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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For quarter ended March 31, 2003 Commission file number 1-6028
LINCOLN NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
Indiana 35-1140070
(State of incorporation) (I.R.S. Employer Identification No.)
1500 Market Street, Suite 3900,
Philadelphia, Pennsylvania 19102-2112
(Address of principal executive offices)
Registrant's telephone number (215) 448-1400
Indicate the number of shares outstanding for each issuer's classes of
common stock, as of the last practicable date:
As of May 2, 2003 LNC had 177,493,113 shares of Common Stock outstanding.
Indicate by check mark whether registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter periods that
the registrant was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days. Yes [ X ] No [ ]
The exhibit index to this report is located on page 59.
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
March 31 December 31
(000s omitted) 2003 2002*
-------------- ---- ----
ASSETS (Unaudited)
Investments:
Securities available-for-sale, at fair value:
Fixed maturity (cost 2003 - $31,904,735;
2002 - $31,103,146) $33,886,789 $32,767,465
Equity (cost 2003 - $241,494;
2002 - $334,493) 249,455 337,216
Mortgage loans on real estate 4,235,509 4,205,470
Real estate 242,011 279,702
Policy loans 1,928,847 1,945,626
Derivative instruments 81,609 86,236
Other investments 384,134 378,136
----------- -----------
Total Investments 41,008,354 39,999,851
Cash and invested cash 1,635,455 1,690,534
Property and equipment 239,360 242,135
Deferred acquisition costs 2,918,952 2,970,866
Premiums and fees receivable 194,007 212,942
Accrued investment income 567,220 536,720
Assets held in separate accounts 34,775,152 36,178,336
Federal income taxes 89,071 317,726
Amounts recoverable from reinsurers 7,323,473 7,280,014
Goodwill 1,232,988 1,233,232
Other intangible assets 1,262,981 1,291,973
Other assets 1,250,565 1,230,316
----------- -----------
Total Assets $92,497,578 $93,184,645
* Restated, see Note 2 - Changes in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
- -CONTINUED-
March 31 December 31
(000s omitted) 2003 2002*
-------------- ---- ----
LIABILITIES AND SHAREHOLDERS' EQUITY (Unaudited)
Liabilities:
Insurance and Investment Contract Liabilities:
Insurance policy and claim reserves $23,619,696 $23,558,874
Contractholder funds 21,843,906 21,286,396
Liabilities related to separate accounts 34,775,152 36,178,336
----------- -----------
Total Insurance and Investment Contract Liabilities 80,238,754 81,023,606
Short-term debt 125,395 153,045
Long-term debt 1,118,644 1,119,245
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 390,797 392,658
Other liabilities 4,214,982 4,171,452
Deferred gain on indemnity reinsurance 958,983 977,149
----------- -----------
Total Liabilities 87,047,555 87,837,155
Shareholders' Equity:
Series A preferred stock-10,000,000 shares authorized
(3/31/03 liquidation value - $1,534) 640 666
Common stock - 800,000,000 shares authorized 1,446,727 1,431,342
Retained earnings 3,163,176 3,180,928
Accumulated Other Comprehensive Income (Loss):
Foreign currency translation adjustment 39,799 50,780
Net unrealized gain on securities available-for-sale 871,952 753,272
Net unrealized gain on derivative instruments 24,973 28,349
Minimum pension liability adjustment (97,244) (97,847)
----------- -----------
Total Accumulated Other Comprehensive Income 839,480 734,554
----------- -----------
Total Shareholders' Equity 5,450,023 5,347,490
----------- -----------
Total Liabilities and Shareholders' Equity $92,497,578 $93,184,645
* Restated, see Note 2 - Changes in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended
March 31
(000s omitted, except per share amounts) 2003 2002*
- ---------------------------------------- ---- ----
(Unaudited)
Revenue:
Insurance premiums $68,297 $77,120
Insurance fees 334,882 354,400
Investment advisory fees 44,185 48,010
Net investment income 654,648 654,798
Realized loss on investments and
derivative instruments (net of amounts
restored /(amortized) against balance sheet
accounts, Note 4) (91,437) (103,343)
Amortization of deferred gain on indemnity reinsurance 18,166 24,162
Other revenue and fees 70,586 70,804
----------- -----------
Total Revenue 1,099,327 1,125,951
Benefits and Expenses:
Benefits 613,029 603,396
Underwriting, acquisition, insurance and other expenses 427,514 402,233
Interest and debt expense 23,335 24,806
----------- -----------
Total Benefits and Expenses 1,063,878 1,030,435
----------- -----------
Income Before Federal Income Taxes 35,449 95,516
Federal income taxes (6,140) 9,911
----------- -----------
Net Income $41,589 $85,605
Net Income Per Common Share-Basic $0.23 $0.46
Net Income Per Common Share-Diluted $0.23 $0.45
* Restated, see Note 2 - Changes in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Three Months Ended March 31
Number of Shares Amounts
(000s omitted from dollar amounts) 2003 2002 2003 2002*
------------------------------------------ ---- ---- ---- ----
(Unaudited) (Unaudited)
Series A Preferred Stock:
Balance at beginning-of-year 20,118 23,034 $666 $762
Conversion into common stock (948) (826) (26) (27)
----------- ----------- ----------- -----------
Balance at March 31 19,170 22,208 640 735
Common Stock:
Balance at beginning-of-year 177,307,999 186,943,738 1,431,342 1,340,002
Conversion of series A preferred stock 15,168 13,216 26 27
Issued/forfeited under benefit plans 101,796 1,605,929 2,751 56,026
Additional paid-in capital - vesting of
stock options granted 12,608 12,249
Additional paid-in capital - tax benefit on
stock options -- 1,243
Retirement of common stock -- (1,000,000) -- (6,714)
----------- ----------- ----------- -----------
Balance at March 31 177,424,963 187,562,883 1,446,727 1,402,833
Retained Earnings:
Balance at beginning-of-year 3,180,928 3,789,870
Comprehensive income 146,515 (89,143)
Less other comprehensive income (loss):
Foreign currency translation adjustment (10,981) (12,768)
Net unrealized gain on
securities available-for-sale 118,680 (163,846)
Net unrealized gain on derivative instruments (3,376) 1,120
Minimum pension liability adjustment 603 746
----------- -----------
Net Income 41,589 85,605
Retirement of common stock -- (44,214)
Dividends declared:
Series A preferred ($0.75 per share) (14) (16)
Common stock (2003-$0.335; 2002-$0.320) (59,327) (60,036)
----------- -----------
Balance at March 31 $3,163,176 $3,771,209
* Restated, see Note 2 - Changes in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Continued)
Three Months Ended March 31
Amounts
(000s omitted from dollar amounts) 2003 2002*
---------------------------------------- ---- ----
(Unaudited)
Foreign Currency Translation Adjustment:
Accumulated adjustment at
beginning-of-year $50,780 $(8,062)
Change during the period (10,981) (12,768)
----------- -----------
Balance at March 31 39,799 (20,830)
----------- -----------
Net Unrealized Gain (Loss) on
Securities Available-for-Sale:
Balance at beginning-of-year 753,272 195,681
Change during the period 118,680 (163,846)
----------- -----------
Balance at March 31 871,952 31,835
----------- -----------
Net Unrealized Gain (Loss) on Derivative Instruments:
Balance at beginning-of-year 28,349 21,523
Change during the period (3,376) 1,120
----------- -----------
Balance at March 31 24,973 22,643
----------- -----------
Minimum Pension Liability Adjustment:
Balance at beginning-of-year (97,847) (35,959)
Change during the period 603 746
----------- -----------
Balance at March 31 (97,244) (35,213)
----------- -----------
Total Shareholders' Equity
at March 31 $5,450,023 $5,173,212
Common Stock at End of Quarter:
Assuming conversion of preferred stock 177,738,083 187,918,211
Diluted basis 178,372,401 190,176,093
* Restated, see Note 2 - Changes in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATION CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended
March 31
(000s omitted) 2003 2002*
---------------------------------------- ---- ----
Cash Flows from Operating Activities: (Unaudited)
Net income $41,589 $85,605
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Deferred acquisition costs (48,374) (77,044)
Premiums and fees receivable 18,936 23,803
Accrued investment income (30,501) (13,607)
Policy liabilities and accruals (114,687) (44,231)
Contractholder funds 249,026 224,134
Amounts recoverable from reinsurers (43,458) (65,937)
Federal income taxes 150,806 79,004
Federal income taxes paid from proceeds of disposition -- (516,152)
Stock-based compensation expense 12,608 12,249
Provisions for depreciation 15,580 19,142
Amortization of other intangible assets 24,711 23,519
Amortization of deferred gain (18,166) (24,162)
Realized loss on investments and derivative instruments 91,437 103,343
Other 94,466 (75,073)
----------- -----------
Net Adjustments 402,384 (331,012)
----------- -----------
Net Cash Provided by (Used in) Operating Activities 443,973 (245,407)
Cash Flows from Investing Activities:
Securities-available-for-sale:
Purchases (3,344,585) (3,618,731)
Sales 1,739,543 2,035,756
Maturities 745,227 606,315
Purchase of other investments (256,609) (206,175)
Sale or maturity of other investments 254,437 405,198
Decrease in cash collateral on loaned securities -- (122,004)
Property and equipment purchases (57,996) --
Property and equipment sales 48,169 --
Other (54,188) (157,875)
----------- -----------
Net Cash Used in Investing Activities (926,002) (1,057,516)
Cash Flows from Financing Activities:
Retirement/call of preferred securities of subsidiary trusts -- (98,497)
Net (decrease) increase in short-term debt (27,650) 160,041
Universal life and investment contract deposits1, 1,144,019 1,271,083
Universal life and investment contract withdrawals (676,699) (993,003)
Investment contract transfers 45,692 (246,000)
Common stock issued for benefit plans 2,751 56,026
Retirement of common stock -- (50,928)
Other liabilities - retirement of common stock -- (131,890)
Dividends paid to shareholders (61,163) (59,841)
----------- -----------
Net Cash Provided by (Used in) Financing Activities 426,950 (93,009)
----------- -----------
Net Decrease in Cash and Invested Cash (55,079) (1,395,932)
Cash and Invested Cash at Beginning-of-Year 1,690,534 3,095,480
----------- -----------
Cash and Invested Cash at March 31 $1,635,455 $1,699,548
* Restated, see Note 2 - Changes in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
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. The collective group of
companies uses "Lincoln Financial Group" as its marketing identity.
Operations are divided into four business segments. Less than
majority-owned entities in which LNC has at least a 20% interest are
reported on the equity basis. These unaudited consolidated statements have
been prepared in conformity with accounting principles generally accepted
in the United States, except that they do not contain complete notes.
However, in the opinion of management, these statements include all normal
recurring adjustments necessary for a fair presentation of the results.
These financial statements should be read in conjunction with the audited
consolidated financial statements and the accompanying notes included in
LNC's latest annual report on Form 10-K for the year ended December 31,
2002.
Operating results for the three months ended March 31, 2003 are not
necessarily indicative of the results that may be expected for the full
year ending December 31, 2003.
2. Change in Accounting Principle
Accounting for Stock Compensation. Effective January 1, 2003, LNC adopted
the fair value recognition method of accounting for its stock option
incentive plans under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("FAS 123"). On December 31,
2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation -Transition and Disclosure" ("FAS 148"), which provides
alternative methods of transition for entities that change to the fair
value method of accounting for stock-based employee compensation. In
addition, FAS 148 amends the disclosure provisions of FAS 123 to require
expanded and more prominent disclosure of the effects of an entity's
accounting policy with respect to stock-based employee compensation on
reported net income and earnings per share in annual and interim financial
statements. LNC adopted the retroactive restatement method under FAS 148
which requires LNC to restate all prior periods presented to reflect
stock-based employee compensation cost under the fair value accounting
method in FAS 123 for all employee awards granted, modified or settled in
fiscal years beginning after December 15, 1994. The earliest year for
which the consolidated income statement will be presented in LNC's 2003
annual report on Form 10-K is 2001 and LNC elects not to restate earlier
periods. Prior to January 1, 2003, LNC accounted for its stock option
incentive plans using the intrinsic value method of accounting under the
recognition and measurement provisions of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and
related Interpretations. No stock-based compensation cost for stock
options was reflected in previously reported results.
The effect of the accounting change on net income as previously reported
for 2002, 2001 and the first quarter of 2002 is as follows:
Year Ended Quarter Ended
December 31, March 31,
(in millions except per share amounts) 2002 2001 2002
---- ---- ----
Net income as previously reported $91.6 $590.2 $94.5
Adjustment for effect of change in accounting principle
that is applied retroactively, net of tax effects (42.8) (44.6) (8.9)
-------- -------- ------
Net income as adjusted $48.8 $545.6 $85.6
Per share amounts:
Earnings per common share - Basic:
Net income as previously reported $0.50 $3.13 $0.51
Adjustment for effect of change in accounting principle
that is applied retroactively, net of tax effects (0.23) (0.24) (0.05)
-------- -------- ------
Net income as adjusted $0.27 $2.89 $0.46
Earnings per common share - Diluted:
Net income as previously reported $0.49 $3.05 $0.49
Adjustment for effect of change in accounting principle
that is applied retroactively, net of tax effects (0.23) (0.20) (0.04)
-------- -------- ------
Net income as adjusted $0.26 $2.85 $0.45
December 31,
2002 2001 March 31, 2002
---- ---- --------------
Retained earnings:
Retained earnings as previously reported $3,268.3 $3,834.4 $3,824.6
Cumulative adjustment for effect of change
in accounting principle that is applied
retroactively, net of tax effects (87.4) (44.6) (53.4)
-------- -------- ------
Retained earnings as adjusted $3,180.9 $3,789.8 $3,771.2
Although LNC did not recognize compensation expense for stock options under
the intrinsic value method of accounting in accordance with APB 25, a tax
benefit was recognized in additional paid-in capital for stock options that
were exercised through December 31, 2002. Because LNC elected not to
restate periods prior to 2001 in the adoption of FAS 123, the tax benefit
for options granted after December 31, 1994 and exercised prior to January
1, 2001 had to be determined under the fair value method and then compared
to the tax benefit that was previously recorded in additional paid-in
capital upon exercise. As of January 1, 2001, a tax benefit was calculated
under the fair value method for outstanding stock options granted after
December 31, 1994 that vested prior to January 1, 2001. An adjustment of
$26.5 million was made to increase additional paid-in capital and the
deferred tax asset as of January 1, 2001 for the adoption of FAS 123.
Accounting for Costs Associated with Exit or Disposal Activities. In June
2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("FAS 146"), which addresses financial
accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Action (including Certain Costs Incurred in a
Restructuring)" ("Issue 94-3"). The principal difference between FAS 146
and Issue 94-3 is that FAS 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the
liability is incurred, rather than at the date of an entity's commitment to
an exit plan. FAS 146 is effective for exit or disposal activities after
December 31, 2002. LNC adopted FAS 146 on January 1, 2003 and the adoption
of the Statement will affect the timing of when an expense is recognized
for restructuring activities.
Accounting for Variable Interest Entities. In January 2003, the Financial
Accounting Standards Board issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("Interpretation No. 46"), which requires the
consolidation of variable interest entities ("VIE") by an enterprise if
that enterprise has a variable interest that will absorb a majority of the
VIE's expected losses if they occur, receive a majority of the entity's
expected residual returns if they occur, or both. If one enterprise will
absorb a majority of a VIE's expected losses and another enterprise will
receive a majority of that VIE's expected residual returns, the enterprise
absorbing a majority of the losses shall consolidate the VIE. VIE refers
to an entity in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated
financial support from other parties. This Interpretation applies in the
third quarter of 2003 to VIEs in which an enterprise holds a variable
interest that is acquired before February 1, 2003. This Interpretation may
be applied prospectively with a cumulative-effect adjustment as of the date
on which it is first applied or by restating previously issued financial
statements for one or more years with a cumulative-effect adjustment as of
the beginning of the first year restated.
Among the matters that LNC is currently reviewing in connection with the
third quarter 2003 effective date of Interpretation No. 46 to existing VIEs
is the potential application to Collateralized Debt Obligation (CDO) pools
that are managed by LNC. Because the fees earned by LNC for managing these
CDOs are required to be included in the analysis of expected residual
returns, it is possible that such CDO pools may fall under the
consolidation requirements of Interpretation No. 46. While LNC does not
currently have access to all information necessary to determine the
ultimate effects of such a required consolidation (because LNC is not the
trustee or administrator to the CDOs), based upon currently available
information, LNC estimates that the effect of consolidation would result in
recording additional assets and liabilities on LNC's consolidated balance
sheet of about $800 million. If such liabilities are required to be
recorded, LNC would disclose that such liabilities are without recourse to
LNC, as LNC's role of investment manager for such CDO pools does not expose
LNC to risk of loss.
Although LNC and the industry continue to review the new rules, at the
present time LNC does not believe there are other significant VIEs that
would result in consolidation with LNC, beyond the managed CDOs discussed
above.
3. Federal Income Taxes
The effective tax rate on net income is lower than the prevailing corporate
federal income tax rate principally from tax-preferred investment income.
LNC recorded a tax benefit on the income before Federal income taxes for
the three months ended March 31, 2003 due to the fact that LNC earns
tax-preferred investment income that does not change proportionately with
the overall change in earnings or losses before Federal income taxes.
4. Supplemental Financial Data
A roll forward of the balance sheet account, "Deferred Acquisition Costs,"
is as follows:
Three Months Ended
March 31
(in millions) 2003 2002
---- ----
Balance at beginning-of-period $2,970.9 $2,885.3
Deferral 148.5 147.9
Amortization (100.2) (70.4)
Adjustment related to realized losses on
securities available-for-sale 30.0 41.9
Adjustment related to unrealized gains
(losses) on securities available-for-sale (119.4) 114.9
Foreign currency translation adjustment (10.8) (12.2)
Other -- 7.5
-------- -------
Balance at end-of-period $2,919.0 $3,114.9
Realized gains and losses on investments and derivative instruments on the
Statements of Income for the three months ended March 31, 2003 and 2002 are
net of amounts restored or (amortized) against deferred acquisition costs
of $30.0 million and $41.9 million, respectively. In addition, realized
gains and losses for the three months ended March 31, 2003 and 2002 are net
of adjustments made to policyholder reserves of $38.9 million and $3.4
million, respectively. LNC has either a contractual obligation or has a
consistent historical practice of making allocations of investment gains or
losses to certain policyholders.
Details underlying the income statement caption, "Underwriting,
Acquisition, Insurance and Other Expenses," are as follows:
Three Months Ended
March 31
(in millions) 2003 2002
- ------------- ---- ----
Commissions $125.7 $144.2
Other volume related expenses 71.5 54.7
Operating and administrative expenses 217.8 220.7
Deferral of acquisition costs (148.5) (147.9)
Amortization of deferred acquisition costs 100.2 70.4
Other intangibles amortization 24.7 23.5
Restructuring charges 5.5 --
Other 30.6 36.6
-------- -------
Total $427.5 $402.2
The carrying amount of goodwill by reportable segment as of March 31, 2003
and December 31, 2002 was as follows:
(in millions) March 31, 2003 December 31, 2002
2003 2002
---- ----
Lincoln Retirement $64.1 $64.1
Life Insurance 855.1 855.1
Investment Management 300.7 300.7
Lincoln UK 13.1 13.3
-------- -------
Total $1,233.0 $1,233.2
The consolidated carrying value of goodwill as of March 31, 2003 changed
from the balance as of December 31, 2002 as a result of the translation of
the Lincoln UK balance from British pounds to U.S. dollars based on the
prevailing exchange rate as of the balance sheet date.
For intangible assets subject to amortization, the total gross carrying
amount and accumulated amortization in total and for each major intangible
asset class by segment are as follows:
As of March 31, 2003 As of December 31, 2002
(in millions) Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
------ ------------ ------ ------------
Amortized Intangible Assets:
Lincoln Retirement Segment:
Present value of in-force $225.0 $104.6 $225.0 $102.3
Life Insurance Segment:
Present value of in-force 1,254.2 381.5 1,254.2 364.1
Investment Management Segment:
Client lists 103.6 63.8 103.6 61.8
Lincoln UK Segment:
Present value of in-force* 337.8 107.7 344.2 106.8
-------- -------- -------- --------
Total $1,920.6 $657.6 $1,927.0 $635.0
* The gross carrying amount of the present value of in-force for the
Lincoln UK segment changed from December 31, 2002 to March 31, 2003 due to
the translation of the balances from British pounds to U.S. dollars based
on the prevailing exchange rate as of the balance sheet dates.
The aggregate amortization expense for other intangible assets for the
three months ended March 31, 2003 and 2002 were $24.7 million and $23.5
million, respectively.
Future estimated amortization of other intangible assets is as follows
(in millions):
2003 - $67.1 2004 - $87.4 2005 - $85.8
2006 - 84.9 2007 - 84.8 Thereafter - 853.0
The amount shown above for 2003 is the amortization expected for the remainder
of 2003 from March 31, 2003.
5. Restrictions, Commitments and Contingencies
Statutory Restriction. 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, the acquisition of two blocks of business in 1998 resulted in
negative statutory earned surplus for The Lincoln National Life Insurance
Company ("LNL") which triggered certain approval requirements in order for
LNL to declare and pay dividends to LNC. As a result of negative earned
surplus, LNL was required to obtain the prior approval of the Indiana
Insurance Commissioner ("Commissioner") before paying any dividends to LNC
until its statutory earned surplus became positive. During the first
quarter 2002, LNL received approval from the Commissioner to reclassify
total dividends of $495 million paid to LNC in 2001 from LNL's earned
surplus to paid-in-capital. This change plus the increase in statutory
earned surplus from the indemnity reinsurance transaction with Swiss Re
resulted in positive statutory earned surplus for LNL at December 31, 2001.
In general, dividends are not subject to prior approval from the
Commissioner provided LNL's statutory earned surplus is positive and such
dividends do not exceed the standard limitation of the greater of 10% of
total statutory earned surplus or the amount of statutory earnings in the
prior calendar year. As a result of the payment of dividends and statutory
losses in 2002, LNL's statutory earned surplus was negative as of December
31, 2002. The statutory losses resulted from realized losses on
investments, the effect of the equity markets and the reserve strengthening
in 2002 related to the reinsurance business sold to Swiss Re. Due to the
negative statutory earned surplus as of December 31, 2002, any dividend(s)
paid by LNL in 2003 will be subject to prior approval from the
Commissioner. As occurred in 2001, dividends approved and paid while
statutory earned surplus is negative are expected to be classified as a
reduction to paid-in-capital.
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 in 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.
Reinsurance Contingencies. On December 7, 2001, Swiss Re acquired LNC's
reinsurance operation. The transaction structure involved a series of
indemnity reinsurance transactions combined with the sale of certain stock
companies that comprised LNC's reinsurance operation.
On October 29, 2002 LNC and Swiss Re settled disputed matters totaling
about $770 million that had arisen in connection with the final closing
balance sheets associated with Swiss Re's acquisition of LNC's reinsurance
operations. The settlement provided for a payment by LNC of $195 million
to Swiss Re, which was recorded by LNC as a reduction in deferred gain. As
a result of additional information made available to LNC following the
settlement with Swiss Re in the fourth quarter of 2002, LNC recorded a
further reduction in the deferred gain of $51.6 million after-tax ($79.4
million pre-tax), as well as a $9.4 million after-tax ($8.3 million
pre-tax) reduction in the gain on the sale of subsidiaries.
As part of the dispute settlement, LNC also paid $100 million to Swiss Re
in satisfaction of LNC's $100 million indemnification obligation with
respect to personal accident business. As a result of this payment, LNC
has no further underwriting risk with respect to the reinsurance business
sold. However, because LNC has not been relieved of its legal liabilities
to the underlying ceding companies with respect to the portion of the
business reinsured by Swiss Re, under FAS 113 the reserves for the
underlying reinsurance contracts as well as a corresponding reinsurance
recoverable from Swiss Re will continue to be carried on LNC's balance
sheet during the run-off period of the underlying reinsurance business.
This is particularly relevant in the case of the exited personal accident
and disability income reinsurance lines of business where the underlying
reserves are based upon various estimates that are subject to considerable
uncertainty.
As a result of developments and information obtained during 2002 relating
to personal accident and disability income matters, LNC increased these
exited business reserves by $198.5 million after-tax ($305.4 million
pre-tax). After giving effect to LNC's $100 million indemnification
obligation, LNC recorded a $133.5 million after-tax ($205.4 million pre-tax)
increase in reinsurance recoverable from Swiss Re with a corresponding
increase in the deferred gain.
Because of ongoing uncertainty related to personal accident and disability
income businesses, the reserves related to these exited business lines
carried on LNC's balance sheet at December 31, 2002 may ultimately prove to
be either excessive or deficient. For instance, in the event that future
developments indicate that these reserves should be increased, under FAS
113 LNC would record a current period non-cash charge to record the
increase in reserves. Because Swiss Re is responsible for paying the
underlying claims to the ceding companies, LNC would record a corresponding
increase in reinsurance recoverable from Swiss Re. However, FAS 113 does
not permit LNC to take the full benefit in earnings for the recording of
the increase in the reinsurance recoverable in the period of the change.
Rather, LNC would increase the deferred gain recognized upon the closing of
the indemnity reinsurance transaction with Swiss Re and would report a
cumulative amortization "catch-up" adjustment to the deferred gain balance
as increased earnings recognized in the period of change. Any amount of
additional increase to the deferred gain above the cumulative amortization
"catch-up" adjustment must continue to be deferred and will be amortized
into income in future periods over the remaining period of expected run-off
of the underlying business. No cash would be transferred between LNC and
Swiss Re as a result of these developments.
Accordingly, even though LNC has no continuing underwriting risk, and no
cash would be transferred between LNC and Swiss Re, in the event that
future developments indicate LNC's March 31, 2003 personal accident or
disability income reserves are deficient or redundant, FAS 113 requires LNC
to adjust earnings in the period of change, with only a partial offset to
earnings for the cumulative deferred gain amortization adjustment in the
period of change. The remaining amount of increased gain would be amortized
into earnings over the remaining run-off period of the underlying business.
United Kingdom Selling Practices. Various selling practices of the Lincoln
UK operations have come under scrutiny by the U.K. regulators. These
include the sale and administration of individual pension products,
mortgage endowments and the selling practices of City Financial Partners
Limited ("CFPL"), a subsidiary company purchased in December 1997.
Regarding the sale and administration of pension products to individuals,
regulatory agencies have raised questions as to what constitutes
appropriate advice to individuals who bought pension products as an
alternative to participation in an employer-sponsored plan. In cases of
alleged inappropriate advice, an extensive investigation has been or is
being carried out and the individual put in a position similar to what
would have been attained if the individual had remained in an
employer-sponsored plan.
Following allegations made by the U.K. Consumers' Association (an
organization which acts on behalf of consumers of goods and services
provided in the U.K.) concerning various selling practices of CFPL, LNC
conducted an internal review of 5,000 ten-year savings plans sold by CFPL
during the period September 1, 1998 to August 31, 2000 and, following
discussions with the U.K. regulator, LNC extended this review to all
customers with a ten-year savings plan sold by CFPL to determine whether
the sales of those policies were appropriate. As of March 31, 2003, this
review was substantially complete. On April 16, 2003, the Financial
Services Authority ("FSA") fined Lincoln UK $762,600 related to the
ten-year savings plans sold by CFPL. This concludes the FSA investigation
on this matter.
At March 31, 2003 and December 31, 2002, the aggregate liability associated
with Lincoln UK selling practices was $56.2 million and $82.2 million,
respectively. The decrease in the aggregate liability was a result of
redress payments and expenditures partially offset by exchange rate
fluctuation. See discussion in LNC's Form 10-K for the year ended December
31, 2002 for background on these matters including pension mis-selling,
mortgage endowment and other Lincoln UK selling practice issues. The
reserves for these issues are based on various estimates that are subject
to considerable uncertainty. Accordingly, the aggregate liability may
prove to be deficient or excessive. However, it is management's opinion
that future developments regarding Lincoln UK selling practices 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.
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 2001, LNL concluded the settlement of all class action lawsuits alleging
fraud in the sale of LNL non-variable universal life and participating
whole life policies issued between January 1, 1981 and December 31, 1998.
Since 2001, LNL has reached settlements with a substantial number of the
owners of policies that opted out of the class action settlement. LNL
continues to defend a small number of opt out claims and lawsuits. While
there is continuing uncertainty about the ultimate costs of settling the
remaining opt out cases, it is management's opinion that established
reserves are adequate and future developments will not materially affect
the consolidated financial position of LNC.
LNC and LNL have pursued claims with their liability insurance carriers for
reimbursement of certain costs incurred in connection with the class action
settlement and the settlement of claims and litigation brought by owners
that opted out of the class action settlement. During the fourth quarter
of 2002, LNC and LNL settled their claims against three liability carriers
on a favorable basis. LNC and LNL continue to pursue similar claims
against a fourth liability insurance carrier.
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 $22.0 million and $22.4 million
were outstanding at March 31, 2003 and December 31, 2002, 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 case of default by the
partnerships, LNC has recourse to the underlying real estate. 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. These guarantees expire in 2003
through 2012.
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. In case of default on the mortgage loans, LNC has recourse
to the underlying real estate. It is management's opinion that the value
of the properties underlying these commitments is sufficient that in the
event of default, the impact would not be material to LNC. These
guarantees expire in 2004 through 2009.
Derivative Instruments. LNC maintains an overall risk management strategy
that incorporates the use of derivative instruments to minimize significant
unplanned fluctuations in earnings that are caused by interest rate risk,
foreign currency risk, equity risk, and credit risk. LNC assesses these
risks by continually identifying and monitoring changes in interest rate
exposure, foreign currency exposure, equity market exposure, and credit
exposure that may adversely impact expected future cash flows and by
evaluating hedging opportunities. Derivative instruments that are
currently used as part of LNC's interest rate risk management strategy
include interest rate swaps, interest rate caps and swaptions. Derivative
instruments that are used as part of LNC's foreign currency risk management
strategy include foreign currency swaps and foreign exchange forwards.
Call options on LNC stock are used as part of LNC's equity market risk
management strategy.
By using derivative instruments, LNC is exposed to credit and market risk.
If the counterparty fails to perform, credit risk is equal to the extent of
the fair value gain in the derivative. When the fair value of a derivative
contract is positive, this generally indicates that the counterparty owes
LNC and, therefore, creates a payment risk for LNC. When the fair value of
a derivative contract is negative, LNC owes the counterparty and therefore
LNC has no payment risk. LNC minimizes the credit (or payment) risk in
derivative instruments by entering into transactions with high quality
counterparties that are reviewed periodically by LNC. LNC also maintains a
policy of requiring that all derivative contracts be governed by an
International Swaps and Derivatives Association ("ISDA") Master Agreement.
LNC and LNL are required to maintain minimum ratings as a matter of routine
practice in negotiating ISDA agreements. Under the majority of ISDA
agreements and as a matter of policy, LNL has agreed to maintain financial
strength or claims-paying ratings above S&P BBB and Moody's Baa2. LNC is
required to maintain long-term senior debt ratings above S&P BBB and
Moody's Baa2. A downgrade below these levels would result in termination
of the derivatives contract at which time any amounts payable by LNC would
be dependent on the market value of the underlying derivative contract. In
certain transactions, LNC and the counterparty have entered into a
collateral support agreement requiring LNC to post collateral upon
significant downgrade. LNC also requires for its own protection minimum
rating standards for counterparty credit protection. LNL is required to
maintain financial strength or claims-paying ratings above S&P A- and
Moody's A3 under certain ISDA agreements, which collectively do not
represent material notional exposure. LNC does not believe the inclusion
of termination or collateralization events pose any material threat to its
liquidity position.
Market risk is the adverse effect that a change in interest rates, currency
rates, implied volatility rates, or a change in certain equity indexes or
instruments has on the value of a financial instrument. LNC manages the
market risk by establishing and monitoring limits as to the types and
degree of risk that may be undertaken.
LNC's derivative instruments are monitored by its risk management committee
as part of that committee's oversight of LNC's derivative activities.
LNC's derivative instruments committee is responsible for implementing
various hedging strategies that are developed through its analysis of
financial simulation models and other internal and industry sources. The
resulting hedging strategies are then incorporated into LNC's overall risk
management strategies.
6. Segment Disclosures
LNC has four business segments: Lincoln Retirement (formerly known as the
Annuities segment), Life Insurance, Investment Management and Lincoln UK.
The following tables show financial data by segment:
Three Months Ended
March 31
(in millions) 2003 2002 (1)
------------- ---- ----
Revenue:
Lincoln Retirement $397.8 $453.0
Life Insurance 457.5 423.9
Investment Management (2) 102.1 107.3
Lincoln UK 68.9 53.2
Other Operations 159.5 166.8
Consolidating adjustments (86.5) (78.2)
-------- --------
Total $1,099.3 $1,126.0
Income (Loss) before Federal Income Taxes
(Tax Benefits):
Lincoln Retirement $(13.3) $45.1
Life Insurance 68.7 62.6
Investment Management 1.9 3.4
Lincoln UK 10.6 9.8
Other Operations (includes interest expense) (32.5) (25.4)
Consolidating adjustments -- --
-------- --------
Total $35.4 $95.5
Federal Income Taxes (Tax Benefits):
Lincoln Retirement $(20.2) $(1.5)
Life Insurance 20.2 19.1
Investment Management 0.9 1.3
Lincoln UK 3.8 (0.5)
Other Operations (10.9) (8.5)
Consolidating adjustments -- --
-------- --------
Total $(6.2) $9.9
Net Income (Loss):
Lincoln Retirement $6.9 $46.6
Life Insurance 48.5 43.5
Investment Management 1.0 2.1
Lincoln UK 6.8 10.3
Other Operations (includes interest expense) (21.6) (16.9)
Consolidating adjustments -- --
-------- --------
Net Income (Loss) $41.6 $85.6
March 31 December 31
(in millions) 2003 2002 (1)
------------- ---- ----
Assets:
Lincoln Retirement $52,154.8 $52,896.4
Life Insurance 19,729.6 19,591.6
Investment Management 1,447.3 1,461.4
Lincoln UK 6,909.5 7,327.1
Other Operations 14,476.6 13,951.4
Consolidating adjustments (2,220.2) (2,043.3)
-------- --------
Total $92,497.6 $93,184.6
(1) 2002 amount have been restated for the retroactive adoption of FAS 123.
See Note 2 for additional information.
(2) Revenues for the Investment Management segment include inter-segment
revenues for asset management services provided to the other segments of
LNC. These inter-segment revenues totaled $20.9 million and $21.2 million
for the three months ended March 31, 2003 and 2002, respectively.
7. Earnings Per Share
Per share amounts for net income are shown in the income statement using 1)
an earnings per common share basic calculation and 2) an earnings per
common share-assuming dilution calculation. Reconciliations of the
factors used in the two calculations are as follows:
Three Months Ended
March 31
2003 2002
- -----------------------------------------------------------------------------------------------------------
Numerator: [millions]
Net income as used in basic calculation $41.6 $85.6
Dividends on convertible preferred stock and adjustments
for minority interests * *
Numerator: [in millions] ------------ ------------
Net income as used in diluted calculation $41.6 $85.6
* Less than $100,000
Denominator: [number of shares]
Weighted-average shares, as used in basic calculation 177,009,728 186,848,304
Shares to cover conversion of preferred stock 316,745 359,880
Shares to cover non-vested stock 50,693 44,793
Average stock options outstanding during the period 6,388,391 18,194,632
Assumed acquisition of shares with assumed proceeds
and benefits from exercising stock options (at average
market price for the period) (5,765,795) (14,566,174)
Shares repurchaseable from measured but unrecognized
stock option expense (606,034) (1,709,461)
Average deferred compensation shares 933,935 837,693
------------ ------------
Weighted-average shares, as
used in diluted calculation 178,327,663 190,009,667
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. Participants in
LNC's deferred compensation plans, who select 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.
8. Employee Benefit Plans
Stock Compensation. Refer to Note 6 to the audited financial statements in
LNC's annual report on Form 10-K for the year ended December 31, 2002, for
a detailed discussion of this matter.
LNC Stock Options
Information with respect to the LNC incentive plans involving stock options
is as follows:
Options Outstanding Options Exercisable
------------------- -------------------
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
- -----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 18,608,009 $38.89 10,883,053 $38.87
Granted-original 398,174 25.11
Granted-reloads 25,085 28.76
Exercised (includes shares tendered) (181,655) 32.02
Forfeited (330,633) 41.64
------------ ------------
Balance at March 31, 2003 18,518,980 $38.68 13,171,660 $38.19
Total compensation expense for LNC incentive plans involving stock options
for the three months ended March 31, 2003 and 2002 was $5.8 million
after-tax ($8.2 million pre-tax) and $7.0 million after-tax ($9.6 million
pre-tax), respectively.
Performance Vesting Awards
Effective January 1, 2003, LNC's employee stock option compensation plan
and long-term cash incentive compensation plan were revised and combined to
provide for performance vesting, and to provide for awards that may be paid
out in a combination of LNC stock options, performance shares of LNC stock
and cash. The performance measures for the initial grant under the new
plan will compare LNC's performance relative to a selected group of peer
companies, over a three-year performance measurement period. Comparative
performance measures for these initial awards are: relative growth in
earnings per share, return on equity and total share performance. Certain
participants in the new plans selected from various combinations of stock
options, performance shares and cash in determining the form of their
award. Other participants will have their award paid in performance
shares.
New grants of LNC option awards are expected be made under the general
terms of this new performance-vesting plan. However, the separate stock
option incentive plans previously established by Delaware Investments U.S.,
Inc. ("DIUS") and DIAL Holding Company, Inc. ("DIAL"), both wholly-owned
subsidiaries of Delaware Management Holdings, Inc., are expected to
continue under their existing plan designs. See the information provided
below under the caption "Delaware Investment U.S. Inc. ("DIUS") and DIAL
Holding Company, Inc. ("DIAL") Plans."
In the first quarter of 2003, LNC granted a combination of performance
vesting stock options, performance share units, and performance vesting
cash awards under the new plan. LNC granted 312,099 of 10-year LNC stock
options, subject to three-year performance vesting. The actual number of
stock options that will vest will be determined by the level of achievement
on LNC's three performance measures over the three-year performance
measurement period. Expense of $0.1 million after tax ($0.1 million
pre-tax) were recorded in the first quarter of 2003 for these LNC stock
options. This amount is included in the total LNC stock option expense
reported in the first quarter of 2003 as discussed above under the caption
"LNC Stock Options."
Also in the first quarter of 2003, LNC granted 741,693 performance share
units which could result in the issuance of LNC shares upon the conclusion
of the three-year performance period. The actual number of LNC shares
issued will be determined by the level of achievement on LNC's three
performance measures over this time-frame. The expense recorded in the
first quarter of 2003 associated with these performance share units was
$1.0 million after-tax ($1.6 million pre-tax). Finally, LNC granted awards
that will be paid in an amount of cash to be determined by the level of
achievement on LNC's three performance measures over the three-year
performance measurement period. The expense recorded in the first quarter
of 2003 with respect to these performance based cash awards was $0.1 million
after-tax ($0.2 million pre-tax).
All expense calculations for performance vesting stock options, performance
shares, and performance vesting cash awards that were granted in the first
quarter of 2003 have been based upon the current assumption that the actual
performance achievement over the three-year performance measurement period
will result in target levels of long-term incentive compensation payouts.
As the three-year performance period progresses, LNC will continue to
refine its estimate of the expense associated with these awards so that by
the end of the three-year performance period, LNC's cumulative expense will
reflect the actual level of awards that vest.
Stock Appreciation Rights ("SARs")
Information with respect to the LNC incentive plan involving SARs is as
follows:
SARs Outstanding SARs Exercisable
---------------- ----------------
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
- ----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 1,382,248 $39.20 301,108 $32.06
Granted-original 320,025 25.11
Exercised (includes shares tendered) (2,375) 31.91
Forfeited (20,925) 37.05
-------- --------
Balance at March 31, 2003 1,678,973 $36.56 664,783 $35.40
Total compensation expense (income) for the LNC incentive plan involving
SARs for the three months ended March 31, 2003 and 2002 was ($0.5) million
after-tax ($0.8 million pre-tax) and $1.2 million after-tax ($2.0 million
pre-tax), respectively.
Delaware Investment U.S. Inc. ("DIUS") and DIAL Holding Company, Inc.
("DIAL") Plans
At March 31, 2003, DIUS had 10,000,000 shares of common stock outstanding.
Information with respect to the DIUS incentive plan involving stock options
is as follows:
Options Options
Outstanding Exercisable
------------------- -------------------
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
- ----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 1,087,996 $104.31 280,877 $103.61
Granted-original 277,200 98.71
Exercised (includes shares tendered) -- --
Forfeited (65,452) 105.18
-------- --------
Balance at March 31, 2003 1,299,744 $103.07 327,489 $104.37
At March 31, 2003, DIAL had 10,000,000 shares of common stock outstanding.
Information with respect to the DIAL incentive plan involving stock
options is as follows:
Options Options
Outstanding Exercisable
------------------- -------------------
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
- -----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 1,088,010 $25.76 202,703 $25.47
Granted-original 583,579 26.79
Exercised (includes shares tendered) -- --
Forfeited -- --
Balance at March 31, 2003 1,671,589 $26.12 202,703 $25.47
Compensation expense for the DIUS and DIAL incentive plan involving stock
options for the three months ended March 31, 2003 and 2002 totaled $2.0
million after-tax ($2.7 million pre-tax) and $1.8 million after-tax ($2.6
million pre-tax), respectively.
9. Restructuring Charges
Included in the discussion below are restructuring plans that were
implemented during the years 1999 through 2002 that were not yet
completed as of December 31, 2002. Any restructuring plans that were
implemented during the years 1999 through 2001 that were completed as of
December 31, 2002 are not included in the discussion below. For
discussion of these completed plans, see Note 12 of LNC's annual report
on Form 10-K for the year ended December 31, 2002. The aggregate
charges associated with the restructuring plans were included in
Underwriting, Acquisition, Insurance and Other Expenses on the
Consolidated Statements of Income in the period incurred.
1999 Restructuring Plan
During 1999, LNC implemented a restructuring plan relating to the
streamlining of Lincoln UK's operations. The following table provides
information about this restructuring plan.
Lincoln UK
(in millions) Plan
------------- -------
Employee severance and termination benefits $3.9
Other Costs- Rent on abandoned office space $6.1
-------
1999 Restructuring Charge (pre-tax) $10.0
Amounts expended through December 31, 2002 $7.5
Amounts reversed through December 31, 2002 $-
-------
Restructuring reserve at December 31, 2002 $2.5
Amounts expended in the first quarter of 2003 $0.7
Amounts reversed in the first quarter of 2003 $-
-------
Restructuring reserve at March 31, 2003 $1.8
=======
Positions to be eliminated under original plan 119
Actual positions eliminated through March 31, 2003 112
Expected completion date 2016
2000 Restructuring Plan
During 2000, LNC implemented a restructuring plan relating to 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.
The following table provides information about this restructuring plan.
Lincoln UK
(in millions) Plan
------------- -------
Employee severance and termination benefits $29.8
Write-off of impaired assets $39.2
Other Costs $30.4
-------
2000 Restructuring Charge (pre-tax) $99.4
Amounts expended and written-off through
December 31, 2002 $88.0
Amounts reversed through December 31, 2002 $1.7
-------
Restructuring reserve at December 31, 2002 $9.7
Amounts expended in the first quarter of 2003 $0.4
Amounts reversed in the first quarter of 2003 $-
-------
Restructuring reserve at March 31, 2003 $9.3
=======
Positions to be eliminated under original plan 671
Actual positions eliminated through March 31, 2003 671
Expected completion date 2015
2001 Restructuring Plan
During 2001, LNC implemented restructuring plans relating to 1) the
elimination of duplicative functions in the Schaumburg, Illinois
operations of First Penn-Pacific (FPP), and the absorption of these
functions into the Lincoln Retirement and Life Insurance segment
operations in Fort Wayne, Indiana and Hartford, Connecticut,
respectively; 2) the planned consolidation of the Boston, Massachusetts
investment and marketing office with the Philadelphia, Pennsylvania
investment and marketing operations in order to eliminate redundant
facilities and functions within the Investment Management segment; 3)
the combination of LFD channel oversight, positioning of LFD to take
better advantage of ongoing "marketplace consolidation" and expansion of
the customer base of wholesalers in certain non-productive territories,
recorded in "Other Operations"; and 4) the consolidation of operations
and space in LNC's Fort Wayne, Indiana operations, recorded in "Other
Operations". The following table provides information about these
restructuring plans.
Schaumburg Boston Office LFD Plan- Fort Wayne
(in millions) Plan Consolidation 4th Quarter Operations Total
------------- ---------- ------------- ----------- ---------- -----
Employee severance and termination benefits $3.2 $- $3.8 $0.3 $7.3
Write-off of impaired assets $- $0.1 0 $3.2 $3.3
Other Costs:
Termination of equipment leases $- $- $- $1.4 $1.4
Rent on abandoned office space $0.9 $0.5 $- $19.5 $20.9
------- ------- ------- ------- ------
Total 2001 Restructuring Charges (pre-tax) $4.1 $0.6 $3.8 $24.4 $32.9
Amounts expended and written-off through Dec. 31, 2002 $3.7 $0.2 3.8 $22.3 $30.0
Amounts reversed through December 31, 2002 $0.1 $- $- $1.5 $1.6
------- ------- ------- ------- ------
Restructuring reserve at December 31, 2002 $0.3 $0.4 $- $0.6 $1.3
Amounts expended in the first quarter of 2003 $0.1 $- $- $0.1 $0.2
Amounts reversed in the first quarter of 2003 $- $- $- $- $-
------- ------- ------- ------- ------
Restructuring reserve at March 31, 2003 $0.2 $0.4 $- $0.5 $1.1
======= ======= ======= ======= ======
Positions to be eliminated under original plan 27 - 63 9
Actual positions eliminated through March 31, 2003 26 - 62 19
Expected completion date 1st Quarter 2004 4th Quarter 2005 Completed 2nd Quarter 2004
2002 Restructuring Plan
During the second quarter of 2002, Lincoln Retirement completed a
review of its entire internal information technology organization. As a
result of that review, Lincoln Retirement decided in the second quarter
of 2002 to reorganize its IT organization in order to better align the
activities and functions conducted within its own organization and its
IT service providers. This change was made in order to focus Lincoln
Retirement on its goal of achieving a common administrative platform for
its annuities products, to better position the organization and its
service providers to respond to changing market conditions, and to
reduce overall costs in response to increased competitive pressures. The
following table provides information about this restructuring plan.
Lincoln
Retirement
(in millions) Plan
------------- -------
Employee severance and termination benefits $1.6
-------
2002 Restructuring Charge (pre-tax) $1.6
Amounts expended through December 31, 2002 $0.9
Amounts reversed through December 31, 2002 $-
-------
Restructuring reserve at December 31, 2002 $0.7
Amounts expended in the first quarter of 2003 $0.3
Amounts reversed in the first quarter of 2003 $-
-------
Restructuring reserve at March 31, 2003 $0.4
=======
Positions to be eliminated under original plan 49
Actual positions eliminated through March 31, 2003 49
Expected completion date 3rd Quarter 2003
2003 Restructuring Plans
In January 2003, the Life Insurance segment announced that it was
realigning its operations in Hartford, Connecticut and Schaumburg,
Illinois to enhance productivity, efficiency and scalability while
positioning the segment for future growth. The financial impact of the
realignment will result in the Life Insurance segment incurring costs of
approximately $15-17 million after-tax during 2003.
Through March 31, 2003, the total expense incurred for the Life
Insurance segment realignment was $4.1 million ($6.4 million pre-tax),
which was accounted for in accordance with FAS 146. This total includes
pre-tax costs of $4.5 million for severance and termination benefits
related to the elimination of 148 positions, the write-off of software
costs of $1.8 million and other costs of $0.1 million. Of this total,
$3.6 million ($5.5 million pre-tax) qualified as a restructuring charge
in accordance with FAS 146 and the remaining $0.5 million ($0.8 million
pre-tax) was recorded as operating and administrative expense.
In February 2003, Lincoln Retirement announced plans to consolidate its
fixed annuity operations in Schaumburg, Illinois into Fort Wayne,
Indiana. Restructuring costs under the plan are expected to be $3-$5
million after-tax and are expected to be incurred during 2003. Through
March 31, 2003, no expenses have been incurred under this plan.
Item 2 Management's Discussion and Analysis of Financial Information
Forward Looking Statements - Cautionary Language This report, among other
things, reviews the results of operations of LNC Consolidated, LNC's four
business segments and "Other Operations"; LNC's consolidated investments;
and consolidated financial condition including liquidity, cash flows and
capital resources. Historical financial information is presented and
analyzed. This report and other written or oral statements made by LNC or
on LNC's behalf may contain forward-looking statements. 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"). A forward-looking statement is any statement that is not
a historical fact and, without limitation, includes any statement that may
predict, forecast, indicate or imply future results, performance or
achievements, and may contain words like: "believe", "anticipate",
"expect", "estimate", "project", "will", "shall" and other words or phrases
with similar meaning. LNC claims the protection afforded by the safe
harbor for forward-looking statements provided by the Act.
Forward-looking statements involve risks and uncertainties that 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 of legal entities and
blocks of business - directly or by means of reinsurance transactions);
* financial markets (e.g., interest rates and securities markets and
stock and bond market performance);
* the performance of the investment portfolios of LNC's subsidiaries and
of the portfolios which they manage (both internal and external);
* competitors and competing products and services;
* LNC's ability to operate its businesses in a relatively normal manner;
* legislation (e.g., corporate, individual, estate and product taxation)
including the Bush Administration's tax proposals on dividends and
retirement savings;
* the price of LNC's stock;
* accounting principles generally accepted in the United States;
* regulations (e.g., insurance and securities regulations);
* debt and claims-paying ratings issued by nationally recognized
statistical rating organizations;
* and the National Association of Insurance Commissioners' (NAIC)
capital requirements.
Other risks and uncertainties include:
* the risk that significant accounting, fraud or corporate governance
issues may adversely affect the value of certain investments in the
portfolios of LNC's companies;
* the risk that LNC could have to accelerate amortization of
deferred policy acquisition costs if the market continues to deteriorate;
* the risk that LNC could have to write off investments in certain
securities if the issuers' financial condition deteriorates;
* the risks associated with having products with guaranteed minimum death
benefits;
* whether necessary regulatory approvals are obtained (e.g., insurance
department, Hart-Scott-Rodino, etc.) and, if obtained, whether they are
obtained on a timely basis;
* whether proceeds from divestitures of legal entities and blocks of
business can be used as planned;
* risks associated with litigation, arbitration and other actions such as:
(a) adverse decisions in significant actions including, but not limited
to extra-contractual and class action damage cases; (b) new decisions
which change the law; (c) unexpected trial court rulings; (d) unavailability
of witnesses; (e) newly discovered evidence and (f) acts of God (e.g.,
hurricanes, earthquakes and storms);
* whether there will be significant charges or benefits resulting from the
contingencies described in the footnotes to LNC's consolidated financial
statements;
* risks associated with acts of terrorism or war;
* the stability of governments in countries in which LNC's subsidiaries do
business;
* and other insurance risks (e.g., policyholder mortality and morbidity).
The risks included here are not exhaustive. Other sections of this
report, and LNC's annual reports on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and other documents filed with
the Securities and Exchange Commission include additional factors which
could impact LNC's business and financial performance. Moreover, LNC
operates in a rapidly changing and competitive environment. New risk
factors emerge from time to time and it is not possible for management
to predict all such risk factors.
Further, it is not possible to assess the impact of all risk factors on
LNC's business or the extent to which any factor, or combination of
factors, may cause actual results to differ materially from those
contained in any forward-looking statements. Given these risks and
uncertainties, investors should not place undo reliance on
forward-looking statements as a prediction of actual results. In
addition, LNC disclaims any obligation to update any forward-looking
statements to reflect events or circumstances that occur after the date
of this report.
Critical Accounting Policies
Refer to Management's Discussion and Analysis of LNC's annual report on
Form 10-K for the year ended December 31, 2002, for a detailed
discussion of LNC's critical accounting policies. Refer to the various
sections captioned Critical Accounting Policy within the discussion that
follows for updates to the information provided in the Form 10-K.
All amounts stated in this "Management's Discussion and Analysis" are
on an after-tax basis except where specifically noted as pre-tax.
RESULTS OF CONSOLIDATED OPERATIONS
Summary Financial Results
Three Months Ended March 31 (in millions) 2003 2002
- ------------------------------------------------------------------------------
Premiums and Insurance Fees $403.2 $431.5
Investment advisory fees 44.2 48.0
Net investment income 654.6 654.8
Realized loss on investments and derivative instruments (91.4) (103.3)
Other revenue and fees 88.7 95.0
------- -------
Total Revenue 1,099.3 1,126.0
Insurance benefits 613.0 603.4
Underwriting, acquisition, insurance and other expenses 427.5 402.3
Interest and debt expenses 23.4 24.8
------- -------
Total Benefits and Expenses 1,063.9 1,030.5
Income Before Federal Income Taxes 35.4 95.5
Federal income taxes (6.2) 9.9
------- -------
Net Income $41.6 $85.6
Items Included in Net Income:
Realized Loss on Investments and Derivatives (after-tax) $(59.4) $(67.5)
Restructuring Charges (after-tax) (3.6) -
LNC has the following business segments: Lincoln Retirement, Life
Insurance, Investment Management and Lincoln UK. Operations not
directly related to the business segments and unallocated corporate
items (i.e., corporate investment income, interest expense on corporate
debt, unallocated overhead expenses, and the operations of Lincoln
Financial Advisors ("LFA") and Lincoln Financial Distributors ("LFD")
and the amortization of the deferred gain on the sale of Lincoln Re) are
reported in "Other Operations".
Stock-Based Compensation
The first three months of 2002 have been restated for the adoption of FAS 148.
See the discussion under the topic "Accounting for Stock-Based
Compensation" presented in the Consolidated Results of Operations for
further discussion of this matter. The effect of adoption was a
decrease in net income of $8.9 million in the first three months of
2002.
Net Income
Net income for the first three months of 2003 decreased by $44.0 million
or 51% compared to the same period in 2002. The negative performance of
the equity markets continued to hinder LNC's results. Net realized
losses on investments were $8.1 million lower in the first quarter 2003
than in the first quarter of 2002. However, in the first quarter of
2003 write-downs for impairments were required primarily for securities
held within the airline industry, electric utilities and asset-backed
securities (ABS). For additional detail on realized losses see the
discussion in the Consolidated Investment section.
In the first quarter of 2003, the equity markets experienced another
decline as the S&P index at March 31, 2003 was 3.6% lower than December
31, 2002 and 26% lower than March 31, 2002. The decline in the equity
markets from December 31, 2002 reduced LNC's overall results by $21.9
million in the first quarter of 2003, primarily within the Lincoln
Retirement segment. The Lincoln UK and Investment Management segments
also experienced a decline with the Life Insurance segment experiencing
a slight decline from the equity market. The following table displays
the impact of the decline in the equity markets by segment for the first
quarter of 2003.
Actual Impact of the Market in the First Quarter of 2003 (Million $)
Segment
---------------------------------------------
Lincoln Life Investment
Retirement Insurance Management Lincoln UK LNC Total
---------------------------------------------------------
Fees- Lagging Effect of 4Q02 Market Changes on 1Q03 $(0.5) $- $0.1 $(0.1) $(0.5)
Fees- Current Effects in First
Quarter $(1.0) $- $(0.5) $(0.5) $(2.0)
----------------------------------------------------------
Total Fee Income $(1.5) $- $(0.4) $(0.6) $(2.5)
Other $- $- $- $- $-
GMDB-No Change Effect $(5.9) $- $- $- $(5.9)
GMDB-Market Change Effect $(7.5) $- $- $- $(7.5)
----------------------------------------------------------
Total GMDB $(13.4) $- $- $- $(13.4)
DAC $(1.8) $(0.6) $- $(3.6) $(6.0)
----------------------------------------------------------
Total Effect $(16.7) $(0.6) $(0.4) $(4.2) $(21.9)
See the discussion of results of operations for each business segment
for additional details on the impact of the equity markets in the first
quarter of 2003. See the discussion presented below under the topic
"Second Quarter 2003 Guidance for the Estimated Effect of Equity Market
Volatility " for information regarding the factors that LNC uses to
estimate the expected effect of equity market volatility for the
upcoming quarter.
Revenue
Consolidated revenue decreased primarily due to lower fee income
in the Lincoln Retirement and Lincoln UK segments from the impact equity
market declines had on average variable annuity (Retirement) and
unit-linked account values (Lincoln UK). The Investment Management
segment had decreased investment advisory fees and other revenue and
fees as a result of lower retail and institutional assets under
management also resulting from the decline in the equity markets.
Expenses
Consolidated expenses were negatively affected by the decline
in the equity markets which resulted in negative unlocking of deferred
acquisition costs ("DAC") and present value of in-force ("PVIF") in the
Lincoln Retirement, Life Insurance and Lincoln UK business segments,
increased reserves and payments for guaranteed minimum death benefits
and decreased tax benefits for the dividends received deduction in the
Lincoln Retirement segment. For further discussion of the results of
operations see the discussion of the results of operations by segment.
Consolidated Deposits and Net Flows
LNC's domestic consolidated product deposits and net cash flows were as
follows:
Three Months Ended March 31(in billions) 2003 2002
----- -----
Deposits (1):
Lincoln Retirement Segment $1.4 $1.7
Life Insurance Segment 0.5 0.4
Investment Management Segment (including
both retail and institutional deposits) 2.2 2.7
Consolidating Adjustments (2) (0.2) (0.3)
----- -----
Total Deposits $3.9 $4.5
Net Flows (1):
Lincoln Retirement Segment $0.1 $0.1
Life Insurance Segment 0.3 0.2
Investment Management Segment (including
both retail and institutional net flows) 0.3 0.8
Consolidating Adjustments (2) 0.1 --
----- -----
Total Net Flows $0.8 $1.1
(1) For additional detail of deposit and net flow information see the
discussion of the Results of Operations by Segment.
(2) Consolidating adjustments represent the elimination of deposits and
net cash flows on products affecting more than one segment.
Second Quarter 2003 Guidance for the Estimated Effect of Equity Market
Volatility
At the end of 2002, Lincoln National Corporation ("LNC") provided
guidance on the estimated effect of equity market volatility on its
first quarter of 2003 results. The following guidance is being provided
for purposes of modeling the expected effects of equity market
volatility for the second quarter of 2003. As will be explained in
greater detail below, the effects on LNC's results of significant
volatility in equity markets are complex and are not expected to be
proportional for market increases and market decreases. The second
quarter 2003 information provided below is based upon market conditions
and LNC's mix of business as of the end of the first quarter of 2003.
All amounts provided in this guidance are on an after-tax basis. This
guidance can be expected to change as actual circumstances change.
Although LNC believes this guidance provides reasonable estimates based
upon conditions as of April 1, 2003, LNC claims no responsibility for
updating this forward-looking information.
This guidance is intended to provide a general indication of the
expected effect of equity market volatility on LNC's fee income;
deferred acquisition costs ("DAC") and present value of in-force
("PVIF") intangible assets; and guaranteed minimum death benefit
("GMDB") reserves. Excluded from this guidance is the effect that
equity market changes may have upon LNC's realized and unrealized gains
and losses on investments and intangible assets, other than DAC and
PVIF. For example, write-downs for impairment of goodwill and deferred
dealer commission assets may be necessary under certain market
conditions. These matters are not included within the guidance provided
in this document.
Market Indices Used For Modeling LNC's Various Operating Segments
In measuring the estimated effects of changes in equity markets on its
Lincoln Retirement segment, LNC uses the S&P 500 index. LNC has
generally found that the S&P 500 index is reasonably correlated to the
effect of overall equity markets performance on this segment's account
values. Because LNC's fee income earned on its variable annuity
business is determined daily, the change in the S&P 500 on a daily
average basis relative to the level of the S&P 500 at the beginning of
each quarter provides a reasonable indication of the impact quarterly
changes in equity markets have on Lincoln Retirement's fee income.
Because end of period account values are used for computing DAC
unlocking and for incurred GMDB costs, the end of period change in the
S&P 500 is used in measuring the estimated market impact of DAC
unlocking and for the impact associated with incurred GMDB costs. In
addition, because DAC and GMDB calculations have an assumed 9% positive
annual equity market return, or a 2.25% quarterly assumption, variances
in actual market performance relative to these calculation assumptions
will generate positive or negative DAC unlocking and GMDB adjustments.
Further, the GMDB reserve adjustment results in an increase or decrease
to estimated gross profits and therefore has an inverse impact on DAC
amortization. The interplay of GMDB reserve changes on DAC unlocking
and DAC amortization is taken into consideration in the model.
It is important to understand that the actual effect on fee income of
market changes in the current quarter of an equity market change and the
effect in the immediately following quarter will not be equal to a
pro-rata 25% of the estimated annualized effect of the market change.
This is due to the fact that the actual change in fee income in the
immediate quarter during which the market changes is measured by the
change in actual variable account values from the beginning of the
quarter compared to the average balance of variable account values for
the quarter. The change in fee income due to the change from average
account values to ending account values does not occur in the immediate
quarter of the market change; rather, that change in fee income will
occur in the quarter following the market change. LNC estimates that
this lagging effect for the first quarter 2003 equity markets change
will create a decrease of $0.8 million in the second quarter of 2003,
because average account values for the first quarter of 2003 exceeded
the level of ending account values at March 31, 2003.
LNC also uses the S&P 500 index when describing the general effects of
changes in equity markets for the Life Insurance segment. For the
Lincoln UK segment, the FTSE 100 index provides a reasonable measure for
approximating the effect of equity markets performance on earnings. LNC
estimates that the lagging effect for the first quarter 2003 equity
markets change will create a decrease of $0.1 million in fee income for
Lincoln UK in the second quarter of 2003, because average account values
for the first quarter of 2003 exceeded the level of ending account
values at March 31, 2003.
Additional market indices are used in measuring the effects of the
market on the results of LNC's Investment Management segment. All of the
relevant equity market indices (S&P, NASDAQ and MSCI EAFE) increased
during the fourth quarter of 2002, ranging from a 6.5% increase in the
MSCI EAFE index to a 13.9% NASDAQ increase. The first quarter of 2003
had a slight increase in the NASDAQ of 0.4%, but an 8.2% decrease in the
MSCI EAFE index. The ongoing effect of the first quarter equity markets
change is expected to be a $0.1 million decrease in the second quarter
of 2003 fee income.
Illustrative Scenarios
The following discussion concerning the estimated effects of ongoing
equity market volatility on LNC's earnings is intended to be
illustrative. Actual effects may vary depending on a variety of
factors, many of which are outside of LNC's control, such as changing
customer behaviors that might result in changes in the mix of LNC's
business between variable or fixed annuity contracts, switching between
investment alternatives available within variable products, or changes
in policy lapsation rates. The relative effects shown in the
illustrative scenarios presented below should not be considered to be
indicative of the proportional effects on earnings that more significant
changes in equity markets may generate. Such non-proportional effects
include those discussed earlier, such as incurred GMDB costs and DAC
unlocking.
Since the effects of continued equity market volatility is complex and
subject to a variety of estimates and assumptions, such as assumed rates
of long-term equity market performance, it is difficult to provide
information that can be reliably applied to predict earnings effects
over a broad range of equity markets performance alternatives. But in
an effort to provide some insight into these matters, LNC has provided
below illustrative examples of the effects that equity market volatility
might be expected to have on LNC's earnings. The underlying assumptions
regarding these illustrations are as follows:
1) The first scenario assumes that equity markets remain unchanged from
their respective levels at March 31, 2003 through the second quarter of
2003.
2) The second scenario assumes that from March 31, 2003 through the end
of the second quarter of 2003 equity markets increase smoothly by 2.5%.
3) The third scenario assumes that from March 31, 2003 through the end
of the second quarter of 2003 equity markets decline smoothly by 2.5%.
As the above assumptions indicate, actual equity market changes that may
have occurred since March 31, 2003 up to the date of issuance of this
guidance are not being considered; rather, the examples that follow are
provided to illustrate the effects of a hypothetical change in equity
markets from March 31, 2003. The following tables are examples of the
estimated effects on earnings that might be expected for each of these
scenarios.
Scenario #1:
No change in equity markets from March 31, 2003 through June 30, 2003.
Estimated Effect on Second Quarter of 2003 Results (Million $):
Segment
---------------------------------------------
Lincoln Life Investment
Retirement Insurance Management Lincoln UK LNC Total
---------------------------------------------------------
Fees- Lagging Effect of 1Q03
Market Changes on 2Q03* $(0.8) $- $(0.1) $(0.1) $(1.0)
Fees- Current Effects in
Second Quarter $- $- $- $- $-
---------------------------------------------------------
Total Fee Income $(0.8) $- $(0.1) $(0.1) $(1.0)
Other $(0.3) $- $- $- $(0.3)
GMDB-No Change Effect $(5.9) $- $- $- $(5.9)
GMDB-Market Change Effect $- $- $- $- $-
---------------------------------------------------------
Total GMDB $(5.9) $- $- $- $(5.9)
DAC** $- $(0.2) $- $(0.9) $(1.1)
---------------------------------------------------------
Total Effect $(7.0) $(0.2) $(0.1) $(1.0) $(8.3)
* Differences exist in the market change effect on fee income for the
current quarter, as compared to the ongoing quarterly effect, because
the change in fee income in the immediate quarter is determined by the
change in beginning variable account balances to average variable
account balances for the current quarter. The change in fee income in
the next subsequent quarter is determined by the change in average
account values to ending variable account values that occurred due to
the market changing in the preceding quarter. However, in all following
quarters, the ongoing effect of changes in the market occurring in the
current quarter will be determined by the difference in beginning of
quarter to end of quarter variable account balances. For purposes of
this guidance, the change in account values is assumed to correlate with
the change in the relevant index.
** This amount includes the impact on DAC/PVIF for the Lincoln UK
segment.
Scenario #2:
2.5% increase in equity markets from March 31, 2003 to June 30, 2003
occurs smoothly during the quarter.
Estimated Effect on Second Quarter of 2003 Results (Million $):
Segment
---------------------------------------------
Lincoln Life Investment
Retirement Insurance Management Lincoln UK LNC Total
---------------------------------------------------------
Fees- Lagging Effect of 1Q03
Market Changes on 2Q03* $(0.8) $- $(0.1) $(0.1) $(1.0)
Fees- Current Effects in
Second Quarter $0.6 $- $0.4 $0.1 $1.1
---------------------------------------------------------
Total Fee Income $(0.2) $- $0.3 $- $0.1
Other $- $- $- $- $-
GMDB-No Change Effect $(5.9) $- $- $- $(5.9)
GMDB-Market Change Effect $2.0 $- $- $- $2.0
---------------------------------------------------------
Total GMDB $(3.9) $- $- $- $(3.9)
DAC** $- $- $- $0.1 $0.1
---------------------------------------------------------
Total Effect $(4.1) $- $0.3 $0.1 $(3.7)
* See * under Scenario #1 for explanation.
** See ** under Scenario #1 for explanation.
Scenario #3:
2.5% decline in equity markets from March 31, 2003 to June
30, 2003 occurs smoothly during the quarter.
Estimated Effect on Second Quarter of 2003 Results- (Million $):
Segment
---------------------------------------------
Lincoln Life Investment
Retirement Insurance Management*** Lincoln UK LNC Total
------------------------------------------------------------
Fees- Lagging Effect of 1Q03
Market Changes on 2Q03* $(0.8) $- $(0.1) $(0.1) $(1.0)
Fees- Current Effects in
Second Quarter $(0.6) $- $(0.4) $(0.1) $(1.1)
------------------------------------------------------------
Total Fee Income $(1.4) $- $(0.5) $(0.2) $(2.1)
Other $(0.6) $- $- $- $(0.6)
GMDB-No Change Effect $(5.9) $- $- $- $(5.9)
GMDB-Market Change Effect $(4.8) $- $- $- $(4.8)
------------------------------------------------------------
Total GMDB $(10.7) $- $- $- $(10.7)
DAC** $(2.4) $(0.5) $- $(1.9) $(4.8)
------------------------------------------------------------
Total Effect $(15.1) $(0.5) $(0.5) $(2.1) $(18.2)
* See * under Scenario #1 for explanation.
** See ** under Scenario #1 for explanation.
*** The above table excludes the impact from an impairment of the
deferred dealer commission asset within the Investment Management
segment, which, in the event of an approximate 8% decline in equity
markets from March 31, 2003 levels could range from a loss of $7.3
million to $11.2 million after-tax with the application of using assumed
discount rates ranging between 10% to 18% for purposes of measuring the
fair value of the deferred dealer commission asset.
Estimated Effect of Each One-Percent Change in Equity Markets
The above examples are based upon the estimated annual effect on
earnings for each one-percentage point change in relevant equity market
indices. Taking one-fourth of this annual estimate will generate the
expected effect of the equity market change on quarterly results, with
the exception of DAC unlocking and GMDB incurred cost calculations where
the effect is fully reflected in one quarter. The estimated annual
effect in millions of dollars per one-percentage change and the changes
in each of the relevant market indices used in the above examples, are
listed in the following table.
2.50% increase 2.50% decline
No Change in Second in Second
Segment and Effect* Relevant Measure in Market Quarter 2003 Quarter 2003
- ------------------------------------------------------------------------------------------------------------------------
Lincoln Retirement - Ave Daily Change
Fee Income in S&P 500 $0.0 M x 0.0 $2.0 M x 1.25 $2.0 M x (1.25)
- ------------------------------------------------------------------------------------------------------------------------
Lincoln Retirement - Actual Change in
Other Items S&P 500 vs. Expected $0.5 M x (2.25) $0.5 M x 0.25 $0.5 M x (4.75)
- ------------------------------------------------------------------------------------------------------------------------
Lincoln Retirement - Actual Change
GMDB Incurred Costs in S&P 500 ($5.9M) ($5.9M)+ $0.8M x 2.5 ($5.9M) + ($1.9 M) x (2.5)
- ------------------------------------------------------------------------------------------------------------------------
Lincoln Retirement - Actual Change in
DAC S&P 500 vs. Expected $0.0 M** x (2.25) $0.0 M x 0.25 $0.5 M x (4.75)
- ------------------------------------------------------------------------------------------------------------------------
Life Insurance - Actual Change in
DAC S&P 500 vs. Expected $0.11 M x (2.25) $0.11 M x 0.25 $0.11 M x (4.75)
- ------------------------------------------------------------------------------------------------------------------------
Investment Management* - Blend of
Fee Income Market Indices $0.6 M x 0.0 $0.6 M x 2.5 $0.6 M x (2.5)
- ------------------------------------------------------------------------------------------------------------------------
Investment Blend of
Management - DAC*** Market Indices $0.0 M x (2.25) $0.00 M x 0.25 $0.00 M x (4.75)
- ------------------------------------------------------------------------------------------------------------------------
Lincoln UK - Ave Daily Change in
Fee Income FTSE 100 $0.2 M x 0.0 $0.2 M x 1.25 $0.2 M x (1.25)
- ------------------------------------------------------------------------------------------------------------------------
Lincoln UK - Actual Change in FTSE
DAC/PVIF 100 vs. Expected Change $0.4 M x (2.25) $0.3 M x 0.25 $0.4 M x (4.75)
- ------------------------------------------------------------------------------------------------------------------------
* The above table excludes the impact from an impairment of the deferred
dealer commission asset within the Investment Management segment. An
approximate 8% decline in equity markets from March 31, 2003 levels may
trigger a loss, which would range from $7.3 million to $11.2 million
after-tax with the application of using assumed discount rates ranging
between 10% to 18% for purposes of measuring the fair value of the
deferred dealer commission asset. The balance of the deferred dealer
commission asset as of March 31, 2003 was approximately $49 million.
** The factor for no change in market for Lincoln Retirement DAC is $0.0
M. This is because the GMDB reserve adjustment results in an increase
or decrease to estimated gross profits and therefore has an inverse
impact on DAC amortization. The interplay of GMDB reserve changes on
DAC unlocking and DAC amortization is taken into consideration in the
model.
*** The factors for a 1% change in the equity markets for the Investment
Management segment DAC are noted as $0.0 M on the above chart. This is
because the trigger points for unlocking are beyond the percentage
changes noted in the above scenarios. The trigger point for negative
DAC unlocking in the second quarter of 2003 is an approximate 18%
decline in the equity markets and the trigger point for positive
unlocking in the second quarter is an approximate 28% increase in the
equity markets.
Sensitivity Factors for Retirement Segment
As the above table indicates, the annual effect of a one percent change
in equity markets varies depending upon the severity of the change.
Presented below are estimated one million dollar effects for various
market changes that are currently used by LNC in modeling the Lincoln
Retirement segment. These estimated effects are subject to ongoing
modification, as they are particularly sensitive to the mix of business
and to the actual level of variable account balances.
The following table provides the annual effect for changes in equity
markets for the Lincoln Retirement segment related to fee income and
other:
($Millions for each 1% Change in Relevant Market Index)
- --------------------------------------------------------------------------------------
20% + 11 - 20% 6 - 10% 1 to 5% No 1 to 5% 6 - 10% 11%+
Decline Decline Decline Decline Change Increase Increase
- --------------------------------------------------------------------------------------
Fee Income (1.6) (1.8) (1.9) (2.0) - 2.0 2.1 2.2
- --------------------------------------------------------------------------------------
Other (0.5) (0.5) (0.5) (0.5) - 0.5 0.5 0.5
- --------------------------------------------------------------------------------------
The estimated annual effects indicated in the table above are applicable
for the second quarter of 2003. For example, assume an estimate is being
computed for the quarterly effect on Lincoln Retirement fee income due
to a 2.5% increase in the markets occurring in the second quarter of
2003. In this example, the expected quarterly effect of a second
quarter 2.5% increase is estimated as: ($2.0*1.25/4) = $0.63 million.
The table provided below contains information for use in estimating the
second quarter 2003 effect for changes in equity markets for the Lincoln
Retirement segment related to GMDB and DAC. For GMDB, quarterly results
will include a reserve adjustment. This is due to the fact that LNC has
established the GMDB reserves net of anticipated future GMDB fee
revenues. As a result, an adjustment will be required to increase GMDB
reserves during periods where a GMDB Net Amount At Risk exists.
Based upon the Net Amount At Risk for GMDB at March 31, 2003, the second
quarter 2003 GMDB reserve adjustment is estimated at $5.9 million
(included in the no change column in the table below).
($Millions for each 1% Change in Relevant Market Index)
- --------------------------------------------------------------------------------------
20% + 11 - 20% 6 - 10% 1 to 5% No 1 to 5% 6 - 10% 11%+
Decline Decline Decline Decline Change Increase Increase
- --------------------------------------------------------------------------------------
GMDB (2.7) (2.3) (2.1) (1.9) (5.9) 0.8 1.0 1.3
- --------------------------------------------------------------------------------------
DAC (0.9) (0.6) (0.6) (0.5) - - 0.3 0.4
- --------------------------------------------------------------------------------------
The estimated quarterly effects indicated in the table above are
applicable for the second quarter of 2003. For example, assume an
estimate is being computed for the quarterly effect on Lincoln
Retirement's GMDB reserve due to a 2.5% increase in the equity markets
occurring in the second quarter of 2003. The estimated quarterly effect
is calculated as follows: $(5.9) + 0.8 * 2.5 = $(3.9) million.
Accounting for Costs Associated with Exit or Disposal Activities. In
June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities" ("FAS 146"), which addresses financial
accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)" ("Issue 94-3"). The principal difference between FAS
146 and Issue 94-3 is that FAS 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the
liability is incurred, rather than at the date of an entity's commitment
to an exit plan. FAS 146 is effective for exit or disposal activities
after December 31, 2002. LNC adopted FAS 146 on January 1, 2003 and the
adoption of the Statement affects the timing of when an expense is
recognized for restructuring activities.
Accounting for Stock-Based Compensation. On December 31, 2002, the
Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation-
Transition and Disclosure" ("FAS 148"), which provides alternative
methods of transition for entities that change to the fair value method
of accounting for stock-based employee compensation.
The three transition methods provided under FAS 148 are the prospective,
the modified prospective and the retroactive restatement methods. LNC
adopted the retroactive restatement method, which requires that
companies restate all periods presented to reflect stock-based employee
compensation cost under the fair value accounting method in FAS 123 for
all employee awards granted, modified or settled in fiscal years
beginning after December 15, 1994. LNC adopted the fair value method of
accounting under FAS 123, as amended by FAS 148, as of January 1, 2003
and has restated financial statements for the years 2002 and 2001.
Effective January 1, 2003, LNC's employee stock option compensation plan
and long-term cash incentive compensation plan were revised and combined
to provide for performance vesting, and to provide for awards that may
be paid out in a combination of stock options, performance shares of LNC
stock and cash. The performance measures for the initial grant under
the new plan will be calculated over a three-year period from grant date
and will compare LNC's performance relative to a selected group of peer
companies. Comparative performance measures will include relative
growth in earnings per share, return on equity and total share
performance. Certain participants in the new plans selected from seven
different combinations of stock options, performance shares and cash in
determining the form of their award. Other participants will have their
award paid in performance shares. This plan replaces the current LNC
stock option plan; however, the separate stock option incentive plans
established by Delaware Investments U.S., Inc. ("DIUS") and DIAL Holding
Company, Inc. ("DIAL"), both wholly-owned subsidiaries of Delaware
Management Holdings, Inc., will continue.
The following table provides the impact of the restatement for
stock-based compensation for the years ended December 31, 2002 and 2001.
For the effect of the restatement on the first quarter of 2002, refer
to Note 2 to the March 31, 2003 unaudited consolidated financial
statements and the discussion of results of operations for each business
segment.
After-tax effect of the retroactive adoption of FAS 123 fair value
method of accounting for stock options on previously reported Net
Income for LNC's segments:
Year Ended December 31,
(in millions) 2002 2001
------ ------
Lincoln Retirement $(4.1) $(4.1)
Life Insurance (2.9) (3.8)
Investment Management (27.1) (20.7)
Lincoln UK (2.3) (2.1)
Other Operations (6.4) (13.9)
------- -------
Total $(42.8) $(44.6)
======= =======
Accounting for Variable Interest Entities. In January 2003, the
Financial Accounting Standards Board issued Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("Interpretation 46"),
which requires the consolidation of variable interest entities ("VIE")
by an enterprise if that enterprise has a variable interest that will
absorb a majority of the VIE's expected losses if they occur, receive a
majority of the entity's expected residual returns if they occur, or
both. If one enterprise will absorb a majority of a VIE's expected
losses and another enterprise will receive a majority of that VIE's
expected residual returns, the enterprise absorbing a majority of the
losses shall consolidate the VIE. VIE refers to an entity in which
equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated
financial support from other parties. This Interpretation applies in
the third quarter of 2003 to VIEs in which an enterprise holds a
variable interest that is acquired before February 1, 2003. This
Interpretation may be applied prospectively with a cumulative-effect
adjustment as of the date on which it is first applied or by restating
previously issued financial statements for one or more years with a
cumulative-effect adjustment as of the beginning of the first year
restated.
Among the matters that LNC is currently reviewing in connection with the
third quarter 2003 effective date of Interpretation No. 46 to existing
VIEs is the potential application to Collateralized Debt Obligation
(CDO) pools that are managed by LNC. Because the fees earned by LNC for
managing these CDOs are required to be included in the analysis of
expected residual returns, it is possible that such CDO pools may fall
under the consolidation requirements of Interpretation No. 46. While
LNC does not currently have access to all information necessary to
determine the ultimate effects of such a required consolidation (because
LNC is not the trustee or the administrator to the CDOs), based upon
currently available information LNC estimates that the effect of
consolidation would result in recording additional assets and
liabilities on LNC's consolidated balance sheet of about $800 million.
If such liabilities are required to be recorded, LNC would disclose that
such liabilities are without recourse to LNC, as LNC's role of
investment manager for such CDO pools does not expose LNC to risk of
loss.
Although LNC and the industry continue to review the new rules, at the
present time LNC does not believe there are other significant VIEs that
would result in consolidation with LNC, beyond the managed CDOs
discussed above.
Accounting for Modified Coinsurance. In April 2003, the Financial
Accounting Standards Board's ("FASB") Derivative Implementation Group
issued Statement 133 Implementation Issue No. B36 addressing the
treatment of modified coinsurance agreements and coinsurance with funds
withheld reinsurance agreements. This implementation guidance concluded
that modified coinsurance and funds withheld reinsurance agreements
contain embedded derivatives that must be accounted for separately from
the underlying reinsurance agreements. Companies that have ceded
business under these types of reinsurance arrangements may reclassify
securities from available-for-sale to trading account classification,
where such securities relate to the embedded derivatives that will be
newly accounted for in conjunction with the initial application of these
new rules. The effective date for adoption is for quarters beginning
after September 15, 2003. LNC expects to adopt in the fourth quarter of
2003. LNC is currently evaluating the impact of this change on its
consolidated financial statements.
Restructuring Charges
For an update on the status of restructuring plans implemented from 1999
through March 31, 2003, refer to Note 9 to the March 31, 2003 unaudited
consolidated financial statements.
RESULTS OF OPERATIONS BY SEGMENT
Lincoln Retirement
Results of Operations
Three Months Ended March 31 (in millions) 2003 2002
- --------------------------------------------------------------------
Net Income $6.9 $46.6
Items Included in Net Income:
Realized Gain (Loss) on Investments and
Derivative Instruments (after-tax) (50.5) (32.8)
March 31 (in billions) 2003 2002
- --------------------------------------------------------------------
Account Values
Variable Annuities $26.5 $35.2
Fixed Annuities 20.6 18.2
Reinsurance Ceded (2.1) (1.7)
------ ------
Total Fixed Annuities 18.5 16.5
Total Account Values $45.0 $51.7
Average Daily Variable Account Values $26.9 $34.3
Net income decreased $39.7 million or 85% for the first three months of
2003 compared to the same period in 2002.
Stock-Based Compensation
The first three months of 2002 have been restated for the adoption of
FAS 123 and FAS 148. See the discussion under the topic "Accounting
for Stock-Based Compensation" presented in the Consolidated Results of
Operations for further discussion of this matter. The effect of adoption
was a decrease of $1.0 million in net income in the first three months of
2002 from previously reported amounts.
Realized Losses on Investments and Derivative Instruments
The Lincoln Retirement segment had an increase in realized losses on
investments and derivative instruments of $17.7 million in the first
quarter of 2003 compared to the same period in 2002. For additional
detail on realized losses see the discussion in the Consolidated
Investments section.
Equity Market Impact
The decline in the equity markets negatively affected the segment's
earnings through lower fees resulting from lower average variable account
values, negative unlocking of deferred acquisition costs ("DAC") and the
present value of in-force intangible ("PVIF"), an increase in reserves and
benefit payments for guaranteed minimum death benefits ("GMDB") and
decreased tax benefits from separate account dividends received deductions
("DRD"). The decline in the equity markets negatively affected earnings by
$23.8 million in the first quarter of 2003 compared to the same period in
2002.
Average variable annuity account values in the first quarter of 2003
were $7.4 billion lower than in the first quarter of 2002 resulting in a
reduction in fees, lowering earnings by $13.0 million. The effect of
equity market impact on DAC and PVIF unlocking and net changes in
amortization increased earnings by $0.2 million compared to the first
three months of 2002. Increases in GMDB reserves and benefit payments
resulted in a negative variance between the comparative three-month
periods of $11.0 million. Reserves for GMBD increased from $13.7
million at March 31, 2002 and $84.5 million at December 31, 2002 to
$91.7 million at March 31, 2003.
Refer to the Second Quarter 2003 Guidance for Estimated Effect of Equity
Market Volatility section for estimates of the effect of movements in
the equity markets on Lincoln Retirement's earnings.
Investment Margins
Investment margins on fixed annuities were $6.9 million higher in the
first quarter of 2003 compared to the first quarter of 2002. The increase
in margins was a result a reduction in crediting rates. (See further
discussion on investment margins and the interest rate risk due to
falling interest rates in Item 3, Quantitative and Qualitative
Disclosures About Market Risk.)
Earnings from investment partnerships relative to expected performance
have been a drag on Lincoln Retirement earnings in the last several
quarters. Performance improved in the first quarter of 2003 and was
$0.5 million higher than the first quarter of 2002.
Net Flows
Average fixed annuity account values at March 31, 2003 were $2.6 billion
higher than at March 31, 2002. This increase contributed additional
earnings of $6.2 million in the first quarter of 2003 compared to the
same period in 2002. The increase in fixed annuity account values was
due to the positive net flows for fixed annuities. (See below for
further discussion of net flows.)
Restructuring Charge
In the first quarter the Lincoln Retirement segment announced it is
consolidating its fixed annuity operations in Schaumburg, Illinois into
Fort Wayne, Indiana. For further details refer to Note 9 to the March
31, 2003 unaudited consolidated financial statements.
Expenses
General and administrative expenses for Lincoln Retirement were
relatively flat between the first quarter of 2003 and 2002.
Critical Accounting Policy - Deferred Acquisition Costs
Refer to Management's Discussion and Analysis of LNC's annual report on
Form 10-K for the year ended December 31, 2002, for a detailed
discussion of this critical accounting policy. At March 31, 2003
Lincoln Retirement's reversion to the mean gross growth rate assumption for
the equity markets was 10.2% which compares to the assumption of 9% at
December 31, 2002. The increase in the growth rate was due to the
decline in the equity markets in the first quarter of 2003.
Critical Accounting Policy - Guarantee Minimum Death Benefit Reserving
Refer to Management's Discussion and Analysis of LNC's annual report on
Form 10-K for the year ended December 31, 2002, for a detailed
discussion of this critical accounting policy. At March 31, 2003,
Lincoln Retirement's net amount at risk ("NAR") was $5.0 billion and the
GAAP reserve was $91.7 million. The reserve for statutory accounting
was $159.6 million. The comparable amounts at December 31, 2002 were a
NAR of $4.6 billion, GAAP reserve of $84.5 million and statutory reserve
of $144.1 million. See the table below for additional statistics
related to GMDB as of March 31, 2003:
Return of High Water
Premium Mark Roll-Up No GMDB Total
--------- ---------- ------- -------- --------
Variable Annuity Account
Value (billions) $18.5 $9.1 $0.3 $8.4 $36.3
% of Total Annuity
Account Value 50.9% 25.1% 0.8% 23.2% 100.0%
Average Account Value $31,272 $57,415 $91,839 $44,619 $41,760
Average NAR $6,171 $20,801 $18,257 N/A $10,733
GAAP Reserve (millions) $30.0 $61.3 $0.4 N/A $91.7
NAR (billions) $1.9 $3.0 $0.1 N/A $5.0
Average Age of Contract
Holder 51 61 63 58 54
% of Contract Holders >
70 Years of Age 9.3% 25.0% 29.0% 20.9% 13.8%
As described in LNC's annual report on Form 10-K for the year ended
December 31, 2002, LNC has variable annuity contracts containing GMDB's
which have a dollar for dollar withdrawal feature. As of March 31, 2003,
there were 409 contracts for which the death benefit to account value ratio
was greater than ten to one. The NAR on these contracts was $28.2 million.
Effective May of 2003, the GMDB feature offered on new sales will be a
pro-rata GMDB feature whereby each dollar of withdrawal will reduce the
GMDB benefit in proportion to the current GMDB to account value ratio.
Net Flows
Three Months Ended March 31 (in billions) 2003 2002
- ------------------------------------------------------------------
Variable Portion of Annuity Deposits $0.6 $0.8
Variable Portion of Annuity Withdrawals (0.8) (0.9)
------- -------
Variable Portion of Annuity Net Flows (0.2) (0.1)
Fixed Portion of Variable Annuity Deposits 0.4 0.4
Fixed Portion of Variable Annuity Withdrawals (0.2) (0.3)
------- -------
Fixed Portion of Variable Annuity Net Flows 0.2 0.1
Fixed Annuity Deposits 0.4 0.5
Fixed Annuity Withdrawals (0.3) (0.4)
------- -------
Fixed Annuity Net Flows 0.1 0.1
Total Annuity Net Flows $0.1 $0.1
Incremental Deposits (1) $1.4 $1.6
(1) Incremental Deposits represent gross deposits reduced by transfers
from other Lincoln annuity products.
Net Flows and Product Sales
In the first three months of 2003, the Lincoln Retirement segment
experienced positive net flows for the seventh consecutive quarter.
Compared to the first quarter of 2002, net flows were flat. Although
gross annuity deposits were down, the Lincoln Retirement segment
experienced an improvement in persistency in the first quarter of 2003
relative to the first quarter of 2002. Overall gross annuity deposits
declined $290 million or 17% in the first three months of 2003 compared
to the same period in 2002. The decline occurred with sales of both
individual variable and fixed annuities. American Legacy Variable
Annuity gross deposits were down $177 million or 36%, while Lincoln
ChoicePlusSM gross variable and fixed annuity deposits were down 25%.
In order to improve sales of variable annuities, the Lincoln Retirement
segment expects to introduce the Lincoln Principal SecuritySM feature
which provides the contractholder with a guaranteed living benefit.
This new feature is in response to growing consumer demand for
guarantees in variable annuity products. The feature will be available
for an additional fee and will provide a guarantee equal to the initial
purchase payment (or contract value if elected after issue) as adjusted
for subsequent purchase payments and withdrawals. It also will allow
investors to make annual withdrawals up to the amount of their original
deposit, provided each annual withdrawal is less than seven percent of
the initial deposit. LNC will waive fees for this feature after year
five as long as withdrawal activity has been and remains minimal and the
benefit has not been reset, an innovative element in the Guaranteed
Minimum Withdrawal Benefit (GMWB) market. In order to manage the equity
market risk associated with this feature, the Lincoln Retirement segment
intends to utilize a hedging strategy. Lincoln Retirement expects to
introduce the Lincoln Principal SecuritySM feature in June of 2003 and
expects this feature to have a positive affect on sales in the second
half of 2003.
In addition to the introduction of the Lincoln Principal SecuritySM
feature, Lincoln Financial Distributors ("LFD") will be adding new
wholesalers to market variable annuity products. These wholesalers are
expected to be in place during the third quarter of 2003. The increase
in wholesalers is expected to strengthen LNC's penetration in the
variable annuity market.
Partially offsetting the decline in individual annuities product sales
was an increase in employer-sponsored annuity product sales, which were
up $145 million or 29% in the first quarter of 2003 compared to the same
period in 2002. The strong sales performance within employer-sponsored
annuities is a result of increased deposits in the Alliance program.
Sales of the Alliance program were $337 million in the first quarter of
2003, up from $149 million in the first quarter of 2002. Alliance sales
are expected to be lower in the second quarter of 2003 relative to the
first quarter of 2003 as the first quarter benefited from the large
number of enrollments from employer-sponsored plans in the fourth
quarter of 2002.
Life Insurance
Results of Operations
Three Months Ended March 31 (in millions) 2003 2002
- ------------------------------------------------------------------------
Net Income $48.5 $43.5
Items Included in Net Income:
Realized Loss on Investments and Derivatives
Instruments (after-tax) (8.6) (26.9)
Restructuring Charges (after-tax) (3.6) -
First Year Premiums (by Product)
Universal Life $130.8 $86.4
Variable Universal Life 24.4 39.0
Whole Life 6.4 5.3
Term 9.1 8.7
------- -------
Total Retail 170.7 139.4
Corporate Owned Life Insurance ("COLI") 10.6 6.9
------- -------
Total First Year Premiums $181.3 $146.3
March 31 (in billions) 2003 2002
- ------------------------------------------------------------------------
Account Values
Universal Life $8.3 $7.6
Variable Universal Life 1.7 1.9
Interest-Sensitive Whole Life 2.2 2.2
------- -------
Total Life Insurance Account Values $12.2 $11.7
In Force - Face Amount
Universal Life and Other $126.4 $122.3
Term Insurance 133.3 117.8
------- -------
Total In-Force $259.7 $240.1
Net income increased $5.0 million or 11% for the first three months of
2003 compared to the same period in 2002.
Stock-Based Compensation
The first three months of 2002 have been restated for the adoption of FAS
123 and FAS 148. See the discussion under the topic "Accounting for
Stock-Based Compensation" presented in the Consolidated Results of
Operations for further discussion of this matter. The effect of adoption
was a decrease of $0.7 million in net income in the first three months of
2002 from previously reported amounts.
Realized Losses on Investments and Derivative Instruments
The Life Insurance segment had an improvement of $18.3 million in
realized investment losses, for the first three months of 2003 relative
to the first three months of 2002. For additional detail on realized
losses see the discussion in the Consolidated Investments section.
Mortality
Improved mortality margin (mortality assessments less net death
benefits, net of DAC unlocking) resulted in a $2.3 million increase in
earnings in the first three months of 2003 over the same period in 2002.
Investment Margins
Lower investment margins reduced income by $2.5 million in the first
three months of 2003 compared to the same period in 2002. The reduction
in investment margins was primarily due to lower investment yields.
This unfavorable variance is primarily related to traditional whole life
insurance products and corporate account investments where LNC bears the
risk for falling interest rates. For universal life and interest
sensitive whole life insurance products, the impact of lower yields were
offset by lowering credited rates to the customers (except for policies
which were already at their guaranteed minimum interest rate). (See
discussion on investment margins and the interest rate risk due to
falling interest rates in Item 3, Quantitative and Qualitative
Disclosures About Market Risk.)
Equity Market Impact
The negative performance of the equity markets resulted in negative DAC
unlocking of $0.6 million in the first quarter of 2003 compared to the
same period in 2002. There was no DAC unlocking in the Life Insurance
segment related to the equity markets in the first quarter of 2002. In
addition to the unlocking impact, the down markets over the last twelve
months have negatively impacted the Life Insurance segment's asset-based
fee revenue on variable universal life ("VUL") insurance products (less
than 15% of account values are VUL). Refer to the Second Quarter 2003
Guidance for Estimated Effect of Equity Market Volatility section for
estimates of the effect of movements in the equity markets on the Life
Insurance segment's earnings.
Critical Accounting Policy - DAC and PVIF
Refer to Management's Discussion and Analysis of LNC's annual report on
Form 10-K for the year ended December 31, 2002, for a detailed
discussion of this critical accounting policy. In the first quarter of
2003, the Life Insurance segment experienced DAC unlocking of $7.9
million related to items other than equity market performance primarily
due to an increase in face amount reductions. The increase in face
amount reductions have been driven by advanced sales design and clients
requesting reductions as a result of a reduced need for life insurance
coverage as their wealth has declined from the weakened economy.
Included in the DAC unlocking was $5.5 million related to a change in
future assumptions regarding face amount reductions (i.e. prospective
unlocking). In addition to the DAC unlocking, the revised face amount
reduction assumptions are expected to lower future gross profits
resulting in an increase in DAC amortization. In the first quarter of
2003, there was an increase of $1.6 million in the rate of amortization
compared to the same period in 2002.
Restructuring Costs
In the first quarter of 2003 the Life Insurance segment announced it is
realigning operations in Hartford, Connecticut and Schaumburg, Illinois
to enhance productivity, efficiency and scalability while positioning
the segment for future growth. In the first quarter of 2003, the Life
Insurance segment incurred restructuring expenses of $3.6 million and
other expenses of $0.5 million related to the realignment activities.
For further details refer to Note 9 to the March 31, 2003 unaudited
consolidated financial statements.
In-force and Product Sales
As measured by life insurance in-force, the Life Insurance segment
increased 8% from March 31, 2002 primarily due to strong growth in term
life insurance in-force (up 13%). Account values increased $0.5 billion
or 4% from March 31, 2002. The drivers of this increase were positive
net flows, net of policyholder assessments, of approximately $0.4
billion across all products during the last twelve months and interest
earned on the fixed products. These increases were partially offset by
the negative effect of the equity markets on VUL account values.
Total sales as measured by first year premiums were up $35.0 million or
24% and retail sales were up $31.3 million or 22% in the first three
months of 2003 compared to the prior year period. In the first three
months of 2003, sales of universal life ("UL") insurance products
improved by $44.4 million or 51%. The increase in UL products was a
result of the volatile equity markets and continued movement from
variable life insurance products to interest-sensitive products. In
contrast to the growth in UL sales, sales of variable universal life
insurance ("VUL") were down $14.6 million or 37% from the prior year
period. Retail Sales results through LNC's distribution organizations
were mixed as sales through LNC's financial planning organization
Lincoln Financial Advisors ("LFA") were flat for in the first quarter of
2003 relative to the same period in 2002 and sales through Lincoln
Financial Distributors ("LFD") were up 32%.
Investment Management
Results of Operations
Three Months Ended March 31
(in millions) 2003 2002
- -----------------------------------------------------------------------
Total Revenue $102.1 $107.3
Total Investment Advisory Fees
(Included in Total Revenue) 68.3 73.0
Net Income 1.0 2.1
Items Included in Net Income:
Realized Loss on Investments (after-tax) (0.3) (1.0)
Income Statement Reclassifications
In the first quarter of 2003, certain reclassifications have been made
in the prior periods to conform to the current year presentation. As a
result, the first quarter 2002 Investment Advisory fees increased by
$3.8 million with a corresponding increase in expenses. In addition,
foreign taxes of $1.7 million were reclassified from operating expenses
to the federal income tax line.
Net Income
Net income decreased $1.1 million in the first quarter of 2003 from the
same period in 2002 primarily relating to lower revenues as the decline in
the equity markets over the last year reduced the retail and institutional
assets under management. Refer to the Second Quarter 2003 Guidance for
Estimated Effect of Equity Market Volatility section for estimates of the
effect of movements in the equity markets on the Investment Management
segment's earnings.
Stock-Based Compensation
The first three months of 2002 have been restated for the adoption of FAS
123 and FAS 148. See the discussion under the topic "Accounting for
Stock-Based Compensation" presented in the Consolidated Results of
Operations for further discussion of this matter. The effect of adoption
was a decrease of $4.9 million in net income for the first three months of
2002 from previously reported amounts.
Net Flows
Positive net cash flows of $2.4 billion over the 12 months ended March
31, 2003 has helped to partially offset the effect of the equity markets
on assets under management.
Critical Accounting Policy - Deferred Acquisition Costs
In the first quarter of 2003, the Investment Management segment
implemented a new system for calculating the amortization of deferred
acquisition costs consistent with the system and methodology utilized by
the Lincoln Retirement and Life Insurance segments. As a result, lower
DAC amortization increased earnings by $1.4 million in the first quarter of
2003 compared to the same period in 2002.
Critical Accounting Policy - Deferred Dealer Commission Asset
At March 31, 2003, the Investment Management segment has a deferred
dealer commission asset of approximately $49 million relating to upfront
sales commissions paid to brokers for the sale of "Class B" shares of
Delaware Investments retail mutual funds. Refer to Management's
Discussion and Analysis of LNC's Annual Report on Form 10-K for the year
ended December 31, 2002 for a detailed discussion of this critical
accounting policy.
A review of the deferred dealer commission asset was performed as of
March 31, 2003. Based on information currently available, it is
estimated that a decline of approximately 8% in the equity markets from
March 31, 2003 levels may trigger a loss, which would range from
approximately $7.3 million to $11.2 million after-tax with the
application of assumed discount rates ranging between 10% to 18% for
purposes of measuring the fair value of the deferred dealer commission
asset.
Assets Under Management and Net Flows(1)
The Investment Management segment's assets under management were as
follows:
March 31 (in billions) 2003 2002
- ----------------------------------------------------------------------
Assets Under Management
Regular Operations:
Retail-Equity $14.3 $18.2
Retail-Fixed 7.9 7.1
------- -------
Total Retail 22.2 25.3
Institutional-Equity 15.9 18.7
Institutional-Fixed 7.6 6.0
------- -------
Total Institutional 23.5 24.7
Insurance Assets 42.1 37.2
------- -------
Total Assets Under Management $87.8 $87.2
The Investment Management segment's net flows were as follows:
Three Months Ended March 31
(in billions) 2003 2002
- ----------------------------------------------------------------------
Retail:
Equity Sales $0.7 $0.9
Equity Redemptions and Transfers (0.9) (0.8)
------- -------
Net Flows (0.2) 0.1
Fixed Sales 0.4 0.3
Fixed Redemptions and Transfers (0.2) (0.3)
------- -------
Net Flows 0.2 --
Total Retail Net Flows -- 0.1
------- -------
Institutional:
Equity Inflows 0.5 0.7
Equity Withdrawals and Transfers (0.5) (0.5)
------- -------
Net Flows -- 0.2
Fixed Inflows 0.6 0.8
Fixed Withdrawals and Transfers (0.3) (0.3)
------- -------
Net Flows 0.3 0.5
------- -------
Total Institutional Net Flows 0.3 0.7
------- -------
Total Retail and Institutional Net Flows $0.3 $0.8
Assets Under Management and Net Flows
Assets under management increased $0.6 billion to $87.8 billion at March
31, 2003 compared to March 31, 2002. The increase was primarily the
result of a $4.9 billion increase in insurance assets (i.e. primarily
general account assets of LNC's insurance subsidiaries). Institutional
assets under management decreased $1.2 billion as a result of market
depreciation of $2.9 billion from overall declines in the equity
markets, offset by positive net inflows of $1.7 billion over the last 12
months. Retail assets under management decreased $3.1 billion primarily
from market depreciation of $3.8 billion due to the overall declines in
the equity markets, offset by $0.7 billion positive net flows during the
last 12 months.
The Investment Management segment's net flows remained positive in the
first quarter of 2003. However, total net flows in the first quarter of
2003 were down approximately $0.5 billion compared to the first quarter
of 2002. The net flows were less than the previous period primarily as
a result of $0.4 billion less in institutional net flows. The
Investment Management segment retained institutional assets as evidenced
by similar levels of withdrawals and transfers between periods, but
institutional sales were down $0.4 billion. Sales in the first quarter
of 2002 included a large institutional inflow of approximately $0.7
billion. Sales in the institutional business tend to fluctuate from
period to period depending upon when large mandates are received.
Retail sales were down $0.1 billion in the first quarter of 2003
compared to the same period in 2002. The decline in sales was
concentrated within the annuities products managed by the Investment
Management segment. Sales of managed account products were up 29% over
the first quarter of 2002. However, for the year of 2003 managed
account sales are expected to be lower than the full year of 2002 as
sales in the third and fourth quarters of 2002 were higher than the
previous quarters of the year as a result of events effecting key
competitors (a group departure of investment professionals from one firm
and a second firm temporarily closing for new business).
Investment Performance
Positive investment performance has been a key driver of the improvement
in net flows. On the institutional side, for the twelve months ended
March 31, 2003, 6 of the 8 largest product composites met or
outperformed their respective indices and these 6 composites accounted
for approximately 85% of institutional assets under management. This
relative performance is above the results experienced for the year ended
December 31, 2002, in which 4 of the 8 largest composites outperformed
their respective indices. On the retail side, for the twelve months
ended March 31, 2003, 17 of 25 or 68% of the largest retail funds in
Delaware Investments Family of Funds (the Delaware Investments Family of
Funds does not include mutual funds managed by Delaware for certain LNC
affiliates) performed in the top half of their respective Lipper
universes. These 17 funds represented 64% of assets under management of
the largest 25 retail funds at March 31, 2003. At March 31, 2003, 39
of Delaware's 52 retail funds have been labeled a Lipper Leader in at
least one category and 19 funds have been selected in multiple
categories. For the Managed Accounts, 5 of the 6 largest product
composites outperformed their respective indices for the one-year period
ending March 31, 2003.
Lincoln UK
Results of Operations
Three Months Ended March 31
(in millions) 2003 2002
- ----------------------------------------------------------------------
Net Income $6.8 $10.3
Items Included in Net Income:
Realized Loss on Investments
(after-tax) -- (3.6)
March 31 (in billions) 2003 2002
- ----------------------------------------------------------------------
Unit-Linked Assets $4.7 $5.6
Individual Life Insurance In-Force $18.5 $20.0
Exchange Rate Ratio - U.S.
Dollars to Pounds Sterling
Average for the Period 1.605 1.423
End of Period 1.580 1.426
Net income for the first three months of 2003 decreased $3.5 million or 34%.
Stock-Based Compensation
The first three months of 2002 have been restated for the adoption of FAS
123 and FAS 148. See the discussion under the topic "Accounting for
Stock-Based Compensation" presented in the Consolidated Results of
Operations for further discussion of this matter. The effect of adoption
was a decrease of $0.6 million in net income in the first three months of
2002 from previously reported amounts.
Realized Losses on Investments
There was an improvement of $3.6 million in realized losses on investments
as the Lincoln UK segment had no net realized losses in the first quarter
of 2003. The losses in the first quarter of 2002 resulted from a
realignment of the Lincoln UK segment's equity investment portfolio for
asset/liability management purposes.
Equity Market Impact
The FSTE 100 index declined 8.3% from December 31, 2002 to March 31, 2002
and declined 31.5% from March 31, 2002. This decline in the UK equity
markets resulted in lower fee income of $2.5 million from unit-linked
accounts and negative net unlocking of $3.6 million of the DAC and PVIF
assets and the deferred front end load revenue ("DFEL") compared to the
first quarter of 2002.
Critical Accounting Policy - Equity Market Sensitivity
Refer to the Second Quarter 2003 Guidance for Estimated Effect of Equity
Market Volatility section for estimates of the effect of movements in
the equity markets on the Investment Management segment's earnings.
Taxes
The Lincoln UK segment's effective tax rate increased in the first quarter
of 2003 compared to the same period in 2002. In 2002, the effective tax rate
was lower than 35% due to the existence of excess foreign tax credits from
years prior to 2002. Now that the foreign tax credits have been fully
utilized, the effective tax rate is expected to be approximately 35%. The
performance of the equity markets could result in future changes to the
Lincoln UK segment's effective tax rate. The increase in the effective tax
rate reduced earnings by $4.3 million in the first three months of 2003
compared to the same period in 2002.
Other Operations
Results of Operations (1)
Three Months Ended March 31 (in millions) 2003 2002
- ---------------------------------------------------------------------------
Net Income by Source:
LFA ($10.4) ($10.1)
LFD (8.1) (6.6)
LNC Financing (15.3) (8.2)
Other Corporate 0.4 (4.5)
Amortization of Deferred Gain
on Indemnity Reinsurance 11.8 15.7
Realized Loss on Investments and Derivatives -- (3.2)
------- ------
Net Loss (21.6) (16.9)
Items Included in Net Loss:
Realized Loss on Investments
and Derivatives (after-tax) -- (3.2)
The net loss reported within Other Operations for the first three months
of 2003 was $4.7 million higher as compared to the first three months of
2002. The primary reasons behind this increased loss are described
below.
Stock-Based Compensation
The first three months of 2002 have been restated for the adoption of
FAS 148. See the discussion under the topic "Accounting for Stock-Based
Compensation" presented in the Consolidated Results of Operations for
further discussion of this matter. The effect of adoption was a
decrease of $1.0 million in net income for LFA and a decrease of $0.3
million for LFD in the first three months of 2002 from previously reported
amounts.
Lincoln Financial Advisors ("LFA")
LFA had an increase in the net loss of $0.3 million in the first quarter
of 2003 compared to the same period in 2002. LFA's net revenues (gross
revenues net of commissions) were down $4.5 million as sales,
particularly sales of variable products, have been negatively impacted by
the equity markets. Overall sales of LNC's life insurance products by
LFA was relatively flat resulting in a 2% increase in revenues from Life
Insurance as sales of universal life insurance products offset lower
sales of variable universal life insurance products. Overall fees
received for financial plans and average fees per plan both increased 7%
in the first quarter of 2003 compared to the first quarter of 2002. In
addition, LFA continues to actively manage its expenses while continuing
to focus on expansion of its planner base. The net number of planners
(new planners joining LFA less planners leaving LFA) increased nearly 3%
compared to the first quarter of 2002.
Lincoln Financial Distributors ("LFD")
LFD experienced an increase of $1.5 million in net loss in the first
quarter of 2003 compared to the same period in 2002. LFD's net loss
increased as lower sales reduced net revenues (gross revenues net of
variable expenses). Although sales of Life Insurance and Investment
products through LFD were up 34% and 11%, respectively, sales of annuity
products were down 35% in the first quarter of 2003 compared to the same
period in 2002.
LNC Financing
LNC Financing costs were $7.1 million higher in the first quarter of 2003
compared to the same period in 2002. In the first quarter of 2002, LNC
Financing included investment income of $7.8 million from the proceeds
of the sale of LNC's reinsurance business to Swiss Re. During 2002, the
proceeds were reduced by the repurchase of LNC stock and various
financing activities. In December of 2002, the remaining proceeds were
allocated to LNC's business units, primarily the Lincoln Retirement and
Life Insurance segments. Excluding the investment income from the Swiss
Re proceeds, LNC's financing costs declined due to lower interest rates
and changes in LNC's debt structure, including the elimination of the
outstanding commercial paper balance in the U.K. in the second quarter
of 2002.
Other Corporate
Other Corporate had an improvement of $4.9 million in the first quarter
of 2003 compared to the same period in 2002. In 2002, certain overhead
expenses were not allocated to the business segments, but were reported
within Other Corporate. In addition, the first quarter of 2002 had
costs associated with the true-up of incentive compensation costs for
2001.
Amortization of Deferred Gain
The amortization of the deferred gain on the indemnity reinsurance
transfer of LNC's reinsurance business to Swiss Re was lower in the
first quarter of 2003 compared to the same period in 2002. In the first
quarter of 2002, accelerated amortization of $1.3 million was recognized
due to the novation of certain Canadian business to Swiss Re. In
addition, the amortization in 2003 is lower as a result of adjustments
to the deferred gain resulting from the settlement with Swiss Re in the
fourth quarter of 2002.
Critical Accounting Policy - Personal Accident and Disability Income Reserves
Refer to Management's Discussion and Analysis of LNC's annual report on
Form 10-K for the year ended December 31, 2002, for a detailed
discussion of this critical accounting policy.
CONSOLIDATED INVESTMENTS
(in billions) March 31, December March 31,
2003 31, 2002 2002
- ---------------------------------------------------------------------------
Assets Managed by Advisor
Investment Management Segment (1):
External Assets $45.7 $46.5 $50.0
Insurance Assets 42.1 41.1 37.2
Lincoln UK 6.0 6.4 6.8
Within Business Units (Policy Loans) 1.9 1.9 1.9
By Non-LNC Entities 19.2 20.0 26.9
------- ------- --------
Total Assets Managed $114.9 $115.9 $122.8
Total Invested Assets $41.0 $40.0 $36.4
Mean Invested Assets (cost basis) $40.34 $38.17
Three Months Ended March 31 (in millions) 2003 2002
- ---------------------------------------------------------------------------
Net Investment Income (pre-tax) $654.6 $654.8
Adjusted Net Investment Income (pre-tax) (2) 656.4 656.3
Investment Yield (ratio of net investment
Income to mean invested assets) 6.51% 6.88%
(1) See Investment Management segment data for additional detail.
(2) Includes tax-exempt income.
The total investment portfolio increased $1.0 billion in the first three
months of 2003 from December 31, 2002, resulting from purchases of
investments from cash flow generated by the business segments and an
increase in the fair value of securities available-for-sale.
LNC's insurance assets are invested primarily in high quality fixed
maturity securities that are expected to generate cash flows that will
enable LNC to meet the liability funding requirements of LNC's life
insurance and annuity businesses. LNC has the ability to maintain its
investment holdings throughout credit cycles because of its capital
position, the long-term nature of its liabilities and matching of LNC's
portfolios of investment assets with the liabilities of LNC's various
products. It is LNC's intent, and has been its practice, to hold
investments to maturity to meet insurance and annuity liabilities.
The quality of LNC's fixed maturity securities portfolio as of March 31,
2003 was as follows:
Treasuries and AAA 20.2% BBB 35.5%
AA 5.5% BB 3.5%
A 32.2% Less than BB 3.1%
The ratings data listed above have been determined by using the lowest
of all publicly available ratings assigned to a particular fixed
maturity security. If no public ratings exist, a rating is assigned
based upon LNC's analysis of the inherent risks of the individual
security.
As of March 31, 2003 and December 31, 2002, $2.2 billion or 6.6% and
$2.1 billion or 6.6%, respectively, of fixed maturity securities were
invested in below investment grade securities (less than BBB). This
represents 5.4% and 5.3% of the total investment portfolio at March 31,
2003 and December 31, 2002, respectively. When viewed on a cost basis,
below investment grade securities held at March 31, 2003 and December
31, 2002 represent 8.0% and 8.4% of the total investment portfolio.
During the three months ended March 31, 2003, the aggregate cost of
below investment grade securities purchased was $24.8 million.
Aggregate proceeds from such investments sold were $21.7 million,
resulting in a net realized pre-tax gain at the time of sale of $3.2
million. This gain does not include the effect on DAC and does not
include securities that were purchased at investment grade and
subsequently fell below investment grade at or prior to the disposal
date.
LNC's fixed maturity securities include residential and commercial
mortgage-backed securities. Given that LNC's current product mix
reflects a growing emphasis on fixed products, LNC has been relatively
conservative in its asset allocation to residential mortgage-backed
securities. LNC manages its prepayment risk on residential
mortgage-backed securities by prudently limiting the portion of its
fixed maturity portfolio that is invested in 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 purchasing securities with enhanced priority in the
trust structure. LNC's investments in residential mortgage-backed
securities at March 31, 2003 and December 31, 2002 totaled $2.8
billion and $3.1 billion, respectively. At March 31, 2003 and December
31, 2002, LNC's investments in commercial mortgage-backed securities
totaled $2.1 billion and $1.8 billion, respectively.
The fair value for all private securities was $4,620.1 million and
$4,601.3 million at March 31, 2003 and December 31, 2002, respectively,
representing about 11.3% and 11.5% of total invested assets,
respectively. This excludes section 144 registered securities, which
have fair values that are readily available for these publicly-traded
securities.
LNC's entire fixed maturity and equity securities portfolio is
classified as "available-for-sale" and is carried at fair value.
Changes in fair value, net of related deferred acquisition costs,
amounts required to satisfy policyholder commitments and taxes, are
charged or credited directly to shareholders' equity. Other than
temporary declines in fair value are recorded as realized losses in the
income statement.
During the three months ended March 31, 2003, LNC sold securities at
gains and at losses. In the process of evaluating whether a security
with an unrealized loss reflects an other than temporary decline, LNC
considers its ability and intent to hold the security until its value
recovers. However, subsequent decisions on securities sales are made
within the context of overall risk monitoring, assessing value relative
to other comparable securities and overall portfolio maintenance.
Although LNC's portfolio managers may, at a given point in time, believe
that the preferred course of action is to hold securities with
unrealized losses that are considered temporary until such losses are
recovered, the dynamic nature of portfolio management may result in a
subsequent decision to sell. These subsequent decisions are consistent
with the classification of LNC's investment portfolio as
available-for-sale. LNC expects to continue to manage all invested
assets within its portfolios in a manner that is consistent with the
available-for-sale classification.
Critical Accounting Policy - Realized Gain (Loss) on Investments Sales
and Write-downs: LNC had net pre-tax realized losses on investments and
derivatives of $91.4 million and $103.3 million for the three months
ended March 31, 2003 and 2002, respectively. Prior to the amortization
of acquisition costs, provision for policyholder commitments and
investment expenses, net pre-tax realized losses were $158.0 million and
$149.8 million in for the three months ended March 31, 2003 and 2002,
respectively.
Gross realized gains on fixed maturity and equity securities were $38.2
million and gross realized losses on fixed maturity and equity securities
were $157.7 million for the first three months of 2003. The realized gains and
losses exclude realized gains and losses on equity securities related to
participating policies in the Lincoln UK segment. These realized gains and
losses are credited to the policyholder and did not affect LNC's net
income. Included within losses are write-downs for impairments of $137.3
million in the first three months of 2003.
While realized realized losses from sales and write-downs occurred in a
number of sectors, approximately 68% of gross losses for the three
months ended March 31, 2003, excluding the losses on equity securities
in the Lincoln UK segment described above, were attributed to
write-downs in airlines, electric utilities and asset-backed securities
(ABS) including ABS investments collateralized by manufactured housing
receivables as well as Collateralized Debt Obligations (CDOs). The
following discussion provides details relating to write-downs taken
during the first three months of 2003 in these sectors.
LNC's exposure to the airline sector is primarily equipment trust
certificates (ETCs) and enhanced equipment trust certificates (EETCs).
Aircraft owned or operated by domestic air carriers collateralize these
securities. The war in Iraq, continued weak economic data, intense
competition in the industry and the sale of several aircraft by one
domestic carrier all put downward pressure on valuations of securities
issued by domestic carriers. The sale of aircraft in the first quarter
of 2003 provided a market-clearing price for used aircraft at levels
lower than what the market had previously anticipated. This resulted in
a re-evaluation of the underlying collateral in ETC and EETC structures.
The combination of these factors, along with increased concerns
reflected in the market during the first quarter of 2003 relating to the
potential bankruptcy filing for AMR Corporation, resulted in a $48.6
million write-down on AMR Corporation's ETCs to current market fair
value. The change in valuation of the underlying aircraft and continued
economic pressures on the sector also led to an additional write-down of
UAL Corporation's ETCs of $5.7 million.
Electric utility sector write-downs were taken on selected issuers whose
securities had not recovered with the rest of the electric utility
issues in the market. The continued deterioration of these securities,
along with a lack of improvement of the underlying credit, led to the
determination that these securities were other than temporarily
impaired. Write-downs taken in this sector totaled $24.7 million.
ABS secured by manufactured housing receivables have experienced
deterioration in value, following the bankruptcy filing of a major
servicer in the industry. This servicer was granted changes to the
existing servicing agreements by the bankruptcy court. Servicing fees
were increased and were moved to a more senior position in the capital
structure. For those securities where the subordination was not at
levels high enough to withstand this increase in fees without impairing
value, write-downs of $14.1 million were recorded in the first quarter of
2003.
Deterioration during the first quarter of 2003 in the underlying
collateral pools of other ABS investments led to decreased expectations
of future cash flows. As a result, additional write-downs of $17.2
million on various ABS holdings, including CDOs, were also recorded in
the three months ended March 31, 2003. Sales and write-downs have
reduced LNC's CDO exposure from 1.6% of invested assets at December 31,
2002 to 1.4% of LNC's invested assets at March 31, 2003 as measured on a
cost basis, with over 90% rated investment grade.
For additional information regarding LNC's process for determining
whether declines in fair value of securities available-for-sale are
other than temporary, see the discussion in LNC's 2002 Form 10-K under
"Critical Accounting Policy Write-Downs and Allowances for Losses."
Unrealized Gains and Losses: When considering unrealized gain and loss
information, it is important to realize that the information relates to
the status of securities at a particular point in time, and may not be
indicative of the status of LNC's investment portfolios subsequent to
the balance sheet date. Further, since the timing of the recognition
of realized investment gains and losses through the selection of which
securities are sold is largely at management's discretion, it is
important to consider the information provided below within the context
of the overall unrealized gain or loss position of LNC's investment
portfolios. These are important considerations that should be included
in any evaluation of the potential impact of unrealized loss securities
upon LNC's future earnings. LNC had an overall net unrealized gain
(after the amortization of acquisition costs, provision for policyholder
commitments, investment expenses and taxes) on securities
available-for-sale under FAS 115 of $872.0 million and $753.3 million at
March 31, 2003 and December 31, 2002, respectively.
At March 31, 2003 and December 31, 2002, gross unrealized gains on
securities available-for-sale were $2,555.0 million and $2,402.5
million, respectively, and gross unrealized losses on securities
available-for-sale were $565.0 million and $735.4 million, respectively.
At March 31, 2003, gross unrealized gains and gross unrealized losses
on fixed maturity securities available-for-sale were $2,530.9 million
and $548.9 million, respectively, and gross unrealized gains and losses
on equity securities available-for-sale were $24.1 million and $16.1
million, respectively. At December 31, 2002, gross unrealized gains and
gross unrealized losses on fixed maturity securities available-for-sale
were $2,355.3 million and $690.9 million, respectively, and gross
unrealized gains and losses on equity securities available-for-sale were
$47.2 million and $44.5 million, respectively
Unrealized Losses on Securities Subject to Enhanced Analysis and
Monitoring: Within the portfolio of securities with unrealized losses
are certain securities that LNC has identified as exhibiting indications
that the decline in fair value may be other than a temporary decline in
value. Where detailed analysis by LNC credit analysts and investment
portfolio managers leads to the conclusion that a security's decline in
fair value is other than temporary, the security is written down to fair
value. In instances where declines are considered temporary, the
security will continue to be carefully monitored. The following
information is applicable to unrealized loss securities that were
subject to these enhanced analysis and monitoring processes.
For traded and private securities held by LNC at March 31, 2003 that
were subject to enhanced analysis and monitoring for potential changes
in unrealized loss status, the fair value, amortized cost, unrealized
loss and total time period that the security has been in an unrealized
loss position are presented in the table below.
Unrealized Losses - Available for Sale Securities
Subject to Enhanced Analysis and Monitoring
March 31, 2003
% %
% Fair Amortized Amortized Unrealized Unrealized
(000s omitted) Fair Value Value Cost Cost Loss Loss
- ------------------------------------------------------------------------------------------------------------
<= 90 days $66,675 22.4% $79,865 18.0% $(13,190) 9.1%
> 90 days but <= 180 days 6,503 2.2% 6,891 1.5% (388) 0.2%
> 180 days but <= 270 days 20,670 6.9% 21,666 4.9% (996) 0.7%
> 270 days but <= 1 year 44,680 15.0% 60,939 13.8% (16,259) 11.2%
> 1 year 159,062 53.5% 273,530 61.8% (114,468) 78.8%
-----------------------------------------------------------------------------
Total $297,590 100.0% $442,891 100.0% $(145,301) 100.0%
=============================================================================
LNC has no concentrations of issuers or guarantors of fixed maturity and
equity securities. The composition by industry categories of securities
subject to enhanced analysis and monitoring for potential changes in
unrealized loss status held by LNC at March 31, 2003 is presented in
the table below.
Unrealized Losses by Industry Sector - Available-for-Sale Securities
Subject to Enhanced Analysis and Monitoring
March 31, 2003
%
% Fair Amortized % Amortized Unrealized Unrealized
(000s omitted) Fair Value Value Cost Cost Loss Loss
- ------------------------------------------------------------------------------------------------------------
Electric Utility $109,971 36.9% $169,567 38.3% $(59,596) 41.0%
Airlines 61,254 20.6% 90,785 20.5% (29,531) 20.3%
Asset-Backed Securities 32,187 10.8% 54,295 12.3% (22,108) 15.2%
Sovereigns 17,212 5.8% 28,416 6.4% (11,204) 7.7%
Pipelines 21,373 7.2% 31,998 7.2% (10,625) 7.3%
Chemicals 5,561 1.9% 13,398 3.0% (7,837) 5.4%
Media Cable 7,488 2.5% 9,386 2.1% (1,898) 1.3%
CMBS 3,408 1.1% 4,821 1.1% (1,413) 1.0%
Retailers 5,888 2.0% 6,262 1.4% (374) 0.3%
Pharmaceuticals 8,241 2.8% 8,525 1.9% (284) 0.2%
Oil Field Services 526 0.2% 780 0.2% (254) 0.2%
Industrial Other 4,542 1.5% 4,646 1.0% (104) 0.1%
Metals and Mining 5,112 1.7% 5,183 1.2% (71) 0.0%
Other 14,827 5.0% 14,829 3.4% (2) 0.0%
---------- ---------- ---------- ---------- ------------ ----------
$297,590 100.0% $442,891 100.0% $(145,301) 100.0%
========== ========== ========== ========== ============ ==========
At March 31, 2003 and December 31, 2002, less than 16% and 9%,
respectively, of the traded and private securities held that were
subject to enhanced analysis and monitoring for potential changes in
unrealized loss status were rated as investment grade. The range of
maturity dates for these securities varies, with about 49% of these
securities maturing between 5 and 10 years, about 30% maturing in
greater than 10 years and the remaining securities maturing in less
than 5 years.
Unrealized Loss on All Below-Investment-Grade Fixed Maturity Securities:
Gross unrealized losses on all below-investment-grade securities were
$363.0 million at March 31, 2003, representing 64.3% of total gross
unrealized losses on all available-for-sale securities. Generally,
below-investment-grade fixed maturity securities are more likely than
investment-grade securities to develop credit concerns. The ratios of
market value to amortized cost reflected in the table below are not
necessarily indicative of the market value to amortized cost
relationships for the securities throughout the entire time that the
securities have been in an unrealized loss position nor are they necessarily
indicative of these ratios subsequent to March 31, 2003.
Unrealized Losses
Below-Investment-Grade Fixed Maturity Securities
March 31, 2003
Aging Category (000s omitted) Bk Mkt Ratio Fair Value Amortized Cost Unrealized Loss
- ------------------------------------------------------------------------------------------------------------
<=90 days 70% to 100% $200,672 $209,796 $(9,124)
40% to 70% 2,177 3,532 (1,355)
Below 40% 2,291 6,580 (4,289)
-----------------------------------------------------------
<=90 days Total 205,140 219,908 (14,768)
>90 days but <=180 days 70% to 100% 189,751 223,707 (33,956)
Below 40% 77 285 (208)
-----------------------------------------------------------
>90 days but <=180 days Total 189,828 223,992 (34,164)
>180 days but <=270 days 70% to 100% 88,350 96,383 (8,033)
40% to 70% 49,820 80,660 (30,840)
-----------------------------------------------------------
>180 days but <=270 days Total 138,170 177,043 (38,873)
>270 days but <=1 year 70% to 100% 193,163 217,597 (24,434)
40% to 70% 18,367 32,766 (14,399)
-----------------------------------------------------------
>270 days but <=1 year Total 211,530 250,363 (38,833)
>1 year 70% to 100% 507,860 593,030 (85,170)
40% to 70% 186,440 333,946 (147,506)
Below 40% 1,543 5,235 (3,692)
-----------------------------------------------------------
>1 year Total 695,843 932,211 (236,368)
-----------------------------------------------------------
Total Below-Investment-Grade $1,440,511 $1,803,517 $(363,006)
===========================================================
Unrealized Losses on All Securities: For total traded and private
available-for-sale securities held by LNC at March 31, 2003 that are in
unrealized loss status, the amortized cost, fair value, unrealized loss
and total time period that the security has been in an unrealized loss
position are presented in the table below.
Unrealized Losses - All Available-for-Sale Securities
March 31, 2003
%
% Fair Amortized % Amortized Unrealized Unrealized
(000s omitted) Fair Value Value Cost Cost Loss Loss
- ------------------------------------------------------------------------------------------------------------
<= 90 days $1,937,223 41.1% $1,979,523 37.5% $(42,300) 7.5%
> 90 days but <= 180 days 638,136 13.5% 709,812 13.5% (71,676) 12.7%
> 180 days but <= 270 days 280,626 6.0% 333,397 6.3% (52,771) 9.3%
> 270 days but <= 1 year 280,252 6.0% 323,713 6.1% (43,461) 7.7%
> 1 year 1,574,137 33.4% 1,928,911 36.6% (354,774) 62.8%
-------------------------------------------------------------------------------
Total $4,710,374 100.0% $5,275,356 100.0% $(564,982)* 100.0%
===============================================================================
* Included in the total unrealized losses are unrealized losses of $2.5
million related primarily to participating polices in the Lincoln UK
segment. Gain and losses on securities supporting this business are
credited to the policyholder when incurred and do not affect the net
income of LNC.
The composition by industry categories of total securities
available-for-sale in unrealized loss status, held by LNC at March 31, 2003,
is presented in the table below.
Unrealized Losses by Industry Sector - All Available-for-Sale Securities
March 31, 2003
%
% Fair Amortized % Amortized Unrealized Unrealized
(000s omitted) Fair Value Value Cost Cost Loss Loss
- ------------------------------------------------------------------------------------------------------------
Electric Utility $594,928 12.6% $710,610 13.5% $(115,682) 20.5%
Airlines 189,953 4.0% 286,581 5.4% (96,628) 17.1%
Asset-Backed Securities 843,445 17.9% 918,375 17.4% (74,930) 13.3%
Banking 364,221 7.7% 403,450 7.6% (39,229) 6.9%
Sovereigns 243,083 5.2% 263,392 5.0% (20,309) 3.6%
Pipelines 155,973 3.3% 175,131 3.3% (19,158) 3.4%
Wirelines 94,960 2.0% 111,269 2.1% (16,309) 2.9%
Chemicals 75,462 1.6% 91,459 1.7% (15,997) 2.8%
Automotive 117,675 2.5% 133,274 2.5% (15,599) 2.8%
Media Cable 28,397 0.6% 41,968 0.8% (13,571) 2.4%
CMBS 63,142 1.3% 74,527 1.4% (11,385) 2.0%
Retailers 61,304 1.3% 72,669 1.4% (11,365) 2.0%
Pharmaceuticals 42,117 0.9% 53,416 1.0% (11,299) 2.0%
Oil Field Services 32,632 0.7% 41,218 0.8% (8,586) 1.5%
Industrial Other 49,683 1.1% 57,981 1.1% (8,298) 1.5%
Refining 50,068 1.1% 57,448 1.1% (7,380) 1.3%
Integrated 30,825 0.7% 37,755 0.7% (6,930) 1.2%
Transportation Services 77,576 1.6% 83,811 1.6% (6,235) 1.1%
Other 493,054 10.5% 498,860 9.6% (5,806) 1.0%
Technology 28,465 0.6% 33,791 0.6% (5,326) 0.9%
Foreign Agencies 24,600 0.5% 29,395 0.6% (4,795) 0.9%
Utility Other 25,223 0.5% 29,985 0.6% (4,762) 0.9%
Food and Beverage 106,060 2.3% 109,994 2.1% (3,934) 0.8%
Metals and Mining 62,101 1.3% 65,738 1.2% (3,637) 0.7%
Supermarkets 25,034 0.5% 28,060 0.5% (3,026) 0.6%
Paper 40,943 0.9% 43,968 0.8% (3,025) 0.5%
Railroads 26,483 0.6% 29,286 0.6% (2,803) 0.5%
Aerospace/Defense 19,520 0.4% 22,282 0.4% (2,762) 0.5%
P&C 88,648 1.9% 90,882 1.7% (2,234) 0.4%
Consumer Non-Cyclical Services 7,488 0.2% 9,386 0.2% (1,898) 0.3%
Mortgage 39,037 0.8% 40,740 0.8% (1,703) 0.3%
Distributors 32,466 0.7% 33,828 0.6% (1,362) 0.2%
Captive 27,881 0.6% 28,935 0.5% (1,054) 0.2%
Wireless 8,779 0.2% 9,787 0.2% (1,008) 0.2%
Building Materials 20,272 0.4% 21,161 0.4% (889) 0.2%
Media Non-Cable 15,628 0.3% 16,450 0.3% (822) 0.1%
Collateralized Mortgage
Obligations 120,416 2.6% 121,161 2.3% (745) 0.1%
Tobacco 47,320 1.0% 47,964 0.9% (644) 0.1%
Municipal 34,259 0.7% 34,835 0.7% (576) 0.1%
Financial Other 27,934 0.6% 28,390 0.5% (456) 0.1%
Life 2,772 0.1% 3,178 0.1% (406) 0.1%
Construction Machinery 4,725 0.1% 5,076 0.1% (351) 0.1%
Foreign Local Governments 4,455 0.1% 4,751 0.1% (296) 0.1%
Non-Capitve Diversified 3,383 0.1% 3,663 0.1% (280) 0.0%
Lodging 16,451 0.3% 16,729 0.3% (278) 0.0%
Independent 12,069 0.3% 12,270 0.2% (201) 0.0%
Basic Industry 3,294 0.1% 3,409 0.1% (115) 0.0%
Non-Captive Consumer 4,542 0.1% 4,646 0.1% (104) 0.0%
Diversified Manufacturing 14,027 0.3% 14,091 0.3% (64) 0.0%
Consumer Cyclical Services 14,947 0.3% 15,000 0.3% (53) 0.0%
Financial Companies 1,435 0.0% 1,485 0.0% (50) 0.0%
Consumer Cyclical 777 0.0% 818 0.0% (41) 0.0%
Entertainment 5,243 0.1% 5,266 0.1% (23) 0.0%
GNMA 15,365 0.3% 15,378 0.3% (13) 0.0%
Brokerage 1,396 0.0% 1,401 0.0% (5) 0.0%
FNMA FHA VA 30YR 199 0.0% 203 0.0% (4) 0.0%
Lincoln UK Fixed Maturity
Securities 154,073 3.3% 158,940 3.0% (4,867) 0.8%
Lincoln UK Equity Securities 14,166 0.3% 19,840 0.4% (5,674) 1.0%
- -----------------------------------------------------------------------------------------------------------
Total $4,710,374 100.0% $5,275,356 100.0% $(564,982) 100.0%
================================================================================
At March 31, 2003, the range of maturity dates for total traded and private
securities available-for-sale in unrealized loss status varies, with about
20% maturing between 5 and 10 years, 47% maturing after 10 years and the
remaining securities maturing in less than 5 years.
As of March 31, 2003 there were unrealized losses of $326.5 million in
the electrical utility, airline, ABS and Banking industries,
representing 57.8% of total unrealized losses. LNC's view of risk
factors at March 31, 2003 with respect to these industries is presented
below.
The electric utility sector continues to be LNC's most significant
unrealized loss sector with $115.7 million of unrealized losses at
March 31, 2003. During the first quarter 2003, several utilities were
able to complete asset sales and secure the financing needed in order to
weather the trough in the energy cycle. The market is now expecting
those yet to secure financing will be able to do so at terms that are
palatable. The announcement of the settlement between the FERC and a
large energy provider relieved some of the concerns regarding the future
litigation risks of all energy providers in California. With the
overhang of litigation and potentially debilitating settlements
mitigated, valuations of utility paper are improving. LNC believes that
as the over-capacity in the market for electricity is rectified from
increased economic activity and as old, inefficient power plants are
taken off-line, margins should begin to revert to mid-cycle valuations.
As this cycle progresses, LNC expects to see further improvement in this
sector and believes that the unrealized losses in this sector are
temporary.
Airline holdings ended the first quarter 2003 with an unrealized loss of
$96.6 million, only a slight improvement over December 31, 2002 despite
the fact that LNC realized losses of $54.3 million in the sector during
the quarter. In contrast to the airline securities that were written
down in the first quarter, LNC has not written down securities issued by
airlines for which there is currently a low expected probability of
bankruptcy, due to the relatively strong financial position of these
carriers. For these stronger airlines, LNC believes that the unrealized
loss positions at March 31, 2003 are temporary, and LNC expects an
ultimate recovery of full principal and interest as these securities
mature. For the portion of the airline sector exposure that is invested
in EETC structures, LNC holds securities that are enhanced through the
liquidity facilities present in these securities and their relatively
higher quality aircraft collateral pools.
The asset-backed securities (ABS) exposure of the LNC portfolio ended
the quarter with an unrealized loss of $74.9 million. Of this amount,
$53.9 million relates to CDOs and $17.2 million relates to ABS secured
by manufactured housing receivables. CDOs have experienced pressure due
to the nature of the assets, poor collateral experience and the specific
risk of downgrade for individual tranches held by LNC. LNC has
performed the cash flow testing required by EITF 99-20 and, based on
that analysis, anticipates full recovery of principal and interest. As
a result, these unrealized losses are considered temporary.
ABSs secured by manufactured housing receivables have experienced
deterioration in value following the bankruptcy filing of a major
servicer in the industry. This servicer was granted changes to the
existing servicing agreements by the bankruptcy court. Servicing fees
were increased and were moved to a more senior position in the capital
structure. For those securities that were adversely affected by this
change, LNC recorded write-downs in the first quarter of 2003. Where
LNC held positions that are not believed to be affected by the change in
fee structure, LNC expects to fully recover principal and interest.
The majority of unrealized loss in the banking sector is economically
offset by unrealized gain in the derivative portfolio for hedging that
is related to these securities. Of the $39.2 million of unrealized loss
in the banking industry, $28.5 million is related to securities with
offsetting derivative gains. The unrealized gain on the derivative
positions relating to these securities was $38.5 million at the end of
the first quarter 2003. All the underlying credits that have been
swapped have an average rating of A+ and LNC does not anticipate any
credit-related losses on these securities.
Unrealized Loss Fixed Maturity Securities Available-for-Sale in Excess of
$10 million: As of March 31, 2003, LNC held fixed maturity securities
available-for-sale with gross unrealized losses of $10 million, or greater,
as discussed below.
Fixed Maturity Securities
Unrealized Losses Greater Than $10 million
March 31, 2003
Amortized Unrealized Length of Time
(000s Omitted) Fair Value Cost Loss in a Loss Position
- -------------- -------------------------------------------------------------
Investment-Grade
-----------------
ABS Secured by Manufactured Housing Receivables $64,601 $78,990 $(14,389) >90 days but <=180 days
Sr. Notes Backed by Pool of High Yield Bonds 15,000 30,000 (15,000) >1 year
------------------------------
Total Investment-Grade $79,601 $108,990 $(29,389)
==============================
Non-Investment-Grade
-----------------
Power Generation Project Finance $33,881 $45,000 $(11,119) >90 days but <=180 days
US Utility Company 32,486 43,619 (11,133) >180 days but <=270 days
US Based International Airline Company 40,860 76,245 (35,385) >1 year
US Based International Airline Company 40,751 69,380 (28,629) >1 year
US Utility Company 26,340 52,134 (25,794) >1 year
US Telecommunications Company 53,563 68,490 (14,927) >1 year
US Media/Cable Company 11,187 24,295 (13,108) >1 year
US Utility Company 36,748 48,931 (12,183) >1 year
US Utility Company 51,261 62,716 (11,455) >1 year
Foreign Pharmaceutical Company 17,212 28,416 (11,204) >1 year
-------------------------------
Total Non-Investment Grade $344,289 $519,226 $(174,937)
===============================
The information presented above is subject to rapidly changing
conditions. As such, LNC expects that the level of securities with
overall unrealized gains and losses will fluctuate, as will the level of
unrealized loss securities that are subject to enhanced analysis and
monitoring.
Mortgage Loans on Real Estate: As of March 31, 2003, mortgage loans on
real estate and investments in real estate represented 10.3% and 0.6% of
LNC's total investment portfolio, respectively. As of March 31, 2003,
the underlying properties supporting the mortgage loans on real estate
consisted of 37.3% in commercial office buildings, 23.2% in retail
stores, 18.0% in industrial buildings, 10.2% in apartments, 7.5% in
hotels/motels and 3.8% in other. In addition to the dispersion by
property type, the mortgage loan portfolio is geographically diversified
throughout the United States.
The following summarizes key information on mortgage loans:
March 31 December 31
(in millions) 2003 2002
-------------- -------- -----------
Total Portfolio (net of reserves) $4,235.5 $4,205.5
Impaired mortgage loans $73.5 $72.3
Impaired mortgage loans as a percentage
of total mortgage loans 1.7% 1.7%
Mortgage loans two or more payments
delinquent (including in process of foreclosure) $35.1 $1.9
Restructured loans in good standing 4.1 4.6
Reserve for mortgage loans 12.2 11.9
All mortgage loans that are impaired have an established allowance for
credit loss. Changing economic conditions impact LNC's valuation of
mortgage loans. Current market data, such as local vacancy, rental,
discount and capitalization rates, are incorporated into the discounted
cash flow analysis that LNC performs for monitored loans and may
contribute to the establishment of (or an increase in) an allowance for
credit losses. In addition, LNC continues to monitor its entire
commercial mortgage portfolio to identify risks. Areas of current
emphasis are the hotel mortgage loan portfolio and retail, office and
industrial properties anchored by deteriorating credits or experienced
debt coverage reduction. Where warranted, LNC has established or
increased loss reserves based upon this analysis. Impaired mortgage
loans as a percentage of total mortgage loans have increased over the
last year as a result of increased credit losses in the sectors noted
above. This percentage was 1.7%, 1.7%, 0.6%, 0.5%, 0.6%, 0.8%, 1.1% and
1.9% and 3.9% as of March, 31, 2003, December 31, 2002, 2001, 2000,
1999, 1998, 1997, 1996 and 1995, respectively.
Fixed maturity securities available-for-sale, mortgage loans on real
estate and real estate that were non-income producing for the three
months ended March 31, 2003 were not significant. As of March 31, 2003
and December 31, 2002, the carrying value of non-income producing
securities was $51.3 million and $37.3 million, respectively.
Net Investment Income
Net investment income was flat in the first three months of 2003 when
compared with the first three months of 2002. The overall yield on
investments decreased to 6.51% from 6.88%. The decrease in the yield
was primarily due to lower interest rates on new securities purchased
along with additional security defaults during the last year. The mean
invested assets increased 5.7% between the three month periods. This
increase was due primarily to positive fixed annuity flows and new life
insurance business generated over the last year.
REVIEW OF CONSOLIDATED FINANCIAL CONDITION
Liquidity, Cash Flow and Capital Resources
Liquidity refers to the ability of an enterprise to generate adequate
amounts of cash from its normal operations to meet cash requirements
with a prudent margin of safety. Because of the interval of time from
receipt of a deposit or premium until payment of benefits or claims, LNC
and other insurers employ investment portfolios as an integral element
of operations. By segmenting its investment portfolios along product
lines, LNC enhances the focus and discipline it can apply to managing
the liquidity as well as the interest rate and credit risk of each
portfolio commensurate with the profile of the liabilities. For
example, portfolios backing products with less certain cash flows and/or
withdrawal provisions are kept more liquid than portfolios backing
products with more predictable cash flows.
The consolidated statements of cash flows in the March 31, 2003
unaudited consolidated financial statements indicates that operating
activities provided cash of $444.0 million during the first three months
of 2003. This statement also classifies the other sources and uses of
cash by investing activities and financing activities and discloses the
total amount of cash available to meet LNC's obligations.
Although LNC generates adequate cash flow to meet the needs of its
normal operations, periodically LNC may issue debt or equity securities
to fund internal expansion, acquisitions, investment opportunities and
the retirement of LNC's debt and equity.
In July 2001, the LNC Board authorized the repurchase of $500 million of
LNC's securities. On August 8, 2002, the LNC Board authorized the
repurchase of up to an additional $600 million of LNC securities. The
remaining amount under the combined repurchase authorization at March
31, 2003 was $675.1 million.
LNC's insurance subsidiaries are subject to certain insurance department
regulatory restrictions as to the transfer of funds and payment of
dividends to the holding company. Generally, these restrictions pose no
short-term liquidity concerns for the holding company. However, the
acquisition of two blocks of business in 1998 resulted in negative
statutory earned surplus for LNL which triggered certain approval
requirements in order for LNL to declare and pay dividends to LNC. As a
result of negative earned surplus, LNL was required to obtain the prior
approval of the Indiana Insurance Commissioner ("Commissioner") before
paying any dividends to LNC until its statutory earned surplus became
positive. During the first quarter 2002, LNL received approval from
the Commissioner to reclassify total dividends of $495 million paid to
LNC in 2001 from LNL's earned surplus to paid-in-capital. This change
plus the increase in statutory earned surplus from the indemnity
reinsurance transaction with Swiss Re resulted in positive statutory
earned surplus for LNL at December 31, 2001.
In general, dividends are not subject to prior approval from the
Commissioner provided LNL's statutory earned surplus is positive and
such dividends do not exceed the standard limitation of the greater of
10% of total statutory earned surplus or the amount of statutory
earnings in the prior calendar year. As a result of the payment of
dividends and statutory losses in 2002, LNL's statutory earned surplus
was negative as of December 31, 2002. The statutory losses resulted
from realized losses on investments, the effect of the equity markets
and the reserve strengthening in 2002 related to the reinsurance
business sold to Swiss Re. Due to the negative statutory earned surplus
as of December 31, 2002, any dividend(s) paid by LNL in 2003 will be
subject to prior approval from the Commissioner. As occurred in 2001,
dividends approved and paid while statutory earned surplus is negative
are expected to be classified as a reduction to paid-in-capital.
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 March 31, 2003, 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"). Although there are
less investors for A-2/P-2 commercial paper and there are periods in
which there is weak investor interest in A-2/P-2 commercial paper,
through March 31, 2003, liquidity has not been adversely impacted. LNC
can draw upon alternative short-term borrowing facilities such as
revolving bank lines of credit.
On the average, LNC's commercial paper borrowing rates have increased
0.20% per annum since LNC was downgraded to an A-2/P-2 issuer. However,
historically there have been times of greater volatility in commercial
paper borrowing rates for an A-2/P-2 issuer with the spread above
A-1/P-1 rates ranging from 0.10% to 0.50%. During such times of greater
volatility, LNC may experience difficulty in placing longer-term
commercial paper (defined as 30-90 day maturities), and as a result,
experience increased short-term financing costs.
Total shareholders' equity increased $102.5 million during the three
months ended March 31, 2003. Accumulated other comprehensive income
increased shareholders' equity by $104.9 million. The components of the
changes to accumulated other comprehensive income were: $115.3 million
related to the increase in the net unrealized gain on securities
available-for-sale and derivative instruments, $0.6 million increase
related to the effect of foreign currency changes on the minimum pension
liability adjustment, and a decrease of $11.0 million related a change
in the accumulated foreign exchange adjustment. Excluding changes due
to other comprehensive income, shareholders' equity decreased $2.4
million. This decrease is the net of increases due to $41.6 million of
net income, $2.7 million from the issuance/forfeiture of common stock
under benefit plans and a $12.6 million increase to additional paid-in
to record stock-based compensation and decreases due to $59.3 million
from the declaration of dividends to shareholders.
Contingencies
See Note 5 to the consolidated financial statements for information
regarding contingencies.
Item 3 Quantitative and Qualitative Disclosure of Market Risk
- ------
LNC provided a discussion of its market risk in Item 7A of its 2002
Annual Report on Form 10-K for the year ended December 31, 2002. During
the first three months of 2003, there was no substantive change to LNC's
market risk except for the items noted below:
Interest Rate Risk - Falling Rates.
As discussed in the Quantitative and Qualitative Disclosures About
Market Risk section of LNC's annual report on Form 10-K for the year
ended December 31, 2002, interest spreads would be at risk on LNC's
fixed annuity and interest-sensitive whole life, universal life and
fixed portion of variable universal life insurance policies if interest
rates continued to fall and remained lower for a period of time. The
following table provides detail on the difference between interest
crediting rates and minimum guaranteed rates as of March 31, 2003. For
example, at March 31, 2003, there are $4.834 billion of combined
Retirement and Life Insurance account values where the excess of the
crediting rate over contact minimums is between 1.51% and 2.00%. The
analysis presented below ignores any non-guaranteed elements within the
life insurance products such as cost of insurance or expense loads
which, for many products, may be redetermined in the event that interest
margins deteriorate below the level that would cause the credited rate
to equal the minimum guaranteed rate.
Excess of Crediting Rates over Contract Minimums
------------------------------------------------------
As of March 31, 2003 (in millions) Retirement Life Total %
- ---------------------------------- -------------- ---------- --------------------------
CD and On-Benefit type annuities $4,548 $- $4,548 14.7%
Discretionary rate setting products*
No difference 3,362 694 4,056 13.1%
up to .1% 174 729 903 2.9%
..11% to .20% 2,679 249 2,928 9.5%
..21% to .30% 119 38 157 0.5%
..31% to .40% 178 - 178 0.6%
..41% to .50% 193 - 193 0.6%
..51% to .60% 349 994 1,343 4.4%
..61% to .70% 5,661 - 5,661 18.3%
..71% to .80% 156 59 215 0.7%
..81% to .90% 266 164 430 1.4%
..91% to 1.0% 411 355 766 2.5%
1.01% to 1.50% 1,458 2,535 3,993 12.9%
1.51% to 2.00% 803 4,031 4,834 15.7%
2.01% to 2.50% 230 273 503 1.6%
2.51% to 3.00% 22 158 180 0.6%
3.01% and above 3 0 3 0.0%
-------------- ---------- ------------------------
Total Discretionary rate setting products 16,064 10,279 26,343 85.3%
-------------- ---------- ------------------------
Grand Total $20,612 $10,279 $30,891 100.0%
============== ========== ========================
Equity Market Exposures.
See the discussion captioned Second Quarter 2003 Guidance for the
Estimated Effect of Equity Market Volatility for updated guidance for
the estimated effect of equity market volatility.
The following is a discussion of changes to LNC's derivative positions.
Derivatives
As discussed in Note 7 to the consolidated financial statements for the
year ended December 31, 2002, LNC has entered into derivative
transactions to reduce its exposure to fluctuations in interest rates,
the risk of changes in liabilities indexed to LNC stock, credit risk and
foreign exchange risk. In addition, LNC is subject to risks associated
with changes in the value of its derivatives; however, such changes in
value are generally offset by changes in the value of the items being
hedged by such contracts. Modifications to LNC's derivative strategy
are initiated periodically upon review of the Company's overall risk
assessment. During the first three months of 2003, the more significant
changes in LNC's derivative positions are as follows:
1. Entered into 0.3 billion notional of interest rate cap agreements
that are used to hedge its annuity business against the negative impact
of a significant and sustained rise in interest rates. A total of 0.2
billion notional expired resulting in a total remaining $1.4 billion
notional. The expiration in notional resulted in no gain or loss.
2. Decreased its use of swaptions that are used to hedge its annuity
business against the negative impact of a significant and sustained rise
in interest rates from 180.0 million notional to 90.0 million
notional. The decrease in notional is a result of expirations and
resulted in no gain or loss.
3. Entered into interest rate swap agreements hedging floating rate bond
coupon payments in the amount of 10.0 million notional. A total of
1.7 million notional expired resulting in a total remaining 437.5
million notional. These interest rate swap agreements convert floating
rate bond coupon payments into a fixed rate of return. No gain or loss
was recognized as a result of the expirations.
4. Entered into foreign exchange forward contracts in the amount of 4.8
million notional that are hedging the foreign currency exposure of a
portion of LNC's investment in its Lincoln UK subsidiary. A total of
18.6 million notional expired resulting in a total remaining 29.2
million notional. No gain or loss was recognized as a result of the
expirations.
5. Decreased its use of credit default swaps from 26.0 million notional
to 8.0 million notional. The decrease in notional is a result of
expirations and resulted in no gain or loss. LNC uses credit default
swaps to hedge against a drop in bond prices due to credit concerns of
certain bond issuers.
6. Entered into 0.3 million call options on an equal number of shares
of LNC stock, resulting in a total of 1.6 million call options on an
equal number of shares of LNC stock. A total of 0.02 million call
options were terminated, resulting in no gain or loss. These call
options are hedging the increase in liabilities arising from stock
appreciation rights granted on LNC stock. Additional stock appreciation
rights were granted to LNC agents during the first quarter of 2003.
LNC is exposed to credit loss in the event of non-performance by
counterparties on various derivative contracts. However, LNC does not
anticipate non-performance by any of the counterparties. The credit
risk associated with such agreements is minimized by purchasing such
agreements from financial institutions with long-standing superior
performance records.
Item 4 -- Controls and Procedures
- ------
(a) Evaluation of disclosure controls and procedures - The Corporation's
Principal Executive Officer and Principal Financial Officer have
reviewed and evaluated the effectiveness of the Corporation's disclosure
controls and procedures [as defined in Rules 240.13a-14(c) and 15d-14(c)
under the Securities Exchange Act of 1934 (the "Exchange Act)] as of a
date within ninety days before the filing date of this quarterly report.
Based on that evaluation, the Principal Executive Officer and the
Principal Financial Officer have concluded that the Corporation's
disclosure controls and procedures are effective, providing them with
material information relating to the Corporation as required to be
disclosed in the reports the Corporation files or submits under the
Exchange Act on a timely basis.
(b) Changes in internal controls - There were no significant changes in
the Corporation's internal controls or in other factors that could
significantly affect the Corporation's disclosure controls and
procedures subsequent to the date of their evaluation, nor were there
any significant deficiencies or material weaknesses in the Corporation's
internal controls.
PART II - OTHER INFORMATION AND EXHIBITS
Items 1, 2, 3, 4 and 5 of this Part II are either inapplicable or are
answered in the negative and are omitted pursuant to the instructions to
Part II.
Item 6 Exhibits and Reports on Form 8-K
(a) The following Exhibits of the Registrant are included in this report.
(Note: The number preceding the exhibit corresponds to the specific
number within Item 601 of Regulation S-K.)
12 Historical Ratio of Earnings to Fixed Charges
99 Additional Exhibit - Section 906 Certifications
(b) Updated Guidance for Estimated Effect of Equity Market Volatility
is incorporated herein by reference to LNC's Form 8-K as filed
with the Securities and Exchange Commission on February, 27, 2003.
Statistical Supplement and Detail of gross realized and
losses on investments is incorporated herein by reference to
LNC's Form 8-K as filed with the Securities and Exchange
Commission on February 14, 2003.
Press release announcing LNC's 2002 4th quarter and annual
earnings is incorporated herein by reference to LNC's Form
8-K as filed with the Securities and Exchange Commission on
February 11, 2003.
Lincoln National Life Insurance Company press release dated
January 29, 2003 announcing a realignment of operations and
Lincoln Financial Group press release dated January 29, 2003
announcing completion of a previously disclosed review of
product assumptions is incorporated herein by reference to
LNC's Form 8-K as filed with the Securities and Exchange
Commission on January 30, 2003.
SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
LINCOLN NATIONAL CORPORATION
By /S/ Richard C. Vaughan
----------------------
Richard C. Vaughan,
Executive Vice President and
Chief Financial Officer
By /S/ Casey J. Trumble
--------------------
Casey J. Trumble,
Senior Vice President and
Chief Accounting Officer
Date May 9, 2003
Certification
I, Jon A. Boscia, Chairman and Chief Executive Officer certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lincoln
National Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: May 9, 2003
/s/ Jon A. Boscia
------------------
Jon A. Boscia
Chairman and Chief Executive Officer
Certification
I, Richard C. Vaughan, Executive Vice President and Chief Financial
Officer certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lincoln
National Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Date: May 9, 2003
/s/ Richard C. Vaughan
-----------------------
Richard C. Vaughan
Executive Vice President and
Chief Financial Officer
LINCOLN NATIONAL CORPORATION
Exhibit Index for the Report on Form 10-Q
for the Quarter Ended March 31, 2003
Exhibit Number Description Page Number
- -------------- ----------- -----------
12 Historical Ratio of
Earnings to Fixed Charges 60
99 Additional Exhibit - Section
906 Certifications 61