any.
Derivatives. For the years ended December 31, 2000, 1999 and 1998, LNC
hedged certain portions of its exposure to interest rate fluctuations,
the widening of bond yield spreads over comparable maturity U.S.
Government obligations, credit risk, foreign exchange risk, commodity
risk and fluctuations in the S&P stock index by entering into derivative
transactions. A description of LNC's accounting for its hedging of such
risks is discussed in the following two paragraphs.
Derivative balances are carried in other investments. The premiums paid
for interest rate caps and swaptions are deferred and amortized to net
investment income on a straight-line basis over the term of the
respective derivative. Interest rate caps that hedge interest credited
on fixed annuity liabilities are carried at amortized cost. Any
settlement received in accordance with the terms of the interest rate
caps is also recorded as net investment income. Realized gain (loss)
from the termination of the interest rate caps is included in net
income.
Swaptions, put options, spread-lock agreements, interest rate swaps,
commodity swaps and financial futures that hedge fixed maturity
securities available-for-sale are carried at fair value. The change in
fair value is reflected directly in shareholders' equity. Settlements on
interest rate swaps and commodity swaps are recognized in net investment
income. Realized gain (loss) from the termination of swaptions, put
options, spread-lock agreements, interest rate swaps, commodity swaps
and financial futures are deferred and amortized over the life of the
hedged assets as an adjustment to the yield. Forward-starting interest
rate swaps are also used to hedge the forecasted purchase of
investments. These interest rate swaps are carried off-balance sheet
until the occurrence of the forecasted transaction at which time the
interest rate swaps are terminated and any gain (loss) on termination is
used to adjust the basis of the forecasted purchase. If the forecasted
purchase does not occur or the interest rate swaps are terminated early,
changes in the fair value of the swaps are recorded in net income.
Over-the-counter call options which hedge liabilities tied to the S&P
stock index are carried at fair value. The change in fair value is
reflected directly in net income. Gain (loss) realized upon termination
of these call options is included in net income. Over-the-counter call
options which hedge stock appreciation rights are carried at fair value
when hedging vested stock appreciation rights and at cost when hedging
unvested stock appreciation rights. The change in fair value of call
options hedging vested stock appreciation rights is included in net
income. Gain (loss) upon termination is reported in net income.
Foreign exchange forward contracts which hedge debt issued by Lincoln UK
in a foreign currency are carried at fair value. The change in fair
value is included in income. Gain (loss) upon termination is reported in
net income. Foreign exchange forward contracts, foreign currency options
and foreign currency swaps, which hedge some of the foreign exchange
risk of investments in fixed maturity securities denominated in foreign
currencies, are carried at fair value. The change in fair value is
included in shareholders' equity. Realized gain (loss) from the
termination of such derivatives is included in net income.
Hedge accounting is applied as indicated above after LNC determines that
the items to be hedged expose LNC to interest rate fluctuations, the
widening of bond yield spreads over comparable maturity U.S. Government
obligations, fluctuations in certain stock indices or foreign exchange
risk. Moreover, the derivatives used to hedge these exposures are
designated as hedges and reduce the indicated risk by demonstrating a
high correlation between changes in the value of the derivatives and the
items being hedged at both the inception of the hedge and throughout the
hedge period. Should such criteria not be met or if the hedged items
have been sold, terminated or matured, the change in value of the
derivatives is included in net income. Foreign exchange forward
contracts are also used to hedge LNC's net investment in a foreign
subsidiary. These foreign exchange forward contracts are initially
carried at zero. Carrying value is adjusted for changes in the currency
spot rate as well as amortization of forward points. Changes in carrying
value are recorded in the translation adjustment.
Loaned Securities. Securities loaned are treated as collateralized
financing transactions and a liability is recorded equal to the cash
collateral received which is typically greater than the market value of
the related securities loaned. In other instances, LNC will hold as
collateral securities with a market value at least equal to the
securities loaned. Securities held as collateral are not recorded in
LNC's balance sheet in accordance with accounting guidance for secured
borrowings and collateral. LNC's agreements with third parties generally
contain contractual provisions to allow for additional collateral to be
obtained when necessary. LNC values collateral daily and obtains
additional collateral when deemed appropriate.
Property and Equipment. Property and equipment owned for company use is
carried at cost less allowances for depreciation.
Premiums and Fees. Revenue for universal life and other
interest-sensitive insurance policies consists of policy charges for the
cost of insurance, policy initiation and administration, and surrender
charges that have been assessed. Traditional individual life-health and
annuity premiums are recognized as revenue over the premium-paying
period of the policies. Group health premiums are prorated over the
contract term of the policies.
Investment Advisory Fees. As specified in the investment advisory
agreements with the mutual funds, fees are determined and recognized as
revenues monthly, based on the average daily net assets of the mutual
funds managed. Investment advisory contracts generally provide for the
determination and payment of advisory fees based on market values of
managed portfolios at the end of a calendar month or quarter. Investment
management and advisory contracts typically are renewable annually with
cancellation clauses ranging up to 90 days.
Notes to Consolidated Financial Statements
Assets Held in Separate Accounts/Liabilities Related to Separate
Accounts. These assets and liabilities represent segregated funds
administered and invested by LNC's insurance subsidiaries for the
exclusive benefit of pension and variable life and annuity
contractholders. Both the assets and liabilities are carried at fair
value. The fees earned by LNC's insurance subsidiaries for
administrative and contractholder maintenance services performed for
these separate accounts are included in insurance fee revenue.
Deferred Acquisition Costs. Commissions and other costs of acquiring
universal life insurance, variable universal life insurance, unit-linked
products, traditional life insurance, annuities and group health
insurance which vary with and are primarily related to the production of
new business, have been deferred to the extent recoverable. Acquisition
costs for universal and variable universal life insurance policies and
unit-linked products are amortized over the lives of the policies in
relation to the incidence of estimated gross profits from surrender
charges and investment, mortality, expense margins and actual realized
gain (loss) on investments. That amortization is adjusted
retrospectively when estimates of current or future gross profits to be
realized from a group of products are revised. Traditional life
acquisition costs are being amortized over periods of 10 to 30 years on
either a straight-line basis or as a level percent of premium of the
related policies depending on the block of business. Annuity acquisition
costs are amortized over a period of 15 years for more recently issued
policies, and over the surrender charge period for all other policies.
For all policies, amortization is based on assumptions consistent with
those used in the development of the underlying policy form adjusted for
emerging experience.
Benefits and Expenses. Benefits and expenses for universal life-type and
other interest-sensitive life insurance products include interest
credited to policy account balances and benefit claims incurred during
the period in excess of policy account balances. Interest crediting
rates associated with funds invested in the general account of LNC's
insurance subsidiaries during 1998 through 2000 ranged from 4.50% to
7.50%. For traditional life, group health and disability income
products, benefits and expenses, other than deferred acquisition costs,
are recognized when incurred in a manner consistent with the related
premium recognition policies.
Interest and debt expense includes interest on company-obligated
mandatorily redeemable preferred securities of subsidiary trusts holding
solely junior subordinated debentures.
Goodwill and Other Intangible Assets. Goodwill, as measured by the
excess of the cost of acquired subsidiaries or businesses over the fair
value of net assets acquired, is amortized using the straight-line
method over periods of 20 to 40 years in accordance with the benefits
expected to be derived from the acquisitions.
Insurance businesses typically produce on-going profit streams from
expected new business generation that extend significantly beyond the
maximum 40-year period allowed for goodwill amortization. Accordingly,
for acquired insurance businesses where financial modeling indicates
that anticipated new business benefits will extend for 40 years or
longer, goodwill is amortized over a 40-year period.
Other intangible assets for acquired insurance businesses consist of the
value of existing blocks of business (referred to as the "present value
of future profits"). The present value of future profits is amortized
over the expected lives of the block of insurance business in relation
to the incidence of estimated profits expected to be generated on
investment type products acquired, (i.e. variable products) and over the
premium paying period for insurance products acquired, (i.e. traditional
life insurance products). Amortization is based upon assumptions used in
pricing the acquisition of the block of business and is adjusted for
emerging experience. Accordingly, amortization periods and methods of
amortization for present value of future profits vary depending upon the
particular characteristics of the underlying blocks of acquired
insurance business.
Goodwill relating to acquisitions of investment management subsidiaries
is amortized on a straight-line method, over a 25 year period. Other
intangible assets relating to these acquisitions include institutional
customer relationships, covenants not to compete and mutual fund
customer relationships. These assets are amortized on a straight-line
basis over periods ranging from 6 to 15 years depending upon the
characteristics of the particular underlying relationships for the
intangible asset.
The carrying values of goodwill and other intangible assets are reviewed
periodically for indicators of impairment in value that are other than
temporary, including unexpected or adverse changes in the following: (1)
the economic or competitive environments in which the company operates,
(2) profitability analyses, (3) cash flow analyses, and (4) the fair
value of the relevant subsidiary. If there is an indication of
impairment then the cash flow method would be used to measure the
impairment and the carrying value would be adjusted as necessary.
Insurance and Investment Contract Liabilities. The liabilities for
future policy benefits and claim reserves for universal and variable
universal life insurance policies consist of policy account balances
that accrue to the benefit of the policyholders, excluding surrender
charges. The liabilities for future insurance policy and claim reserves
for traditional life policies are computed using assumptions for
investment yields, mortality and withdrawals based principally on
generally accepted actuarial methods and assumptions at the time of
policy issue. Interest assumptions for traditional direct individual
life reserves for all policies range from 2.25% to 7.5% depending on the
time of policy issue. Interest rate assumptions for individual life
reinsurance reserves range from 2.6% to 11.0%. The interest assumptions
for immediate and deferred paid-up annuities range from 2.25% to 14.50%.
With respect to its insurance and investment contract liabilities,
LNC continually reviews its: 1) overall reserve position; 2)
reserving techniques and 3) reinsurance arrangements. As experience
develops and new information becomes known, liabilities are adjusted
as deemed necessary. The effects of changes in estimates are
included in the operating results for the period in which such
changes occur.
Reinsurance. LNC's insurance companies enter into reinsurance agreements
with other companies in the normal course of their business. LNC's
insurance subsidiaries may assume reinsurance from unaffiliated
companies and/or cede reinsurance to such companies. Assets/liabilities
and premiums/benefits from certain reinsurance contracts that grant
statutory surplus to other insurance companies have been netted on the
balance sheets and income statements, respectively, since there is a
right of offset. All other reinsurance agreements are reported on a
gross basis.
Depreciation. Provisions for depreciation of investment real estate and
property and equipment owned for company use are computed principally on
the straight-line method over the estimated useful lives of the assets.
Postretirement Medical and Life Insurance Benefits. LNC accounts for its
postretirement medical and life insurance benefits using the full
accrual method.
Stock Options. LNC recognizes compensation expense for its stock option
incentive plans using the intrinsic value method of accounting. Under
the terms of the intrinsic value method, compensation cost is the
excess, if any, of the quoted market price of the stock at the grant
date, or other measurement date, over the amount an employee must pay to
acquire the stock.
Foreign Exchange. LNC's foreign subsidiaries' balance sheet accounts and
income statement items are translated at the current exchange and
average exchange rates for the year, respectively. Resulting translation
adjustments are reported as a component of shareholders' equity. Other
translation adjustments for foreign currency transactions that affect
cash flows are reported in comprehensive income.
Earnings per Share. Basic earnings per share is computed by dividing
earnings available to common shareholders by the average common shares
outstanding. Diluted earnings per share is computed assuming the conversion
or exercise of dilutive convertible preferred securities, non-vested stock,
stock options and deferred compensation shares outstanding during the year.
Reclassifications. Certain amounts reported in prior years' consolidated
financial statements have been reclassified to conform with the
presentation adopted in the current year. These reclassifications have
no effect on net income or shareholders' equity of the prior years.
Notes to Consolidated Financial Statements
2. Changes in Estimates and Changes in Accounting Principles
Change in Estimate for United Kingdom Pension Mis-Selling. During the
fourth quarter of 1999, LNC recorded a charge of $126.1 million
after-tax or $0.64 per share ($194.0 million pre-tax) to further
strengthen its reserve for pension mis-selling in the UK. The additional
reserve strengthening was made following: 1) the mandate issued by the
Financial Services Authority, the UK regulating body, for the use of
more up to date mortality rates in determining redress and reduced
interest rate assumptions to be used in calculating redress, thereby
causing the amount of redress to increase and 2) the change to guidance
that would have allowed a simplified process for the calculation and
payment of redress for certain policy groups and the inclusion of
redress relating to additional voluntary contributions made to pension
plans by individuals, retroactive to 1988.
Change in Estimate for Personal Accident Programs. During the fourth
quarter of 1999, LNC's Reinsurance segment conducted an in-depth review
of its exposure related to its participation in workers' compensation
carve-out (i.e., life and health risks associated with workers'
compensation coverage) programs managed by Unicover Managers, Inc. As a
result of this review as well as settlement proceedings conducted to
resolve this issue, LNC took a charge of $40.4 million after-tax or
$0.20 per share ($62.2 million pre-tax) in the fourth quarter of 1999.
Change in Estimate for HMO Excess-of-Loss Reinsurance Programs. During
the third quarter of 1999, reported claims experience for certain HMO
excess-of-loss reinsurance programs deteriorated causing loss ratios to
significantly exceed pricing assumptions. The unfavorable loss ratio
development related primarily to business written in 1998 and 1997. Time
lags in the reporting of claims experience to Lincoln Re by clients and
larger than anticipated costs for prescription drugs were significant
factors that led to losses exceeding pricing assumptions. As a result of
these developments, the reserve level for these programs was deemed
inadequate to meet future obligations. Consequently, Lincoln Re took a
charge in the third quarter of 1999 of $25.0 million after-tax or $0.12
per share ($38.5 million pre-tax) to strengthen reserves for claims on
the HMO excess-of-loss reinsurance programs.
Accounting for Derivative Instruments and Hedging Activities. In June
1998, the Financial Accounting Standards Board ("FASB"), issued
Statement of Financial Accounting Standard No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("FAS 133"). In July
1999, the FASB issued Statement of Financial Accounting Standard No.
137, "Accounting for Derivative Instruments and Hedging
Activities-Deferral of the Effective Date of FASB Statement No. 133"
("FAS 137"), which delayed the effective date of FAS 133 one year (i.e.,
adoption required no later than the first quarter of 2001). In June
2000, the FASB issued Statement of Financial Accounting Standard No.
138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities" ("FAS 138"), which addresses a limited number of
implementation issues arising from FAS 133.
LNC adopted FAS 133 on January 1, 2001. Upon adoption, the provisions of
FAS 133 were applied prospectively. The financial statement impact
resulting from the adoption of FAS 133 was dependent upon actual market
conditions and other relevant information as of January 1, 2001. The
pre-tax transition adjustments that LNC recorded upon adoption of FAS
133 on January 1, 2001 resulted in a net loss of $11.5 million (pre-tax)
recorded in net income as a component of realized gains and losses on
investments, and a net gain of $45.4 million (pre-tax) recorded in
equity as a component of Other Comprehensive Income. These transition
adjustments will be reported in LNC's first quarter 2001 financial
statements as the effects of a change in accounting principle.
In addition to the net transition adjustments that were recorded as of
January 1, 2001 relating to the adoption of FAS 133, LNC also expects
that FAS 133 will result in increased volatility in ongoing reported net
income. Certain derivative instruments, such as interest rate caps and
swaptions, that are regularly used by LNC to manage risks associated
with fluctuating interest rates, do not meet the requirements of the new
rules of FAS 133 for hedge accounting treatment. In these instances, LNC
expects to record changes in the fair market value of such derivatives
as a component of gains and losses on investments in net income.
3. Investments
The amortized cost, gross unrealized gains and losses, and fair value of securities available-for-sale
are as follows:
Amortized Fair
December 31 (in millions) Cost Gains Losses Value
- ----------------------------------------------------------------------------------------------------------------
2000:
Corporate bonds $21,369.6 $514.1 $(634.0) $21,249.7
U.S. Government bonds 479.9 71.8 (8.9) 542.8
Foreign government bonds 1,264.0 74.1 (17.0) 1,321.1
Asset and mortgage-backed securities:
Mortgage pass-through securities 970.8 13.1 (10.6) 973.3
Collateralized mortgage obligations 1,675.7 59.6 (14.7) 1,720.6
Other asset-backed securities 1,440.8 36.5 (10.8) 1,466.5
State and municipal bonds 14.6 0.1 (0.1) 14.6
Redeemable preferred stocks 161.7 0.9 (1.4) 161.2
- ----------------------------------------------------------------------------------------------------------------
Total fixed maturity securities 27,377.1 770.2 (697.5) 27,449.8
Equity securities 462.8 106.8 (19.9) 549.7
- ----------------------------------------------------------------------------------------------------------------
Total $27,839.9 $877.0 $(717.4) $27,999.5
- ----------------------------------------------------------------------------------------------------------------
1999:
Corporate bonds $21,760.2 $272.3 $(913.0) $21,119.5
U.S. Government bonds 552.5 29.8 (44.0) 538.3
Foreign government bonds 1,383.8 88.1 (24.5) 1,447.4
Asset and mortgage-backed securities:
Mortgage pass-through securities 1,043.9 6.8 (31.4) 1,019.3
Collateralized mortgage obligations 2,015.0 39.1 (46.6) 2,007.5
Other asset-backed securities 1,415.7 14.7 (53.2) 1,377.2
State and municipal bonds 15.3 -- (0.6) 14.7
Redeemable preferred stocks 170.7 2.8 (8.8) 164.7
- ----------------------------------------------------------------------------------------------------------------
Total fixed maturity securities 28,357.1 453.6 (1,122.1) 27,688.6
Equity securities 481.5 151.4 (28.9) 604.0
- ----------------------------------------------------------------------------------------------------------------
Total $28,838.6 $605.0 $(1,151.0) $28,292.6
================================================================================================================
Future maturities of fixed maturity securities available-for-sale are as follows:
Amortized Fair
December 31, 2000 (in millions) Cost Value
- ----------------------------------------------------------------------------------------
Due in one year or less $953.8 $955.5
Due after one year through five years 5,940.0 5,927.8
Due after five years through ten years 7,454.2 7,357.6
Due after ten years 8,941.8 9,048.5
- ----------------------------------------------------------------------------------------
Subtotal 23,289.8 23,289.4
Asset and mortgage-backed securities 4,087.3 4,160.4
- ----------------------------------------------------------------------------------------
Total $27,377.1 $27,449.8
========================================================================================
The foregoing data is based on stated maturities. Actual maturities will
differ in some cases because borrowers may have the right to call or
pre-pay obligations.
Notes to Consolidated Financial Statements
Par value, amortized cost and estimated fair value of investments in
asset and mortgage-backed securities summarized by interest rates of the
underlying collateral are as follows:
Par Amortized Fair
December 31, 2000 (in millions) Value Cost Value
- -----------------------------------------------------------------
Below 7% $1,088.4 $326.7 $332.6
7% - 8% 2,237.7 2,221.4 2,226.7
8% - 9% 1,027.8 1,014.0 1,046.3
Above 9% 532.6 525.2 554.8
- -----------------------------------------------------------------
Total $4,886.5 $4,087.3 $4,160.4
=================================================================
The quality ratings for fixed maturity securities available-for-sale are
as follows:
December 31 2000
- -----------------------------------------------------------------
Treasuries and AAA 22.1%
AA 7.0
A 30.9
BBB 33.1
BB 3.6
Less than BB 3.3
- -----------------------------------------------------------------
100.0%
=================================================================
The major categories of net investment income are as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Fixed maturity securities $2,148.7 $2,232.9 $2,065.8
Equity securities 19.4 20.1 22.9
Mortgage loans on real estate 373.8 369.2 383.6
Real estate 51.8 64.1 86.8
Policy loans 125.0 116.5 99.5
Invested cash 87.2 110.2 156.7
Other investments 66.9 51.8 88.4
- ----------------------------------------------------------------------------------------------------
Investment revenue 2,872.8 2,964.8 2,903.7
Investment expense 125.7 157.3 222.3
- ----------------------------------------------------------------------------------------------------
Net investment income $2,747.1 $2,807.5 $2,681.4
====================================================================================================
The realized gain (loss) on investments is as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Fixed maturity securities available-for-sale:
Gross gain $146.5 $129.1 $211.7
Gross loss (218.2) (251.7) (211.2)
Equity securities available-for-sale:
Gross gain 58.0 97.0 107.8
Gross loss (48.6) (36.5) (50.4)
Other investments 5.9 49.3 11.9
Associated amortization of deferred acquisition costs,
provision for policyholder commitments and investment expenses 28.1 15.8 (50.8)
- ----------------------------------------------------------------------------------------------------
Total $(28.3) $3.0 $19.0
====================================================================================================
Provisions (credits) for write-downs and net changes in allowances for
loss, which are included in the realized gain (loss) on investments
shown above, are as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Fixed maturity securities $41.2 $29.3 $74.2
Equity securities 14.6 5.6 6.0
Mortgage loans on real estate 0.2 (0.1) (0.2)
Real estate -- -- (7.2)
Other long-term investments -- (7.6) 5.4
Guarantees -- -- (0.5)
- ----------------------------------------------------------------------------------------------------
Total $56.0 $27.2 $77.7
====================================================================================================
The change in unrealized appreciation (depreciation) on investments in
fixed maturity and equity securities available-for-sale is as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Fixed maturity securities $741.2 $(2,261.8) $152.9
Equity securities (35.6) 16.4 (37.1)
- ----------------------------------------------------------------------------------------------------
Total $705.6 $(2,245.4) $115.8
====================================================================================================
During the second quarter of 1998, LNC purchased three bonds issued
with offsetting interest rate characteristics. Subsequent to the
purchase of these bonds, interest rates increased and the value of
one of these bonds decreased. This bond was sold at the end of the
second quarter 1998 and a realized loss of $28.8 million ($18.7
million after-tax) was recorded. The other two bonds are still owned
by LNC and are producing net investment income on an annual basis of
$9.9 million ($6.4 million after-tax). Subsequent to these
transactions being recorded, the Emerging Issues Task Force of the
Financial Accounting Standards Board reached consensus with regard
to accounting for this type of investment strategy. LNC is not
required to apply the new accounting rules, however, if such rules
were applied, the realized loss on the sale of $28.8 million ($18.7
million after-tax) on one of these bonds recorded at the end of the
second quarter of 1998 would be reduced to $8.8 million ($5.7
million after-tax) and the difference would be applied as a change
in the carrying amount of the two bonds that remain in LNC's
portfolio. Also, net investment income for the year ended December
31, 2000, 1999 and 1998 would be less than reported by $2.5 million
($1.6 million after-tax), $2.3 million ($1.5 million after-tax) and
$1.9 million ($1.2 million after-tax), respectively.
The balance sheet captions, "Real Estate" and "Property and
Equipment," are shown net of allowances for depreciation as follows:
Year Ended December 31 (in millions) 2000 1999
- ---------------------------------------------------------------------
Real estate $40.4 $40.3
Property and equipment 247.9 238.1
=====================================================================
Mortgage loans on real estate which are primarily held in the Life
Insurance and Annuities segments are considered impaired when, based
on current information and events, it is probable that LNC will be
unable to collect all amounts due according to the contractual terms
of the loan agreement. When LNC determines that a loan is impaired,
the cost is adjusted or a provision for loss is established equal to
the difference between the initial cost of the mortgage loan and the
estimated value. Estimated value is based on: 1) the present value
of expected future cash flows discounted at the loan's effective
interest rate; 2) the loan's observable market price; or 3) the fair
value of the collateral. The provision for losses is reported as
realized gain (loss) on investments. Mortgage loans deemed to be
uncollectible are charged against the allowance for losses and
subsequent recoveries, if any, are credited to the allowance for
losses.
Notes to Consolidated Financial Statements
The allowance for losses is maintained at a level believed adequate
by management to absorb estimated probable credit losses.
Management's periodic evaluation of the adequacy of the allowance
for losses is based on LNC's past loan loss experience, known and
inherent risks in the portfolio, adverse situations that may affect
the borrower's ability to repay (including the timing of future
payments), the estimated value of the underlying collateral,
composition of the loan portfolio, current economic conditions and
other relevant factors. This evaluation is inherently subjective, as
it requires estimating the amounts and timing of future cash flows
expected to be received on impaired loans that may be susceptible to
significant change.
Impaired mortgage loans along with the related allowance for losses
are as follows:
December 31 (in millions) 2000 1999
- ----------------------------------------------------------------------
Impaired loans with allowance for losses $26.9 $35.1
Allowance for losses (4.9) (4.7)
Impaired loans with no allowance for losses -- --
- ----------------------------------------------------------------------
Net impaired loans $22.0 $30.4
======================================================================
Impaired mortgage loans with no allowance for losses are a result
of: 1) direct write-downs; or 2) collateral dependent loans where
the fair value of the collateral is greater than the recorded
investment in the loan.
A reconciliation of the mortgage loan allowance for losses for these
impaired mortgage loans is as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------
Balance at beginning-of-year $4.7 $4.8 $5.0
Provisions for losses 1.8 0.8 0.7
Releases due to principal paydowns (1.6) (0.9) (0.9)
Releases due to foreclosures -- -- --
- ----------------------------------------------------------------------
Balance at end-of-year $4.9 $4.7 $4.8
======================================================================
The average recorded investment in impaired mortgage loans and the
interest income recognized on impaired mortgage loans were as
follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------
Average recorded investment
in impaired loans $27.9 $29.6 $33.4
Interest income recognized
on impaired loans 2.6 2.9 3.5
======================================================================
All interest income on impaired mortgage loans was recognized on the
cash basis of income recognition.
As of December 31, 2000 and 1999, LNC had restructured mortgage
loans of $4.1 million and $3.3 million, respectively. LNC recorded
$0.3 million and $0.3 million of interest income on these
restructured mortgage loans in 2000 and 1999, respectively. Interest
income in the amount of $0.4 million and $0.4 million would have
been recorded on these mortgage loans according to their original
terms in 2000 and 1999, respectively. As of December 31, 2000 and
1999, LNC had no outstanding commitments to lend funds on
restructured mortgage loans.
An investment in real estate is considered impaired when the
projected undiscounted cash flow from the investment is less than
the carrying value. When LNC determines that an investment in real
estate is impaired, it is written-down to reduce the carrying value
to the estimated value.
As of December 31, 2000, LNC's investment commitments for fixed
maturity securities (primarily private placements), mortgage loans
on real estate and real estate were $883.1 million. This includes
$330.8 million of standby commitments to purchase real estate upon
completion and leasing.
For the year ended December 31, 2000, fixed maturity securities
available-for-sale, mortgage loans on real estate and real estate
investments which were non-income producing were not significant.
The cost information for mortgage loans on real estate, real estate
and other long-term investments is net of allowances for losses. The
balance sheet account for other liabilities includes a reserve for
guarantees of third-party debt. The amount of allowances and
reserves for such items is as follows:
December 31 (in millions) 2000 1999
- ----------------------------------------------------------------------
Mortgage loans on real estate 4.9 4.7
Real estate -- --
Guarantees 0.3 0.3
======================================================================
During the fourth quarter of 2000, LNC completed a securitization of
commercial mortgage loans. In the aggregate, the loans had a fair
value of $186.0 million and carrying value of $185.7 million. LNC
retained a 6.3% beneficial interest in the securitized assets along
with the mortgage loan servicing rights for the trust. LNC received
$172.7 million from the trust for the sale of the senior trust
certificates representing the other 93.7% beneficial interest. A
realized gain of $0.4 million pre-tax was recorded on this sale. A
recourse liability was not recorded since LNC is not obligated to
repurchase any loans from the trust that may later become
delinquent. Servicing fees of $0.02 million were received in 2000.
Cash flows received during 2000 from interests retained in the trust
were $0.4 million. The fair values of the mortgage loans were based
on a discounted cash flow method based on credit rating, maturity
and future income. Prepayments are expected to be less than 1% with
an expected weighted-average life of 6.4 years. Credit losses are
anticipated to be minimal over the life of the trust.
4. Federal Income Taxes
The Federal income tax expense (benefit) is as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Current $25.2 $(55.5) $(37.0)
Deferred 189.7 165.1 224.6
- ----------------------------------------------------------------------------------------------------
Total tax expense $214.9 $109.6 $187.6
====================================================================================================
The effective tax rate on pre-tax income is lower than the prevailing
corporate Federal income tax rate. A reconciliation of this difference is
as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Tax rate times pre-tax income from continuing operations $292.7 $199.5 $244.1
Effect of:
Tax-preferred investment income (64.3) (47.7) (51.1)
Change in valuation allowance -- (38.2) (5.3)
Other items (13.5) (4.0) (0.1)
- ----------------------------------------------------------------------------------------------------
Provision for income taxes $214.9 $109.6 $187.6
Effective tax rate 26% 19% 27%
====================================================================================================
The Federal income tax recoverable asset (liability) is as follows:
December 31 (in millions) 2000 1999
- ----------------------------------------------------------------------------------------
Current $(73.8) $15.4
Deferred 281.3 329.6
- ----------------------------------------------------------------------------------------
Total Federal income tax asset $207.5 $345.0
========================================================================================
Notes to Consolidated Financial Statements
December 31 (in millions) 2000 1999
- ----------------------------------------------------------------------------------------
Deferred tax assets:
Insurance and investment contract liabilities $1,218.3 $1,252.8
Net operating loss carryforwards 170.0 186.7
Postretirement benefits other than pensions 48.4 46.5
Compensation related 69.6 74.4
Net unrealized loss on securities available-for-sale -- 232.3
Other 93.4 41.5
- ----------------------------------------------------------------------------------------
Total deferred tax assets 1,599.7 1,834.2
Valuation allowance for deferred tax assets -- 229.0
- ----------------------------------------------------------------------------------------
Net deferred tax assets 1,599.7 1,605.2
Deferred tax liabilities:
Deferred acquisition costs 541.2 572.3
Premiums and fees receivable 83.0 23.4
Investments related 134.8 66.2
Net unrealized gain on securities available-for-sale 17.0 --
Present value of business in-force 423.4 473.7
Other 119.0 140.0
- ----------------------------------------------------------------------------------------
Total deferred tax liabilities 1,318.4 1,275.6
- ----------------------------------------------------------------------------------------
Net deferred tax asset $281.3 $329.6
========================================================================================
Cash received for Federal income taxes in 2000 was $79.1 million due
to the carry back of 1999 tax losses. Cash paid for Federal income
taxes in 1999 and 1998 was $70.6 million and $379.6 million,
respectively.
LNC is required to establish a valuation allowance for any gross
deferred tax assets that are unlikely to reduce taxes that will be
paid upon the filing of future years' tax returns. At December 31,
2000, LNC believes that it is more likely than not that all gross
deferred tax assets will reduce taxes payable in future years.
Accordingly, no valuation allowance was necessary at December 31,
2000. During 2000 the net unrealized capital loss position that
existed at December 31, 1999 for LNC's fixed maturity and equity
securities was eliminated primarily due to changes in market
conditions. The deferred tax asset valuation allowance of $229
million that was established in 1999 due to the uncertainty of the
realizability of tax benefits associated with the unrealized capital
losses that existed at December 31, 1999 was reversed in 2000.
Because this valuation allowance was established in shareholder's
equity at December 31, 1999, LNC recorded the reversal of this tax
valuation allowance during 2000 in shareholders' equity.
At December 31, 1999, $232.3 million of gross deferred tax assets
relating to net unrealized capital losses on fixed maturity and
equity securities available-for-sale were recorded in shareholders'
equity. In evaluating the realizability of these gross deferred tax
assets, LNC considered the Federal income tax restrictions on the
use of corporate capital losses. Under the corporate income tax
rules, corporate capital losses may only be used to offset capital
gains. A three-year carryback and a five-year carryforward of unused
capital losses to offset capital gains generated within these years
are also permitted. Due to these restrictions, LNC determined that a
valuation allowance of $229 million at December 31, 1999 was
necessary. That valuation allowance was established in shareholders'
equity at December 31, 1999.
When LNC management announced its intention to explore exiting the
UK insurance market in 1999, LNC was required to change its method
of accounting for Lincoln UK's taxes. Previously, taxes were
computed based upon LNC's intention to permanently reinvest earnings
in the UK subsidiaries. Under this approach, Lincoln UK was unable
to recognize UK tax benefits for a portion of the pension
mis-selling losses recorded in 1997, since UK tax law restricted the
use of these losses. However, when the decision was made in the
fourth quarter of 1999 that earnings would no longer be permanently
reinvested, U.S. tax rules rather than UK tax rules became the
primary factor in determining the overall deferred taxes for the
segment. LNC was required to adjust the level of deferred taxes
based upon U.S. tax rules, under the new operating assumption that
earnings from Lincoln UK will ultimately be repatriated to LNC.
Accordingly, LNC eliminated the $38.2 million valuation allowance
and reduced its deferred tax liabilities by another $3.9 million in
the fourth quarter of 1999. A tax benefit of $42.1 million was
reported in net income by LNC in 1999 relating to these matters.
At December 31, 1998, LNC held a $38.2 million tax valuation
allowance relating to the Lincoln UK segment. Prior to 1999, U.S.
GAAP taxes for Lincoln UK were computed based upon LNC's intention
to permanently reinvest earnings in the UK subsidiaries. Under this
approach, Lincoln UK was unable to recognize UK tax benefits for a
portion of the pension mis-selling losses recorded in 1997, since UK
tax law restricted the use of these losses.
At December 31, 2000, LNC had net operating losses for Federal
income tax purposes of: $295.0 million for foreign life reinsurance
companies that expire in years 2007 through 2015; $79.1 million for
Delaware Management Holdings, Inc. ("Delaware") that expire in years
2003 through 2008; $52.6 million for Lincoln Life & Annuity Company
of New York ("Lincoln Life New York") that expire in the year 2013;
and $59.0 million of U.S. non-life consolidated losses that expire
in the year 2020. The foreign reinsurance companies are expected to
utilize most of their respective tax net operating losses as the
reinsurance business on their books runs off. Although the net
operating losses of the foreign reinsurance companies are generally
subject to limitations that require the companies generating the
loss to have future taxable income, LNC believes that it is more
likely than not that these net operating losses will be fully
utilized within the allowable carryforward period. Because the
Delaware, Lincoln Life New York, and U.S. non-life consolidated net
operating losses can be used in future LNC consolidated U.S. tax
returns, management also believes that it is more likely than not
that these net operating losses will also be fully utilized within
the allowable carryforward period.
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,
2000, LNC has approximately $196.0 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. Barring the passage of unfavorable tax
legislation, LNC does not believe that any significant portion of
the account will be taxed in the foreseeable future. Accordingly, no
deferred tax liability has been recognized relating to LNC's
Policyholders' Surplus balance. If the entire Policyholders' Surplus
balance became taxable at the current Federal rate, the tax would be
approximately $68.6 million.
5. Supplemental Financial Data
Reinsurance transactions included in the income statement captions,
"Insurance Premiums" and "Insurance Fees", are as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Insurance assumed $1,299.8 $1,509.3 $1,259.8
Insurance ceded 559.9 621.0 695.4
- ----------------------------------------------------------------------------------------------------
Net reinsurance premiums and fees $739.9 $888.3 $564.4
====================================================================================================
The income statement caption, "Benefits", is net of reinsurance recoveries
of $0.448 billion, $0.611 billion and $0.749 billion for the years ended
December 31, 2000, 1999 and 1998, respectively. Details underlying the
income statement caption, "Underwriting, Acquisition, Insurance and Other
Expenses", are as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Commissions $919.1 $961.0 $740.1
Other volume related expenses 262.8 205.5 150.7
Operating and administrative expenses 1,148.0 1,156.9 995.8
Deferred acquisition costs net of amortization (423.1) (314.6) (208.2)
Restructuring charges 104.9 27.3 52.8
Other 306.8 258.9 212.5
- ----------------------------------------------------------------------------------------------------
Total $2,318.5 $2,295.0 $1,943.7
====================================================================================================
The income statement caption, "Underwriting, Acquisition, Insurance
and Other Expenses", includes amortization of deferred acquisition
costs of $340.1 million, $302.0 million and $403.9 million for the
years ended December 31, 2000, 1999 and 1998, respectively. An
additional $38.5 million, $26.9 million and $(34.5) million of
deferred acquisition costs was restored (amortized) and netted
against "Realized Gain (Loss) on Investments" for the years ended
December 31, 2000, 1999 and 1998, respectively.
Notes to Consolidated Financial Statements
A reconciliation of the present value of insurance business acquired
included in other intangible assets is as follows:
December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Balance at beginning of year $1,654.2 $1,753.3 $501.3
Acquisitions of insurance companies/business -- -- 1,323.2
Adjustments to balance (15.6) 3.4 --
Interest accrued on unamortized balance (Interest rates range
from 5% to 7%) 69.9 44.4
Amortization (224.9) (163.7) (117.4)
Foreign exchange adjustment (22.6) (8.7) 1.8
- ----------------------------------------------------------------------------------------------------
Balance at end-of-year 1,483.3 1,654.2 1,753.3
Other intangible assets (non-insurance) 73.7 92.3 95.1
- ----------------------------------------------------------------------------------------------------
Total other intangible assets at end-of-year $1,557.0 $1,746.5 $1,848.4
====================================================================================================
Future estimated amortization of insurance business acquired net of
interest on unamortized balance for LNC's insurance subsidiaries is as
follows (in millions):
- ----------------------------------------------------------------
2001 - $111.8 2003 - $99.8 2005 - $92.4
2002 - 98.6 2004 - 95.4 Thereafter - 985.3
================================================================
Details underlying the balance sheet caption, "Contractholder Funds", are as follows:
December 31 (in millions) 2000 1999
- ----------------------------------------------------------------------------------------
Premium deposit funds $17,715.5 $19,624.1
Undistributed earnings on participating business 139.4 132.0
Other 522.2 472.7
- ----------------------------------------------------------------------------------------
Total $18,377.1 $20,228.8
========================================================================================
Details underlying the balance sheet captions related to total debt are as follows:
December 31 (in millions) 2000 1999
- ----------------------------------------------------------------------------------------
Short-term debt:
Commercial paper $311.9 $414.0
Other short-term notes 0.8 45.6
Current portion of long-term debt 0.2 0.5
- ----------------------------------------------------------------------------------------
Total short-term debt 312.9 460.1
Long-term debt less current portion:
7.625% notes payable, due 2002 99.9 99.9
7.250% notes payable, due 2005 192.0 191.8
6.500% notes payable, due 2008 100.1 100.2
7% notes payable, due 2018 200.3 200.3
9.125% notes payable, due 2024 119.9 119.8
- ----------------------------------------------------------------------------------------
Total long-term debt 712.2 712.0
Company-obligated mandatorily redeemable preferred securities of
subsidiary trusts holding solely junior subordinated debentures:
8.75% Quarterly Income Preferred Securities 215.0 215.0
8.35% Trust Originated Preferred Securities 100.0 100.0
7.40% Trust Originated Preferred Securities 200.0 200.0
7.75% FELINE PRIDES 230.0 230.0
- ----------------------------------------------------------------------------------------
Total 745.0 745.0
- ----------------------------------------------------------------------------------------
Total Debt $1,770.1 $1,917.1
========================================================================================
The combined U.S. and U.K. commercial paper outstanding at December 31,
2000 and 1999, had a blended weighted average interest rate of
approximately 6.81% and 5.77%, respectively.
Future maturities of long-term debt are as follows (in millions):
- -------------------------------------------------------------------
2001 - $ -- 2003 - $-- 2005 - $193.0
2002 - 100.0 2004 - -- Thereafter - 420.3
===================================================================
LNC also has access to capital from minority interest in preferred
securities of subsidiary companies. In May 1996, LNC filed a shelf
registration with the Securities and Exchange Commission that would
allow LNC to offer and sell up to $500 million of various forms of
hybrid securities. These securities, which combine debt and equity
characteristics, are offered through a series of three subsidiaries
(Lincoln National Capital I, II and III). These subsidiaries were
formed solely for the purpose of issuing preferred securities and
lending the proceeds to LNC. The common securities of these
subsidiaries are owned by LNC. The only assets of Lincoln National
Capital I, II and III are the notes receivable from LNC for such
loans. Distributions are paid by these subsidiaries to the preferred
securityholders on a quarterly basis. The principal obligations of
these subsidiaries are irrevocably guaranteed by LNC. Upon
liquidation of these subsidiaries, the holders of the preferred
securities would be entitled to a fixed amount per share plus
accumulated and unpaid distributions. LNC reserves the right to: 1)
redeem the preferred securities at a fixed price plus accumulated
and unpaid distributions and; 2) extend the stated redemption date
up to 19 years if certain conditions are met.
In April 1998, LNC filed a shelf registration with the Securities
and Exchange Commission, that would allow LNC to offer and sell up
to $1.3 billion of various securities, including regular debt,
preferred stock, common stock or hybrid securities. This filing
included an aggregate of $300 million from a previous filing that
had not been utilized. In conjunction with this shelf registration,
three additional subsidiaries were added (Lincoln National Capital
IV, V and VI) to accommodate the issuance of additional preferred
securities. The purpose and terms of these new subsidiaries
essentially parallel Lincoln National Capital I, II and III.
In July 1996, Lincoln National Capital I issued 8,600,000 shares or
$215 million, 8.75% Quarterly Income Preferred Securities ("QUIPS").
In August 1996, Lincoln National Capital II issued 4,000,000 shares
or $100 million, 8.35% Trust Originated Preferred Securities
("TOPrS"). Both issues mature in 2026 at $25 per share and the QUIPS
and 8.35% TOPrS are redeemable in whole or in part at LNC's option
any time after July 2001 and August 2001, respectively. In March
1998, LNC issued notes of 1) $100 million, 6.5% due 2008 and 2) $200
million, 7% due 2018. In July 1998, Lincoln National Capital III
issued 8,000,000 shares or $200 million of 7.4% TOPrS which mature
in 2028 at $25 per share and are redeemable in whole or in part at
LNC's option anytime after July 2003. In August 1998, Lincoln
National Capital IV issued 9,200,000 shares or $230 million of 7.75%
FELINE PRIDES (service mark of Merrill Lynch & Co. Inc.). The
purchasers of such securities were also provided stock purchase
contract agreements that indicate they will receive a specified
amount of LNC common stock on or before the August 2001 maturity
date of the FELINE PRIDES. A portion of the issuance costs
associated with this offering along with the present value of the
payments associated with the stock purchase agreements were charged
to the common stock line within shareholders' equity. In December
1998, LNC filed a shelf registration with the Securities Exchange
Commission that combines unused portions of the April 1998
registration ($640 million) and the May 1996 registration ($185
million) resulting in an active shelf registration allowing LNC to
sell up to an additional $825 million of securities.
The funds raised in 1998 from the various public offerings of hybrid
securities described above were used to acquire a block of
individual life insurance business from Aetna (see Note 11).
Finally, LNC maintains two revolving credit agreements with a group
of domestic and foreign banks totaling $700 million. One agreement,
in the amount of $300 million, expires in December 2005 and the
second agreement, in the amount of $400 million, expires in December
2001. These agreements replaced a $750 million credit agreement that
was terminated in December 2000. Both agreements provide for
interest on borrowings based on various money market indices. Under
the terms of these agreements, LNC must maintain a prescribed level
of adjusted consolidated net worth. In addition, LNC must maintain
the debt ratings that existed at December 31, 2000 or be restricted
by an adjusted debt to total capitalization ratio. At December 31,
2000, LNC had no outstanding borrowings under these agreements.
During 2000, 1999 and 1998, fees paid for maintaining revolving
credit agreements amounted to $642,000, $633,000 and $662,000,
respectively.
Notes to Consolidated Financial Statements
Cash paid for interest for 2000, 1999 and 1998 was $145.4 million,
$132.2 million and $108.3 million, respectively.
6. Employee Benefit Plans
Pension and Other Postretirement Benefit Plans - U.S. LNC maintains
funded defined benefit pension plans for most of its U.S. employees,
and prior to January 1, 1995, most full-time agents. Benefits for
employees are based on total years of service and the highest 60
months of compensation during the last 10 years of employment. All
benefits applicable to the funded defined benefit plan for agents
were frozen as of December 31, 1994. The plans are funded by
contributions to tax-exempt trusts. LNC's funding policy is
consistent with the funding requirements of Federal law and
regulations. Contributions are intended to provide not only the
benefits attributed to service to date, but also those expected to
be earned in the future. Effective January 1, 1998, the defined
benefit pension plans were amended to increase benefits for certain
retired individuals. The effect of this amendment was to increase
the pension benefit obligation by $10.7 million.
LNC sponsors three types of unfunded, nonqualified, defined benefit
plans for certain U.S. employees and agents: supplemental retirement
plans, a salary continuation plan, and supplemental executive
retirement plans.
The supplemental retirement plans provide defined benefit pension
benefits in excess of limits imposed by Federal tax law. Effective
January 1, 2000, one of these plans was amended to limit the maximum
compensation recognized for benefit payment calculation purposes.
The effect of this amendment was to reduce the pension benefit
obligation by $5.4 million.
The salary continuation plan provides certain officers of LNC
defined pension benefits based on years of service and final monthly
salary upon death or retirement.
The supplemental executive retirement plan provides defined pension
benefits for certain executives who became employees of LNC as a
result of the acquisition of a block of individual life insurance
and annuity business from CIGNA Corporation ("CIGNA"). Effective
January 1, 2000, this plan was amended to freeze benefits payable
under this plan. The effect of this plan curtailment was to decrease
the pension benefit obligation by $2.4 million. Effective January 1,
2000, a second supplemental executive retirement plan was
established for this same group of executives to guarantee that the
total benefit payable under the LNC employees' defined benefit
pension plan benefit formula will be determined using an average
compensation not less than the minimum three-year average
compensation as of December 31, 1999. All benefits payable from this
plan are reduced by benefits payable from the LNC employees' defined
benefit pension plan.
LNC also sponsors unfunded defined benefit plans that provide
postretirement medical, dental and life insurance benefits to
full-time U.S. employees and agents who, depending on the plan, have
worked for LNC 10 years and attained age 55 (60 for agents). Medical
and dental benefits are also available to spouses and other
dependents of employees and agents. For medical and dental benefits,
limited contributions are required from individuals who retired
prior to November 1, 1988. Contributions for later retirees, which
can be adjusted annually, are based on such items as years of
service at retirement and age at retirement. Life insurance benefits
are noncontributory; however, participants can elect supplemental
contributory life benefits up to age 70. Effective July 1, 1999, the
agents' postretirement plan was changed to require agents retiring
on or after that date to pay the full premium costs. This change in
the plan resulted in a one-time curtailment gain of $10.2 million.
As a result of the acquisitions of a block of individual life
insurance business from Aetna, Inc. ("Aetna"), former Aetna
employees became LNC employees and entered the employees' defined
benefit pension and postretirement benefit plans effective January
1, 1999. The plans were amended as of that date to approve the
entrance of these participants, to provide these participants with
credit for past service for benefit purposes, and to specify that
the accrued pension benefits determined by the plan benefit formula
are to be offset by the benefits accrued in the Aetna plans, as
applicable. This resulted in increases in the pension benefits
obligation and the postretirement benefits obligation of $5.2
million and $2.0 million, respectively during the year ended
December 31, 1999.
Information with respect to defined benefit plan asset activity and
defined benefit plan obligations is as follows:
Other Postretirement
Pension Benefits Benefits
----------------- -----------------
Year Ended December 31 (in millions) 2000 1999 2000 1999
- ------------------------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning-of-year $390.0 $362.4 $-- $--
Actual return on plan assets 3.8 41.6 -- --
Company contributions 6.7 -- -- --
Administrative expenses (0.3) (0.3) -- --
Benefits paid (14.7) (13.6) -- --
- ------------------------------------------------------------------------------------------------
Fair value of plan assets at end-of-year $385.5 $390.1 $-- $--
Change in benefit obligation:
Benefit obligation at beginning-of-year $434.7 $485.9 $108.0 $111.1
Plan amendments (5.4) -- 0.3 --
Acquisitions -- 5.2 -- 2.0
Service cost 14.2 19.2 2.3 3.6
Interest cost 32.1 30.2 6.9 6.6
Plan participants' contributions -- -- 0.5 1.3
Plan curtailment gain (2.4) -- -- (10.2)
Actuarial (gains) losses 13.5 (89.2) (8.0) 0.1
Benefits paid (17.4) (16.6) (1.7) (6.5)
- ------------------------------------------------------------------------------------------------
Benefit obligation at end-of-year $469.3 $434.7 $108.3 $108.0
Underfunded status of the plans $(83.8) $(44.6) $(108.3) $(108.0)
Unrecognized net actuarial gains (8.9) (54.3) (3.9) --
Unrecognized prior service cost 2.5 8.2 -- 3.3
- ------------------------------------------------------------------------------------------------
Accrued benefit cost $(90.2) $(90.7) $(112.2) $(104.7)
Weighted-average assumptions as of December 31:
Weighted-average discount rate 7.50% 7.75% 7.50% 7.75%
Expected return on plan assets 9.00% 9.00% -- --
Rate of increase in compensation:
Salary continuation plan 5.50% 5.50% -- --
All other plans 4.50% 4.50% 4.50% 4.50%
=================================================================================================
The funded status amounts in the pension benefits columns above
combine plans with projected benefit obligations in excess of plan
assets and plans with plan assets in excess of projected benefit
obligations. For plans that have projected benefit obligations in
excess of plan assets, the aggregate projected benefit obligations
were $397.2 million and $67.6 million at December 31, 2000 and 1999,
respectively, the aggregate accumulated benefit obligations were
$322.2 million and $50.1 million at December 31, 2000 and 1999,
respectively, and the aggregate fair value of plan assets was $303.4
million and $0 at December 31, 2000 and 1999, respectively.
Plan assets for both the funded employees and agents plans consist
principally of listed equity securities, corporate obligations and
government bonds.
Notes to Consolidated Financial Statements
The components of net defined benefit pension plan and
postretirement benefit plan costs are as follows:
Other Postretirement
Pension Benefits Benefits
----------------------------- ------------------------------
Year Ended December 31 (in millions) 2000 1999 1998 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------
Service cost $14.6 $19.5 $16.4 $2.3 $3.6 $3.6
Interest cost 32.1 30.2 27.7 7.0 6.6 6.5
Actual return on plan assets (34.5) (32.6) (29.3) -- -- --
Amortization of prior service cost 0.4 1.0 1.1 -- -- --
Recognized net actuarial (gains) losses (2.2) 1.6 0.6 (0.9) 0.3 (0.2)
- ------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $10.4 $19.7 $16.5 $8.4 $10.5 $9.9
==================================================================================================================
The calculation of the accumulated postretirement benefits
obligation assumes a weighted-average annual rate of increase in the
per capita cost of covered benefits (i.e. health care cost trend
rate) of 10.0% for 2001. It further assumes the rate will gradually
decrease to 5.0% by 2011 and remain at that level. The health care
cost trend rate assumption has a significant effect on the amounts
reported. For example, increasing the assumed health care cost trend
rates by one percentage point each year would increase the
accumulated postretirement benefits obligation as of December 31,
2000 and 1999 by $8.6 million and $8.6 million, respectively. The
aggregate of the estimated service and interest cost components of
net periodic postretirement benefits cost for the year ended
December 31, 2000 would increase by $0.8 million.
LNC maintains a defined contribution plan for its United States
insurance agents. Contributions to this plan are based on a
percentage of the agents' annual compensation as defined in the
plan. Expense for this plan amounted to $4.3 million, $2.1 million
and $1.9 million in 2000, 1999 and 1998, respectively.
Effective January 1, 1998, LNC assumed the liabilities for a
non-contributory defined contribution plan covering certain highly
compensated former CIGNA agents and employees. Contributions for
this plan are made annually based upon varying percentages of annual
eligible earnings as defined in the plan. Contributions to this plan
are in lieu of any contributions to the qualified agent defined
contribution plan. Effective January 1, 2000, this plan was expanded
to include certain highly compensated Lincoln agents. Expense
(income) for this plan amounted to $(0.1) million, $1.7 million and
$0.9 million in 2000, 1999 and 1998, respectively.
Pension Plan -- Non U.S. The employees of LNC's primary foreign
subsidiary are covered by a defined benefit pension plan. The plan
provides death and pension benefits based on final pensionable
salary. At December 31, 2000 and 1999, plan assets were under the
projected benefit obligations by $6.5 million and $0.8 million,
respectively, and were included in other liabilities in LNC's
balance sheet. Net pension costs for the foreign plan were $4.4
million, $3.6 million and $2.9 million for 2000, 1999 and 1998,
respectively.
401(k) and Profit Sharing Plans. LNC also sponsors contributory
defined contribution plans for eligible U.S. employees and agents.
These plans include 401(k) plans and a profit sharing plan for
eligible employees of Delaware Management Holdings, Inc. ("DMH").
LNC's contributions to the 401(k) plans are equal to a participant's
pre-tax contribution, not to exceed 6% of base pay, multiplied by a
percentage, ranging from 25% to 150%, which varies according to
certain incentive criteria as determined by LNC's Board of
Directors. As a result of LNC attaining the goals established under
the three-year long-term incentive plan for 1998 through 2000, an
additional match will be made on a participant's 2000 pre-tax
contribution, not to exceed 6% of base pay, multiplied by 50%. LNC's
contributions to the profit sharing plan of DMH is equal to an
amount, if any, determined in accordance with a resolution of the
Board of Directors. Each plan year's contribution is allocated in
the proportion that the plan compensation of each eligible
participant bears to the total plan compensation of all eligible
participants for such plan year. Compensation is defined as all of
an eligible participant's plan year earnings and is subject to the
limitation of Section 401(a) of the Internal Revenue Code of 1986,
as amended. In 2000, 1999 and 1998, the Board of Directors issued a
resolution authorizing a 15% contribution. Expense for the 401(k)
and profit sharing plans amounted to $44.7 million, $29.0 million
and $18.8 million in 2000, 1999 and 1998, respectively.
Deferred Compensation Plans. LNC sponsors contributory deferred
compensation plans for certain U.S. employees and agents. Plan
participants may elect to defer payment of a portion of their
compensation, as defined by the plans. At this point, LNC has not
chosen to fund these plans. Plan participants may select from a
variety of alternative measures for purposes of calculating the
investment return considered attributable to their deferral. Under
the terms of these plans, LNC agrees to pay out amounts based upon
the alternative measure selected by the participant. Plan
participants who are also participants in an LNC 401(k) plan and who
have reached the contribution limit for that plan may also elect to
defer the additional amounts into the deferred compensation plan.
LNC makes matching contributions to these plans based upon amounts
placed into the deferred compensation plans by individuals who have
reached the contribution limit under the 401(k) plan. The amount of
LNC's contribution is calculated in a manner similar to the employer
match calculation described in the 401(k) plans section above.
Expense for these plans amounted to $7.9 million, $12.7 million and
$16.0 million in 2000, 1999 and 1998, respectively. These expenses
reflect both LNC's employer matching contributions, as well as
changes in the measurement of LNC's liabilities under these plans.
In the fourth quarter of 1999, LNC modified the terms of the
deferred compensation plans to provide that plan participants that
selected LNC stock as the measure for their investment return would
receive shares of LNC stock in satisfaction of this portion of their
deferral. In addition, participants were precluded from diversifying
any portion of their deferred compensation plan account that is
measured by LNC's stock performance. As a result of these
modifications to the plans, ongoing changes in value of LNC's stock
no longer affect the expenses associated with this portion of the
deferred compensation plans.
In connection with the acquisition of the block of individual life
insurance and annuity business from CIGNA, LNC assumed the liability
for an unfunded contributory deferred compensation plan covering
certain former CIGNA employees and agents. These participants became
immediately eligible for the LNC contributory deferred compensation
plans, and therefore this plan was frozen as to future deferrals as
of January 1, 1998. Expense for this plan amounted to $0.2 million,
$1.1 million and $2.0 million in 2000, 1999 and 1998, respectively.
The total liabilities associated with these plans were $129.0
million and $119.3 million at December 31, 2000 and 1999,
respectively.
Incentive Plans. LNC has various incentive plans for employees,
agents and directors of LNC and its subsidiaries that provide for
the issuance of stock options, stock appreciation rights, restricted
stock awards and stock incentive awards. These plans are comprised
primarily of stock option incentive plans. Stock options awarded
under the stock option incentive plans are granted with an exercise
price equal to the market value of LNC stock at the date of grant
and, subject to termination of employment, expire 10 years from the
date of grant. Such options are transferable only upon death.
Options granted prior to 1992 are exercisable one year after the
date of grant and options issued subsequent to 1991 become
exercisable in 25% increments over the four year period following
the option grant anniversary date. A "reload option" feature was
added on May 14, 1997. In most cases, persons exercising an option
after that date have been granted new options in an amount equal to
the number of matured shares tendered to exercise the original
option award. The reload options are granted for the remaining term
of the related original option and have an exercise price equal to
the market value of LNC stock at the date of the reload award.
Reload options can be exercised two years after the grant date if
the value of the new option has appreciated by at least 25%.
As a result of changes in the interpretation of the existing
accounting rules for stock options, LNC has decided not to continue
issuing stock options to agents that do not meet the stringent
definition of a common law employee. In the first quarter of 2000,
LNC adopted a stock appreciation right ("SAR") program as a
replacement to the agent stock option program. The first awards
under this program were also made in the first quarter of 2000. The
SARs under this program are rights on LNC stock that are cash
settled and become exercisable in 25% increments over the four year
period following the SAR grant date. SARs are granted with an
exercise price equal to the market value of LNC stock at the date of
grant and, subject to termination of employment, expire five years
from the date of grant. Such SARs are transferable only upon death.
Notes to Consolidated Financial Statements
LNC recognizes compensation expense for the 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 treatment
causes volatility in net income as a result of changes in the market
value of LNC stock. LNC hedges this volatility by purchasing call
options on LNC stock. These call options are also marked-to-market
through net income.
Information with respect to incentive plan stock options outstanding
at December 31, 2000 is as follows:
Options Outstanding Options Exercisable
- ----------------------------------------------------------------------- --------------------------------
Weighted-Average
Number Remaining Number
Range of Outstanding at Contractual Life Weighted-Average Exercisable at Weighted-Average
Exercise Prices Dec 31, 2000 (Years) Exercise Price Dec 31, 2000 Exercise Price
- -----------------------------------------------------------------------------------------------------------
$10 - $20 902,165 2.04 $18.18 902,165 $18.18
21 - 30 9,603,439 6.53 25.08 2,511,085 25.52
31 - 40 3,119,145 8.84 33.50 108,470 36.40
41 - 50 4,448,795 6.14 44.77 2,238,392 44.76
51 - 60 3,624,746 7.37 50.86 1,037,743 50.85
- -----------------------------------------------------------------------------------------------------------
$10 - $60 21,698,290 6,797,855
===========================================================================================================
LNC recognizes compensation expense for its stock option incentive
plans using the intrinsic value based method of accounting (see Note
1) and provides the required pro forma information for stock options
granted after December 31, 1994. Accordingly, no compensation
expense has been recognized for stock option incentive plans. Had
compensation expense for LNC's stock option incentive plans been
determined based on the estimated fair value at the grant dates for
awards under those plans, LNC's pro forma net income and earnings
per share for the last three years (2000, 1999 and 1998) would have
been $589.6 million ($3.03 per diluted share); $443.0 million
($2.21 per diluted share) and $501.0 million ($2.46 per diluted
share), respectively (a decrease of $31.8 million or $.16 per
diluted share; $17.4 million or $.09 per diluted share and $8.8
million or $.04 per diluted share, respectively). These effects on
pro forma net income and earnings per share of expensing the
estimated fair value of stock options are not necessarily
representative of the effects on reported net income for future
years due to factors such as the vesting period of the stock options
and the potential for issuance of additional stock options in future
years.
The fair value of options used as a basis for the proforma
disclosures, shown above, was estimated as of the date of grant
using a Black-Scholes option pricing model.
The option price assumptions used were as follows:
Year Ended December 31 2000 1999 1998
- -----------------------------------------------------------------------------
Dividend yield 4.4% 2.7% 3.6%
Expected volatility 39.2% 29.7% 20.4%
Risk-free interest rate 6.6% 5.4% 5.6%
Expected life (in years) 4.9 5.5 6.1
Weighted-average fair value per option granted $8.33 $14.31 $9.08
- -----------------------------------------------------------------------------
Restricted stock (non-vested stock) awarded from 1998 through 2000 was
as follows:
Year Ended December 31 2000 1999 1998
- -----------------------------------------------------------------------------
Restricted stock (number of shares) 237,358 57,012 876,006
Weighted-average price per share at time
of grant $38.10 $43.91 $41.25
- -----------------------------------------------------------------------------
Information with respect to the incentive plans involving stock
options is as follows:
Options Outstanding Options Exercisable
--------------------- ------------------------
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
- ---------------------------------------------------------------------------------------------------
Balance at January 1, 1998 6,601,772 $22.54 3,203,944 $17.91
Granted - original 5,211,750 44.60
Granted - reloads 87,450 44.71
Exercised (includes shares tendered) (976,882) 18.11
Forfeited (139,238) 35.95
- ---------------------------------------------------------------------------------------------------
Balance at December 31, 1998 10,784,852 33.61 3,596,946 21.63
Granted - original 4,445,316 50.51
Granted - reloads 104,422 49.32
Exercised (includes shares tendered) (1,216,263) 48.68
Forfeited (453,892) 44.90
- ---------------------------------------------------------------------------------------------------
Balance at December 31, 1999 13,664,435 39.59 5,141,438 29.21
Granted - original 10,756,413 27.62
Granted - reloads 100,544 46.13
Exercised (includes shares tendered) (1,558,639) 46.38
Forfeited (1,264,463) 43.14
- ---------------------------------------------------------------------------------------------------
Balance at December 31, 2000 21,698,290 34.35 6,797,855 34.92
===================================================================================================
7. Restrictions, Commitments and Contingencies
Statutory Information and Restrictions
Net income (loss) as determined in accordance with statutory
accounting practices for LNC's insurance subsidiaries was $0.871
billion, $0.579 billion and $(1.452) billion for 2000, 1999 and
1998, respectively. The 1998 amounts includes the statutory ceding
commissions associated with the acquisition of two blocks of
business as described below. Excluding the impact of these
acquisitions, net income for 1998 would have been $0.546 billion.
Statutory net income (loss) for 2000, 1999 and 1998, excluding LNC's
foreign life reinsurance companies, was $0.629 billion, $0.447
billion and $(1.398) billion, respectively.
Shareholders' equity as determined in accordance with statutory
accounting practices for LNC's insurance subsidiaries was $3.315
billion and $2.920 billion for December 31, 2000 and 1999,
respectively.
The National Association of Insurance Commissioners revised the
Accounting Practices and Procedures Manual in a process referred to
as Codification. The revised manual is effective January 1, 2001.
The domiciliary states of LNC's U.S. insurance subsidiaries have
adopted the provisions of the revised manual. The revised manual has
changed, to some extent, prescribed statutory accounting practices
and will result in changes to the accounting practices that LNC's
U.S. insurance subsidiaries use to prepare their statutory-basis
financial statements. Management believes the impact of these
changes to LNC and its U.S. insurance subsidiaries' statutory-based
capital and surplus as of January 1, 2001 will not be significant.
Notes to Consolidated Financial Statements
LNC's primary insurance subsidiary, Lincoln National Life Insurance
Company ("LNL") acquired a block of individual life insurance and
annuity business from CIGNA in January 1998 and a block of
individual life insurance from Aetna Inc. in October 1998. These
acquisitions were structured as indemnity reinsurance transactions.
The statutory accounting regulations do not allow goodwill to be
recognized on indemnity reinsurance transactions and therefore, the
related statutory ceding commission flows through the statement of
operations as an expense resulting in a reduction of statutory
earned surplus. As a result of these acquisitions, LNL's statutory
earned surplus is negative. It is necessary for LNL to obtain the
prior approval of the Indiana Insurance Commissioner before paying
any dividends to LNC until such time as statutory earned surplus is
positive. The time frame for statutory earned surplus to return to a
positive position is dependent upon future statutory earnings and
dividends paid by LNL. Although no assurance can be given that
additional dividends to LNC will be approved, during 2000, LNL
received regulatory approval and paid extraordinary dividends
totaling $420 million to LNC. In the event such approvals are not
obtained in the future, management believes that LNC can obtain the
funds required to satisfy its obligations from its existing credit
facilities and other sources.
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, in addition to regulatory
restrictions imposed by the state of Indiana, LNL is also subject to
the regulatory requirements that the State of New York imposes upon
accredited reinsurers.
Disability Income Claims
The liabilities for disability income claims net of the related
assets for amounts recoverable from reinsurers at December 31, 2000
and 1999 were $1.309 billion and $1.316 billion, respectively,
excluding deferred acquisition costs. The liability is based on the
assumption that recent experience will continue in the future. If
incidence levels and/or claim termination rates fluctuate
significantly from the assumptions underlying the reserves,
adjustments to reserves could be required in the future.
Accordingly, this liability may prove to be deficient or excessive.
However, it is management's opinion that such future development
will not materially affect the consolidated financial position of
LNC.
United Kingdom Pension Products
Operations in the United Kingdom ("UK") have included the sale and
administration of pension products to individuals. Regulatory
agencies have raised questions as to what constitutes appropriate
advice to individuals who bought pension products as an alternative
to participation in an employer sponsored plan. In cases of
inappropriate advice, an extensive investigation may have to be done
and the individual put in a position similar to what would have been
attained if the individual had remained in the employer-sponsored
plan. At December 31, 2000 and 1999, liabilities of $284.0 million
and $294.4 million, respectively, were carried on the books for this
issue. The December 31, 1999 amount includes a change in estimate
for this liability (see Note 2). The liability at December 31, 1999
was net of expected recoveries of $99.7 million from previous owners
of companies acquired in past years as specified in the
indemnification clauses of the purchase agreements. In the third
quarter of 2000, settlements with the previous owners were reached
which resulted in the receipt by LNC of amounts that were in line
with the expected recoverables. This liability is based on various
estimates that are subject to considerable uncertainty. Accordingly,
this liability may prove to be deficient or excessive. However, it
is management's opinion that such future developments will not
materially affect the consolidated financial position of LNC.
Personal Accident Programs
From 1997 through 1999, the Reinsurance segment reduced new writings
of personal accident programs and has now exited the personal
accident line of business. As an exited line of business, new
agreements are not being entered into by the personal accident unit
of the Reinsurance segment; however, the unit must continue to
accept premiums for a limited period according to contract terms
under agreements in force. As the existing block of personal
accident programs runs off, the personal accident reinsurance profit
center within LNC's Reinsurance segment continues to review the
status of the reserves associated with these programs, and the
development of related financial results.
The exited programs managed within the personal accident reinsurance
profit center include certain excess-of-loss personal accident
reinsurance programs created in the London market and certain
workers' compensation carve-out programs managed by Unicover
Managers, Inc. The aggregate liabilities associated with the exited
personal accident line of business were $270.1 million and $264.9
million at December 31, 2000 and 1999, respectively.
The reserves for the various programs included within the personal
accident line of business are based on various estimates that are
subject to considerable uncertainty. Accordingly, the liability
established for the personal accident line of business may prove to
be deficient or excessive. However, it is management's opinion that
future developments in the personal accident line of business will
not materially affect the consolidated financial position of LNC.
HMO Excess-of-Loss and Group Carrier Medical Reinsurance Programs
The liabilities for HMO excess-of-loss and group carrier medical
claims, net of the related assets for amounts recoverable from
reinsurers, were $85.9 million and $132.6 million at December 31,
2000 and 1999, respectively. The December 31, 1999 amount includes a
change in estimate for this liability (see Note 2). LNC reviews
reserve levels on an on-going basis. The liabilities are based on
the assumption that recent experience will continue in the future.
If claims and loss ratios fluctuate significantly from the
assumptions underlying the reserves, adjustments to reserves could
be required in the future. Accordingly, the liabilities may prove to
be deficient or excessive. However, it is management's opinion that
such future developments will not materially affect the consolidated
financial position of LNC.
Marketing and Compliance Issues
Regulators continue to focus on market conduct and compliance
issues. Under certain circumstances, companies operating in the
insurance and financial services markets have been held responsible
for providing incomplete or misleading sales materials and for
replacing existing policies with policies that were less
advantageous to the policyholder. LNC's management continues to
monitor the company's sales materials and compliance procedures and
is making an extensive effort to minimize any potential liability.
Due to the uncertainty surrounding such matters, it is not possible
to provide a meaningful estimate of the range of potential outcomes
at this time; however, it is management's opinion that such future
developments will not materially affect the consolidated financial
position of LNC.
On November 30, 2000 UK regulators issued a paper containing draft
guidelines explaining how mortgage endowment holders would be
compensated in instances where it is determined that mis-selling
occurred. This release also indicated that an extensive analysis is
underway of mortgage endowment products offered by insurance
companies in the UK marketplace since 1988. Where the results of
this analysis indicate that products are designed in a way that
could lead to potential mis-selling, UK regulators are contacting
companies to review sales practices.
Lincoln UK received a letter from UK regulators on February 8, 2001,
raising concerns with certain mortgage endowment products sold by
British National Life Assurance Company ("BNLA"). The specific
policies at issue were sold between the period of July 1988 through
March 1994. Lincoln UK acquired BNLA from Citibank in August of
1993. Less than 6,000 of these BNLA policies remain in force.
UK regulators are contending that BNLA's sales literature was
written in a manner that provides a contractual warranty that, if
certain assumptions were achieved, the mortgage endowment would grow
to a balance sufficient to repay the contractholder's mortgage. LNC
strongly disagrees that any contractual warranties were made in the
sale of these mortgage endowment policies. LNC is prepared to
proceed with all available means of resolution, including pursuing
regulatory, administrative and legal means of concluding this
matter.
While the ultimate outcome of these matters is uncertain, LNC
believes that it will prevail on the merits of its argument that no
contractual warranties were provided in the sale of BNLA's mortgage
endowment contracts. If LNC does not prevail, and is consequently
required to incur compensatory remedies under the UK regulator's
breach of warranty theory, LNC has estimated that it could incur
costs of up to $20 million.
Following allegations made by the UK Consumers' Association (a
watchdog organization which acts on behalf of consumers of goods and
services provided in the UK) concerning various selling practices of
City Financial Partners Limited ("CFPL") , LNC is undertaking a
review of savings plans sold by CFPL to a total of 5,000 customers
during the period September 1, 1998 to August 31, 2000.
This review period and the methodology of the review process has
been agreed with by the UK Regulators. In addition, the accountancy
firm Deloitte & Touche has been appointed to oversee the process and
perform a quality assurance role.
Notes to Consolidated Financial Statements
Euro Conversion
LNC owns operating companies in Europe and conducts business with
companies located within Europe. LNC has modified its systems,
financial activities and currency risk exposures to align with the
first phase of the European Union's conversion to a new common
currency (the Euro) that was adopted January 1, 1999. It is
management's opinion that the additional phases of this conversion,
which will be implemented during the next few years, will not
materially affect the consolidated financial position of LNC.
Leases
Certain of LNC's subsidiaries lease their home office properties
through sale-leaseback agreements. The agreements provide for a 25
year lease period with options to renew for six additional terms of
five years each. The agreements also provide LNC with the right of
first refusal to purchase the properties during the term of the
lease, including renewal periods, at a price defined in the
agreements. LNC also has the option to purchase the leased
properties at fair market value as defined in the agreements on the
last day of the initial 25-year lease period ending in 2009 or the
last day of any of the renewal periods.
Total rental expense on operating leases in 2000, 1999 and 1998 was
$88.4 million, $81.5 million and $81.3 million, respectively. Future
minimum rental commitments are as follows (in millions):
- -----------------------------------------------------------------------
2001 - $76.8 2003 - $60.9 2005 - $57.0
2002 - 68.6 2004 - 58.0 Thereafter - 212.3
=======================================================================
Information Technology Commitment
In February 1998, Lincoln Life signed a seven-year contract with IBM
Global Services for information technology services for the Fort
Wayne operations. Annual costs are dependent on usage but are
expected to range from $50.1 million to $66.4 million.
Insurance Ceded and Assumed
LNC's insurance companies cede insurance to other companies. The
portion of risks exceeding each company's retention limit is
reinsured with other insurers. LNC seeks reinsurance coverage within
the businesses that sell life insurance to limit its liabilities. As
of December 31, 2000, LNC's maximum retention was $10.0 million on a
single insured. Portions of LNC's deferred annuity business have
also been co-insured with other companies to limit LNC's exposure to
interest rate risks. At December 31, 2000, the reserves associated
with these reinsurance arrangements totaled $1,268.5 million. To
cover products other than life insurance, LNC acquires other
insurance coverages with retentions and limits that management
believes are appropriate for the circumstances. The accompanying
financial statements reflect premiums, benefits and deferred
acquisition costs, net of insurance ceded (see Note 5). LNC's
insurance companies remain liable if their reinsurers are unable to
meet contractual obligations under applicable reinsurance agreements.
Certain LNC insurance companies assume insurance from other
companies. At December 31, 2000, LNC's insurance companies have
provided $105.7 million of statutory surplus relief to other
insurance companies under reinsurance transactions. Generally, such
amounts are offset by corresponding receivables from the ceding
company, which are secured by future profits on the reinsured
business. However, LNC's insurance companies are subject to the risk
that the ceding company may become insolvent and the right of offset
would not be permitted.
Associated with these transactions, LNC's insurance companies have
obtained letters of credit in favor of various insurance companies.
This allows the ceding companies to take statutory reserve credit.
The letters of credit issued by the banks represent a guarantee of
performance under the reinsurance agreements. At December 31, 2000,
there was a total of $950.5 million in outstanding bank letters of
credit. In exchange for the letters of credit, LNC paid the banks
approximately $4.2 million in fees in 2000.
Vulnerability from Concentrations
At December 31, 2000, LNC did not have a material concentration of
financial instruments in a single investee, industry or geographic
location. Also at December 31, 2000, LNC did not have a
concentration of: 1) business transactions with a particular
customer or lender ; 2) sources of supply of labor or services used
in the business or; 3) a market or geographic area in which business
is conducted that makes it vulnerable to an event that is at least
reasonably possible to occur in the near term and which could cause
a severe impact to LNC's financial position. Although LNC does not
have any significant concentration of customers, LNC's Annuities
segment has a long-standing distribution relationship with American
Funds Distributors that is significant to this segment. In 2000, the
American Legacy Variable Annuity sold through American Funds
Distributors accounted for about 44% of LNC's total gross annuity
deposits. The relationship with American Funds Distributors is
highly valued by LNC. Both LNC and American Funds Distributors are
continuously seeking ways to increase sales and to retain the
existing business.
Other Contingency Matters
LNC and its 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 the consolidated
financial position of LNC.
In the first quarter of 2000, a lawsuit was filed against LNL by an
annuity contractholder. In this case, the plaintiff sought class
certification on behalf of all contractholders who had acquired
variable annuities from LNL to fund tax-deferred qualified
retirement plans. The plaintiff claimed that marketing variable
annuities for use in such plans is inappropriate. This action was
recently dismissed without prejudice. This action might be refiled
in another form.
During the fourth quarter of 2000, LNL reached an agreement in
principle to settle all class action lawsuits alleging fraud in the
sale of non-variable universal life and participating whole life
insurance policies. The agreement is subject to court approval and
is expected to become final in 2001. It requires that LNL provide
benefits and a claim process to policyholders who purchased
non-variable universal life and participating whole life policies
between January 1, 1981 and December 31, 1998. The settlement covers
approximately 431,000 policies.
Total charges recorded during 2000 for this preliminary settlement
aggregated $42.1 million after-tax ($64.7 million pre-tax). A charge
of $13.8 million after-tax ($21.2 million pre-tax) was recorded in
the first quarter of 2000 relating to the preliminary settlement of
one such class action lawsuit against LNL. A charge of $28.3 million
after-tax ($43.5 million pre-tax) was recorded in the fourth quarter
of 2000 related to this preliminary settlement.
State guaranty funds assess insurance companies to cover losses to
policyholders of insolvent or rehabilitated companies. Mandatory
assessments may be partially recovered through a reduction in future
premium taxes in some states. LNC has accrued for expected
assessments net of estimated future premium tax deductions.
Guarantees
LNC has guarantees with off-balance-sheet risks whose contractual
amounts represent credit exposure. Guarantees with off-balance-sheet
risks having contractual values of $35.5 million and $52.3 million
were outstanding at December 31, 2000 and 1999, respectively.
Certain subsidiaries of LNC have invested in real estate
partnerships that use industrial revenue bonds to finance their
projects. LNC has guaranteed the repayment of principal and interest
on these bonds. Certain subsidiaries of LNC are also involved in
other real estate partnerships that use conventional mortgage loans.
In some cases, the terms of these arrangements involve guarantees by
each of the partners to indemnify the mortgagor in the event a
partner is unable to pay its principal and interest payments. In
addition, certain 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. 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.
Notes to Consolidated Financial Statements
Derivatives
LNC has derivatives with off-balance-sheet risks whose notional or
contract amounts exceed the credit exposure. For the years ended
December 31, 2000, 1999 and 1998, LNC has entered into derivative
transactions to reduce its exposure to fluctuations in interest
rates, the widening of bond yield spreads over comparable maturity
U.S. Government obligations, credit risk, commodity risk, foreign
exchange risk and fluctuations in the S&P indexes. In addition, LNC
is subject to the risks associated with changes in the value of its
derivatives; however, such changes in value generally are offset by
changes in the value of the items being hedged by such contracts.
Outstanding derivatives with off-balance-sheet risks, shown in
notional or contract amounts along with their carrying value and
estimated fair values, are as follows:
Assets (Liabilities)
----------------------------------------------
Notional or Carrying Fair Carrying Fair
Contract Amounts Value Value Value Value
----------------------- -----------------------------------------------
December 31 (in millions) 2000 1999 2000 2000 1999 1999
- ------------------------------------------------------------------------------------------------------------------
Interest rate derivatives:
Interest rate cap agreements 1,558.8 2,508.8 $ 2.7 $ 0.4 $ 5.2 $ 3.2
Swaptions 1,752.0 1,837.5 0.9 0.9 10.8 10.8
Interest rate swap agreements 708.2 630.9 7.2 38.1 (19.5) (19.5)
Put options -- 21.3 -- -- 1.9 1.9
- ------------------------------------------------------------------------------------------------------------------
Total interest rate derivatives 4,019.0 4,998.5 10.8 39.4 (1.6) (3.6)
Foreign currency derivatives:
Foreign exchange forward contracts 124.3 -- (3.1) (3.1) -- --
Foreign currency swaps 37.5 44.2 2.5 2.5 (0.4) (0.4)
- ------------------------------------------------------------------------------------------------------------------
Total foreign currency derivatives 161.8 44.2 (0.6) (0.6) (0.4) (0.4)
Credit derivatives:
Credit default swaps 29.0 -- -- -- -- --
Equity indexed derivatives:
Call options (based on S&P) 183.3 129.6 19.3 19.3 24.8 24.8
Call options (based on LNC Stock) 0.6 -- 10.0 15.3 -- --
- ------------------------------------------------------------------------------------------------------------------
Total equity indexed derivatives 183.9 129.6 29.3 34.6 24.8 24.8
- ------------------------------------------------------------------------------------------------------------------
Total derivatives 4,393.7 5,172.3 $39.5 $73.4 $22.8 $20.8
==================================================================================================================
A reconciliation of the notional or contract amounts for the significant
programs using derivative agreements and contracts is as follows:
Interest Rate Interest Rate
Cap Agreements Swaptions Swap Agreements
-------------------------------------------------------------------------
December 31 (in millions) 2000 1999 2000 1999 2000 1999
- ------------------------------------------------------------------------------------------------------------------
Balance at beginning-of-year 2,508.8 4,108.8 1,837.5 1,899.5 630.9 258.3
New contracts -- -- -- -- 652.2 482.4
Terminations and maturities (950.0) (1,600.0) (85.5) (62.0) (574.9) (109.8)
- ------------------------------------------------------------------------------------------------------------------
Balance at end-of-year 1,558.8 2,508.8 1,752.0 1,837.5 708.2 630.9
==================================================================================================================
Spread-Lock Financial Futures
Agreements Contracts Put Options
-------------------------------------------------------------------------
December 31 (in millions) 2000 1999 2000 1999 2000 1999
- ------------------------------------------------------------------------------------------------------------------
Balance at beginning-of-year -- -- -- -- 21.3 21.3
New contracts 100.0 -- 267.2 -- -- --
Terminations and maturities (100.0) -- (267.2) -- (21.3) --
- ------------------------------------------------------------------------------------------------------------------
Balance at end-of-year -- -- -- -- -- 21.3
==================================================================================================================
Foreign Exchange Foreign Currency Swap
Commodity Swaps Forward Contracts Agreements
-------------------------------------------------------------------------
December 31 (in millions) 2000 1999 2000 1999 2000 1999
- ------------------------------------------------------------------------------------------------------------------
Balance at beginning-of-year -- 8.1 -- 1.5 44.2 47.2
New contracts -- -- 1,945.4 42.7 -- --
Terminations and maturities -- (8.1) (1,822.6) (44.2) (6.7) (3.0)
Foreign exchange adjustment -- -- 1.5 -- -- --
- ------------------------------------------------------------------------------------------------------------------
Balance at end-of-year -- -- 124.3 -- 37.5 44.2
==================================================================================================================
Credit Default Call Options Call Options
Swaps (Based on S&P) (Based on LNC Stock)
-------------------------------------------------------------------------
December 31 (in millions) 2000 1999 2000 1999 2000 1999
- ------------------------------------------------------------------------------------------------------------------
Balance at beginning-of-year -- -- 129.6 79.9 -- --
New contracts 29.0 -- 100.0 52.9 0.6 --
Terminations and maturities -- -- (46.3) (3.2) -- --
- ------------------------------------------------------------------------------------------------------------------
Balance at end-of-year 29.0 -- 183.3 129.6 0.6 --
==================================================================================================================
Interest Rate Cap Agreements. The interest rate cap agreements,
which expire in 2001 through 2006, entitle LNC to receive quarterly
payments from the counterparties on specified future reset dates,
contingent on future interest rates. For each cap, the amount of
such quarterly payments, if any, is determined by the excess of a
market interest rate over a specified cap rate multiplied by the
notional amount divided by four. The purpose of LNC's interest rate
cap agreement program is to protect its annuity line of business
from the effect of rising interest rates. The premium paid for the
interest rate caps is included in other investments (amortized cost
of $2.7 million as of December 31, 2000) and is being amortized over
the terms of the agreements. This amortization is included in net
investment income.
Swaptions. Swaptions, which expire in 2002 through 2003, entitle LNC
to receive settlement payments from the counterparties on specified
expiration dates, contingent on future interest rates. For each
swaption, the amount of such settlement payments, if any, is
determined by the present value of the difference between the fixed
rate on a market rate swap and the strike rate multiplied by the
notional amount. The purpose of LNC's swaption program is to protect
its annuity line of business from the effect of rising interest
rates. The premium paid for the swaptions is included in other
investments (amortized cost of $8.2 million as of December 31, 2000)
and is being amortized over the terms of the agreements. This
amortization is included in net investment income.
Spread-Lock Agreements. Spread-lock agreements provide for a lump
sum payment to or by LNC, depending on whether the spread between
the swap rate and a specified Government note is larger or smaller
than a contractually specified spread. Cash payments are based on
the product of the notional amount, the spread between the swap rate
and the yield of an equivalent maturity Government security, and the
price sensitivity of the swap at that time. The purpose of LNC's
spread-lock program is to protect against widening spreads. While
spread-locks are used periodically, there are no spread-lock
agreements outstanding at December 31, 2000.
Financial Futures Contracts. LNC used exchange-traded financial
futures contracts to hedge against interest rate risks on a portion
of its fixed maturity securities. Financial futures contracts
obligate LNC to buy or sell a financial instrument at a specified
future date for a specified price. They may be settled in cash or
through delivery of the financial instrument. Cash settlements on
the change in market values of financial futures contracts are made
daily. There are no financial futures contracts outstanding at
December 31, 2000.
Interest Rate Swap Agreements. LNC uses interest rate swap
agreements to hedge its exposure to floating rate bond coupon
payments, replicating a fixed rate bond. An interest rate swap is a
contractual agreement to exchange payments at one or more times
based on the actual or expected price level, performance or value of
one or more underlying interest rates. LNC is required to pay the
counterparty the stream of variable interest payments based on the
coupon payments from the hedged bonds, and in turn, receives a fixed
payment from the counterparty, at a predetermined interest rate. The
net receipts/payments from these interest rate swaps are recorded in
net investment income. LNC also uses interest rate swap agreements
to hedge its exposure to interest rate fluctuations related to the
forecasted purchase of assets to support newly acquired blocks of
business and certain other portfolios of assets. Once the assets are
purchased, the gains (losses) resulting from the termination of the
swap agreements will be applied to the basis of the assets. The
gains (losses) will be recognized in earnings over the life of the
assets. The forecasted purchase of assets to support newly acquired
blocks of business was completed in 1999. The forecasted purchase of
assets related to certain other portfolios of assets is a continuing
hedge program. Current interest rate swap positions in this program
will hedge asset purchases in 2001.
Notes to Consolidated Financial Statements
Put Options. LNC used put options, combined with various perpetual
fixed-income securities and interest rate swaps to replicate fixed
income, fixed maturity investments. The risk being hedged is a drop
in bond prices due to credit concerns with international bond
issuers. The put options allowed LNC to put the bonds back to the
counterparties at original par. The put options were sold in 2000.
Foreign Currency Derivatives. LNC uses a combination of foreign
exchange forward contracts and foreign currency swaps, both of which
are traded over-the-counter, to hedge some of the foreign exchange
risk of investments in fixed maturity securities denominated in
foreign currencies. In 2000, LNC used foreign exchange forward
contracts to hedge its net investment in Lincoln UK. In addition,
Lincoln UK uses foreign exchange forward contracts to hedge debt
issuance in currencies other than the British pound. The foreign
currency forward contracts obligate LNC to deliver a specified
amount of currency at a future date at a specified exchange rate. A
foreign currency swap is a contractual agreement to exchange the
currencies of two different countries at a specified rate of
exchange in the future.
Credit Default Swaps. LNC uses credit default swaps to hedge against
a drop in bond prices due to credit concerns of certain bond
issuers. A credit swap allows LNC to put the bond back to the
counterparty at par upon a credit event by the bond issuer. A credit
event is defined as bankruptcy, failure to pay, or obligation
acceleration.
Commodity Swap. LNC used a commodity swap to hedge its exposure to
fluctuations in the price of gold. A commodity swap is a contractual
agreement to exchange a certain amount of a particular commodity for
a fixed amount of cash. LNC owned a fixed income security that met
its coupon payment obligations in gold bullion. LNC was obligated to
pay to the counterparty the gold bullion, and in return receive from
the counterparty a stream of fixed income payments. The fixed income
payments were the product of the swap notional multiplied by the
fixed rate stated in the swap agreement. The net receipts/payments
from the commodity swap were recorded in net investment income. The
fixed income security was called in the third quarter of 1999 and
the commodity swap expired.
Call Options. LNC uses S&P 500 index call options which expire in
2001 through 2007 to offset the increase in its liabilities
resulting from certain reinsurance agreements which guarantee
payment of the appreciation of the S&P 500 index on certain
underlying annuity products. The call options provide LNC with
settlement payments from the counterparties on specified expiration
dates. The payment, if any, is the percentage increase in the index,
over the strike price defined in the contract, applied to the
notional amount. LNC also uses call options on LNC stock to hedge
the expected increase in liabilities arising from stock appreciation
rights granted on LNC stock. Upon option expiration, the payment, if
any, is the increase in LNC's stock price over the strike price of
the option applied to the number of contracts.
Additional Derivative Information. Expenses for the agreements and
contracts described above amounted to $7.3 million, $9.9 million and
$11.6 million in 2000, 1999 and 1998, respectively. Deferred losses
of $6.2 million for the year ended December 31, 2000 were primarily
the result of terminated interest rate swaps, spread-locks, put
options, and financial futures contracts. These losses are included
with the related fixed maturity securities to which the hedge
applied or as deferred assets and are being amortized over the life
of such securities.
LNC is exposed to credit loss in the event of nonperformance by
counterparties on various derivative contracts. However, LNC does
not anticipate nonperformance 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. The amount of such
exposure is essentially the net replacement cost or market value
less collateral held for such agreements with each counterparty if
the net market value is in LNC's favor. At December 31, 2000, the
exposure was $62.5 million.
8. Fair Value of Financial Instruments
The following discussion outlines the methodologies and assumptions
used to determine the estimated fair value of LNC's financial
instruments. Considerable judgment is required to develop these fair
values. Accordingly, the estimates shown are not necessarily
indicative of the amounts that would be realized in a one-time,
current market exchange of all of LNC's financial instruments.
Fixed Maturity and Equity Securities. Fair values for fixed maturity
securities are based on quoted market prices, where available. For
fixed maturity securities not actively traded, fair values are
estimated using values obtained from independent pricing services.
In the case of private placements, fair values are estimated by
discounting expected future cash flows using a current market rate
applicable to the coupon rate, credit quality and maturity of the
investments. The fair values for equity securities are based on
quoted market prices.
Mortgage Loans on Real Estate. The estimated fair value of mortgage
loans on real estate was established using a discounted cash flow
method based on credit rating, maturity and future income. The
ratings for mortgages in good standing are based on property type,
location, market conditions, occupancy, debt service coverage, loan
to value, caliber of tenancy, borrower and payment record. Fair
values for impaired mortgage loans are based on: 1) the present
value of expected future cash flows discounted at the loan's
effective interest rate; 2) the loan's market price or; 3) the fair
value of the collateral if the loan is collateral dependent.
Policy Loans. The estimated fair value of investments in policy
loans was calculated on a composite discounted cash flow basis using
Treasury interest rates consistent with the maturity durations
assumed. These durations were based on historical experience.
Other Investments, and Cash and Invested Cash. The carrying value
for assets classified as other investments, and cash and invested
cash in the accompanying balance sheets approximates their fair
value.
Investment Type Insurance Contracts. The balance sheet captions,
"Future Policy Benefits, Claims and Claim Expenses" and
"Contractholder Funds", include investment type insurance contracts
(i.e. deposit contracts and guaranteed interest contracts). The fair
values for the deposit contracts and certain guaranteed interest
contracts are based on their approximate surrender values. The fair
values for the remaining guaranteed interest and similar contracts
are estimated using discounted cash flow calculations. These
calculations are based on interest rates currently offered on
similar contracts with maturities that are consistent with those
remaining for the contracts being valued.
The remainder of the balance sheet captions "Future Policy Benefits,
Claims and Claim Expenses" and "Contractholder Funds" that do not
fit the definition of "investment type insurance contracts" are
considered insurance contracts. Fair value disclosures are not
required for these insurance contracts and have not been determined
by LNC. It is LNC's position that the disclosure of the fair value
of these insurance contracts is important because readers of these
financial statements could draw inappropriate conclusions about
LNC's shareholders' equity determined on a fair value basis. It
could be misleading if only the fair value of assets and liabilities
defined as financial instruments are disclosed. LNC and other
companies in the insurance industry are monitoring the related
actions of the various rule-making bodies and attempting to
determine an appropriate methodology for estimating and disclosing
the "fair value" of their insurance contract liabilities.
Short-term and Long-term Debt. Fair values for long-term debt issues
are based on quoted market prices or estimated using discounted cash
flow analysis based on LNC's current incremental borrowing rate for
similar types of borrowing arrangements where quoted prices are not
available. For short-term debt, the carrying value approximates fair
value.
Company-Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trusts Holding Solely Junior Subordinated Debentures.
Fair values for company-obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior subordinated
debentures are based on quoted market prices less the unamortized
cost of issue.
Guarantees. LNC's guarantees include guarantees related to
industrial revenue bonds, real estate partnerships and mortgage loan
pass-through certificates. Based on historical performance where
repurchases have been negligible and the current status, which
indicates none of the loans are delinquent, the fair value liability
for the guarantees related to the mortgage loan pass-through
certificates is insignificant.
Notes to Consolidated Financial Statements
Derivatives. LNC employs several different methods for determining
the fair value of its derivative instruments. Fair values for these
contracts are based on current settlement values. These values are
based on: 1) quoted market prices for foreign currency exchange
contracts and financial futures contracts; 2) industry standard
models that are commercially available for interest rate cap
agreements, swaptions, spread-lock agreements, interest rate swaps,
commodity swaps and put options; and 3) Monte Carlo techniques for
the exotic equity call options. These techniques project cash flows
of the derivatives using current and implied future market
conditions. The cash flows are then present valued to arrive at the
derivatives current fair market value. 4) Black-Scholes pricing
methodology for standard European equity call options.
Investment Commitments. Fair values for commitments to make
investments in fixed maturity securities (primarily private
placements), mortgage loans on real estate and real estate are based
on the difference between the value of the committed investments as
of the date of the accompanying balance sheets and the commitment
date. These estimates would take into account changes in interest
rates, the counterparties' credit standing and the remaining terms
of the commitments.
Separate Accounts. Assets held in separate accounts are reported in
the accompanying consolidated balance sheets at fair value. The
related liabilities are also reported at fair value in amounts equal
to the separate account assets.
The carrying values and estimated fair values of LNC's financial
instruments are as follows:
Carrying Fair Carrying Fair
Value Value Value Value
----------------------------------------------
December 31 (in millions) 2000 2000 1999 1999
- -------------------------------------------------------------------------------------------------
Assets (liabilities):
Fixed maturities securities $27,449.8 $27,449.8 $27,688.6 $27,688.6
Equity securities 549.7 549.7 604.0 604.0
Mortgage loans on real estate 4,663.0 4,702.5 4,735.4 4,615.4
Policy loans 1,960.9 2,096.4 1,892.4 2,024.8
Other investments 463.3 463.3 401.8 401.8
Cash and Invested cash 1,927.4 1,927.4 1,895.9 1,895.9
Investment type insurance contracts:
Deposit contracts and certain
guaranteed interest contracts (16,813.2) (16,654.8) (18,601.5) (18,267.5)
Remaining guaranteed interest
and similar contracts (817.3) (784.5) (1,129.8) (1,091.7)
Short-term debt (312.9) (312.9) (460.1) (460.1)
Long-term debt (712.2) (707.4) (712.0) (690.7)
Company-obligated mandatorily redeemable
preferred securities of subsidiary trusts
holding solely junior subordinated debentures (745.0) (722.7) (745.0) (655.7)
Guarantees (0.3) -- (0.3) --
Derivatives 39.5 73.4 22.8 20.8
Investment commitments -- 2.8 -- (3.5)
=================================================================================================
As of December 31, 2000 and 1999, the carrying value of the deposit
contracts and certain guaranteed contracts is net of deferred
acquisition costs of $169.6 million and $58.0 million, respectively,
excluding adjustments for deferred acquisition costs applicable to
changes in fair value of securities. The carrying values of these
contracts are stated net of deferred acquisition costs so that they
are comparable with the fair value basis.
9. Segment Information
LNC has five business segments: Annuities, Life Insurance,
Reinsurance, Investment Management and Lincoln UK.
The Annuities segment, headquartered in Fort Wayne, Indiana,
provides tax-deferred investment growth and lifetime income
opportunities for its clients through the manufacture and sale of
fixed and variable annuities. Through a broad-based distribution
network, the Annuities segment provides an array of annuity products
to individuals and employer-sponsored groups in all 50 states of the
United States. The Annuities segment distributes some of its
products through LNC's wholesaling unit, Lincoln Financial
Distributors ("LFD"), as well LNC's retail unit, Lincoln Financial
Advisors ("LFA"). In addition, the Annuities segment has alliances
with a variety of unrelated companies where LNC provides the
manufacturing platform for annuity products and the alliance company
provides marketing and distribution.
The Life Insurance segment, headquartered in Hartford, Connecticut,
focuses on the creation and protection of wealth for its clients
through the manufacture and sale of life insurance products
throughout the United States. The Life Insurance segment offers,
through its Hartford operations, universal life, variable universal
life, interest-sensitive whole life and corporate owned life
insurance. Additional offerings through its First Penn-Pacific
operations include universal life and term life insurance along with
deferred fixed annuities. All of the Life Insurance segment's
products are distributed through LFD and LFA.
The Reinsurance segment ("Lincoln Re") manufactures and sells
reinsurance products and services to insurance companies,
self-funded employers and other primary risk accepting organizations
in the U.S. and economically attractive international markets.
Lincoln Re utilizes a customization process to meet the needs of its
clients and it also relies on alliance partners to reach and service
its clients.
The Investment Management segment offers a variety of asset management
services to retail and institutional clients throughout the United States
and certain foreign countries. Its product offerings include mutual funds
and separate account wrap products. It also provides investment management
and account administration services for variable annuity products, and
401(k), pension, endowment and trust accounts. Retail products are
distributed through both LFD and LFA. Institutional products including
large case 401(k) plans are marketed by a separate sales force in
conjunction with pension consultants. The Investment Management segment
also provides investment advisory services for LNC's corporate portfolios.
Although LNC announced the transfer of the Lincoln UK sales force to
Inter-Alliance and the decision to cease writing new business in the
UK through direct sales distribution, the Lincoln UK segment
continues to manage, administer and accept new deposits on its
current block of business and as required by UK regulation, accept
new business for certain products. Lincoln UK's product portfolio
principally consists of unit-linked life and pension products, which
are similar to U.S. produced variable life and annuity products.
Activity which is not included in the major business segments is
shown as "Other Operations." "Other Operations" includes operations
not directly related to the business segments, unallocated corporate
items (i.e., corporate investment income, interest expense on
corporate debt and unallocated overhead expenses) and LFA.
Notes to Consolidated Financial Statements
Financial data by segment for 1998 through 2000 is as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- -----------------------------------------------------------------------------------------------
Revenue, Excluding Net Investment Income and Realized
Gain (Loss) on Investments and Subsidiaries:
Annuities $740.6 $644.4 $544.5
Life Insurance 970.1 932.2 742.0
Reinsurance 1,451.6 1,509.6 1,267.5
Investment Management 402.4 403.2 399.5
Lincoln UK 364.7 368.3 350.7
Other Operations (includes consolidating adjustments) 203.3 135.5 82.5
- -----------------------------------------------------------------------------------------------
Total $4,132.7 $3,993.2 $3,386.7
Net Investment Income:
Annuities $1,247.1 $1,325.4 $1,349.8
Life Insurance 1,042.3 1,016.0 818.6
Reinsurance 321.7 318.6 316.2
Investment Management 58.6 57.9 66.8
Lincoln UK 70.3 75.3 87.9
Other Operations (includes consolidating adjustments) 7.1 14.3 42.1
- -----------------------------------------------------------------------------------------------
Total $2,747.1 $2,807.5 $2,681.4
Realized Gain (Loss) on Investments and Subsidiaries:
Annuities $(3.8) $(11.4) $18.3
Life Insurance (18.8) (2.9) (1.8)
Reinsurance (1.0) 5.7 (3.5)
Investment Management (3.9) (0.1) 0.9
Lincoln UK 3.2 3.0 1.1
Other Operations (includes consolidating adjustments) (4.0) 8.7 4.0
- -----------------------------------------------------------------------------------------------
Total $(28.3) $3.0 $19.0
Net Income (Loss) before Federal Income Taxes:
Annuities $415.4 $348.9 $312.7
Life Insurance 428.9 368.9 245.6
Reinsurance 180.8 65.1 160.6
Investment Management 11.4 39.0 37.6
Lincoln UK (23.7) (100.1) 106.9
Other Operations (includes consolidating adjustments) (176.5) (151.8) (166.0)
- -----------------------------------------------------------------------------------------------
Total $836.3 $570.0 $697.4
===============================================================================================
Year Ended December 31 (in millions) 2000 1999 1998
- -----------------------------------------------------------------------------------------------
Income Tax Expense (Benefit):
Annuities $73.0 $70.5 $57.1
Life Insurance 154.6 133.3 87.5
Reinsurance 55.9 21.0 55.9
Investment Management 4.5 15.4 16.4
Lincoln UK (10.5) (81.9) 35.2
Other Operations (includes consolidating adjustments) (62.6) (48.7) (64.5)
- -----------------------------------------------------------------------------------------------
Total $214.9 $109.6 $187.6
Net Income (Loss):
Annuities $342.4 $278.4 $255.6
Life Insurance 274.3 235.6 158.1
Reinsurance 124.9 44.1 104.7
Investment Management 6.9 23.6 21.2
Lincoln UK (13.2) (18.2) 71.7
Other Operations (includes consolidating adjustments) (113.9) (103.1) (101.5)
- -----------------------------------------------------------------------------------------------
Total $621.4 $460.4 $509.8
===============================================================================================
Year Ended December 31 (in millions) 2000 1999 1998
- -----------------------------------------------------------------------------------------------
Assets:
Annuities $57,103.4 $60,414.0 $53,382.4
Life Insurance 21,103.9 19,941.3 19,355.6
Reinsurance 6,972.7 6,757.7 6,556.1
Investment Management 1,439.0 1,483.1 1,648.0
Lincoln UK 8,763.7 9,712.8 8,757.3
Other Operations (includes consolidating adjustments) 4,461.4 4,786.8 4,136.9
- -----------------------------------------------------------------------------------------------
Total $99,844.1 $103,095.7 $93,836.3
===============================================================================================
In December 1999, management initiated a plan to change the
structure of LNC's internal organization in a manner that caused the
composition of its reportable segments to change beginning in 2000.
During the first quarter of 2000, the implementation of these
changes were finished so that beginning with the quarter ending
March 31, 2000, decisions about resource allocation and performance
assessment were made separately for an Annuities segment and a Life
Insurance segment. As of and for the year ended December 31, 2000,
financial reporting for the two separate segments is presented and
the corresponding information for earlier periods is presented on a
basis consistent with the new segment reporting structure. Most of
the lines of business previously included in the Life Insurance and
Annuities segment are now reported within either the Annuities
segment or the Life Insurance segment based on how the lines of
business are being managed.
Consistent with current management structures, the life and annuity
results for First Penn-Pacific are now reported in the Life
Insurance segment, Legacy Life results are now reported in the
Annuities segment and results for LFA are now reported in "Other
Operations". Also, net investment income and related unrealized and
realized gain/loss on surplus investments and certain unallocated
expenses previously reported in the Life Insurance and Annuities
segment are now allocated to the Annuities, Life Insurance,
Reinsurance and Investment Management segments and Other Operations
based on various methodologies.
During 2000, management initiated a plan to change the operational
and management reporting structure of LNC's wholesale distribution
organization, such that beginning in 2001, Lincoln Financial
Distributors ("LFD"), the wholesaling arm of LNC's distribution
network, will be reported within Other Operations. Earlier periods
will be restated to aid comparability of segment reporting between
periods. LFD, comprised of approximately 250 wholesalers, is
responsible for the sale of various internally manufactured life
insurance products, annuities, mutual funds and wrap accounts
through multiple distribution channels. Previously, LNC's
wholesaling efforts were conducted separately within the Annuities,
Life Insurance and Investment Management segments. The purpose of
the distribution reorganization is to improve client service, reduce
redundancies, increase efficiencies and effectiveness and achieve
economies of scale.
Notes to Consolidated Financial Statements
Also, in the fourth quarter of 2000, a decision was made to change
the management reporting and operational responsibilities for First
Penn-Pacific's ("First Penn") annuities business. This decision will
result in the consolidation of the management of all annuities
products. The financial reporting for the annuities portion of First
Penn will be moved from the Life Insurance segment where it had
previously been reported. Beginning with the quarter ending March
31, 2001, the financial reporting for First Penn's annuities
business will be included in the Annuities segment. Earlier periods
will be restated to aid the comparability of segment reporting
between periods.
Prior to 2001, primarily all of the management of general account
investments performed by Lincoln Investment Management for LNC's
U.S. based insurance operations was generally priced on an "at cost"
basis. Effective January 1, 2001, substantially all of these
internal investment management services will be priced on an
arms-length "profit" basis. To reflect this new internal pricing
standard, Lincoln Investment Management will receive approximately
18.5 basis points on certain assets under management. Lincoln
Investment Management is reported within the Investment Management
segment and, subsequent to December 31, 2000, its operations were
combined into Delaware Management Holdings, Inc. The change in
pricing of internal investment management services will impact
segment reporting results for the Annuities, Life Insurance,
Reinsurance and Investment Management segments, along with Other
Operations. Beginning with the quarter ending March 31, 2001,
earlier periods will be restated to aid the comparability of segment
reporting between periods.
Most of LNC's foreign operations are conducted by Lincoln UK, a UK
company. The data for this company is shown above under the Lincoln
UK segment heading. The other segments have non-U.S. operations.
Foreign intracompany revenues are not significant. Financial data
for Lincoln UK and the other non-U.S. units is as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ------------------------------------------------------------------------
Revenue $536.3 $572.4 $606.3
Net Income (Loss) before Federal
Income Taxes (7.1) (60.4) 134.0
Income Tax Expense (Benefit) (10.2) (56.6) 45.2
- ------------------------------------------------------------------------
Net Income (Loss) $ 3.1 $(3.8) $88.8
Assets (at end of year) $8,896.8 $9,820.0 $9,164.2
========================================================================
10. Shareholders' Equity
LNC's common and series A preferred stock is without par value.
All of the issued and outstanding series A preferred stock is $3
cumulative convertible and is convertible at any time into shares of
common stock. The conversion rate is sixteen shares of common stock
for each share of series A preferred stock, subject to adjustment
for certain events. The series A preferred stock is redeemable at
the option of LNC at $80 per share plus accrued and unpaid
dividends. Outstanding series A preferred stock has full voting
rights, subject to adjustment if LNC is in default as to the payment
of dividends. If LNC is liquidated or dissolved, holders of series A
preferred stock will be entitled to payments of $80 per share. The
difference between the aggregate preference on liquidation value and
the financial statement balance for the series A preferred stock was
$1.2 million at December 31, 2000.
LNC has outstanding one common share purchase right ("Right") on
each outstanding share of LNC's common stock. A Right will also be
issued with each share of LNC's common stock that is issued before
the Rights become exercisable or expire. If a person or group
announces an offer that would result in beneficial ownership of 15%
or more of LNC's common stock, the Rights will become exercisable
and each Right will entitle its holder to purchase one share of
LNC's common stock for $100. Upon the acquisition of 15% or more of
LNC's common stock, each holder of a Right (other than the person
acquiring the 15% or more) will have the right to acquire the number
of shares of LNC common stock that have a market value of two times
the exercise price of the Right. If LNC is acquired in a business
combination transaction in which LNC does not survive, each holder
of a Right (other than the acquiring person) will have the right to
acquire common stock of the acquiring person having a market value
of two times the exercise price of the Right. LNC can redeem each
Right for one cent at any time prior to the tenth day after a person
or group has acquired 15% or more of LNC's common stock. The Rights
expire on November 14, 2006. As of December 31, 2000, there were
190,748,050 Rights outstanding.
During 2000, 1999 and 1998, LNC purchased and retired 6,222,581,
7,675,000 and 1,246,562 shares, respectively, of its common stock at
a total cost of $210.0 million, $377.7 million and $46.9 million,
respectively. The common stock account was reduced for these
purchases in proportion to the percentage of shares acquired. The
remainder of the purchase price was charged to retained earnings.
During May 1999, LNC's Board of Directors approved a two-for-one
stock split for its common stock. The record date for the stock
split was June 4, 1999 and the additional shares were distributed to
shareholders on June 21, 1999. The consolidated financial statements
including per share disclosures in these notes, have been adjusted
to reflect the effects of the common stock split for all periods
presented.
Per share amounts for 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 are as follows:
Year Ended December 31 2000 1999 1998
- ---------------------------------------------------------------------------------------------------
Numerator: [millions]
Net income as used in basic calculation $621.3 $460.3 $509.7
Dividends on convertible preferred stock 0.1 0.1 0.1
- ---------------------------------------------------------------------------------------------------
$621.4 $460.4 $509.8
Denominator: [number of shares]
Weighted-average shares, as used in basic calculation 191,257,414 197,817,053 200,714,158
Shares to cover conversion of preferred stock 438,391 491,014 542,038
Shares to cover non-vested stock 10,673 347,145 456,576
Average stock options outstanding during the period 13,652,143 8,464,229 6,390,310
Assumed acquisition of shares with assumed proceeds
and benefits from exercising stock options (at average
market price for the year). (11,102,355) (6,796,998) (4,840,628)
Average deferred compensation shares 664,551 95,236 --
- ---------------------------------------------------------------------------------------------------
Weighted-average shares, as used in diluted calculation 194,920,817 200,417,679 203,262,454
- ---------------------------------------------------------------------------------------------------
LNC has stock options outstanding which were issued at prices that
are above the current average market price of LNC common stock. In
the event the average market price of LNC's common stock exceeds the
issue price of stock options, such options would be dilutive to
LNC's earnings per share and will be shown in the table above.
During 1999, LNC changed its deferred compensation plans so that
participants selecting LNC stock for measuring the investment return
attributable to their deferral amounts will be paid out in LNC
stock. The obligation to satisfy these deferred compensation plan
liabilities is dilutive and is shown in the table above. Also, LNC
has purchase contracts outstanding which require the holder to
purchase LNC common stock by August 16, 2001. These purchase
contracts were issued in conjunction with the FELINE PRIDES
financing. The common shares involved are not currently dilutive to
LNC's earnings per share and will not be dilutive in the future
except during periods when the average market price of LNC's common
stock exceeds a stated threshold price of $55.725 per share.
Notes to Consolidated Financial Statements
Details underlying the balance sheet caption "Net Unrealized Gain
(Loss) on Securities Available-for-Sale," are as follows:
December 31 (in millions) 2000 1999
- -----------------------------------------------------------------------------------
Fair value of securities available-for-sale $27,999.5 $28,292.6
Cost of securities available-for-sale 27,839.9 28,838.6
- -----------------------------------------------------------------------------------
Unrealized gain (loss) 159.6 (546.0)
Adjustments to deferred acquisition costs 74.8 257.3
Amounts required to satisfy policyholder commitments (243.4) (84.3)
Deferred income credits (taxes) 19.7 (79.7)
- -----------------------------------------------------------------------------------
Net unrealized gain (loss) on securities available-for-sale 10.7 (452.7)
Change in fair value of derivatives designated as a hedge
(classified as other investment) 1.3 (13.0)
- -----------------------------------------------------------------------------------
Net unrealized gain (loss) on securities available-for-sale $12.0 $(465.7)
- -----------------------------------------------------------------------------------
Adjustments to deferred acquisition costs and amounts required to
satisfy policyholder commitments are netted against the Deferred
Acquisition Costs asset line and included within the Insurance
Policy and Claim Reserves line on the balance sheet, respectively.
Details underlying "Unrealized Gain (Loss) on Securities
Available-for-Sale, Net of Reclassification Adjustment" shown on the
Consolidated Statements of Shareholders' Equity are as follows:
Year Ended December 31 (in millions) 2000 1999 1998
- ----------------------------------------------------------------------------------------------------
Unrealized gains (losses) on securities
available-for-sale arising during the year $317.4 $(1,202.4) $210.7
Less: reclassification adjustment for gains (losses)
included in net income(1) (60.9) (3.0) 50.9
Less: Federal income tax expense (benefit) (99.4) (181.3) 43.4
- ----------------------------------------------------------------------------------------------------
Unrealized gain (loss) on securities available-for-sale, net of
reclassification and Federal income tax expense (benefit) $477.7 $(1,018.1) $116.4
- ----------------------------------------------------------------------------------------------------
(1) The reclassification adjustment for gains (losses) does not include the impact of associated
adjustments to deferred acquisition costs and amounts required to satisfy policyholder commitments.
The "Foreign Currency Translation" component of other comprehensive
income shown on the Consolidated Statements of Shareholders' Equity
is net of Federal income tax expense (benefit) of $(4.4) million,
$(10.7) million and $2.0 million for 2000, 1999 and 1998,
respectively.
11. Acquisitions, Divestitures and Discontinued Operations
On January 2, 1998, LNC acquired a block of individual life
insurance and annuity business from CIGNA Corporation ("CIGNA") for
$1.414 billion. Additional funds of $228.5 million were required to
cover expenses associated with the purchase and to provide
additional capital for the Life Insurance and Annuities segment to
support this business. Funding used to complete this acquisition was
from the proceeds of the sale of LNC's 83.3% ownership interest in
American States Financial Corporation, a property-casualty business,
in 1997. This transaction was accounted for using purchase
accounting and, accordingly, operating results generated by this
block of business after the closing date are included in LNC's
consolidated financial statements. At the time of closing, this
block of business had liabilities, measured on a statutory basis, of
$5.5 billion that became LNC's obligations. LNC also received assets
measured on a historical statutory basis, equal to the liabilities.
Subsequent to this acquisition, LNC announced that it had reached an
agreement to sell the administration rights to a variable annuity
portfolio that had been acquired as part of the block of business
acquired on January 2, 1998. This sale closed on October 12, 1998
with an effective date of September 1, 1998. As of December 31,
2000, goodwill and other intangible assets were $701.5 million and
$367.1 million, respectively.
On October 1, 1998, LNC acquired a block of individual life
insurance from Aetna for $1.0 billion. Funding used to complete this
acquisition was primarily from public securities offered in 1998
(see Note 5). This transaction was accounted for using purchase
accounting and, accordingly, the operating results generated by this
block of business after the closing date are included in LNC's
consolidated financial statements. At the time of closing, this
block of business had liabilities, measured on a statutory basis, of
$3.3 billion. These liabilities became LNC's obligations at the time
of closing. At closing, LNC received assets, measured on a
historical statutory basis, equal to the liabilities. On August 7,
1998, LNC announced that it had reached an agreement to sell the
sponsored life business acquired as part of the Aetna block of
business. The sale closed on October 14, 1998 with an effective date
of October 1, 1998 at a sales price of $99.5 million. As of December
31, 2000, goodwill and other intangibles were $219.8 million and
$710.0 million, respectively.
The consolidated proforma results of operations shown below assumes
that the two blocks of business described in the preceding
paragraphs were purchased on January 1, 1997. Approximately one-half
of the funding for this acquisition came from available funds within
the consolidated group. The other half was from the proceeds of the
third quarter 1998 public securities offerings from available shelf
registrations.
Year Ended December 31 (in millions, except per share data) 1998
- -----------------------------------------------------------------------
Revenue $6,469.4
Net income 547.3
Net income per diluted share $2.69
=======================================================================
This proforma financial information is not necessarily indicative of
the actual results that would have occurred had the purchases been
made on January 1, 1997 or of the results which may occur in the
future.
For the 1998 acquisitions noted above, other intangible assets
represent the present value of future profits on the blocks of
acquired insurance business. Goodwill is amortized over 40 years and
other intangible assets are amortized over the expected lives of the
business acquired.
On November 1, 1999, LNC closed its previously announced agreement
to transfer a block of disability income business to MetLife. Under
this indemnity reinsurance agreement, LNC transferred $490.4 million
of cash to MetLife representing the statutory reserves transferred
on this business, net of $18.5 million of purchase price
consideration. A gain on sale of $56.7 million was deferred and will
be recognized in future periods over the premium-paying period of
the business.
On September 13, 1999, LNC announced that it had reached an
agreement to purchase Alden Risk Management Services, the employer
medical stop-loss business of the John Alden Life Insurance Company
for $41.5 million in cash. The agreement also includes the purchase
of a block of group life and accidental death and dismemberment
business. The purchase closed on November 1, 1999. As of December
31, 1999, the application of purchase accounting to this block of
business resulted in goodwill of $34.1 million and other intangible
assets (i.e., present value of future service rights) of $13.7
million.
On March 30, 2000, LNC transferred its 49% share of Seguros Serfin
Lincoln to its partner, Grupo Financiero Serfin S.A., for $100.5
million. The proceeds included the recovery of LNC's investment
which freed up approximately $90.0 million of capital and included
interest income of $14.1 million ($9.2 million after-tax).
12. Restructuring Charges
During 1998, LNC implemented a restructuring plan relating to the
integration of existing life and annuity operations with the new
business operations acquired from CIGNA, and a second restructuring
plan related to downsizing LNC's corporate center operations. The
aggregate charges associated with these two unrelated restructuring
plans totaled $34.3 million after-tax ($52.8 million pre-tax). These
aggregate pre-tax costs include $19.6 million for employee severance
and termination benefits, $9.9 million for asset impairments and
$23.3 million for costs relating to exiting business activities. The
CIGNA restructuring plan was completed in the first quarter of 2000.
During the fourth quarter of 2000, $0.5 million (pre-tax) of the
original charge to downsize LNC's corporate center operations was
reversed. As of December 31, 2000, actual pre-tax costs of $55.1
million have been expended or written-off under these restructuring
plans and a balance of $1.3 million pre-tax related to the
downsizing of LNC's corporate center operations remains in the
restructuring reserves for these 1998 plans. LNC anticipates that
the remaining reserves will be utilized in completing this
restructuring plan. Details of each of these 1998 restructuring
plans are provided below.
Notes to Consolidated Financial Statements
During the first quarter of 1998, the operations of the Life
Insurance and Annuities segment were restructured to downsize and
integrate existing operations with the new business operations
acquired from CIGNA. LNC recorded a charge of $30.8 million
(pre-tax) related to this restructuring plan. This charge was
included in Underwriting, Acquisition, Insurance and Other Expenses
on the Consolidated Statement of Income for the year ended December
31, 1998. The overall objective of this restructuring plan is to
downsize the existing life insurance operations in Fort Wayne,
Indiana and to move the platform for these operations to Hartford,
Connecticut. The restructuring plan identified $10.7 million
(pre-tax) for severance and employee termination costs related to
the elimination of 211 positions and $20.1 million (pre-tax) for the
merging and closing of field offices and for the merging and
reduction of duplicative policyholder administrative systems. These
actions were required as part of this restructuring plan in order to
eliminate redundancies in existing operations resulting from the
acquisition of the CIGNA block of business. These restructuring
activities were completed in the first quarter of 2000. As of
December 31, 2000, $34.9 million (pre-tax) was expended or
written-off under this restructuring plan and all 211 positions have
been eliminated. Of the $4.1 million (pre-tax) that was expended in
excess of the restructuring charge of $30.8 million pre-tax, $2.2
million was expensed as incurred and reduced 2000 income from
operations and the remaining $1.9 million was expensed as incurred
in 1999.
During the fourth quarter of 1998, LNC completed an organizational
expense review that centered around the size and make-up of the
parent company. LNC recorded a restructuring charge of $22 million
(pre-tax) relating to the restructuring plan that resulted from this
review. This charge was included in Underwriting, Acquisition,
Insurance and Other Expenses on the Consolidated Statement of Income
for the year ended December 31, 1998. The objectives of this
restructuring plan are to realign the activities and functions
conducted within the parent company, in light of the series of
acquisitions and divestitures that LNC executed in recent years, and
to reduce overall costs in response to increasing competitive
pressures in the businesses that LNC operates. To achieve these
objectives, the restructuring plan includes reductions in the number
of corporate center employees along with a reduction in the size of
LNC's facilities. The following activities and associated costs are
included in this restructuring plan: (1) $8.9 million for severance
and termination benefits related to the elimination of 143
positions; (2) $9.9 million for the write-off of leasehold
improvements related to abandoned facilities and other impaired
assets; and (3) $3.2 million for rents on abandoned facilities.
During the fourth quarter of 2000, $0.5 million (pre-tax) of the
original restructuring charge was reversed due primarily to changes in
severance costs and outplacement costs. More employees whose
positions were eliminated under the restructuring plan found
employment in other areas of LNC than had been originally
anticipated; therefore, actual severance and outplacement costs were
less than previously estimated. All expenditures for severance and
termination benefits under the plan were completed in the fourth
quarter of 2000. Expenditures for rents on abandoned facilities are
expected to be completed by the end of 2004 consistent with the
remaining lease commitment. As of December 31, 2000, $20.2 million
(pre-tax) has been expended or written-off under this restructuring
plan and 118 employees have been terminated.
In 1999, LNC implemented three different restructuring plans
relating to 1) the downsizing and consolidation of the operations of
Lynch & Mayer, Inc. ("Lynch & Mayer"), 2) the discontinuance of HMO
excess-of-loss reinsurance programs and 3) the streamlining of
Lincoln UK's operations. The aggregate charges associated with these
three unrelated restructuring plans totaled $21.8 million after-tax
($31.8 million pre-tax). These aggregate pre-tax costs include $8.3
million for employee severance and termination benefits, $9.8
million for asset impairments and $13.7 million for costs relating
to exiting business activities. As of December 31, 2000, actual
pre-tax costs of $21.8 million have been expended or written-off
under these restructuring plans. During the fourth quarter of 1999,
$3.0 million (pre-tax) of the original charge recorded for the Lynch
& Mayer restructuring plan was reversed due primarily to a change in
estimate for space cost. This reversal reduced the reported fourth
quarter 1999 restructuring charges. In addition, during the fourth
quarter of 1999, $1.5 million (pre-tax) associated with lease
terminations was released into income. During the fourth quarter of
2000, the Lynch & Mayer restructuring plan was completed and $0.3
million (pre-tax) of the original charge for the Lynch & Mayer was
reversed. Also, during the fourth quarter of 2000, $1.0 million
(pre-tax) of the original charge for the discontinuance of HMO
excess-of-loss restructuring plan was reversed. As of December 31,
2000, a balance of $5.7 million (pre-tax) remains in the
restructuring reserves for the HMO excess-of-loss and Lincoln UK
restructuring plans. LNC anticipates that the remaining reserves for
the HMO excess-of-loss and Lincoln UK restructuring plans will be
utilized in completing these. Details of each of these 1999
restructuring plans are provided below.
During the first quarter of 1999, LNC recorded a restructuring
charge in its Investment Management segment of $12.1 million
after-tax ($16.9 million pre-tax). The objective of this
restructuring plan is to downsize and consolidate the back office
operations of Lynch & Mayer into Delaware Management Holdings, Inc.,
in order to reduce ongoing operating costs and eliminate redundant
facilities within this business segment. This charge was included in
Underwriting, Acquisition, Insurance and Other Expenses on the
Consolidated Statement of Income for the year ended December 31,
1999. The restructuring plan identified the following activities and
associated costs to achieve the objectives of the restructuring
plan: (1) severance and termination benefits of $2.8 million related
to the elimination of 34 positions, (2) write-off of impaired assets
of $9.8 million and (3) other costs of $4.3 million. Expenditures
and write-offs under the restructuring plan began in the first
quarter of 1999. During the fourth quarter of 1999, LNC determined
that part of rent expense related to abandoned office space included
in (3) above would not be incurred due to the landlord allowing
Lynch & Mayer to surrender the lease, rather than to sublease the
space. As a result, the original estimate was reduced by $3.0
million (pre-tax). This reduction was recorded in the fourth quarter
of 1999 as a reversal to the restructuring charge and related
reserve. In addition, during the fourth quarter of 1999, $1.5
million (pre-tax) associated with lease terminations was released
into income. During the fourth quarter of 2000, $0.3 million (pre-tax)
of the original charge was reversed as Lynch & Mayer was able to
successfully exit certain contracts without any further obligations
or penalties. This plan was completed during the fourth quarter of
2000.As of December 31, 2000, $13.6 million (pre-tax) has been
expended or written-off under this restructuring plan and all 34
positions have been eliminated under this restructuring plan.
LNC discontinued writing new HMO excess-of-loss reinsurance programs
in the third quarter of 1999. Consequently, during the third quarter
of 1999, LNC recorded within its Reinsurance segment a charge of
$3.2 million after-tax ($4.9 million pre-tax) for employee severance
and termination benefits, and other costs related to the
discontinuance of the business. The restructuring plan identified
the following activities and associated costs to achieve the
objectives of the restructuring plan: (1) severance and termination
benefits of $2.4 million related to the elimination of 71 positions
and (2) other costs of $2.5 million. This charge was included in
Underwriting, Acquisition, Insurance and Other Expenses on the
Consolidated Statement of Income for the year ended December 31,
1999. Activities under the restructuring plan began in the third
quarter of 1999 with expenditures expected to be paid out under this
restructuring plan as the discontinuance of this line of business is
completed. During the fourth quarter of 2000, $1.0 million (pre-tax)
of the original charge was reversed due to changes in severance and
outplacement costs. More employees whose positions were eliminated
under the restructuring plan found employment in other areas of LNC
than had been originally anticipated; therefore, actual severance
were less than previously estimated. As of December 31, 2000, $3.3
million (pre-tax) has been expended and 30 employees have been
terminated under this restructuring plan.
During the fourth quarter of 1999, LNC recorded a restructuring
charge in its Lincoln UK segment of $6.5 million after-tax ($10.0
million pre-tax). The objective of this restructuring plan is to
reduce operating costs by consolidating and eliminating redundant
staff functions and facilities. This charge was included in
Underwriting, Acquisition, Insurance and Other Expenses on the
Consolidated Statement of Income for the year ended December 31,
1999. The restructuring plan identified the following activities and
associated costs to achieve the objectives of the restructuring
plan: (1) severance and termination benefits of $3.9 million related
to the elimination of 119 positions, and (2) other costs of $6.1
million primarily related to the remaining lease payments on closed
facilities. Expenditures and write-offs under the restructuring plan
began in the fourth quarter of 1999 and are expected to be completed
by the second quarter of 2001. As of December 31, 2000, $4.9 million
(pre-tax) has been expended or written-off under this restructuring
plan and 108 positions have been eliminated.
During 2000, LNC implemented restructuring plans relating to 1) the
downsizing and consolidation of the operations of Vantage Global
Advisors, Inc. ("Vantage") 2) the exit of all direct sales and sales
support operations of Lincoln UK and the consolidation of its
Uxbridge home office with its Barnwood home office and 3) the
downsizing and consolidation of the investment management operations
of Lincoln Investment Management. The Vantage restructuring charge
was recorded in the second quarter, the Lincoln UK restructuring was
recorded in the third and fourth quarters, and the Lincoln
Investment Management restructuring charge was recorded in the
fourth quarter of 2000. The aggregate charges associated with all
restructuring plans entered into during 2000 totaled $81.8 million
after-tax ($107.4 million pre-tax). The component elements of these
aggregate pre-tax costs include employee severance and termination
benefits of $33.8 million, write-off of impaired assets of $40.9
million and other exit costs of $32.7 million. During the fourth
quarter of 2000, $0.6 million (pre-tax) of the original charge
recorded for the Vantage restructuring plan was reversed as a
reduction of restructuring costs. Actual pre-tax costs totaling
$64.3 million have been expended or written off for these plans
through December 31, 2000. Details of each of these 2000
restructuring plans are provided below.
Notes to Consolidated Financial Statements
During the second quarter of 2000, LNC recorded a restructuring
charge in its Investment Management segment of $2.7 million
after-tax ($4.1 million pre-tax). The objective of this
restructuring plan is to combine the structured products team of
Delaware Management Holdings, Inc. ("Delaware") and Vantage in
Philadelphia and consolidate the back office operations of Vantage
into Delaware, in order to reduce ongoing operating costs and
eliminate redundant facilities within this business segment. This
charge was included in Underwriting, Acquisition, Insurance and
Other Expenses on the Consolidated Statement of Income. The
restructuring plan identified the following activities and
associated pre-tax costs to achieve the objectives of the
restructuring plan: (1) severance and termination benefits of $2.3
million related to the elimination of 15 positions, (2) write-off of
impaired assets of $1.4 million and (3) other costs of $0.4 million.
Write-offs under the restructuring plan began in the second quarter
of 2000. During the fourth quarter of 2000, LNC determined that part
of rent expense related to abandoned office space included in (3)
above would not be incurred due to the landlord allowing LNC to
surrender the lease earlier than expected. In addition, Vantage
determined that some of the termination benefit payments included in
(1) above would not be required to be made. As a result, $0.6
million (pre-tax) of the original charge was reversed. All remaining
expenditures under this restructuring plan are expected to be
completed by the second quarter of 2001. As of December 31, 2000,
$2.8 million (pre-tax) has been expended or written-off under this
restructuring plan. As of December 31, 2000, a balance of $0.7
million remains in the restructuring reserve for this plan.
On September 28, 2000, LNC announced the transfer of the Lincoln UK
sales force to Inter-Alliance and the decision to cease writing new
business in the UK through direct sales distribution. As a result of
these decisions, Lincoln UK continues to manage, administer and
accept new deposits on its current block of business and will only
accept new business for certain products as required by UK
regulations. To implement these decisions, LNC entered into an exit
plan ("restructuring plan") in the third quarter of 2000. The
objective of this restructuring plan is to exit all sales and sales
support operations and consolidate the Uxbridge home office with the
Barnwood home office. Where all commitment date and liability
recognition criteria were met in the third quarter of 2000, charges
for this restructuring plan were recorded in the third quarter of
2000. The charges associated with this restructuring plan that were
recorded in the fourth quarter of 2000 occurred as final decisions
under the contract with Inter-Alliance related to personnel and
facilities were made, as regulatory requirements related to certain
employee involuntary termination benefits were met, and as the
decision to consolidate the Uxbridge home office with the Barnwood
home office was finalized. These charges were included in
Underwriting, Acquisition, Insurance and Other Expenses on the
Consolidated Statement of Income.
The charges recorded in the third and fourth quarters of 2000
related to this restructuring plan were $40.5 million after-tax
($53.5 million pre-tax) and $36.1 million after-tax ($45.9 million
pre-tax), respectively. The components of the pre-tax costs include
employee severance and termination benefits of $29.8 million related
to the elimination of 671 positions, write-off of impaired assets of
$39.2 million and other costs to exit of $30.4 million. All
expenditures under this plan except for those related to abandoned
office facilities are expected to be completed by the end of 2001.
Expenditures for rents on abandoned office facilities are expected
to be completed by 2015. As of December 31, 2000, $61.4 million
(pre-tax) has been expended or written-off under this restructuring
plan and 392 positions have been eliminated. As of December 31,
2000, a balance of $38.0 remains in the restructuring reserve for
this plan.
During the fourth quarter of 2000, LNC recorded a restructuring
charge in its Investment Management segment of $2.5 million
after-tax ($3.9 million pre-tax). The objective of this
restructuring plan is to combine the investment management
operations of Lincoln Investment Management and Delaware in
Philadelphia, in order to reduce ongoing operating costs and
eliminate redundant facilities within this business segment. This
charge was included in Underwriting, Acquisition, Insurance and
Other Expenses on the Consolidated Statement of Income. The
restructuring plan identified the following activities and
associated pre-tax costs to achieve the objectives of the
restructuring plan: (1) severance and termination benefits of $1.7
million related to the elimination of 19 positions, (2) write-off of
impaired assets of $0.3 million and (3) other costs of $1.9 million
(primarily lease payments on abandoned office space). Expenditures
and write-offs under the restructuring plan began in the fourth
quarter of 2000. All remaining expenditures under this restructuring
plan are expected to be completed by the end of the first quarter of
2002, except for lease payments on abandoned office space which will
continue until the end of the lease term in November 2014. As of
December 31, 2000, $0.1 million (pre-tax) has been expended or
written-off under this restructuring plan and 12 positions have
been eliminated. As of December 31, 2000, a balance of $3.8 million
remains in the restructuring reserve for this plan.
Report of Ernst & Young LLP, Independent Auditors
Board of Directors Lincoln National Corporation
We have audited the accompanying consolidated balance sheets of
Lincoln National Corporation as of December 31, 2000 and 1999, and
the related consolidated statements of income, shareholders' equity,
and cash flows for each of the three years in the period ended
December 31, 2000. These financial statements are the responsibility
of the Corporation's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards
generally accepted in the United States. 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.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial
position of Lincoln National Corporation at December 31, 2000 and
1999, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December 31,
2000, in conformity with accounting principles generally accepted in
the United States.
/s/Ernst & Young LLP
Philadelphia, Pennsylvania
February 2, 2001
Stock Market and Dividend Information
The dividend on LNC's common stock is declared each quarter by LNC's
Board of Directors. In determining dividends, the Board takes into
consideration items such as LNC's financial condition, including current
and expected earnings, projected cash flows and anticipated financing
needs. The range of market prices and cash dividends declared by
calendar quarter for the past two years are as follows:
Common Stock Data: (per share) 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
- ----------------------------------------------------------------------------------------------------------------------
2000
High $41.375 $40.063 $56.375 $50.938
Low 22.625 29.000 35.625 40.875
Dividend Declared $.290 $.290 $.290 $.305
1999
High $50.250 $53.438 $57.500 $48.313
Low 39.281 45.688 36.000 36.500
Dividend Declared $.275 $.275 $.275 $.290
- ----------------------------------------------------------------------------------------------------------------------
Notes:
At Dec. 31, 2000, the number of shareholders of record of LNC's
common stock was 11,102.
The payment of dividends to shareholders is subject to the restrictions
described in Note 7 to the consolidated financial statements and is
discussed in the Management's Discussion and Analysis of "Liquidity and
Cash Flow."
Exchanges: New York, Chicago and Pacific.
Stock Exchange Symbol: LNC