Back to GetFilings.com
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 June 30, 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 issurer's classes of
common stock, as of the last applicable date:
As of August 1, 2003 LNC had 177,728,818 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No
The exhibit index to this report is located on page 66.
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30 December 31
(000s omitted) 2003 2002*
-------------- ---- ----
ASSETS (Unaudited)
Investments:
Securities available-for-sale, at fair value:
Fixed maturity (cost 2003 - $32,256,822;
2002 - $31,103,146) $35,354,502 $32,767,465
Equity (cost 2003 - $244,287;
2002 - $334,493) 257,308 337,216
Mortgage loans on real estate 4,314,281 4,205,470
Real estate 240,328 279,702
Policy loans 1,919,586 1,945,626
Derivative instruments 104,976 86,236
Other investments 400,601 378,136
----------- -----------
Total Investments 42,591,582 39,999,851
Cash and invested cash 1,945,847 1,690,534
Property and equipment 239,080 242,135
Deferred acquisition costs 2,697,078 2,970,866
Premiums and fees receivable 395,994 212,942
Accrued investment income 555,141 536,720
Assets held in separate accounts 39,942,847 36,178,336
Federal income taxes -- 317,726
Amounts recoverable from reinsurers 7,377,104 7,280,014
Goodwill 1,233,614 1,233,232
Other intangible assets 1,258,611 1,291,973
Other assets 1,295,902 1,230,316
----------- -----------
Total Assets $99,532,800 $93,184,645
* Restated, see Note 2 - Change in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
- -CONTINUED-
June 30 December 31
(000s omitted) 2003 2002*
-------------- ---- ----
(Unaudited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Insurance and Investment Contract Liabilities:
Insurance policy and claim reserves $23,918,880 $23,558,874
Contractholder funds 22,253,232 21,286,396
Liabilities related to separate accounts 39,942,847 36,178,336
----------- -----------
Total Insurance and Investment Contract Liabilities 86,114,959 81,023,606
Federal Income Taxes 71,953 --
Short-term debt 83,399 153,045
Long-term debt 1,121,439 1,119,245
Company-obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 397,150 392,658
Other liabilities 4,989,023 4,171,452
Deferred gain on indemnity reinsurance 938,938 977,149
----------- -----------
Total Liabilities 93,716,861 87,837,155
Shareholders' Equity:
Series A preferred stock-10,000,000 shares authorized
(6/30/03 liquidation value - $1,528) 638 666
Common stock - 800,000,000 shares authorized 1,454,828 1,431,342
Retained earnings 3,244,339 3,180,928
Accumulated Other Comprehensive Income (Loss):
Foreign currency translation adjustment 68,324 50,780
Net unrealized gain on securities available-for-sale 1,117,804 753,272
Net unrealized gain on derivative instruments 28,799 28,349
Minimum pension liability adjustment (98,793) (97,847)
----------- -----------
Total Accumulated Other Comprehensive Income 1,116,134 734,554
----------- -----------
Total Shareholders' Equity 5,815,939 5,347,490
----------- -----------
Total Liabilities and Shareholders' Equity $99,532,800 $93,184,645
* Restated, see Note 2 - Change in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended Three Months Ended
June 30 June 30
(000s omitted, except per share amounts) 2003 2002* 2003 2002*
- ---------------------------------------- ---- ---- ---- ----
(Unaudited) (Unaudited)
Revenue:
Insurance premiums $134,285 $154,119 $65,988 $76,999
Insurance fees 682,650 714,245 347,768 359,845
Investment advisory fees 93,537 95,766 49,353 47,756
Net investment income 1,314,867 1,312,205 660,219 657,407
Realized loss on investments and
derivative instruments
(net of amounts restored/(amortized) against
balance sheet accounts, Note 4) (94,127) (184,403) (2,690) (81,060)
Amortization of deferred gain on
indemnity reinsurance 36,211 46,200 18,045 22,038
Other revenue and fees 145,056 145,298 74,470 74,494
----------- ----------- ----------- -----------
Total Revenue 2,312,479 2,283,430 1,213,153 1,157,479
Benefits and Expenses:
Benefits 1,206,219 1,251,722 593,189 648,326
Underwriting, acquisition,
insurance and other expenses 836,832 839,804 409,319 437,571
Interest and debt expense 46,301 49,455 22,966 24,649
----------- ----------- ----------- -----------
Total Benefits and Expenses 2,089,352 2,140,981 1,025,474 1,110,546
----------- ----------- ----------- -----------
Income before Federal Income Taxes 223,127 142,449 187,679 46,933
Federal income taxes 38,836 8,296 44,977 (1,615)
----------- ----------- ----------- -----------
Net Income $184,291 $134,153 $142,702 $48,548
Net Income Per Common Share- Basic $1.04 $0.72 $0.81 $0.26
Net Income Per Common Share- Diluted $1.03 $0.71 $0.80 $0.26
*Restated, see Note 2- Change in Accounting Principle for more information.
See notes to consolidated financial statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Six Months Ended June 30
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 (1,018) (2,464) (28) (81)
----------- ----------- ----------- -----------
Balance at June 30 19,100 20,570 638 681
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 16,288 39,424 28 81
Issued/forfeited under benefit plans 337,999 2,075,366 8,100 71,805
Additional paid-in capital - vesting of
stock options granted 23,546 27,546
Additional paid-in capital - tax benefit on
stock options (8,188) 2,486
Retirement of common stock -- (4,885,000) -- (27,079)
----------- ----------- ----------- -----------
Balance at June 30 177,662,286 184,173,528 1,454,828 1,414,841
Retained Earnings:
Balance at beginning-of-year 3,180,928 3,789,870
Comprehensive income 565,871 293,431
Less other comprehensive income (loss):
Foreign currency translation adjustment 17,544 30,009
Net unrealized gain on
securities available-for-sale 364,532 129,994
Net unrealized gain on derivative instruments 450 1,154
Minimum pension liability adjustment (946) (1,879)
----------- -----------
Net Income 184,291 134,153
Retirement of common stock -- (199,596)
Dividends declared:
Series A preferred ($1.50 per share) (30) (30)
Common stock (2003-$0.67; 2002-$0.64) (120,850) (119,584)
----------- -----------
Balance at June 30 $3,244,339 $3,604,813
*Restated, see Note 2- Change in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Continued)
Six Months Ended June 30
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 17,544 30,009
----------- -----------
Balance at June 30 68,324 21,947
----------- -----------
Net Unrealized Gain (Loss) on
Securities Available-for-Sale:
Balance at beginning-of-year 753,272 195,681
Change during the period 364,532 129,994
----------- -----------
Balance at June 30 1,117,804 325,675
----------- -----------
Net Unrealized Gain (Loss) on Derivative Instruments:
Balance at beginning-of-year 28,349 21,523
Change during the period 450 1,154
----------- -----------
Balance at June 30 28,799 22,677
----------- -----------
Minimum Pension Liability Adjustment:
Balance at beginning-of-year (97,847) (35,959)
Change during the period (946) (1,879)
----------- -----------
Balance at June 30 (98,793) (37,838)
----------- -----------
Total Shareholders' Equity
at June 30 $5,815,939 $5,352,796
Common Stock at End of Quarter:
Assuming conversion of preferred stock 177,967,886 184,502,648
Diluted basis 179,535,988 186,141,360
* Restated, see Note 2 - Change in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30
(000s omitted) 2003 2002*
---------------------------------------- ---- ----
Cash Flows from Operating Activities: (Unaudited)
Net income $184,291 $134,153
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Deferred acquisition costs (124,923) (145,091)
Premiums and fees receivable (183,052) (61,322)
Accrued investment income (18,421) 7,157
Policy liabilities and accruals (115,211) (38,478)
Contractholder funds 627,485 485,650
Amounts recoverable from reinsurers (97,090) (479,566)
Federal income taxes 151,437 67,583
Federal income taxes paid from proceeds of disposition -- (516,152)
Stock-based compensation expense 23,546 27,546
Provisions for depreciation 26,268 24,946
Amortization of other intangible assets 40,266 57,484
Amortization of deferred gain (36,211) (46,200)
Realized loss on investments and derivative instruments 94,127 184,403
Other (172,846) 258,310
----------- -----------
Net Adjustments 215,375 (173,730)
----------- -----------
Net Cash Provided (Used in) by Operating Activities 399,666 (39,577)
Cash Flows from Investing Activities:
Securities-available-for-sale:
Purchases (6,034,829) (6,851,274)
Sales 3,326,550 4,316,833
Maturities 1,547,234 1,253,870
Purchase of other investments (657,178) (471,458)
Sale or maturity of other investments 569,646 783,146
Increase (Decrease) in cash collateral on loaned securities 256,631 (105,800)
Property and equipment purchases (66,992) (72,133)
Property and equipment sales 49,823 57,452
Other 246,606 118,661
----------- -----------
Net Cash Used in Investing Activities (762,509) (970,703)
Cash Flows from Financing Activities:
Retirement/call of preferred securities of subsidiary trusts -- (94,632)
Issuance of long-term debt -- 248,990
Net decrease in short-term debt (69,645) (139,184)
Universal life and investment contract deposits 2,334,640 2,541,811
Universal life and investment contract withdrawals (1,329,594) (1,711,976)
Investment contract transfers (204,754) (264,000)
Common stock issued for benefit plans 8,100 71,804
Retirement of common stock -- (223,116)
Other liabilities - retirement of common stock -- (128,330)
Dividends paid to shareholders (120,591) (121,123)
----------- -----------
Net Cash Provided by Financing Activities 618,156 180,244
----------- -----------
Net Increase (decrease) in Cash and Invested Cash 255,313 (830,036)
Cash and Invested Cash at Beginning-of-Year 1,690,534 3,095,480
----------- -----------
Cash and Invested Cash at June 30 $1,945,847 $2,265,444
* Restated, see Note 2 - Change in Accounting Principle for more information.
See notes to consolidated financial statements.
LINCOLN NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Basis of Presentation
The accompanying consolidated financial statements include Lincoln
National Corporation ("LNC") and its majority-owned subsidiaries.
Through subsidiary companies, LNC operates multiple insurance and
investment management businesses. The collective group of companies
uses "Lincoln Financial Group" as its marketing identity. Operations
are divided into 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
incorporated by reference into LNC's latest annual report on Form 10-K
for the year ended December 31, 2002.
Operating results for the six months ended June 30, 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 and New Accounting Pronouncements
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.
See LNC's Form 10-Q for the period ended March 31, 2003 on file with the
SEC. 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 for 2002 is as
follows:
Six Months Ended Three Months Ended
June 30, June 30,
(in millions except per share amounts) 2002 2002
---- ----
Net income as previously reported $153.9 $59.4
Adjustment for effect of change in accounting principle
that is applied retroactively, net of tax effects (19.8) (10.9)
-------- ------
Net income as adjusted $134.1 $48.5
Per share amounts:
Earnings per common share - Basic:
Net income as previously reported $0.83 $0.32
Adjustment for effect of change in accounting principle
that is applied retroactively, net of tax effects (0.11) (0.06)
-------- ------
Net income as adjusted $0.72 $0.26
Earnings per common share - Diluted:
Net income as previously reported $0.81 $0.31
Adjustment for effect of change in accounting principle
that is applied retroactively, net of tax effects (0.10) (0.05)
-------- ------
Net income as adjusted $0.71 $0.26
Retained earnings at June 30, 2002:
Retained earnings as previously reported $3,669.1
Cumulative adjustment for effect of change in accounting
principle that is applied retroactively, net of tax effects (64.3)
--------
Retained earnings as adjusted $3,604.8
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 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. LNC intends
to adopt this Interpretation prospectively with a cumulative-effect
adjustment as of the beginning of the third quarter of 2003. As key
guidance with respect to certain aspects of the new Interpretation is
still emerging, LNC has not been able to finalize the expected effect of
adoption.
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 likely that such CDO pools may fall
under the consolidation requirements of Interpretation No. 46. If the
invested assets within the CDO pools and the liabilities owed by the CDO
pools to the third party investors are required to be brought onto LNC's
consolidated balance sheet, LNC would disclose that the CDO pool
liabilities are nonrecourse to LNC.
Because the fair value of the underlying invested assets in the CDO
pools is currently below amortized cost basis, if LNC is required to
consolidate the CDO pools, the value of the assets recorded upon initial
adoption of the new Interpretation will be less than the amount of
nonrecourse debt. Based upon information currently available, LNC
estimates that the fair value of the CDO pool assets is about $1.2
billion and that the nonrecourse debt would be recorded at about $1.5
billion. LNC has an investment of about $22.5 million in certain of the
CDO pools that it manages; at June 30, 2003 these investments had a fair
value of $21.5 million. So LNC does not bear the economic risk of the
loss represented by the approximate $300 million difference between the
value of all of the CDO pool assets and the total amount of CDO pool
nonrecourse debt. Yet under this emerging guidance, at the time of
adopting these new rules LNC's financial statements would not reflect
the fact that it is the third party investor group, and not LNC, that
bears the economic risk of these losses.
To record the difference between the value of the CDO pool assets and
the CDO pool nonrecourse debt on LNC's balance sheet upon the adoption
of Interpretation 46, LNC would record a charge to equity through Other
Comprehensive Income for the cumulative temporary declines in underlying
investment asset values and LNC would record a charge to net income
equal to the cumulative declines in value of the underlying investment
assets that are considered other than temporary. While LNC has not
been able to complete the analysis of all of the underlying investment
assets held within these CDO pools in order to determine which of these
investments have experienced declines in fair value that are other than
temporary, based upon the analysis completed to date it appears likely
that 50% or more of the cumulative declines in the fair value of the CDO
pool assets may be determined to be other than temporary.
In subsequent periods, when the underlying invested assets are sold and the
proceeds are distributed to the investors, LNC would record gains
associated with the extinguishment of nonrecourse debt. This reversal of
the losses recorded upon the initial adoption of Interpretation 46 as the
CDO pools liquidate reflects the fact that it is the third party investors,
and not LNC, that ultimatley bears the risk of loss from these CDO pools.
The Financial Accounting Standards Board is still considering important
guidance relating to these types of investment pools. Until final
guidance is issued, LNC is unable to finalize its review of these
matters. In addition, 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 of the CDO pools. Accordingly, the estimated effects of
the adoption of Interpretation 46 that are discussed in the preceding
paragraphs are subject to change, pending the issuance of final guidance
by the FASB and LNC's obtaining the necessary information from the CDO
pool trustees and administrators.
Since LNC's role of investment manager for the CDO pools does not expose
LNC to risk of loss on the underlying invested assets, LNC management
does not believe the accounting model imposed under Interpretation 46 is
reflective of the true underlying economics for the investment manager
of these types of CDO pool arrangements. However, based upon the current
status of this emerging guidance, it appears that LNC may be required
to apply this accounting model in order to comply with generally
accepted accounting principles.
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 CDO pools
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 ("DIG B36") addressing
the accounting for modified coinsurance agreements ("Modco") and
coinsurance with funds withheld ("CFW") reinsurance agreements. This
implementation guidance concluded that Modco and CFW agreements contain
embedded derivatives that must be accounted for separately from the
underlying reinsurance agreements. In conjunction with the initial
application of these new rules, companies that have ceded business and
are holding invested assets under these types of reinsurance
arrangements may reclassify available for sale invested assets to
trading account classification, where such securities relate to the
embedded derivatives in the reinsurance agreements.
The effective date for implementation of DIG B36 for LNC will be the
October 1, 2003 start date of the fourth quarter. Upon adoption, LNC will
record the fair value of the applicable embedded derivatives in net income
as a cumulative effect of a change in accounting principle. The new rules
do not provide guidance with respect to a number of key implementation
matters, presenting LNC and the life insurance industry with several
challenging decisions and numerous alterative interpretations as to the
application of the new rules. Accordingly, LNC is currently evaluating
alternative interpretations, as well as potential changes in its
reinsurance agreements, that could affect the amounts recorded at the time
of adoption as well as the way changes in the fair values of invested
assets and embedded derivatives associated with these reinsurance
agreements will be reflected within LNC's financial statements on an
ongoing basis.
Among the matters LNC is currently evaluating is how to characterize the
embedded derivatives in various Modco and CFW reinsurance agreements.
Alternatives under consideration include viewing the embedded derivatives
as total return swaps or credit default swaps. Once the characterizations
of the various embedded derivatives are decided upon, LNC must then
determine what methodologies to use to measure the fair value of the
embedded derivatives. For instance, if LNC determines that
characterization of an embedded derivative as a total return swap is
appropriate for a particular agreement, LNC might look to the unrealized
gains and losses included within the invested assets supporting the
agreement as a means of measuring the fair value of the embedded
derivative. In such circumstances, upon adoption of the new rules LNC may
decide to reclassify that portion of the underlying invested assets that
are currently classified as available for sale securities to trading
account assets.
To illustrate the potential effect that the initial adoption of these
rules could have on LNC's financial statements, information relating to
invested assets held by LNC at June 30, 2003 under Modco and CFW
agreements is provided below. The actual effect of adoption will vary
depending upon a number of factors, such as how the embedded derivatives
are characterized, the valuation methodologies selected, whether the
terms of the reinsurance agreements provide for a pass through of the
total return of an identified investment portfolio or some other
measure, whether or not invested assets within such reinsurance
investment portfolios are reclassified from available for sale to
trading account, the amount of unrealized gains or losses of the
relevant invested assets at the adoption date, and any changes in the
terms or structure of a large number of existing LNC Modco and CFW
reinsurance agreements.
At June 30, 2003, the fair value of LNC invested assets associated with
Modco and CFW agreements totaled about $3.3 billion. The net unrealized
pre-tax gain associated with these assets at June 30, 2003 was about
$481 million. Included within that total net gain is about $450 million
of net gain related to available for sale securities and $31 million of
net gain related to other invested assets. If LNC should determine that
the best characterization of the embedded derivatives associated with
these various agreements is that of total return swaps, and if LNC
determines that the unrealized gains and losses of the underlying
invested asset portfolios can be used to measure the value of the
embedded derivative, and provided further that there were no changes in
the value of the underlying investment portfolios and that there are no
changes in the reinsurance agreements between June 30, 2003 and October
1, 2003, then LNC would record a $481 million pre-tax loss in net income
upon the initial adoption of the new rules to record the various
embedded derivatives. LNC would also record a pre-tax increase in
equity of $450 million to reverse the "shadow adjustment" entries
previously recorded through Other Comprehensive Income. The shadow
adjustments were previously recorded due to the fact that unrealized
gains or losses on the reinsurance portfolios generally inure to the
benefit or detriment of the assuming reinsurance company. The $31
million pretax net effect on LNC's equity of the initial adoption
adjustments would reverse over the term of the reinsurance agreements,
as the net unrealized gains associated with invested assets that are not
classified as available-for-sale securities are realized in future
periods.
If LNC decided to concurrently reclassify all relevant available-for-sale
invested assets to trading account assets upon the initial adoption of
these new rules, LNC would record a pre-tax gain in net income of $450
million. However, LNC's equity would not be affected by this
reclassification accounting, as the previously recorded increases to
shareholder's equity booked in Other Comprehensive Income as a result of
the available-for-sale classification of these investments would be
reversed upon the reclassification of these invested assets from
available-for-sale to trading account.
On an ongoing basis, changes in the fair value of the embedded derivative
would flow through net income, as would changes in the fair value of
trading account assets. Changes in the fair value of other invested assets
supporting these agreements would flow through net income as unrealized
gains or losses on these assets are realized. Because the recognition of
the fair value of embedded derivatives does not affect either the cash
flows or the economic profits to be recognized over the life of the
reinsurance agreement, it is expected that these new rules will only change
the pattern of earnings associated with these reinsurance agreements.
Importantly, it is expected that the new rules will not change the ultimate
profit or loss that will be reported over the entire term of the
reinsurance agreement.
Not included in the above discussion are a number of reinsurance
agreements where LNC accepts business as a reinsurer on a Modco basis
and then cedes the business off on a Modco basis to Swiss Re. LNC does
not hold the underlying invested assets under these agreements, and LNC
has effectively transferred all underwriting and investment risks
associated with these agreements. LNC is a party to a number of such
reinsurance agreements, which at June 30, 2003 aggregated about $1.8
billion of business. While LNC continues to review the treatment of
these Modco agreements under these new rules, it appears that the
embedded derivatives associated with these agreements will be
characterized as total return swaps. Based upon information available at
this time and the preliminary conclusion that these embedded derivatives
should be characterized as total return swaps, LNC expects that its
position as an accepting reinsurer and a ceding company on the same
business should result in equal and offsetting changes in the value of
the embedded derivatives associated with these agreements. Accordingly,
LNC would not expect that the embedded derivatives associated with these
reinsurance agreements would create significant volatility in reported
net income in future periods.
In addition, LNC has acquired certain blocks of variable annuity and
life business using Modco reinsurance structures. At June 30, 2003
there was about $336 million of business acquired in this manner. LNC
continues to review whether the accounting for these agreements will
change under the new rules; based upon information available at this
time LNC does not believe there will be any new effects on net income
created by the adoption of the new embedded derivative accounting rules
for these agreements, given the fact that the assets and liabilities
associated with these variable blocks of business are already reflected
at fair value within LNC's financial statements.
Statement of Position 03-1. In July 2003, the American Institute of
Certified Public Accountants issued Statement of Position 03-1, "Accounting
and Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts" ("SOP 03-1"). SOP 03-1
provides guidance related to the reporting and disclosure of certain insurance
contracts and separate accounts, including guidance for computing reserves
for products with guaranteed benefits, such as guaranteed minimum death
benefits ("GMDB"), and for products with annuitization benefits such as
guaranteed minimum income benefits. In addition, SOP 03-1 addresses the
presentation and reporting of separate accounts, as well as rules
concerning the capitalization and amortization of sales inducements.
Based upon a preliminary comparison of the requirements of SOP 03-1 to
LNC's established practice of reserving for GMDB, the adoption of the
GMDB reserving methodology under SOP 03-1 is not expected to have
material effect on LNC's financial statements.
In addition to GMDB reserving matters, LNC is also assessing the other
requirements included in SOP 03-1. At this point, LNC has not had
sufficient time to complete an estimate of the expected effect of these
other SOP 03-01 requirements; however, based upon a preliminary review,
LNC does not currently expect that the adoption of these new rules
should have a material effect on LNC's financial statements. LNC
expects to adopt SOP 03-1 in the first quarter of 2004.
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 June 30, 2002 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. Preferred Securities of Subsidiary Trusts
On June 24, 2003 LNC announced plans to redeem the $200 million 7.40% TOPrS
issued by Lincoln Capital III and guaranteed by LNC. The redemption date
was July 24, 2003. A loss of $3.6 million relating to unamortized issuance
costs, will be reported in the third quarter of 2003 related to the
redemption.
5. Supplemental Financial Data
A roll forward of the balance sheet account, "Deferred Acquisition
Costs," is as follows:
Six Months Ended
June 30
(in millions) 2003 2002
---- ----
Balance at beginning-of-period $2,970.9 $2,885.3
Deferral 289.1 304.0
Amortization (164.1) (171.0)
Adjustment related to realized losses on
securities available-for-sale 38.3 74.3
Adjustments related to unrealized (gains)
losses on securities available-for-sale (453.5) (37.2)
Foreign currency translation adjustment -- 29.5
Other 16.4 (28.3)
-------- --------
Balance at end-of-period $2,697.1 $3,056.6
Realized gains and losses on investments and derivative instruments on
the Statements of Income for the six months ended June 30, 2003 and 2002
are net of amounts restored or (amortized) against deferred acquisition
costs of $38.3 million and $74.3 million, respectively. In addition,
realized gains and losses for the six months ended June 30, 2003 and
2002 are net of adjustments made to policyholder reserves of $44.8
million and $18.5 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:
Six Months Ended Three Months Ended
June 30 June 30
(in millions) 2003 2002* 2003 2002*
- ------------- ----- ----- ----- -----
Commissions $258.6 $292.8 $132.9 $148.6
Other volume related expenses 137.0 120.2 65.4 65.5
Operating and administrative expenses 453.2 440.1 235.4 219.4
Deferral of acquisition costs (289.1) (304.0) (140.6) (156.1)
Amortization of deferred acquisition costs 164.1 171.0 64.0 100.5
Other intangibles amortization 4.0 4.2 2.0 2.0
Restructuring charges 19.0 1.6 13.5 1.6
Other 90.0 113.9 36.7 56.1
-------- ------- -------- -------
Total $836.8 $839.8 $409.3 $437.6
* 2002 amounts have been restated for the retroactive adoption of FAS 123. See Note 2 for additional information.
The carrying amount of goodwill by reportable segment as of June 30,
2003 and December 31, 2002 was as follows:
(in millions) June 30, December 31,
2003 2002
---- ----
Lincoln Retirement $64.1 $64.1
Life Insurance 855.1 855.1
Investment Management 300.7 300.7
Lincoln UK 13.7 13.3
-------- -------
Total $1,233.6 $1,233.2
The consolidated carrying value of goodwill as of June 30, 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 June 30, 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 $106.7 $225.0 $102.3
Life Insurance Segment:
Present value of in-force 1,254.2 398.8 1,254.2 364.1
Investment Management Segment:
Client lists 103.6 65.7 103.6 61.8
Lincoln UK Segment:
Present value of in-force* 354.0 107.0 344.2 106.8
-------- -------- -------- --------
Total $1,936.8 $678.2 $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 June 30, 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
six months ended June 30, 2003 and 2002 was $40.3 million and $57.5
million, respectively. The aggregate amortization expense for other
intangible assets for the three months ended June 30, 2003 and 2002 was
$15.6 million and $33.9 million, respectively.
Future estimated amortization of other intangible assets is as follows
(in millions):
2003 - $43.8 2004 - $88.0 2005 - $86.3
2006 - $85.2 2007 - $84.8 Thereafter - $870.5
The 2003 amount shown above is the amortization expected for the
remaining six months of 2003.
6. 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 June 30, 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. 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 concluded the
FSA investigation on this matter.
At June 30, 2003 and December 31, 2002, the aggregate liability
associated with Lincoln UK selling practices was $40.6 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. Outstanding guarantees
with off-balance sheet risks had contractual values of $21.5 million and
$22.4 million at June 30, 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. LNC also uses
credit default swaps as part of its credit 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.
7. 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:
Six Months Three Months
Ended June 30 Ended June 30
(in millions) 2003 2002 (1) 2003 2002 (1)
------------- ---- ---- ---- ----
Revenue:
Lincoln Retirement $884.2 $895.6 $486.4 $442.6
Life Insurance 931.5 863.8 474.0 439.8
Investment Management (2) 218.5 213.4 116.4 106.1
Lincoln UK 129.1 133.6 60.2 80.5
Other operations 316.3 331.4 156.7 164.7
Consolidating adjustments (167.1) (154.4) (80.6) (76.2)
-------- -------- -------- --------
Total $2,312.5 $2,283.4 $1,213.1 $1,157.5
Income (Loss) before Federal Income Taxes
(Tax Benefits):
Lincoln Retirement $85.7 $42.9 $99.0 $(2.2)
Life Insurance 164.4 142.0 95.7 79.4
Investment Management 9.1 2.4 7.2 (1.0)
Lincoln UK 29.7 18.8 19.0 9.0
Other operations (includes interest expense) (65.8) (63.7) (33.2) (38.3)
Consolidating adjustments -- -- -- --
-------- -------- -------- --------
Total $223.1 $142.4 $187.7 $46.9
Federal Income Taxes (Tax Benefits):
Lincoln Retirement $(2.9) $(12.8) $17.3 $(11.3)
Life Insurance 50.3 41.8 30.1 22.7
Investment Management 3.5 1.1 2.6 (0.2)
Lincoln UK 10.4 (0.7) 6.6 (0.3)
Other operations (22.5) (21.1) (11.6) (12.5)
Consolidating adjustments -- -- -- --
-------- -------- -------- --------
Total $38.8 $8.3 $45.0 $(1.6)
Net Income (Loss):
Lincoln Retirement $88.6 $55.7 $81.7 $9.2
Life Insurance 114.1 100.2 65.6 56.7
Investment Management 5.6 1.3 4.6 (0.8)
Lincoln UK 19.3 19.5 12.4 9.2
Other operations (includes interest expense) (43.3) (42.5) (21.6) (25.8)
Consolidating adjustments -- -- -- --
-------- -------- -------- --------
Total $184.3 $134.2 $142.7 $48.5
June 30 December 31
(in millions) 2003 2002 (1)
------------- ---- ----
Assets:
Lincoln Retirement $56,669.9 $52,896.4
Life Insurance 20,583.5 19,591.6
Investment Management 1,481.1 1,461.4
Lincoln UK 7,735.8 7,327.1
Other operations 15,122.8 13,951.4
Consolidating adjustments (2,060.3) (2,043.3)
-------- ---------
Total $99,532.8 $93,184.6
(1) 2002 amounts 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 $49.6 million and $49.4
million for the six months ended June 30, 2003 and 2002, respectively,
and $25.4 million and $24.3 million for the three months ended June 30,
2003 and 2002, respectively.
8. Earnings Per Share
Per share amounts for net income are shown on the income statement using
1) an earnings per common share basic calculation and 2) an earnings per
common share-assuming dilution calculation. Reconciliations of the
factors used in the two calculations are as follows:
Six Months Three Months
Ended June 30 Ended June 30
2003 2002 (1) 2003 2002 (1)
---- ---- ---- ----
Numerator: [in millions]
Net income, as used in basic calculation (1) $184.3 $134.2 $142.7 $48.5
Dividends on convertible preferred stock
and adjustments for minority interests * * * *
------------ ------------ ------------ ------------
Net income, as used in diluted calculation $184.3 $134.2 $142.7 $48.5
* Less than $100,000.
Denominator: [number of shares]
Weighted-average shares, as used
in basic calculation 177,114,725 186,367,782 177,218,568 185,892,541
Shares to cover conversion of
preferred stock 311,385 348,481 306,085 337,207
Shares to cover non-vested stock 73,141 40,455 95,636 34,619
Average stock options outstanding
during the period 6,382,767 16,457,348 6,377,143 14,720,064
Assumed acquisition of shares
with assumed proceeds and
benefits from exercising stock options
(at average market price during
the period) (5,587,472) (13,383,816) (5,428,905) (12,117,474)
Shares repurchaseable from measured
but unrecognized stock option expense (448,845) (1,442,144) (291,655) (1,174,826)
Average deferred compensation shares 934,302 836,765 934,669 835,836
Numerator: [in millions] ------------ ------------ ------------ ------------
Weighted-average shares, as
used in diluted calculation 178,780,003 189,224,871 179,211,541 188,527,967
(1) 2002 net income amounts have been restated for the retroactive
adoption of FAS 123. See Note 2 for additional information.
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.
9. 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-Average Weighted-Average
Shares Exercise Price Shares Exercise Price
- -----------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 18,608,009 $38.89 10,883,053 $38.87
Granted-original 410,896 25.41
Granted-reloads 94,436 31.30
Exercised (includes shares tendered) (466,839) 32.70
Forfeited (472,587) 41.78
-----------------------------------------------------------------------
Balance at June 30, 2003 18,173,915 $38.84 13,568,082 $38.96
Total compensation expense for LNC incentive plans involving stock
options for the six months ended June 30, 2003 and 2002 was $12.8
million after-tax ($18.0 million pre-tax) and $15.6 million after-tax
($21.6 million pre-tax), respectively. Total compensation expense for
LNC incentive plans involving stock options for the three months ended
June 30, 2003 and 2002 was $6.9 million after-tax ($9.8 million pre-tax)
and $8.6 million after-tax ($12.0 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 to 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 Investments U.S.,
Inc. ("DIUS") and DIAL Holding Company, Inc. ("DIAL") Plans.
In the first six months of 2003, LNC granted a combination of performance
vesting stock options, performance share units and performance vesting
cash awards under the new plan. These awards consisted of 319,786
10-year LNC stock options, 756,737 performance share units that could
result in the issuance of LNC shares, and cash awards. The ultimate
amount of stock to be issued for either the stock option or performance
share awards, or cash to be paid for the cash awards will be determined
by the level of achievement on LNC's three performance measures over the
three-year performance measurement period. Information with respect to
the expenses recorded for awards under these programs is as follows:
Periods Ended June 30, 2003
-----------------------------------------------
Six Months Three Months
After-Tax Pre-Tax After-Tax Pre-Tax
-----------------------------------------------
Stock Options $0.1 $0.2 $0.1 $0.1
Performance Shares 2.1 3.2 1.0 1.6
Cash Awards 0.3 0.4 0.1 0.2
The amount of stock option expense for the performance vesting awards is
included in the total LNC stock option expense as discussed above under
the caption "LNC Stock Options."
All expense calculations for performance vesting stock options,
performance shares, and performance vesting cash awards that were
granted in the second 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 326,650 25.27
Exercised (includes shares tendered) (29,200) 33.90
Forfeited (29,550) 38.74
-------- --------
Balance at June 30, 2003 1,650,148 $36.71 638,143 $35.85
Total compensation expense for the LNC incentive plan involving SARs for
the six months ended June 30, 2003 and 2002 was $1.1 million after-tax
($1.7 million pre-tax) and $0.4 million after-tax ($0.6 million
pre-tax), respectively. Total compensation expense (income) for the LNC
incentive plan involving SARs for the three months ended June 30, 2003
and 2002 was $1.6 million after-tax ($2.5 million pre-tax) and $(0.9)
million after-tax ($(1.3) million pre-tax), respectively. As discussed in
Note 6 to the audited financial statements in LNC's annual report on
Form 10K, compensation expense (income) for the LNC incentive plan
involving SARs represents the net amount of the mark-to-market
adjustment for options to acquire LNC shares purchased at the time of
the grants, combined with the change in LNC's stock price compared to
the SAR's grant price.
Delaware Investments U.S., Inc. ("DIUS") and DIAL Holding Company, Inc.
("DIAL") Plans
At June 30, 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 (161,256) 104.68
-------- --------
Balance at June 30, 2003 1,203,940 $102.97 231,685 $104.24
At June 30, 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 (45,686) 25.76
-------- --------
Balance at June 30, 2003 1,625,903 $26.13 260,581 $25.76
Compensation expense for the DIUS and DIAL incentive plan involving
stock options for the six months ended June 30, 2003 and 2002 totaled
$4.6 million after-tax ($6.4 million pre-tax) and $4.1 million after-tax
($5.9 million pre-tax), respectively. Compensation expense for the DIUS
and DIAL incentive plan involving stock options for the three months
ended June 30, 2003 and 2002 totaled $2.6 million after-tax ($3.7
million pre-tax) and $2.3 million after-tax ($3.3 million pre-tax),
respectively.
10. 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 to the audited
financial statements 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 six months of 2003 0.9
Amounts reversed in the first six months of 2003 --
-------
Restructuring reserve at June 30, 2003 $1.6
=======
Positions to be eliminated under original plan 119
Actual positions eliminated through June 30, 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 six months of 2003 1.0
Amounts reversed in the first six months of 2003 --
-------
Restructuring reserve at June 30, 2003 $8.7
=======
Positions to be eliminated under original plan 671
Actual positions eliminated through June 30, 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 - 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 six months of 2003 0.1 -- -- 0.4 0.5
Amounts reversed in the first six months of 2003 -- -- -- -- --
------- ------- ------- ------- ------
Restructuring reserve at June 30, 2003 $0.2 $0.4 $-- $0.2 $0.8
======= ======= ======= ======= ======
Positions to be eliminated under original plan 27 - 63 9
Actual positions eliminated through June 30, 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 six months of 2003 0.6
Amounts reversed in the first six months of 2003 --
-------
Restructuring reserve at June 30, 2003 $0.1
=======
Positions to be eliminated under original plan 49
Actual positions eliminated through June 30, 2003 49
Expected completion date Third quarter 2003
2003 Restructuring Plan
In January 2003, the Life Insurance segment announced that it was
realigning its operations in Hartford, Connecticut and Schaumburg,
Illinois to enhance productivity, efficiency and scalability while
positioning the segment for future growth. In February 2003, Lincoln
Retirement announced plans to consolidate its fixed annuity operations
in Schaumburg, Illinois into Fort Wayne, Indiana. In June 2003, LNC
announced that it will combine its retirement and life insurance
businesses into a single operating unit focused on providing wealth
accumulation and protection, income distribution and wealth transfer
products. The realigned organization is expected to significantly
reduce operating expenses while positioning LNC for future growth and to
take advantage of the recent market recovery. The following table
provides information about these restructuring plans.
Retirement and Life
Life Insurance Fixed Annuity Insurance
Realignment Consolidation Combination
(in millions) Jan 2003 Feb 2003 June 2003 Total
------------- ---------- ------------- ----------- ----------
Employee severance and termination benefits $4.1 $1.0 $2.9 $8.0
Write-off of impaired assets 1.9 -- -- $1.9
Other Costs:
Rent on abandoned office space 6.0 2.2 -- $8.2
Other 0.8 0.1 -- $0.9
------- ------- ------- -------
Total 2003 Restructuring Charges (pre-tax) 12.8 3.3 2.9 $19.0
Amounts expended in the first six months of 2003 5.5 3.3 2.9 $11.7
Amounts reversed in the first six months of 2003 -- -- -- --
------- ------- ------- -------
Restructuring reserve at June 30, 2003 $7.3 $-- $-- $7.3
======= ======= ======= =======
Positions to be eliminated under original plan 147 64 To be determined
Actual positions eliminated through June 30, 2003 135 52 3
Expected completion date Second Second
Quarter 2006 Quarter 2006 To be determined
11. Subsequent Event
On August 4, 2003, LNC announced that in addition to the previously
announced realignment of LNC's life and annuity businesses (see 2003
Restructuring Plan within Note 9 above), it is taking further action to
position LNC for future growth. The actions are expected to be impact
all domestic operations. Charges of approximately $95 million are
expected to be incurred during 2003, which includes $19 million incurred
as restructuring charges through June 30, 2003.
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.
* future interpretations of NAIC Actuarial Guidelines may require LNC to
establish additional statutory reserves for guaranteed minimum death
benefits under variable annuity contracts.
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 the LNC could have to accelerate amortization of
deferred policy acquisition costs if the market continues to
deteriorate;
* the risk that the LNC could have to write off investments in certain
securities if the issuers' financial condition deteriorates;
* the risks associated with having products with guaranteed 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
Six Months Ended Three Months Ended
June 30 June 30
(in millions) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Insurance premiums and fees $816.9 $868.3 $413.8 $436.8
Investment advisory fees 93.5 95.8 49.4 47.8
Net investment income 1,314.9 1,312.2 660.2 657.4
Realized loss on investments and
derivative instruments (94.1) (184.4) (2.7) (81.0)
Other revenue and fees 181.3 191.5 92.5 96.5
------- ------- ------- -------
Total Revenue 2,312.5 2,283.4 1,213.2 1,157.5
Insurance benefits 1,206.2 1,251.7 593.2 648.3
Underwriting, acquisition, insurance and
other expenses 836.9 839.8 409.3 437.6
Interest and debt expenses 46.3 49.4 23.0 24.7
------- ------- ------- -------
Total Benefits and Expenses 2,089.4 2,140.9 1,025.5 1,110.6
Income Before Federal Income Taxes 223.1 142.5 187.7 46.9
Federal income taxes 38.8 8.3 45.0 (1.6)
------- ------- ------- -------
Net Income $184.3 $134.2 $142.7 $48.5
Items Included in Net Income:
Realized Loss on Investments and
Derivative Instruments (after-tax) $(61.2) $(119.9) $(1.7) $(52.4)
Restructuring Charges (after-tax) (12.4) (1.0) (8.8) (1.0)
Reserve Development on Business Sold
Through Indemnity Reinsurance and Related
Amortization of
Deferred Gain (after-tax) $(0.2) $(14.4) $(0.1) $(14.4)
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, 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 periods presented for 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 the adoption was a
decrease in net income of $19.7 million for the six months ended June
30, 2002 and $10.9 million for the three months ended June 30, 2002 from
previously reported amounts.
Net Income
Net income for the six months ended June 30, 2003 increased by $50.1
million, or 37%, compared to the same period in 2002. Net income for the
three months ended June 30, 2003 increased by $94.2 million over the same
period in 2002. Net realized losses on investments and derivative
instruments were $58.7 million and $50.7 million lower in the six and three
months ended June 30, 2003, respectively, than in the same periods of 2002.
Net realized investment losses for the first six months of 2002 were
largely due to sales and write-downs of investments in Worldcom, other
telecommunications issuers and collateralized debt obligations. Write-downs
for impairments were required for the six months ended June 30, 2003 for
securities held within primarily the airline industry, electric utilities
and asset-backed securities (ABS). For additional detail on realized
losses see the discussion in the Consolidated Investment section.
For the six months ended June 30, 2003, the equity markets experienced
overall improvement as the S&P index at June 30, 2003 was 11% higher than
December 31, 2002, with all of the improvement occurring in the three
months ended June 30, 2003. The S&P index gained 15% in the second quarter
of 2003, but ended the period 1.5% lower than June 30, 2002. The equity
market improvement from December 31, 2002 increased LNC's overall results
by $3.5 million in the first six months of 2003, and $25.4 million in the
second quarter of 2003, primarily within the Lincoln Retirement segment.
Excluding the $5.9 million impact of the No Change Effect on GMDB, the
equity market impact in the second quarter of 2003 relative to the first
quarter of 2003 was $31.3 million. The following table displays the impact
of the improvement in the equity markets by segment for the first six
months of 2003.
Impact of the Equity Markets by Segment ($ Millions)
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- Lagging Effect of 1Q03 Market Changes on 2Q03 (0.8) -- (0.1) (0.1) (1.0)
Fees- Current Effects in 1Q03 (1.0) -- (0.5) (0.5) (2.0)
Fees- Current Effects in 2Q03 6.0 0.3 2.7 0.4 9.4
---------------------------------------------------------
Total Fee Income 3.7 0.3 2.2 (0.3) 5.9
Other 1.5 1.5
GMDB-No Change Effect 1Q03 (5.9) -- -- -- (5.9)
GMDB-Market Change Effect 1Q03 (7.5) -- -- -- (7.5)
GMDB-No Change Effect 2Q03 (5.9) -- -- -- (5.9)
GMDB-Market Change Effect 2Q03 13.6 -- -- -- 13.6
---------------------------------------------------------
Total GMDB (5.7) -- -- -- (5.7)
DAC/DFEL 1Q03 (1.8) (0.6) -- (3.6) (6.0)
DAC/DFEL 2Q03 2.7 1.3 -- 3.8 7.8
---------------------------------------------------------
Total Effect $0.4 $1.0 $2.2 $(0.1) $3.5
The following table displays the impact of the improvement in the equity
markets by segment for the second quarter of 2003.
Impact of the Equity Markets by Segment ($ Millions)
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 2Q03 6.0 0.3 2.7 0.4 9.4
---------------------------------------------------------
Total Fee Income 5.2 0.3 2.6 0.3 8.4
Other 1.5 1.5
GMDB-No Change Effect 2Q03 (5.9) -- -- -- (5.9)
GMDB-Market Change Effect 2Q03 13.6 -- -- -- 13.6
---------------------------------------------------------
Total GMDB 7.7 -- -- -- 7.7
DAC/DFEL 2Q03 2.7 1.3 -- 3.8 7.8
---------------------------------------------------------
Total Effect $17.1 $1.6 $2.6 $4.1 $25.4
See the discussion of results of operations for each business segment
for additional details on the impact of the equity markets for the six
and three months ended June 30, 2003. See the discussion presented
below under the topic "Third 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 increased primarily due to the declines in net
realized investment losses for both the six month and three month
periods ended June 30, 2003 compared to the same periods last year.
Strong sales in the Life Insurance segment combined with growth in the
Investment Management segment in assets under management resulting from
favorable net flows and the effects of the equity markets also
contributed to these increases. These improvements were partially
offset by lower fee income in the Lincoln Retirement and Lincoln UK
segments from the impact of declines in the equity markets from June 30,
2002 to June 30, 2003 on average variable annuities (Retirement) and
unit-linked account values (Lincoln UK).
Expenses
Consolidated expenses were favorably affected by the improvement in the
equity markets in the first six months of 2003, which resulted in
positive unlocking of deferred acquisition costs ("DAC") and present
value of in-force ("PVIF") in the Lincoln Retirement and Lincoln UK
business segments, decreased reserves and payments for guaranteed
minimum death benefits 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:
Periods ended June 30, Six Months Three Months
(in billions) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------
Deposits (1):
Lincoln Retirement Segment $2.8 $3.3 $1.4 $1.6
Life Insurance Segment 1.0 1.0 0.5 0.6
Investment Management Segment (including
both retail and institutional deposits) 4.3 5.2 2.1 2.6
Consolidating Adjustments (2) (0.3) (0.5) (0.2) (0.3)
----------------------------------------------------
Total Deposits $7.8 $9.0 $3.8 $4.5
Net Flows (1):
Lincoln Retirement Segment $0.2 $0.3 $0.1 $0.2
Life Insurance Segment 0.6 0.6 0.3 0.4
Investment Management Segment (including
both retail and institutional net flows) 0.9 1.4 0.6 0.6
Consolidating Adjustments (2) 0.2 -- -- --
----------------------------------------------------
Total Net Flows $1.9 $2.3 $1.0 $1.2
(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.
Third Quarter 2003 Guidance for the Estimated Effect of Equity Market
Volatility
After the first quarter of 2003, Lincoln National Corporation ("LNC")
provided guidance on the estimated effect of equity market volatility on
its second quarter of 2003 results. The following guidance is being
provided for purposes of modeling the expected effects of equity market
volatility for the third 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 third
quarter of 2003 information provided below is based upon market
conditions and LNC's mix of business as of the end of the second 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 July 1, 2003, actual results may
differ materially from those projected and LNC claims no responsibility
for updating this forward-looking information (see Forward-Looking
Statements - Cautionary Language at the beginning of Item 2.)
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; deferred front-end load revenue ("DFEL"); 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 actual 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 second quarter of 2003 equity markets change
will create an increase of $2.2 million in the third quarter of 2003 for
the Lincoln Retirement segment, because average account values for the
second quarter of 2003 were less than the level of ending account values
at June 30, 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 second quarter of 2003 equity
markets change will create an increase of $0.1 million in fee income for
Lincoln UK in the third quarter of 2003, because average account values
for the second quarter of 2003 were less than the level of ending
account values at June 30, 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 second quarter of 2003, ranging from a 14.9% increase in the
S&P 500 to a 21.0% NASDAQ increase. The ongoing effect of the second
quarter equity markets change is expected to be a $0.6 million increase
in the third 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 are 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 June 30, 2003 through the third quarter of
2003.
2) The second scenario assumes that from June 30, 2003 through the end
of the third quarter of 2003 equity markets increase smoothly by 2.5%.
3) The third scenario assumes that from June 30, 2003 through the end of
the third quarter of 2003 equity markets decline smoothly by 2.5%.
As the above assumptions indicate, actual equity market changes that may
have occurred since June 30, 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 June 30, 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 June 30, 2003 through September 30,
2003.
Estimated After-tax Effect on Third Quarter of 2003 Results (in
millions):
Segment
---------------------------------------------
Lincoln Life Investment
Retirement Insurance Management Lincoln UK LNC Total
---------------------------------------------------------
Fees- Lagging Effect of 2Q03
Market Changes on 3Q03* $2.2 $-- $0.6 $0.1 $2.9
Fees- Current Effects in
Third Quarter -- -- -- -- --
---------------------------------------------------------
Total Fee Income 2.2 -- 0.6 0.1 2.9
Other (0.3) -- -- -- (0.3)
GMDB-No Change Effect (3.6) -- -- -- (3.6)
GMDB-Market Change Effect -- -- -- -- --
---------------------------------------------------------
Total GMDB (3.6) -- -- -- (3.6)
DAC/DFEL** -- (0.3) -- (0.8) (1.1)
---------------------------------------------------------
Total Effect $(1.7) $(0.3) $0.6 $(0.7) $(2.1)
* 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, DFEL and PVIF for the Life
Insurance and Lincoln UK segments.
Scenario #2:
2.5% increase in equity markets from June 30, 2003 to September 30, 2003
occurs smoothly during the quarter.
Estimated After-tax Effect on Third Quarter of 2003 Results (in
millions):
Segment
---------------------------------------------
Lincoln Life Investment
Retirement Insurance Management Lincoln UK LNC Total
---------------------------------------------------------
Fees- Lagging Effect of 2Q03
Market Changes on 3Q03* $2.2 $-- $0.6 $0.1 $2.9
Fees- Current Effects in
Third Quarter 0.7 -- 0.4 0.1 1.2
---------------------------------------------------------
Total Fee Income 2.9 -- 1.0 0.2 4.1
Other -- -- -- -- --
GMDB-No Change Effect (3.6) -- -- -- (3.6)
GMDB-Market Change Effect 3.0 -- -- -- 3.0
---------------------------------------------------------
Total GMDB (0.6) -- -- -- (0.6)
DAC/DFEL** -- -- -- 0.1 0.1
---------------------------------------------------------
Total Effect $2.3 $-- $1.0 $0.3 $3.6
* See * under Scenario #1 for explanation.
** See ** under Scenario #1 for explanation.
Scenario #3: 2.5% decline in equity markets from June 30, 2003 to
September 30, 2003 occurs smoothly during the quarter.
Estimated After-tax Effect on Third Quarter of 2003 Results (in
millions):
Segment
---------------------------------------------
Lincoln Life Investment
Retirement Insurance Management Lincoln UK LNC Total
---------------------------------------------------------
Fees- Lagging Effect of 2Q03
Market Changes on 3Q03* $2.2 $-- $0.6 $0.1 $2.9
Fees- Current Effects in
Third Quarter (0.7) -- (0.4) (0.1) (1.2)
---------------------------------------------------------
Total Fee Income 1.5 -- 0.2 -- 1.7
Other (0.6) -- -- -- (0.6)
GMDB-No Change Effect (3.6) -- -- -- (3.6)
GMDB-Market Change Effect (3.5) -- -- -- (3.5)
---------------------------------------------------------
Total GMDB (7.1) -- -- -- (7.1)
DAC/DFEL** (1.4) (0.5) -- (1.7) (3.6)
---------------------------------------------------------
Total Effect $(7.6) $(0.5) $0.2 $(1.7) $(9.6)
* See * under Scenario #1 for explanation.
** See ** under Scenario #1 for explanation.
Estimated Effect of Each One-Percent Change in Equity Markets
The above examples are based upon the estimated annual after-tax 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 Third in Third
Segment and Effect* Relevant Measure in Market Quarter 2003 Quarter 2003
- -----------------------------------------------------------------------------------------------------------------------
Lincoln Retirement - Ave Daily Change in
Fee Income S&P 500 $0.0 M x 0.0 $2.2 M x 1.25 $2.2 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 in
GMDB Incurred Costs S&P 500 ($3.6M) ($3.6M)+ $1.2M x 2.5 ($3.6M) + $1.4 M x (2.5)
- -----------------------------------------------------------------------------------------------------------------------
Lincoln Retirement - Actual Change in
DAC/DFEL S&P 500 vs. Expected $0.0 M* x (2.25) $0.1 M x 0.25 $0.3 M x (4.75)
- -----------------------------------------------------------------------------------------------------------------------
Life Insurance - Actual Change in
DAC/DFEL/PVIF 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 Management - Blend of
DAC** Market Indices $0.0 M x (2.25) $0.0 M x 0.25 $0.0 M x (4.75)
- -----------------------------------------------------------------------------------------------------------------------
Lincoln UK - Ave Daily Change
Fee Income in 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/DFEL/PVIF 100 vs. Expected Change $0.35 M x (2.25) $0.35 M x 0.25 $0.35 M x (4.75)
- -----------------------------------------------------------------------------------------------------------------------
* 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 actual 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 approximately $0.0 M on the above
chart. This is because the trigger points for unlocking are beyond the
percentage changes noted in the above scenarios. The trigger point for
negative DAC unlocking in the third quarter of 2003 is an approximate
22% decline in the equity markets and the trigger point for positive
unlocking in the third quarter is an approximate 24% increase in the
equity markets.
Sensitivity Factors for Retirement Segment
As the above table indicates, the annual effect of a one percent change
in equity markets varies depending upon the severity of the change.
Presented below are estimated one million dollar effects for various
market changes that are currently used by LNC in modeling the Lincoln
Retirement segment. These estimated effects are subject to ongoing
modification, as they are particularly sensitive to the mix of business
and to the actual level of variable account balances.
The following table provides the annual after-tax effect for changes in
equity markets for the Lincoln Retirement segment related to fee income
and other:
($ Millions for each 1% Change in Relevant Market Index)
- --------------------------------------------------------------------------------------
20% + 11 - 20% 6 - 10% 1 to 5% No 1 to 5% 6 - 10% 10%+
Decline Decline Decline Decline Change Increase Increase
- --------------------------------------------------------------------------------------
Fee Income (1.8) (2.0) (2.1) (2.2) -- 2.2 2.3 2.4
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 third 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 third quarter of
2003. In this example, the expected quarterly effect of a third quarter
2.5% increase is estimated as: ($2.2 x 1.25/4) = $0.69 million.
The table provided below contains information for use in estimating the
third quarter 2003 after-tax 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 June 30, 2003, the third
quarter 2003 GMDB reserve adjustment is estimated at $3.6 million
(included in the no change column in the table below).
($ Millions for each 1% Change in Relevant Market Index)
- --------------------------------------------------------------------------------------
20% + 11 - 20% 6 - 10% 1 to 5% No 1 to 5% 6 - 10% 10%+
Decline Decline Decline Decline Change Increase Increase
- --------------------------------------------------------------------------------------
GMDB (2.2) (1.7) (1.5) (1.4) (3.6) 1.2 1.2 1.2
DAC (1.0) (0.6) (0.5) (0.3) -- 0.1 0.1 0.2
- --------------------------------------------------------------------------------------
The estimated quarterly effects indicated in the table above are
applicable for the third 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 third quarter of 2003. The estimated quarterly effect
is calculated as follows: $(3.6) + $1.2 x 2.5 = $(0.6) 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, under LNC's Incentive Compensation Plan,
LNC's employee stock option compensation program and long-term cash
incentive compensation program 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 programs
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 six and three months ended June
30, 2002, refer to Note 2 to the June 30, 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. LNC intends
to adopt this Interpretation prospectively with a cumulative-effect
adjustment as of the beginning of the third quarter of 2003. As key
guidance with respect to certain aspects of the new Interpretation is
still emerging, LNC has not been able to finalize the expected effect of
adoption.
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 likely that such CDO pools may fall
under the consolidation requirements of Interpretation No. 46. If the
invested assets within the CDO pools and the liabilities owed by the CDO
pools to the third party investors are required to be brought onto LNC's
consolidated balance sheet, LNC would disclose that the CDO pool
liabilities are nonrecourse to LNC.
Because the fair value of the underlying invested assets in the CDO
pools is currently below amortized cost basis, if LNC is required to
consolidate the CDO pools, the value of the assets recorded upon initial
adoption of the new Interpretation will be less than the amount of
nonrecourse debt. Based upon information currently available, LNC
estimates that the fair value of the CDO pool assets is about $1.2
billion and that the nonrecourse debt would be recorded at about $1.5
billion. LNC has an investment of about $22.5 million in certain of the
CDO pools that it manages; at June 30, 2003 these investments had a fair
value of $21.5 million. So LNC does not bear the economic risk of the
loss represented by the approximate $300 million difference between the
value of all of the CDO pool assets and the total amount of CDO pool
nonrecourse debt. Yet under this emerging guidance, at the time of
adopting these new rules LNC's financial statements would not reflect
the fact that it is the third party investor group, and not LNC, that
bears the economic risk of these losses.
To record the difference between the value of the CDO pool assets and the
CDO pool nonrecourse debt on LNC's balance sheet upon the adoption of
Interpretation 46, LNC would record a charge to equity through Other
Comprehensive Income for the cumulative temporary declines in underlying
investment asset values and LNC would record a charge to net income equal
to the declines in value of the underlying investment assets that are
considered other than temporary. While LNC has not been able to complete
the analysis of all of the underlying investment assets held within these
CDO pools in order to determine which of these investments have experienced
declines in fair value that are other than temporary, based upon the
analysis completed to date it appears likely that 50% or more of the
cumulative declines in the fair value of the CDO pool assets may be
determined to be other than temporary.
In subsequent periods, when the underlying invested assets are sold and the
proceeds are distributed to the investors, LNC would record gains
associated with the extinguishment of nonrecourse debt. This reversal of
the losses recorded upon the initial adoption of Interpretation 46 as the
CDO pools liquidate reflects the fact that it is the third party investors,
and not LNC, that ultimatley bears the risk of loss from these CDO pools.
The Financial Accounting Standards Board is still considering important
guidance relating to these types of investment pools. Until final
guidance is issued, LNC is unable to finalize its review of these
matters. In addition, 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 of the CDO pools. Accordingly, the estimated effects of
the adoption of Interpretation 46 that are discussed in the preceding
paragraphs are subject to change, pending the issuance of final guidance
by the FASB and LNC's obtaining the necessary information from the CDO
pool trustees and administrators.
Since LNC's role of investment manager for the CDO pools does not expose
LNC to risk of loss on the underlying invested assets, LNC management
does not believe the accounting model imposed under Interpretation 46 is
reflective of the true underlying economics for the investment manager
of these types of CDO pool arrangements. However, based upon the current
status of this emerging guidance, it appears that LNC may be required
to apply this accounting model in order to comply with generally
accepted accounting principles.
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 CDO pools
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 ("DIG B36") addressing
the accounting for modified coinsurance agreements ("Modco") and
coinsurance with funds withheld ("CFW") reinsurance agreements. This
implementation guidance concluded that Modco and CFW agreements contain
embedded derivatives that must be accounted for separately from the
underlying reinsurance agreements. In conjunction with the initial
application of these new rules, companies that have ceded business and
are holding invested assets under these types of reinsurance
arrangements may reclassify available for sale invested assets to
trading account classification, where such securities relate to the
embedded derivatives in the reinsurance agreements.
The effective date for implementation of DIG B36 for LNC will be the
October 1, 2003 start date of the fourth quarter. Upon adoption, LNC will
record the fair value of the applicable embedded derivatives in net income
as a cumulative effect of a change in accounting principle. The new rules
do not provide guidance with respect to a number of key implementation
matters, presenting LNC and the life insurance industry with several
challenging decisions and numerous alterative interpretations as to the
application of the new rules. Accordingly, LNC is currently evaluating
alternative interpretations, as well as potential changes in its
reinsurance agreements, that could affect the amounts recorded at the time
of adoption as well as the way changes in the fair values of invested
assets and embedded derivatives associated with these reinsurance
agreements will be reflected within LNC's financial statements on an
ongoing basis.
Among the matters LNC is currently evaluating is how to characterize the
embedded derivatives in various Modco and CFW reinsurance agreements.
Alternatives under consideration include viewing the embedded derivatives
as total return swaps or credit default swaps. Once the characterizations
of the various embedded derivatives are decided upon, LNC must then
determine what methodologies to use to measure the fair value of the
embedded derivatives. For instance, if LNC determines that
characterization of an embedded derivative as a total return swap is
appropriate for a particular agreement, LNC might look to the unrealized
gains and losses included within the invested assets supporting the
agreement as a means of measuring the fair value of the embedded
derivative. In such circumstances, upon adoption of the new rules LNC may
decide to reclassify that portion of the underlying invested assets that
are currently classified as available for sale securities to trading
account assets.
To illustrate the potential effect that the initial adoption of these
rules could have on LNC's financial statements, information relating to
invested assets held by LNC at June 30, 2003 under Modco and CFW
agreements is provided below. The actual effect of adoption will vary
depending upon a number of factors, such as how the embedded derivatives
are characterized, the valuation methodologies selected, whether the
terms of the reinsurance agreements provide for a pass through of the
total return of an identified investment portfolio or some other
measure, whether or not invested assets within such reinsurance
investment portfolios are reclassified from available for sale to
trading account, the amount of unrealized gains or losses of the
relevant invested assets at the adoption date, and any changes in the
terms or structure of a large number of existing LNC Modco and CFW
reinsurance agreements.
At June 30, 2003, the fair value of LNC invested assets associated with
Modco and CFW agreements totaled about $3.3 billion. The net unrealized
pre-tax gain associated with these assets at June 30, 2003 was about
$481 million. Included within that total net gain is about $450 million
of net gain related to available for sale securities and $31 million of
net gain related to other invested assets. If LNC should determine that
the best characterization of the embedded derivatives associated with
these various agreements is that of total return swaps, and if LNC
determines that the unrealized gains and losses of the underlying
invested asset portfolios can be used to measure the value of the
embedded derivative, and provided further that there were no changes in
the value of the underlying investment portfolios and that there are no
changes in the reinsurance agreements between June 30, 2003 and October
1, 2003, then LNC would record a $481 million pre-tax loss in net income
upon the initial adoption of the new rules to record the various
embedded derivatives. LNC would also record a pre-tax increase in
equity of $450 million to reverse the "shadow adjustment" entries
previously recorded through Other Comprehensive Income. The shadow
adjustments were previously recorded due to the fact that unrealized
gains or losses on the reinsurance portfolios generally inure to the
benefit or detriment of the assuming reinsurance company. The $31
million pretax net effect on LNC's equity of the initial adoption
adjustments would reverse over the term of the reinsurance agreements,
as the net unrealized gains associated with invested assets that are not
classified as available-for-sale securities are realized in future
periods.
If LNC decided to concurrently reclassify all relevant available-for-sale
invested assets to trading account assets upon the initial adoption of
these new rules, LNC would record a pre-tax gain in net income of $450
million. However, LNC's equity would not be affected by this
reclassification accounting, as the previously recorded increases to
shareholder's equity booked in Other Comprehensive Income as a result of
the available-for-sale classification of these investments would be
reversed upon the reclassification of these invested assets from
available-for-sale to trading account.
On an ongoing basis, changes in the fair value of the embedded derivative
would flow through net income, as would changes in the fair value of
trading account assets. Changes in the fair value of other invested assets
supporting these agreements would flow through net income as unrealized
gains or losses on these assets are realized. Because the recognition of
the fair value of embedded derivatives does not affect either the cash
flows or the economic profits to be recognized over the life of the
reinsurance agreement, it is expected that these new rules will only change
the pattern of earnings associated with these reinsurance agreements.
Importantly, it is expected that the new rules will not change the ultimate
profit or loss that will be reported over the entire term of the
reinsurance agreement.
Not included in the above discussion are a number of reinsurance
agreements where LNC accepts business as a reinsurer on a Modco basis
and then cedes the business off on a Modco basis to Swiss Re. LNC does
not hold the underlying invested assets under these agreements, and LNC
has effectively transferred all underwriting and investment risks
associated with these agreements. LNC is a party to a number of such
reinsurance agreements, which at June 30, 2003 aggregated about $1.8
billion of business. While LNC continues to review the treatment of
these Modco agreements under these new rules, it appears that the
embedded derivatives associated with these agreements will be
characterized as total return swaps. Based upon information available at
this time and the preliminary conclusion that these embedded derivatives
should be characterized as total return swaps, LNC expects that its
position as an accepting reinsurer and a ceding company on the same
business should result in equal and offsetting changes in the value of
the embedded derivatives associated with these agreements. Accordingly,
LNC would not expect that the embedded derivatives associated with these
reinsurance agreements would create significant volatility in reported
net income in future periods.
In addition, LNC has acquired certain blocks of variable annuity and
life business using Modco reinsurance structures. At June 30, 2003
there was about $336 million of business acquired in this manner. LNC
continues to review whether the accounting for these agreements will
change under the new rules; based upon information available at this
time LNC does not believe there will be any new effects on net income
created by the adoption of the new embedded derivative accounting rules
for these agreements, given the fact that the assets and liabilities
associated with these variable blocks of business are already reflected
at fair value within LNC's financial statements.
Restructuring Charges
In June 2003, LNC announced the realignment of its life insurance and
annuity businesses into a single operating unit focused on providing
wealth accumulation and protection; income distribution and wealth
transfer products.
On August 4, 2003, LNC announced that in addition to the previously
announced realignment of LNC's life and annuity businesses it is taking
further action to position LNC for future growth. The actions are
expected to impact all domestic operations. In total, the planned
actions, including the previously announced realignments, are expected
to result in pre-tax savings of $25 million in 2003, $80 million in 2004
and $105 million in 2005. Offsetting these savings are related pre-tax
charges estimated to be $135 million which are expected to occur over a
three year period, with an estimated $95 million in 2003, $30 million in
2004 and $10 million in 2005. Also, offsetting the savings are pre-tax
investments in business growth initiatives of which $15 million are
expected to be recognized in 2003, $30 million in 2004 and $35 million
in 2005. The after-tax impact to net income from the investments in
business growth initiatives, expense savings and charges is estimated to
result in a net charge of $55 million in 2003, net savings of $13
million in 2004 and net savings of $39 million in 2005. The number of
job eliminations is expected to range between 800 and 1,000, including
approximately 200 which have occurred during 2003.
For an update on the status of restructuring plans implemented from 1999
through June 30, 2003, refer to Note 9 to the June 30, 2003 unaudited
consolidated financial statements.
RESULTS OF OPERATIONS BY SEGMENT
Lincoln Retirement
Results of Operations
Six Months Ended Three Months Ended
June 30, June 30,
2003 2002 2003 2002
- ----------------------------------------------------------------------------
Net Income (in millions) $88.6 $55.7 $81.7 $9.2
Items Included in Net Income:
Realized Loss on Investments and
Derivative Instruments (after-tax) $(50.9) $(69.4) $(0.4) $(36.5)
Restructuring Charge (4.0) (1.0) (4.0) (1.0)
Average Daily Variable Account
Values (in billions) $29.2 $33.5
June 30 (in billions) 2003 2002
- ----------------------------------------------------------------------------
Account Values
Variable Annuities $30.5 $31.2
Fixed Annuities $20.9 $18.7
Reinsurance Ceded (2.2) (1.8)
------ ------
Total Fixed Annuities $18.7 $16.9
Total Account Values $49.2 $48.1
Net income increased $32.9 million and $72.5 million for the six and
three months ended June 30, 2003, respectively, compared to the same
periods in 2002.
Stock-Based Compensation
The periods presented for 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 $2.1 million and $1.0 million in net income
in the six and three months ended June 30, 2002, respectively, from
previously reported amounts.
Realized Losses on Investments and Derivative Instruments
Realized losses on investments and derivative instruments for the
Lincoln Retirement segment decreased $18.5 million and $36.1 million for
the six and three months ended June 30, 2003, respectively, compared to
the same periods in 2002. For additional detail on realized losses see
the discussion in the Consolidated Investments section.
Equity Market Impact
The improvement in the equity markets favorably affected the segment's
earnings through positive unlocking of deferred acquisition costs
("DAC") and the present value of in-force intangible ("PVIF"), a
decrease in reserves and benefit payments for guaranteed minimum death
benefits ("GMDB"), partially offset by lower fees resulting from lower
average variable account values compared to the first six months of
2002. The increase in the equity markets positively affected earnings
by $11.4 million in the six months ended June 30, 2003 and $35.9 million
in the three months ended June 30, 2003 compared to the same periods in
2002.
Average variable annuity account values were $5.9 billion and $4.3
billion lower for the six months and three months ended June 30, 2003
compared to the same periods in 2002, resulting in a reduction of fees,
lowering earnings by $21.1 million and $7.4 million, respectively. The
effect of equity market impact on DAC and PVIF unlocking and net changes
in amortization increased earnings by $18.8 million and $18.6 million in
the six months and three months ended June 30, 2003, respectively,
compared to the same periods of 2002. Decreases in GMDB reserves and
benefit payments resulted in a positive variance of $10.0 million and
$21.0 million for the six and three months ended June 30, 2003,
respectively, compared to 2002 periods. (See the section captioned
"Critical Accounting Policy - Guaranteed Minimum Death Benefit Reserving
for additional details.) In addition, there was a positive variance of
$3.7 million for the six and three month 2003 periods related Lincoln
Retirement's Separate Account Dividends Received Deduction ("DRD") tax
benefit.
Refer to the Third 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 $7.0 million and $3.3
million higher in the six and three months ended June 30, 2003,
respectively, compared to the same periods 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.)
Included in the investment margins variance were earnings from
investment partnerships. The returns on the investment partnerships were
below expected levels by $1.5 million and $2.0 million, respectively for
the six and three months ended June 30, 2003 compared to the same
periods of 2002.
Net Flows - Fixed Annuities
Average gross fixed annuity account values for the six months and three
months ended June 30, 2003 were $2.3 billion higher than the same
periods in 2002. This increase contributed additional earnings of $11.5
million and $6.0 million in the first six months and second quarter of
2003 compared to the same periods 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 Charges
During the second quarter of 2003, the Lincoln Retirement segment
completed the consolidation of its fixed annuity operations in
Schaumburg, Illinois into Fort Wayne, Indiana. This resulted in
expenses of $2.1 million in the second quarter of 2003. In addition,
the Lincoln Retirement segment recognized $1.9 million of expenses in
the second quarter of 2003 related to the combining of the Lincoln
Retirement and Life Insurance operations announced in June of 2003. For
further details refer to Note 9 to the June 30, 2003 unaudited
consolidated financial statements.
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 June 30, 2003,
Lincoln Retirement's reversion to the mean gross growth rate assumption
for the equity markets was 6.9%, which compares to the assumption of 9%
at December 31, 2002. The decrease in the growth rate was due to the
increase in the equity markets in the second quarter of 2003.
During the third quarter of 2003, the Lincoln Retirement segment expects
to perform a comprehensive review of the assumptions underlying the
amortization of the DAC asset. The review will encompass the
fundamental assumptions including lapses, mortality, expenses,
reinsurance and investment margins.
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 June 30, 2003,
Lincoln Retirement's net amount at risk ("NAR") was $3.0 billion and the
GAAP reserve was $70.9 million. The reserve for statutory accounting
was $90.7 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 June 30, 2003:
Return of High Water
Premium Mark Roll-Up No GMDB Total
--------- ---------- ------- -------- --------
Variable Annuity Account
Value (billions) $22.6 $10.5 $0.3 $6.9 $40.3
% of Total Annuity
Account Value 56.0% 26.0% 0.7% 17.3% 100.0%
Average Account Value $32,461 $64,805 $98,566 $47,832 $41,392
Average NAR $7,992 $8,387 $16,254 N/A $8,167
GAAP Reserve (millions) $21.9 $48.5 $0.5 N/A $70.9
NAR (billions) $2.0 $1.0 $0.0 N/A $3.0
Average Age of Contract
Holder 51 61 63 58 54
% of Contract Holders >
70 Years of Age 9.4% 25.5% 29.7% 21.3% 14.1%
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 June 30, 2003,
there were 503 contracts for which the death benefit to account value
ratio was greater than ten to one. The NAR on these contracts was $34.7
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.
The IRS recently issued guidance permitting tax-free treatment for
partial exchanges of non-qualified contracts. LNC has not previously
allowed partial withdrawals on non-qualified contracts. In light of
this new IRS guidance, LNC is considering changing its administrative
procedures to permit partial withdrawals. If LNC decides to allow
partial exchanges, LNC would treat a partial exchange as a tax-free
partial surrender of a pro rata portion of the contract. The
proportionate share of the contract value, contract holder's investment,
death benefit and surrender charges would be allocated to the portion of
the contract being surrendered. The pro rata amount of gain on the
contract would not be reported as taxable income to the contract holder
as it would be considered reinvested in a tax-free exchange for a new
contract.
However, to take advantage of the dollar for dollar feature discussed
earlier, the contract holder must take a taxable withdrawal, and pay any
applicable surrender charges. Such withdrawals would not qualify for
tax-free partial exchange treatment. LNC reports the appropriate
amount of withdrawals as taxable income to the IRS, as well as
indicating whether or not tax penalties apply under the premature
distribution rules.
Net Flows
Six Months Ended Three Months Ended
June 30, June 30,
- ----------------------------------------------------------------------------------------
(in billions) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------
Variable Portion of Annuity Deposits $1.2 $1.6 $0.6 $0.8
Variable Portion of Annuity Withdrawals (1.5) (1.8) (0.8) (0.9)
------- ------- ------- -------
Variable Portion of Variable Annuity Net Flows (0.3) (0.2) (0.2) (0.1)
Fixed Portion of Variable Annuity Deposits 0.9 0.8 0.4 0.4
Fixed Portion of Variable Annuity Withdrawals (0.7) (0.5) (0.2) (0.3)
------- ------- ------- -------
Fixed Portion of Variable Annuity Net Flows 0.2 0.3 0.2 0.1
Fixed Annuity Deposits 0.7 0.9 0.3 0.4
Fixed Annuity Withdrawals (0.4) (0.7) (0.2) (0.2)
------- ------- ------- -------
Fixed Annuity Net Flows 0.3 0.2 0.1 0.2
Total Annuity Net Flows $0.2 $0.3 $0.1 $0.2
Incremental Deposits (1) $2.7 $3.2 $1.3 $1.6
(1) Incremental Deposits represent gross deposits reduced by transfers
from other Lincoln annuity products.
Net Flows and Product Sales
With positive net flows in the second quarter of 2003, the Lincoln
Retirement segment experienced positive net flows for the eighth
consecutive quarter. Net flows for the first six months and second
quarter of 2003 were $116 million and $124 million lower, respectively
compared to the same periods in 2002. Although gross annuity deposits
were down, the Lincoln Retirement segment experienced an improvement in
persistency, as evidenced by lower withdrawals. Overall gross annuity
deposits declined $567 million, or 17%, and $277 million, or 17%, in the
first six months and second quarter of 2003, respectively compared to
the same periods in 2002. The decline occurred with sales of both
individual variable and fixed annuities. American Legacy Variable
Annuity gross deposits were down $313 million, or 33%, and $136 million,
or 29%, while Lincoln ChoicePlusSM gross variable and fixed annuity
deposits were down $93 million, or 18%, and $25 million, or 11%, for the
respective six-month and three-month periods.
In order to improve sales of variable annuities, in June of 2003 the
Lincoln Retirement segment introduced 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 is available for an additional
fee and provides 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 allows 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 implemented a hedging strategy.
In addition to the introduction of the Lincoln Principal SecuritySM
feature, Lincoln Financial Distributors ("LFD") expects to add 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 $142 million, or 14%, in the six months ended June 30, 2003 and were
flat for the second quarter of 2003 compared to the same periods in
2002. The strong sales performance in 2003 within employer-sponsored
annuities is a result of increased deposits in the Alliance program.
Sales of the Alliance program were $531 million in the first six months
of 2003, up from $280 million in the first six months of 2002. Alliance
sales are expected to moderate over the remainder of 2003 as first
quarter 2003 sales of $337 million benefited from the large number of
enrollments from employer-sponsored plans.
Life Insurance
Results of Operations
Six Months Ended Three Months Ended
June 30, June 30,
2003 2002 2003 2002
- ---------------------------------------------------------------------------------
Net Income $114.1 $100.2 $65.6 $56.7
Items Included in Net Income:
Realized Loss on Investments and
Derivative Instruments (after-tax) $(10.0) $(43.1) $(1.5) $(16.1)
Restructuring Charge (after-tax) (8.3) -- (4.7) --
First Year Premiums (by Product)
Universal Life $273.4 $185.3 $142.7 $98.9
Variable Universal Life 38.5 81.4 14.1 42.4
Whole Life 13.5 11.6 7.1 6.4
Term 18.8 16.8 9.6 8.1
------- ------- ------- -------
Total Retail 344.2 295.1 173.5 155.8
Corporate Owned Life Insurance ("COLI") 72.4 53.6 61.8 46.6
------- ------- ------- -------
Total First Year Premiums $416.6 $348.7 $235.3 $202.4
June 30 (in billions) 2003 2002
- ---------------------------------------------------------------------------------
Account Values
Universal Life $8.6 $7.8
Variable Universal Life 1.9 1.8
Interest-Sensitive Whole Life 2.2 2.2
------- -------
Total Life Insurance Account Values $12.7 $11.8
In Force - Face Amount
Universal Life and Other $127.3 $123.7
Term Insurance 139.2 121.1
------- -------
Total In-Force $266.5 $244.8
Net income increased $13.9 million, or 14%, and $8.9 million, or 16%,
for the six and three months ended June 30, 2003, respectively, compared
to the same periods in 2002.
Stock-Based Compensation
The 2002 periods 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 $1.4 million and $0.7 million to net income in the six and
three months ended June 30, 2002, respectively, from previously reported
amounts.
Realized Losses on Investments and Derivative Instruments
The Life Insurance segment had an improvement of $33.1 million and $14.6
million in realized investment losses, for the six and three months
ended June 30, 2003, respectively, relative to the same periods 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 $4.6 million increase in
earnings in the six months ended June 30, 2003 and a $2.3 million
increase in the three months ended June 30, 2003 over the same periods
in 2002.
Investment Margins
Lower investment margins reduced income by $2.5 million in the six
months ended June 30, 2003 compared to the same period in 2002,
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 the three months ended June 30, 2003 investment
margins improved $0.4 million compared to the same 2002 period, as the
impact of lower yields was offset by lowering credited rates to the
customers of universal life and interest sensitive whole life insurance
products, (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 overall positive performance of the equity markets resulted in
positive DAC unlocking of $0.7 million in the six months ended June 30,
2003 and $1.3 million in the three months ended June 30, 2003 compared
to negative DAC unlocking of $1.4 million for the same periods in 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 Third
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 2003, the Life
Insurance segment experienced negative DAC unlocking of $8.9 million and
$1.0 million in the first six months and second quarter, respectively,
compared to positive unlocking of $1.3 million in the same periods of
2002. The DAC unlocking in 2003 related to items other than equity
market performance primarily due to an increase in face amount
reductions. The increase in face amount reductions has 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 six and three
months ended June 30, 2003, there was an increase of $3.6 million and
$2.0 million, respectively, in the rate of amortization of the DAC asset
compared to the same periods in 2002.
During the third quarter of 2003, the Life Insurance segment expects to
perform a comprehensive review of the assumptions underlying the
amortization of the DAC asset. The review will encompass the
fundamental assumptions including lapses, mortality, expenses,
reinsurance and investment margins.
Restructuring Charges
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 six months of 2003, the
Life Insurance segment incurred restructuring charges of $8.3 million
and other realignment related expenses of $1.2 million related to the
realignment activities. In the second quarter of 2003, the Life
Insurance segment incurred restructuring charges of $4.7 million and
other realignment related expenses of $0.7 million. For further
details refer to Note 9 to the June 30, 2003 unaudited consolidated
financial statements.
In-force and Product Sales
As measured by life insurance in-force, the Life Insurance segment
increased 9% from June 30, 2002 primarily due to strong growth in term
life insurance in-force (up 15%). Account values increased $904
million, or 8%, from June 30, 2002. The drivers of this increase were
positive net flows, net of policyholder assessments, of approximately
$299 million across all products during the twelve months ended June
30, 2003, and interest earned on the fixed products.
Total sales as measured by first year premiums were up $67.8 million, or
19%, and $32.9 million, or 16%, for the six months and three months of
2003 compared to prior year periods. Sales of retail life insurance
products were up $49.0 million, or 17%, in the first six months of 2003
and $17.7 million, or 11%, in the second quarter of 2003. Sales of
retail life insurance products 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 six months
of 2003 relative to the same period in 2002 and sales through Lincoln
Financial Distributors ("LFD") were up 22%. Sales for LFA were flat,
while sales for LFD increased 18% for the second quarter of 2003
compared to the second quarter of 2002.
Within retail, sales of universal life ("UL") insurance products
improved by $88.1 million, or 48%, in the first six months of 2003, and
$43.8 million, or 44%, for the second quarter of 2003 compared to prior
year periods. 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
$42.9 million, or 53%, during the first six months of 2003 from the
prior year period. The decrease was $28.3 million, or 67%, during the
second quarter of 2003 compared to the same period of 2002.
Sales of Corporate Owned Life Insurance ("COLI") were up $18.9 million,
or 35%, and $15.2 million, or 33%, in the six months and three months
ended June 30, 2003 compared to the same periods in 2002. Sales of COLI
products consist of very large cases resulting in fluctuations in first
year premium from period to period. One such case, which contributed
$33.2 million of premium in the second quarter of 2003, was sold through
the M-Group Financial ("M-Group") relationship. This case is subject to
the modified coinsurance arrangement and as such, profits will be shared
50/50 with M-Group Life Insurance Company.
Investment Management
Results of Operations
Six Months Ended Three Months Ended
June 30, June 30,
2003 2002 2003 2002
- ---------------------------------------------------------------------------------
Total Revenue $218.5 $213.4 $116.4 106.1
Total Investment Advisory Fees
(Included in Total Revenue) 143.1 145.2 74.8 72.1
Net Income $5.6 $1.3 $4.6 $(0.8)
Items Included in Net Income:
Realized Gain (Loss) on Investments
(after-tax) $(0.2) $(1.4) $0.1 $(0.4)
Income Statement Reclassifications
In 2003, certain reclassifications have been made in the prior periods
to conform to the current year presentation. As a result, Investment
Advisory fees for the six and three month periods ended June 30, 2002
were increased by $7.6 million, and $3.7 million, respectively, with
corresponding increases in expenses for the same periods. In addition,
foreign taxes of $2.8 million and $1.1 million for the six and three
months ended June 30, 2002, respectively, were reclassified from
operating expenses to the federal income tax line.
Net Income
Net income increased $4.3 million and $5.4 million in the six and three
months ended June 30, 2003, respectively, from the same periods in 2002.
Realized Losses on Investments and Derivative Instruments
The Investment Management segment had an improvement of $1.2 million and
$0.5 million in realized investment losses, for the six and three months
ended June 30, 2003, respectively, relative to the same periods of 2002.
For additional detail on realized losses see the discussion in the
Consolidated Investments section.
Equity Market Impact
Institutional and Retail assets under management increased $3.7 billion
from June 30, 2002 to June 30, 2003, with $1.3 billion of the increase
due to increases in the equity markets. Of this increase, $6.1 billion
occurred in the second quarter of 2003. As a result, earnings for the
first six months of 2003 were negatively impacted by the decrease in the
equity market through March 31, 2003, but the second quarter of 2003
earnings were higher relative to the second quarter of 2002. As a
result of the improved equity markets in the second quarter of 2003,
this segment had higher revenues due to higher assets. However, these
increased revenues in the second quarter of 2003 were partially offset
by the effect of the equity market increase on variable expenses.
Positive net flows of $2.4 billion over the 12 months ended June 30,
2003 partially offset the decrease in equity markets on assets under
managements from June 30, 2002 through March 31, 2003.
Refer to the Third 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 2002 periods 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 $11.8 million and $6.9 million in net income for the six and
three months ended June 30, 2002, respectively, from previously reported
amounts.
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 $2.8 million and $1.4 million in
the six and three months ended June 30, 2003, respectively, compared to
the same periods in 2002.
Critical Accounting Policy - Deferred Dealer Commission Asset
As discussed in the Management's Discussion and Analysis section of
LNC's Annual Report on Form 10-K for the year ended December 31, 2002,
the Investment Management segment has a deferred dealer commission asset
relating to upfront sales commissions paid to brokers for the sale of
"Class B" shares of Delaware Investments retail mutual funds. At June
30, 2003, the deferred dealer commission asset was approximately $45
million. The improvement in the equity markets during the second quarter
of 2003 has significantly reduced the risk of a loss for impairment of
this asset.
Assets Under Management and Net Flows
The Investment Management segment's assets under management were as
follows:
June 30 (in billions) 2003 2002
- ----------------------------------------------------------------------
Assets Under Management
Regular Operations:
Retail-Equity $16.9 $16.6
Retail-Fixed 8.2 7.2
------- -------
Total Retail $25.1 $23.8
Institutional-Equity $19.6 $18.1
Institutional-Fixed 7.7 6.8
------- -------
Total Institutional $27.3 $24.9
Insurance Assets $43.9 $38.5
------- -------
Total Assets Under Management $96.3 $87.2
The Investment Management segment's net flows were as follows:
Six Months Ended Three Months Ended
June 30, June 30,
(in billions) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------
Retail:
Equity Sales $1.5 $2.0 $0.8 $1.1
Equity Redemptions and Transfers (1.5) (1.7) (0.6) (0.9)
------- ------- ------- -------
Net Flows -- 0.3 0.2 0.2
Fixed Sales 0.9 0.5 0.5 0.3
Fixed Redemptions and Transfers (0.6) (0.6) (0.4) (0.3)
------- ------- ------- -------
Net Flows 0.3 (0.1) 0.1 --
------- ------- ------- -------
Total Retail Net Flows $0.3 $0.2 $0.3 $0.2
Institutional:
Equity Inflows $1.2 $1.2 $0.7 $0.5
Equity Withdrawals and Transfers (0.8) (1.1) (0.3) (0.6)
------- ------- ------- -------
Net Flows 0.4 0.1 0.4 (0.1)
Fixed Inflows 0.7 1.5 0.1 0.7
Fixed Withdrawals and Transfers (0.5) (0.4) (0.2) (0.2)
------- ------- ------- -------
Net Flows 0.2 1.1 (0.1) 0.5
------- ------- ------- -------
Total Institutional Net Flows $0.6 $1.2 $0.3 $0.4
Total Retail and Institutional Net Flows $0.9 $1.4 $0.6 $0.6
Assets Under Management and Net Flows
Assets under management increased $9.1 billion to $96.3 billion at June
30, 2003 compared to June 30, 2002. The increase was primarily the
result of net flows of $2.4 billion and $1.3 billion in market
appreciation in Institutional and Retail assets under management. In
addition, Insurance assets (i.e. primarily general account assets of
LNC's insurance subsidiaries) increased $5.4 billion for the period.
Institutional assets under management increased $2.4 billion as a result
of positive net inflows of $1.5 billion and market appreciation of $0.9
billion. Retail assets under management increased $1.3 billion as a
result of positive flows of $0.9 billion and market appreciation of $0.4
billion.
The Investment Management segment's net flows remained positive in the
first six months and second quarter of 2003. However, total net flows
for the six-month period were down approximately $0.5 billion compared
to the same period in 2002, with the entire decline resulting from lower
institutional net flows. The Investment Management segment retained
institutional assets as evidenced by a lower level of withdrawals and
transfers between periods, but institutional sales were down $0.8
billion. The decline in the institutional sales and net flows for the
first six months ending June 30, 2003 compared to the same period in
2002 was due to a large funding of $0.7 billion in March 2002. Sales in
the institutional business tend to fluctuate from period to period
depending upon when large institutional mandates are received.
Retail sales were down $0.1 billion in the six and three month
periods ended June 30, 2003 compared to the same periods in 2002. The
decline in sales was concentrated within the annuities products managed
by the Investment Management segment. Sales of managed account products
for the first six months of 2003 were up 15% over the same period of
2002, with substantially all the increase occurring in the first quarter
of 2003 compared to the first quarter of 2002. However, full year 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 affecting 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
June 30, 2003, 6 of the 8 largest product composites met or outperformed
their respective indices and these 6 composites accounted for
approximately 75% 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 June 30, 2003, 68% of the 25 largest retail funds in the 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 70% of assets under management of
the largest 25 retail funds at June 30, 2003. At June 30, 2003, of the
funds rated by Lipper, Delaware had 39 of its 50 retail funds labeled as
a Lipper Leader in at least one category and 20 funds were selected in
multiple categories. For the Managed Accounts, 3 of the 6 largest
product composites outperformed their respective indices for the
one-year period ending June 30, 2003.
Lincoln UK
Results of Operations
Six Months Ended Three Months Ended
June 30, June 30,
(in millions) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------
Net Income $19.3 $19.5 $12.4 $9.3
Items Included in Net Income:
Realized Gain (Loss) on Investments
(after-tax) $-- $(0.4) $-- $3.2
June 30,
(in billions) 2003 2002
- ---------------------------------------------------------------------------------
Unit-Linked Assets $5.5 $5.5
Individual Life Insurance In-Force $19.1 $20.4
Exchange Rate Ratio - U.S. Dollars to Pounds Sterling
Average for the Period 1.618 1.464
End of Period 1.656 1.532
Net income for the six months ended June 30, 2003 was level compared to
the same 2002 period. Net income for the three months ended June 30,
2003 increased $3.1 million compared to the three months ended June 30,
2002.
Stock-Based Compensation
The 2002 periods 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 in net income for the six and three months ended June 30, 2002
of $1.2 million and $0.6 million, respectively, from previously reported
amounts.
Realized Losses on Investments
There were no realized investment gains or losses for the six and three
months ended June 30, 2003, compared to realized investment losses of
$0.4 million for the six months and realized investment gains of $3.2
million for the three months ended June 30, 2002.
Critical Accounting Policy - Equity Market Sensitivity
The FTSE 100 index at June 30, 2003 increased 2.3% from December 31,
2002 and declined 13.4% from June 30, 2002. These movements in the UK
equity markets resulted in lower fee income from unit-linked accounts of
$4.0 million and $1.5 million for the six month and the three month
periods ended June 30, 2003, respectively, compared to the same periods
in 2002. The increase in the FTSE 100 for both the six and three month
periods ended June 30, 2003 resulted in positive net unlocking of $11.8
million and $14.1 million, respectively for DAC and PVIF assets and
deferred front end load revenue ("DFEL") compared the same periods in
2002.
Refer to the Third Quarter 2003 Guidance for Estimated Effect of Equity
Market Volatility section for estimates of the effect of movements in
the equity markets on the segment's earnings.
Taxes
The Lincoln UK segment's effective tax rate increased in the six month
and three month periods ended June 30, 2003 compared to the same periods
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 in the six and three months ended June 30, 2003 by $8.3 million
and $4.0 million, respectively, compared to the same periods in 2002.
Other Operations
Results of Operations
Six Months Ended Three Months Ended
June 30, June 30,
(in millions) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------
Net Income (Loss) by Source:
LFA $(17.8) $(18.8) $(7.4) $(8.7)
LFD (18.8) (14.2) (10.7) (7.6)
LNC Financing (29.7) (18.4) (14.4) (10.2)
Other Corporate (0.5) (1.0) (0.9) 3.2
Amortization of Deferred Gain
on Indemnity Reinsurance 23.8 30.0 11.9 14.4
Reserve Development on Business
Sold Through Indemnity Reinsurance
and Related Amortization of
Deferred Gain (0.2) (14.4) (0.1) (14.4)
Realized Loss on Investments
and Derivatives (0.1) (5.7) -- (2.5)
------- ------- ------- -------
Net Loss $(43.3) $(42.5) $(21.6) $(25.8)
The net loss reported within Other Operations for the six and three
months ended June 30, 2003 increased $0.7 million and decreased $4.2
million, respectively, compared to same periods of 2002. The primary
reasons behind the increased losses in 2003 amounts are described below.
Stock-Based Compensation
The 2002 periods 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 in net income of $1.9 million for LFA and $0.7 million for LFD
in the first six months of 2002 and a decrease in net income of $1.0
million for LFA and $0.3 million for LFD in the second quarter of 2002
from previously reported amounts.
Lincoln Financial Advisors ("LFA")
LFA net losses for the six and three months ended June 30, 2003
decreased $1.0 million and $1.3 million, respectively, compared to the
same periods in 2002. LFA's net revenues (gross revenues net of
commissions) were down $5.6 million and $1.4 million as sales,
particularly sales of variable products, have been negatively impacted
by the equity markets. Sales by LFA of LNC's life insurance products, as
measured by first year premiums, were $90.5 million for the first six
months of 2003, about level with the same period in 2002, as sales of
universal life insurance products were offset by lower sales of variable
universal life insurance products. Sales by LFA of LNC's individual
annuity products, as measured by deposits, were down $52.4 million, or
19%, and $16.1 million, or 11%, for the first six months and second
quarter of 2003, respectively, compared to the same periods in 2003.
Sales by LFA of Delaware retail mutual funds decreased 2% for the first
six months of 2003 compared to the same period in 2002, but were up 28%
in the second quarter of 2003 compared to the second quarter of 2002.
Overall fees received for financial plans increased 10% in the first six
months of 2003 and 13% in the second quarter of 2003 compared to the
same periods of the prior year. The average fees per plan as calculated
on a rolling twelve month average increased 5% for the twelve month
period ending June 30, 2003 compared to the same period ending June 30,
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
1% at June 30, 2003 from June 30, 2002.
Lincoln Financial Distributors ("LFD")
LFD experienced an increase of $4.6 million in net loss for the six
months ended June 30, 2003 and an increase of $3.1 million for the three
months ended June 30, 2003 compared to the same periods 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 27% and 6%, respectively, sales
of annuity products were down 28% for the six months of 2003 compared to
2002.
LNC Financing
LNC Financing costs were $11.3 million higher in the six months ended
June 30, 2003 and $4.2 million in the three months ended June 30, 2003
compared to the same periods in 2002. LNC Financing for the six and
three month periods of 2002 included investment income of $14.1 million
and $6.3 million, respectively, 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 $0.5 million in the first half of
2003 and a decrease of $4.1 million in the second quarter of 2003
compared to the same periods in 2002. In 2002, certain overhead
expenses were not allocated to the business segments, but were reported
within Other Corporate. There were various other accruals during the
second quarter of 2002 that did not recur in 2003.
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 for the six
and three month periods ended June 30, 2003 compared to the same periods
in 2002. Adjustments to the deferred gain resulting from the settlement
with Swiss Re were recorded in the fourth quarter of 2002 resulting in
lower amortization in 2003. In addition, 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.
Critical Accounting Policy - Personal Accident and Disability Income
Reserves
In the second quarter of 2002, LNC recognized a loss of $14.4 million
resulting from an adjustment to certain reserves for disability income
business sold to Swiss Re. There were no adjustments in 2003. 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) June 30, Dec 31, June 30,
2003 2000 2002
- ---------------------------------------------------------------------------
Assets Managed by Advisor
Investment Management Segment (1):
External Assets $52.4 $46.5 $48.7
Insurance Assets 43.9 41.1 38.5
Lincoln UK 6.7 6.4 6.7
Within Business Units (Policy Loans) 1.9 1.9 1.9
By Non-LNC Entities 22.5 20.0 23.7
------- ------- --------
Total Assets Managed $127.4 $115.9 $119.5
Total Invested Assets $42.6 $40.0 $37.2
Six Months Ended Three Months Ended
June 30, June 30,
(in millions) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------
Net Investment Income (pre-tax) $1,314.9 $1,312.2 $660.2 $657.4
Adjusted Net Investment Income
(pre-tax) (2) 1,318.4 1,315.7 662.0 659.4
Mean Invested Assets
(cost basis, in billions) $40.7 $38.2 $41.0 $38.2
Investment Yield (ratio of adjusted net
investment income to mean invested assets) 6.49% 6.89% 6.46% 6.90%
(1) See Investment Management segment data for additional detail.
(2) Includes tax-exempt income on a tax equivalent basis.
The total investment portfolio increased $2.6 billion in the first six
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.
The quality of LNC's fixed maturity securities portfolio, as measured by
the percentage of fixed maturity securities invested in various ratings
categories relative to the entire fixed maturity security portfolio, as
of June 30, 2003 was as follows:
Treasuries and AAA 19.5% BBB 35.9%
AA 5.6% BB 3.9%
A 32.4% Less than BB 2.7%
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 June 30, 2003 and December 31, 2002, $2.3 billion, or 6.6%, and
$2.1 billion, or 6.6%, respectively, of all fixed maturity securities
were invested in below investment grade securities (less than BBB).
This represents 5.5% and 5.3% of the total investment portfolio at June
30, 2003 and December 31, 2002, respectively. When viewed on a cost
basis, below investment grade securities held at June 30, 2003 and
December 31, 2002 represented 7.5% and 8.4%, respectively, of fixed
maturity securities. The rally in the credit markets continued through
the second quarter of 2003 resulting in below investment grade
securities, when measured on a market value basis, remaining at level
consistent with December 31, 2002. When measured on cost basis, below
investment grade securities showed a decrease from December 31, 2002
levels which resulted from asset sales, impairments and maturities.
LNC's fixed maturity securities include residential and commercial
mortgage-backed securities. Given that LNC's current product mix reflects
an 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 and by purchasing securities with no
more prepayment sensitivity than the underlying collateral. LNC's
investments in residential mortgage-backed securities at June 30, 2003 and
December 31, 2002 totaled $2.5 billion and $3.1 billion, respectively,
representing 5.9% and 7.8% of total invested assets, respectively.
Investments in commercial mortgage-backed securities at June 30, 2003 and
December 31, 2002 totaled $2.2 billion and $1.8 billion, respectively,
representing 5.2% and 4.5%, respectively.
The fair value of all private securities was $4.9 billion and $4.6 billion
at June 30, 2003 and December 31, 2002, respectively, representing
about 11.5% of total invested assets for both periods. 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 changes in fair value are recorded as realized losses in the
income statement.
During the six and three months ended June 30, 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. LNC is also considering whether to
reclassify certain invested assets associated with reinsurance
agreements as trading account assets. See discussion under "Accounting
for Modified Coinsurance" for more information.
Critical Accounting Policy - Realized Gain (Loss) on Investments Sales
and Write-downs: LNC had net pre-tax realized losses on investments and
derivatives of $94.1 million and $184.4 million for the six months ended
June 30, 2003 and 2002, respectively, and $2.7 million and $81.1 million
for the three months ended June 30, 2003 and 2002, respectively.
Prior to the amortization of acquisition costs, provision for
policyholder commitments and investment expenses, net pre-tax realized
losses were $172.3 million and $269.7 million for the six months ended
June 30, 2003 and 2002, respectively, and $14.4 million and $119.9
million for the three months ended June 30, 2003 and 2002, respectively.
Gross realized gains on fixed maturity and equity securities were $124.9
million and $86.7 million, and gross realized losses on fixed maturity
and equity securities were $256.9 million and $99.2 million for the six
and three months ended June 30, 2003, respectively. 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 were credited to the policyholder and did not
affect LNC's net income. Included within losses are write-downs for
impairments of $174.1 million and $36.8 million in the six and three
months ended June 30, 2003, respectively.
While realized losses from sales and write-downs occurred in a number of
sectors, approximately 61% of gross losses for the six months ended June
30, 2003, excluding the losses on equity securities in the Lincoln UK
segment described above, were attributed to losses on sales and
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). In the
second quarter of 2003, approximately 36% of the gross losses were
attributed to losses on sales and write-downs in ABS, mainly from CDOs,
and electric utilities. The remaining gross realized losses were
distributed among several sectors and industries, none of which
represented more than 10% of total gross realized losses. The following
discussion provides details relating to gross realized losses taken
during the first six months and second quarter 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 half 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 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 in the first quarter of
2003. There were no further losses reported on AMR in the second quarter
of 2003. The change in valuation of the underlying aircraft and
continued economic pressures on the sector also led to additional
write-downs of UAL Corporation's ETCs/EETCs of $8.9 million and $3.3 million
during the six and three months ended June 30, 2003, respectively.
Electric utility sector losses were taken on selected issuers whose
securities had not recovered with the rest of the electric utility
issues in the market. The 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. Losses
taken in this sector totaled $40.5 million in the first six months of
2003 and $15.8 million in the second quarter of 2003.
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 during the six months
ended June 30, 2003, all of which occurred in the first quarter of 2003.
Deterioration in the underlying collateral pools of other ABS
investments during the first six months of 2003 led to decreased
expectations of future cash flows. As a result, additional losses of
$43.5 million and $20.0 million, respectively, on various ABS holdings,
including CDOs, were also recorded during the six and three months ended
June 30, 2003. Sales and write-downs have reduced LNC's CDO exposure
from 1.6% of invested assets at December 31, 2002 to 1.3% of LNC's
invested assets at June 30, 2003 as measured on a cost basis, with over
90% of the CDOs remaining investment grade. The unrealized loss
position on the CDO portfolio has been reduced to approximately $26
million. Any further deterioration or additional realized losses in the
CDO portfolio will depend on economic factors such as economic growth,
corporate profitability and future asset default rates. Cash flow
testing of the CDO portfolio as required under EITF 99-20 supports the
conclusion that these unrealized losses are temporary. A full recovery of
principal and interest is expected under the current economic environment.
Following the strong rally in the credit markets that extended through
the second quarter 2003, especially in the higher risks sectors of the
market, several securities were liquidated in order to reposition the
below investment grade and investment grade investments within selected
portfolios. The sale of these higher risk securities resulted in a
reduction of below investment grade securities as well as a
repositioning of our investment grade holdings. Gross realized losses of
$15.8 million in the electric utility sector as well as losses in
industrials, pipelines, sovereigns and other sectors contributed to
gross realized losses on sold securities of $63.9 million. Other than
the losses discussed above, no sector or industry contributed more than
$10 million to realized losses for the quarter. Both gains and losses
were realized as a result of this asset repositioning.
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 Form 10-K for the year
ended December 31, 2002 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 $1,117.8 million and $753.3 million
at June 30, 2003 and December 31, 2002, respectively.
At June 30, 2003 and December 31, 2002, gross unrealized gains on
securities available-for-sale were $3,405.1 million and $2,402.5
million, respectively, and gross unrealized losses on securities
available-for-sale were $294.4 million and $735.4 million, respectively.
At June 30, 2003, gross unrealized gains and gross unrealized losses on
fixed maturity securities available-for-sale were $3,382.9 million and
$285.3 million, respectively, and gross unrealized gains and losses on
equity securities available-for-sale were $22.1 million and $9.1
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 June 30, 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
June 30, 2003
% %
% Fair Amortized Amortized Unrealized Unrealized
(000s omitted) Fair Value Value Cost Cost Loss Loss
- ------------------------------------------------------------------------------------------------------------
<= 90 days $45,692 17.1% $48,095 14.5% $(2,403) 3.8%
> 90 days but <= 180 days 41,135 15.4 50,132 15.2 (8,997) 14.1
> 180 days but <= 270 days 59,818 22.4 69,974 21.2 (10,156) 15.9
> 270 days but <= 1 year 10,595 4.0 10,595 3.2 -- --
> 1 year 109,616 41.1 151,757 45.9 (42,141) 66.2
-----------------------------------------------------------------------------
Total $266,856 100.0% $330,553 100.0% $(63,697) 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 June 30, 2003 is presented in the
table below.
Unrealized Losses by Industry Sector - Available-for-Sale Securities
Subject to Enhanced Analysis and Monitoring
June 30, 2003
%
% Fair Amortized % Amortized Unrealized Unrealized
(000s omitted) Fair Value Value Cost Cost Loss Loss
- ------------------------------------------------------------------------------------------------------------
Electric Utility $78,281 29.3% $104,371 31.6% $(26,090) 41.0%
Asset-Backed Securities 83,516 31.3 100,504 30.4 (16,988) 26.7
Chemicals 21,000 7.9 30,000 9.1 (9,000) 14.1
Media Cable 18,466 6.9 24,424 7.4 (5,958) 9.3
Airlines 7,062 2.7 9,836 3.0 (2,774) 4.4
Consumer Non-Cyclical 7,488 2.8 9,386 2.8 (1,898) 3.0
CMBS 7,368 2.8 7,904 2.4 (536) 0.8
Consumer Cyclical 625 0.2 769 0.2 (144) 0.2
Oil Field Services 8,375 3.2 8,509 2.6 (134) 0.2
Consumer Services Cyclical 5,947 2.2 6,064 1.8 (117) 0.2
Textile 8,617 3.2 8,672 2.6 (55) 0.1
Other 20,111 7.5 20,114 6.1 (3) --
---------- ---------- ---------- ---------- ------------ ----------
Total $266,856 100.0% $330,553 100.0% $(63,697) 100.0%
========== ========== ========== ========== ============ ==========
At June 30, 2003 and December 31, 2002, about 28% 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 35% of these securities maturing between 5
and 10 years, about 43% 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
$168.4 million at June 30, 2003, representing 58.9% of total gross
unrealized losses on all available-for-sale securities, excluding the
available-for-sale securities in the Lincoln UK segment. Generally,
below-investment-grade fixed maturity securities are more likely than
investment-grade securities to develop credit concerns. The remaining
$117.3 million or 41.1% of the gross unrealized losses relates to
investment grade available-for-sale securities. 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 June 30, 2003.
Unrealized Losses
Below-Investment-Grade Fixed Maturity Securities
June 30, 2003
Aging Category (000s omitted) Bk Mkt Ratio Fair Value Amortized Cost Unrealized Loss
- ------------------------------------------------------------------------------------------------------------
<=90 days 70% to 100% $246,551 $256,718 $(10,167)
40% to 70% 1,425 3,360 (1,935)
Below 40% -- 173 (173)
-----------------------------------------------------------
<=90 days Total 247,976 260,251 (12,275)
>90 days but <=180 days 70% to 100% 18,028 19,185 (1,157)
40% to 70% 300 500 (200)
Below 40% -- -- --
-----------------------------------------------------------
>90 days but <=180 days Total 18,328 19,685 (1,357)
>180 days but <=270 days 70% to 100% 213,415 241,683 (28,268)
40% to 70% 1,350 2,252 (902)
Below 40% 42 107 (65)
-----------------------------------------------------------
>180 days but <=270 days Total 214,807 244,042 (29,235)
>270 days but <=1 year 70% to 100% 110,912 128,176 (17,264)
40% to 70% 9,989 14,270 (4,281)
Below 40% -- -- --
-----------------------------------------------------------
>270 days but <=1 year Total 120,901 142,446 (21,545)
>1 year 70% to 100% 447,607 508,902 (61,295)
40% to 70% 71,563 114,221 (42,658)
Below 40% -- -- --
-----------------------------------------------------------
>1 year Total 519,170 623,123 (103,953)
-----------------------------------------------------------
Total Below-Investment-Grade $1,121,182 $1,289,547 $(168,365)
===========================================================
Unrealized Losses on All Securities: For total traded and private
available-for-sale securities held by LNC at June 30, 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
June 30, 2003
%
% Fair Amortized % Amortized Unrealized Unrealized
(000s omitted) Fair Value Value Cost Cost Loss Loss
- ------------------------------------------------------------------------------------------------------------
<= 90 days $1,643,386 44.3% $1,667,860 41.6% $(24,474) 8.3%
> 90 days but <= 180 days 248,970 6.7 262,880 6.6 (13,910) 4.7
> 180 days but <= 270 days 521,339 14.0 569,212 14.2 (47,873) 16.3
> 270 days but <= 1 year 207,298 5.6 233,918 5.8 (26,620) 9.0
> 1 year 1,090,925 29.4 1,272,399 31.8 (181,474) 61.7
-------------------------------------------------------------------------------
Total $3,711,918 100.0% $4,006,269 100.0% $(294,351) 100.0%
===============================================================================
The composition by industry categories of total securities
available-for-sale in unrealized loss status, held by LNC at June 30,
2003 is presented in the table below.
Unrealized Losses by Industry Sector - All Available-for-Sale Securities
June 30, 2003
%
% Fair Amortized % Amortized Unrealized Unrealized
(000s omitted) Fair Value Value Cost Cost Loss Loss
- ------------------------------------------------------------------------------------------------------------
Electric Utility $393,107 10.6% $453,901 11.3% $(60,794) 20.7%
Airlines 188,494 5.1 237,356 5.9 (48,862) 16.6
Banking 370,130 10.0 410,446 10.3 (40,316) 13.7
Asset-Backed Securities 583,852 15.7 623,093 15.6 (39,241) 13.3
Sovereigns 192,857 5.2 205,008 5.1 (12,151) 4.1
Chemicals 55,557 1.5 66,741 1.7 (11,184) 3.8
Automotive 96,336 2.6 106,975 2.7 (10,639) 3.6
CMBS 69,129 1.9 79,735 2.0 (10,606) 3.6
Refining 16,835 0.5 23,400 0.6 (6,565) 2.2
Media Cable 23,746 0.6 29,790 0.7 (6,044) 2.1
Retailers 43,679 1.2 49,457 1.2 (5,778) 2.0
Industrial Other 27,623 0.8 31,523 0.8 (3,900) 1.3
Pipelines 41,993 1.1 45,010 1.1 (3,017) 1.0
Transportation Services 50,804 1.4 53,792 1.3 (2,988) 1.0
Utility Other 27,123 0.7 29,996 0.7 (2,873) 1.0
Wirelines 78,393 2.1 80,516 2.0 (2,123) 0.7
CMO 156,577 4.2 158,670 4.0 (2,093) 0.7
Consumer Non Cyclical 7,488 0.2 9,386 0.2 (1,898) 0.7
Metals and Mining 56,925 1.5 58,748 1.5 (1,823) 0.6
Mortgage 18,218 0.5 19,444 0.5 (1,226) 0.4
Media Non-Cable 15,273 0.4 16,495 0.4 (1,222) 0.4
Food and Beverage 14,058 0.4 15,149 0.4 (1,091) 0.4
Supermarkets 40,837 1.1 41,859 1.0 (1,022) 0.4
Industries with unrealized
losses of < $1 million 939,995 25.3 948,240 23.7 (8,245) 2.8
Lincoln UK Fixed Maturity
Securities 186,742 5.0 191,456 4.8 (4,714) 1.6
Lincoln UK Equity Securities 16,147 0.4 20,083 0.5 (3,936) 1.3
- -----------------------------------------------------------------------------------------------------------
Total $3,711,918 100.0% $4,006,269 100.0% $(294,351) 100.0%
================================================================================
At June 30, 2003, the range of maturity dates for total traded and
private securities available-for-sale in unrealized loss status varies,
with about 18% maturing between 5 and 10 years, 45% maturing after 10
years and the remaining securities maturing in less than 5 years.
As of June 30, 2003, gross unrealized losses including assets held at
Lincoln UK totaled $294.4 million, a 48% improvement over gross
unrealized losses of $565.0 million at March 31, 2003. This improvement
resulted from a strong recovery in market values of securities in
high-risk sectors as well as sales of securities that participated in
this rally. As of June 30, 2003 there were unrealized losses of $189.2
million in the electrical utility, airline, banking and ABS sectors,
representing 64.3% of total unrealized losses. LNC's view of risk
factors at June 30, 2003 with respect to these industries is presented
below.
The electric utility sector continues to be LNC's most significant
unrealized loss sector with $60.8 million of unrealized losses at June
30, 2003. During the first half of 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 in the first quarter of 2003 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 by 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 second quarter 2003 with an unrealized loss
of $48.9 million, an improvement of $50.4 million over December 31, 2002
and $47.7 million over March 31, 2003. In contrast to the airline
securities that were written down in the first quarter of 2003, the
securities of relatively stronger carriers have improved in market value
significantly during the second quarter. For these relatively stronger
airlines, LNC believes that the unrealized loss positions at June 30,
2003 are temporary, and LNC expects an ultimate recovery of full
principal and interest as these securities mature. All of LNC's airline
holdings in an unrealized loss position are secured as either ETC or EETC
structures. 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 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 $40.3 million of unrealized loss
in the banking industry, $30.6 million is related to securities with
offsetting derivative gains. The unrealized gain on the derivative
positions relating to these securities was $45.6 million at the end of
the second 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.
The asset-backed securities (ABS) exposure of the LNC portfolio ended
the second quarter of 2003 with an unrealized loss of $39.2 million. Of
this amount, $25.9 million relates to CDOs and $8.4 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 six months 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.
Unrealized Loss on Fixed Maturity Securities Available-for-Sale in
Excess of $10 million: As of June 30, 2003, LNC held fixed maturity
securities available-for-sale with gross unrealized losses of $10
million, or greater, as discussed below. At June 30, 2003 there were no
investment grade securities with gross unrealized losses of $10 million
or greater.
Fixed Maturity Securities
Unrealized Losses Greater Than $10 million
June 30, 2003
Amortized Unrealized Length of Time
(000s Omitted) Fair Value Cost Loss in a Loss Position
- -------------- -------------------------------------------------------------
Non-Investment-Grade
--------------------
Power Generation Project Finance $33,750 $45,000 $(11,250) >180 days but <=270 days
U.S. Utility Company 30,943 52,112 (21,169) >1 year
U.S. Based International Airline 52,663 73,242 (20,579) >1 year
U.S. Based International Airline 51,964 65,473 (13,509) >1 year
------------------------------
Total Non-Investment Grade $169,320 $235,827 $(66,507)
==============================
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 June 30, 2003, mortgage loans on
real estate and investments in real estate represented 10.1% and 0.6% of
LNC's total investment portfolio, respectively. As of June 30, 2003,
the underlying properties supporting the mortgage loans on real estate
consisted of 38.7% in commercial office buildings, 22.4% in retail
stores, 17.9% in industrial buildings, 10.0% in apartments, 7.4% in
hotels/motels and 3.6% 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:
June 30 December 31
(in millions) 2003 2002
-------------- -------- -----------
Total Portfolio (net of reserves) $4,314.3 $4,205.5
Impaired mortgage loans $75.5 $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) $33.3 $1.9
Restructured loans in good standing 3.4 4.6
Reserve for mortgage loans $12.1 $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 at June 30, 2003 have
increased over the last year as a result of increased credit losses in
the sectors noted above, but has remained at a level consistent with
December 31, 2002. This percentage was 1.7%, 1.7%, 0.6%, 0.5%, 0.6%,
0.8%, 1.1%, 1.9% and 3.9% as of June, 30, 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 six and
three months ended June 30, 2003 were not significant. As of June 30,
2003 and December 31, 2002, the fair value of non-income producing
securities was $82.3 million and $37.3 million, respectively.
Net Investment Income
Net investment income was flat in the six and three months ended June 30,
2003 when compared with the same periods of 2002. The overall yield on
investments decreased to 6.49% from 6.89% for the six months ended June 30,
2003 compared to the same period in 2002. 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. Mean invested
assets increased 6.5% for the six months ended June 30, 2003 compared to
the first six months of 2002. 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 June 30, 2003 unaudited
consolidated financial statements indicates that operating activities
provided cash of $399.7 million during the first six 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 June 30,
2003 was $675.1 million.
On June 24, 2003 LNC announced plans to redeem the $200 million 7.40% TOPrS
issued by Lincoln Capital III and guaranteed by LNC. The redemption date
was July 24, 2003. A loss of $3.6 million related to unamortized issuance
costs will be reported in the third quarter of 2003 related to the
redemption.
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.
A key component of managing LNC's overall liquidity and capital position
is managing the capital of LNC's insurance subsidiaries. The level of
capital maintained in the domestic insurance subsidiaries is subject to
the requirements of the NAIC's risk based capital ("RBC"). While
maintaining capital within the requirements of the NAIC RBC formula is a
primary focus, LNC actively monitors similar capital quality measures
produced by the rating agencies. These models are subject to adjustment
from time-to-time and, together with potential NAIC RBC adjustments,
could impact LNC's ongoing capital and liquidity management.
As of June 30, 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 June 30, 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 $468.5 million during the six
months ended June 30, 2003. Accumulated other comprehensive income
increased shareholders' equity by $381.6 million. The components of the
changes to accumulated other comprehensive income were: $365.0 million
related to the increase in the net unrealized gain on securities
available-for-sale and derivative instruments, $17.5 million related to a
change in the accumulated foreign exchange adjustment, and a decrease of
$0.9 million related to the effect of foreign currency changes on the
minimum pension liability adjustment. Excluding changes due to other
comprehensive income, shareholders' equity increased $86.9 million. This
increase is due to $184.3 million of net income, $8.1 million from the
issuance/forfeiture of common stock under benefit plans and a $15.4
million net increase to additional paid-in to record stock-based
compensation and decreases due to $120.9 million from the declaration of
dividends to shareholders.
Contingencies
Refer to Note 5 to the June 30, 2003 unaudited 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 six 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 June 30, 2003. For
example, at June 30, 2003, there are $5.276 billion of combined
Retirement and Life Insurance account values where the excess of the
crediting rate over contract minimums is between 1.01% and 1.50%. The
analysis presented below ignores any non-guaranteed elements within the
life insurance products such as cost of insurance or expense loads
which, for many products, may be redetermined in the event that interest
margins deteriorate below the level that would cause the credited rate
to equal the minimum guaranteed rate.
Excess of Crediting Rates over Contract Minimums
-----------------------------------------------------
As of June 30, 2003 (in millions) Retirement Life Total %
- ---------------------------------- -------------- ---------- ----------- ------------
CD and On-Benefit type annuities $4,577 $-- $4,577 14.6%
Discretionary rate setting products*
No difference 6,226 1,569 7,795 24.8%
up to .1% 372 -- 372 1.2%
..11% to .20% 102 110 212 0.7%
..21% to .30% 92 -- 92 0.3%
..31% to .40% 132 991 1,123 3.6%
..41% to .50% 5,377 38 5,415 17.3%
..51% to .60% 537 -- 537 1.7%
..61% to .70% 55 59 114 0.4%
..71% to .80% 133 495 628 2.0%
..81% to .90% 89 111 200 0.6%
..91% to 1.0% 1,524 1,050 2,574 8.2%
1.01% to 1.50% 590 4,686 5,276 16.8%
1.51% to 2.00% 803 1,226 2,029 6.5%
2.01% to 2.50% 230 148 378 1.2%
2.51% to 3.00% 22 18 40 0.1%
3.01% and above 3 -- 3 0.0%
- ---------------------------------- -------------- ---------- ----------- ------------
Total Discretionary rate setting products 16,287 10,501 26,788 85.4%
- ---------------------------------- -------------- ---------- ----------- ------------
Grand Total $20,864 $10,501 $31,365 100.0%
============== ========== ========== ============
Equity Market Exposures.
See the discussion captioned Third 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 six months of 2003, the more significant
changes in LNC's derivative positions are as follows:
1. Entered into 1.1 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 2.1 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 30.0 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 40.0 million notional. A total of 13.6
million notional expired resulting in a total remaining 455.5 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 53.0
million notional that are hedging the foreign currency exposure of a
portion of LNC's investment in its Lincoln UK subsidiary. A total of
54.9 million notional expired resulting in a total remaining 41.1
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
- ------
LNC maintains disclosure controls and procedures, which are designed to
ensure that information required to be disclosed in the reports it files
or submits under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission's
rules and forms, and that such information is accumulated and
communicated to the Company's management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.
An evaluation of the effectiveness of LNC's disclosure controls and
procedures as of June 30, 2003 was conducted under the supervision and
with the participation of LNC's Chief Executive Officer and Chief
Financial Officer. Based on that evaluation, the LNC's Chief Executive
Officer and Chief Financial Officer have concluded that LNC's disclosure
controls and procedures were adequate and designed to ensure that
material information relating to LNC and its consolidated subsidiaries
would be made known to the Chief Executive Officer and Chief Financial
Officer by others within those entities, particularly during the periods
when periodic reports under the Exchange Act are being prepared.
Furthermore, there has been no change in the LNC's internal control over
financial reporting, identified in connection with the evaluation of
such control, that occurred during LNC's last fiscal quarter that has
materially affected, or is reasonably likely to materially affect, LNC's
internal control over financial reporting. Refer to the Certifications
by the Company's Chief Executive Officer and Chief Financial Officer
filed as exhibits to this report.
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 4 Submission of Matters to a Vote of Security Holders
(a) The matters discussed below were submitted to and voted on by
Shareholders of the Registrant at the Annual Meeting of Shareholders of
the Registrant on May 8, 2003.
1. To elect four directors for three year terms
Jenne K. Britell M. Leanne Lachman
Votes cast for = 149,900,171 Votes cast for = 148,171,078
Votes withheld = 4,435,208 Votes withheld = 6,164,321
Ron J. Ponder Jill S. Ruckelshaus
Votes cast for = 151,772,215 Votes cast for = 151,416,370
Votes withheld = 2,563,184 Votes withheld = 2,919,029
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.)
10 (a) Agreement, Waiver and General Release Agreement between Lorry J.
Stensrud and The Lincoln National Life Insurance Company on behalf of
itself and Lincoln National Corporation, their affiliates and subsidiaries,
dated July 7, 2003
12 Historical Ratio of Earnings to Fixed Charges
21 List of Subsidiaries of LNC
31 Additional Exhibit - Section 302 Certifications
32 Additional Exhibit - Section 906 Certifications
(b) Reports on Form 8-K
During the three months ended June 30, 2003, the following Current
Reports on Form 8-K were filed or furnished by LNC:
1. Form 8-K dated May 9, 2003 under item 9 furnishing the Statistical
Supplement for the quarter ended March 31, 2003.
2. Form 8-K dated June 6, 2003 under Item 5 containing a press release
dated June 6, 2003, announcing the combination of life and annuity
businesses into a single operating unit and related matters.
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 August 8 , 2003
LINCOLN NATIONAL CORPORATION
Exhibit Index for the Report on Form 10-Q
for the Quarter Ended June 30, 2003
Exhibit Number Description Page Number
- -------------- ----------- -----------
10 (a) Agreement, Waiver and
General Release - Lorry J. Stensrud 67
12 Historical Ratio of
Earnings to Fixed Charges 76
21 List of Subsidiaries of LNC
31 Additional Exhibit -
Section 302 Certifications 77
32 Additional Exhibit -
Section 906 Certifications 79
Note: This is an abbreviated version of the Lincoln National Corporation
Form 10-Q. Copies of the exhibits (pages XX-XX) are not attached.
Copies of these exhibits are available electronically at www.sec.gov or
by writing to the Corporate Secretary at Lincoln National Corporation,
Centre Square, 1500 Market Street, Suite 3900, Philadelphia,
Pennsylvania 19102-2112