d10q.htm
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
(Mark
One)
x
|
Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
|
For
the quarterly period ended September 30, 2009
OR
¨
|
Transition
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
|
For
the transition period from
to
Commission
File Number 1-6028
LINCOLN
NATIONAL CORPORATION
(Exact
name of registrant as specified in its charter)
_______________________
|
|
Indiana
|
35-1140070
|
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer
Identification
No.)
|
|
|
150 N. Radnor Chester Road, Radnor,
Pennsylvania
|
19087
|
(Address
of principal executive offices)
|
(Zip
Code)
|
(484)
583-1400
(Registrant’s
telephone number, including area code)
Not
Applicable
(Former
name, former address and former fiscal year, if changed since last
report.)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). Yes x No ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
Large
accelerated filer x Accelerated
filer ¨ Non-accelerated filer
¨ (Do not check if a
smaller reporting company)
Smaller
reporting company ¨
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨
No x
As of
November 2, 2009, there were 302,080,185 shares of the registrant’s common
stock outstanding.
PART
I – FINANCIAL INFORMATION
Item 1. Financial
Statements
LINCOLN
NATIONAL CORPORATION
CONSOLIDATED
BALANCE SHEETS
(in millions, except share
data)
|
|
As
of
|
|
|
As
of
|
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(Unaudited)
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
Available-for-sale
securities, at fair value:
|
|
|
|
|
|
|
Fixed
maturity (amortized cost: 2009 – $60,442; 2008 –
$54,381)
|
|
$ |
60,666 |
|
|
$ |
48,141 |
|
Equity
(cost: 2009 – $393; 2008 – $428)
|
|
|
283 |
|
|
|
254 |
|
Trading
securities
|
|
|
2,548 |
|
|
|
2,333 |
|
Mortgage
loans on real estate
|
|
|
7,277 |
|
|
|
7,715 |
|
Real
estate
|
|
|
154 |
|
|
|
125 |
|
Policy
loans
|
|
|
2,893 |
|
|
|
2,921 |
|
Derivative
investments
|
|
|
1,282 |
|
|
|
3,397 |
|
Other
investments
|
|
|
1,080 |
|
|
|
1,624 |
|
Total
investments
|
|
|
76,183 |
|
|
|
66,510 |
|
Cash
and invested cash
|
|
|
3,161 |
|
|
|
5,589 |
|
Deferred
acquisition costs and value of business acquired
|
|
|
9,182 |
|
|
|
11,402 |
|
Premiums
and fees receivable
|
|
|
323 |
|
|
|
449 |
|
Accrued
investment income
|
|
|
943 |
|
|
|
814 |
|
Reinsurance
recoverables
|
|
|
7,664 |
|
|
|
8,396 |
|
Reinsurance
related embedded derivatives
|
|
|
- |
|
|
|
31 |
|
Goodwill
|
|
|
3,096 |
|
|
|
3,696 |
|
Other
assets
|
|
|
10,827 |
|
|
|
10,594 |
|
Separate
account assets
|
|
|
70,111 |
|
|
|
55,655 |
|
Total
assets
|
|
$ |
181,490 |
|
|
$ |
163,136 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
Future
contract benefits
|
|
$ |
15,970 |
|
|
$ |
18,431 |
|
Other
contract holder funds
|
|
|
63,956 |
|
|
|
60,570 |
|
Short-term
debt
|
|
|
400 |
|
|
|
815 |
|
Long-term
debt
|
|
|
4,789 |
|
|
|
4,731 |
|
Reinsurance
related embedded derivatives
|
|
|
39 |
|
|
|
- |
|
Funds
withheld reinsurance liabilities
|
|
|
1,220 |
|
|
|
2,042 |
|
Deferred
gain on business sold through reinsurance
|
|
|
511 |
|
|
|
619 |
|
Payables
for collateral on investments
|
|
|
2,240 |
|
|
|
3,706 |
|
Other
liabilities
|
|
|
10,598 |
|
|
|
8,590 |
|
Separate
account liabilities
|
|
|
70,111 |
|
|
|
55,655 |
|
Total
liabilities
|
|
|
169,834 |
|
|
|
155,159 |
|
|
|
|
|
|
|
|
|
|
Contingencies
and Commitments (See Note 11)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders'
Equity
|
|
|
|
|
|
|
|
|
Series
A preferred stock – 10,000,000 shares authorized; 11,547 and 11,562
shares
|
|
|
|
|
|
|
|
|
issued
and outstanding as of September 30, 2009, and December 31, 2008,
respectively
|
|
|
- |
|
|
|
- |
|
Series
B preferred stock – 950,000 shares authorized and
outstanding
|
|
|
|
|
|
|
|
|
as
of September 30, 2009
|
|
|
800 |
|
|
|
- |
|
Common
stock – 800,000,000 shares authorized; 302,073,869 and 255,869,859
shares
|
|
|
|
|
|
|
|
|
issued
and outstanding as of September 30, 2009, and December 31, 2008,
respectively
|
|
|
7,842 |
|
|
|
7,035 |
|
Retained
earnings
|
|
|
3,234 |
|
|
|
3,745 |
|
Accumulated
other comprehensive loss
|
|
|
(220 |
) |
|
|
(2,803 |
) |
Total
stockholders' equity
|
|
|
11,656 |
|
|
|
7,977 |
|
Total
liabilities and stockholders' equity
|
|
$ |
181,490 |
|
|
$ |
163,136 |
|
See
accompanying Notes to Consolidated Financial Statements
LINCOLN
NATIONAL CORPORATION
CONSOLIDATED
STATEMENTS OF INCOME (LOSS)
(Unaudited,
in millions, except per share data)
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$ |
491 |
|
|
$ |
514 |
|
|
$ |
1,541 |
|
|
$ |
1,507 |
|
Insurance
fees
|
|
|
766 |
|
|
|
754 |
|
|
|
2,158 |
|
|
|
2,314 |
|
Net
investment income
|
|
|
1,071 |
|
|
|
1,068 |
|
|
|
3,055 |
|
|
|
3,170 |
|
Realized
loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
other-than-temporary impairment losses on securities
|
|
|
(148 |
) |
|
|
(237 |
) |
|
|
(578 |
) |
|
|
(395 |
) |
Portion
of loss recognized in other comprehensive income
|
|
|
68 |
|
|
|
- |
|
|
|
259 |
|
|
|
- |
|
Net
other-than-temporary impairment losses on securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
recognized
in earnings
|
|
|
(80 |
) |
|
|
(237 |
) |
|
|
(319 |
) |
|
|
(395 |
) |
Realized
gain (loss), excluding other-than-temporary
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
impairment
losses on securities
|
|
|
(288 |
) |
|
|
30 |
|
|
|
(684 |
) |
|
|
49 |
|
Total
realized loss
|
|
|
(368 |
) |
|
|
(207 |
) |
|
|
(1,003 |
) |
|
|
(346 |
) |
Amortization
of deferred gain on business sold through
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
reinsurance
|
|
|
18 |
|
|
|
19 |
|
|
|
56 |
|
|
|
57 |
|
Other
revenues and fees
|
|
|
103 |
|
|
|
122 |
|
|
|
293 |
|
|
|
369 |
|
Total
revenues
|
|
|
2,081 |
|
|
|
2,270 |
|
|
|
6,100 |
|
|
|
7,071 |
|
Benefits
and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
credited
|
|
|
623 |
|
|
|
625 |
|
|
|
1,848 |
|
|
|
1,849 |
|
Benefits
|
|
|
569 |
|
|
|
813 |
|
|
|
2,072 |
|
|
|
2,118 |
|
Underwriting,
acquisition, insurance and other expenses
|
|
|
760 |
|
|
|
642 |
|
|
|
2,103 |
|
|
|
2,065 |
|
Interest
and debt expense
|
|
|
68 |
|
|
|
69 |
|
|
|
130 |
|
|
|
209 |
|
Impairment
of intangibles
|
|
|
(1 |
) |
|
|
- |
|
|
|
601 |
|
|
|
175 |
|
Total
benefits and expenses
|
|
|
2,019 |
|
|
|
2,149 |
|
|
|
6,754 |
|
|
|
6,416 |
|
Income
(loss) from continuing operations before taxes
|
|
|
62 |
|
|
|
121 |
|
|
|
(654 |
) |
|
|
655 |
|
Federal
income tax expense (benefit)
|
|
|
(19 |
) |
|
|
(8 |
) |
|
|
(141 |
) |
|
|
162 |
|
Income
(loss) from continuing operations
|
|
|
81 |
|
|
|
129 |
|
|
|
(513 |
) |
|
|
493 |
|
Income
(loss) from discontinued operations, net of federal
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
income
taxes
|
|
|
72 |
|
|
|
19 |
|
|
|
(74 |
) |
|
|
69 |
|
Net
income (loss)
|
|
|
153 |
|
|
|
148 |
|
|
|
(587 |
) |
|
|
562 |
|
Preferred
stock dividends and accretion of discount
|
|
|
(16 |
) |
|
|
- |
|
|
|
(16 |
) |
|
|
- |
|
Net
income (loss) available to common stockholders
|
|
$ |
137 |
|
|
$ |
148 |
|
|
$ |
(603 |
) |
|
$ |
562 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
(Loss) Per Common Share – Basic
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations
|
|
$ |
0.21 |
|
|
$ |
0.51 |
|
|
$ |
(1.94 |
) |
|
$ |
1.91 |
|
Income
(loss) from discontinued operations
|
|
|
0.24 |
|
|
|
0.07 |
|
|
|
(0.27 |
) |
|
|
0.27 |
|
Net
income (loss)
|
|
$ |
0.45 |
|
|
$ |
0.58 |
|
|
$ |
(2.21 |
) |
|
$ |
2.18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
(Loss) Per Common Share – Diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations
|
|
$ |
0.21 |
|
|
$ |
0.51 |
|
|
$ |
(1.94 |
) |
|
$ |
1.90 |
|
Income
(loss) from discontinued operations
|
|
|
0.23 |
|
|
|
0.07 |
|
|
|
(0.27 |
) |
|
|
0.26 |
|
Net
income (loss)
|
|
$ |
0.44 |
|
|
$ |
0.58 |
|
|
$ |
(2.21 |
) |
|
$ |
2.16 |
|
See
accompanying Notes to Consolidated Financial Statements
LINCOLN
NATIONAL CORPORATION
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited,
in millions, except per share data)
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
Preferred
Stock
|
|
|
|
|
|
|
Balance
as of beginning-of-year
|
|
$ |
- |
|
|
$ |
- |
|
Issuance
of Series B preferred stock
|
|
|
794 |
|
|
|
- |
|
Accretion
of discount on Series B preferred stock
|
|
|
6 |
|
|
|
- |
|
Balance
as of end-of-period
|
|
|
800 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
|
|
|
|
|
|
Balance
as of beginning-of-year
|
|
|
7,035 |
|
|
|
7,200 |
|
Issuance
of common stock
|
|
|
652 |
|
|
|
- |
|
Issuance
of common stock warrant
|
|
|
156 |
|
|
|
- |
|
Stock
compensation/issued for benefit plans
|
|
|
(6 |
) |
|
|
51 |
|
Deferred
compensation payable in stock
|
|
|
5 |
|
|
|
4 |
|
Retirement
of common stock/cancellation of shares
|
|
|
- |
|
|
|
(249 |
) |
Balance
as of end-of-period
|
|
|
7,842 |
|
|
|
7,006 |
|
|
|
|
|
|
|
|
|
|
Retained
Earnings
|
|
|
|
|
|
|
|
|
Balance
as of beginning-of-year
|
|
|
3,745 |
|
|
|
4,293 |
|
Cumulative
effect from adoption of new accounting standards
|
|
|
102 |
|
|
|
(4 |
) |
Comprehensive
income (loss)
|
|
|
2,098 |
|
|
|
(1,473 |
) |
Other
comprehensive income (loss), net of tax
|
|
|
(2,685 |
) |
|
|
2,035 |
|
Net
income (loss)
|
|
|
(587 |
) |
|
|
562 |
|
Retirement
of common stock
|
|
|
- |
|
|
|
(227 |
) |
Dividends
declared: Common (2009 - $0.03; 2008 - $1.245)
|
|
|
(10 |
) |
|
|
(320 |
) |
Dividends
on preferred stock
|
|
|
(10 |
) |
|
|
- |
|
Accretion
of discount on Series B preferred stock
|
|
|
(6 |
) |
|
|
- |
|
Balance
as of end-of-period
|
|
|
3,234 |
|
|
|
4,304 |
|
|
|
|
|
|
|
|
|
|
Accumulated
Other Comprehensive Income (Loss)
|
|
|
|
|
|
|
|
|
Balance
as of beginning-of-year
|
|
|
(2,803 |
) |
|
|
225 |
|
Cumulative
effect from adoption of new accounting standards
|
|
|
(102 |
) |
|
|
- |
|
Other
comprehensive income (loss), net of tax
|
|
|
2,685 |
|
|
|
(2,035 |
) |
Balance
as of end-of-period
|
|
|
(220 |
) |
|
|
(1,810 |
) |
Total
stockholders' equity as of end-of-period
|
|
$ |
11,656 |
|
|
$ |
9,500 |
|
See
accompanying Notes to Consolidated Financial Statements
LINCOLN
NATIONAL CORPORATION
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Unaudited,
in millions)
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
Cash
Flows from Operating Activities
|
|
|
|
Net
income (loss)
|
|
$ |
(587 |
) |
|
$ |
562 |
|
Adjustments
to reconcile net income (loss) to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
Deferred
acquisition costs, value of business acquired, deferred sales
inducements
|
|
|
|
|
|
|
|
|
and
deferred front end loads deferrals and interest, net of
amortization
|
|
|
(217 |
) |
|
|
(492 |
) |
Trading
securities purchases, sales and maturities, net
|
|
|
(36 |
) |
|
|
141 |
|
Change
in premiums and fees receivable
|
|
|
244 |
|
|
|
47 |
|
Change
in accrued investment income
|
|
|
(129 |
) |
|
|
(78 |
) |
Change
in future contract benefits
|
|
|
(694 |
) |
|
|
159 |
|
Change
in other contract holder funds
|
|
|
205 |
|
|
|
202 |
|
Change
in funds withheld reinsurance liabilities and reinsurance
recoverables
|
|
|
167 |
|
|
|
(57 |
) |
Change
in federal income tax accruals
|
|
|
(27 |
) |
|
|
(228 |
) |
Realized
loss
|
|
|
1,003 |
|
|
|
346 |
|
Loss
on disposal of discontinued operations
|
|
|
220 |
|
|
|
13 |
|
Gain
on early extinguishment of debt
|
|
|
(64 |
) |
|
|
- |
|
Impairment
of intangibles
|
|
|
601 |
|
|
|
175 |
|
Amortization
of deferred gain on business sold through reinsurance
|
|
|
(56 |
) |
|
|
(57 |
) |
Other
|
|
|
(78 |
) |
|
|
78 |
|
Net
cash provided by operating activities
|
|
|
552 |
|
|
|
811 |
|
|
|
|
|
|
|
|
|
|
Cash
Flows from Investing Activities
|
|
|
|
|
|
|
|
|
Purchases
of available-for-sale securities
|
|
|
(11,468 |
) |
|
|
(5,578 |
) |
Sales
of available-for-sale securities
|
|
|
2,850 |
|
|
|
1,803 |
|
Maturities
of available-for-sale securities
|
|
|
2,533 |
|
|
|
2,978 |
|
Purchases
of other investments
|
|
|
(3,232 |
) |
|
|
(1,848 |
) |
Sales
or maturities of other investments
|
|
|
3,521 |
|
|
|
1,383 |
|
Increase
(decrease) in payables for collateral on investments
|
|
|
(1,466 |
) |
|
|
533 |
|
Proceeds
from sale of subsidiaries/businesses and from disposal of discontinued
operations
|
|
|
13 |
|
|
|
645 |
|
Other
|
|
|
(51 |
) |
|
|
(90 |
) |
Net
cash used in investing activities
|
|
|
(7,300 |
) |
|
|
(174 |
) |
|
|
|
|
|
|
|
|
|
Cash
Flows from Financing Activities
|
|
|
|
|
|
|
|
|
Payment
of long-term debt, including current maturities
|
|
|
(522 |
) |
|
|
(285 |
) |
Issuance
of long-term debt, net of issuance costs
|
|
|
491 |
|
|
|
450 |
|
Decrease
in commercial paper, net
|
|
|
(166 |
) |
|
|
(145 |
) |
Deposits
of fixed account values, including the fixed portion of
variable
|
|
|
8,805 |
|
|
|
7,366 |
|
Withdrawals
of fixed account values, including the fixed portion of
variable
|
|
|
(4,282 |
) |
|
|
(4,373 |
) |
Transfers
to and from separate accounts, net
|
|
|
(1,566 |
) |
|
|
(1,838 |
) |
Payment
of funding agreements
|
|
|
- |
|
|
|
(550 |
) |
Common
stock issued for benefit plans and excess tax benefits
|
|
|
- |
|
|
|
32 |
|
Issuance
of Series B preferred stock and associated common stock
warrant
|
|
|
950 |
|
|
|
- |
|
Issuance
of common stock
|
|
|
652 |
|
|
|
- |
|
Repurchase
of common stock
|
|
|
- |
|
|
|
(476 |
) |
Dividends
paid to common and preferred stockholders
|
|
|
(64 |
) |
|
|
(323 |
) |
Net
cash provided by (used in) financing activities
|
|
|
4,298 |
|
|
|
(142 |
) |
Net
increase (decrease) in cash and invested cash, including discontinued
operations
|
|
|
(2,450 |
) |
|
|
495 |
|
Cash
and invested cash, including discontinued operations, as of
beginning-of-year
|
|
|
5,926 |
|
|
|
1,665 |
|
Cash
and invested cash, including discontinued operations, as of
end-of-period
|
|
$ |
3,476 |
|
|
$ |
2,160 |
|
See
accompanying Notes to Consolidated Financial Statements
LINCOLN
NATIONAL CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Nature
of Operations and Basis of Presentation
Nature of
Operations
Lincoln
National Corporation and its majority-owned subsidiaries (“LNC” or the
“Company,” which also may be referred to as “we,” “our” or “us”) operate
multiple insurance businesses through four business segments. See
Note 17 for additional details. The collective group of businesses
uses “Lincoln Financial Group” as its marketing identity. Through our
business segments, we sell a wide range of wealth protection, accumulation and
retirement income products. These products include institutional
and/or retail fixed and indexed annuities, variable annuities, universal life
(“UL”) insurance, variable universal life (“VUL”) insurance, term life insurance
and mutual funds.
Basis
of Presentation
The
accompanying unaudited consolidated financial statements are prepared in
accordance with United States of America generally accepted accounting
principles (“GAAP”) for interim financial information and with the instructions
for the Securities and Exchange Commission (“SEC”) Quarterly Report on Form
10-Q, including Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and notes required by GAAP for complete financial
statements. Therefore, the information contained in the Notes to
Consolidated Financial Statements included in the Company’s Annual Report on
Form 10-K for the year ended December 31, 2008 (“2008 Form 10-K”) should be read
in connection with the reading of these interim unaudited consolidated financial
statements.
In the
opinion of management, these statements include all normal recurring adjustments
necessary for a fair presentation of the Company’s results. Operating
results for the nine month period ended September 30, 2009, are not necessarily
indicative of the results that may be expected for the full year ending December
31, 2009. All material intercompany accounts and transactions have been
eliminated in consolidation.
We have
evaluated our subsequent events through the time of filing this Form 10-Q with
the SEC, on November 6, 2009.
Certain
amounts reported in prior periods’ consolidated financial statements have been
reclassified to conform to the presentation adopted in the current
year. These reclassifications have no effect on net income or
stockholders’ equity of the prior periods.
2. New
Accounting Standards
Adoption
of New Accounting Standards
Statement
of Financial Accounting Standards No. 168 – The FASB Accounting Standards
CodificationTM and
the Hierarchy of Generally Accepted Accounting Principles – a replacement of
FASB Standard No. 162
In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards (“SFAS”) No. 168, “The FASB Accounting Standards CodificationTM and
the Hierarchy of Generally Accepted Accounting Principles – a replacement of
FASB Standard No. 162” (“SFAS 168”). The FASB Accounting Standards CodificationTM (“ASC”)
is now the single source of authoritative GAAP recognized by the
FASB. Although the FASB ASC does not change current GAAP, it
supersedes all existing non-SEC accounting and reporting standards as of the
effective date. The accounting guidance in the FASB ASC is organized
by topical reference, with all the contents having the same level of
authority. In accordance with Accounting Standards Update (“ASU”)
No. 2009-01, “Topic 105 – Generally Accepted Accounting Principles –
amendments based on – Statement of Financial Accounting Standards No. 168 – The
FASB Accounting Standards
CodificationTM and the Hierarchy of
Generally Accepted Accounting Principles” (“ASU 2009-01”) the guidance in SFAS
168 will remain authoritative until it has been integrated into the FASB
ASC. We adopted SFAS 168 as of September 30, 2009, and have revised
all of the referencing of GAAP accounting standards in this filing to reflect
the appropriate references in the new FASB ASC.
Business
Combinations Topic
In
December 2007, the FASB revised the accounting guidance related to the Business
Combinations Topic of the FASB ASC. This revised accounting guidance
retains the fundamental requirements of the business combination accounting
standard, but establishes revised principles and requirements for the acquirer
in a business combination to recognize and measure the identifiable assets
acquired, liabilities assumed and any noncontrolling interests in the acquiree
and the goodwill acquired or the gain from a bargain purchase. For a
more detailed description of this accounting guidance see “SFAS No. 141(R) – Business Combinations” in
Note 2 of our 2008 Form 10-K. We adopted these revisions for
acquisitions occurring after January 1, 2009. The adoption did not
have a material impact on our consolidated financial condition or results of
operations.
In April
2009, the FASB further amended the guidance in the Business Combinations Topic
related to the recognition and measurement of contingencies acquired in a
business combination. Contingent assets acquired and liabilities
assumed (jointly referred to as “pre-acquisition contingencies”) in a business
combination are measured as of the acquisition-date fair value only if fair
value can be determined during the measurement period. If the fair
value cannot be determined during the measurement period, but information is
available as of the end of the measurement period indicating the pre-acquisition
contingency is both probable and can be reasonably estimated, then the
pre-acquisition contingency is recognized as of the acquisition date based on
the estimated amount. Subsequent to the acquisition date, the
measurement of pre-acquisition contingencies is dependent on the nature of the
contingency. We adopted these amendments for acquisitions occurring
after January 1, 2009. The adoption did not have a material impact on
our consolidated financial condition or results of operations.
Consolidations
Topic
In
December 2007, the FASB amended the Consolidations Topic of the FASB ASC in
order to establish accounting and reporting standards surrounding noncontrolling
interests, or minority interests, which are the portions of equity in a
subsidiary not attributable, directly or indirectly, to a parent. For
a more detailed description of these amendments see “SFAS No. 160 – Noncontrolling
Interests in Consolidated Financial Statements – an Amendment of Accounting
Research Bulletin No. 51” in Note 2 of our 2008 Form 10-K. We
adopted these amendments effective January 1, 2009. The adoption did
not have a material impact on our consolidated financial condition and results
of operations.
Derivatives
and Hedging Topic
In March
2008, the FASB amended the Derivatives and Hedging Topic of the FASB ASC to
expand the qualitative and quantitative disclosure requirements for derivative
instruments and hedging activities. For a more detailed description
of the new disclosure requirements, see “SFAS No. 161 – Disclosures about
Derivative Instruments and Hedging Activities – an Amendment of FASB Statement No.
133” in Note 2 of our 2008 Form 10-K. The amended and expanded
disclosure requirements apply to all derivative instruments within the scope of
the Derivatives and Hedging Topic, nonderivative hedging instruments and all
hedged items designated and qualifying as hedges. We adopted these
amendments effective January 1, 2009, and have prospectively included the
enhanced disclosures related to derivative instruments and hedging activities in
Note 6.
In
addition, in June 2008, the FASB amended the Derivatives and Hedging Topic
regarding the evaluation of an instrument (or embedded feature) indexed to an
entity’s own stock. The amendments to the accounting guidance require
a two-step process to determine whether an equity-linked instrument (or embedded
feature) is indexed to an entity’s own stock first by evaluating the
instrument’s contingent exercise provisions, if any, and second, by evaluating
the instrument’s settlement provisions. We adopted this updated
accounting guidance on January 1, 2009, for all outstanding instruments as
of that date. The adoption did not have a material impact on our
consolidated financial condition and results of operations.
Fair
Value Measurements and Disclosures Topic
In
February 2008, the FASB amended the Fair Value Measurements and Disclosures
Topic of the FASB ASC in order to delay the effective date of fair value
measurement for nonfinancial assets and nonfinancial liabilities to fiscal years
beginning after November 15, 2008, except for items that are recognized or
disclosed at fair value in the financial statements on a recurring basis (at
least annually). We applied fair value measurement to nonfinancial
assets and nonfinancial liabilities beginning on January 1, 2009. The
application did not have a material impact on our consolidated financial
condition and results of operations.
In
addition, in April 2009, the FASB amended the Fair Value Measurements and
Disclosures Topic to provide additional guidance on estimating fair value when
the volume and level of activity for an asset or liability have significantly
decreased in relation to normal market activity for the asset or liability and
additional guidance on circumstances that may indicate a transaction is not
orderly. The FASB provided illustrative examples of key
considerations when applying fair value measurement principles to estimate fair
value in nonactive markets when there has been a significant decrease in the
volume and level of activity for the asset. Additional financial
statement disclosures are also required about an entity’s fair value
measurements in annual and interim reporting periods. Any changes in
valuation techniques resulting from the adoption of this amended guidance are
accounted for as a change in accounting estimate in accordance with the FASB ASC
guidance related to accounting changes and error corrections. As
permitted under the transition guidance, we elected to early adopt these
amendments to the Fair Value Measurements and Disclosures Topic effective
January 1, 2009. The adoption did not have a material impact on our
consolidated financial condition or results of operations.
Financial
Instruments Topic
In April
2009, the FASB extended the financial statement disclosures under the Financial
Instruments Topic of the FASB ASC to require that the fair value of financial
instrument disclosures be included in the notes to the interim financial
statements. In addition, entities must disclose the method(s) and
significant assumptions used to estimate the fair value of financial instruments
in the financial statements on an interim basis and to highlight any change in
the method(s) and significant assumptions used from prior periods. We
included the disclosures related to the fair value of financial instruments as
of June 30, 2009, and have included these enhanced disclosures in Note
16.
Financial
Services – Insurance Industry Topic
In May
2008, the FASB updated the Financial Services – Insurance Industry Topic of the
FASB ASC with accounting guidance applicable to financial guarantee insurance
and reinsurance contracts not accounted for as derivative
instruments. For a more detailed description of these amendments, see
“SFAS No. 163 – Accounting for
Financial Guarantee Insurance Contracts – an Interpretation of FASB Statement
No. 60” in Note 2 of our 2008 Form 10-K. We do not hold a
significant amount of financial guarantee insurance and reinsurance contracts,
and as such, the adoption on January 1, 2009, did not have a material impact on
our consolidated financial condition and results of operations.
Intangibles
– Goodwill and Other Topic
In April
2008, the FASB amended the Intangibles – Goodwill and Other Topic of the FASB
ASC related to the determination of the useful life of intangible
assets. For a more detailed description of these amendments, see
“FSP FAS No. 142-3
– Determination of the Useful Life of
Intangible Assets” in Note 2 of our 2008 Form 10-K. We adopted
these amendments effective January 1, 2009, and applied the guidance
prospectively to recognized intangible assets acquired after the effective date
and applied the disclosure requirements to all intangible assets recognized as
of, and subsequent to, the effective date. The adoption did not have
a material impact on our consolidated financial condition and results of
operations.
Investments
– Debt and Equity Securities Topic
In April
2009, the FASB replaced the guidance in the Investments – Debt and Equity
Securities Topic of the FASB ASC related to other-than-temporary impairments
(“OTTI”). Under this new accounting guidance, management’s assertion
that it has the intent and ability to hold an impaired debt security until
recovery is replaced by the requirement for management to assert if it either
has the intent to sell the debt security or if it is more likely than not the
entity will be required to sell the debt security before recovery of its
amortized cost basis. If management intends to sell the debt security
or it is more likely than not the entity will be required to sell the debt
security before recovery of its amortized cost basis, an OTTI shall be
recognized in earnings equal to the entire difference between the debt
security’s amortized cost basis and its fair value as of the balance sheet
date. After the recognition of an OTTI, the debt security is
accounted for as if it had been purchased on the measurement date of the OTTI,
with an amortized cost basis equal to the previous amortized cost basis less the
OTTI recognized in earnings.
If
management does not intend to sell the debt security and it is not more likely
than not the entity will be required to sell the debt security before recovery
of its amortized cost basis, but the present value of the cash flows expected to
be collected is less than the amortized cost basis of the debt security
(referred to as the credit loss), an OTTI is considered to have
occurred. In this instance, the total OTTI must be bifurcated into
the amount related to the credit loss, which is recognized in earnings, with the
remaining amount of the total OTTI attributed to other factors (referred to as
the noncredit portion) recognized as a separate component in other comprehensive
income (loss) (“OCI”). After the recognition of an OTTI, the debt
security is accounted for as if it had been purchased on the measurement date of
the OTTI, with an amortized cost basis equal to the previous amortized cost
basis less the OTTI recognized in earnings. In addition, the
amendments to this topic expand and increase the frequency of existing
disclosures about OTTIs for debt and equity securities regarding expected cash
flows, credit losses and the aging of securities with unrealized
losses.
As
permitted by the transition guidance, we elected to early adopt the amendments
to the Investments – Debt and Equity Securities Topic effective January 1,
2009, by recording an increase of $102 million to the opening balance of
retained earnings with a corresponding decrease to accumulated OCI on our
Consolidated Statements of Stockholders’ Equity to reclassify the noncredit
portion of previously other-than-temporarily impaired debt securities held as of
January 1, 2009. The following summarizes the components (in
millions) for this cumulative effect adjustment:
|
|
Unrealized
|
|
|
Net
|
|
|
|
|
|
|
OTTI
|
|
|
Unrealized
|
|
|
|
|
|
|
on
|
|
|
Loss
|
|
|
|
|
|
|
AFS
|
|
|
on
AFS
|
|
|
|
|
|
|
Securities
|
|
|
Securities
|
|
|
Total
|
|
Increase
in amortized cost of fixed maturity available-for-sale ("AFS")
securities
|
|
$ |
34 |
|
|
$ |
165 |
|
|
$ |
199 |
|
Change
in DAC, VOBA, DSI and DFEL
|
|
|
(7 |
) |
|
|
(35 |
) |
|
|
(42 |
) |
Income
tax
|
|
|
(9 |
) |
|
|
(46 |
) |
|
|
(55 |
) |
Net
cumulative effect adjustment
|
|
$ |
18 |
|
|
$ |
84 |
|
|
$ |
102 |
|
The
cumulative effect adjustment was calculated for all debt securities held as of
January 1, 2009, for which an OTTI was previously recognized, but as of January
1, 2009, we did not intend to sell the security and it was not more likely than
not that we would be required to sell the security before recovery of its
amortized cost, by comparing the present value of cash flows expected to be
received as of January 1, 2009, to the amortized cost basis of the debt
securities. The discount rate used to calculate the present value of
the cash flows expected to be collected was the rate for each respective debt
security in effect before recognizing any OTTI. In addition, because
the carrying amounts of deferred acquisition costs (“DAC”), value of business
acquired (“VOBA”), deferred sales inducements (“DSI”) and deferred front-end
loads (“DFEL”) are adjusted for the effects of realized and unrealized gains and
losses on fixed maturity AFS securities, we recognized a true-up to our DAC,
VOBA, DSI and DFEL balances for this cumulative effect adjustment.
The
following summarizes the increase to the amortized cost of our fixed maturity
AFS securities (in millions) as of January 1, 2009, resulting from the
recognition of the cumulative effect adjustment:
Corporate
bonds
|
|
$ |
131 |
|
Residential
collateralized mortgage obligations ("CMOs")
|
|
|
65 |
|
Collateralized
debt obligations ("CDOs")
|
|
|
3 |
|
Total
fixed maturity AFS securities
|
|
$ |
199 |
|
The
impact of this adoption to basic and diluted per share amounts for the three
months ended September 30, 2009, was an increase of $0.23 and $0.22 per share,
respectively. The impact of this adoption to both basic and diluted
per share amounts for the nine months ended September 30, 2009, was an increase
of $0.95 per share.
In
addition, we have enhanced our financial statement presentation to present the
total OTTI recognized in realized loss, with an offset for the amount of
noncredit impairments recognized in accumulated OCI, on the face of our
Consolidated Statements of Income (Loss). We disclose the amount of
OTTI recognized in accumulated OCI in Note 12, and the enhanced disclosures
related to OTTI are included in Note 5.
Investments
– Equity Method and Joint Ventures Topic
In
November 2008, the FASB amended the guidance in the Investments – Equity
Method and Joint Ventures Topic of the FASB ASC to addresses the impact of
recent amendments to the Business Combinations and Consolidations Topics on the
accounting for equity method investments. For a more detailed
description of these amendments, see “EITF No. 07-5 – Determining Whether
an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock”
in Note 2 of our 2008 Form 10-K. We adopted these amendments
on January 1, 2009, prospectively for all investments accounted for under
the equity method. The adoption did not have a material impact on our
consolidated financial condition and results of operations.
Subsequent
Events Topic
In May
2009, the FASB updated the Subsequent Events Topic of the FASB ASC in order to
establish standards of accounting for the disclosure of events that take place
after the balance sheet date, but before the financial statements are
issued. The effect of all subsequent events must be recognized in the
financial statements that provide information about conditions that existed as
of the balance sheet date. For those events that did not exist as of
the balance sheet date, but arose after the balance sheet date and before the
financial statements are issued, recognition is not required, but depending on
the nature of the unrecognized subsequent event, disclosure of the event may be
required in order to keep the financial statements from being
misleading. In addition, entities must disclose in the financial
statements the date through which subsequent events have been
evaluated. We adopted these provisions, prospectively, as of the
interim reporting period ended June 30, 2009, and have include the enhanced
disclosures in Note 1. The adoption of these amendments to the
Subsequent Event Topic did not have a material impact on our consolidated
financial condition or results of operations.
Transfers
and Servicing Topic
In
February 2008, the FASB updated the Transfers and Servicing Topic of the FASB
ASC regarding transfers of financial assets and the guidance for when a
repurchase financing should be considered a linked transaction. For a
more detailed description of these amendments see “FSP FAS No. 140-3 – Accounting for
Transfers of Financial Assets and Repurchase Financing Transactions” in
Note 2 of our 2008 Form 10-K. We adopted this update effective
January 1, 2009, and applied the guidance prospectively to initial transfers and
repurchase financings executed after that date. The adoption did not
have a material impact on our consolidated financial condition and results of
operations.
Future
Adoption of New Accounting Standards
Compensation
– Retirement Benefits Topic
In
December 2008, the FASB amended the disclosure requirements for the Compensation
– Retirement Benefits Topic of the FASB ASC, which will require enhanced
disclosures regarding the plan assets of an employer’s defined benefit pension
or other postretirement benefit plans. The new disclosures will
include information regarding the investment allocation decisions made for plan
assets, the fair value of each major category of plan assets disclosed
separately for pension plans and other postretirement benefit plans and the
inputs and valuation techniques used to measure the fair value of plan assets,
including the level within the fair value hierarchy as defined by the Fair Value
Measurements and Disclosures Topic of the FASB ASC. In addition,
disclosures will now be required for fair value measurements of plan assets
using Level 3 inputs. These new disclosures are effective for fiscal
years ending after December 15, 2009, and are not required for earlier periods
presented for comparative purposes. We will include the disclosures
required by the Compensation – Retirement Benefits Topic in the notes to our
consolidated financial statements for the year ending December 31,
2009.
Fair
Value Measurements and Disclosures Topic
In August
2009, the FASB issued ASU No. 2009-05, “Measuring Liabilities at Fair Value”
(“ASU 2009-05”) which amends the Fair Value Measurements and Disclosures Topic
of the FASB ASC to provide further guidance on the application of fair value
measurements, due to the general lack of observable market information available
for liabilities. These amendments to the Fair Value Measurements and
Disclosures Topic identify valuation techniques which can be used to measure the
fair value of a liability when a quoted price in an active market is not
available. In addition, the amendments clarify that an entity is not
required to include a separate input or adjustment to other inputs related to a
restriction that prevents the transfer of the liability and clarifies when a
quoted price for a liability would be considered a Level 1 input. ASU
2009-05 is effective for the reporting period ending December 31,
2009. Any revisions resulting from a change in a valuation technique,
or its application, must be accounted for as a change in accounting estimate and
the specified disclosure for a change in accounting estimate must be included in
the notes to the financial statements. We will adopt these amendments
to the Fair Value Measurements and Disclosures Topic in the fourth quarter of
2009, and are currently evaluating the impact of the adoption on our
consolidated financial condition and results of operations.
In
September 2009, the FASB issued ASU No. 2009-12, “Investments in Certain
Entities That Calculate Net Asset Value per Share (or Its Equivalent)” (“ASU
2009-12”), which amends the Fair Value Measurements and Disclosures Topic of the
FASB ASC to permit the use of net asset value per share, without further
adjustment, to estimate the fair value of investments in investment companies
that do not have readily determinable fair values. The net asset
value per share must be calculated in a manner consistent with the measurement
principles of the Financial Services – Investment Companies Topic of the FASB
ASC and can be used by investors in investments such as hedge funds, private
equity funds, venture capital funds and real estate funds. If it is
probable the investment will be sold for an amount other than net asset value,
the investor would be required to estimate the fair value of the investment
considering all of the rights and obligations of the investment and any other
market available data. In addition, the amendments will require
enhanced disclosure for the investments within the scope of this accounting
update. The accounting guidance in ASU 2009-12 is effective for
periods ending after December 15, 2009, and entities will be permitted to early
adopt this accounting guidance without providing the enhanced
disclosures. Upon the effective date of ASU 2009-12, the enhanced
disclosures must be provided in the notes to the financial
statements. We will adopt these amendments in the fourth quarter of
2009, and are currently evaluating the impact of the adoption on our
consolidated financial condition and results of operations.
SFAS
No. 166 – Accounting for Transfers of Financial Assets – an amendment of FASB
Statement No. 140
In June
2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial
Assets – an amendment of FASB Statement No. 140” (“SFAS 166”). In
accordance with ASU 2009-01, the guidance in SFAS 166 will remain authoritative
until it has been integrated into the FASB ASC. SFAS 166 will, among
other things, eliminate the concept of a qualifying special-purpose entity
(“SPE”) and remove the scope exception for a qualifying SPE from the
Consolidations Topic of the FASB ASC. As a result, previously
unconsolidated qualifying SPEs must be re-evaluated for consolidation by the
sponsor or transferor. In addition, this standard amends the
accounting guidance related to transfers of financial assets in order to address
practice issues that have been highlighted by the events of the recent economic
decline. SFAS 166 is effective as of the beginning of the annual
reporting period that begins after November 15, 2009. The recognition
and measurement provisions will be applied to transfers that occur on or after
the effective date and all qualifying SPEs that exist on and after the effective
date must be evaluated for consolidation. We will adopt the
provisions of SFAS 166 effective January 1, 2010, and are currently evaluating
the impact of the adoption on our consolidated financial condition and results
of operations.
SFAS
No. 167 – Amendments to FASB Interpretation No. 46(R)
In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R)” (“SFAS 167”). In accordance with ASU 2009-01, the guidance in
SFAS 167 will remain authoritative until it has been integrated into the FASB
ASC. SFAS 167 amends the consolidation guidance related to variable
interest entities (“VIEs”) to require entities to perform an analysis of their
respective variable interests to determine if a controlling financial interest
exists in the VIE. The current quantitative analysis used under the
Consolidations Topic of the FASB ASC will be eliminated and replaced with a
qualitative approach that is focused on identifying the variable interest that
has the power to direct the activities that most significantly impact the
performance of the VIE and absorb losses or receive returns that could
potentially be significant to the VIE. In addition, this new
accounting standard will require an ongoing reassessment of the primary
beneficiary of the VIE, rather than reassessing the primary beneficiary only
upon the occurrence of certain events defined in the FASB ASC. SFAS
167 will be effective as of the beginning of the annual reporting period that
begins after November 15, 2009, and requires that on the effective date all VIEs
in which an entity has a variable interest be reconsidered for consolidation
based on this amended accounting guidance. The investments we hold
that we are evaluating are certain of our partnership investments in our
alternative investment portfolio and the credit linked notes
(“CLNs”). See Notes 4 and 5 for details on the CLNs. If we
were required to consolidate our CLNs, it would also result in requiring us to
record changes in fair value through the income statement with the initial
mark-to-market recorded as a cumulative effect adjustment to retained
earnings. We will adopt the provisions of SFAS 167 effective January
1, 2010, and are currently evaluating the impact of the adoption on our
consolidated financial condition and results of operations.
3. Acquisitions
and Dispositions
Acquisitions
Newton
County Loan & Savings, FSB (“NCLS”)
On
January 8, 2009, the Office of Thrift Supervision approved our application to
become a savings and loan holding company and our acquisition of NCLS, a
federally regulated savings bank located in Indiana. We contributed
$10 million to the capital of NCLS. We closed on our purchase of NCLS
on January 15, 2009, which did not have a material impact on our consolidated
financial condition or results of operations.
Dispositions
Discontinued
Investment Management Operations
On
August 18, 2009, we entered into a purchase and sale agreement with
Macquarie Bank Limited (“MBL”), pursuant to which we agreed to sell to MBL all
of the outstanding capital stock of Delaware Management Holdings, Inc.
(“Delaware”), our subsidiary, which provides investment products and services to
individuals and institutions.
In
addition, certain of our subsidiaries, including The Lincoln National Life
Insurance Company (“LNL”), our primary insurance subsidiary, will enter into
investment advisory agreements with Delaware, pursuant to which Delaware will
continue to manage the majority of the general account insurance assets of the
subsidiaries. The investment advisory agreements will have ten-year
terms, and we may terminate them without cause by paying an aggregate
termination fee of up to $84 million in the event that all of the agreements
with our subsidiaries are terminated that will decline on a pro rata basis over
the ten-year term of the advisory agreements.
Accordingly,
the assets and liabilities of this business have been reclassified as
held-for-sale for all periods presented and are reported within other assets and
other liabilities on our Consolidated Balance Sheets. The major
classes of assets and liabilities held-for-sale (in millions) were as
follows:
|
|
As
of
|
|
|
As
of
|
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Assets
|
|
|
|
|
|
|
Cash
and invested cash
|
|
$ |
152 |
|
|
$ |
165 |
|
Premiums
and fees receivable
|
|
|
34 |
|
|
|
32 |
|
Goodwill
|
|
|
248 |
|
|
|
248 |
|
Other
assets
|
|
|
84 |
|
|
|
77 |
|
Total
assets held-for-sale
|
|
$ |
518 |
|
|
$ |
522 |
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
Other
liabilities
|
|
$ |
162 |
|
|
$ |
166 |
|
Total
liabilities held-for-sale
|
|
$ |
162 |
|
|
$ |
166 |
|
We have
reclassified the results of operations of Delaware into income (loss) from
discontinued operations for all periods presented on our Consolidated Statements
of Income (Loss), and selected amounts (in millions) were as
follows:
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Discontinued
Operations Before Disposal
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
advisory fees – external
|
|
$ |
55 |
|
|
$ |
67 |
|
|
$ |
146 |
|
|
$ |
220 |
|
Investment
advisory fees – internal
|
|
|
22 |
|
|
|
21 |
|
|
|
62 |
|
|
|
61 |
|
Other
revenues and fees
|
|
|
23 |
|
|
|
22 |
|
|
|
66 |
|
|
|
75 |
|
Gain
on sale of business
|
|
|
2 |
|
|
|
2 |
|
|
|
6 |
|
|
|
6 |
|
Total
revenues
|
|
$ |
102 |
|
|
$ |
112 |
|
|
$ |
280 |
|
|
$ |
362 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from discontinued operations before disposal,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
before
federal income tax expense
|
|
$ |
12 |
|
|
$ |
10 |
|
|
$ |
29 |
|
|
$ |
57 |
|
Federal
income tax expense
|
|
|
5 |
|
|
|
3 |
|
|
|
13 |
|
|
|
21 |
|
Income
from discontinued operations before disposal
|
|
$ |
7 |
|
|
$ |
7 |
|
|
$ |
16 |
|
|
$ |
36 |
|
We expect
this transaction to close on or around December 31, 2009. The
completion of the transaction contemplated by the purchase and sale agreement is
subject to regulatory approvals and the satisfaction of other customary
conditions, some of which are beyond our control, and no assurance can be given
that such completion will occur. The transaction is expected to be
neutral to earnings per share assuming reinvestment of net proceeds back into
core insurance businesses. We expect a modest gain on disposal, which
will be recorded as of the close of the transaction; however, the actual gain
(loss) may differ from our expected result depending upon, among other things,
the actual purchase price after closing adjustments.
Discontinued
U.K. Operations
On
June 15, 2009, we entered into a share purchase agreement with SLF of
Canada UK Limited (“SLF”) and Sun Life Assurance Company of Canada, as the
guarantor, pursuant to which we agreed to sell to SLF all of the outstanding
capital stock of Lincoln National (UK) plc (“Lincoln UK”), our subsidiary, which
is focused primarily on providing life and retirement income products in the
United Kingdom. This transaction closed on October 1, 2009, and we
retained Lincoln UK’s pension plan assets and liabilities.
Accordingly,
the assets and liabilities of this business have been reclassified as
held-for-sale for all periods presented and are reported within other assets and
other liabilities on our Consolidated Balance Sheets. The major
classes of assets and liabilities held-for-sale (in millions) were as
follows:
|
|
As
of
|
|
|
As
of
|
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Assets
|
|
|
|
|
|
|
Investments
|
|
$ |
998 |
|
|
$ |
831 |
|
Cash
and invested cash
|
|
|
163 |
|
|
|
172 |
|
DAC
and VOBA
|
|
|
562 |
|
|
|
534 |
|
Accrued
investment income
|
|
|
21 |
|
|
|
18 |
|
Reinsurance
recoverables
|
|
|
60 |
|
|
|
54 |
|
Other
assets
|
|
|
45 |
|
|
|
44 |
|
Separate
account assets
|
|
|
6,193 |
|
|
|
4,978 |
|
Total
assets held-for-sale
|
|
$ |
8,042 |
|
|
$ |
6,631 |
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
Future
contract benefits
|
|
$ |
896 |
|
|
$ |
829 |
|
Other
contract holder funds
|
|
|
287 |
|
|
|
277 |
|
Other
liabilities
|
|
|
159 |
|
|
|
129 |
|
Separate
account liabilities
|
|
|
6,193 |
|
|
|
4,978 |
|
Total
liabilities held-for-sale
|
|
$ |
7,535 |
|
|
$ |
6,213 |
|
We have
reclassified the results of operations of Lincoln UK into income (loss) from
discontinued operations for all periods presented on our Consolidated Statements
of Income (Loss), and selected amounts (in millions) were as
follows:
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Discontinued
Operations Before Disposal
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$ |
17 |
|
|
$ |
19 |
|
|
$ |
41 |
|
|
$ |
64 |
|
Insurance
fees
|
|
|
42 |
|
|
|
40 |
|
|
|
99 |
|
|
|
138 |
|
Net
investment income
|
|
|
15 |
|
|
|
21 |
|
|
|
43 |
|
|
|
61 |
|
Realized
gain (loss)
|
|
|
- |
|
|
|
1 |
|
|
|
(1 |
) |
|
|
(7 |
) |
Total
revenues
|
|
$ |
74 |
|
|
$ |
81 |
|
|
$ |
182 |
|
|
$ |
256 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from discontinued operations before disposal,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
before
federal income tax expense
|
|
$ |
16 |
|
|
$ |
20 |
|
|
$ |
38 |
|
|
$ |
58 |
|
Federal
income tax expense
|
|
|
6 |
|
|
|
7 |
|
|
|
13 |
|
|
|
20 |
|
Income
from discontinued operations before disposal
|
|
|
10 |
|
|
|
13 |
|
|
|
25 |
|
|
|
38 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Disposal
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain
(loss) on disposal, before federal income tax benefit
|
|
|
17 |
|
|
|
- |
|
|
|
(220 |
) |
|
|
- |
|
Federal
income tax benefit
|
|
|
38 |
|
|
|
- |
|
|
|
105 |
|
|
|
- |
|
Gain
(loss) on disposal
|
|
|
55 |
|
|
|
- |
|
|
|
(115 |
) |
|
|
- |
|
Income
(loss) from discontinued operations
|
|
$ |
65 |
|
|
$ |
13 |
|
|
$ |
(90 |
) |
|
$ |
38 |
|
There
will be a post-closing adjustment of the purchase price based upon a final
actuarial appraisal of the value of the business as set forth in the share
purchase agreement.
Discontinued
Media Operations
During
the fourth quarter of 2007, we entered into definitive agreements to sell our
television broadcasting, Charlotte radio and sports programming
businesses. These businesses were acquired as part of the
Jefferson-Pilot merger on April 3, 2006. The sports programming sale
closed on November 30, 2007, the Charlotte radio broadcasting sale closed on
January 31, 2008, and the television broadcasting sale closed on March 31,
2008.
The
results of operations of these businesses were reclassified into income (loss)
from discontinued operations on our Consolidated Statements of Income (Loss),
and selected amounts (in millions) were as follows:
|
|
For
the
|
|
|
For
the
|
|
|
|
Three
|
|
|
Nine
|
|
|
|
Months
|
|
|
Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2008
|
|
|
2008
|
|
Discontinued
Operations Before Disposal
|
|
|
|
|
|
|
Media
revenues, net of agency commissions
|
|
$ |
- |
|
|
$ |
22 |
|
|
|
|
|
|
|
|
|
|
Income
from discontinued operations before disposal, before federal income
expense
|
|
$ |
- |
|
|
$ |
8 |
|
Federal
income tax expense
|
|
|
- |
|
|
|
3 |
|
Income
from discontinued operations before disposal
|
|
|
- |
|
|
|
5 |
|
|
|
|
|
|
|
|
|
|
Disposal
|
|
|
|
|
|
|
|
|
Loss
on disposal, before federal income tax expense (benefit)
|
|
|
- |
|
|
|
(13 |
) |
Federal
income tax expense (benefit)
|
|
|
1 |
|
|
|
(3 |
) |
Loss
on disposal
|
|
|
(1 |
) |
|
|
(10 |
) |
Loss
from discontinued operations
|
|
$ |
(1 |
) |
|
$ |
(5 |
) |
4. Variable
Interest Entities
Our
involvement with VIEs is primarily to obtain financing and to invest in assets
that allow us to gain exposure to a broadly diversified portfolio of asset
classes. We have carefully analyzed each VIE to determine whether we
are the primary beneficiary. Based on our analysis of the expected
losses and residual returns of the VIEs in which we have a variable interest, we
have concluded that there are no VIEs for which we are the primary beneficiary,
and, as such, we have not consolidated the VIEs in our consolidated financial
statements. However, for those VIEs in which we are not the primary
beneficiary, but hold a variable interest, we recognize the fair value of our
variable interest on our consolidated financial statements.
Information
(in millions) included on our Consolidated Balance Sheets for those VIEs where
we had significant variable interest and where we were a sponsor was as
follows:
|
|
As
of September 30, 2009
|
|
|
As
of December 31, 2008
|
|
|
|
|
|
|
|
|
|
Maximum
|
|
|
|
|
|
|
|
|
Maximum
|
|
|
|
Total
|
|
|
Total
|
|
|
Loss
|
|
|
Total
|
|
|
Total
|
|
|
Loss
|
|
|
|
Assets
|
|
|
Liabilities
|
|
|
Exposure
|
|
|
Assets
|
|
|
Liabilities
|
|
|
Exposure
|
|
Affiliated
trust
|
|
$ |
5 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
5 |
|
|
$ |
- |
|
|
$ |
- |
|
Credit-linked
notes
|
|
|
318 |
|
|
|
- |
|
|
|
600 |
|
|
|
50 |
|
|
|
- |
|
|
|
600 |
|
Affiliated
Trust
We are
the sponsor of an affiliated trust, Lincoln National Capital Trust VI, which was
formed solely for the purpose of issuing trust preferred securities and lending
the proceeds to us. We own the common securities of this trust,
approximately a 3% ownership, and the only assets of the trust are the junior
subordinated debentures issued by us. Our common stock investment in this
trust was financed by the trust and is reported in other investments on our
Consolidated Balance Sheets. Distributions are paid by the trust to
the preferred security holders on a quarterly basis and the principal
obligations of the trust are irrevocably guaranteed by us. Upon
liquidation of the trust, the holders of the preferred securities are entitled
to a fixed amount per share plus accumulated and unpaid distributions. We
reserve the right to redeem the preferred securities at a fixed price plus
accumulated and unpaid distributions and defer the interest payments due on the
subordinated debentures for up to 20 consecutive quarters, but not beyond the
maturity date of the subordinated debenture.
Our
common stock investment does not represent a significant variable interest in
the trust, as we do not receive any distributions or absorb any losses from the
trust. In addition, our guarantee of the principal obligations of the
trust does not represent a variable interest, as we are guaranteeing our own
performance. Therefore, we are not the primary beneficiary and do not
consolidate the trust. Since our investment in the common stock of
the trust was financed directly by the trust, we do not have any equity
investment at risk, and, therefore, do not have exposure to loss from the
trust.
Credit-Linked
Notes
We
invested in two CLNs where the note holders do not have voting rights or
decision-making capabilities. The entities that issued the CLNs are
financed by the note holders, and, as such, the note holders participate in the
expected losses and residual returns of the entities. Because the
note holders’ investment does not permit them to make decisions about the
entities’ activities that would have a significant effect on the success of the
entities, we have determined that these entities are VIEs. We are not
the primary beneficiary of the VIEs as the multi-tiered class structure of the
CLNs requires the subordinated classes of the investment pool to absorb credit
losses prior to our class of notes. As a result, we will not absorb
the majority of the expected losses and the coupon we receive on the CLNs limits
our participation in the residual returns. For information regarding
our exposure to loss in our CLNs, see “Credit-Linked Notes” in Note
5.
5. Investments
AFS
Securities
Pursuant
to the Fair Value Measurements and Disclosures Topic of the FASB ASC, we have
categorized AFS securities into a three-level hierarchy, based on the priority
of the inputs to the respective valuation technique. The fair value
hierarchy gives the highest priority to quoted prices in active markets for
identical assets or liabilities (Level 1) and the lowest priority to
unobservable inputs (Level 3), as described in Note 16, which also includes
additional disclosures regarding our fair value measurements.
The
amortized cost, gross unrealized gains, losses and OTTI and fair value of AFS
securities (in millions) were as follows:
|
|
As
of September 30, 2009
|
|
|
|
Amortized
|
|
|
Gross
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
OTTI
(1)
|
|
|
Value
|
|
Fixed
Maturity Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
44,579 |
|
|
$ |
2,612 |
|
|
$ |
1,265 |
|
|
$ |
78 |
|
|
$ |
45,848 |
|
U.S.
Government bonds
|
|
|
203 |
|
|
|
20 |
|
|
|
2 |
|
|
|
- |
|
|
|
221 |
|
Foreign
government bonds
|
|
|
473 |
|
|
|
31 |
|
|
|
11 |
|
|
|
- |
|
|
|
493 |
|
Mortgage-backed
securities ("MBS"):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
6,237 |
|
|
|
306 |
|
|
|
342 |
|
|
|
172 |
|
|
|
6,029 |
|
Residential
mortgage pass-through
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
securities
("MPTS")
|
|
|
2,594 |
|
|
|
85 |
|
|
|
14 |
|
|
|
- |
|
|
|
2,665 |
|
Commercial
MBS ("CMBS")
|
|
|
2,592 |
|
|
|
52 |
|
|
|
391 |
|
|
|
- |
|
|
|
2,253 |
|
Asset-backed
securities ("ABS"):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
191 |
|
|
|
5 |
|
|
|
47 |
|
|
|
9 |
|
|
|
140 |
|
CLNs
|
|
|
600 |
|
|
|
- |
|
|
|
282 |
|
|
|
- |
|
|
|
318 |
|
State
and municipal bonds
|
|
|
1,425 |
|
|
|
54 |
|
|
|
15 |
|
|
|
- |
|
|
|
1,464 |
|
Hybrid
and redeemable preferred securities
|
|
|
1,548 |
|
|
|
21 |
|
|
|
334 |
|
|
|
- |
|
|
|
1,235 |
|
Total
fixed maturity securities
|
|
|
60,442 |
|
|
|
3,186 |
|
|
|
2,703 |
|
|
|
259 |
|
|
|
60,666 |
|
Equity
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Banking
securities
|
|
|
274 |
|
|
|
- |
|
|
|
118 |
|
|
|
- |
|
|
|
156 |
|
Insurance
securities
|
|
|
43 |
|
|
|
1 |
|
|
|
- |
|
|
|
- |
|
|
|
44 |
|
Other
financial services securities
|
|
|
23 |
|
|
|
11 |
|
|
|
7 |
|
|
|
- |
|
|
|
27 |
|
Other
securities
|
|
|
53 |
|
|
|
4 |
|
|
|
1 |
|
|
|
- |
|
|
|
56 |
|
Total
equity securities
|
|
|
393 |
|
|
|
16 |
|
|
|
126 |
|
|
|
- |
|
|
|
283 |
|
Total
AFS securities
|
|
$ |
60,835 |
|
|
$ |
3,202 |
|
|
$ |
2,829 |
|
|
$ |
259 |
|
|
$ |
60,949 |
|
(1)
|
This
amount is comprised of the gross unrealized OTTI cumulative effect
adjustment as discussed in Note 2 and the amount reflected on our
Consolidated Statements of Income (Loss) during the first nine months of
2009 adjusted for other changes, including but not limited to, sales of
fixed maturity AFS securities.
|
|
|
As
of December 31, 2008
|
|
|
|
Amortized
|
|
|
Gross
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
OTTI
|
|
|
Value
|
|
Fixed
Maturity Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
39,773 |
|
|
$ |
638 |
|
|
$ |
4,463 |
|
|
$ |
- |
|
|
$ |
35,948 |
|
U.S.
Government bonds
|
|
|
204 |
|
|
|
42 |
|
|
|
- |
|
|
|
- |
|
|
|
246 |
|
Foreign
government bonds
|
|
|
532 |
|
|
|
37 |
|
|
|
49 |
|
|
|
- |
|
|
|
520 |
|
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
6,918 |
|
|
|
174 |
|
|
|
780 |
|
|
|
- |
|
|
|
6,312 |
|
MPTS
|
|
|
1,875 |
|
|
|
62 |
|
|
|
38 |
|
|
|
- |
|
|
|
1,899 |
|
CMBS
|
|
|
2,535 |
|
|
|
9 |
|
|
|
625 |
|
|
|
- |
|
|
|
1,919 |
|
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
256 |
|
|
|
7 |
|
|
|
103 |
|
|
|
- |
|
|
|
160 |
|
CLNs
|
|
|
600 |
|
|
|
- |
|
|
|
550 |
|
|
|
- |
|
|
|
50 |
|
State
and municipal bonds
|
|
|
125 |
|
|
|
2 |
|
|
|
2 |
|
|
|
- |
|
|
|
125 |
|
Hybrid
and redeemable preferred securities
|
|
|
1,563 |
|
|
|
6 |
|
|
|
607 |
|
|
|
- |
|
|
|
962 |
|
Total
fixed maturity securities
|
|
|
54,381 |
|
|
|
977 |
|
|
|
7,217 |
|
|
|
- |
|
|
|
48,141 |
|
Equity
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Banking
securities
|
|
|
274 |
|
|
|
- |
|
|
|
146 |
|
|
|
- |
|
|
|
128 |
|
Insurance
securities
|
|
|
71 |
|
|
|
1 |
|
|
|
19 |
|
|
|
- |
|
|
|
53 |
|
Other
financial services securities
|
|
|
29 |
|
|
|
4 |
|
|
|
8 |
|
|
|
- |
|
|
|
25 |
|
Other
securities
|
|
|
54 |
|
|
|
4 |
|
|
|
10 |
|
|
|
- |
|
|
|
48 |
|
Total
equity securities
|
|
|
428 |
|
|
|
9 |
|
|
|
183 |
|
|
|
- |
|
|
|
254 |
|
Total
AFS securities
|
|
$ |
54,809 |
|
|
$ |
986 |
|
|
$ |
7,400 |
|
|
$ |
- |
|
|
$ |
48,395 |
|
The
amortized cost and fair value of fixed maturity AFS securities by contractual
maturities (in millions) were as follows:
|
|
As
of September 30, 2009
|
|
|
|
Amortized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Value
|
|
Due
in one year or less
|
|
$ |
1,717 |
|
|
$ |
1,734 |
|
Due
after one year through five years
|
|
|
13,444 |
|
|
|
13,930 |
|
Due
after five years through ten years
|
|
|
16,609 |
|
|
|
17,327 |
|
Due
after ten years
|
|
|
16,458 |
|
|
|
16,270 |
|
Subtotal
|
|
|
48,228 |
|
|
|
49,261 |
|
MBS
|
|
|
11,423 |
|
|
|
10,947 |
|
CDOs
|
|
|
191 |
|
|
|
140 |
|
CLNs
|
|
|
600 |
|
|
|
318 |
|
Total
fixed maturity AFS securities
|
|
$ |
60,442 |
|
|
$ |
60,666 |
|
Actual
maturities may differ from contractual maturities because issuers may have the
right to call or pre-pay obligations.
The fair
value and gross unrealized losses, including the portion of OTTI recognized in
OCI, of AFS securities (in millions), aggregated by investment category and
length of time that individual securities have been in a continuous unrealized
loss position, were as follows:
|
|
As
of September 30, 2009
|
|
|
|
Less
Than or Equal
|
|
|
Greater
Than
|
|
|
|
|
|
|
|
|
|
to
Twelve Months
|
|
|
Twelve
Months
|
|
|
Total
|
|
|
|
|
|
|
Gross
|
|
|
|
|
|
Gross
|
|
|
|
|
|
Gross
|
|
|
|
|
|
|
Unrealized
|
|
|
|
|
|
Unrealized
|
|
|
|
|
|
Unrealized
|
|
|
|
Fair
|
|
|
Losses
and
|
|
|
Fair
|
|
|
Losses
and
|
|
|
Fair
|
|
|
Losses
and
|
|
|
|
Value
|
|
|
OTTI
|
|
|
Value
|
|
|
OTTI
|
|
|
Value
|
|
|
OTTI
|
|
Fixed
Maturity Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
1,905 |
|
|
$ |
190 |
|
|
$ |
7,399 |
|
|
$ |
1,153 |
|
|
$ |
9,304 |
|
|
$ |
1,343 |
|
U.S.
Government bonds
|
|
|
41 |
|
|
|
2 |
|
|
|
- |
|
|
|
- |
|
|
|
41 |
|
|
|
2 |
|
Foreign
government bonds
|
|
|
24 |
|
|
|
- |
|
|
|
50 |
|
|
|
11 |
|
|
|
74 |
|
|
|
11 |
|
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
261 |
|
|
|
172 |
|
|
|
1,018 |
|
|
|
342 |
|
|
|
1,279 |
|
|
|
514 |
|
MPTS
|
|
|
223 |
|
|
|
2 |
|
|
|
103 |
|
|
|
12 |
|
|
|
326 |
|
|
|
14 |
|
CMBS
|
|
|
103 |
|
|
|
17 |
|
|
|
782 |
|
|
|
374 |
|
|
|
885 |
|
|
|
391 |
|
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
9 |
|
|
|
7 |
|
|
|
117 |
|
|
|
49 |
|
|
|
126 |
|
|
|
56 |
|
CLNs
|
|
|
- |
|
|
|
- |
|
|
|
318 |
|
|
|
282 |
|
|
|
318 |
|
|
|
282 |
|
State
and municipal bonds
|
|
|
285 |
|
|
|
7 |
|
|
|
60 |
|
|
|
8 |
|
|
|
345 |
|
|
|
15 |
|
Hybrid
and redeemable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
preferred
securities
|
|
|
128 |
|
|
|
45 |
|
|
|
912 |
|
|
|
289 |
|
|
|
1,040 |
|
|
|
334 |
|
Total
fixed maturity securities
|
|
|
2,979 |
|
|
|
442 |
|
|
|
10,759 |
|
|
|
2,520 |
|
|
|
13,738 |
|
|
|
2,962 |
|
Equity
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Banking
securities
|
|
|
138 |
|
|
|
103 |
|
|
|
18 |
|
|
|
15 |
|
|
|
156 |
|
|
|
118 |
|
Insurance
securities
|
|
|
6 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
6 |
|
|
|
- |
|
Other
financial services securities
|
|
|
8 |
|
|
|
7 |
|
|
|
- |
|
|
|
- |
|
|
|
8 |
|
|
|
7 |
|
Other
securities
|
|
|
2 |
|
|
|
1 |
|
|
|
- |
|
|
|
- |
|
|
|
2 |
|
|
|
1 |
|
Total
equity securities
|
|
|
154 |
|
|
|
111 |
|
|
|
18 |
|
|
|
15 |
|
|
|
172 |
|
|
|
126 |
|
Total
AFS securities
|
|
$ |
3,133 |
|
|
$ |
553 |
|
|
$ |
10,777 |
|
|
$ |
2,535 |
|
|
$ |
13,910 |
|
|
$ |
3,088 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
number of securities in an unrealized loss position
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,680 |
|
|
|
As
of December 31, 2008
|
|
|
|
Less
Than or Equal
|
|
|
Greater
Than
|
|
|
|
|
|
|
|
|
|
to
Twelve Months
|
|
|
Twelve
Months
|
|
|
Total
|
|
|
|
|
|
|
Gross
|
|
|
|
|
|
Gross
|
|
|
|
|
|
Gross
|
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Unrealized
|
|
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
|
Value
|
|
|
Losses
|
|
Fixed
Maturity Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
18,864 |
|
|
$ |
2,341 |
|
|
$ |
5,893 |
|
|
$ |
2,122 |
|
|
$ |
24,757 |
|
|
$ |
4,463 |
|
U.S.
Government bonds
|
|
|
3 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
3 |
|
|
|
- |
|
Foreign
government bonds
|
|
|
147 |
|
|
|
17 |
|
|
|
50 |
|
|
|
32 |
|
|
|
197 |
|
|
|
49 |
|
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
853 |
|
|
|
299 |
|
|
|
720 |
|
|
|
481 |
|
|
|
1,573 |
|
|
|
780 |
|
MPTS
|
|
|
96 |
|
|
|
26 |
|
|
|
52 |
|
|
|
12 |
|
|
|
148 |
|
|
|
38 |
|
CMBS
|
|
|
1,133 |
|
|
|
175 |
|
|
|
498 |
|
|
|
450 |
|
|
|
1,631 |
|
|
|
625 |
|
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
76 |
|
|
|
20 |
|
|
|
68 |
|
|
|
83 |
|
|
|
144 |
|
|
|
103 |
|
CLNs
|
|
|
- |
|
|
|
- |
|
|
|
50 |
|
|
|
550 |
|
|
|
50 |
|
|
|
550 |
|
State
and municipal bonds
|
|
|
29 |
|
|
|
2 |
|
|
|
2 |
|
|
|
- |
|
|
|
31 |
|
|
|
2 |
|
Hybrid
and redeemable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
preferred
securities
|
|
|
461 |
|
|
|
267 |
|
|
|
418 |
|
|
|
340 |
|
|
|
879 |
|
|
|
607 |
|
Total
fixed maturity securities
|
|
|
21,662 |
|
|
|
3,147 |
|
|
|
7,751 |
|
|
|
4,070 |
|
|
|
29,413 |
|
|
|
7,217 |
|
Equity
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Banking
securities
|
|
|
128 |
|
|
|
146 |
|
|
|
- |
|
|
|
- |
|
|
|
128 |
|
|
|
146 |
|
Insurance
securities
|
|
|
30 |
|
|
|
19 |
|
|
|
- |
|
|
|
- |
|
|
|
30 |
|
|
|
19 |
|
Other
financial services securities
|
|
|
16 |
|
|
|
8 |
|
|
|
- |
|
|
|
- |
|
|
|
16 |
|
|
|
8 |
|
Other
securities
|
|
|
23 |
|
|
|
9 |
|
|
|
2 |
|
|
|
1 |
|
|
|
25 |
|
|
|
10 |
|
Total
equity securities
|
|
|
197 |
|
|
|
182 |
|
|
|
2 |
|
|
|
1 |
|
|
|
199 |
|
|
|
183 |
|
Total
AFS securities
|
|
$ |
21,859 |
|
|
$ |
3,329 |
|
|
$ |
7,753 |
|
|
$ |
4,071 |
|
|
$ |
29,612 |
|
|
$ |
7,400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
number of securities in an unrealized loss position
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,563 |
|
Each
quarter we review the cash flows for the MBS to determine whether or not they
are sufficient to provide for the recovery of our amortized cost. We
revise our cash flow projections only for those securities that are at most risk
for impairment based on current credit enhancement and trends in the underlying
collateral performance. We use the process described below to
evaluate the level of the expected cash flows.
When
evaluating MBS and mortgage-related ABS, we consider a number of pool-specific
factors as well as market level factors when determining whether or not the
impairment on the security is temporary or other-than-temporary. The
most important factor is the performance of the underlying collateral in the
security and the trends of that performance in the prior periods. We
use this information about the collateral to forecast the timing and rate of
mortgage loan defaults, including making projections for loans that are already
delinquent and for those loans that are currently performing but may become
delinquent in the future. Other factors used in this analysis include
type of underlying collateral (e.g., prime, Alt-A or subprime), geographic
distribution of underlying loans and timing of liquidations by
state. Once default rates and timing assumptions are determined, we
then make assumptions regarding the severity of a default if it were to
occur. Factors that impact the severity assumption include
expectations for future home price appreciation/depreciation, loan size, first
lien versus second lien, existence of loan level private mortgage insurance,
type of occupancy and geographic distribution of loans. Once default
and severity assumptions are determined for the security in question, cash flows
for the underlying collateral are projected including expected defaults and
prepayments. These cash flows on the collateral are then translated
to cash flows on our tranche based on the cash flow waterfall of the entire
capital security structure. If this analysis indicates the entire
principal on a particular security will not be returned, the security is
reviewed for other-than-temporary impairment by comparing the expected cash
flows to amortized cost. To the extent that the security has already
been impaired or was purchased at a discount, such that the amortized cost of
the security is less than or equal to the present value of cash flows expected
to be collected, no impairment is required.
Otherwise,
if the amortized cost of the security is greater than the present value of the
cash flows expected to be collected, and the security was not purchased at a
discount greater than the expected principal loss, then impairment is
recognized.
We
further monitor the cash flows of all of our AFS securities backed by pools on
an ongoing basis. We also perform detailed analysis on all of our
subprime, Alt-A, non-agency residential MBS and on a significant percentage of
our AFS securities backed by pools of commercial mortgages. The
detailed analysis includes revising projected cash flows by updating the cash
flows for actual cash received and applying assumptions with respect to expected
defaults, foreclosures and recoveries in the future. These revised
projected cash flows are then compared to the amount of credit enhancement
(subordination) in the structure to determine whether the amortized cost of the
security is recoverable. If it is not recoverable, we record an
impairment of the security.
We
perform detailed analysis on the AFS securities backed by pools that are most at
risk of impairment based on factors noted above. Selected information
for these securities in a gross unrealized loss position (in millions) was as
follows:
|
|
As
of September 30, 2009
|
|
|
|
Amortized
|
|
|
|
|
|
Unrealized
|
|
|
|
Cost
|
|
|
Fair
Value
|
|
|
Loss
|
|
Total
|
|
|
|
|
|
|
|
|
|
AFS
securities backed by pools of residential mortgages
|
|
$ |
3,285 |
|
|
$ |
2,267 |
|
|
$ |
1,018 |
|
AFS
securities backed by pools of commercial mortgages
|
|
|
1,347 |
|
|
|
930 |
|
|
|
417 |
|
Total
|
|
$ |
4,632 |
|
|
$ |
3,197 |
|
|
$ |
1,435 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subject
to Detailed Analysis
|
|
|
|
|
|
|
|
|
|
|
|
|
AFS
securities backed by pools of residential mortgages
|
|
$ |
2,985 |
|
|
$ |
1,971 |
|
|
$ |
1,014 |
|
AFS
securities backed by pools of commercial mortgages
|
|
|
363 |
|
|
|
204 |
|
|
|
159 |
|
Total
|
|
$ |
3,348 |
|
|
$ |
2,175 |
|
|
$ |
1,173 |
|
For the
nine months ended September 30, 2009, we recorded OTTI for AFS securities backed
by pools of residential and commercial mortgages of $499 million, pre-tax, and
before associated amortization expense for DAC, VOBA, DSI and DFEL, of which
$247 million was recognized in OCI and $252 million was recognized in net income
(loss).
The fair
value, gross unrealized losses, the portion of OTTI recognized in OCI (in
millions) and number of AFS securities where the fair value had declined and
remained below amortized cost by greater than 20% were as follows:
|
|
As
of September 30, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
Number
|
|
|
|
Fair
|
|
|
Gross
Unrealized
|
|
|
of
|
|
|
|
Value
|
|
|
Losses
|
|
|
OTTI
|
|
|
Securities
(1)
|
|
Less
than six months
|
|
$ |
277 |
|
|
$ |
120 |
|
|
$ |
- |
|
|
|
71 |
|
Six
months or greater, but less than nine months
|
|
|
301 |
|
|
|
114 |
|
|
|
89 |
|
|
|
69 |
|
Nine
months or greater, but less than twelve months
|
|
|
989 |
|
|
|
509 |
|
|
|
14 |
|
|
|
169 |
|
Twelve
months or greater
|
|
|
1,668 |
|
|
|
1,376 |
|
|
|
137 |
|
|
|
277 |
|
Total
AFS securities
|
|
$ |
3,235 |
|
|
$ |
2,119 |
|
|
$ |
240 |
|
|
|
586 |
|
|
|
As
of December 31, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
Number
|
|
|
|
Fair
|
|
|
Gross
Unrealized
|
|
|
of
|
|
|
|
Value
|
|
|
Losses
|
|
|
OTTI
|
|
|
Securities
(1)
|
|
Less
than six months
|
|
$ |
6,711 |
|
|
$ |
3,497 |
|
|
$ |
- |
|
|
|
982 |
|
Six
months or greater, but less than nine months
|
|
|
496 |
|
|
|
505 |
|
|
|
- |
|
|
|
102 |
|
Nine
months or greater, but less than twelve months
|
|
|
485 |
|
|
|
646 |
|
|
|
- |
|
|
|
147 |
|
Twelve
months or greater
|
|
|
173 |
|
|
|
869 |
|
|
|
- |
|
|
|
90 |
|
Total
AFS securities
|
|
$ |
7,865 |
|
|
$ |
5,517 |
|
|
$ |
- |
|
|
|
1,321 |
|
(1)
|
We
may reflect a security in more than one aging category based on various
purchase dates.
|
As
described more fully below, we regularly review our investment holdings for
OTTIs. Based upon this review, the cause of the $4.3 billion decrease
in our gross AFS securities unrealized losses for the nine months ended
September 30, 2009, was attributable primarily to increased liquidity in several
market segments and improved credit fundamentals (i.e., market improvement and
narrowing credit spreads), partially offset by the cumulative adjustment
resulting from the adoption of new accounting guidance related to the
recognition of OTTI, which resulted in the $165 million increase in amortized
cost in AFS securities as discussed in Note 2. We believe that the
securities in an unrealized loss position as of September 30, 2009, were not
other-than-temporarily impaired as we do not intend to sell these debt
securities or it is not more likely than not that we will be required to sell
the debt securities before recovery of their amortized cost basis, and we have
the ability and intent to hold the equity securities for a period of time
sufficient for recovery.
Changes
in the amount of credit loss of OTTIs recognized in net income (loss) where the
portion related to other factors was recognized in OCI (in millions) on fixed
maturity AFS securities were as follows:
|
|
For
the
|
|
|
For
the
|
|
|
|
Three
|
|
|
Nine
|
|
|
|
Months
|
|
|
Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2009
|
|
Balance
as of beginning-of-period
|
|
$ |
132 |
|
|
$ |
31 |
|
Increases
attributable to:
|
|
|
|
|
|
|
|
|
Credit
losses on securities for which an OTTI was not previously
recognized
|
|
|
32 |
|
|
|
127 |
|
Credit
losses on securities for which an OTTI was previously
recognized
|
|
|
64 |
|
|
|
100 |
|
Decreases
attributable to:
|
|
|
|
|
|
|
|
|
Securities
sold
|
|
|
(6 |
) |
|
|
(6 |
) |
Amounts
recognized in net income (loss)
|
|
|
- |
|
|
|
(30 |
) |
Balance
as of end-of-period
|
|
$ |
222 |
|
|
$ |
222 |
|
During
the three and nine months ended September 30, 2009, we recorded credit losses on
securities for which an OTTI was not previously recognized as we determined that
it is no longer likely that we would receive cash flows sufficient to recover
the entire amortized cost basis of the security. The credit losses we
recorded on securities for which an OTTI was not previously recognized were
attributable primarily to one or a combination of the following
reasons:
·
|
Failure
of the issuer of the security to make scheduled
payments;
|
·
|
Deterioration
of creditworthiness of the issuer;
|
·
|
Deterioration
of conditions specifically related to the
security;
|
·
|
Deterioration
of fundamentals of the industry in which the issuer
operates;
|
·
|
Deterioration
of fundamentals in the economy including, but not limited to, higher
unemployment and lower housing prices
and
|
·
|
Deterioration
of the rating of the security by a rating
agency.
|
We
recognize the OTTI attributed to the noncredit portion as a separate component
in OCI referred to as unrealized OTTI on AFS securities. See Note 12
for details.
Details
of the amount of credit loss of OTTIs recognized in net income (loss) where the
portion related to other factors was recognized in OCI (in millions) as of
September 30, 2009, were as follows:
|
|
|
|
|
Gross
|
|
|
|
|
|
OTTI
in
|
|
|
|
Amortized
|
|
|
Unrealized
|
|
|
Fair
|
|
|
Credit
|
|
|
|
Cost
|
|
|
OTTI
|
|
|
Value
|
|
|
Losses
|
|
Corporate
bonds
|
|
$ |
160 |
|
|
$ |
72 |
|
|
$ |
88 |
|
|
$ |
58 |
|
MBS
CMOs
|
|
|
383 |
|
|
|
172 |
|
|
|
211 |
|
|
|
164 |
|
|
|
$ |
543 |
|
|
$ |
244 |
|
|
$ |
299 |
|
|
$ |
222 |
|
Realized
Loss Related to Investments
The
detail of the realized loss related to investments (in millions) was as
follows:
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Fixed
maturity AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
gains
|
|
$ |
23 |
|
|
$ |
19 |
|
|
$ |
110 |
|
|
$ |
44 |
|
Gross
losses
|
|
|
(166 |
) |
|
|
(372 |
) |
|
|
(579 |
) |
|
|
(592 |
) |
Equity
AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
gains
|
|
|
- |
|
|
|
1 |
|
|
|
4 |
|
|
|
1 |
|
Gross
losses
|
|
|
(8 |
) |
|
|
(25 |
) |
|
|
(16 |
) |
|
|
(32 |
) |
Gain
(loss) on other investments
|
|
|
2 |
|
|
|
1 |
|
|
|
(58 |
) |
|
|
29 |
|
Associated
amortization expense of DAC, VOBA, DSI
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
DFEL and changes in other contract holder funds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
funds withheld reinsurance liabilities
|
|
|
25 |
|
|
|
91 |
|
|
|
128 |
|
|
|
139 |
|
Total
realized loss on investments, excluding trading securities
|
|
|
(124 |
) |
|
|
(285 |
) |
|
|
(411 |
) |
|
|
(411 |
) |
Loss
on certain derivative instruments
|
|
|
(12 |
) |
|
|
(30 |
) |
|
|
(33 |
) |
|
|
(62 |
) |
Total
realized loss on investments and certain
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
derivative
instruments, excluding trading securities
|
|
$ |
(136 |
) |
|
$ |
(315 |
) |
|
$ |
(444 |
) |
|
$ |
(473 |
) |
Details
underlying write-downs taken as a result of OTTI (in millions) that was
recognized in net income (loss) and included in realized loss on AFS securities
above, and the portion of OTTI recognized in OCI (in millions) were as
follows:
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
OTTI
Recognized in Net Income (Loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
29 |
|
|
$ |
205 |
|
|
$ |
187 |
|
|
$ |
331 |
|
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
70 |
|
|
|
76 |
|
|
|
213 |
|
|
|
153 |
|
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
10 |
|
|
|
- |
|
|
|
39 |
|
|
|
1 |
|
Hybrid
and redeemable preferred securities
|
|
|
17 |
|
|
|
1 |
|
|
|
18 |
|
|
|
1 |
|
Total
fixed maturity securities
|
|
|
126 |
|
|
|
282 |
|
|
|
457 |
|
|
|
486 |
|
Equity
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
securities
|
|
|
- |
|
|
|
1 |
|
|
|
- |
|
|
|
1 |
|
Other
financial services securities
|
|
|
8 |
|
|
|
24 |
|
|
|
10 |
|
|
|
24 |
|
Other
securities
|
|
|
- |
|
|
|
- |
|
|
|
6 |
|
|
|
7 |
|
Total
equity securities
|
|
|
8 |
|
|
|
25 |
|
|
|
16 |
|
|
|
32 |
|
Gross
OTTI recognized in net income (loss)
|
|
|
134 |
|
|
|
307 |
|
|
|
473 |
|
|
|
518 |
|
Associated
amortization expense of DAC, VOBA,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DSI
and DFEL
|
|
|
(54 |
) |
|
|
(70 |
) |
|
|
(154 |
) |
|
|
(123 |
) |
Net
OTTI recognized in net income (loss), pre-tax
|
|
$ |
80 |
|
|
$ |
237 |
|
|
$ |
319 |
|
|
$ |
395 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Portion
of OTTI Recognized in OCI
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
OTTI recognized in OCI
|
|
$ |
97 |
|
|
$ |
- |
|
|
$ |
338 |
|
|
$ |
- |
|
Associated
amortization expense of DAC, VOBA, DSI
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
DFEL
|
|
|
(29 |
) |
|
|
- |
|
|
|
(79 |
) |
|
|
- |
|
Net
portion of OTTI recognized in OCI, pre-tax
|
|
$ |
68 |
|
|
$ |
- |
|
|
$ |
259 |
|
|
$ |
- |
|
We
regularly review our AFS securities for declines in fair value that we determine
to be other-than-temporary. For an equity security, if we do not have
the ability and intent to hold the security for a sufficient period of time to
allow for a recovery in value, we conclude that an OTTI has occurred and the
amortized cost of the equity security is written down to the current fair value,
with a corresponding charge to realized gain (loss) on our Consolidated
Statements of Income (Loss). When assessing our ability and intent to
hold the equity security to recovery, we consider, among other things, the
severity and duration of the decline in fair value of the equity security as
well as the cause of the decline, a fundamental analysis of the liquidity,
business prospects and overall financial condition of the issuer.
For a
debt security, if we intend to sell a security or it is more likely than not we
will be required to sell a debt security before recovery of its amortized cost
basis and the fair value of the debt security is below amortized cost, we
conclude that an OTTI has occurred and the amortized cost is written down to
current fair value, with a corresponding charge to realized gain (loss) on our
Consolidated Statements of Income (Loss). If we do not intend to sell
a debt security or it is not more likely than not we will be required to sell a
debt security before recovery of its amortized cost basis but the present value
of the cash flows expected to be collected is less than the amortized cost of
the debt security (referred to as the credit loss), we conclude that an OTTI has
occurred and the amortized cost is written down to the estimated recovery value
with a corresponding charge to realized gain (loss) on our Consolidated
Statements of Income (Loss), as this amount is deemed the credit portion of the
OTTI. The remainder of the decline to fair value is recorded in OCI
to unrealized OTTI on AFS securities on our Consolidated Statements of
Stockholders’ Equity, as this amount is considered a noncredit (i.e.,
recoverable) impairment.
When
assessing our intent to sell a debt security or if it is more likely than not we
will be required to sell a debt security before recovery of its cost basis, we
evaluate facts and circumstances such as, but not limited to, decisions to
reposition our security portfolio, sale of securities to meet cash flow needs
and sales of securities to capitalize on favorable pricing. In order
to determine the amount of the credit loss for a debt security, we calculate the
recovery value by performing a discounted cash flow analysis based on the
current cash flows and future cash flows we expect to recover. The
discount rate is the effective interest rate implicit in the underlying debt
security. The effective interest rate is the original yield or the
coupon if the debt security was previously impaired. See the
discussion below for additional information on the methodology and significant
inputs, by security type, which we use to determine the amount of a credit
loss.
To
determine the recovery period of a debt security, we consider the facts and
circumstances surrounding the underlying issuer including, but not limited to,
the following:
·
|
Historic
and implied volatility of the
security;
|
·
|
Length
of time and extent to which the fair value has been less than amortized
cost;
|
·
|
Adverse
conditions specifically related to the security or to specific conditions
in an industry or geographic area;
|
·
|
Failure,
if any, of the issuer of the security to make scheduled payments;
and
|
·
|
Recoveries
or additional declines in fair value subsequent to the balance sheet
date.
|
In
periods subsequent to the recognition of an OTTI, the AFS security is accounted
for as if it had been purchased on the measurement date of the
OTTI. Therefore, for the fixed maturity AFS security, the original
discount or reduced premium is reflected in net investment income over the
contractual term of the investment in a manner that produces a constant
effective yield.
Determination
of Credit Losses on Corporate Bonds
To
determine recovery value of a corporate bond, we perform analysis related to the
underlying issuer including, but not limited to, the following:
·
|
Fundamentals
of the issuer to determine what we would recover if they were to file
bankruptcy versus the price at which the market is
trading;
|
·
|
Fundamentals
of the industry in which the issuer
operates;
|
·
|
Earnings
multiples for the given industry or sector of an industry that the
underlying issuer operates within, divided by the outstanding debt to
determine an expected recovery value of the security in the case of a
liquidation;
|
·
|
Expected
cash flows of the issuer (e.g., whether the issuer has cash flows in
excess of what is required to fund its
operations);
|
·
|
Expectations
regarding defaults and recovery
rates;
|
·
|
Changes
to the rating of the security by a rating agency;
and
|
·
|
Additional
market information (e.g., if there has been a replacement of the corporate
debt security).
|
As of
September 30, 2009, we reviewed our corporate bond portfolio for potential
shortfall in contractual principal and interest based on numerous subjective and
objective inputs. Due to the number and variety of securities in an
unrealized loss position, as well as the variety of factors for each individual
corporate bond, which are used in the determination of the potential shortfall
in contractual principal and interest, including, but not limited to, near term
risk, substantial discrepancy between book and market value, sector or
company-specific volatility, negative operating trends and trading levels wider
than peers, we can not quantify the significant inputs used to measure the
amounts of credit losses.
Determination
of Credit Losses on MBS
To
determine recovery value of a MBS, we perform analysis related to the underlying
issuer including, but not limited to, the following:
·
|
Discounted
cash flow analysis based on the current cash flows and future cash flows
we expect to recover;
|
·
|
Level
of creditworthiness of the home equity loans that back a CMO, residential
mortgages that back a MPTS or commercial mortgages that back a
CMBS;
|
·
|
Susceptibility
to fair value fluctuations for changes in the interest rate
environment;
|
·
|
Susceptibility
to reinvestment risks, in cases where market yields are lower than the
securities’ book yield earned;
|
·
|
Susceptibility
to reinvestment risks, in cases where market yields are higher than the
book yields earned on a security and our expectations of sale of such a
security; and
|
·
|
Susceptibility
to variability of prepayments.
|
As of
September 30, 2009, default rates were projected by considering underlying MBS
loan performance and collateral type. Projected default rates on
existing delinquencies vary between 25% to 100% depending on loan type and
severity of delinquency status. In addition, we estimate the potential
contributions of currently performing loans that may become delinquent in the
future based on the change in delinquencies and loan liquidations experienced in
the recent history. Finally, we develop a default rate timing curve
by aggregating the defaults for all loans (delinquent loans, foreclosure and
real estate owned and new delinquencies from currently performing loans) in the
pool to project the future expected cash flows.
We use
certain available loan characteristics such as lien status, loan sizes and
occupancy to estimate the loss severity of loans. Second lien loans
are assigned 100% severity if defaulted. For first lien loans, we
assume a minimum of 30% loan severity with higher severity assumed for investor
properties and further housing price depreciation.
Payables
for Collateral on Investments
When we
enter into collateralized financing transactions on our investments, a liability
is recorded equal to the cash collateral received. This liability is
included within payables for collateral on investments on our Consolidated
Balance Sheets. Income and expenses associated with these
transactions are recorded as investment income and investment expenses within
net investment income on our Consolidated Statements of Income
(Loss). Changes in payables for collateral on investments are
reflected within cash flows from investing activities on our Consolidated
Statements of Cash Flows.
The
carrying values of the payables for collateral on investments (in millions) and
the fair value of the related investments included on our Consolidated Balance
Sheets consisted of the following:
|
|
As
of September 30, 2009
|
|
|
As
of December 31, 2008
|
|
|
|
Carrying
|
|
|
Fair
|
|
|
Carrying
|
|
|
Fair
|
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
Collateral
payable held for derivative investments (1)
|
|
$ |
714 |
|
|
$ |
714 |
|
|
$ |
2,809 |
|
|
$ |
2,809 |
|
Securities
pledged under securities lending agreements (2)
|
|
|
694 |
|
|
|
668 |
|
|
|
427 |
|
|
|
410 |
|
Securities
pledged under reverse repurchase agreements (3)
|
|
|
344 |
|
|
|
364 |
|
|
|
470 |
|
|
|
496 |
|
Securities
pledged for Treasury Asset-Backed Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan
Facility ("TALF") (4)
|
|
|
388 |
|
|
|
441 |
|
|
|
- |
|
|
|
- |
|
Securities
pledged for Federal Home Loan Bank of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indianapolis
Securities ("FHLBI") (5)
|
|
|
100 |
|
|
|
113 |
|
|
|
- |
|
|
|
- |
|
Total
payables for collateral on investments
|
|
$ |
2,240 |
|
|
$ |
2,300 |
|
|
$ |
3,706 |
|
|
$ |
3,715 |
|
(1)
|
We
obtain collateral based upon contractual provisions with our
counterparties. These agreements take into consideration the
counterparties’ credit rating as compared to ours, the fair value of the
derivative investments and specified thresholds that once exceeded result
in the receipt of cash that is typically invested in cash and invested
cash. See Note 6 for details about maximum collateral
potentially required to post on our credit default
swaps.
|
(2)
|
Our
pledged securities under securities lending agreements are included in
fixed maturity AFS securities on our Consolidated Balance
Sheets. We generally obtain collateral in an amount equal to
102% and 105% of the fair value of the domestic and foreign securities,
respectively. We value collateral daily and obtain additional
collateral when deemed appropriate. The cash received in our
securities lending program is typically invested in cash and invested cash
or fixed maturity AFS securities.
|
(3)
|
Our
pledged securities under reverse repurchase agreements are included in
fixed maturity AFS securities on our Consolidated Balance
Sheets. We obtain collateral in an amount equal to 95% of the
fair value of the securities, and our agreements with third parities
contain contractual provisions to allow for additional collateral to be
obtained when necessary. The cash received in our reverse
repurchase program is typically invested in fixed maturity AFS
securities.
|
(4)
|
Our
pledged securities for TALF are included in fixed maturity AFS securities
on our Consolidated Balance Sheets. We obtain collateral in an
amount that has typically averaged 90% of the fair value of the TALF
securities. The cash received in these transactions is invested
in fixed maturity AFS securities.
|
(5)
|
Our
pledged securities for FHLBI are included in fixed maturity AFS securities
on our Consolidated Balance Sheets. We generally obtain
collateral in an amount equal to 85% to 95% of the fair value of the FHLBI
securities. The cash received in these transactions is
typically invested in cash and invested cash or fixed maturity AFS
securities.
|
Increase
(decrease) in payables for collateral on investments (in millions) included in
the Consolidated Statements of Cash Flows consisted of the
following:
|
|
For
the Nine Months
|
|
|
|
Ended
September 30,
|
|
|
|
2009
|
|
|
2008
|
|
Collateral
payable held for derivative investments
|
|
$ |
(2,095 |
) |
|
$ |
797 |
|
Securities
pledged under securities lending agreements
|
|
|
267 |
|
|
|
(192 |
) |
Securities
pledged under reverse repurchase agreements
|
|
|
(126 |
) |
|
|
(200 |
) |
Securities
pledged for TALF
|
|
|
388 |
|
|
|
- |
|
Securities
pledged for FHLBI
|
|
|
100 |
|
|
|
128 |
|
Total
increase (decrease) in payables for collateral on
investments
|
|
$ |
(1,466 |
) |
|
$ |
533 |
|
Investment
Commitments
As of
September 30, 2009, our investment commitments for fixed maturity AFS securities
(primarily private placements), limited partnerships, real estate and mortgage
loans on real estate were $797 million, which included $372 million of limited
partnerships and $219 million of standby commitments to purchase real estate
upon completion and leasing.
Credit-Linked
Notes
As of
September 30, 2009, and December 31, 2008, other contract holder funds on our
Consolidated Balance Sheets included $600 million outstanding in funding
agreements of LNL. LNL invested the proceeds of $600 million received
for issuing two funding agreements in 2006 and 2007 into two separate CLNs
originated by a third party company. The CLNs are included in fixed
maturity AFS securities on our Consolidated Balance Sheets.
We earn a
spread between the coupon received on the CLNs and the interest credited on the
funding agreements. Our CLNs were created using a special purpose
trust that combines highly rated assets with credit default swaps to produce a
multi-class structured security. The high quality assets in these
transactions are AAA-rated ABS secured by a pool of credit card
receivables. The credit default swaps in the underlying portfolios
are actively managed by the investment manager for the pool of underlying
issuers in each of the transactions, as permitted in the CLN
agreements. The investment manager, from time to time, has directed
substitutions of corporate names in the reference portfolio. When
substituting corporate names, the issuing special purpose trust transacts with a
third party to sell credit protection on a new issuer, selected by the
investment manager. The cost to substitute the corporate names is based on
market conditions and the liquidity of the corporate names. This new
issuer will replace the issuer the investment manager has identified to remove
from the pool of issuers. The substitution of corporate issuers does not
revise the CLN agreement. The subordination and the participation in
credit losses may change as a result of the substitution. The amount of
the change is dependent upon the relative risk of the issuers removed and
replaced in the pool of issuers.
Consistent
with other debt market instruments, we are exposed to credit losses within the
structure of the CLNs, which could result in principal losses to our
investments. However, we have attempted to protect our investments
from credit losses through the multi-tiered class structure of the CLN, which
requires the subordinated classes of the investment pool to absorb all of the
credit losses up to the current attachment point. LNL owns the
mezzanine tranche of these investments.
Our
evaluation of the CLNs for OTTI involves projecting defaults in the underlying
collateral pool, making assumptions regarding severity and then comparing losses
on the underlying collateral pool to the amount of subordination. We
apply current published industry data of projected default rates to the
underlying collateral pool to estimate the expected future
losses. If expected losses were to exceed the attachment point,
we may recognize an OTTI on the CLN. To date, there has been one
default in the underlying collateral pool of the $400 million CLN and two
defaults in the underlying collateral pool of the $200 million
CLN. There has been no event of default on the CLNs
themselves. Based upon our analysis, the remaining subordination as
represented by the attachment point should be sufficient to absorb future credit
losses, subject to changing market conditions. Similar to other debt
market instruments, our maximum principal loss is limited to our original
investment of $600 million as of September 30, 2009.
During
the nine months ended September 30, 2009, as in the general markets, spreads on
these transactions have tightened, reducing unrealized losses. We had
unrealized losses of $282 million on the $600 million in CLNs as of September
30, 2009, and $550 million on the $600 million in CLNs as of December 31,
2008. As described more fully in the realized loss related to
investments section above, we regularly review our investment holdings for
OTTIs. Based upon this review, we believe that these securities were
not other-than-temporarily impaired as of September 30, 2009, and December 31,
2008. The following summarizes the fair value to amortized cost ratio
of the CLNs:
|
As
of
|
|
As
of
|
|
As
of
|
|
October
31,
|
|
September
30,
|
|
December
31,
|
|
2009
|
|
2009
|
|
2008
|
Fair
value to amortized cost ratio
|
50%
|
|
53%
|
|
8%
|
The
following summarizes information regarding our investments in these securities
(dollars in millions) as of September 30, 2009:
|
|
Amount
and Date of Issuance
|
|
|
|
|
$400 |
|
|
|
$200 |
|
|
|
December
2006
|
|
|
April
2007
|
|
Amortized
cost
|
|
$ |
400 |
|
|
$ |
200 |
|
Fair
value
|
|
|
205 |
|
|
|
113 |
|
Original
attachment point (subordination)
|
|
|
5.50 |
% |
|
|
2.05 |
% |
Current
attachment point (subordination)
|
|
|
4.79 |
% |
|
|
1.48 |
% |
Maturity
|
|
12/20/2016
|
|
|
3/20/2017
|
|
Current
rating of tranche
|
|
BBB-
|
|
|
Ba3
(1)
|
|
Current
rating of underlying collateral pool
|
|
Aa1-Caa2
|
|
|
Aaa-B3
|
|
Number
of entities
|
|
|
124 |
|
|
|
98 |
|
Number
of countries
|
|
|
19 |
|
|
|
23 |
|
(1)
|
As
of October 31, 2009, the current rating of this tranche was
B2.
|
The
following summarizes the exposure of the CLNs’ underlying collateral by industry
and rating as of September 30, 2009:
Industry
|
|
AAA
|
|
AA
|
|
A
|
|
BBB
|
|
BB
|
|
B
|
|
CC
|
|
Total
|
Financial
intermediaries
|
|
0.4%
|
|
3.5%
|
|
7.1%
|
|
0.5%
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
|
11.5%
|
Telecommunications
|
|
0.0%
|
|
0.0%
|
|
5.5%
|
|
4.5%
|
|
1.1%
|
|
0.0%
|
|
0.0%
|
|
11.1%
|
Oil
and gas
|
|
0.0%
|
|
1.4%
|
|
1.7%
|
|
4.4%
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
|
7.5%
|
Utilities
|
|
0.0%
|
|
0.0%
|
|
2.4%
|
|
1.8%
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
|
4.2%
|
Chemicals
and plastics
|
|
0.0%
|
|
0.0%
|
|
2.3%
|
|
1.6%
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
|
3.9%
|
Property
and casualty insurance
|
|
0.0%
|
|
0.0%
|
|
2.2%
|
|
1.1%
|
|
0.0%
|
|
0.0%
|
|
0.5%
|
|
3.8%
|
Drugs
|
|
0.3%
|
|
2.5%
|
|
0.9%
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
|
3.7%
|
Retailers
(except food and drug)
|
|
0.0%
|
|
0.0%
|
|
0.6%
|
|
1.8%
|
|
1.1%
|
|
0.0%
|
|
0.0%
|
|
3.5%
|
Industrial
equipment
|
|
0.0%
|
|
0.0%
|
|
3.0%
|
|
0.3%
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
|
3.3%
|
Sovereign
|
|
0.0%
|
|
0.3%
|
|
1.6%
|
|
1.4%
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
|
3.3%
|
Forest
products
|
|
0.0%
|
|
0.0%
|
|
0.0%
|
|
1.6%
|
|
1.4%
|
|
0.0%
|
|
0.0%
|
|
3.0%
|
Other
industry < 3% (28 industries)
|
|
0.9%
|
|
2.8%
|
|
15.2%
|
|
16.6%
|
|
3.9%
|
|
1.8%
|
|
0.0%
|
|
41.2%
|
Total
by industry
|
|
1.6%
|
|
10.5%
|
|
42.5%
|
|
35.6%
|
|
7.5%
|
|
1.8%
|
|
0.5%
|
|
100.0%
|
Alternative
Investments
Alternative
investments, which consist primarily of investments in Limited Partnerships
("LPs"), are included in other investments on our Consolidated Balance
Sheets.
We
account for our investments in LPs using the equity method to determine the GAAP
carrying value. The LPs where LNC is a participant generally report
their assets at fair value. Since the assets of the LPs are measured
at fair value and the values of the LPs’ liabilities would generally approximate
fair value according to the audited financial statements received from the
partnerships, the GAAP carrying value on our consolidated balance sheet would
approximate a fair value for our LP investments.
Recognition
of alternative investment income is delayed due to the availability of the
related financial statements, as our venture capital, real estate and oil and
gas portfolios are generally on a three-month delay and our hedge funds are on a
one-month delay and are generally obtained from the partnerships’ general
partners. In addition, the impact of audit adjustments related to
completion of calendar-year financial statement audits of the investees are
typically received after the filing of Form 10-K. Accordingly,
our investment income from alternative investments for any calendar year
period may not include the complete impact of the change in the underlying net
assets for the partnership for that calendar year period.
6. Derivative
Instruments
Types
of Derivative Instruments and Derivative Strategies
We
maintain an overall risk management strategy that incorporates the use of
derivative instruments to minimize significant unplanned fluctuations in
earnings that are caused by interest rate risk, foreign currency exchange risk,
equity market risk and credit risk. We assess these risks by
continually identifying and monitoring changes in interest rate exposure,
foreign currency exposure, equity market exposure and credit exposure that may
adversely impact expected future cash flows and by evaluating hedging
opportunities. Derivative instruments that are used as part of our interest
rate risk management strategy include interest rate swap agreements, interest
rate futures, interest rate cap agreements, forward-starting interest rate swaps
and treasury locks. Derivative instruments that are used as part of our
foreign currency risk management strategy include foreign currency swaps,
currency futures and foreign currency forwards. Call options based on
our stock, call options based on the Standard & Poor’s (“S&P”) 500
Index® (“S&P 500”), total return swaps, variance swaps, equity collars, put
options and equity futures are used as part of our equity market risk management
strategy. We also use credit default swaps as part of our credit risk
management strategy.
We
evaluate and recognize our derivative instruments in accordance with the
Derivatives and Hedging Topic of the FASB ASC. As of September 30,
2009, we had derivative instruments that were designated and qualifying as cash
flow hedges, fair value hedges and the hedge of a net investment in a foreign
subsidiary, as well as embedded derivatives that qualified as hedging
instruments. In addition, we had embedded derivatives that did not
qualify as hedging instruments, and derivative instruments that were economic
hedges, but were not designed to meet the requirements to be accounted for as a
hedge. See Note 1 of our 2008 Form 10-K for a detailed discussion of
the accounting treatment for derivative instruments.
Our
derivative instruments are monitored by our Asset Liability Management Committee
and our Equity Risk Management Committee as part of those committees’ oversight
of our derivative activities. Our committees are responsible for
implementing various hedging strategies that are developed through their
analysis of financial simulation models and other internal and industry
sources. The resulting hedging strategies are incorporated into our
overall risk management strategies.
We use a
hedging strategy designed to mitigate the risk and income statement volatility
caused by changes in the equity markets, interest rates and volatility
associated with living benefit guarantees offered in our variable annuity
products, including the Lincoln SmartSecurity®
Advantage guaranteed withdrawal benefit (“GWB”) feature, the 4LATER® Advantage
guaranteed income benefit (“GIB”) feature and the i4LIFE® Advantage GIB
feature. See “Guaranteed Living Benefit Embedded Derivative Reserves”
below for further details.
See Note
16 for disclosures required by the Fair Value Measurements and Disclosures Topic
of the FASB ASC.
We have
derivative instruments with off-balance-sheet risks whose notional or contract
amounts exceed the credit exposure. Outstanding derivative
instruments with off-balance-sheet risks (in millions) were as
follows:
|
|
As
of September 30, 2009
|
|
|
|
Number
|
|
|
|
|
|
Asset
Carrying
|
|
|
(Liability)
Carrying
|
|
|
|
of
|
|
|
Notional
|
|
|
or
Fair Value
|
|
|
or
Fair Value
|
|
|
|
Instruments
|
|
|
Amounts
|
|
|
Gain
|
|
|
Loss
|
|
|
Gain
|
|
|
Loss
|
|
Derivative
Instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Designated
and Qualifying
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
as
Hedging Instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flow hedges:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
rate swap agreements (1)
|
|
|
92 |
|
|
$ |
649 |
|
|
$ |
37 |
|
|
$ |
(68 |
) |
|
$ |
- |
|
|
$ |
- |
|
Foreign
currency swaps (1)
|
|
|
13 |
|
|
|
340 |
|
|
|
37 |
|
|
|
(19 |
) |
|
|
- |
|
|
|
- |
|
Forward-starting
interest rate swaps (1)
|
|
|
1 |
|
|
|
75 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Total
cash flow hedges
|
|
|
106 |
|
|
|
1,064 |
|
|
|
74 |
|
|
|
(87 |
) |
|
|
- |
|
|
|
- |
|
Fair
value hedges:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
rate swap agreements (1)
|
|
|
1 |
|
|
|
375 |
|
|
|
92 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Equity
collars (1)
|
|
|
1 |
|
|
|
49 |
|
|
|
128 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Total
fair value hedges
|
|
|
2 |
|
|
|
424 |
|
|
|
220 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Net
investment in foreign subsidiary:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency forwards (1)
|
|
|
2 |
|
|
|
324 |
|
|
|
12 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Embedded
derivatives:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
compensation plans (2)
|
|
|
7 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(418 |
) |
Indexed
annuity contracts
(3)
|
|
|
104,642 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(391 |
) |
GLB
embedded derivative reserves
(3)
|
|
|
248,669 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
281 |
|
|
|
(1,382 |
) |
Reinsurance
related embedded
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
derivatives
(4)
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(39 |
) |
Total
embedded derivatives
|
|
|
353,318 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
281 |
|
|
|
(2,230 |
) |
Total
derivative instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
designated
and qualifying as
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
hedging
instruments
|
|
|
353,428 |
|
|
|
1,812 |
|
|
|
306 |
|
|
|
(87 |
) |
|
|
281 |
|
|
|
(2,230 |
) |
Derivative
Instruments Not
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Designated
and Not Qualifying
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
as
Hedging Instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
rate cap agreements (1)
|
|
|
34 |
|
|
|
1,700 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Interest
rate futures (1)
|
|
|
31,555 |
|
|
|
4,163 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Equity
futures (1)
|
|
|
24,073 |
|
|
|
1,299 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Interest
rate swap agreements (1)
|
|
|
109 |
|
|
|
6,611 |
|
|
|
283 |
|
|
|
(399 |
) |
|
|
- |
|
|
|
- |
|
Foreign
currency forwards (1)
|
|
|
17 |
|
|
|
1,016 |
|
|
|
12 |
|
|
|
(130 |
) |
|
|
- |
|
|
|
- |
|
Credit
default swaps (2)
|
|
|
15 |
|
|
|
249 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(78 |
) |
Total
return swaps (1)
|
|
|
2 |
|
|
|
142 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Put
options (1)
|
|
|
120 |
|
|
|
4,259 |
|
|
|
1,022 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Call
options (based on LNC stock) (1)
|
|
|
1 |
|
|
|
9 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Call
options (based on S&P 500) (1)
|
|
|
557 |
|
|
|
3,342 |
|
|
|
174 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Variance
swaps (1)
|
|
|
36 |
|
|
|
26 |
|
|
|
101 |
|
|
|
(18 |
) |
|
|
- |
|
|
|
- |
|
Currency
futures (1)
|
|
|
3,432 |
|
|
|
487 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
AFS
securities embedded derivatives (1)
|
|
|
2 |
|
|
|
- |
|
|
|
18 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Total
derivative instruments not
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
designated
and not qualifying as
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
hedging
instruments
|
|
|
59,953 |
|
|
|
23,303 |
|
|
|
1,610 |
|
|
|
(547 |
) |
|
|
- |
|
|
|
(78 |
) |
Total
derivative instruments
|
|
|
413,381 |
|
|
$ |
25,115 |
|
|
$ |
1,916 |
|
|
$ |
(634 |
) |
|
$ |
281 |
|
|
$ |
(2,308 |
) |
(1)
|
Reported
in derivative investments on our Consolidated Balance
Sheets.
|
(2)
|
Reported
in other liabilities on our Consolidated Balance
Sheets.
|
(3)
|
Reported
in future contract benefits on our Consolidated Balance
Sheets.
|
(4)
|
Reported
in reinsurance related embedded derivatives on our Consolidated Balance
Sheets.
|
The
maturity of the notional amounts of derivative financial instruments (in
millions) was as follows:
|
|
Remaining
Life as of September 30, 2009
|
|
|
|
Less
Than
|
|
|
|
1
– 5 |
|
|
|
5
– 10 |
|
|
|
10
– 30 |
|
|
|
|
|
|
1
Year
|
|
|
Years
|
|
|
Years
|
|
|
Years
|
|
|
Total
|
|
Derivative
Instruments Designated and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Qualifying
as Hedging Instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flow hedges:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
rate swap agreements
|
|
$ |
53 |
|
|
$ |
90 |
|
|
$ |
240 |
|
|
$ |
266 |
|
|
$ |
649 |
|
Foreign
currency swaps
|
|
|
- |
|
|
|
68 |
|
|
|
191 |
|
|
|
81 |
|
|
|
340 |
|
Forward-starting
interest rate swaps
|
|
|
- |
|
|
|
- |
|
|
|
75 |
|
|
|
- |
|
|
|
75 |
|
Total
cash flow hedges
|
|
|
53 |
|
|
|
158 |
|
|
|
506 |
|
|
|
347 |
|
|
|
1,064 |
|
Fair
value hedges:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
rate swap agreements
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
375 |
|
|
|
375 |
|
Equity collars
|
|
|
49 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
49 |
|
Total
fair value hedges
|
|
|
49 |
|
|
|
- |
|
|
|
- |
|
|
|
375 |
|
|
|
424 |
|
Net
investment in foreign subsidiary:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency forwards
|
|
|
324 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
324 |
|
Total
derivative instruments designated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
qualifying as hedging instruments
|
|
|
426 |
|
|
|
158 |
|
|
|
506 |
|
|
|
722 |
|
|
|
1,812 |
|
Derivative
Instruments Not Designated and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Not
Qualifying as Hedging Instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
rate cap agreements
|
|
|
1,550 |
|
|
|
150 |
|
|
|
- |
|
|
|
- |
|
|
|
1,700 |
|
Interest
rate futures
|
|
|
4,163 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
4,163 |
|
Equity
futures
|
|
|
1,299 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1,299 |
|
Interest
rate swap agreements
|
|
|
477 |
|
|
|
1,635 |
|
|
|
1,494 |
|
|
|
3,005 |
|
|
|
6,611 |
|
Foreign
currency forwards
|
|
|
1,016 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1,016 |
|
Credit
default swaps
|
|
|
20 |
|
|
|
40 |
|
|
|
189 |
|
|
|
- |
|
|
|
249 |
|
Total
return swaps
|
|
|
142 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
142 |
|
Put
options
|
|
|
134 |
|
|
|
1,200 |
|
|
|
2,750 |
|
|
|
175 |
|
|
|
4,259 |
|
Call
options (based on LNC stock)
|
|
|
9 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
9 |
|
Call
options (based on S&P 500)
|
|
|
2,534 |
|
|
|
808 |
|
|
|
- |
|
|
|
- |
|
|
|
3,342 |
|
Variance
swaps
|
|
|
- |
|
|
|
3 |
|
|
|
23 |
|
|
|
- |
|
|
|
26 |
|
Currency
futures
|
|
|
487 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
487 |
|
Total
derivative instruments not designated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
not qualifying as hedging instruments
|
|
|
11,831 |
|
|
|
3,836 |
|
|
|
4,456 |
|
|
|
3,180 |
|
|
|
23,303 |
|
Total
derivative instruments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
with
notional amounts
|
|
$ |
12,257 |
|
|
$ |
3,994 |
|
|
$ |
4,962 |
|
|
$ |
3,902 |
|
|
$ |
25,115 |
|
The
change in our unrealized gain on derivative instruments in accumulated OCI (in
millions) was as follows:
|
|
For
the
|
|
|
|
Nine
|
|
|
|
Months
|
|
|
|
Ended
|
|
|
|
September
30,
|
|
|
|
2009
|
|
Unrealized
Gain on Derivative Instruments
|
|
|
|
Balance
as of beginning-of-year
|
|
$ |
127 |
|
Other
comprehensive income (loss):
|
|
|
|
|
Unrealized
holding losses arising during the period:
|
|
|
|
|
Cash
flow hedges:
|
|
|
|
|
Interest
rate swap agreements
|
|
|
23 |
|
Foreign
currency swaps
|
|
|
(49 |
) |
Fair
value hedges:
|
|
|
|
|
Interest
rate swap agreements
|
|
|
3 |
|
Equity
collars
|
|
|
(28 |
) |
Net
investment in foreign subsidiary
|
|
|
(61 |
) |
Change
in DAC, VOBA, DSI and other contract holder funds
|
|
|
16 |
|
Income
tax benefit
|
|
|
(16 |
) |
Less:
|
|
|
|
|
Reclassification
adjustment for gains included in net income:
|
|
|
|
|
Cash
flow hedges:
|
|
|
|
|
Interest
rate swap agreements (1)
|
|
|
2 |
|
Foreign
currency swaps (1)
|
|
|
1 |
|
Fair
value hedges:
|
|
|
|
|
Interest
rate swap agreements (2)
|
|
|
3 |
|
Income
tax expense
|
|
|
(2 |
) |
Balance
as of end-of-period
|
|
$ |
11 |
|
(1)
|
The
OCI offset is reported within net investment income on our Consolidated
Statements of Income (Loss).
|
(2)
|
The
OCI offset is reported within interest and debt expense on our
Consolidated Statements of Income
(Loss).
|
The
settlement payments and mark-to-market adjustments on derivative instruments (in
millions) recorded on our Consolidated Statements of Income (Loss) were as
follows:
|
|
For
the
|
|
|
For
the
|
|
|
|
Three
|
|
|
Nine
|
|
|
|
Months
|
|
|
Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2009
|
|
Derivative
Instruments Designated and Qualifying as Hedging
Instruments
|
|
|
|
|
|
|
Cash
flow hedges:
|
|
|
|
|
|
|
Interest
rate swap agreements (1)
|
|
$ |
- |
|
|
$ |
2 |
|
Foreign
currency swaps (1)
|
|
|
1 |
|
|
|
2 |
|
Total
cash flow hedges
|
|
|
1 |
|
|
|
4 |
|
Fair
value hedges:
|
|
|
|
|
|
|
|
|
Interest
rate swap agreements (2)
|
|
|
5 |
|
|
|
12 |
|
Embedded
derivatives:
|
|
|
|
|
|
|
|
|
Deferred
compensation plans (3)
|
|
|
(17 |
) |
|
|
(42 |
) |
Indexed
annuity contracts (4)
|
|
|
(54 |
) |
|
|
(4 |
) |
GLB
embedded derivative reserves (4)
|
|
|
(28 |
) |
|
|
1,793 |
|
Reinsurance
related embedded derivatives (4)
|
|
|
(85 |
) |
|
|
(70 |
) |
Total
embedded derivatives
|
|
|
(184 |
) |
|
|
1,677 |
|
Total
derivative instruments designated and qualifying as hedging
instruments
|
|
|
(178 |
) |
|
|
1,693 |
|
Derivative
Instruments Not Designated and Not Qualifying as Hedging
Instruments
|
|
|
|
|
|
Interest
rate futures (4)
|
|
|
(3 |
) |
|
|
(586 |
) |
Equity
futures
(4)
|
|
|
(285 |
) |
|
|
(599 |
) |
Interest
rate swap agreements (4)
|
|
|
93 |
|
|
|
(686 |
) |
Foreign
currency forwards (1)
|
|
|
(36 |
) |
|
|
(119 |
) |
Credit
default swaps (1)
|
|
|
- |
|
|
|
1 |
|
Total
return swaps (3)
|
|
|
19 |
|
|
|
28 |
|
Put
options (4)
|
|
|
(116 |
) |
|
|
(526 |
) |
Call
options (based on S&P 500) (4)
|
|
|
48 |
|
|
|
50 |
|
Variance
swaps (4)
|
|
|
5 |
|
|
|
(78 |
) |
Currency
futures (4)
|
|
|
9 |
|
|
|
7 |
|
AFS
securities embedded derivatives (1)
|
|
|
1 |
|
|
|
4 |
|
Total
derivative instruments not designated and not qualifying as hedging
instruments
|
|
|
(265 |
) |
|
|
(2,504 |
) |
Total
derivative instruments
|
|
$ |
(443 |
) |
|
$ |
(811 |
) |
(1)
|
Reported
in net investment income on our Consolidated Statements of Income
(Loss).
|
(2)
|
Reported
in interest and debt expense on our Consolidated Statements of Income
(Loss).
|
(3)
|
Reported
in underwriting, acquisition, insurance and other expenses on our
Consolidated Statements of Income
(Loss).
|
(4)
|
Reported
in realized loss on our Consolidated Statements of Income
(Loss).
|
Derivative
Instruments Designated and Qualifying as Cash Flow Hedges
There was
zero and $1 million in ineffective portions of cash flow hedges recognized
through realized loss for the three and nine months ended September 30, 2009,
respectively.
As of
September 30, 2009, $6 million of the deferred net gains on derivative
instruments in accumulated OCI were expected to be reclassified to earnings
during the next twelve months. This reclassification is due primarily
to the receipt of interest payments associated with variable rate securities and
forecasted purchases, payment of interest on our senior debt, the receipt of
interest payments associated with foreign currency securities and the periodic
vesting of stock appreciation rights (“SARs”).
For both
the three and nine months ended September 30, 2009, there were no
reclassifications to earnings due to hedged firm commitments no longer deemed
probable or due to hedged forecasted transactions that had not occurred by the
end of the originally specified time period.
Interest
Rate Swap Agreements
We use a
portion of our interest rate swap agreements to hedge the interest rate risk to
our exposure to floating rate bond coupon payments, replicating a fixed rate
bond. An interest rate swap is a contractual agreement to exchange
payments at one or more times based on the actual or expected price level,
performance or value of one or more underlying interest rates. We are
required to pay the counterparty the stream of variable interest payments based
on the coupon payments from the hedged bonds, and in turn, receive a fixed
payment from the counterparty at a predetermined interest rate. The
net receipts/payments from these interest rate swaps are recorded on our
Consolidated Statements of Income (Loss) as specified in the table
above. Gains or losses on interest rate swaps hedging our interest
rate exposure on floating rate bond coupon payments are reclassified from
accumulated OCI to net income as the related bond interest is
accrued.
In
addition, we use interest rate swap agreements to hedge our exposure to fixed
rate bond coupon payments and the change in underlying asset values as interest
rates fluctuate. The net receipts/payments from these interest rate
swaps are recorded on our Consolidated Statements of Income (Loss) as specified
in the table above.
As of
September 30, 2009, the latest maturity date for which we were hedging our
exposure to the variability in future cash flows for these instruments
was June 2037.
Foreign
Currency Swaps
We use
foreign currency swaps, which are traded over-the-counter, to hedge some of the
foreign exchange risk of investments in fixed maturity securities denominated in
foreign currencies. A foreign currency swap is a contractual
agreement to exchange the currencies of two different countries at a specified
rate of exchange in the future. Gains or losses on foreign currency
swaps hedging foreign exchange risk exposure on foreign currency bond coupon
payments are reclassified from accumulated OCI to net income as the related bond
interest is accrued.
As of
September 30, 2009, the latest maturity date for which we were hedging our
exposure to the variability in future cash flows for these instruments was July
2022.
Forward-Starting
Interest Rate Swaps
We use
forward-starting interest rate swaps to hedge our exposure to interest rate
fluctuations related to the forecasted purchase of assets for certain investment
portfolios. The gains or losses resulting from the swap agreements
are recorded in OCI. The gains or losses are reclassified from
accumulated OCI to earnings over the life of the assets once the assets are
purchased.
As of
September 30, 2009, the latest maturity date for which we were hedging our
exposure to the variability in future cash flows for these instruments
was September 2017.
Derivative
Instruments Designated and Qualifying as Fair Value Hedges
There
were no ineffective portions of fair value hedges for both the three and nine
months ended September 30, 2009. We recognized $1 million as a
component of realized investment loss for our equity collars for both the three
and nine months ended September 30, 2009.
Interest
Rate Swap Agreements
We use a
portion of our interest rate swap agreements to hedge the risk of paying a
higher fixed rate of interest on junior subordinated debentures issued to
affiliated trusts and on senior debt than would be paid on long-term debt based
on current interest rates in the marketplace. We are required to pay
the counterparty a stream of variable interest payments based on the referenced
index, and in turn, we receive a fixed payment from the counterparty at a
predetermined interest rate. The net receipts/payments from these
interest rate swaps are recorded as an adjustment to the interest expense for
the debt being hedged. The changes in fair value of the interest rate
swap are recorded on our Consolidated Statements of Income (Loss) as specified
in the table above in the period of change, along with the offsetting changes in
fair value of the debt being hedged.
Equity
Collars
We used
an equity collar on four million shares of our Bank of America (“BOA”) stock
holdings. The equity collar is structured such that we purchased a
put option on the BOA stock and simultaneously sold a call option with the
identical maturity date as the put option. This structure effectively
protects us from a price decline in the stock while allowing us to participate
in some of the upside if the BOA stock appreciates over the time of the
transaction. With the equity collar in place, we are able to pledge
the BOA stock as collateral, which then allows us to advance a substantial
portion of the stock’s value, effectively monetizing the stock for liquidity
purposes. This variable forward contract is scheduled to settle in
September 2010, at which time we will be required to deliver shares or
cash. If we choose to settle in shares, the number of shares to be
delivered will be determined based on the volume-weighted average price of BOA
common stock over a period of 10 trading days prior to
settlement. The change in fair value of the equity collar is recorded
on our Consolidated Statements of Income (Loss) as specified in the table above
in the period of change, along with the offsetting changes (when applicable) in
fair value of the stock being hedged.
Derivative
Instruments Designated and Qualifying as a Net Investment in Foreign
Subsidiary
We use
foreign currency forwards to hedge a portion of our net investment in our
foreign subsidiary, Lincoln UK. The foreign currency forwards
obligate us to deliver a specified amount of currency at a future date at a
specified exchange rate. The foreign currency forwards outstanding as of
December 31, 2008, were terminated on February 5, 2009. The gain on
the termination of the foreign currency forward of $38 million was recorded in
OCI. During 2009, we entered into foreign currency forward to hedge a
significant portion of the foreign currency fluctuations associated with the
expected proceeds from the sale of Lincoln UK. The loss upon the
termination of these foreign currency contracts of $12 million was also recorded
in OCI.
Embedded
Derivative Instruments Designated and Qualifying as Hedging
Instruments
Deferred Compensation
Plans
We have
certain deferred compensation plans that have embedded derivative
instruments. The liability related to these plans varies based on the
investment options selected by the participants. The liability
related to certain investment options selected by the participants is
marked-to-market through net income on our Consolidated Statements of Income
(Loss) as specified in the table above.
Indexed
Annuity Contracts
We
distribute indexed annuity contracts that permit the holder to elect an interest
rate return or an equity market component, where interest credited to the
contracts is linked to the performance of the S&P 500. This
feature represents an embedded derivative under the Derivatives and Hedging
Topic of the FASB ASC. Contract holders may elect to re-balance index
options at renewal dates, either annually or biannually. As of each
renewal date, we have the opportunity to re-price the indexed component by
establishing participation rates, subject to minimum guarantees. We
purchase S&P 500 call options that are highly correlated to the portfolio
allocation decisions of our contract holders, such that we are economically
hedged with respect to equity returns for the current reset
period. The mark-to-market of the options held generally offsets the
change in value of the embedded derivative within the indexed annuity, both of
which are recorded on our Consolidated Statements of Income (Loss) as specified
in the table above.
Guaranteed
Living Benefit Embedded Derivative Reserves
We have
certain guaranteed living benefit (“GLB”) variable annuity products with GWB and
GIB features that are embedded derivatives. Certain features of these
guarantees, notably our GIB and 4LATER® features, have elements of both
insurance benefits accounted for under the Financial Services – Insurance –
Claim Costs and Liabilities for Future Policy Benefits Subtopic of the FASB ASC
(“benefit reserves”) and embedded derivatives accounted for under the
Derivatives and Hedging and the Fair Value Measurements and Disclosures Topics
of the FASB ASC (“embedded derivative reserves”). We calculate the value of
the embedded derivative reserve and the benefit reserve based on the specific
characteristics of each GLB feature. The change in embedded
derivative reserves flows through our Consolidated Statements of Income (Loss)
as specified in the table above. As of September 30, 2009, we
had $21.5 billion of account values that were attributable to variable
annuities with a GWB feature and $8.8 billion of account values that
were attributable to variable annuities with a GIB feature.
We use a
hedging strategy designed to mitigate the risk and income statement volatility
caused by changes in the equity markets, interest rates and volatility
associated with GWB and GIB features. The hedging strategy is
designed such that changes in the value of the hedge contracts due to changes in
equity markets, interest rates and implied volatilities move in the opposite
direction of changes in embedded derivative reserves of the GWB and GIB caused
by those same factors. As part of our current hedging program, equity
markets, interest rates and volatility in market conditions are monitored on a
daily basis. We re-balance our hedge positions based upon changes in these
factors as needed. While we actively manage our hedge positions,
these hedge positions may not be totally effective in offsetting changes in the
embedded derivative reserve due to, among other things, differences in timing
between when a market exposure changes and corresponding changes to the hedge
positions, extreme swings in the equity markets and interest rates, market
volatility, contract holder behavior, divergence between the performance of the
underlying funds and the hedging indices, divergence between the actual and
expected performance of the hedge instruments and our ability to purchase
hedging instruments at prices consistent with our desired risk and return trade
off.
Reinsurance
Related Embedded Derivative
We have
certain modified coinsurance (“Modco”) and coinsurance with funds withheld
(“CFW”) reinsurance arrangements with embedded derivatives related to the
withheld assets of the related funds. These derivatives are
considered total return swaps with contractual returns that are attributable to
various assets and liabilities associated with these reinsurance
arrangements. Changes in the estimated fair value of these derivatives as
they occur are recorded on our Consolidated Statements of Income (Loss) as
specified in the table above. Offsetting these amounts are
corresponding changes in the estimated fair value of trading securities in
portfolios that support these arrangements. During the first quarter
of 2009, the portion of the embedded derivative liability related to the funds
withheld reinsurance agreement on our disability income business was released
due to the rescission of the underlying reinsurance agreement. See
Note 11 for additional details.
Derivative
Instruments Not Designated and Not Qualifying as Hedging
Instruments
We use
various other derivative instruments for risk management and income generation
purposes that either do not qualify for hedge accounting treatment or have not
currently been designated by us for hedge accounting treatment in accordance
with the Derivatives and Hedging Topic of the FASB ASC.
Interest
Rate Cap Agreements
Interest
rate cap agreements entitle us to receive quarterly payments from the
counterparties on specified future reset dates, contingent on future interest
rates. For each cap, the amount of such quarterly payments, if any,
is determined by the excess of a market interest rate over a specified cap rate,
multiplied by the notional amount divided by four. The purpose of our
interest rate cap agreement program is to provide a level of protection from the
effect of rising interest rates for our annuity business, within our Retirement
Solutions – Annuities and Retirement Solutions – Defined Contribution
segments. The interest rate cap agreements provide an economic hedge
of the annuity line of business. However, the interest rate cap
agreements do not qualify for hedge accounting treatment.
Interest
Rate Futures and Equity Futures
We use
interest rate futures and equity futures contracts to hedge the liability
exposure on certain options in variable annuity products. These
futures contracts require payment between our counterparty and us on a daily
basis for changes in the futures index price. Cash settlements on the
change in market value of financial futures contracts, along with the resulting
gains or losses, are recorded on our Consolidated Statements of Income (Loss) as
specified in the table above.
Interest
Rate Swap Agreements
We use
interest rate swap agreements to hedge the liability exposure on certain options
in variable annuity products. The change in market value and periodic
cash settlements are recorded on our Consolidated Statements of Income (Loss) as
specified in the table above.
Foreign
Currency Forwards
We use
foreign currency forwards to hedge dividends received from our U.K.-based
subsidiary, Lincoln UK. The foreign currency forwards obligate us to
deliver a specified amount of currency at a future date and a specified exchange
rate.
Credit
Default Swaps
We buy
credit default swaps to hedge against a drop in bond prices due to credit
concerns of certain bond issuers. A credit default swap allows us to
put the bond back to the counterparty at par upon a default event by the bond
issuer. A default event is defined as bankruptcy, failure to pay,
obligation acceleration or restructuring. Our credit default swaps
are not currently qualified for hedge accounting treatment, as amounts are
insignificant.
We also
sell credit default swaps to offer credit protection to
investors. The credit default swaps hedge the investor against a drop
in bond prices due to credit concerns of certain bond issuers. A
credit default swap allows the investor to put the bond back to us at par upon a
default event by the bond issuer. A default event is defined as
bankruptcy, failure to pay, obligation acceleration or
restructuring.
Information
related to our open credit default swap liabilities for which we are the seller
(in millions) as of September 30, 2009, was as follows:
|
|
|
|
|
|
|
|
Credit
|
|
|
|
|
|
|
|
|
|
Reason
|
|
|
Nature
|
|
|
Rating
of
|
|
|
|
|
|
Maximum
|
|
|
|
for
|
|
|
of
|
|
|
Counter-
|
|
|
Fair
|
|
|
Potential
|
|
Maturity
|
|
Entering
|
|
|
Recourse
|
|
|
party
|
|
|
Value
(1)
|
|
|
Payout
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3/20/2010
|
|
|
(2) |
|
|
|
(4) |
|
|
|
A2/A |
|
|
$ |
- |
|
|
$ |
10 |
|
6/20/2010
|
|
|
(2) |
|
|
|
(4) |
|
|
|
A1/A |
|
|
|
- |
|
|
|
10 |
|
12/20/2012
|
|
|
(3) |
|
|
|
(4) |
|
|
Aa2/A+
|
|
|
|
- |
|
|
|
10 |
|
12/20/2012
|
|
|
(3) |
|
|
|
(4) |
|
|
Aa2/A+
|
|
|
|
- |
|
|
|
10 |
|
12/20/2012
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A1/A |
|
|
|
- |
|
|
|
10 |
|
12/20/2012
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A1/A |
|
|
|
- |
|
|
|
10 |
|
12/20/2016
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A2/A(5) |
|
|
|
13 |
|
|
|
29 |
|
12/20/2016
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A2/A(5) |
|
|
|
8 |
|
|
|
24 |
|
12/20/2016
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A2/A(5) |
|
|
|
10 |
|
|
|
24 |
|
3/20/2017
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A2/A(5) |
|
|
|
8 |
|
|
|
22 |
|
3/20/2017
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A2/A(5) |
|
|
|
12 |
|
|
|
15 |
|
3/20/2017
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A2/A(5) |
|
|
|
6 |
|
|
|
18 |
|
3/20/2017
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A2/A(5) |
|
|
|
12 |
|
|
|
17 |
|
3/20/2017
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A2/A(5) |
|
|
|
4 |
|
|
|
23 |
|
3/20/2017
|
|
|
(3) |
|
|
|
(4) |
|
|
|
A2/A(5) |
|
|
|
5 |
|
|
|
17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
78 |
|
|
$ |
249 |
|
(1)
|
Broker
quotes are used to determine the market value of credit default
swaps.
|
(2)
|
Credit
default swap was entered into in order to generate income by providing
protection on a highly rated basket of securities in return for a
quarterly payment.
|
(3)
|
Credit
default swap was entered into in order to generate income by providing
default protection in return for a quarterly
payment.
|
(4)
|
Seller
does not have the right to demand indemnification/compensation from third
parties in case of a loss (payment) on the
contract.
|
(5)
|
These
credit default swaps were sold to a counter party of the issuing special
purpose trust as discussed in the “Credit-Linked Notes” section in Note
5.
|
Details
underlying the associated collateral of our open credit default swaps for which
we are the seller as of September 30, 2009, if credit risk related contingent
features were triggered (in millions) were as follows:
Maximum
potential payout
|
|
$ |
249 |
|
Less:
|
|
|
|
|
Counterparty
thresholds
|
|
|
30 |
|
Maximum
collateral potentially required to post
|
|
$ |
219 |
|
Certain
of our credit default swap agreements contain contractual provisions that allow
for the netting of collateral with our counterparties related to all of our
collateralized financing transactions that we have outstanding. In
the event that these netting agreements were not in place, fair values of the
associated investments, counterparties’ credit ratings as compared to ours and
specified thresholds that once exceeded result in the payment of cash would have
required that we post approximately $70 million as of September 30,
2009. Netting of these contracts allowed us to post approximately $62
million.
Total
Return Swaps
We use
total return swaps to hedge a portion of the liability related to our deferred
compensation plans. We receive the total return on a portfolio of
indexes and pay a floating rate of interest. Cash settlements on the
change in market value of the total return swaps along with the resulting gains
or losses recorded on our Consolidated Statements of Income (Loss) as specified
in the table above.
Put
Options
We use
put options to hedge the liability exposure on certain options in variable
annuity products. Put options are contracts that require
counterparties to pay us at a specified future date the amount, if any, by which
a specified equity index is less than the strike rate stated in the agreement,
applied to a notional amount. The change in market value of the put
options along with the resulting gains or losses on terminations and expirations
are recorded on our Consolidated Statements of Income (Loss) as specified in the
table above.
Call
Options (Based on LNC Stock)
We use
call options on our stock to hedge the expected increase in liabilities arising
from SARs granted on our stock. Call options hedging vested SARs are
not eligible for hedge accounting treatment. The mark-to-market
changes are recorded on our Consolidated Statements of Income (Loss) as
specified in the table above.
Call
Options (Based on S&P 500)
We use
indexed annuity contracts to permit the holder to elect an interest rate return
or an equity market component, where interest credited to the contracts is
linked to the performance of the S&P 500. Contract holders may
elect to re-balance index options at renewal dates, either annually or
biannually. As of each renewal date, we have the opportunity to
re-price the indexed component by establishing participation rates, subject to
minimum guarantees. We purchase call options that are highly
correlated to the portfolio allocation decisions of our contract holders, such
that we are economically hedged with respect to equity returns for the current
reset period. The mark-to-market of the options held generally
offsets the change in value of the embedded derivative within the indexed
annuity, both of which are recorded on our Consolidated Statements of Income
(Loss) as specified in the table above.
Variance
Swaps
We use
variance swaps to hedge the liability exposure on certain options in variable
annuity products. Variance swaps are contracts entered into at no
cost and whose payoff is the difference between the realized variance of an
underlying index and the fixed variance rate determined as of
inception. The change in market value and resulting gains and losses
on terminations and expirations are recorded on our Consolidated Statements of
Income (Loss) as specified in the table above.
Currency
Futures
We use
currency futures to hedge foreign exchange risk associated with certain options
in variable annuity products. Currency futures exchange one currency
for another at a specified date in the future at a specified exchange
rate. These contracts do not qualify for hedge accounting treatment;
therefore, all cash settlements along with the resulting gains or losses are
recorded on our Consolidated Statements of Income (Loss) as specified in the
table above.
AFS
Securities Embedded Derivatives
We own
various debt securities that either contain call options to exchange the debt
security for other specified securities of the borrower, usually common stock,
or contain call options to receive the return on equity-like
indexes. These embedded derivatives have not been qualified for hedge
accounting treatment; therefore, the change in fair value of the embedded
derivatives flows through our Consolidated Statements of Income (Loss) as
specified in the table above.
Credit
Risk
We are
exposed to credit loss in the event of nonperformance by our counterparties on
various derivative contracts and reflect assumptions regarding the credit or
nonperformance risk. The nonperformance risk is based upon
assumptions for each counterparty’s credit spread over the estimated weighted
average life of the counterparty exposure less collateral held. As of September 30,
2009, the nonperformance risk adjustment was $10 million. The credit risk
associated with such agreements is minimized by purchasing such agreements from
financial institutions with long-standing, superior performance
records. Additionally, we maintain a policy of requiring all
derivative contracts to be governed by an International Swaps and Derivatives
Association (“ISDA”) Master Agreement. We are required to maintain
minimum ratings as a matter of routine practice in negotiating ISDA
agreements. Under some ISDA agreements, our insurance subsidiaries
have agreed to maintain certain financial strength or claims-paying
ratings. A downgrade below these levels could result in termination
of the derivatives contract, at which time any amounts payable by us would be
dependent on the market value of the underlying derivative
contract. In certain transactions, we and the counterparty have
entered into a collateral support agreement requiring either party to post
collateral when net exposures exceed pre-determined thresholds. These
thresholds vary by counterparty and credit rating. We do not believe
the inclusion of termination or collateralization events pose any material
threat to the liquidity position of any insurance subsidiary of the
Company. The amount of such exposure is essentially the net
replacement cost or market value less collateral held for such agreements with
each counterparty if the net market value is in our favor. As of
September 30, 2009, the exposure was $426 million.
The
amounts recognized (in millions) by S&P credit rating of counterparty as of
September 30, 2009, for which we had the right to reclaim cash collateral or
were obligated to return cash collateral, were as follows:
|
|
|
Collateral
|
|
|
Collateral
|
|
S&P
|
|
|
Posted
by
|
|
|
Posted
by
|
|
Credit
|
|
|
Counterparty
|
|
|
LNC
|
|
Rating
of
|
|
|
(Held
by
|
|
|
(Held
by
|
|
Counterparty
|
|
|
LNC)
|
|
|
Counterparty)
|
|
|
|
|
|
|
|
|
|
AAA
|
|
|
$ |
9 |
|
|
$ |
- |
|
AA
|
|
|
|
115 |
|
|
|
- |
|
AA-
|
|
|
|
187 |
|
|
|
- |
|
A+ |
|
|
|
275 |
|
|
|
(16 |
) |
A |
|
|
|
288 |
|
|
|
(88 |
) |
|
|
|
|
$ |
874 |
|
|
$ |
(104 |
) |
7. Federal
Income Taxes
The
effective tax rate is a ratio of tax expense over pre-tax income
(loss). Because the pre-tax income of $62 million and $121 million
resulted in a tax benefit of $19 million and $8 million for the three months
ended September 30, 2009 and 2008, respectively, the effective tax rate was not
meaningful. The effective tax rate for the nine months ended
September 30, 2009 and 2008 was 22% and 25%, respectively. The
effective tax rate on pre-tax income (loss) from continuing operations was lower
than the prevailing corporate federal income tax rate. Differences in
the effective rates and the U.S. statutory rate of 35% for the nine months ended
September 30, 2009 and 2008 were the result of certain tax preferred investment
income, separate account dividends-received deduction (“DRD”), foreign tax
credits and other tax preference items and the impact of the goodwill impairment
related to our Retirement Solutions – Annuities reporting segment, which did not
have a corresponding tax effect.
Federal
income tax benefit for the first nine months of 2009 included an increase of $60
million related to favorable adjustments from the 2008 tax return, filed during
2009, relating primarily to the separate account DRD, foreign tax credits and
other tax preference items. Federal income tax expense for the first
nine months of 2008 included a reduction of $34 million related to favorable
adjustments from the 2007 tax return, filed during 2008, relating primarily to
the separate account DRD, foreign tax credits and other tax preference
items.
The
application of GAAP requires us to evaluate the recoverability of our deferred
tax assets and establish a valuation allowance if necessary, to reduce our
deferred tax asset to an amount that is more likely than not to be
realizable. Considerable judgment and the use of estimates are
required in determining whether a valuation allowance is necessary, and if so,
the amount of such valuation allowance. In evaluating the need for a
valuation allowance, we consider many factors, including: the nature and
character of the deferred tax assets and liabilities; taxable income in prior
carryback years; future reversals of temporary differences; the length of time
carryovers can be utilized; and any tax planning strategies we would employ to
avoid a tax benefit from expiring unused. Although realization is not
assured, management believes it is more likely than not that the deferred tax
assets, including our capital loss deferred tax asset, will be
realized.
As of
September 30, 2009, there have been no material changes to the balance of
unrecognized tax benefits reported as of December 31, 2008. We
anticipate a change to our unrecognized tax benefits within the next 12 months
in the range of $0 million to $53 million.
We
recognize interest and penalties, if any, accrued related to unrecognized tax
benefits as a component of tax expense.
8. Goodwill
The
changes in the carrying amount of goodwill (in millions) by reportable segment
were as follows:
|
|
For
the Nine Months Ended
|
|
|
|
September
30, 2009
|
|
|
|
Balance
|
|
|
Purchase
|
|
|
|
|
|
Balance
|
|
|
|
As
of
|
|
|
Accounting
|
|
|
|
|
|
As
of
|
|
|
|
Beginning-
|
|
|
Adjust-
|
|
|
Impair-
|
|
|
End-of-
|
|
|
|
of-Year
|
|
|
ments
|
|
|
ment
|
|
|
Period
|
|
Retirement
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$ |
1,040 |
|
|
$ |
- |
|
|
$ |
(600 |
) |
|
$ |
440 |
|
Defined
Contribution
|
|
|
20 |
|
|
|
- |
|
|
|
- |
|
|
|
20 |
|
Insurance
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
Insurance
|
|
|
2,188 |
|
|
|
- |
|
|
|
- |
|
|
|
2,188 |
|
Group
Protection
|
|
|
274 |
|
|
|
- |
|
|
|
- |
|
|
|
274 |
|
Other
Operations
|
|
|
174 |
|
|
|
1 |
|
|
|
(1 |
) |
|
|
174 |
|
Total
goodwill
|
|
$ |
3,696 |
|
|
$ |
1 |
|
|
$ |
(601 |
) |
|
$ |
3,096 |
|
We
performed a Step 1 goodwill impairment analysis on all of our reporting units as
of March 31, 2009. The Step 1 analysis for our Insurance Solutions –
Life Insurance and Retirement Solutions – Annuities reporting units utilized
primarily a discounted cash flow valuation technique. In determining
the estimated fair value of these reporting units, we incorporated consideration
of discounted cash flow calculations, the level of our own share price and
assumptions that market participants would make in valuing these reporting
units. Our fair value estimations were based primarily on an in-depth
analysis of projected future cash flows and relevant discount rates, which
considered market participant inputs (“income approach”). The
discounted cash flow analysis required us to make judgments about revenues,
earnings projections, capital market assumptions and discount
rates. For our other reporting units, we used other available
information including market data obtained through strategic reviews and other
analysis to support our Step 1 conclusions.
All of
our reporting units passed the Step 1 analysis, except for our Retirement
Solutions – Annuities reporting unit, which required a Step 2 analysis to be
completed. In our Step 2 analysis, we estimated the implied fair
value of the reporting unit’s goodwill as determined by allocating the reporting
unit’s fair value determined in Step 1 to all of its net assets (recognized and
unrecognized) as if the reporting unit had been acquired in a business
combination as of the date of the impairment test.
Based
upon our Step 2 analysis, we recorded goodwill impairment for the Retirement
Solutions – Annuities reporting unit in the first quarter of 2009, which was
attributable primarily to higher discount rates driven by higher debt costs and
equity market volatility, deterioration in sales and declines in equity
markets. There were no indicators of impairment as of September 30,
2009, due primarily to the continued improvement in the equity markets and lower
discount rates.
For our
acquisition of NCLS, we are in the process of finalizing the fair value of the
assets acquired and liabilities assumed as of the acquisition
date. As such, these values are subject to change. During
the first nine months of 2009, we impaired the estimated goodwill that arose
from the acquisition after giving consideration to the expected financial
performance and other relevant factors of this business.
9. Guaranteed
Benefit Features
We issue
variable annuity contracts through our separate accounts for which investment
income and investment gains and losses accrue directly to, and investment risk
is borne by, the contract holder (traditional variable annuities). We
also issue variable annuity and life contracts through separate accounts that
include various types of guaranteed death benefit (“GDB”), GWB and GIB
features. The GDB features include those where we contractually
guarantee to the contract holder either: return of no less than total
deposits made to the contract less any partial withdrawals (“return of net
deposits”); total deposits made to the contract less any partial withdrawals
plus a minimum return (“minimum return”); or the highest contract value on any
contract anniversary date through age 80 minus any payments or withdrawals
following the contract anniversary (“anniversary contract
value”).
As
discussed in Note 6, certain features of these guarantees are accounted for as
embedded derivative reserves, whereas other guarantees are accounted for as
benefit reserves. Other guarantees contain characteristics of both
and are accounted for under an approach that calculates the value of the
embedded derivative reserve and the benefit reserve based on the specific
characteristics of each GLB feature. We use derivative instruments to
hedge our exposure to the risks and earnings volatility that result from the
embedded derivatives for living benefits in certain of our variable annuity
products. The change in fair value of these instruments tends to move
in the opposite direction of the change in the value of the associated
reserves. The net impact of these changes is reported as a component
of realized loss on our Consolidated Statements of Income (Loss) in a category
referred to as GLBs.
The
“market consistent scenarios” used in the determination of the fair value
of the GWB liability are similar to those used by an investment bank
to value derivatives for which the pricing is not transparent and the
aftermarket is nonexistent or illiquid. In our calculation, risk-neutral
Monte-Carlo simulations resulting in over 10 million scenarios are utilized to
value the entire block of guarantees. The market consistent scenario
assumptions, as of each valuation date, are those we view to be appropriate for
a hypothetical market participant. The market consistent inputs include
assumptions for the capital markets (e.g., implied volatilities, correlation
among indices, risk-free swap curve, etc.), policyholder behavior (e.g., policy
lapse, benefit utilization, mortality, etc.), risk margins, administrative
expenses and a margin for profit. We believe these assumptions are
consistent with those that would be used by a market participant; however, as
the related markets develop we will continue to reassess our
assumptions. It is possible that different valuation techniques and
assumptions could produce a materially different estimate of fair
value.
Information
on the GDB features outstanding (dollars in millions) was as follows (our
variable contracts with guarantees may offer more than one type of guarantee in
each contract; therefore, the amounts listed are not mutually
exclusive):
|
|
As
of
|
|
|
As
of
|
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Return
of Net Deposits
|
|
|
|
|
|
|
Total
account value
|
|
$ |
42,415 |
|
|
$ |
33,907 |
|
Net
amount at risk (1)
|
|
|
2,446 |
|
|
|
6,337 |
|
Average
attained age of contract holders
|
|
57
years
|
|
|
56
years
|
|
Minimum
Return
|
|
|
|
|
|
|
|
|
Total
account value
|
|
$ |
204 |
|
|
$ |
191 |
|
Net
amount at risk (1)
|
|
|
72 |
|
|
|
109 |
|
Average
attained age of contract holders
|
|
69
years
|
|
|
68
years
|
|
Guaranteed
minimum return
|
|
|
5 |
% |
|
|
5 |
% |
Anniversary
Contract Value
|
|
|
|
|
|
|
|
|
Total
account value
|
|
$ |
20,605 |
|
|
$ |
16,950 |
|
Net
amount at risk (1)
|
|
|
4,764 |
|
|
|
8,402 |
|
Average
attained age of contract holders
|
|
65
years
|
|
|
65
years
|
|
(1)
|
Represents
the amount of death benefit in excess of the account
balance. The decrease in net amount at risk when comparing
September 30, 2009, to December 31, 2008, was attributable primarily to
the rise in equity markets and associated increase in the account
values.
|
The
determination of GDB liabilities is based on models that involve a range of
scenarios and assumptions, including those regarding expected market rates of
return and volatility, contract surrender rates and mortality
experience. The following summarizes the balances of and changes in
the liabilities for GDB (in millions), which were recorded in future contract
benefits on our Consolidated Balance Sheets:
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
Balance
as of beginning-of-year
|
|
$ |
277 |
|
|
$ |
38 |
|
Change
in reserves
|
|
|
(39 |
) |
|
|
87 |
|
Benefits
paid
|
|
|
(150 |
) |
|
|
(22 |
) |
Balance
as of end-of-period
|
|
$ |
88 |
|
|
$ |
103 |
|
Account
balances of variable annuity contracts with guarantees (in millions) were
invested in separate account investment options as follows:
|
|
As
of
|
|
|
As
of
|
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Asset
Type
|
|
|
|
|
|
|
Domestic
equity
|
|
$ |
31,318 |
|
|
$ |
24,878 |
|
International
equity
|
|
|
11,737 |
|
|
|
9,204 |
|
Bonds
|
|
|
9,041 |
|
|
|
6,701 |
|
Money
market
|
|
|
5,958 |
|
|
|
5,802 |
|
Total
|
|
$ |
58,054 |
|
|
$ |
46,585 |
|
|
|
|
|
|
|
|
|
|
Percent
of total variable annuity separate account values
|
|
|
97 |
% |
|
|
99 |
% |
Future
contract benefits also include reserves for our products with secondary
guarantees for our products sold through our Insurance Solutions – Life
Insurance segment. These UL and VUL products with secondary
guarantees represented approximately 39% of permanent life insurance in
force as of September 30, 2009, and approximately 58% and 66% of sales
for these products for the three and nine months ended September 30,
2009.
10. Long-Term
Debt
Changes
in long-term debt, excluding current portion (in millions), were as
follows:
|
|
For
the
|
|
|
|
Nine
|
|
|
|
Months
|
|
|
|
Ended
|
|
|
|
September
30,
|
|
|
|
2009
|
|
Balance
as of beginning-of-year
|
|
$ |
4,731 |
|
Early
extinguishment of the following capital securities:
|
|
|
|
|
Portion
of 7%, due 2066 (1)
|
|
|
(78 |
) |
Portion
of 6.05%, due 2067 (2)
|
|
|
(9 |
) |
Senior
notes issued (3)
|
|
|
495 |
|
Maturity
of LIBOR + 11 bps notes, due 2009
|
|
|
(500 |
) |
Reclassification
to short-term debt
|
|
|
250 |
|
Change
in fair value hedge
|
|
|
(104 |
) |
Accretion
(amortization) of discounts (premiums), net
|
|
|
4 |
|
Balance
as of end-of-period
|
|
$ |
4,789 |
|
(1)
|
The
results of the extinguishment of debt were favorable by a ratio of 25
cents to one dollar.
|
(2)
|
The
results of the extinguishment of debt were favorable by a ratio of 23
cents to one dollar.
|
(3)
|
On
June 22, 2009, we issued 8.75% fixed rate senior notes due
2019. We have the option to repurchase the outstanding notes by
paying the greater of (i) 100% of the principal amount of the notes to be
redeemed and (ii) the make-whole amount, plus in each case any accrued and
unpaid interest as of the date of redemption. The make-whole
amount is equal to the sum of the present values of the remaining
scheduled payments on the senior notes, discounted to the date of
redemption on a semi-annual basis, at a rate equal to the sum of the
applicable treasury rate (as defined in the senior notes) plus 50 basis
points.
|
Details
underlying the recognition of a gain on the extinguishment of debt (in millions)
reported within interest and debt expense on our Consolidated Statements of
Income (Loss) were as follows:
|
|
For
the
|
|
|
|
Three
|
|
|
|
Months
|
|
|
|
Ended
|
|
|
|
March
31,
|
|
|
|
2009
|
|
Principal
balance outstanding prior to payoff
|
|
$ |
87 |
|
Unamortized
debt issuance costs and discounts prior to payoff
|
|
|
(1 |
) |
Amount
paid to retire
|
|
|
(22 |
) |
Gain
on extinguishment of debt, pre-tax
|
|
$ |
64 |
|
11. Contingencies
and Commitments
Regulatory
and Litigation Matters
In the
ordinary course of its business, 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, after consideration of any reserves and rights to
indemnification, ultimately will be resolved without materially affecting the
consolidated financial position of LNC. However, given the large and
indeterminate amounts sought in certain of these proceedings and the inherent
difficulty in predicting the outcome of such legal proceedings, including the
proceeding described below, it is possible that an adverse outcome in certain
matters could be material to our operating results for any particular reporting
period.
Transamerica Investment Management,
LLC and Transamerica Investments Services, Inc. v. Delaware Management Holdings,
Inc. (dba Delaware Investments), Delaware Investment Advisers and certain
individuals, was filed in the San Francisco County Superior Court on
April 28, 2005. The plaintiffs are seeking substantial
compensatory and punitive damages. The complaint alleges breach of
fiduciary duty, breach of duty of loyalty, breach of contract, breach of the
implied covenant of good faith and fair dealing, unfair competition,
interference with prospective economic advantage, conversion, unjust enrichment
and conspiracy, in connection with Delaware Investment Advisers’ hiring of a
portfolio management team from the plaintiffs. We and the individual
defendants dispute the allegations and are vigorously defending these
actions. The pending sale of Delaware has no impact on this
matter.
Contingencies
Rescission
of Indemnity Reinsurance for Disability Income Business
Included
in the business sold to Swiss Re through indemnity reinsurance in 2001 was
disability income business. In response to the rescission award of a
panel of arbitrators on January 24, 2009, of the underlying reinsurance
agreement with Swiss Re, we recorded an adjustment to write down our reinsurance
recoverable and the corresponding funds withheld liability, and we released the
embedded derivative liability related to the funds withheld nature of the
reinsurance agreement, as discussed below. Although these adjustments
were based on our best estimate of the impact of the rescission, we may record
further adjustments depending on the outcome of our review of the adequacy of
the reserves, which we expect to complete during the fourth quarter of
2009. Any resulting adjustment may have a material impact on our
results for the quarter in which the adjustment is recorded. The
rescission resulted in our being responsible for paying claims on the business
and maintaining sufficient reserves to support the
liabilities.
For the
three months ended March 31, 2009, an unfavorable adjustment of $64 million,
after-tax, was reflected in segment income from operations within Other
Operations, comprised of increases of $78 million to benefits, $15 million to
interest credited and $5 million to underwriting, acquisition, insurance and
other expenses, partially offset by a tax benefit of $34 million. In
addition, during the first three months of 2009, the embedded derivative
liability release discussed above increased net income by approximately $31
million. The combined adjustments reduced net income by approximately
$33 million, after-tax. In addition, as a result of the rescission we
reduced our reinsurance recoverables by approximately $900 million related to
the reserves for the disability income business and a reduction of approximately
$840 million in the funds withheld liability.
12. Shares
and Stockholders’ Equity
The
changes in our preferred and common stock (number of shares) were as
follows:
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Series
A Preferred Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of beginning-of-period
|
|
|
11,557 |
|
|
|
11,662 |
|
|
|
11,565 |
|
|
|
11,960 |
|
Conversion
into common stock
|
|
|
(10 |
) |
|
|
(100 |
) |
|
|
(18 |
) |
|
|
(398 |
) |
Balance
as of end-of-period
|
|
|
11,547 |
|
|
|
11,562 |
|
|
|
11,547 |
|
|
|
11,562 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Series
B Preferred Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of beginning-of-period
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Stock
issued
|
|
|
950,000 |
|
|
|
- |
|
|
|
950,000 |
|
|
|
- |
|
Balance
as of end-of-period
|
|
|
950,000 |
|
|
|
- |
|
|
|
950,000 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of beginning-of-period
|
|
|
302,093,017 |
|
|
|
256,801,622 |
|
|
|
255,869,859 |
|
|
|
264,233,303 |
|
Stock
issued
|
|
|
- |
|
|
|
- |
|
|
|
46,000,000 |
|
|
|
- |
|
Conversion
of Series A preferred stock
|
|
|
160 |
|
|
|
1,600 |
|
|
|
288 |
|
|
|
6,368 |
|
Stock
compensation/issued for benefit plans
|
|
|
12,070 |
|
|
|
114,919 |
|
|
|
284,637 |
|
|
|
861,220 |
|
Retirement/cancellation
of shares
|
|
|
(31,378 |
) |
|
|
(1,076,508 |
) |
|
|
(80,915 |
) |
|
|
(9,259,258 |
) |
Balance
as of end-of-period
|
|
|
302,073,869 |
|
|
|
255,841,633 |
|
|
|
302,073,869 |
|
|
|
255,841,633 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common
stock as of end-of-period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assuming
conversion of preferred stock
|
|
|
302,258,621 |
|
|
|
256,026,625 |
|
|
|
302,258,621 |
|
|
|
256,026,625 |
|
Diluted
basis
|
|
|
311,845,511 |
|
|
|
256,908,832 |
|
|
|
311,845,511 |
|
|
|
256,908,832 |
|
Our
common and Series A preferred stocks are without par value.
Common
Stock Issued
On
June 22, 2009, we closed on the issuance and sale of 40,000,000 shares of
common stock and on June 25, 2009, we closed on the issuance and sale of
6,000,000 shares of common stock, both at a price of $15.00 per
share.
Series
B Preferred Stock Issued
On July
10, 2009, in connection with the Troubled Asset Relief Program (“TARP”) Capital
Purchase Program (“CPP”), established as part of the Emergency Economic
Stabilization Act of 2008 (“EESA”), we issued and sold to the U.S. Treasury
950,000 shares of Series B preferred stock together with a related warrant to
purchase up to 13,049,451 shares of our common stock at an exercise price of
$10.92 per share, in accordance with the terms of the TARP CPP, for an aggregate
purchase price of $950 million. The Series B
preferred stock has no maturity date and ranks senior to our common
stock. The Series B preferred stock is non-voting. Holders of this Series B preferred
stock are entitled to a cumulative cash dividend at the annual rate per share of
5% of the liquidation preference, $1,000 per share, or $48 million
annually, for the first five years from issuance. After July 10,
2014, if the preferred shares are still outstanding, the annual dividend rate
will increase to 9% per year. The warrant will expire on July 10,
2019.
As
required under the TARP CPP, dividend payments on, and repurchases of, the
Company’s outstanding preferred and common stock are subject to certain
restrictions (unless the U.S. Treasury consents). Additionally, any
increase in the quarterly common stock dividend for the next three years will
require the consent of the U.S. Government while our obligations under the CPP
remain outstanding.
Upon
issuance, the fair values of the Series B preferred stock and the
associated warrant were computed as if the instruments were issued on a stand
alone basis. The fair value of the Series B preferred stock was estimated
based on a five-year holding period and cash flows discounted at a rate of 10%,
resulting in a fair value estimate of approximately $777 million. We used a
binomial lattice model to estimate the fair value of the warrant, resulting in a
stand alone fair value of approximately $152 million. The relative
fair value of each security to the total combined fair value of both securities
was 83.6% for the preferred stock and 16.4% for the common stock
warrant. The most significant and unobservable assumption in this
valuation was our share price volatility. We used a long-term
realized volatility of our stock of 73.17%.
The
individual fair values were then used to record the Series B preferred
stock and associated warrant on a relative fair value basis of $794 million and
$156 million, respectively. The warrant was recorded to common
stock. The Series B preferred stock amount was recorded at the
liquidation value of $1,000 per share or $950 million, net of discount of
$156 million. The discount is being amortized over a five-year period
from the date of issuance, using the effective yield method and is recorded as a
direct reduction to retained earnings and deducted from income (loss) available
to common stockholders in the calculation of earnings (loss) per share
(“EPS”). The accretion of discount totaled $6 million for the three
months ended September 30, 2009.
A
reconciliation of the denominator (number of shares) in the calculations of
basic and diluted earnings (loss) per common share was as follows:
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Weighted-average
shares, as used in basic calculation
|
|
|
301,803,107 |
|
|
|
255,865,067 |
|
|
|
272,651,819 |
|
|
|
258,192,178 |
|
Shares
to cover exercise of CPP warrant
|
|
|
11,786,601 |
|
|
|
- |
|
|
|
3,928,867 |
|
|
|
- |
|
Shares
to cover conversion of preferred stock
|
|
|
184,787 |
|
|
|
185,672 |
|
|
|
184,931 |
|
|
|
187,101 |
|
Shares
to cover non-vested stock
|
|
|
568,933 |
|
|
|
315,939 |
|
|
|
525,534 |
|
|
|
276,132 |
|
Average
stock options outstanding during the period
|
|
|
577,045 |
|
|
|
6,241,386 |
|
|
|
295,438 |
|
|
|
8,478,357 |
|
Assumed
acquisition of shares with assumed
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
proceeds
from exercising CPP warrant
|
|
|
(5,909,851 |
) |
|
|
- |
|
|
|
(1,969,950 |
) |
|
|
- |
|
Assumed
acquisition of shares with assumed
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
proceeds
and benefits from exercising stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
options
(at average market price for the year)
|
|
|
(386,354 |
) |
|
|
(6,240,810 |
) |
|
|
(207,216 |
) |
|
|
(8,392,562 |
) |
Shares
repurchaseable from measured but
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
unrecognized
stock option expense
|
|
|
(160,867 |
) |
|
|
(2,279 |
) |
|
|
(55,922 |
) |
|
|
(57,531 |
) |
Average
deferred compensation shares
|
|
|
1,576,482 |
|
|
|
1,280,279 |
|
|
|
1,563,073 |
|
|
|
1,278,454 |
|
Weighted-average
shares, as used in diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
calculation
(1)
|
|
|
310,039,883 |
|
|
|
257,645,254 |
|
|
|
276,916,574 |
|
|
|
259,962,129 |
|
(1)
|
As
a result of a loss from continuing operations for the nine months ended
September 30, 2009, shares used in the EPS calculation represent basic
shares, since using diluted shares would have been anti-dilutive to the
calculation.
|
In the
event the average market price of LNC common stock exceeds the issue price of
stock options, such options would be dilutive to our EPS and will be shown in
the table above. Participants in our deferred compensation plans that
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.
The
income used in the calculation of our diluted EPS is our net income (loss),
reduced by preferred stock dividends and accretion of discount along with our
minority interest adjustments related to outstanding stock options under the
Delaware Investments U.S., Inc. (“DIUS”) stock option incentive plan of less
than $1 million for the three and nine months ended September 30, 2009, and
2008. These amounts are presented on our Consolidated Statements of
Income (Loss).
OCI
The
following summarizes the changes in OCI (in millions):
|
|
For
the Nine Months
|
|
|
For
the Nine Months
|
|
|
|
Ended
September 30, 2009
|
|
|
Ended
September 30, 2008
|
|
|
|
Pre-Tax
|
|
|
Tax
|
|
|
Net
|
|
|
Pre-Tax
|
|
|
Tax
|
|
|
Net
|
|
Net
unrealized gain (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
on
AFS securities
|
|
$ |
4,434 |
|
|
$ |
(1,568 |
) |
|
$ |
2,866 |
|
|
$ |
(3,046 |
) |
|
$ |
1,056 |
|
|
$ |
(1,990 |
) |
Unrealized
OTTI on AFS securities
|
|
|
(161 |
) |
|
|
56 |
|
|
|
(105 |
) |
|
|
- |
|
|
|
- |
|
|
|
- |
|
Net
unrealized gain (loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
on
derivative instruments
|
|
|
(102 |
) |
|
|
(14 |
) |
|
|
(116 |
) |
|
|
3 |
|
|
|
(2 |
) |
|
|
1 |
|
Foreign
currency translation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
adjustment
|
|
|
98 |
|
|
|
(36 |
) |
|
|
62 |
|
|
|
(90 |
) |
|
|
36 |
|
|
|
(54 |
) |
Funded
status of employee benefit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
plans
|
|
|
(34 |
) |
|
|
12 |
|
|
|
(22 |
) |
|
|
12 |
|
|
|
(4 |
) |
|
|
8 |
|
Total
OCI
|
|
$ |
4,235 |
|
|
$ |
(1,550 |
) |
|
$ |
2,685 |
|
|
$ |
(3,121 |
) |
|
$ |
1,086 |
|
|
$ |
(2,035 |
) |
13. Realized
Loss
Details
underlying realized loss (in millions) reported on our Consolidated Statements
of Income (Loss) were as follows:
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Total
realized loss on investments and certain
|
|
|
|
|
|
|
|
|
|
|
|
|
derivative
instruments, excluding trading securities (1)
|
|
$ |
(136 |
) |
|
$ |
(315 |
) |
|
$ |
(444 |
) |
|
$ |
(473 |
) |
Gain
(loss) on certain reinsurance derivative/trading securities (2)
|
|
|
71 |
|
|
|
(2 |
) |
|
|
83 |
|
|
|
- |
|
Indexed
annuity net derivative results (3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
gain (loss)
|
|
|
(9 |
) |
|
|
8 |
|
|
|
- |
|
|
|
19 |
|
Associated
amortization benefit (expense) of DAC, VOBA, DSI
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
DFEL
|
|
|
5 |
|
|
|
(5 |
) |
|
|
- |
|
|
|
(10 |
) |
Guaranteed
living benefits (4):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
gain (loss)
|
|
|
(216 |
) |
|
|
159 |
|
|
|
(450 |
) |
|
|
196 |
|
Associated
amortization benefit (expense) of DAC, VOBA, DSI
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
DFEL
|
|
|
2 |
|
|
|
(59 |
) |
|
|
(16 |
) |
|
|
(85 |
) |
Guaranteed
death benefits (5):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
gain (loss)
|
|
|
(97 |
) |
|
|
8 |
|
|
|
(203 |
) |
|
|
10 |
|
Associated
amortization benefit (expense) of DAC, VOBA, DSI
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
DFEL
|
|
|
12 |
|
|
|
(1 |
) |
|
|
26 |
|
|
|
(3 |
) |
Gain
on sale of subsidiaries/businesses
|
|
|
- |
|
|
|
- |
|
|
|
1 |
|
|
|
- |
|
Total
realized loss
|
|
$ |
(368 |
) |
|
$ |
(207 |
) |
|
$ |
(1,003 |
) |
|
$ |
(346 |
) |
(1)
|
See
“Realized Loss Related to Investments” section in Note
5.
|
(2)
|
Represents
changes in the fair value of total return swaps (embedded derivatives)
related to various modified coinsurance and coinsurance with funds
withheld reinsurance arrangements that have contractual returns related to
various assets and liabilities associated with these
arrangements. Changes in the fair value of these derivatives
are offset by the change in fair value of trading securities in the
portfolios that support these
arrangements.
|
(3)
|
Represents
the net difference between the change in the fair value of the S&P 500
call options that we hold and the change in the fair value of the embedded
derivative liabilities of our indexed annuity products along with changes
in the fair value of embedded derivative liabilities related to index call
options we may purchase in the future to hedge contract holder index
allocations applicable to future reset periods for our indexed annuity
products as required under the Fair Value Measurements and Disclosures
Topic of the FASB ASC. The nine months ended September 30,
2008, included a $10 million gain from the initial impact of adopting the
Fair Value Measurements and Disclosures Topic of the FASB
ASC.
|
(4)
|
Represents
the net difference in the change in embedded derivative reserves of our
GLB products and the change in the fair value of the derivative
instruments we own to hedge, including the cost of purchasing the hedging
instruments. The nine months ended September 30, 2008, included
a $34 million loss from the initial impact of adopting the Fair Value
Measurements and Disclosures Topic of the FASB
ASC.
|
(5)
|
Represents
the change in the fair value of the derivatives used to hedge our GDB
riders.
|
14. Pension and Other Postretirement
Benefit Plans
The
components of net defined benefit pension plan and other postretirement benefit
plan expense (in millions) reported in underwriting, acquisition, insurance and
other expenses on our Consolidated Statements of Income (Loss) were as
follows:
|
|
For
the Three Months Ended September 30,
|
|
|
|
Pension
Benefits
|
|
|
Other
Postretirement
Benefits
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
U.S.
Plans
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost (1)
|
|
$ |
1 |
|
|
$ |
- |
|
|
$ |
1 |
|
|
$ |
1 |
|
Interest
cost
|
|
|
15 |
|
|
|
15 |
|
|
|
2 |
|
|
|
2 |
|
Expected
return on plan assets
|
|
|
(14 |
) |
|
|
(19 |
) |
|
|
(1 |
) |
|
|
- |
|
Recognized
net actuarial loss
|
|
|
7 |
|
|
|
1 |
|
|
|
- |
|
|
|
- |
|
Net
periodic benefit expense (recovery)
|
|
$ |
9 |
|
|
$ |
(3 |
) |
|
$ |
2 |
|
|
$ |
3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-U.S.
Plans
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
cost
|
|
$ |
1 |
|
|
$ |
5 |
|
|
|
|
|
|
|
|
|
Expected
return on plan assets
|
|
|
(1 |
) |
|
|
(5 |
) |
|
|
|
|
|
|
|
|
Recognized
net actuarial loss
|
|
|
- |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
Recognized
net actuarial loss due to curtailment
(2)
|
|
|
1 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
Net
periodic benefit expense
|
|
$ |
1 |
|
|
$ |
1 |
|
|
|
|
|
|
|
|
|
|
|
For
the Nine Months Ended September 30,
|
|
|
|
Pension
Benefits
|
|
|
Other
Postretirement
Benefits
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
U.S.
Plans
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost (1)
|
|
$ |
3 |
|
|
$ |
1 |
|
|
$ |
2 |
|
|
$ |
2 |
|
Interest
cost
|
|
|
46 |
|
|
|
46 |
|
|
|
6 |
|
|
|
6 |
|
Expected
return on plan assets
|
|
|
(42 |
) |
|
|
(58 |
) |
|
|
(2 |
) |
|
|
(1 |
) |
Recognized
net actuarial (gain) loss
|
|
|
21 |
|
|
|
3 |
|
|
|
(1 |
) |
|
|
(1 |
) |
Net
periodic benefit expense (recovery)
|
|
$ |
28 |
|
|
$ |
(8 |
) |
|
$ |
5 |
|
|
$ |
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-U.S.
Plans
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$ |
1 |
|
|
$ |
2 |
|
|
|
|
|
|
|
|
|
Interest
cost
|
|
|
12 |
|
|
|
15 |
|
|
|
|
|
|
|
|
|
Expected
return on plan assets
|
|
|
(11 |
) |
|
|
(16 |
) |
|
|
|
|
|
|
|
|
Recognized
net actuarial loss (2)
|
|
|
1 |
|
|
|
2 |
|
|
|
|
|
|
|
|
|
Recognized
net actuarial loss due to curtailment
(2)
|
|
|
1 |
|
|
|
- |
|
|
|
|
|
|
|
|
|
Net
periodic benefit expense
|
|
$ |
4 |
|
|
$ |
3 |
|
|
|
|
|
|
|
|
|
(1)
|
Amounts
for our pension plans represent general and administrative
expenses.
|
(2)
|
We
retained the UK pension and as a result of the Lincoln UK sale, the plan
was frozen, which resulted in a
curtailment.
|
15. Stock-Based
Incentive Compensation Plans
We
sponsor various incentive plans for our employees, agents, directors and
subsidiaries that provide for the issuance of stock options, stock incentive
awards, SARs, restricted stock awards, restricted stock units (“performance
shares”) and deferred stock units. DIUS has a separate stock-based
incentive compensation plan, which has DIUS stock underlying the
awards.
In the
second quarter of 2009, a performance period from 2009-2011 was approved for our
executive officers by the Compensation Committee. The award for executive
officers participating in this performance period consists of LNC restricted
stock units representing approximately 27%, LNC stock options representing
approximately 40% and performance cash awards representing approximately 33% of
the total award. LNC stock options granted for this performance period
vest ratably over the three-year period, based solely on a service
condition. DIUS restricted stock units granted for this performance period
vest ratably over a four-year period, based solely on a service condition and
were granted only to employees of DIUS. Under the 2009-2011 plan,
609,175 LNC stock options, 243,313 DIUS restricted stock units and 684,619 LNC
restricted stock units were granted during the nine months ended September 30,
2009. In addition, as required under TARP CPP, we have complied
with enhanced compensation restrictions for certain executives and
employees. None of the awards for the three months ended September
30, 2009 were granted to employees who are currently subject to enhanced
compensation restrictions.
Total LNC
stock-based awards granted during the three and nine months ended September 30,
2009, were as follows:
|
|
For
the
|
|
|
For
the
|
|
|
|
Three
|
|
|
Nine
|
|
|
|
Months
|
|
|
Months
|
|
|
|
Ended
|
|
|
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
(1)
|
|
|
2009
|
|
Awards
|
|
|
|
|
|
|
10-year
LNC stock options
|
|
|
(9,072 |
) |
|
|
478,521 |
|
Non-employee
director stock options
|
|
|
- |
|
|
|
84,901 |
|
Non-employee
agent stock options
|
|
|
(65 |
) |
|
|
130,654 |
|
Restricted
stock
|
|
|
105,566 |
|
|
|
684,619 |
|
Performance
shares
|
|
|
- |
|
|
|
48,840 |
|
SARs
|
|
|
(2,651 |
) |
|
|
114,800 |
|
(1)
|
For
the three months ended September 30, 2009, negative amounts for specific
classes of awards were the result of the revocation of previously granted
awards.
|
16. Fair
Value of Financial Instruments
The
carrying values and estimated fair values of our financial instruments (in
millions) were as follows:
|
|
As
of September 30, 2009
|
|
|
As
of December 31, 2008
|
|
|
|
Carrying
|
|
|
Fair
|
|
|
Carrying
|
|
|
Fair
|
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
|
Value
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
AFS
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity
|
|
$ |
60,666 |
|
|
$ |
60,666 |
|
|
$ |
48,141 |
|
|
$ |
48,141 |
|
Equity
|
|
|
283 |
|
|
|
283 |
|
|
|
254 |
|
|
|
254 |
|
Trading
securities
|
|
|
2,548 |
|
|
|
2,548 |
|
|
|
2,333 |
|
|
|
2,333 |
|
Mortgage
loans on real estate
|
|
|
7,277 |
|
|
|
7,541 |
|
|
|
7,715 |
|
|
|
7,424 |
|
Derivative
instruments
|
|
|
1,282 |
|
|
|
1,282 |
|
|
|
3,397 |
|
|
|
3,397 |
|
Other
investments
|
|
|
1,080 |
|
|
|
1,080 |
|
|
|
1,624 |
|
|
|
1,624 |
|
Cash
and invested cash
|
|
|
3,161 |
|
|
|
3,161 |
|
|
|
5,589 |
|
|
|
5,589 |
|
Reinsurance
related embedded derivatives
|
|
|
- |
|
|
|
- |
|
|
|
31 |
|
|
|
31 |
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Future
contract benefits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indexed
annuity contracts
|
|
|
(391 |
) |
|
|
(391 |
) |
|
|
(252 |
) |
|
|
(252 |
) |
GLB
embedded derivative reserves
|
|
|
(1,101 |
) |
|
|
(1,101 |
) |
|
|
(2,904 |
) |
|
|
(2,904 |
) |
Other
contract holder funds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
guaranteed interest and similar contracts
|
|
|
(919 |
) |
|
|
(919 |
) |
|
|
(782 |
) |
|
|
(782 |
) |
Account
value of certain investment contracts
|
|
|
(24,028 |
) |
|
|
(24,045 |
) |
|
|
(21,974 |
) |
|
|
(22,372 |
) |
Short-term
debt (1)
|
|
|
(400 |
) |
|
|
(398 |
) |
|
|
(815 |
) |
|
|
(775 |
) |
Long-term
debt
|
|
|
(4,789 |
) |
|
|
(4,414 |
) |
|
|
(4,731 |
) |
|
|
(2,909 |
) |
Reinsurance
related embedded derivatives
|
|
|
(39 |
) |
|
|
(39 |
) |
|
|
- |
|
|
|
- |
|
Off-Balance-Sheet
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Guarantees
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
(1 |
) |
(1)
|
The
difference between the carrying value and fair value of short-term debt as
of September 30, 2009, and December 31, 2008, related to current
maturities of long-term debt.
|
Valuation
Methodologies and Associated Inputs for Financial Instruments Not Carried at
Fair Value
The
following discussion outlines the methodologies and assumptions used to
determine the fair value of our financial instruments not carried at fair
value. Considerable judgment is required to develop these assumptions
used to measure fair value. Accordingly, the estimates shown are not
necessarily indicative of the amounts that would be realized in a one-time,
current market exchange of all of our financial instruments.
Mortgage
Loans on Real Estate
The fair
value of mortgage loans on real estate is established using a discounted cash
flow method based on credit rating, maturity and future income. The
ratings for mortgages in good standing are based on property type, location,
market conditions, occupancy, debt service coverage, loan to value, quality of
tenancy, borrower and payment record. The fair value for impaired
mortgage loans is based on the present value of expected future cash flows
discounted at the loan’s effective interest rate, the loan’s market price or the
fair value of the collateral if the loan is collateral dependent.
Other
Investments and Cash and Invested Cash
The
carrying value of our assets classified as other investments and cash and
invested cash on our Consolidated Balance Sheets approximates their fair
value. Other investments include limited partnership and other
privately held investments that are accounted for using the equity method of
accounting.
Other
Contract Holder Funds
Other
contract holder funds on our Consolidated Balance Sheets includes remaining
guaranteed interest and similar contracts and account values of certain
investment contracts. The fair value for the remaining guaranteed
interest and similar contracts is estimated using discounted cash flow
calculations as of the balance sheet date. These calculations are
based on interest rates currently offered on similar contracts with maturities
that are consistent with those remaining for the contracts being
valued. As of September 30, 2009, and December 31, 2008, the
remaining guaranteed interest and similar contracts carrying value approximates
fair value. The fair value of the account values of certain
investment contracts is based on their approximate surrender value as of the
balance sheet date.
Short-term
and Long-term Debt
The fair
value of long-term debt is based on quoted market prices or estimated using
discounted cash flow analysis determined in conjunction with our incremental
borrowing rate as of the balance sheet date for similar types of borrowing
arrangements where quoted prices are not available. For short-term
debt, excluding current maturities of long-term debt, the carrying value
approximates fair value.
Guarantees
Our
guarantees relate to mortgage loan pass-through certificates. Based
on historical performance where repurchases have been negligible and the current
status of the debt, none of the loans are delinquent and the fair value
liability for the guarantees related to mortgage loan pass-through certificates
is insignificant.
Financial
Instruments Carried at Fair Value
Our
measurement of fair value is based on assumptions used by market participants in
pricing the asset or liability, which may include inherent risk, restrictions on
the sale or use of an asset or non-performance risk, which would include our own
credit risk. Our estimate of an exchange price is the price in an
orderly transaction between market participants to sell the asset or transfer
the liability (“exit price”) in the principal market, or the most advantageous
market in the absence of a principal market, for that asset or liability, as
opposed to the price that would be paid to acquire the asset or receive a
liability (“entry price”). Pursuant to the Fair Value Measurements
and Disclosures Topic of the FASB ASC, we categorize our financial instruments
carried at fair value into a three-level fair value hierarchy, based on the
priority of inputs to the respective valuation technique. The
three-level hierarchy for fair value measurement is defined as
follows:
·
|
Level
1 – inputs to the valuation methodology are quoted prices available in
active markets for identical investments as of the reporting date as
“blockage discounts” for large holdings of unrestricted financial
instruments where quoted prices are readily and regularly available for an
identical asset or liability in an active market are
prohibited;
|
·
|
Level
2 – inputs to the valuation methodology are other than quoted prices in
active markets, which are either directly or indirectly observable as of
the reporting date, and fair value can be determined through the use of
models or other valuation methodologies;
and
|
·
|
Level
3 – inputs to the valuation methodology are unobservable inputs in
situations where there is little or no market activity for the asset or
liability and the reporting entity makes estimates and assumptions related
to the pricing of the asset or liability, including assumptions regarding
risk.
|
In
certain cases, the inputs used to measure fair value may fall into different
levels of the fair value hierarchy. In such cases, an investment’s
level within the fair value hierarchy is based on the lowest level of input that
is significant to the fair value measurement. Our assessment of the
significance of a particular input to the fair value measurement in its entirety
requires judgment and considers factors specific to the investment.
When a
determination is made to classify an asset or liability within Level 3 of the
fair value hierarchy, the determination is based upon the significance of the
unobservable inputs to the overall fair value measurement. Because
certain securities trade in less liquid or illiquid markets with limited or no
pricing information, the determination of fair value for these securities is
inherently more difficult. However, Level 3 fair value investments
may include, in addition to the unobservable or Level 3 inputs, observable
components, which are components that are actively quoted or can be validated to
market-based sources.
We did
not have any assets or liabilities measured at fair value on a nonrecurring
basis as of September 30, 2009, or December 31, 2008, and we noted no changes in
our valuation methodologies between these periods.
The
following summarizes our financial instruments carried at fair value (in
millions) on a recurring basis by the fair value hierarchy levels described
above:
|
|
As
of September 30, 2009
|
|
|
|
Quoted
|
|
|
|
|
|
|
|
|
|
|
|
|
Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
in
Active
|
|
|
|
|
|
|
|
|
|
|
|
|
Markets
for
|
|
|
Significant
|
|
|
Significant
|
|
|
|
|
|
|
Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
Total
|
|
|
|
Assets
|
|
|
Inputs
|
|
|
Inputs
|
|
|
Fair
|
|
|
|
(Level
1)
|
|
|
(Level
2)
|
|
|
(Level
3)
|
|
|
Value
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
61 |
|
|
$ |
43,711 |
|
|
$ |
2,076 |
|
|
$ |
45,848 |
|
U.S.
Government bonds
|
|
|
185 |
|
|
|
33 |
|
|
|
3 |
|
|
|
221 |
|
Foreign
government bonds
|
|
|
- |
|
|
|
417 |
|
|
|
76 |
|
|
|
493 |
|
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
- |
|
|
|
5,933 |
|
|
|
96 |
|
|
|
6,029 |
|
MPTS
|
|
|
- |
|
|
|
2,557 |
|
|
|
108 |
|
|
|
2,665 |
|
CMBS
|
|
|
- |
|
|
|
2,006 |
|
|
|
247 |
|
|
|
2,253 |
|
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
- |
|
|
|
3 |
|
|
|
137 |
|
|
|
140 |
|
CLNs
|
|
|
- |
|
|
|
- |
|
|
|
318 |
|
|
|
318 |
|
State
and municipal bonds
|
|
|
- |
|
|
|
- |
|
|
|
1,464 |
|
|
|
1,464 |
|
Hybrid
and redeemable preferred stocks
|
|
|
13 |
|
|
|
1,112 |
|
|
|
110 |
|
|
|
1,235 |
|
Equity
AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Banking
securities
|
|
|
18 |
|
|
|
138 |
|
|
|
- |
|
|
|
156 |
|
Insurance
securities
|
|
|
3 |
|
|
|
- |
|
|
|
41 |
|
|
|
44 |
|
Other
financial services securities
|
|
|
- |
|
|
|
6 |
|
|
|
21 |
|
|
|
27 |
|
Other
securities
|
|
|
31 |
|
|
|
2 |
|
|
|
23 |
|
|
|
56 |
|
Trading
securities
|
|
|
4 |
|
|
|
2,442 |
|
|
|
102 |
|
|
|
2,548 |
|
Derivative
investments
|
|
|
- |
|
|
|
(170 |
) |
|
|
1,452 |
|
|
|
1,282 |
|
Cash
and invested cash
|
|
|
- |
|
|
|
3,161 |
|
|
|
- |
|
|
|
3,161 |
|
Separate
account assets
|
|
|
- |
|
|
|
70,111 |
|
|
|
- |
|
|
|
70,111 |
|
Total
assets
|
|
$ |
315 |
|
|
$ |
131,462 |
|
|
$ |
6,274 |
|
|
$ |
138,051 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Future
contract benefits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indexed
annuity contracts
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
(391 |
) |
|
$ |
(391 |
) |
GLB
embedded derivative reserves
|
|
|
- |
|
|
|
- |
|
|
|
(1,101 |
) |
|
|
(1,101 |
) |
Reinsurance
related embedded derivatives
|
|
|
- |
|
|
|
(39 |
) |
|
|
- |
|
|
|
(39 |
) |
Total
liabilities
|
|
$ |
- |
|
|
$ |
(39 |
) |
|
$ |
(1,492 |
) |
|
$ |
(1,531 |
) |
The
following summarizes changes to our financial instruments carried at fair value
(in millions) and classified within Level 3 of the fair value
hierarchy. This summary excludes any impact of amortization on DAC,
VOBA, DSI and DFEL. The gains and losses below may include changes in
fair value due in part to observable inputs that are a component of the
valuation methodology.
|
|
For
the Three Months Ended September 30, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales,
|
|
|
Transfers
|
|
|
|
|
|
|
|
|
|
Items
|
|
|
|
|
|
Issuances,
|
|
|
In
or
|
|
|
|
|
|
|
|
|
|
Included
|
|
|
Gains
|
|
|
Maturities,
|
|
|
Out
|
|
|
|
|
|
|
Beginning
|
|
|
in
|
|
|
(Losses)
|
|
|
Settlements,
|
|
|
of
|
|
|
Ending
|
|
|
|
Fair
|
|
|
Net
|
|
|
in
|
|
|
Calls,
|
|
|
Level
3,
|
|
|
Fair
|
|
|
|
Value
|
|
|
Income
|
|
|
OCI
|
|
|
Net
|
|
|
Net
(1)
|
|
|
Value
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
1,991 |
|
|
$ |
(11 |
) |
|
$ |
171 |
|
|
$ |
59 |
|
|
$ |
(134 |
) |
|
$ |
2,076 |
|
U.S.
Government bonds
|
|
|
3 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
3 |
|
Foreign
government bonds
|
|
|
100 |
|
|
|
- |
|
|
|
5 |
|
|
|
(5 |
) |
|
|
(24 |
) |
|
|
76 |
|
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
123 |
|
|
|
(11 |
) |
|
|
15 |
|
|
|
(9 |
) |
|
|
(22 |
) |
|
|
96 |
|
MPTS
|
|
|
154 |
|
|
|
- |
|
|
|
3 |
|
|
|
(2 |
) |
|
|
(47 |
) |
|
|
108 |
|
CMBS
|
|
|
230 |
|
|
|
- |
|
|
|
27 |
|
|
|
(10 |
) |
|
|
- |
|
|
|
247 |
|
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
110 |
|
|
|
(8 |
) |
|
|
38 |
|
|
|
(3 |
) |
|
|
- |
|
|
|
137 |
|
CLNs
|
|
|
219 |
|
|
|
- |
|
|
|
99 |
|
|
|
- |
|
|
|
- |
|
|
|
318 |
|
State
and municipal bonds
|
|
|
907 |
|
|
|
- |
|
|
|
54 |
|
|
|
423 |
|
|
|
80 |
|
|
|
1,464 |
|
Hybrid
and redeemable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
preferred
stocks
|
|
|
97 |
|
|
|
- |
|
|
|
10 |
|
|
|
3 |
|
|
|
- |
|
|
|
110 |
|
Equity
AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
securities
|
|
|
34 |
|
|
|
(8 |
) |
|
|
15 |
|
|
|
- |
|
|
|
- |
|
|
|
41 |
|
Other
financial services securities
|
|
|
16 |
|
|
|
- |
|
|
|
5 |
|
|
|
- |
|
|
|
- |
|
|
|
21 |
|
Other
securities
|
|
|
23 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
23 |
|
Trading
securities
|
|
|
86 |
|
|
|
23 |
|
|
|
- |
|
|
|
4 |
|
|
|
(11 |
) |
|
|
102 |
|
Derivative
investments
|
|
|
1,465 |
|
|
|
(85 |
) |
|
|
3 |
|
|
|
69 |
|
|
|
- |
|
|
|
1,452 |
|
Future
contract benefits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indexed
annuity contracts
|
|
|
(294 |
) |
|
|
(54 |
) |
|
|
- |
|
|
|
(43 |
) |
|
|
- |
|
|
|
(391 |
) |
GLB
embedded derivative reserves
|
|
|
(1,072 |
) |
|
|
20 |
|
|
|
- |
|
|
|
(49 |
) |
|
|
- |
|
|
|
(1,101 |
) |
Total,
net
|
|
$ |
4,192 |
|
|
$ |
(134 |
) |
|
$ |
445 |
|
|
$ |
437 |
|
|
$ |
(158 |
) |
|
$ |
4,782 |
|
|
|
For
the Nine Months Ended September 30, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales,
|
|
|
Transfers
|
|
|
|
|
|
|
|
|
|
Items
|
|
|
|
|
|
Issuances,
|
|
|
In
or
|
|
|
|
|
|
|
|
|
|
Included
|
|
|
Gains
|
|
|
Maturities,
|
|
|
Out
|
|
|
|
|
|
|
Beginning
|
|
|
in
|
|
|
(Losses)
|
|
|
Settlements,
|
|
|
of
|
|
|
Ending
|
|
|
|
Fair
|
|
|
Net
|
|
|
in
|
|
|
Calls,
|
|
|
Level
3,
|
|
|
Fair
|
|
|
|
Value
|
|
|
Income
|
|
|
OCI
|
|
|
Net
|
|
|
Net
(1)
|
|
|
Value
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
2,356 |
|
|
$ |
(49 |
) |
|
$ |
223 |
|
|
$ |
(125 |
) |
|
$ |
(329 |
) |
|
$ |
2,076 |
|
U.S.
Government bonds
|
|
|
3 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
3 |
|
Foreign
government bonds
|
|
|
60 |
|
|
|
- |
|
|
|
3 |
|
|
|
(7 |
) |
|
|
20 |
|
|
|
76 |
|
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
161 |
|
|
|
(16 |
) |
|
|
18 |
|
|
|
(18 |
) |
|
|
(49 |
) |
|
|
96 |
|
MPTS
|
|
|
18 |
|
|
|
- |
|
|
|
4 |
|
|
|
96 |
|
|
|
(10 |
) |
|
|
108 |
|
CMBS
|
|
|
244 |
|
|
|
1 |
|
|
|
44 |
|
|
|
(42 |
) |
|
|
- |
|
|
|
247 |
|
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
152 |
|
|
|
(40 |
) |
|
|
45 |
|
|
|
(20 |
) |
|
|
- |
|
|
|
137 |
|
CLNs
|
|
|
50 |
|
|
|
- |
|
|
|
268 |
|
|
|
- |
|
|
|
- |
|
|
|
318 |
|
State
and municipal bonds
|
|
|
126 |
|
|
|
- |
|
|
|
52 |
|
|
|
1,169 |
|
|
|
117 |
|
|
|
1,464 |
|
Hybrid
and redeemable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
preferred
stocks
|
|
|
96 |
|
|
|
- |
|
|
|
- |
|
|
|
6 |
|
|
|
8 |
|
|
|
110 |
|
Equity
AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
securities
|
|
|
50 |
|
|
|
(7 |
) |
|
|
19 |
|
|
|
(21 |
) |
|
|
- |
|
|
|
41 |
|
Other
financial services securities
|
|
|
21 |
|
|
|
(3 |
) |
|
|
6 |
|
|
|
(3 |
) |
|
|
- |
|
|
|
21 |
|
Other
securities
|
|
|
23 |
|
|
|
2 |
|
|
|
(1 |
) |
|
|
(1 |
) |
|
|
- |
|
|
|
23 |
|
Trading
securities
|
|
|
81 |
|
|
|
22 |
|
|
|
- |
|
|
|
1 |
|
|
|
(2 |
) |
|
|
102 |
|
Derivative
investments
|
|
|
2,148 |
|
|
|
(571 |
) |
|
|
(6 |
) |
|
|
(119 |
) |
|
|
- |
|
|
|
1,452 |
|
Future
contract benefits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indexed
annuity contracts
|
|
|
(252 |
) |
|
|
(4 |
) |
|
|
- |
|
|
|
(135 |
) |
|
|
- |
|
|
|
(391 |
) |
GLB
embedded derivative reserves
|
|
|
(2,904 |
) |
|
|
1,934 |
|
|
|
- |
|
|
|
(131 |
) |
|
|
- |
|
|
|
(1,101 |
) |
Total,
net
|
|
$ |
2,433 |
|
|
$ |
1,269 |
|
|
$ |
675 |
|
|
$ |
650 |
|
|
$ |
(245 |
) |
|
$ |
4,782 |
|
(1)
|
Transfers
in or out of Level 3 for AFS and trading securities are displayed at
amortized cost as of the beginning-of-period. For AFS and
trading securities, the difference between beginning-of-period amortized
cost and beginning-of-period fair value was included in OCI and earnings,
respectively, in prior periods.
|
The
following provides the components of the items included in net income, excluding
any impact of amortization on DAC, VOBA, DSI and DFEL and changes in future
contract benefits, (in millions) as reported above:
|
|
For
the Three Months Ended September 30, 2009
|
|
|
|
|
|
|
|
|
|
Gains
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Losses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales,
|
|
|
Unrealized
|
|
|
|
|
|
|
(Amortization)
|
|
|
|
|
|
Maturities,
|
|
|
Holding
|
|
|
|
|
|
|
Accretion,
|
|
|
|
|
|
Settlements,
|
|
|
Gains
|
|
|
|
|
|
|
Net
|
|
|
OTTI
|
|
|
Calls
|
|
|
(Losses)
(1)
|
|
|
Total
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
1 |
|
|
$ |
(10 |
) |
|
$ |
(2 |
) |
|
$ |
- |
|
|
$ |
(11 |
) |
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
- |
|
|
|
(10 |
) |
|
|
(1 |
) |
|
|
- |
|
|
|
(11 |
) |
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
- |
|
|
|
(9 |
) |
|
|
1 |
|
|
|
- |
|
|
|
(8 |
) |
Equity
AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
securities
|
|
|
- |
|
|
|
(8 |
) |
|
|
- |
|
|
|
- |
|
|
|
(8 |
) |
Trading
securities (2)
|
|
|
- |
|
|
|
(1 |
) |
|
|
- |
|
|
|
24 |
|
|
|
23 |
|
Derivative
investments (3)
|
|
|
- |
|
|
|
- |
|
|
|
(8 |
) |
|
|
(77 |
) |
|
|
(85 |
) |
Future
contract benefits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indexed
annuity contracts
|
|
|
- |
|
|
|
- |
|
|
|
5 |
|
|
|
(59 |
) |
|
|
(54 |
) |
GLB
embedded derivative reserves
|
|
|
- |
|
|
|
- |
|
|
|
8 |
|
|
|
12 |
|
|
|
20 |
|
Total,
net
|
|
$ |
1 |
|
|
$ |
(38 |
) |
|
$ |
3 |
|
|
$ |
(100 |
) |
|
$ |
(134 |
) |
|
|
For
the Nine Months Ended September 30, 2009
|
|
|
|
|
|
|
|
|
|
Gains
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Losses)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales,
|
|
|
Unrealized
|
|
|
|
|
|
|
(Amortization)
|
|
|
|
|
|
Maturities,
|
|
|
Holding
|
|
|
|
|
|
|
Accretion,
|
|
|
|
|
|
Settlements,
|
|
|
Gains
|
|
|
|
|
|
|
Net
|
|
|
OTTI
|
|
|
Calls
|
|
|
(Losses)
(1)
|
|
|
Total
|
|
Investments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
3 |
|
|
$ |
(47 |
) |
|
$ |
(5 |
) |
|
$ |
- |
|
|
$ |
(49 |
) |
MBS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
1 |
|
|
|
(16 |
) |
|
|
(1 |
) |
|
|
- |
|
|
|
(16 |
) |
CMBS
|
|
|
1 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1 |
|
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
- |
|
|
|
(42 |
) |
|
|
2 |
|
|
|
- |
|
|
|
(40 |
) |
Equity
AFS securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
securities
|
|
|
- |
|
|
|
(8 |
) |
|
|
1 |
|
|
|
- |
|
|
|
(7 |
) |
Other
financial services securities
|
|
|
- |
|
|
|
(3 |
) |
|
|
- |
|
|
|
- |
|
|
|
(3 |
) |
Other
securities
|
|
|
- |
|
|
|
- |
|
|
|
2 |
|
|
|
- |
|
|
|
2 |
|
Trading
securities (2)
|
|
|
2 |
|
|
|
(2 |
) |
|
|
|
|
|
|
22 |
|
|
|
22 |
|
Derivative
investments (3)
|
|
|
- |
|
|
|
- |
|
|
|
(48 |
) |
|
|
(523 |
) |
|
|
(571 |
) |
Future
contract benefits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indexed
annuity contracts
|
|
|
- |
|
|
|
- |
|
|
|
23 |
|
|
|
(27 |
) |
|
|
(4 |
) |
GLB
embedded derivative reserves
|
|
|
- |
|
|
|
- |
|
|
|
37 |
|
|
|
1,897 |
|
|
|
1,934 |
|
Total,
net
|
|
$ |
7 |
|
|
$ |
(118 |
) |
|
$ |
11 |
|
|
$ |
1,369 |
|
|
$ |
1,269 |
|
(1)
|
This
change in unrealized gains or losses relates to assets and liabilities
that we still held as of September 30,
2009.
|
(2)
|
Amortization
and accretion, net and unrealized holding losses are included in net
investment income on our Consolidated Statements of Income
(Loss). All other amounts are included in realized loss on our
Consolidated Statements of Income
(Loss).
|
(3)
|
All
amounts are included in realized loss on our Consolidated Statements of
Income (Loss).
|
Valuation
Methodologies and Associated Inputs for Financial Instruments Carried at Fair
Value
Investments
We
measure our investments that are required to be carried at fair value based on
assumptions used by market participants in pricing the security. The
most appropriate valuation methodology is selected based on the specific
characteristics of the fixed maturity or equity security, and we consistently
apply the valuation methodology to measure the security’s fair
value. Our fair value measurement is based on a market approach,
which utilizes prices and other relevant information generated by market
transactions involving identical or comparable securities. Sources of
inputs to the market approach include third-party pricing services, independent
broker quotations or pricing matrices. We use observable and
unobservable inputs to our valuation methodologies. Observable inputs
include benchmark yields, reported trades, broker-dealer quotes, issuer spreads,
two-sided markets, benchmark securities, bids, offers and reference
data. In addition, market indicators, industry and economic events
are monitored and further market data is acquired if certain triggers are
met. For certain security types, additional inputs may be used, or some of
the inputs described above may not be applicable. For broker-quoted
only securities, quotes from market makers or broker-dealers are obtained from
sources recognized to be market participants. In order to validate the
pricing information and broker-dealer quotes, we employ, where possible,
procedures that include comparisons with similar observable positions,
comparisons with subsequent sales, discussions with senior business leaders and
brokers and observations of general market movements for those security
classes. For those securities trading in less liquid or illiquid
markets with limited or no pricing information, we use unobservable inputs in
order to measure the fair value of these securities. In cases where
this information is not available, such as for privately placed securities, fair
value is estimated using an internal pricing matrix. This matrix
relies on management’s judgment concerning the discount rate used in calculating
expected future cash flows, credit quality, industry sector performance and
expected maturity.
We do not
adjust prices received from third parties; however, we do analyze the
third-party pricing services’ valuation methodologies and related inputs and
perform additional evaluation to determine the appropriate level within the fair
value hierarchy.
The
observable and unobservable inputs to our valuation methodologies are based on a
set of standard inputs that we generally use to evaluate all of our AFS
securities. The standard inputs used in order of priority are
benchmark yields, reported trades, broker/dealer quotes, issuer spreads,
two-sided markets, benchmark securities, bids, offers and reference
data. Depending on the type of security or the daily market activity,
standard inputs may be prioritized differently or may not be available for all
AFS securities on any given day. In addition to the defined standard
inputs to our valuation methodologies, we also use Trade Reporting and
Compliance EngineTM
reported tables for our corporate bonds and vendor trading platform data for our
U.S. Government bonds. MBS and ABS utilize additional inputs which
include new issues data, monthly payment information and monthly collateral
performance, including prepayments, severity, delinquencies, step down features
and over collateralization features. The valuation methodologies for
our state and municipal bonds use additional inputs which include information
from the Municipal Securities Rule Making Board, as well as material event
notices, new issue data, issuer financial statements and Municipal Market Data
benchmark yields. Our hybrid and redeemable preferred stocks and equity AFS
securities utilize additional inputs of exchange prices (underlying and common
stock of the same issuer).
Trading
securities consist of fixed maturity and equity securities in designated
portfolios, which support Modco and CFW reinsurance arrangements. The
valuation methodologies and inputs for our trading securities are determined in
the same manner as our securities classified as AFS discussed
above. For discussion of the significant inputs of our embedded
derivatives for Level 2 and Level 3, see the discussion of derivative
investments below.
Derivative
Investments
We employ
several different methods for determining the fair value of our derivative
instruments. The fair value of our derivative instruments is measured
based on current settlement values, which are based on quoted market prices,
industry standard models that are commercially available and broker
quotes. These techniques project cash flows of the derivatives using
current and implied future market conditions. We calculate the
present value of the cash flows to measure the current fair market value of the
derivative.
Cash
and Invested Cash
Cash and
invested cash is carried at cost, which approximates fair value. This
category includes highly liquid debt instruments purchased with a maturity of
three months or less. Due to the nature of these assets, we believe
these assets should be classified as Level 2.
Reinsurance
Related Embedded Derivative
The fair
value of our reinsurance embedded derivative is estimated using the same
methodologies and associated inputs as our investments as discussed
above.
Separate
Account Assets
The fair
value of our separate account assets is estimated using the same methodologies
and associated inputs as our investments, as discussed above. The
related separate account liabilities are reported at an amount equivalent to the
separate account assets. Investment risks associated with market
value changes are borne by the contract holders, except to the extent of minimum
guarantees made by the Company with respect to certain accounts. See
Note 9 for additional information regarding arrangements with contractual
guarantees.
Future
Contract Benefits
The fair
value of our indexed annuity contracts is based on their approximate surrender
values.
The fair
value of the GLB embedded derivative reserves is based on their approximate
surrender values, including an estimate for our non-performance
risk.
17. Segment
Information
We
provide products and services in two operating businesses and report results
through four business segments as follows:
Business
|
|
Corresponding
Segments
|
Retirement
Solutions
|
|
Annuities
|
|
|
Defined
Contribution
|
|
|
|
Insurance
Solutions
|
|
Life
Insurance
|
|
|
Group
Protection
|
We also
have Other Operations, which includes the financial data for operations that are
not directly related to the business segments. Our reporting segments
reflect the manner by which our chief operating decision makers view and manage
the business. The following is a brief description of these segments
and Other Operations.
Retirement
Solutions
The
Retirement Solutions business provides its products through two
segments: Annuities and Defined Contribution. The
Retirement Solutions – Annuities segment provides tax-deferred investment growth
and lifetime income opportunities for its clients by offering individual fixed
annuities, including indexed annuities and variable annuities. The
Retirement Solutions – Defined Contribution segment provides employer-sponsored
variable and fixed annuities and mutual-fund based programs in the 401(k),
403(b) and 457 marketplaces.
Insurance
Solutions
The
Insurance Solutions business provides its products through two
segments: Life Insurance and Group Protection. The
Insurance Solutions – Life Insurance segment offers wealth protection and
transfer opportunities through term insurance, a linked-benefit product (which
is a UL policy linked with riders that provide for long-term care costs) and
both single and survivorship versions of UL and VUL, including corporate-owned
UL and VUL insurance and bank-owned UL and VUL insurance
products. The Insurance Solutions – Group Protection segment offers
group life, disability and dental insurance to employers, and its products are
marketed primarily through a national distribution system of regional group
offices. These offices develop business through employee benefit
brokers, third-party administrators and other employee benefit
firms.
Other
Operations
Other
Operations includes investments related to the excess capital in our insurance
subsidiaries, investments in media properties and other corporate investments,
benefit plan net assets, the unamortized deferred gain on indemnity reinsurance
related to the sale of reinsurance to Swiss Re in 2001 and external
debt. We are actively managing our remaining radio station clusters
to maximize performance and future value. Other Operations also
includes the Institutional Pension business, which is a closed-block of pension
business, the majority of which was sold on a group annuity basis, and is
currently in run-off; and the results of certain disability income business due
to the rescission of this business previously sold to Swiss Re.
Segment
operating revenues and income (loss) from operations are internal measures used
by our management and Board of Directors to evaluate and assess the results of
our segments. Income (loss) from operations is GAAP net income
excluding the after-tax effects of the following items, as
applicable:
·
|
Realized
gains and losses associated with the following (“excluded realized
loss”):
|
|
§
|
Sale
or disposal of securities;
|
|
§
|
Impairments
of securities;
|
|
§
|
Change
in the fair value of embedded derivatives within certain reinsurance
arrangements and the change in the fair value of our trading
securities;
|
|
§
|
Net
difference between the portion of the change in the GDB benefit reserves
resulting from benefit ratio unlocking (“benefit ratio reserves”) within
our variable annuities and the change in the fair value of the derivatives
we own to hedge the changes in the benefit ratio reserves, excluding our
expected cost of purchasing the hedging
instruments;
|
|
§
|
Change
in the GLB embedded derivative reserves and GLB benefit ratio reserves
within our variable annuities net of the change in the fair value of the
derivatives we own to hedge the changes in the embedded derivative
reserves; and
|
|
§
|
Changes
in the fair value of the embedded derivative liabilities related to index
call options we may purchase in the future to hedge contract holder index
allocations applicable to future reset periods for our indexed annuity
products accounted for under the Derivatives and Hedging and the Fair
Value Measurements and Disclosures Topics of the FASB
ASC.
|
·
|
Income
(loss) from the initial adoption of new accounting
standards;
|
·
|
Income
(loss) from reserve changes (net of related amortization) on business sold
through reinsurance;
|
·
|
Gains
(losses) on early retirement of
debt;
|
·
|
Losses
from the impairment of intangible assets;
and
|
·
|
Income
(loss) from discontinued
operations.
|
Operating
revenues represent GAAP revenues excluding the pre-tax effects of the following
items, as applicable:
·
|
Excluded
realized loss;
|
·
|
Amortization
of deferred gains arising from the reserve changes on business sold
through reinsurance; and
|
·
|
Revenue
adjustments from the initial adoption of new accounting
standards.
|
Operating
revenues and income (loss) from operations do not replace revenues and net
income as the GAAP measures of our consolidated results of
operations.
Segment
information (in millions) was as follows:
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
revenues:
|
Retirement
Solutions:
|
Annuities
|
|
$ |
523 |
|
|
$ |
675 |
|
|
$ |
1,559 |
|
|
$ |
1,916 |
|
Defined
Contribution
|
|
|
236 |
|
|
|
241 |
|
|
|
676 |
|
|
|
718 |
|
Total
Retirement Solutions
|
|
|
759 |
|
|
|
916 |
|
|
|
2,235 |
|
|
|
2,634 |
|
Insurance
Solutions:
|
Life
Insurance
|
|
|
1,089 |
|
|
|
1,074 |
|
|
|
3,168 |
|
|
|
3,216 |
|
Group
Protection
|
|
|
414 |
|
|
|
403 |
|
|
|
1,279 |
|
|
|
1,227 |
|
Total
Insurance Solutions
|
|
|
1,503 |
|
|
|
1,477 |
|
|
|
4,447 |
|
|
|
4,443 |
|
Other
Operations
|
|
|
120 |
|
|
|
135 |
|
|
|
340 |
|
|
|
412 |
|
Excluded
realized loss, pre-tax
|
|
|
(302 |
) |
|
|
(259 |
) |
|
|
(924 |
) |
|
|
(420 |
) |
Amortization
of deferred gain arising from
|
|
|
|
|
|
|
|
|
|
|
|
|
reserve
changes on business sold through
|
|
|
|
|
|
|
|
|
|
|
|
|
reinsurance,
pre-tax
|
|
|
1 |
|
|
|
1 |
|
|
|
2 |
|
|
|
2 |
|
Total
revenues
|
|
$ |
2,081 |
|
|
$ |
2,270 |
|
|
$ |
6,100 |
|
|
$ |
7,071 |
|
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
Net
Income (Loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from operations:
|
Retirement
Solutions:
|
Annuities
|
|
$ |
95 |
|
|
$ |
131 |
|
|
$ |
234 |
|
|
$ |
365 |
|
Defined
Contribution
|
|
|
43 |
|
|
|
42 |
|
|
|
100 |
|
|
|
124 |
|
Total
Retirement Solutions
|
|
|
138 |
|
|
|
173 |
|
|
|
334 |
|
|
|
489 |
|
Insurance
Solutions:
|
Life
Insurance
|
|
|
137 |
|
|
|
137 |
|
|
|
412 |
|
|
|
458 |
|
Group
Protection
|
|
|
35 |
|
|
|
27 |
|
|
|
94 |
|
|
|
86 |
|
Total
Insurance Solutions
|
|
|
172 |
|
|
|
164 |
|
|
|
506 |
|
|
|
544 |
|
Other
Operations
|
|
|
(34 |
) |
|
|
(39 |
) |
|
|
(195 |
) |
|
|
(128 |
) |
Excluded
realized loss, after-tax
|
|
|
(196 |
) |
|
|
(169 |
) |
|
|
(600 |
) |
|
|
(274 |
) |
Gain
on early extinguishment of debt, net of tax
|
|
|
- |
|
|
|
- |
|
|
|
42 |
|
|
|
- |
|
Income
from reserve changes (net of related
|
|
|
|
|
|
|
|
|
|
|
|
|
amortization)
on business sold through
|
|
|
|
|
|
|
|
|
|
|
|
|
reinsurance,
after-tax
|
|
|
- |
|
|
|
- |
|
|
|
1 |
|
|
|
1 |
|
Impairment
of intangibles, after-tax
|
|
|
1 |
|
|
|
- |
|
|
|
(601 |
) |
|
|
(139 |
) |
Income
(loss) from continuing operations, after-tax
|
|
|
81 |
|
|
|
129 |
|
|
|
(513 |
) |
|
|
493 |
|
Income
(loss) from discontinued operations, after-tax |
|
72
|
|
|
19 |
|
|
|
(74 |
) |
|
|
69 |
|
Net
income (loss)
|
|
$ |
153 |
|
|
$ |
148 |
|
|
$ |
(587 |
) |
|
$ |
562 |
|
18. Supplemental
Disclosures of Cash Flow
The
following summarizes our supplemental cash flow data (in millions):
|
|
|
|
|
|
|
|
|
For
the Nine
|
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
Significant
non-cash investing and financing transactions:
|
|
|
|
|
|
|
Business
dispositions:
|
|
|
|
|
|
|
Assets disposed (includes
cash and invested cash)
|
|
$ |
- |
|
|
$ |
(732 |
) |
Liabilities disposed
|
|
|
- |
|
|
|
126 |
|
Cash
received
|
|
|
- |
|
|
|
647 |
|
Realized
gain on disposal
|
|
|
- |
|
|
|
41 |
|
Estimated
loss on net assets held-for-sale in prior periods
|
|
|
- |
|
|
|
(54 |
) |
Loss
on dispositions
|
|
$ |
- |
|
|
$ |
(13 |
) |
Item
2. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
The
following Management’s Discussion and Analysis (“MD&A”) is intended to help
the reader understand the financial condition of Lincoln National Corporation
and its consolidated subsidiaries (“LNC,” “Lincoln” or the “Company” which also
may be referred to as “we,” “our” or “us”) as of September 30, 2009, compared
with December 31, 2008, and the results of operations of LNC for the three and
nine months ended September 30, 2009, as compared with the corresponding periods
in 2008. The MD&A is provided as a supplement to, and should be
read in conjunction with: our consolidated financial statements and
the accompanying notes to the consolidated financial statements (“Notes”)
presented in “Item 1. Financial Statements”; our Form 10-K for the year ended
December 31, 2008 (“2008 Form 10-K”), including the sections entitled “Part I –
Item 1A. Risk Factors,” “Part II – Item 7. Management’s Discussion and Analysis
of Financial Condition and Results of Operations” and “Part II – Item 8.
Financial Statements and Supplementary Data”; our quarterly reports on Form 10-Q
filed in 2009; and our current reports on Form 8-K filed in 2009.
See Note
2 for a detailed discussion of how the Financial Accounting Standards Board
(“FASB”) Accounting Standards
CodificationTM
(“ASC”) is now the single source of authoritative United States of
America generally accepted accounting principles (“GAAP”) recognized by the
FASB. Accordingly, we have revised all references to GAAP accounting
standards in this filing to reflect the appropriate references in the new FASB
ASC.
In this
report, in addition to providing consolidated revenues and net income (loss), we
also provide segment operating revenues and income (loss) from operations
because we believe they are meaningful measures of revenues and the
profitability of our operating segments. Income (loss) from
operations is net income recorded in accordance with GAAP excluding the
after-tax effects of the following items, as applicable:
·
|
Realized
gains and losses associated with the following (“excluded realized
loss”):
|
|
§
|
Sale
or disposal of securities;
|
|
§
|
Impairments
of securities;
|
|
§
|
Change
in the fair value of embedded derivatives within certain reinsurance
arrangements and the change in the fair value of our trading
securities;
|
|
§
|
Net
difference between the portion of the change in reserves accounted for
under the Financial Services – Insurance – Claim Costs and Liabilities for
Future Policy Benefits Subtopic of the FASB ASC resulting from benefit
ratio unlocking (“benefit ratio reserves”) of our guaranteed death benefit
(“GDB”) riders within our variable annuities and the change in the fair
value of the derivatives we own to hedge the changes in the benefit ratio
reserves, excluding our expected cost of purchasing the hedging
instruments, the net of which is referred to as “GDB derivatives
results”;
|
|
§
|
Change
in the fair value of the embedded derivatives of our guaranteed living
benefit (“GLB”) riders within our variable annuities accounted for under
the Derivatives and Hedging and the Fair Value Measurements and
Disclosures Topics of the FASB ASC (“embedded derivative reserves”) and
GLB benefit ratio reserves, net of the change in the fair value of the
derivatives we own to hedge the changes in the embedded derivative
reserves, the net of which is referred to as “GLB net derivative results”;
and
|
|
§
|
Changes
in the fair value of the embedded derivative liabilities related to index
call options we may purchase in the future to hedge contract holder index
allocations applicable to future reset periods for our indexed annuity
products accounted for under the Derivatives and Hedging and the Fair
Value Measurements and Disclosures Topics of the FASB ASC (“indexed
annuity forward-starting option”).
|
·
|
Income
(loss) from the initial adoption of new accounting
standards;
|
·
|
Income
(loss) from reserve changes (net of related amortization) on business sold
through reinsurance;
|
·
|
Gains
(losses) on early retirement of
debt;
|
·
|
Losses
from the impairment of intangible assets;
and
|
·
|
Income
(loss) from discontinued
operations.
|
Operating
revenues represent GAAP revenues excluding the pre-tax effects of the following
items, as applicable:
·
|
Excluded
realized loss;
|
·
|
Amortization
of deferred gains arising from the reserve changes on business sold
through reinsurance; and
|
·
|
Revenue
adjustments from the initial adoption of new accounting
standards.
|
Operating
revenues and income (loss) from operations are the financial performance
measures we use to evaluate and assess the results of our
segments. Accordingly, we report operating revenues and income (loss)
from operations by segment in Note 17. Our management and Board of
Directors believe that operating revenues and income (loss) from operations
explain the results of our ongoing businesses in a manner that allows for a
better understanding of the underlying trends in our current businesses because
the excluded items are unpredictable and not necessarily indicative of current
operating fundamentals or future performance of the business segments, and, in
many instances, decisions regarding these items do not necessarily relate to the
operations of the individual segments. In addition, we believe that
our definitions of operating revenues and income (loss) from operations will
provide investors with a more valuable measure of our performance because it
better reveals trends in our business.
Operating
revenues and income (loss) from operations do not replace revenues and net
income as the GAAP measures of our consolidated results of
operations.
FORWARD-LOOKING STATEMENTS –
CAUTIONARY
LANGUAGE
Certain
statements made in this report and in other written or oral statements made by
LNC or on LNC’s behalf are “forward-looking statements” within the meaning of
the Private Securities Litigation Reform Act of 1995 (“PSLRA”). A
forward-looking statement is a statement that is not a historical fact and,
without limitation, includes any statement that may predict, forecast, indicate
or imply future results, performance or achievements, and may contain words
like: “believe,” “anticipate,” “expect,” “estimate,” “project,”
“will,” “shall” and other words or phrases with similar meaning in connection
with a discussion of future operating or financial performance. In
particular, these include statements relating to future actions, trends in our
businesses, prospective services or products, future performance or financial
results and the outcome of contingencies, such as legal
proceedings. LNC claims the protection afforded by the safe harbor
for forward-looking statements provided by the PSLRA.
Forward-looking
statements involve risks and uncertainties that may cause actual results to
differ materially from the results contained in the forward-looking
statements. Risks and uncertainties that may cause actual results to
vary materially, some of which are described within the forward-looking
statements, include, among others:
·
|
Continued
deterioration in general economic and business conditions, both domestic
and foreign, that may affect foreign exchange rates, premium levels,
claims experience, the level of pension benefit costs and funding and
investment results;
|
·
|
Continued
economic declines and credit market illiquidity could cause us to realize
additional impairments on investments and certain intangible assets,
including goodwill and a valuation allowance against deferred tax assets,
which may reduce future earnings and/or affect our financial condition and
ability to raise additional capital or refinance existing debt as it
matures;
|
·
|
Uncertainty
about the impact of the U.S. Treasury’s Troubled Asset Relief Program
(“TARP”) on the economy;
|
·
|
The
cost and other consequences of our participation in the TARP Capital
Purchase Program (“CPP”), including the impact of existing regulation and
future regulations to which we may become
subject;
|
·
|
Legislative,
regulatory or tax changes, both domestic and foreign, that affect the cost
of, or demand for, LNC’s products, the required amount of reserves and/or
surplus, or otherwise affect our ability to conduct business, including
changes to statutory reserves and/or risk-based capital (“RBC”)
requirements related to secondary guarantees under universal life and
variable annuity products such as Actuarial Guideline (“AG”) 43 (“AG43,”
also known as Commissioners Annuity Reserve Valuation Method for Variable
Annuities or “VACARVM”); restrictions on revenue sharing and 12b-1
payments; and the potential for U.S. Federal tax
reform;
|
·
|
The
initiation of legal or regulatory proceedings against LNC or its
subsidiaries, and the outcome of any legal or regulatory proceedings, such
as: adverse actions related to present or past business
practices common in businesses in which LNC and its subsidiaries compete;
adverse decisions in significant actions including, but not limited to,
actions brought by federal and state authorities and extra-contractual and
class action damage cases; new decisions that result in changes in law;
and unexpected trial court rulings;
|
·
|
Changes
in interest rates causing a reduction of investment income, the margins of
LNC’s fixed annuity and life insurance businesses and demand for LNC’s
products;
|
·
|
A
decline in the equity markets causing a reduction in the sales of LNC’s
products, a reduction of asset-based fees that LNC charges on various
investment and insurance products, an acceleration of amortization of
deferred acquisition costs (“DAC”), value of business acquired (“VOBA”),
deferred sales inducements (“DSI”) and deferred front-end loads (“DFEL”)
and an increase in liabilities related to guaranteed benefit features of
LNC’s variable annuity products;
|
·
|
Ineffectiveness
of LNC’s various hedging strategies used to offset the impact of changes
in the value of liabilities due to changes in the level and volatility of
the equity markets and interest
rates;
|
·
|
A
deviation in actual experience regarding future persistency, mortality,
morbidity, interest rates or equity market returns from LNC’s assumptions
used in pricing its products, in establishing related insurance reserves
and in the amortization of intangibles that may result in an increase in
reserves and a decrease in net income, including as a result of
stranger-originated life insurance
business;
|
·
|
Changes
in GAAP that may result in unanticipated changes to LNC’s net
income;
|
|
Lowering
of one or more of LNC’s debt ratings issued by nationally recognized
statistical rating organizations and the adverse impact such action may
have on LNC’s ability to raise capital and on its liquidity and financial
condition;
|
·
|
Lowering
of one or more of the insurer financial strength ratings of LNC’s
insurance subsidiaries and the adverse impact such action may have on the
premium writings, policy retention, profitability of its insurance
subsidiaries and liquidity;
|
·
|
Significant
credit, accounting, fraud or corporate governance issues that may
adversely affect the value of certain investments in the portfolios of
LNC’s companies requiring that LNC realize losses on such
investments;
|
·
|
The
impact of acquisitions and divestitures, restructurings, product
withdrawals and other unusual items, including LNC’s ability to integrate
acquisitions and to obtain the anticipated results and synergies from
acquisitions;
|
·
|
The
adequacy and collectibility of reinsurance that LNC has
purchased;
|
·
|
Acts
of terrorism, a pandemic, war or other man-made and natural catastrophes
that may adversely affect LNC’s businesses and the cost and availability
of reinsurance;
|
·
|
Competitive
conditions, including pricing pressures, new product offerings and the
emergence of new competitors, that may affect the level of premiums and
fees that LNC can charge for its
products;
|
·
|
The
unknown impact on LNC’s business resulting from changes in the
demographics of LNC’s client base, as aging baby-boomers move from the
asset-accumulation stage to the asset-distribution stage of life;
and
|
·
|
Loss
of key management, financial planners or
wholesalers.
|
The risks
included here are not exhaustive. Other sections of this report, our
2008 Form 10-K, current reports on Form 8-K and other documents filed with the
Securities and Exchange Commission (“SEC”) include additional factors that could
impact LNC’s business and financial performance, including “Item 3. Quantitative
and Qualitative Disclosures About Market Risk” and the risk discussions included
in this section under “Critical Accounting Policies and Estimates,”
“Consolidated Investments” and “Reinsurance,” which are incorporated herein by
reference. 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 undue 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.
INTRODUCTION
Executive
Summary
We are a
holding company that operates multiple insurance businesses through subsidiary
companies. Through our business segments, we sell a wide range of
wealth protection, accumulation and retirement income products and
solutions. These products include institutional and/or retail fixed
and indexed annuities, variable annuities, universal life insurance (“UL”),
variable universal life insurance (“VUL”), linked-benefit UL, term life
insurance and mutual funds.
We
provide products and services in two operating businesses and report results
through four business segments as follows:
Business
|
Corresponding
Segments
|
Retirement
Solutions
|
Annuities
|
|
Defined
Contribution
|
|
|
Insurance
Solutions
|
Life
Insurance
|
|
Group
Protection
|
These
operating businesses and their segments are described in “Part I – Item 1. Business”
of our 2008 Form 10-K.
We also
have Other Operations, which includes the financial data for operations that are
not directly related to the business segments. Other Operations also
includes our run-off Institutional Pension business, the results of certain
disability income business due to the rescission of this business previously
sold to Swiss Re and the results of our remaining media businesses.
Our
former Lincoln UK and Investment Management segments are reported in
discontinued operations for all periods presented.
Current
Market Conditions
Subsequent
to the first quarter of 2009, the capital and credit markets showed signs of
improvement following a period of extreme volatility and disruption that
affected both equity market returns and interest rates. During this
period, credit spreads widened across asset classes and reduced liquidity in the
credit markets. The price of our common stock steadily increased
during the second and third quarters of 2009 to close at $25.91 on September 30,
2009, as compared to $18.84 on December 31, 2008, after having traded at a low
of $4.90 during the first quarter of 2009. Analysts and economists
noted in January 2009 that the U.S. economy lost more jobs in 2008 than in any
year subsequent to World War II and projected that the economic recovery might
take longer than previously expected. We also experienced a series of
ratings downgrades primarily from February 2009 to May 2009 as depressed capital
markets continued to strain our liquidity as we prepared to fund debt maturities
in the second quarter of 2009; however, during June of 2009 and following the
announcement about our planned capital actions discussed below, all four of the
major independent rating agencies affirmed our financial strength ratings, and
Standard & Poor’s (“S&P”) improved its outlook on our company to stable
from negative.
Earnings
will continue to be unfavorably impacted by the prior significant decline in the
equity markets. Due to these challenges, the capital markets had a
significant effect on our segment income (loss) from operations and consolidated
net income during the first nine months of 2009. In the face of these
capital market challenges, we continue to focus on building our businesses
through these difficult markets and beyond by developing and introducing high
quality products, expanding distribution in new and existing key accounts and
channels and targeting market segments that have high growth potential while
maintaining a disciplined approach to managing our expenses. During
the third quarter of 2009, we experienced modestly lower deposits but
significantly higher net flows than in the corresponding period of
2008.
The
markets have primarily impacted the following areas:
Adequacy
of Our Liquidity and Capital Positions
We are
committed to managing our capital effectively. The continued adequacy
of our liquidity resources to meet requirements of our businesses and our
holding company depends upon such factors as market conditions and our ability
to access sources of liquidity. In addition, market volatility
impacts the level of capital required to support our businesses.
Given
this dynamic and challenging environment, we have taken measures to prudently
and actively manage our liquidity and capital positions. As discussed
in “Review of Consolidated Financial Condition – Liquidity and Capital Resources
– Sources of Liquidity and Cash Flow – Financing Activities,” we issued $690
million of common stock and $500 million of senior notes during the second
quarter of 2009 and issued $950 million preferred stock and a common stock
warrant through the U.S. Treasury’s TARP CPP in the third quarter of 2009, as
discussed below in “TARP CPP.” These actions compliment our past
actions of reducing the dividend on our common stock, suspending stock
repurchase activity, restructuring the company to reduce overall expenses and
entering into a reinsurance transaction to increase statutory capital for our
primary insurance subsidiary.
Currently,
we expect to meet the ongoing cash needs of the holding company for the
foreseeable future as a result of the raising of $2.1 billion as part of several
capital transactions and in combination with expense savings and sales discussed
below in “Acquisitions and Dispositions.” We also expect to maintain
more liquidity at the holding company as compared to prior years.
For more
information on our liquidity and capital positions, see “Review of Consolidated
Financial Condition” below.
Earnings
from Account Values
Our
asset-gathering segments – Retirement Solutions – Annuities and Retirement
Solutions – Defined Contribution – are the most sensitive to the equity
markets. We discuss the earnings impact of the equity markets on
account values and the related asset-based earnings below in “Item
3. Quantitative and Qualitative Disclosures About Market Risk –
Equity Market Risk – Impact of Equity Market Sensitivity.” From
December 31, 2008, to September 30, 2009, our account values were up $19 billion
driven by strong deposits, positive net flows and recent improvements in the
equity markets. The effect of the negative equity markets on
our account values that subsided in the second quarter of 2009 will continue to
dampen our earnings in 2009 even if the equity market returns become consistent
with our long-term assumptions. While our ending variable account
values as of September 30, 2009, were modestly higher than as of September 30,
2008, the daily average account values for the three and nine months ended
September 30, 2009, were much lower than the corresponding period in the prior
year, consistent with the reduction in our asset-based
earnings. Accordingly, we may continue to report lower asset-based
fees, higher DAC and VOBA amortization and higher reserves related to our GDB
guarantees relative to expectations or prior periods.
Investment
Income on Alternative Investments
We
believe that overall market conditions in both the equity and credit markets
caused our alternative investments portfolio, which consists primarily of hedge
funds and various limited partnership investments, to under-perform relative to
our long-term return expectations, and we expect these assets to continue to
under-perform at least in the short term. During the first nine
months of 2009, the most significant unfavorable impact from these investments
was related to audit adjustments from the completion of calendar-year financial
statement audits of our investees, determined and recognized during the second
quarter of 2009. The audit reports that we received for these
investees reflected a lower equity balance than the unaudited financial
statements that we had been provided previously that were used as the basis for
valuation at year end 2008 and the first quarter of 2009. These
investments impact primarily our Insurance Solutions – Life Insurance segment
and to a lesser extent our Retirement Solutions – Annuities and Retirement
Solutions – Defined Contribution segments. See “Consolidated
Investments – Alternative Investments” for additional information on our
investment portfolio and further discussion on the nature of the audit
adjustments referred to above.
Variable
Annuity Hedge Program Results
We offer
variable annuity products with living benefit guarantees. As
described below in “Critical Accounting Policies and Estimates – Derivatives –
Guaranteed Living Benefits,” we use derivative instruments to hedge our exposure
to the risks and earnings volatility that result from the GLB embedded
derivatives in certain of our variable annuity products. The change
in fair value of these instruments tends to move in the opposite direction of
the change in embedded derivative reserves. For the first nine months
of 2009, impacts of changes in interest rate risk unfavorably affected the net
change in GLB embedded derivative reserves, excluding the effect of our
non-performance risk (“NPR”), and the change in fair value of the hedging
derivatives. This impact was heightened as a result of our decision
not to hedge all of the interest rate risk in response to the pending adoption
of VACARVM, which is discussed further below.
The NPR
factors result in an additional amount added to the discount rate in the
calculation of the GLB embedded derivative reserve. The NPR factors
are impacted by our holding company’s credit default swap (“CDS”) spreads
adjusted for items, such as the liquidity of our holding company
CDS. Because the guaranteed benefit liabilities are contained within
our insurance subsidiaries, we apply items, such as the impact of our insurance
subsidiaries’ claims-paying ratings compared to holding company credit risk and
the over-collateralization of insurance liabilities, in order to determine
factors that are representative of a theoretical market participant’s view of
the NPR of the specific liability within our insurance
subsidiaries. This had an unfavorable effect during the first nine
months of 2009 attributable to narrowing of credit spreads. These
results are excluded from the Retirement Solutions – Annuities and Defined
Contribution segments’ operating revenues and income from
operations. See “Realized Loss – Operating Realized Gain (Loss) –
GLB” for information on our methodology for calculating the NPR.
We also
offer variable products with death benefit guarantees. As described
in “Critical Accounting Policies and Estimates – Future Contract Benefits and
Other Contract Holder Obligations – Guaranteed Death Benefits” in our 2008 Form
10-K, we use derivative instruments to attempt to hedge in the opposite
direction of the changes in our associated GDB benefit ratio reserves for
movements in equity markets. These results are excluded from income
(loss) from operations.
Variable
Annuity Business Model
In order
to address the realities of the current market conditions in the variable
annuity marketplace, in late January 2009, we introduced changes to our GLB
riders including increased rider fees, reduced roll-up periods and tighter
investment restrictions on new business and a large percentage of in-force
account value. Increased equity market implied volatility and falling
interest rates have increased the cost of providing GLBs. The January
product changes reduce our exposure to equity market volatility and interest
rate movements while compensating us for increasing costs to provide the
benefits.
Credit
Losses, Impairments and Unrealized Losses
Related
to our investments in fixed income and equity securities, we experienced net
realized losses which reduced net income by $82 million and $238 million for the
three and nine months ended September 30, 2009, and included credit related
write-downs of securities for other-than-temporary impairments (“OTTI”) of $52
million and $207 million, respectively. Although economic conditions
have improved, we expect a continuation of some level of OTTI. If we
were to experience another period of weakness in the economic environment like
we did in late 2008 and early 2009, it could lead to increased credit defaults,
resulting in additional write-downs of securities for OTTI.
Increased
liquidity in several market segments and improved credit fundamentals (i.e.,
market improvement and narrowing credit spreads) as of September 30, 2009,
compared to December 31, 2008, has resulted in the $4.3 billion decrease in
gross unrealized losses on the available-for-sale (“AFS”) fixed maturity
securities in our general account as of September 30, 2009. Our
unrealized losses are concentrated in the investment grade category of
investments and demonstrate how reduced liquidity in the credit markets has
impacted asset values.
Stimulus
Legislation
In
reaction to the recession, credit market illiquidity and global financial crisis
experienced during the latter part of 2008 and into 2009, Congress enacted the
Emergency Economic Stabilization Act of 2008 (“EESA”) on October 3, 2008, and
the American Recovery and Reinvestment Act of 2009 (“ARRA”) which was signed
into law on February 17, 2009, in an effort to restore liquidity to the U.S.
credit markets and stimulate the U.S. economy. The ARRA and TARP
authorized the purchase of “troubled assets” from financial institutions,
including insurance companies. Pursuant to the authority granted
under the TARP, the U.S. Treasury also adopted the CPP, the Generally Available
Capital Access Program and the Exceptional Financial Recovery Assistance
Program. It remains unclear at this point, if and when the EESA and
ARRA will restore sustained liquidity and confidence in the markets and its
affect on the fair value of our invested assets.
TARP
CPP
On
November 13, 2008, we filed an application to participate in the CPP that was
established under the EESA. On January 8, 2009, the Office of Thrift
Supervision approved our application to become a savings and loan holding
company and our acquisition of Newton County Loan & Savings, FSB, a
federally regulated savings bank, located in Indiana. We contributed
$10 million to the capital of Newton County Loan & Savings, FSB, and closed
on the purchase on January 15, 2009. On May 8, 2009, the U.S.
Treasury granted us preliminary approval to participate in the
CPP. On July 10, 2009, we issued, in a private placement, $950
million of Series B preferred stock and a warrant for 13,049,451 shares of our
common stock with an exercise price of $10.92 per share to the U.S. Treasury
under the CPP. See “Review of Consolidated Financial Condition –
Liquidity and Capital Resources – Sources of Liquidity and Cash Flow – Financing
Activities” for more information about our preferred stock
issuance.
Participation
in the CPP subjects us to increased oversight by the U.S.
Treasury. The U.S. Treasury has the power to unilaterally amend the
terms of the purchase agreement to the extent required to comply with changes in
applicable statutes and to inspect our corporate books and records through our
federal banking regulators. In addition, the U.S. Treasury has the
right to appoint two directors to our Board if we miss dividend payments on the
preferred stock as discussed below. Participation in the CPP may also
subject us to increased Congressional scrutiny.
In
connection with participating in the CPP, we registered as a savings and loan
holding company, which subjects us to new legal and regulatory requirements,
including minimum capital requirements, and subjects us to oversight, regulation
and examination by the Office of Thrift Supervision.
We are
also subject to certain restrictions, notably, limits on incentive compensation
for certain executives and employees for the duration of the U.S. Treasury’s
investment. We are also subject to limits on increasing the dividend
on our common stock and redeeming capital stock (unless the U.S. Treasury
consents), both of which apply until the third anniversary of the U.S.
Treasury’s investment unless we redeem the Series B preferred shares in whole or
the U.S. Treasury transfers all of the Series B preferred stock to third
parties.
The U.S.
Treasury will not vote the Series B preferred stock or the common stock it may
receive upon exercise of the warrant. However, with respect to the
Series B preferred stock, the U.S. Treasury would have class voting rights on
the issuance of shares ranking senior to the Series B preferred stock,
amendments to the rights of the Series B preferred stock or any merger, exchange
or similar transaction that would adversely affect the rights of the Series B
preferred stock. If dividends on the Series B preferred stock are not
paid in full for six dividend periods, whether or not consecutive, the Series B
preferred stock holders will have the right, together with the holders of any
other affected classes of future parity stock, voting as a single class, to
elect two directors.
Under
current CPP documentation, if we receive aggregate cash proceeds equal to not
less than 100% of the aggregate liquidation preference of the Series B preferred
stock sold to the U.S. Treasury from the sale of shares of common stock,
perpetual preferred stock or any combination of such securities after the
closing of our CPP transaction and on or prior to December 31, 2009, the number
of shares of common stock underlying the warrant held by the U.S. Treasury will
be reduced by half. In addition, under current guidance, after
redeeming the Series B preferred stock, we will have the right to repurchase the
warrant for its appraised market value, and if we do not repurchase the warrant,
the U.S. Treasury can liquidate the warrant. In addition, we have
granted the U.S. Treasury registration rights covering the shares of Series B
preferred stock, the warrant and the shares of common stock issuable upon the
exercise of the warrant.
Challenges
and Outlook
For the
remainder of 2009, we expect major challenges to include:
·
|
Unstable
credit markets that impact our financing alternatives, spreads and
other-than-temporary securities
impairments;
|
·
|
Volatile
equity markets that have a significant impact on our hedge program
performance and revenues;
|
·
|
Continuation
of the low interest rate environment, which affects the investment margins
and reserve levels for many of our products, such as fixed annuities and
UL;
|
·
|
Possible
additional intangible asset impairments, such as goodwill, if the
financial performance of our reporting units deteriorates, our market
capitalization remains below book value for a prolonged period of time or
business valuation assumptions (such as discount rates and equity market
volatility) are adversely affected;
|
·
|
Achieving
continued sales success with our portfolio of products, including
marketplace acceptance of new variable annuity features, as well as
retaining management and wholesaler talent to maintain our competitive
position; and
|
·
|
Continuing
focus by the government on tax and healthcare reform including potential
changes in company dividends-received deduction (“DRD”) calculations,
which may affect the value and profitability of our products and overall
earnings.
|
In the
face of these challenges, we expect to focus on the following throughout the
remainder of 2009:
·
|
Increase
our product development activities together with identifying future
product development initiatives, with a focus on further reducing risk
related to guaranteed benefit riders available on with certain variable
annuity contracts;
|
·
|
Manage
our expenses aggressively through cost reduction and process improvement
initiatives combined with continued financial discipline and execution
excellence throughout our
operations;
|
·
|
Execute
on financing strategies addressing the statutory reserve strain related to
our secondary guarantee UL products in order to manage our capital
position effectively in accordance with our pricing guidelines;
and
|
·
|
Closely
monitor our capital and liquidity positions taking into account the
fragile economic recovery and changing statutory accounting and reserving
practices.
|
For
additional factors that could cause actual results to differ materially from
those set forth in this section, see “Part I – Item 1A. Risk Factors” in our
2008 Form 10-K and “Forward-Looking Statements – Cautionary Language” in this
report.
Critical
Accounting Policies and Estimates
The
MD&A included in our 2008 Form 10-K contains a detailed discussion of our
critical accounting policies and estimates. The following information
updates the “Critical Accounting Policies and Estimates” provided in our 2008
Form 10-K and, accordingly, should be read in conjunction with the “Critical
Accounting Policies and Estimates” discussed in our 2008 Form 10-K.
DAC,
VOBA, DSI and DFEL
On a
quarterly basis, we may record an adjustment to the amounts included within our
Consolidated Balance Sheets for DAC, VOBA, DSI and DFEL with an offsetting
benefit or charge to revenue or expense for the impact of the difference between
future estimated gross profits (“EGPs”) used in the prior quarter and the
emergence of actual and updated future EGPs in the current quarter
(“retrospective unlocking”). In addition, in the third quarter of
each year, we conduct our annual comprehensive review of the assumptions and the
projection models used for our estimates of future gross profits underlying the
amortization of DAC, VOBA, DSI and DFEL and the calculations of the embedded
derivatives and reserves for annuity and life insurance products with living
benefit and death benefit guarantees. These assumptions include
investment margins, mortality, retention, rider utilization and maintenance
expenses (costs associated with maintaining records relating to insurance and
individual and group annuity contracts and with the processing of premium
collections, deposits, withdrawals and commissions). Based on our
review, the cumulative balances of DAC, VOBA, DSI and DFEL, included on our
Consolidated Balance Sheets, are adjusted with an offsetting benefit or charge
to revenue or amortization expense to reflect such change (“prospective
unlocking – assumption changes”). We may also identify and implement
actuarial modeling refinements (“prospective unlocking – model refinements”)
that result in increases or decreases to the carrying values of DAC, VOBA, DSI,
DFEL, embedded derivatives and reserves for annuity and life insurance products
with living benefit and death benefit guarantees. The primary
distinction between retrospective and prospective unlocking is that
retrospective unlocking is driven by the difference between actual gross profits
compared to EGPs each period, while prospective unlocking is driven by changes
in assumptions or projection models related to our projections of future
EGPs.
In
discussing our results of operations below in this MD&A, we refer to
favorable and unfavorable unlocking. With respect to DAC, VOBA and
DSI, favorable unlocking refers to a decrease in the amortization expense in the
period, whereas unfavorable unlocking refers to an increase in the amortization
expense in the period. With respect to DFEL, favorable unlocking
refers to an increase in the amortization income in the period, whereas
unfavorable unlocking refers to a decrease in the amortization income in the
period. With respect to the calculations of the embedded derivatives
and reserves for annuity and life insurance products with living benefit and
death benefit guarantees, favorable unlocking refers to a decrease in reserves
in the period, whereas unfavorable unlocking refers to an increase in reserves
in the period.
For
illustrative purposes, the following presents the hypothetical impacts to EGP
and DAC (1)
amortization attributable to changes in assumptions from those our model
projections assume, assuming all other factors remain constant:
|
|
|
|
Hypothetical
|
|
|
|
|
|
|
|
|
|
|
Hypothetical
|
|
Impact
to
|
|
|
|
|
|
|
|
|
Actual
Experience Differs
|
|
Impact
to
|
|
Net
Income
|
|
|
|
|
|
|
|
|
From
Those Our Model
|
|
Net
Income
|
|
for
DAC (1)
|
|
|
|
|
|
|
|
|
Projections
Assume
|
|
for
EGPs
|
|
Amortization
|
|
Description
of Expected Impact
|
|
|
Higher
equity markets
|
|
Favorable
|
|
Favorable
|
|
Increase
to fee income and decrease to changes in
|
|
|
|
|
|
|
reserves.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lower
equity markets
|
|
Unfavorable
|
|
Unfavorable
|
|
Decrease
to fee income and increase to changes in
|
|
|
|
|
|
|
reserves.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Higher
investment margins
|
|
Favorable
|
|
Favorable
|
|
Increase
to interest rate spread on our fixed product
|
|
|
|
|
|
|
line,
including fixed portion of variable.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lower
investment margins
|
|
Unfavorable
|
|
Unfavorable
|
|
Decrease
to interest rate spread on our fixed product
|
|
|
|
|
|
|
line,
including fixed portion of variable.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Higher
credit losses
|
|
Unfavorable
|
|
Unfavorable
|
|
Decrease
to realized gains on investments.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lower
credit losses
|
|
Favorable
|
|
Favorable
|
|
Increase
to realized gains on investments.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Higher
lapses
|
|
Unfavorable
|
|
Unfavorable
|
|
Decrease
to fee income, partially offset by decrease to
|
|
|
|
|
|
|
benefits
due to shorter contract life.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lower
lapses
|
|
Favorable
|
|
Favorable
|
|
Increase
to fee income, partially offset by increase to
|
|
|
|
|
|
|
benefits
due to longer contract life.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Higher
death claims
|
|
Unfavorable
|
|
Unfavorable
|
|
Decrease
to fee income and increase to changes in
|
|
|
|
|
|
|
reserves
due to shorter contract life.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lower
death claims
|
|
Favorable
|
|
Favorable
|
|
Increase
to fee income and decrease to changes in
|
|
|
|
|
|
|
reserves
due to longer contract life.
|
|
|
(1)
|
DAC
refers to the associated amortization of DAC, VOBA, DSI and DFEL and
changes in future contract
benefits.
|
Details
underlying the increase to income from continuing operations from our
prospective unlocking (in millions) were as follows:
|
|
For
the Three
|
|
|
|
Months
Ended
|
|
|
|
September
30,
|
|
|
|
2009
|
|
|
2008
|
|
Insurance
fees:
|
|
|
|
|
|
|
Retirement
Solutions - Annuities
|
|
$ |
3 |
|
|
$ |
(1 |
) |
Insurance
Solutions - Life Insurance
|
|
|
20 |
|
|
|
(28 |
) |
Total
insurance fees
|
|
|
23 |
|
|
|
(29 |
) |
Realized
gain (loss):
|
|
|
|
|
|
|
|
|
GLB
|
|
|
(26 |
) |
|
|
48 |
|
Total
realized gain (loss)
|
|
|
(26 |
) |
|
|
48 |
|
Total
revenues
|
|
|
(3 |
) |
|
|
19 |
|
Benefits:
|
|
|
|
|
|
|
|
|
Retirement Solutions - Annuities
|
|
|
1 |
|
|
|
1 |
|
Insurance
Solutions - Life Insurance
|
|
|
(2 |
) |
|
|
85 |
|
Total
benefits
|
|
|
(1 |
) |
|
|
86 |
|
Underwriting,
acquisition, insurance and other expenses:
|
|
|
|
|
|
|
|
|
Retirement Solutions - Annuities
|
|
|
10 |
|
|
|
(2 |
) |
Retirement Solutions - Defined Contribution
|
|
|
(8 |
) |
|
|
- |
|
Insurance Solutions - Life Insurance
|
|
|
33 |
|
|
|
(81 |
) |
Total
underwriting, acquisition, insurance and other expenses
|
|
|
35 |
|
|
|
(83 |
) |
Total
benefits and expenses
|
|
|
34 |
|
|
|
3 |
|
Income
from continuing operations before taxes
|
|
|
(37 |
) |
|
|
16 |
|
Federal
income tax expense (benefit)
|
|
|
(13 |
) |
|
|
6 |
|
Income
from continuing operations
|
|
$ |
(24 |
) |
|
$ |
10 |
|
As equity
markets do not move in a systematic manner, we reset the baseline of account
values from which EGPs are projected, which we refer to as our “reversion to the
mean” (“RTM”) process. Under our current RTM process, on each
valuation date, future EGPs are projected using stochastic modeling of a large
number of future equity market scenarios in conjunction with best estimates of
lapse rates, interest rate spreads and mortality to develop a statistical
distribution of the present value of future EGPs for our variable annuity,
annuity-based 401(k) and VUL blocks of business. Because future
equity market returns are unpredictable, the underlying premise of this process
is that best estimate projections of future EGPs need not be affected by random
short-term and insignificant deviations from expectations in equity market
returns. However, long-term or significant deviations from expected
equity market returns require a change to best estimate projections of EGPs and
prospective unlocking of DAC, VOBA, DSI, DFEL and changes in future contract
benefits. The statistical distribution is designed to identify when
the equity market return deviations from expected returns have become
significant enough to warrant a change of the future equity return EGP
assumption.
The
stochastic modeling performed for our variable annuity blocks of business as
described above is used to develop a range of reasonably possible future
EGPs. We compare the range of the present value of the future EGPs
from the stochastic modeling to that used in our amortization
model. A set of intervals around the mean of these scenarios is
utilized to calculate two separate statistical ranges of reasonably possible
EGPs. These intervals are then compared again to the present value of
the EGPs used in the amortization model. If the present value of EGP
assumptions utilized for amortization were to exceed the margin of the
reasonable range of statistically calculated EGPs, a revision of the EGPs used
to calculate amortization would occur. If a revision is deemed
necessary, future EGPs would be re-projected using the current account values at
the end of the period during which the revision occurred along with a revised
long-term annual equity market gross return assumption such that the reprojected
EGPs would be our best estimate of EGPs.
Notwithstanding
these intervals, if a severe decline or advance in equity markets were to occur
or should other circumstances, including contract holder behavior, suggest that
the present value of future EGPs no longer represents our best estimate, we
could determine that a revision of the EGPs is necessary.
Our
practice is not necessarily to unlock immediately after exceeding the first of
the two statistical ranges, but, rather, if we stay between the first and second
statistical range for several quarters, we would likely
unlock. Additionally, if we exceed the ranges as a result of a
short-term market reaction, we would not necessarily unlock. However,
if the second statistical range is exceeded for more than one quarter, it is
likely that we would unlock. While this approach reduces adjustments
to DAC, VOBA, DSI and DFEL due to short-term equity market fluctuations,
significant changes in the equity markets that extend beyond one or two quarters
could result in a significant favorable or unfavorable unlocking.
Goodwill
and Other Intangible Assets
Under the
Intangibles – Goodwill and Other Topic of the FASB ASC, goodwill and intangible
assets with indefinite lives are not amortized, but are subject to impairment
tests conducted at least annually. Intangibles that do not have
indefinite lives are amortized over their estimated useful lives. We
are required to perform a two-step test in our evaluation of the carrying value
of goodwill. In Step 1 of the evaluation, the fair value of each
reporting unit is determined and compared to the carrying value of the reporting
unit. If the fair value is greater than the carrying value, then the
carrying value is deemed to be sufficient and Step 2 is not
required. If the fair value estimate is less than the carrying value,
it is an indicator that impairment may exist and Step 2 is required to be
performed. In Step 2, the implied fair value of the reporting unit’s
goodwill is determined by allocating the reporting unit’s fair value as
determined in Step 1 to all of its net assets (recognized and unrecognized) as
if the reporting unit had been acquired in a business combination at the date of
the impairment test. If the implied fair value of the reporting
unit’s goodwill is lower than its carrying amount, goodwill is impaired and
written down to its fair value. Refer to Note 8 of our consolidated
financial statements for goodwill by reporting unit.
We use
October 1 as the annual review date for goodwill and other intangible assets
impairment testing. However, when factors indicate that an impairment
could be present, we reassess our conclusions related to goodwill recoverability
through completion of an interim test. Subsequent reviews of goodwill
could result in impairment of goodwill. Due to volatile capital
markets and their unfavorable impact to our liquidity, earnings and discount
rate assumptions and the execution of a reinsurance transaction on our life
business, we completed an interim test of goodwill impairment as of March 31,
2009.
We
performed a Step 1 goodwill impairment analysis on all of our reporting units as
of March 31, 2009. The Step 1 analysis for Insurance Solutions – Life
and Retirement Solutions – Annuities reporting units utilized primarily a
discounted cash flow valuation technique. In determining the
estimated fair value of these reporting units, we incorporated consideration of
discounted cash flow calculations, the level of our own share price and
assumptions that market participants would make in valuing these reporting
units. Our fair value estimations were based primarily on an in-depth
analysis of projected future cash flows and relevant discount rates, which
considered market participant inputs (“income approach”). The
discounted cash flow analysis required us to make judgments about revenues,
earnings projections, capital market assumptions and discount
rates. The key assumptions used in the analysis to determine the fair
value of these reporting units included:
·
|
New
business for 10 years and run off of cash flows on in-force and new
business for the life of the reporting
unit;
|
·
|
Adjustments
of several assumptions in our projections to reflect conservatism in the
near-term as a result of the current volatility in the capital markets,
including:
|
|
§
|
Lower
equity market returns for 2 years;
|
|
§
|
Lower
alternative investment income returns for 2
years;
|
|
§
|
Higher
line of credit costs related to reserve
securitizations;
|
·
|
Discount
rates ranging from 11.0% to 16.0%, which were based on the weighted
average cost of capital for each of our reporting units adjusted for the
risks associated with the operations. We used 11.0% for our
Insurance Solutions – Life reporting unit and 16.0% for our Retirement
Solutions – Annuities reporting
unit.
|
For our
other reporting units, we used other available information including market data
obtained through strategic reviews and other analysis to support our Step 1
conclusions.
In the
first quarter of 2009, all of our reporting units passed the Step 1 analysis,
except for our Retirement Solutions – Annuities reporting unit, which required a
Step 2 analysis to be completed. In our Step 2 analysis, we estimated
the implied fair value of the reporting unit’s goodwill as determined by
allocating the reporting unit’s fair value determined in Step 1 to all of its
net assets (recognized and unrecognized) as if the reporting unit had been
acquired in a business combination at the date of the impairment
test.
Based
upon our Step 2 analysis, we recorded a goodwill impairment of $600 million for
the Retirement Solutions – Annuities reporting unit in the first quarter of
2009, which was attributable primarily to higher discount rates related to
higher debt costs and equity market volatility, deterioration in equity markets,
which unfavorably impacted our account values and lower annuity
sales.
There
were no indicators of impairment as of September 30, 2009, due primarily to the
continued improvement in the equity markets and lower discount rates during the
second and third quarters of 2009. Media
results are showing signs of weakness, and the associated intangibles will
be reviewed for impairment during our fourth quarter testing
process.
Investments
Investment
Valuation
We use an
internationally recognized pricing service as our primary pricing source, and we
generally do not obtain multiple prices for our financial
instruments. We generally use prices from the pricing service rather
than broker quotes as we have documentation from the pricing service on the
observable market inputs that they use to determine the prices in contrast
to the broker quotes where we have limited information on the pricing
inputs.
Our
primary third party pricing service has policies and processes to ensure that
they are using objectively verifiable observable market data. The
pricing service regularly reviews the evaluation inputs for securities covered,
including broker quotes, executed trades and credit information, as
applicable. If the pricing service determines it does not have
sufficient objectively verifiable information about a security’s valuation, they
discontinue providing a valuation for the security. The pricing
service regularly publishes and updates a summary of inputs used in their
valuations by major security type. In addition, we have policies and
procedures in place to review the process that is utilized by the third party
pricing service and the output that is provided to ensure we are in agreement
with the output provided by the pricing service. On a periodic basis,
we test the pricing for a sample of securities to evaluate the inputs and
assumptions used by the pricing service. In addition, we perform a
check on prices provided by our primary pricing service to ensure that they are
not stale or unreasonable by reviewing the prices for unusual changes from
period to period based on certain parameters or for lack of change
from one period to the next. If such anomalies in the pricing are
observed, we verify the price provided by our pricing service with another
pricing source.
As of
September 30, 2009, we only obtained multiple prices for 106 available-for-sale
and trading securities. These multiple prices were primarily related
to instances where the vendor was providing a price for the first time and we
also received a broker quote. In these instances, we used the price
from the pricing service due to the higher reliability as discussed
above.
For
certain available-for-sale and trading securities, such as synthetic
convertibles, index-linked certificates of deposit and collateralized debt
obligations (“CDOs”), we obtain a broker quote when sufficient information, such
as security structure or other market information, is not available to produce
an evaluation. The brokers are asked to provide prices at which they
believe they would trade the security; however, the inputs used by the brokers
are unknown. Broker-quoted securities are adjusted based solely on
receipt of updated quotes from market makers or broker-dealers recognized as
market participants. Generally, the price for a security on this list
is based on a quote from a single broker or market maker. As of
September 30, 2009, we used broker quotes for 290 securities as our final price
source.
For
additional information, see “Critical Accounting Policies and Estimates –
Investments – Investment Valuation” in our 2008 Form 10-K.
Adoption
of Updates to the Investments – Debt and Equity Securities Topic
We
adopted updates to the Investments – Debt and Equity Securities
Topic of the FASB
ASC for our debt securities effective January 1, 2009. This adoption
required that an OTTI loss be separated into the amount representing the
decrease in cash flows expected to be collected (“credit loss”), which is
recognized in earnings, and the amount related to all other factors (“noncredit
loss”), which is recognized in other comprehensive income (“OCI”). In
addition, the requirement for management to assert that it has the intent and
ability to hold an impaired security until recovery was replaced with the
requirement that management assert that it does not have the intent to sell the
security and that it is more likely than not that it will not be required to
sell the security before recovery of its cost basis.
We
regularly review our AFS securities for declines in fair value that we determine
to be other-than-temporary. If we intend to sell a security and the
market value of the security is below amortized cost, the amortized cost is
written down to current fair value with a corresponding charge to realized loss
on our Consolidated Statements of Income (Loss), as this is deemed a
credit-related event. If we do not intend to sell a security but
believe we will not recover a security’s amortized cost, the amortized cost is
written down to the estimated recovery value with a corresponding charge to
realized loss on our Consolidated Statements of Income (Loss), as this is also
deemed a credit-related event, and the remainder of the decline to fair value is
recorded to OCI – unrealized OTTI on AFS securities on our Consolidated
Statements of Stockholders’ Equity, as this is considered a noncredit (i.e.,
recoverable) event.
The
determination of our intent to sell a security is based upon whether we can
assert that we do not have the intent to sell the security and if it is more
likely than not that we will not be required to sell the security before
recovery of the security’s cost basis. In making this determination,
we evaluate facts and circumstances such as, but not limited to, decisions to
reposition our security portfolio, sales of securities to meet cash flow needs
and sales of securities to capitalize on favorable pricing. The
credit loss on a security is based upon our estimate of the decrease in expected
cash flows or our best estimate of credit deterioration.
As a
result of the adoption, we recorded a cumulative effect adjustment, resulting in
an increase of $102 million to our opening balance of retained earnings with a
corresponding decrease to accumulated OCI, to reclassify the noncredit portion
of previously other-than-temporarily impaired debt securities. In
addition, the amortized cost basis of debt securities for which a noncredit OTTI
loss was previously recognized was increased by $199 million, or the amount of
the cumulative effect adjustment, pre-DAC, VOBA, DSI, DFEL and
tax. The fair value of our debt securities did not change as a result
of the adoption.
We
recognized an OTTI loss of $96 million and $376 million for the three and nine
months ended September 30, 2009, of which $52 million and $207 million were
recognized in net income on our Consolidated Statements of Income (Loss) related
to credit losses and $44 million and $169 million were recognized in OCI on our
Consolidated Statements of Stockholders’ Equity related to noncredit losses,
respectively. For additional details, see “Investments” below and
Notes 2 and 5.
Adoption
of Updates to the Fair Value Measurements and Disclosures Topic
We
adopted updates to the Fair Value Measurements and Disclosures Topic of the FASB
ASC, effective January 1, 2009. The FASB provided additional guidance
on estimating fair value when the volume and level of activity for an asset or
liability have significantly decreased in relation to normal market activity for
the asset or liability and additional guidance on circumstances that may
indicate that a transaction is not orderly.
This
guidance does not change the objective of a fair value
measurement. That is, even when there has been a significant decrease
in market activity for a security, the fair value objective remains the
same. Fair value is the price that would be received to sell the
security in an orderly transaction (i.e., not a forced liquidation or distressed
sale), between market participants at the measurement date in the current
inactive market (i.e., an “exit price” notion).
The FASB
provided additional guidance on estimating fair value when the volume and level
of activity for an asset or liability have significantly decreased in relation
to normal market activity for the asset or liability. The FASB also
provided additional guidance on circumstances that may indicate that a
transaction is not orderly. Specifically, the guidance provided
factors that indicate that a market is not active, including:
·
|
Few
recent transactions based on volume and level of activity in the market,
therefore there is not sufficient frequency and volume to provide pricing
information on an ongoing basis;
|
·
|
Price
quotations are not based on current
information;
|
·
|
Price
quotations vary substantially either over time or among market
makers;
|
·
|
Indexes
that previously were highly correlated with the fair values of the asset
are demonstrably uncorrelated with recent fair
values;
|
·
|
Abnormal,
or significant increases in, liquidity risk premiums or implied yields for
quoted prices when compared with reasonable estimates using realistic
assumptions of credit and other nonperformance risk for the asset
class;
|
·
|
Abnormally
wide bid-ask spread or significant increases in the bid-ask spread;
and
|
·
|
Little
information is released publicly.
|
After
evaluating all factors and considering the significance and relevance of each
factor, the reporting entity shall use its judgment in determining whether there
has been a significant decrease in the volume and level of activity for the
asset when the market for that asset is not active. The factors
should be considered in relation to the normal market activity for the
asset.
When the
market for an asset or liability has exhibited a significant decrease in
transaction volume when compared to normal market activity for the asset or
liability (or similar assets and liabilities), additional analysis is required
to ascertain whether or not observed transactions or quoted prices are
reflective of fair values. When there has been a significant decline
in activity and a market is no longer active, the use of multiple valuation
techniques (or a change in valuation technique) may be
appropriate. The circumstances that may indicate a transaction is not
orderly could include:
·
|
The
seller is in or near bankruptcy or receivership or the seller was required
to sell the asset to meet regulatory
requirements;
|
·
|
There
was a usual and customary marketing period, but the seller marketed the
asset to a single market participant;
and
|
·
|
The
transaction price is significantly different relative to other similar
transactions.
|
Transactions
that are deemed not orderly would not be determinative of fair value or of
market participant risk premiums. In estimating fair value, an entity
should place more weight on transactions that it concludes are
orderly. Less weight should be placed on transactions that the
reporting entity does not have sufficient information to conclude whether the
transaction is orderly. As of
September 30, 2009, we evaluated the markets that our securities trade in and
concluded that none were inactive. We will continue to re-evaluate
this conclusion, as needed, based on market conditions.
Derivatives
We use
derivative instruments to manage a variety of equity market and interest rate
risks that are inherent in many of our life insurance and annuity
products. Assessing the effectiveness of these hedging programs and
evaluating the carrying values of the related derivatives often involve a
variety of assumptions and estimates. We use derivatives to hedge
equity market risks, interest rate risk and foreign currency exposures that are
embedded in our annuity and life insurance product liabilities or investment
portfolios. Derivatives held as of September 30, 2009, contain
industry standard terms. Our accounting policies for derivatives and
the potential impact on interest spreads in a falling rate environment are
discussed in “Item 3. Quantitative and Qualitative Disclosures About Market
Risk” and Note 6 of this report and “Part II – Item 7A.
Quantitative and Qualitative Disclosures About Market Risk” and Note 6 to the
consolidated financial statements in our 2008 Form 10-K.
Guaranteed
Living Benefits
We have a
dynamic hedging strategy designed to mitigate selected risk and income statement
volatility caused by changes in the equity markets, interest rates and market
implied volatilities associated with the Lincoln SmartSecurity®
Advantage guaranteed withdrawal benefit (“GWB”) feature and our i4LIFE® Advantage and 4LATER®
Advantage guaranteed income benefit (“GIB”) features that are available in our
variable annuity products. We have certain GLB variable annuity
products with GWB and GIB features that are embedded
derivatives. Certain features of these guarantees, notably our GIB
and 4LATER® features, have elements of both insurance benefits accounted for
under the Financial Services – Insurance – Claim Costs and Liabilities for
Future Policy Benefits Subtopic of the FASB ASC (“benefit reserves”) and
embedded derivative reserves. We calculate the value of the embedded
derivative reserve and the benefit reserve based on the specific characteristics
of each GLB feature. In addition to mitigating selected risk and
income statement volatility, the hedge program is also focused on a long-term
goal of accumulating assets that could be used to pay claims under these
benefits, recognizing that such claims are likely to begin no earlier than
approximately a decade in the future.
If we
were to experience unfavorable capital markets as we did late in 2008, then we
would expect greater liabilities associated with the contractual
guarantees. However, the relationship between the components of the
guarantees, namely, the embedded derivative reserves and the benefit reserves,
is not linear. As the exposure to net amount at risk increases, the
relative portion of the projected benefits that is accounted for as benefit
reserves increases relative to the portion that is accounted for as embedded
derivative reserves.
The
hedging strategy is designed such that changes in the value of the hedge
contracts move in the opposite direction of changes in GLB embedded derivative
reserves. This dynamic hedging strategy utilizes options on
U.S.-based equity indices, futures on U.S.-based and international equity
indices and variance swaps on U.S.-based equity indices, as well as interest
rate futures and swaps. The notional amounts of the underlying hedge
instruments are such that the magnitude of the change in the value of the hedge
instruments due to changes in equity markets, interest rates and implied
volatilities is designed to offset the magnitude of the change in the fair value
of the GLB guarantees caused by those same factors. As of September
30, 2009, the fair value of the embedded derivative reserve, before adjustment
for the required NPR factors, for GWB, the i4LIFE® Advantage GIB and the
4LATER® Advantage GIB were valued at $631 million, $283 million and $100
million, respectively. See “Realized Loss – Operating Realized Gain
(Loss) – GLB” for information on how we determine our NPR.
As part
of our current hedging program, equity market, interest rate and market implied
volatility conditions are monitored on a daily basis. We rebalance
our hedge positions based upon changes in these factors as
needed. While we actively manage our hedge positions, our hedge
positions may not completely offset changes in the fair value embedded
derivative reserve caused by movements in these factors due to, among other
things, differences in timing between when a market exposure changes and
corresponding changes to the hedge positions, extreme swings in the equity
markets, interest rates and market implied volatilities, realized market
volatility, contract holder behavior, divergence between the performance of the
underlying funds and the hedging indices, divergence between the actual and
expected performance of the hedge instruments or our ability to purchase hedging
instruments at prices consistent with our desired risk and return
trade-off. This hedging strategy is managed on a combined basis with
the hedge for our GDB features.
For more
information on our GDB hedging strategy, see “Critical Accounting Policies and
Estimates – Future Contract Benefits and Other Contract Holder Obligations –
Guaranteed Death Benefits” in our 2008 Form 10-K.
As of
September 30, 2009, the fair value of our derivative assets, which hedge both
our GLB and GDB features, and including margins generated by futures contracts,
was $1.2 billion. As of September 30, 2009, the sum of all GLB
liabilities at fair value, excluding the NPR adjustment, and GDB reserves was
$1.1 billion, comprised of $1.0 billion for GLB liabilities and $0.1 billion for
the GDB reserves. The fair value of the hedge assets exceeded the
liabilities by $0.1 billion, which we believe indicates that the hedge strategy
has performed well by providing funding for our best estimate of the present
value of the liabilities related to our GLB and GDB
features. However, the relationship of hedge assets to the
liabilities for the guarantees may vary in any given reporting period due to
market conditions, hedge performance and/or changes to the hedging
strategy.
Approximately
38% of our variable annuity account values contain a GWB rider as of September
30, 2009. Declines in the equity markets increase our exposure to
potential benefits under the GWB contracts, leading to an increase in our
existing liability for those benefits. For example, a GWB contract is
“in the money” if the contract holder’s account balance falls below the
guaranteed amount. As of September 30, 2009, and September 30, 2008,
59% and 79%, respectively, of all GWB in-force contracts were “in the money,”
and our exposure to the guaranteed amounts, after reinsurance, as of September
30, 2009, and September 30, 2008, was $2.5 billion. Our exposure
before reinsurance for these same periods was $2.8 billion and $2.9 billion,
respectively. However, the only way the GWB contract holder can
monetize the excess of the guaranteed amount over the account value of the
contract is upon death or through a series of withdrawals that do not exceed a
specific percentage per year of the guaranteed amount. If, after the
series of withdrawals, the account value is exhausted, the contract holder will
receive a series of annuity payments equal to the remaining guaranteed amount,
and, for our lifetime GWB products, the annuity payments can continue beyond the
guaranteed amount. The account value can also fluctuate with equity
market returns on a daily basis resulting in increases or decreases in the
excess of the guaranteed amount over account value.
As a
result of these factors, the ultimate amount to be paid by us related to GWB
guarantees is uncertain and could be significantly more or less than $2.5
billion, net of reinsurance. Our fair value estimates of the GWB
liabilities, which are based on detailed models of future cash flows under a
wide range of market-consistent scenarios, reflect a more comprehensive view of
the related factors and represent our best estimate of the present value of
these potential liabilities. The market-consistent scenarios used
in the determination of the fair value of the GWB liabilities are similar
to those used by an investment bank to value derivatives for which the pricing
is not transparent and the aftermarket is nonexistent or illiquid. In
our calculation, risk-neutral Monte Carlo simulations resulting in over 10
million scenarios are utilized to value the entire block of
guarantees. The market-consistent scenario assumptions, at each
valuation date, are those we view to be appropriate for a hypothetical market
participant. The market consistent inputs include assumptions for the
capital markets (e.g., implied volatilities, correlation among indices,
risk-free swap curve, etc.), policyholder behavior (e.g., policy lapse, benefit
utilization, mortality, etc.), risk margins, administrative expenses and a
margin for profit. We believe these assumptions are consistent with
those that would be used by a market participant; however, as the related
markets develop, we will continue to reassess our assumptions. It is possible
that different valuation techniques and assumptions could produce a materially
different estimate of fair value.
For
information on our GLB hedging results, see our discussion in “Realized Loss”
below.
Income
Taxes
The
application of GAAP requires us to evaluate the recoverability of our deferred
tax assets and establish a valuation allowance, if necessary, to reduce our
deferred tax asset to an amount that is more likely than not to be
realizable. Considerable judgment and the use of estimates are
required in determining whether a valuation allowance is necessary, and if so,
the amount of such valuation allowance. In evaluating the need for a
valuation allowance, we consider many factors, including: the nature
and character of the deferred tax assets and liabilities; taxable income in
prior carryback years; future reversals of existing temporary differences; the
length of time carryovers can be utilized; and any tax planning strategies we
would employ to avoid a tax benefit from expiring unused. Although
realization is not assured, management believes it is more likely than not that
the deferred tax assets, including our capital loss deferred tax asset, will be
realized. For additional information on our income taxes, see Note 7
in this report and Note 7 to the consolidated financial statements in our 2008
Form 10-K.
Acquisitions
and Dispositions
As of
August 18, 2009, LNC and its wholly owned subsidiary, Lincoln National
Investment Companies, entered into a Purchase and Sale Agreement with Macquarie
Bank Limited (“MBL”), pursuant to which we agreed to sell to MBL all of the
outstanding capital stock of Delaware Management Holdings, Inc., our subsidiary,
or “Delaware,” which provides investment products and services to individuals
and institutions. We expect this transaction to close on or around
December 31, 2009. At closing, we will receive $320 million in
addition to the value of net assets (excluding goodwill and as otherwise defined
in the Purchase and Sale Agreement) of Delaware and its subsidiaries as
estimated at closing. In addition, a revenue run-rate adjustment
mechanism will be applied in the event that the closing revenue run-rate of
Delaware is less than 90% of its revenue run-rate on April 30, 2009 (the “Base
Revenue Run-Rate”), provided that the reduction in the purchase price shall not
exceed 15%. In the event that the closing revenue run-rate of
Delaware is less than 75% of the Base Revenue Run-Rate, the buyer may exercise
the option to terminate the transaction. The revenue run-rates will
be calculated in a manner that excludes the impact of any distributions of
interest, dividends, income or capital gains from any client account and any
increase or decrease in assets under management due to changes in the markets
and/or currency fluctuations. Based on the foregoing, we currently
expect to receive cash consideration at closing of approximately $430 million;
however, this number may differ based on the adjustments set forth
above.
The
closing purchase price is also subject to other post-closing adjustments,
including an adjustment based on the final closing balance sheet (as determined
under the Purchase and Sale Agreement). In addition, certain of our
subsidiaries, including The Lincoln National Life Insurance Company (“LNL”), our
primary insurance subsidiary, will enter into investment advisory agreements
with Delaware, pursuant to which Delaware will continue to manage the majority
of the general account insurance assets of the subsidiaries. The
investment advisory agreements will have ten-year terms, and we may terminate
them without cause by paying an aggregate termination fee of up to $84 million
in the event that all of the agreements with our subsidiaries are terminated
that will decline on a pro rata basis over the ten-year term of the advisory
agreements.
MBL and
we have each made customary representations, warranties and covenants, as
applicable, in the Purchase and Sale Agreement. The Purchase and Sale
Agreement also contains customary indemnifications, including our indemnifying
MBL with respect to the Transamerica litigation, which is described in Note
11. The completion of the transaction contemplated by the Purchase
and Sale Agreement is subject to regulatory approvals and the satisfaction of
other customary conditions, some of which are beyond our control, and no
assurance can be given that such completion will occur.
The
transaction is expected to be neutral to earnings per share assuming
reinvestment of net proceeds back into core insurance businesses. We
expect a modest gain on disposal, which will be recorded as of the close of the
transaction. The actual gain or loss may differ from our expected
result depending upon, among other things, the actual purchase price after
closing adjustments.
This
summary of the material terms and provisions of the Purchase and Sale Agreement
is subject in its entirety to the Purchase and Sale Agreement attached hereto as
Exhibit 2.1 and incorporated herein by reference.
On
October 1, 2009, we completed the previously announced sale of the capital stock
of Lincoln National (UK) plc to SLF of Canada UK Limited for proceeds of
approximately $305 million, after-tax, subject to customary post-closing
adjustments. We retained Lincoln UK’s pension plan assets and
liabilities. The results of Lincoln National (UK) plc and its
subsidiaries comprised the former Lincoln UK segment. The Lincoln UK
segment primarily focused on providing life and retirement income products in
the U.K. In the third quarter of 2009, there was a $55 million
adjustment to the loss on disposition of our Lincoln UK segment as a result of
finalizing treatment of the UK pension, refining certain tax estimates and
closing out various hedges put in place at the time of the
announcement.
Accordingly,
we have reported the results of these businesses as discontinued operations on
our Consolidated Statements of Income (Loss) and the assets and liabilities as
held for sale on our Consolidated Balance Sheets for all periods
presented. See Note 3 for additional details.
For
additional information about acquisitions and divestitures, see Note 3 to the
consolidated financial statements in our 2008 Form 10-K.
|
RESULTS
OF CONSOLIDATED OPERATIONS
|
Net
Income
Details
underlying the consolidated results, deposits, net flows and account values (in
millions) were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$ |
491 |
|
|
$ |
514 |
|
|
|
-4 |
% |
|
$ |
1,541 |
|
|
$ |
1,507 |
|
|
|
2 |
% |
Insurance
fees
|
|
|
766 |
|
|
|
754 |
|
|
|
2 |
% |
|
|
2,158 |
|
|
|
2,314 |
|
|
|
-7 |
% |
Net
investment income
|
|
|
1,071 |
|
|
|
1,068 |
|
|
|
0 |
% |
|
|
3,055 |
|
|
|
3,170 |
|
|
|
-4 |
% |
Realized
loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
OTTI losses on securities
|
|
|
(148 |
) |
|
|
(237 |
) |
|
|
38 |
% |
|
|
(578 |
) |
|
|
(395 |
) |
|
|
-46 |
% |
Portion
of loss recognized in OCI
|
|
|
68 |
|
|
|
- |
|
|
NM
|
|
|
|
259 |
|
|
|
- |
|
|
NM
|
|
Net
OTTI losses on securities recognized
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
in
earnings
|
|
|
(80 |
) |
|
|
(237 |
) |
|
|
66 |
% |
|
|
(319 |
) |
|
|
(395 |
) |
|
|
19 |
% |
Realized
gain (loss), excluding OTTI
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
losses
on securities
|
|
|
(288 |
) |
|
|
30 |
|
|
NM
|
|
|
|
(684 |
) |
|
|
49 |
|
|
NM
|
|
Total
realized loss
|
|
|
(368 |
) |
|
|
(207 |
) |
|
|
-78 |
% |
|
|
(1,003 |
) |
|
|
(346 |
) |
|
NM
|
|
Amortization
of deferred gain on business sold
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
through
reinsurance
|
|
|
18 |
|
|
|
19 |
|
|
|
-5 |
% |
|
|
56 |
|
|
|
57 |
|
|
|
-2 |
% |
Other
revenues and fees
|
|
|
103 |
|
|
|
122 |
|
|
|
-16 |
% |
|
|
293 |
|
|
|
369 |
|
|
|
-21 |
% |
Total
revenues
|
|
|
2,081 |
|
|
|
2,270 |
|
|
|
-8 |
% |
|
|
6,100 |
|
|
|
7,071 |
|
|
|
-14 |
% |
Benefits
and Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
credited
|
|
|
623 |
|
|
|
625 |
|
|
|
0 |
% |
|
|
1,848 |
|
|
|
1,849 |
|
|
|
0 |
% |
Benefits
|
|
|
569 |
|
|
|
813 |
|
|
|
-30 |
% |
|
|
2,072 |
|
|
|
2,118 |
|
|
|
-2 |
% |
Underwriting,
acquisition, insurance and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
other
expenses
|
|
|
760 |
|
|
|
642 |
|
|
|
18 |
% |
|
|
2,103 |
|
|
|
2,065 |
|
|
|
2 |
% |
Interest
and debt expense
|
|
|
68 |
|
|
|
69 |
|
|
|
-1 |
% |
|
|
130 |
|
|
|
209 |
|
|
|
-38 |
% |
Impairment
of intangibles
|
|
|
(1 |
) |
|
|
- |
|
|
NM
|
|
|
|
601 |
|
|
|
175 |
|
|
|
243 |
% |
Total
benefits and expenses
|
|
|
2,019 |
|
|
|
2,149 |
|
|
|
-6 |
% |
|
|
6,754 |
|
|
|
6,416 |
|
|
|
5 |
% |
Income
(loss) from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
before
taxes
|
|
|
62 |
|
|
|
121 |
|
|
|
-49 |
% |
|
|
(654 |
) |
|
|
655 |
|
|
NM
|
|
Federal
income tax expense (benefit)
|
|
|
(19 |
) |
|
|
(8 |
) |
|
NM
|
|
|
|
(141 |
) |
|
|
162 |
|
|
NM
|
|
Income
(loss) from continuing operations
|
|
|
81 |
|
|
|
129 |
|
|
|
-37 |
% |
|
|
(513 |
) |
|
|
493 |
|
|
NM
|
|
Income
(loss) from discontinued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operations,
net of federal income taxes
|
|
|
72 |
|
|
|
19 |
|
|
|
279 |
% |
|
|
(74 |
) |
|
|
69 |
|
|
NM
|
|
Net
income (loss)
|
|
$ |
153 |
|
|
$ |
148 |
|
|
|
3 |
% |
|
$ |
(587 |
) |
|
$ |
562 |
|
|
NM
|
|
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retirement
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$ |
523 |
|
|
$ |
675 |
|
|
|
-23 |
% |
|
$ |
1,559 |
|
|
$ |
1,916 |
|
|
|
-19 |
% |
Defined
Contribution
|
|
|
236 |
|
|
|
241 |
|
|
|
-2 |
% |
|
|
676 |
|
|
|
718 |
|
|
|
-6 |
% |
Total
Retirement Solutions
|
|
|
759 |
|
|
|
916 |
|
|
|
-17 |
% |
|
|
2,235 |
|
|
|
2,634 |
|
|
|
-15 |
% |
Insurance
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
Insurance
|
|
|
1,089 |
|
|
|
1,074 |
|
|
|
1 |
% |
|
|
3,168 |
|
|
|
3,216 |
|
|
|
-1 |
% |
Group
Protection
|
|
|
414 |
|
|
|
403 |
|
|
|
3 |
% |
|
|
1,279 |
|
|
|
1,227 |
|
|
|
4 |
% |
Total
Insurance Solutions
|
|
|
1,503 |
|
|
|
1,477 |
|
|
|
2 |
% |
|
|
4,447 |
|
|
|
4,443 |
|
|
|
0 |
% |
Other
Operations
|
|
|
120 |
|
|
|
135 |
|
|
|
-11 |
% |
|
|
340 |
|
|
|
412 |
|
|
|
-17 |
% |
Excluded
realized loss, pre-tax
|
|
|
(302 |
) |
|
|
(259 |
) |
|
|
-17 |
% |
|
|
(924 |
) |
|
|
(420 |
) |
|
NM
|
|
Amortization
of deferred gain arising from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
reserve
changes on business sold through
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
reinsurance,
pre-tax
|
|
|
1 |
|
|
|
1 |
|
|
|
0 |
% |
|
|
2 |
|
|
|
2 |
|
|
|
0 |
% |
Total
revenues
|
|
$ |
2,081 |
|
|
$ |
2,270 |
|
|
|
-8 |
% |
|
$ |
6,100 |
|
|
$ |
7,071 |
|
|
|
-14 |
% |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Net
Income (Loss)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retirement
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$ |
95 |
|
|
$ |
131 |
|
|
|
-27 |
% |
|
$ |
234 |
|
|
$ |
365 |
|
|
|
-36 |
% |
Defined
Contribution
|
|
|
43 |
|
|
|
42 |
|
|
|
2 |
% |
|
|
100 |
|
|
|
124 |
|
|
|
-19 |
% |
Total
Retirement Solutions
|
|
|
138 |
|
|
|
173 |
|
|
|
-20 |
% |
|
|
334 |
|
|
|
489 |
|
|
|
-32 |
% |
Insurance
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
Insurance
|
|
|
137 |
|
|
|
137 |
|
|
|
0 |
% |
|
|
412 |
|
|
|
458 |
|
|
|
-10 |
% |
Group
Protection
|
|
|
35 |
|
|
|
27 |
|
|
|
30 |
% |
|
|
94 |
|
|
|
86 |
|
|
|
9 |
% |
Total
Insurance Solutions
|
|
|
172 |
|
|
|
164 |
|
|
|
5 |
% |
|
|
506 |
|
|
|
544 |
|
|
|
-7 |
% |
Other
Operations
|
|
|
(34 |
) |
|
|
(39 |
) |
|
|
13 |
% |
|
|
(195 |
) |
|
|
(128 |
) |
|
|
-52 |
% |
Excluded
realized loss, after-tax
|
|
|
(196 |
) |
|
|
(169 |
) |
|
|
-16 |
% |
|
|
(600 |
) |
|
|
(274 |
) |
|
NM
|
|
Early
extinguishment of debt
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
42 |
|
|
|
- |
|
|
NM
|
|
Income
from reserve changes (net of related
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
amortization)
on business sold through
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
reinsurance,
after-tax
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
1 |
|
|
|
1 |
|
|
|
0 |
% |
Impairment
of intangibles, after-tax
|
|
|
1 |
|
|
|
- |
|
|
NM
|
|
|
|
(601 |
) |
|
|
(139 |
) |
|
NM
|
|
Income
(loss) from continuing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operations,
after-tax
|
|
|
81 |
|
|
|
129 |
|
|
|
-37 |
% |
|
|
(513 |
) |
|
|
493 |
|
|
NM
|
|
Income
(loss) from discontinued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operations,
after-tax
|
|
|
72 |
|
|
|
19 |
|
|
|
279 |
% |
|
|
(74 |
) |
|
|
69 |
|
|
NM
|
|
Net
income (loss)
|
|
$ |
153 |
|
|
$ |
148 |
|
|
|
3 |
% |
|
$ |
(587 |
) |
|
$ |
562 |
|
|
NM
|
|
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Deposits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retirement
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$ |
3,088 |
|
|
$ |
2,948 |
|
|
|
5 |
% |
|
$ |
7,901 |
|
|
$ |
9,410 |
|
|
|
-16 |
% |
Defined
Contribution
|
|
|
1,103 |
|
|
|
1,334 |
|
|
|
-17 |
% |
|
|
3,794 |
|
|
|
4,306 |
|
|
|
-12 |
% |
Insurance
Solutions - Life Insurance
|
|
|
1,074 |
|
|
|
1,082 |
|
|
|
-1 |
% |
|
|
3,151 |
|
|
|
3,276 |
|
|
|
-4 |
% |
Total
deposits
|
|
$ |
5,265 |
|
|
$ |
5,364 |
|
|
|
-2 |
% |
|
$ |
14,846 |
|
|
$ |
16,992 |
|
|
|
-13 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retirement
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$ |
1,601 |
|
|
$ |
944 |
|
|
|
70 |
% |
|
$ |
3,074 |
|
|
$ |
3,714 |
|
|
|
-17 |
% |
Defined
Contribution
|
|
|
144 |
|
|
|
93 |
|
|
|
55 |
% |
|
|
1,057 |
|
|
|
610 |
|
|
|
73 |
% |
Insurance
Solutions - Life Insurance
|
|
|
562 |
|
|
|
690 |
|
|
|
-19 |
% |
|
|
1,659 |
|
|
|
2,018 |
|
|
|
-18 |
% |
Total
net flows
|
|
$ |
2,307 |
|
|
$ |
1,727 |
|
|
|
34 |
% |
|
$ |
5,790 |
|
|
$ |
6,342 |
|
|
|
-9 |
% |
|
|
As
of September 30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Account
Values
|
|
|
|
|
|
|
|
|
|
Retirement
Solutions:
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$ |
71,146 |
|
|
$ |
66,475 |
|
|
|
7 |
% |
Defined
Contribution
|
|
|
34,322 |
|
|
|
32,573 |
|
|
|
5 |
% |
Insurance
Solutions - Life Insurance
|
|
|
31,272 |
|
|
|
32,283 |
|
|
|
-3 |
% |
Total
account values
|
|
$ |
136,740 |
|
|
$ |
131,331 |
|
|
|
4 |
% |
Comparison
of the Three Months Ended September 30, 2009 to 2008
Net
income increased due primarily to the following:
·
|
A
$10 million net favorable retrospective unlocking of DAC, VOBA, DSI, DFEL
and the reserves for annuity and life insurance products with living
benefit and death benefit guarantees in the third quarter of 2009 due
primarily to lower lapses and higher equity market performance than our
model projections assumed, compared to a $107 million unfavorable
retrospective unlocking in the third quarter of 2008 due primarily to
lower equity market performance and premiums received and higher death
claims and future GDB claims than our model projections
assumed;
|
·
|
A
decrease in realized losses on our AFS securities attributable primarily
to lower OTTI;
|
·
|
A $55 million adjustment to the
loss on disposition of our Lincoln UK segment as a result of finalizing
treatment of the UK pension, refining certain tax estimates and closing
out various hedges put in place at the time of the announcement (see
“Acquisitions and
Dispositions” above
and Note 3 for additional information on the disposition of our
discontinued operations);
and
|
·
|
A
reduction in the federal income tax expense due primarily to lower income
from continuing operations, partially offset by more favorable permanent
differences in 2008 relating to favorable tax return true-ups driven by
the separate account DRD and other
items.
|
The
increase in net income was partially offset by the following:
·
|
The overall unfavorable GLB net
derivatives results, excluding unlocking, in the third quarter 2009, which
was due to a reduction in the NPR component of the liability that is not
included in the hedge program attributable to a narrowing of credit
spreads, compared to favorable GLB net derivatives results in the third
quarter of 2008 as the NPR adjustment was favorable attributable primarily
to widening credit spreads that more than offset the unfavorable GLB hedge
program performance due to extreme market conditions (see “Realized Loss” below for
more information on our GLB liability and derivative
performance);
|
·
|
Higher
DAC, VOBA, DSI and DFEL amortization, net of interest and excluding
unlocking, due primarily to the reduction in EGPs (see “Retirement
Solutions – Annuities – Additional Segment Information” below for more
information);
|
·
|
Higher
benefits due primarily to an increase in the growth in benefit
reserves from higher expected GDB benefit
payments;
|
·
|
A
$25 million unfavorable prospective unlocking (a $19 million decrease from
assumption changes and a $6 million decrease from model refinements) of
DAC, VOBA, DSI, DFEL and the reserves for annuity and life insurance
products with living benefit and death benefit guarantees due primarily to
lower investment spreads and higher expenses, mortality and lapses in the
third quarter of 2009 than our model projections assumed, compared to a
$10 million favorable prospective unlocking (a $44 million increase from
assumption changes reflecting primarily updates to implied ultimate
volatility net of a $34 million decrease from model refinements) in the
third quarter of 2008 (see “Critical Accounting Policies and Estimates –
DAC, VOBA, DSI and DFEL” for more information);
and
|
·
|
Higher
underwriting, acquisition, insurance and other expenses, excluding
amortization of DAC and VOBA, due primarily to higher account-value-based
trail commissions driven by positive net flows that more than offset the
impact of unfavorable equity markets since the third quarter of 2008,
higher incentive compensation accruals as a result of higher earnings and
production performance relative to planned goals and higher expenses
attributable to our U.S. pension plans (see discussion in “Additional
Segment Information” below), partially offset by lower merger expenses as
many of our integration efforts related to our acquisition of
Jefferson-Pilot have been
completed.
|
Comparison
of the Nine Months Ended September 30, 2009 to 2008
Net
income decreased due primarily to the following:
·
|
Impairment
of goodwill in the first quarter of 2009 of $600 million for Retirement
Solutions – Individual Annuities due to continued market volatility, the
corresponding increase in discount rates and lower annuity sales compared
to $139 million of impairment of goodwill and our Federal Communications
Commission license intangible assets on our remaining radio clusters in
the second quarter of 2008 attributable to declines in
advertising revenues for the entire radio market (see “Critical Accounting
Policies and Estimates – Goodwill and Other Intangible Assets” above for
additional information on our goodwill impairment); however, these
non-cash impairments did not impact our liquidity and will not impact our
future liquidity;
|
·
|
The overall unfavorable GLB net
derivatives results, excluding unlocking, in the first nine months of
2009, which was due to a reduction in the NPR component of the liability
that is not included in the hedge program attributable to a narrowing of
credit spreads, compared to favorable GLB net derivatives results in the
first nine months of 2008 as the NPR adjustment was favorable attributable
primarily to widening credit spreads that more than offset the unfavorable
GLB hedge program performance due to extreme market conditions (see “Realized Loss” below for
more information on our GLB liability and derivative
performance);
|
·
|
The
$115 million loss on disposition of our Lincoln UK segment during 2009
(see “Acquisitions and Dispositions” above and Note 3 for additional
information on the disposition of our discontinued
operations);
|
·
|
Lower
earnings from our variable annuity and mutual fund products as a result of
declines in the equity markets;
|
·
|
Lower
net investment income attributable primarily to less favorable investment
income on surplus and alternative investments due primarily to a
deterioration of the capital markets (see “Consolidated Investments –
Alternative Investments” below for additional information on our
alternative investments) as well as holding higher cash balances related
to our short-term liquidity strategy during the recent volatile markets
that has reduced our portfolio
yield;
|
·
|
The
$64 million unfavorable impact from the rescission of the reinsurance
agreement on certain disability income business sold to Swiss Re in the
first quarter of 2009, as discussed in “Reinsurance”
below;
|
·
|
Higher
DAC, VOBA, DSI and DFEL amortization, net of interest and excluding
unlocking, due primarily to the reduction in EGPs (see “Retirement
Solutions – Annuities – Additional Segment Information” below for more
information);
|
·
|
Higher
benefits due primarily to an increase in the growth in benefit
reserves from higher expected GDB benefit payments;
and
|
·
|
The
impact of prospective unlocking discussed
above.
|
The
decrease in net income was partially offset by the following:
·
|
A
$42 million gain in the first quarter of 2009 associated with the early
extinguishment of long-term debt;
|
·
|
A
reduction in federal income tax expense due primarily to favorable tax
return true-ups driven by the separate account DRD, foreign tax credit
adjustments and other items;
|
·
|
Lower
broker-dealer expenses due primarily to lower sales of non-proprietary
products, lower interest and debt expenses as a result of a decline in
interest rates and average balances of outstanding debt in 2009, lower
merger expenses as many of our integration efforts related to our
acquisition of Jefferson-Pilot have been completed and the implementation
of several expense initiatives, partially offset by restructuring charges
related to many of these initiatives and higher incentive compensation
accruals as a result of higher earnings and production performance
relative to planned goals;
|
·
|
A
$97 million unfavorable retrospective unlocking of DAC, VOBA, DSI, DFEL
and the reserves for annuity and life insurance products with living
benefit and death benefit guarantees during the first nine months of 2009
due primarily to the overall performance of our GLB derivative program
(see “Realized Loss” below for more information on our GLB derivative
performance), partially offset by lower lapses and higher equity market
performance than our model projections assumed, compared to a $118 million
unfavorable retrospective unlocking during the first nine months of 2008
due primarily to the impact of lower equity market performance and
premiums received, higher death claims and future GDB claims than our
model projections assumed and model adjustments on certain life insurance
policies;
|
·
|
A
decrease in realized losses on our AFS securities attributable primarily
to lower OTTI; and
|
·
|
The
$16 million impact of the initial adoption of the Fair Value Measurements
and Disclosures Topic of the FASB ASC on January 1,
2008.
|
The
foregoing items are discussed in further detail in results of operations by
segment discussions and “Realized Loss” below. In addition, for a
discussion of the earnings impact of the equity markets, see “Item 3.
Quantitative and Qualitative Disclosures About Market Risk – Equity Market Risk
– Impact of Equity Market Sensitivity.”
RESULTS
OF RETIREMENT SOLUTIONS
The
Retirement Solutions business provides its products through two
segments: Annuities and Defined Contribution. The
Retirement Solutions – Annuities segment provides tax-deferred investment growth
and lifetime income opportunities for its clients by offering individual fixed
annuities, including indexed annuities, and variable annuities. The
Retirement Solutions – Defined Contribution segment provides employer-sponsored
variable and fixed annuities and mutual-fund based programs in the 401(k),
403(b) and 457 marketplaces.
Retirement
Solutions – Annuities
Income
from Operations
Details
underlying the results for Retirement Solutions – Annuities (in millions) were
as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums (1)
|
|
$ |
17 |
|
|
$ |
52 |
|
|
|
-67 |
% |
|
$ |
77 |
|
|
$ |
103 |
|
|
|
-25 |
% |
Insurance
fees
|
|
|
223 |
|
|
|
246 |
|
|
|
-9 |
% |
|
|
598 |
|
|
|
749 |
|
|
|
-20 |
% |
Net
investment income
|
|
|
271 |
|
|
|
243 |
|
|
|
12 |
% |
|
|
756 |
|
|
|
736 |
|
|
|
3 |
% |
Operating
realized gain (loss) (2)
|
|
|
(61 |
) |
|
|
52 |
|
|
NM
|
|
|
|
(73 |
) |
|
|
74 |
|
|
NM
|
|
Other
revenues and fees (3)
|
|
|
73 |
|
|
|
82 |
|
|
|
-11 |
% |
|
|
201 |
|
|
|
254 |
|
|
|
-21 |
% |
Total
operating revenues
|
|
|
523 |
|
|
|
675 |
|
|
|
-23 |
% |
|
|
1,559 |
|
|
|
1,916 |
|
|
|
-19 |
% |
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
credited
|
|
|
185 |
|
|
|
170 |
|
|
|
9 |
% |
|
|
511 |
|
|
|
496 |
|
|
|
3 |
% |
Benefits
(2)
|
|
|
(43 |
) |
|
|
112 |
|
|
NM
|
|
|
|
69 |
|
|
|
199 |
|
|
|
-65 |
% |
Underwriting,
acquisition, insurance and other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
expenses
|
|
|
268 |
|
|
|
254 |
|
|
|
6 |
% |
|
|
728 |
|
|
|
774 |
|
|
|
-6 |
% |
Total
operating expenses
|
|
|
410 |
|
|
|
536 |
|
|
|
-24 |
% |
|
|
1,308 |
|
|
|
1,469 |
|
|
|
-11 |
% |
Income
from operations before taxes
|
|
|
113 |
|
|
|
139 |
|
|
|
-19 |
% |
|
|
251 |
|
|
|
447 |
|
|
|
-44 |
% |
Federal
income tax expense
|
|
|
18 |
|
|
|
8 |
|
|
|
125 |
% |
|
|
17 |
|
|
|
82 |
|
|
|
-79 |
% |
Income
from operations
|
|
$ |
95 |
|
|
$ |
131 |
|
|
|
-27 |
% |
|
$ |
234 |
|
|
$ |
365 |
|
|
|
-36 |
% |
(1)
|
Insurance
premiums includes primarily our single premium immediate annuities, which
have a corresponding offset in benefits for changes in
reserves.
|
(2)
|
The
change in benefit ratio reserves for this segment was $(76) million and
$(101) million for the three and nine months ended September 30, 2009,
respectively, driven by variable account growth, as compared to $50
million and $65 million in the corresponding periods of 2008; however,
this impact is offset within operating realized gain (loss) as discussed
below.
|
(3)
|
Other
revenues and fees consists primarily of broker-dealer earnings that are
subject to market volatility.
|
Comparison
of the Three Months Ended September 30, 2009 to 2008
Income
from operations for this segment decreased due primarily to the
following:
·
|
Lower
insurance fees driven primarily by lower average daily variable account
values due to unfavorable equity
markets;
|
·
|
A
reduction in federal income tax expense in the third quarter of 2008 due
primarily to favorable tax return true-ups driven by the separate account
DRD and other items;
|
·
|
Higher
underwriting, acquisition, insurance and other expenses, excluding
amortization of DAC and VOBA, due primarily to higher account-value-based
trail commissions driven by positive net flows that more than offset the
impact of unfavorable equity markets since the third quarter of 2008,
higher incentive compensation accruals as a result of higher earnings and
production performance relative to planned goals and higher expenses
attributable to our U.S. pension plans (see discussion in “Additional
Segment Information” below);
|
·
|
Higher
benefits, excluding the change in benefit ratio reserves in operating
realized gain (loss), due primarily to an increase in the growth in
benefit reserves from higher expected
GDB
benefit payments;
|
·
|
A
$6 million unfavorable prospective unlocking from assumption changes of
DAC, VOBA, DSI, DFEL and reserves for our guarantee riders in 2009 due
primarily to higher maintenance expenses partially offset by higher
expense assessments than our model projections assumed compared to none in
2008 (see “Critical Accounting Policies and Estimates – DAC, VOBA, DSI and
DFEL” for more information);
|
·
|
Higher
DAC, VOBA, DSI and DFEL amortization, net of interest and excluding
unlocking, due primarily to the reduction in EGPs discussed in “Additional
Segment Information” below; and
|
·
|
A
less favorable net broker-dealer margin attributable primarily to lower
sales of non-proprietary products, lower earnings due to lower production
levels and higher legal accruals.
|
The
decrease in income from operations was partially offset by the
following:
·
|
A
$16 million favorable retrospective unlocking of DAC, VOBA, DSI, DFEL and
reserves for our guarantee riders during the third quarter of 2009 due
primarily to lower lapses and the impact of higher equity market
performance than our model projections assumed, compared to a $9 million
unfavorable retrospective unlocking during the third quarter of 2008 due
primarily to lower equity market performance than our model projections
assumed; and
|
·
|
Higher
net investment income, partially offset by higher interest credited,
driven primarily by higher average fixed account values, including the
fixed portion of variable annuity contracts, attributable primarily to
positive net flows and an increase in investment income on surplus
investments due primarily to more favorable investment income on
alternative investments, partially offset by our liquidity strategy of
maintaining higher cash balances during the recent volatile markets that
remained present early in the third quarter of 2009 that has reduced our
portfolio yield by 3 basis points for the third quarter of
2009.
|
Comparison
of the Nine Months Ended September 30, 2009 to 2008
Income
from operations for this segment decreased due primarily to the
following:
·
|
Lower
insurance fees driven primarily by lower average daily variable account
values due to unfavorable equity
markets;
|
·
|
Higher
benefits, excluding the change in benefit ratio reserves in operating
realized gain (loss), due primarily to an increase in the growth in
benefit reserves from higher expected GDB benefit
payments;
|
·
|
A
less favorable net broker-dealer margin attributable primarily to lower
sales of non-proprietary products;
|
·
|
The
impact of the prospective unlocking discussed
above;
|
·
|
Higher
underwriting, acquisition, insurance and other expenses, excluding
amortization of DAC and VOBA, due primarily to higher account-value-based
trail commissions driven by positive net flows since the third quarter of
2008, partially offset by the impact of unfavorable equity markets on
account values, higher incentive compensation accruals as a result of
higher earnings and production performance relative to planned goals and
higher expenses attributable to our U.S. pension plans (see discussion in
“Additional Segment Information” below);
and
|
·
|
Higher
DAC, VOBA, DSI and DFEL amortization, net of interest and excluding
unlocking, due primarily to the reduction in EGPs discussed in “Additional
Segment Information” below.
|
The
decrease in income from operations was partially offset by the
following:
·
|
A
reduction in federal income tax expense due primarily to the decrease in
earnings and favorable tax return true-ups driven by the separate account
DRD, foreign tax credit adjustments and other items in the first nine
months of 2009;
|
·
|
A
$14 million favorable retrospective unlocking of DAC, VOBA, DSI, DFEL and
reserves for our guarantee riders during the first nine months of 2009 due
primarily to lower lapses and higher equity market performance than our
model projections assumed, compared to a $6 million unfavorable
retrospective unlocking during the first nine months of 2008 due primarily
to lower equity market performance than our model projections assumed;
and
|
·
|
Higher
net investment income, partially offset by higher interest credited,
driven primarily by higher average fixed account values, including the
fixed portion of variable annuity contracts, attributable primarily to
positive net flows and by actions implemented since the third quarter of
2008 to reduce interest crediting rates, partially offset by our liquidity
strategy of maintaining higher cash balances during the recent volatile
markets that has reduced our portfolio yield by 25 basis points for the
first nine months of 2009, a decline in investment income on surplus
investments due primarily to less favorable investment income on
alternative investments (see “Consolidated Investments – Alternative
Investments” below for additional
information).
|
Additional
Segment Information
Prior to
the second quarter of 2009, the equity markets unfavorably impacted our average
variable account values and the resulting fees earned on these
accounts. Additionally, weaker credit fundamentals negatively
impacted our investment margins and increased our realized losses on
investments, including OTTI. As a result, we lowered the projected
EGPs for this segment, which will result in higher DAC, VOBA, DSI and DFEL
amortization and lower earnings for this segment.
We
experienced higher expenses attributable to our U.S. pension plans (see
“Critical Accounting Policies and Estimates – Pension and Other Postretirement
Benefit Plans” in our 2008 Form 10-K) during the first nine months of 2009, and
the fourth quarter of 2009 will continue this unfavorable trend when compared to
the corresponding period in 2008.
Although
the segment’s results during the first nine months of 2009 were unfavorably
impacted by lower average account values and the economic environment, its
overall net flows were strong in a challenging economic environment and our end
of period account values were higher. New deposits are an important
component of net flows and key to our efforts to grow our
business. Although deposits do not significantly impact current
period income from operations, they are an important indicator of future
profitability.
The other
component of net flows relates to the retention of the business. An
important measure of retention is the lapse rate, which compares the amount of
withdrawals to the average account values. The overall lapse rates
for our annuity products were 7% and 9% for the three and nine months ended
September 30, 2009, compared to 9% and 8% for the corresponding periods in
2008.
See Note
9 above for information on contractual guarantees to contract holders related to
GDB features for our Retirement Solutions business.
We expect
to manage the effect of changing market investment returns by managing interest
rate spreads for near-term income from operations through a combination of
crediting rate actions and portfolio management. Our expectation
includes the assumption that there are no significant changes in net flows in or
out of our fixed accounts or other changes that may cause interest rate spreads
to differ from our expectation.
Our fixed
annuity business includes products with crediting rates that are reset on an
annual basis and are not subject to surrender charges. Account values
for these products, including the fixed portion of variable, were $7.1 billion
as of September 30, 2009, with 68% already at their minimum guaranteed
rates. The average crediting rates for these products were
approximately 37 basis points in excess of average minimum guaranteed
rates. Our ability to retain annual reset annuities will be subject
to current competitive conditions at the time interest rates for these products
reset. For information on interest rate spreads and the interest rate
risk due to falling interest rates, see “Item 7A. Quantitative and Qualitative
Disclosures About Market Risk – Interest Rate Risk on Fixed Insurance Business –
Falling Rates” in our 2008 Form 10-K.
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I – Item 1A. Risk Factors” in our 2008 Form
10-K and “Forward-Looking Statements – Cautionary Language” in this
report.
We
provide information about this segment’s operating revenue and operating expense
line items, the period in which amounts are recognized, key drivers of changes
and historical details underlying the line items and their associated drivers
below. For detail on the operating realized gain (loss), see
“Realized Loss” below.
Insurance
Fees
Details
underlying insurance fees, account values and net flows (in millions) were as
follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Insurance
Fees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortality,
expense and other assessments
|
|
$ |
228 |
|
|
$ |
245 |
|
|
|
-7 |
% |
|
$ |
609 |
|
|
$ |
748 |
|
|
|
-19 |
% |
Surrender
charges
|
|
|
9 |
|
|
|
13 |
|
|
|
-31 |
% |
|
|
27 |
|
|
|
32 |
|
|
|
-16 |
% |
DFEL:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferrals
|
|
|
(16 |
) |
|
|
(13 |
) |
|
|
-23 |
% |
|
|
(39 |
) |
|
|
(38 |
) |
|
|
-3 |
% |
Prospective
unlocking - assumption changes
|
|
|
3 |
|
|
|
(1 |
) |
|
NM
|
|
|
|
3 |
|
|
|
(1 |
) |
|
NM
|
|
Retrospective
unlocking
|
|
|
(2 |
) |
|
|
3 |
|
|
NM
|
|
|
|
(11 |
) |
|
|
3 |
|
|
NM
|
|
Amortization,
net of interest, excluding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
unlocking
|
|
|
1 |
|
|
|
(1 |
) |
|
|
200 |
% |
|
|
9 |
|
|
|
5 |
|
|
|
80 |
% |
Total
insurance fees
|
|
$ |
223 |
|
|
$ |
246 |
|
|
|
-9 |
% |
|
$ |
598 |
|
|
$ |
749 |
|
|
|
-20 |
% |
|
|
As
of September 30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Account
Values
|
|
|
|
|
|
|
|
|
|
Variable
portion of variable annuities
|
|
$ |
52,429 |
|
|
$ |
49,982 |
|
|
|
5 |
% |
Fixed
portion of variable annuities
|
|
|
3,990 |
|
|
|
3,547 |
|
|
|
12 |
% |
Total
variable annuities
|
|
|
56,419 |
|
|
|
53,529 |
|
|
|
5 |
% |
Fixed
annuities, including indexed
|
|
|
15,776 |
|
|
|
14,142 |
|
|
|
12 |
% |
Fixed
annuities ceded to reinsurers
|
|
|
(1,049 |
) |
|
|
(1,196 |
) |
|
|
12 |
% |
Total
fixed annuities
|
|
|
14,727 |
|
|
|
12,946 |
|
|
|
14 |
% |
Total
account values
|
|
$ |
71,146 |
|
|
$ |
66,475 |
|
|
|
7 |
% |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Averages
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Daily
variable account values, excluding the fixed
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
portion
of variable
|
|
$ |
49,135 |
|
|
$ |
54,717 |
|
|
|
-10 |
% |
|
$ |
44,036 |
|
|
$ |
55,929 |
|
|
|
-21 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Daily
S&P 500
|
|
|
994.45 |
|
|
|
1,255.42 |
|
|
|
-21 |
% |
|
|
900.22 |
|
|
|
1,325.03 |
|
|
|
-32 |
% |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Net
Flows on Account Values
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable
portion of variable annuity deposits
|
|
$ |
1,063 |
|
|
$ |
1,672 |
|
|
|
-36 |
% |
|
$ |
2,741 |
|
|
$ |
5,602 |
|
|
|
-51 |
% |
Variable
portion of variable annuity withdrawals
|
|
|
(977 |
) |
|
|
(1,216 |
) |
|
|
20 |
% |
|
|
(2,914 |
) |
|
|
(3,704 |
) |
|
|
21 |
% |
Variable
portion of variable annuity net flows
|
|
|
86 |
|
|
|
456 |
|
|
|
-81 |
% |
|
|
(173 |
) |
|
|
1,898 |
|
|
NM
|
|
Fixed
portion of variable annuity deposits
|
|
|
766 |
|
|
|
896 |
|
|
|
-15 |
% |
|
|
2,400 |
|
|
|
2,631 |
|
|
|
-9 |
% |
Fixed
portion of variable annuity withdrawals
|
|
|
(105 |
) |
|
|
(124 |
) |
|
|
15 |
% |
|
|
(391 |
) |
|
|
(358 |
) |
|
|
-9 |
% |
Fixed
portion of variable annuity net flows
|
|
|
661 |
|
|
|
772 |
|
|
|
-14 |
% |
|
|
2,009 |
|
|
|
2,273 |
|
|
|
-12 |
% |
Total
variable annuity deposits
|
|
|
1,829 |
|
|
|
2,568 |
|
|
|
-29 |
% |
|
|
5,141 |
|
|
|
8,233 |
|
|
|
-38 |
% |
Total
variable annuity withdrawals
|
|
|
(1,082 |
) |
|
|
(1,340 |
) |
|
|
19 |
% |
|
|
(3,305 |
) |
|
|
(4,062 |
) |
|
|
19 |
% |
Total
variable annuity net flows
|
|
|
747 |
|
|
|
1,228 |
|
|
|
-39 |
% |
|
|
1,836 |
|
|
|
4,171 |
|
|
|
-56 |
% |
Fixed
indexed annuity deposits
|
|
|
846 |
|
|
|
215 |
|
|
|
293 |
% |
|
|
1,864 |
|
|
|
789 |
|
|
|
136 |
% |
Fixed
indexed annuity withdrawals
|
|
|
(115 |
) |
|
|
(114 |
) |
|
|
-1 |
% |
|
|
(516 |
) |
|
|
(299 |
) |
|
|
-73 |
% |
Fixed
indexed annuity net flows
|
|
|
731 |
|
|
|
101 |
|
|
NM
|
|
|
|
1,348 |
|
|
|
490 |
|
|
|
175 |
% |
Other
fixed annuity deposits
|
|
|
413 |
|
|
|
165 |
|
|
|
150 |
% |
|
|
896 |
|
|
|
388 |
|
|
|
131 |
% |
Other
fixed annuity withdrawals
|
|
|
(290 |
) |
|
|
(550 |
) |
|
|
47 |
% |
|
|
(1,006 |
) |
|
|
(1,335 |
) |
|
|
25 |
% |
Other
fixed annuity net flows
|
|
|
123 |
|
|
|
(385 |
) |
|
|
132 |
% |
|
|
(110 |
) |
|
|
(947 |
) |
|
|
88 |
% |
Total
annuity deposits
|
|
|
3,088 |
|
|
|
2,948 |
|
|
|
5 |
% |
|
|
7,901 |
|
|
|
9,410 |
|
|
|
-16 |
% |
Total
annuity withdrawals
|
|
|
(1,487 |
) |
|
|
(2,004 |
) |
|
|
26 |
% |
|
|
(4,827 |
) |
|
|
(5,696 |
) |
|
|
15 |
% |
Total
annuity net flows
|
|
$ |
1,601 |
|
|
$ |
944 |
|
|
|
70 |
% |
|
$ |
3,074 |
|
|
$ |
3,714 |
|
|
|
-17 |
% |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Other
Changes to Account Values
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
credited and change in market value on
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
variable,
excluding the fixed portion of variable
|
|
$ |
6,211 |
|
|
$ |
(7,069 |
) |
|
|
188 |
% |
|
$ |
9,928 |
|
|
$ |
(12,571 |
) |
|
|
179 |
% |
Transfers
from the fixed portion of variable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
annuity
products to the variable portion of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
variable
annuity products
|
|
|
609 |
|
|
|
742 |
|
|
|
-18 |
% |
|
|
1,749 |
|
|
|
2,218 |
|
|
|
-21 |
% |
We charge
contract holders mortality and expense assessments on variable annuity accounts
to cover insurance and administrative expenses. These assessments are
a function of the rates priced into the product and the average daily variable
account values. Average daily account values are driven by net flows
and the equity markets. In addition, for our fixed annuity contracts
and for some variable contracts, we collect surrender charges when contract
holders surrender their contracts during their surrender charge periods to
protect us from premature withdrawals. Insurance fees include charges
on both our variable and fixed annuity products, but exclude the attributed fees
on our GLB products; see “Realized Loss – Operating Realized Gain (Loss) – GLB”
below for discussion of these attributed fees.
Net
Investment Income and Interest Credited
Details
underlying net investment income, interest credited (in millions) and our
interest rate spread were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Net
Investment Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities, mortgage loans on real
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
estate
and other, net of investment expenses
|
|
$ |
248 |
|
|
$ |
222 |
|
|
|
12 |
% |
|
$ |
707 |
|
|
$ |
675 |
|
|
|
5 |
% |
Commercial
mortgage loan prepayment and bond
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
makewhole
premiums
(1)
|
|
|
1 |
|
|
|
1 |
|
|
|
0 |
% |
|
|
1 |
|
|
|
2 |
|
|
|
-50 |
% |
Alternative
investments
(2)
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
- |
|
|
|
(1 |
) |
|
|
100 |
% |
Surplus
investments (3)
|
|
|
22 |
|
|
|
19 |
|
|
|
16 |
% |
|
|
48 |
|
|
|
57 |
|
|
|
-16 |
% |
Broker-dealer
|
|
|
- |
|
|
|
1 |
|
|
|
-100 |
% |
|
|
- |
|
|
|
3 |
|
|
|
-100 |
% |
Total
net investment income
|
|
$ |
271 |
|
|
$ |
243 |
|
|
|
12 |
% |
|
$ |
756 |
|
|
$ |
736 |
|
|
|
3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
Credited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount
provided to contract holders
|
|
$ |
205 |
|
|
$ |
187 |
|
|
|
10 |
% |
|
$ |
541 |
|
|
$ |
550 |
|
|
|
-2 |
% |
Adjustment
(4)
|
|
|
(8 |
) |
|
|
- |
|
|
NM
|
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
DSI
deferrals
|
|
|
(20 |
) |
|
|
(25 |
) |
|
|
20 |
% |
|
|
(54 |
) |
|
|
(76 |
) |
|
|
29 |
% |
Interest
credited before DSI amortization
|
|
|
177 |
|
|
|
162 |
|
|
|
9 |
% |
|
|
487 |
|
|
|
474 |
|
|
|
3 |
% |
DSI
amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retrospective
unlocking
|
|
|
(7 |
) |
|
|
3 |
|
|
NM
|
|
|
|
(8 |
) |
|
|
2 |
|
|
NM
|
|
Amortization,
excluding unlocking
|
|
|
15 |
|
|
|
5 |
|
|
|
200 |
% |
|
|
32 |
|
|
|
20 |
|
|
|
60 |
% |
Total
interest credited
|
|
$ |
185 |
|
|
$ |
170 |
|
|
|
9 |
% |
|
$ |
511 |
|
|
$ |
496 |
|
|
|
3 |
% |
(1)
|
See
“Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond
Makewhole Premiums” below for additional
information.
|
(2)
|
See
“Consolidated Investments – Alternative Investments” below for additional
information.
|
(3)
|
Represents
net investment income on the required statutory surplus for this segment
and includes the impact of investment income on alternative investments
for such assets that are held in the portfolios supporting statutory
surplus versus the portfolios supporting product
liabilities.
|
(4)
|
During
the third quarter of 2009, we recorded an adjustment for a
misclassification between benefits and interest credited that did not
impact the results for the nine months ended September 30,
2009.
|
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
Basis
|
|
|
Months
Ended
|
|
|
Basis
|
|
|
|
September
30,
|
|
|
Point
|
|
|
September
30,
|
|
|
Point
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Interest
Rate Spread
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities, mortgage loans on real
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
estate
and other, net of investment expenses
|
|
|
5.68 |
% |
|
|
5.82 |
% |
|
|
(14 |
) |
|
|
5.47 |
% |
|
|
5.85 |
% |
|
|
(38 |
) |
Commercial
mortgage loan prepayment and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
bond
make whole premiums
|
|
|
0.02 |
% |
|
|
0.02 |
% |
|
|
- |
|
|
|
0.01 |
% |
|
|
0.02 |
% |
|
|
(1 |
) |
Alternative
investments
|
|
|
0.01 |
% |
|
|
0.00 |
% |
|
|
1 |
|
|
|
0.00 |
% |
|
|
-0.01 |
% |
|
|
1 |
|
Net
investment income yield on reserves
|
|
|
5.71 |
% |
|
|
5.84 |
% |
|
|
(13 |
) |
|
|
5.48 |
% |
|
|
5.86 |
% |
|
|
(38 |
) |
Interest
rate credited to contract holders (1)
|
|
|
3.98 |
% |
|
|
3.95 |
% |
|
|
3 |
|
|
|
3.81 |
% |
|
|
3.83 |
% |
|
|
(2 |
) |
Interest
rate spread
|
|
|
1.73 |
% |
|
|
1.89 |
% |
|
|
(16 |
) |
|
|
1.67 |
% |
|
|
2.03 |
% |
|
|
(36 |
) |
(1)
|
The
adjustment to interest credited discussed above had a 17 basis point
impact on the interest rate credited to contract holders for the third
quarter of 2009.
|
Note: The
yields, rates and spreads above are calculated using whole dollars instead of
dollars rounded to millions.
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Other
Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
invested assets on reserves
|
|
$ |
17,496 |
|
|
$ |
15,615 |
|
|
|
12 |
% |
|
$ |
17,220 |
|
|
$ |
15,691 |
|
|
|
10 |
% |
Average
fixed account values, including the
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
fixed
portion of variable
|
|
|
18,715 |
|
|
|
17,174 |
|
|
|
9 |
% |
|
|
17,892 |
|
|
|
17,291 |
|
|
|
3 |
% |
Transfers
from the fixed portion of variable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
annuity
products to the variable portion of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
variable
annuity products
|
|
|
(609 |
) |
|
|
(742 |
) |
|
|
18 |
% |
|
|
(1,749 |
) |
|
|
(2,218 |
) |
|
|
21 |
% |
Net
flows for fixed annuities, including the
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
fixed
portion of variable
|
|
|
1,515 |
|
|
|
488 |
|
|
|
210 |
% |
|
|
3,247 |
|
|
|
1,816 |
|
|
|
79 |
% |
A portion
of our investment income earned is credited to the contract holders of our fixed
annuity products, including the fixed portion of variable annuity
contracts. We expect to earn a spread between what we earn on the
underlying general account investments supporting the fixed annuity product
line, including the fixed portion of variable annuity contracts, and what we
credit to our fixed annuity contract holders’ accounts, including the fixed
portion of variable annuity contracts. The interest rate spread for
this segment represents the excess of the yield on invested assets on reserves
over the average crediting rate. The yield on invested assets on
reserves is calculated as net investment income, excluding the amounts
attributable to our surplus investments, reverse repurchase agreement interest
expense, inter-segment cash management program interest expense and interest on
collateral divided by average invested assets on reserves. The
average invested assets on reserves is calculated based upon total invested
assets, excluding hedge derivatives and collateral. The average
crediting rate is calculated as interest credited before DSI amortization, plus
the immediate annuity reserve change (included within benefits) divided by the
average fixed account values, including the fixed portion of variable annuity
contracts, net of coinsured account values. Fixed account values
reinsured under modified coinsurance agreements are included in account values
for this calculation. Changes in commercial mortgage loan prepayments
and bond makewhole premiums, investment income on alternative investments and
surplus investment income can vary significantly from period to period due to a
number of factors and, therefore, may contribute to investment income results
that are not indicative of the underlying trends.
Benefits
Benefits
for this segment include changes in reserves of immediate annuity account values
driven by premiums and changes in GDB and GLB benefit reserves.
The
changes in the GDB benefit ratio reserves for this segment are offset in
operating realized gain (loss). See “Realized Loss – Operating
Realized Gain (Loss) – GDB” below for additional information.
Underwriting,
Acquisition, Insurance and Other Expenses
Details
underlying underwriting, acquisition, insurance and other expenses (in millions)
were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Underwriting,
Acquisition, Insurance and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions
|
|
$ |
185 |
|
|
$ |
161 |
|
|
|
15 |
% |
|
$ |
467 |
|
|
$ |
513 |
|
|
|
-9 |
% |
General
and administrative expenses
|
|
|
82 |
|
|
|
83 |
|
|
|
-1 |
% |
|
|
231 |
|
|
|
243 |
|
|
|
-5 |
% |
Taxes,
licenses and fees
|
|
|
5 |
|
|
|
5 |
|
|
|
0 |
% |
|
|
15 |
|
|
|
21 |
|
|
|
-29 |
% |
Total
expenses incurred, excluding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
broker-dealer
|
|
|
272 |
|
|
|
249 |
|
|
|
9 |
% |
|
|
713 |
|
|
|
777 |
|
|
|
-8 |
% |
DAC
and VOBA deferrals
|
|
|
(181 |
) |
|
|
(170 |
) |
|
|
-6 |
% |
|
|
(467 |
) |
|
|
(534 |
) |
|
|
13 |
% |
Total
pre-broker-dealer expenses incurred,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
excluding
amortization, net of interest
|
|
|
91 |
|
|
|
79 |
|
|
|
15 |
% |
|
|
246 |
|
|
|
243 |
|
|
|
1 |
% |
DAC
and VOBA amortization, net of interest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prospective
unlocking - assumption changes
|
|
|
10 |
|
|
|
(2 |
) |
|
NM
|
|
|
|
10 |
|
|
|
(2 |
) |
|
NM
|
|
Retrospective
unlocking
|
|
|
(53 |
) |
|
|
35 |
|
|
NM
|
|
|
|
(68 |
) |
|
|
35 |
|
|
NM
|
|
Amortization,
net of interest, excluding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
unlocking
|
|
|
145 |
|
|
|
63 |
|
|
|
130 |
% |
|
|
330 |
|
|
|
241 |
|
|
|
37 |
% |
Broker-dealer
expenses incurred
|
|
|
75 |
|
|
|
79 |
|
|
|
-5 |
% |
|
|
210 |
|
|
|
257 |
|
|
|
-18 |
% |
Total
underwriting, acquisition, insurance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
other expenses
|
|
$ |
268 |
|
|
$ |
254 |
|
|
|
6 |
% |
|
$ |
728 |
|
|
$ |
774 |
|
|
|
-6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DAC
and VOBA Deferrals
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
a percentage of sales/deposits
|
|
|
5.9 |
% |
|
|
5.8 |
% |
|
|
|
|
|
|
5.9 |
% |
|
|
5.7 |
% |
|
|
|
|
Commissions
and other costs that vary with and are related primarily to the production of
new business are deferred to the extent recoverable and are amortized over the
lives of the contracts in relation to EGPs. We have certain trail
commissions that are based upon account values that are expensed as incurred
rather than deferred and amortized.
Broker-dealer
expenses that vary with and are related to sales are expensed as incurred and
not deferred and amortized. Fluctuations in these expenses correspond
with fluctuations in other revenues and fees.
Retirement Solutions – Defined
Contribution
Income
from Operations
Details
underlying the results for Retirement Solutions – Defined Contribution (in
millions) were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
fees
|
|
$ |
48 |
|
|
$ |
56 |
|
|
|
-14 |
% |
|
$ |
133 |
|
|
$ |
178 |
|
|
|
-25 |
% |
Net
investment income
|
|
|
190 |
|
|
|
181 |
|
|
|
5 |
% |
|
|
541 |
|
|
|
527 |
|
|
|
3 |
% |
Operating
realized loss
(1)
|
|
|
(5 |
) |
|
|
- |
|
|
NM
|
|
|
|
(6 |
) |
|
|
- |
|
|
NM
|
|
Other
revenues and fees
|
|
|
3 |
|
|
|
4 |
|
|
|
-25 |
% |
|
|
8 |
|
|
|
13 |
|
|
|
-38 |
% |
Total
operating revenues
|
|
|
236 |
|
|
|
241 |
|
|
|
-2 |
% |
|
|
676 |
|
|
|
718 |
|
|
|
-6 |
% |
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
credited
|
|
|
111 |
|
|
|
107 |
|
|
|
4 |
% |
|
|
334 |
|
|
|
320 |
|
|
|
4 |
% |
Benefits
(1)
|
|
|
(6 |
) |
|
|
- |
|
|
NM
|
|
|
|
(12 |
) |
|
|
- |
|
|
NM
|
|
Underwriting,
acquisition, insurance and other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
expenses
|
|
|
71 |
|
|
|
77 |
|
|
|
-8 |
% |
|
|
220 |
|
|
|
229 |
|
|
|
-4 |
% |
Total
operating expenses
|
|
|
176 |
|
|
|
184 |
|
|
|
-4 |
% |
|
|
542 |
|
|
|
549 |
|
|
|
-1 |
% |
Income
from operations before taxes
|
|
|
60 |
|
|
|
57 |
|
|
|
5 |
% |
|
|
134 |
|
|
|
169 |
|
|
|
-21 |
% |
Federal
income tax expense
|
|
|
17 |
|
|
|
15 |
|
|
|
13 |
% |
|
|
34 |
|
|
|
45 |
|
|
|
-24 |
% |
Income
from operations
|
|
$ |
43 |
|
|
$ |
42 |
|
|
|
2 |
% |
|
$ |
100 |
|
|
$ |
124 |
|
|
|
-19 |
% |
(1)
|
The
change in benefit ratio reserves for this segment was $(6) million and
$(9) million for the three and nine months ended September 30, 2009,
respectively, driven by variable account growth, as compared to none in
the corresponding periods of 2008; however, this impact is offset within
operating realized gain (loss) as discussed
below.
|
Comparison
of the Three Months Ended September 30, 2009 to 2008
Income
from operations for this segment modestly increased due primarily to the
following:
·
|
Higher
net investment income driven primarily by higher average fixed account
values, including the fixed portion of variable annuity contracts, driven
by transfers from variable to fixed since the third quarter of 2008,
partially offset by our liquidity strategy of maintaining higher cash
balances during the recent volatile markets that remained present early in
the third quarter of 2009 that has reduced our portfolio yield by 11 basis
points for the third quarter of
2009;
|
·
|
A
$5 million favorable prospective unlocking from assumption changes of DAC,
VOBA, DSI and reserves for our guarantee riders in 2009 due primarily to a
compensation-related change in our wholesaling distribution organization
that lowered deferrals as a percentage of total expenses incurred and
lower maintenance expenses than our model projections assumed (see
“Critical Accounting Policies and Estimates – DAC, VOBA, DSI and DFEL” for
more information); and
|
·
|
A
$2 million unfavorable retrospective unlocking of DAC, VOBA, DSI and
reserves for our guarantee riders during the third quarter of 2008 due
primarily to lower equity market performance and higher lapses than our
model projections assumed.
|
The
increase in income from operations was partially offset by the
following:
·
|
Lower
insurance fees driven primarily by lower average daily variable account
values resulting from the unfavorable equity markets and an overall shift
in business mix toward products with lower expense assessment
rates;
|
·
|
Higher
interest credited driven primarily by higher average fixed account values,
including the fixed portion of variable annuity contracts, driven by
transfers from variable to fixed since the third quarter of 2008,
partially offset by actions implemented during the third quarter of 2009
to reduce interest crediting rates;
and
|
·
|
Higher
underwriting, acquisition, insurance and other expenses, excluding
unlocking, due primarily to higher incentive compensation accruals as a
result of higher earnings and production performance relative to planned
goals.
|
Comparison
of the Nine Months Ended September 30, 2009 to 2008
Income
from operations for this segment decreased due primarily to the
following:
·
|
Lower
insurance fees driven primarily by lower average daily variable account
values resulting from the unfavorable equity markets and an overall shift
in business mix toward products with lower expense assessment rates;
and
|
·
|
Higher
interest credited driven primarily by higher average fixed account values,
including the fixed portion of variable annuity contracts, driven by
transfers from variable to fixed since the third quarter of 2008,
partially offset by actions implemented during the third quarter of 2009
to reduce interest crediting rates.
|
The
decrease in income from operations was partially offset by the
following:
·
|
Higher
net investment income driven primarily by higher average fixed account
values, including the fixed portion of variable annuity contracts, driven
by transfers from variable to fixed since the third quarter of 2008,
partially offset by our liquidity strategy of maintaining higher cash
balances during the recent volatile markets that has reduced our portfolio
yield by 15 basis points and a decline in investment income on surplus
investments due primarily to less favorable investment income on
alternative investments (see “Consolidated Investments – Alternative
Investments” below for additional
information);
|
·
|
The
impact of the prospective unlocking discussed above;
and
|
·
|
A
$1 million unfavorable retrospective unlocking of DAC, VOBA, DSI and
reserves for our guarantee riders during the first nine months of 2009 due
primarily to higher lapses and maintenance expenses and lower equity
market performance than our model projections assumed, compared to a $3
million unfavorable retrospective unlocking during the first nine months
of 2008 due primarily to lower equity market performance and higher lapses
than our model projections assumed.
|
Additional
Segment Information
We
experienced higher expenses attributable to our U.S. pension plans (see
“Critical Accounting Policies and Estimates – Pension and Other Postretirement
Benefit Plans” in our 2008 Form 10-K) during the first nine months of 2009, and
the fourth quarter of 2009 will continue this unfavorable trend when compared to
the corresponding period in 2008.
New
deposits are an important component of net flows and key to our efforts to grow
our business. Although deposits do not significantly impact current
period income from operations, they are an important indicator of future
profitability.
The other
component of net flows relates to the retention of the business. An
important measure of retention is the lapse rate, which compares the amount of
withdrawals to the average account values. The overall lapse rates
for our annuity products were 12% for the three and nine months ended September
30, 2009, compared to 14% and 15% for the corresponding periods in
2008.
Due to an
expected overall shift in business mix towards products with lower expense
assessment rates, a substantial increase in new deposit production will be
necessary to maintain earnings at current levels.
See Note
9 above for information on contractual guarantees to contract holders related to
GDB features for our Retirement Solutions Business.
We expect
to manage the effect of changing market investment returns by managing interest
rate spreads for near-term income from operations through a combination of
crediting rate actions and portfolio management. Our expectation
includes the assumption that there are no significant changes in net flows in or
out of our fixed accounts or other changes that may cause interest rate spreads
to differ from our expectation. For information on interest rate
spreads and the interest rate risk due to falling interest rates, see “Item 3.
Quantitative and Qualitative Disclosures About Market Risk.”
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I – Item 1A. Risk Factors” in our 2008 Form
10-K and “Forward-Looking Statements – Cautionary Language” in this
report.
We
provide information about this segment’s operating revenue and operating expense
line items, the period in which amounts are recognized, key drivers of changes
and historical details underlying the line items and their associated drivers
below. For detail on the operating realized loss, see “Realized Loss”
below.
Insurance
Fees
Details
underlying insurance fees, account values and net flows (in millions) were as
follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Insurance
Fees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuity
expense assessments
|
|
$ |
41 |
|
|
$ |
50 |
|
|
|
-18 |
% |
|
$ |
113 |
|
|
$ |
159 |
|
|
|
-29 |
% |
Mutual
fund fees
|
|
|
6 |
|
|
|
5 |
|
|
|
20 |
% |
|
|
16 |
|
|
|
14 |
|
|
|
14 |
% |
Total
expense assessments
|
|
|
47 |
|
|
|
55 |
|
|
|
-15 |
% |
|
|
129 |
|
|
|
173 |
|
|
|
-25 |
% |
Surrender
charges
|
|
|
1 |
|
|
|
1 |
|
|
|
0 |
% |
|
|
4 |
|
|
|
5 |
|
|
|
-20 |
% |
Total
insurance fees
|
|
$ |
48 |
|
|
$ |
56 |
|
|
|
-14 |
% |
|
$ |
133 |
|
|
$ |
178 |
|
|
|
-25 |
% |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Averages
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Daily
variable account values, excluding the
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
fixed
portion of variable
|
|
$ |
11,881 |
|
|
$ |
15,582 |
|
|
|
-24 |
% |
|
$ |
10,839 |
|
|
$ |
16,369 |
|
|
|
-34 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Daily
S&P 500
|
|
|
994.45 |
|
|
|
1,255.42 |
|
|
|
-21 |
% |
|
|
900.22 |
|
|
|
1,325.03 |
|
|
|
-32 |
% |
|
|
As
of September 30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Account
Values
|
|
|
|
|
|
|
|
|
|
Variable
portion of variable annuities
|
|
$ |
12,620 |
|
|
$ |
13,480 |
|
|
|
-6 |
% |
Fixed
portion of variable annuities
|
|
|
6,128 |
|
|
|
6,114 |
|
|
|
0 |
% |
Total
variable annuities
|
|
|
18,748 |
|
|
|
19,594 |
|
|
|
-4 |
% |
Fixed
annuities
|
|
|
6,030 |
|
|
|
5,304 |
|
|
|
14 |
% |
Total
annuities
|
|
|
24,778 |
|
|
|
24,898 |
|
|
|
0 |
% |
Mutual
funds
|
|
|
9,544 |
|
|
|
7,675 |
|
|
|
24 |
% |
Total
annuities and mutual funds
|
|
$ |
34,322 |
|
|
$ |
32,573 |
|
|
|
5 |
% |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Account
Value Roll Forward – By Product
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Micro – Small
Segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at beginning-of-period
|
|
$ |
5,234 |
|
|
$ |
7,286 |
|
|
|
-28 |
% |
|
$ |
4,888 |
|
|
$ |
7,798 |
|
|
|
-37 |
% |
Gross
deposits
|
|
|
290 |
|
|
|
389 |
|
|
|
-25 |
% |
|
|
852 |
|
|
|
1,276 |
|
|
|
-33 |
% |
Withdrawals
and deaths
|
|
|
(319 |
) |
|
|
(465 |
) |
|
|
31 |
% |
|
|
(853 |
) |
|
|
(1,429 |
) |
|
|
40 |
% |
Net
flows
|
|
|
(29 |
) |
|
|
(76 |
) |
|
|
62 |
% |
|
|
(1 |
) |
|
|
(153 |
) |
|
|
99 |
% |
Transfers
between fixed and variable accounts
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
(4 |
) |
|
|
(12 |
) |
|
|
67 |
% |
Inter-product
transfer (1)
|
|
|
- |
|
|
|
(653 |
) |
|
|
100 |
% |
|
|
- |
|
|
|
(653 |
) |
|
|
100 |
% |
Investment
increase and change in market value
|
|
|
580 |
|
|
|
(767 |
) |
|
|
176 |
% |
|
|
902 |
|
|
|
(1,190 |
) |
|
|
176 |
% |
Balance
at end-of-period
|
|
$ |
5,785 |
|
|
$ |
5,790 |
|
|
|
0 |
% |
|
$ |
5,785 |
|
|
$ |
5,790 |
|
|
|
0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Mid – Large Segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at beginning-of-period
|
|
$ |
11,425 |
|
|
$ |
9,985 |
|
|
|
14 |
% |
|
$ |
9,540 |
|
|
$ |
9,463 |
|
|
|
1 |
% |
Gross
deposits
|
|
|
617 |
|
|
|
687 |
|
|
|
-10 |
% |
|
|
2,304 |
|
|
|
2,203 |
|
|
|
5 |
% |
Withdrawals
and deaths
|
|
|
(259 |
) |
|
|
(222 |
) |
|
|
-17 |
% |
|
|
(703 |
) |
|
|
(679 |
) |
|
|
-4 |
% |
Net
flows
|
|
|
358 |
|
|
|
465 |
|
|
|
-23 |
% |
|
|
1,601 |
|
|
|
1,524 |
|
|
|
5 |
% |
Transfers
between fixed and variable accounts
|
|
|
16 |
|
|
|
(4 |
) |
|
NM
|
|
|
|
13 |
|
|
|
(44 |
) |
|
|
130 |
% |
Inter-product
transfer (1)
|
|
|
- |
|
|
|
653 |
|
|
|
-100 |
% |
|
|
- |
|
|
|
653 |
|
|
|
-100 |
% |
Investment
increase and change in market value
|
|
|
1,173 |
|
|
|
(789 |
) |
|
|
249 |
% |
|
|
1,818 |
|
|
|
(1,286 |
) |
|
|
241 |
% |
Balance
at end-of-period
|
|
$ |
12,972 |
|
|
$ |
10,310 |
|
|
|
26 |
% |
|
$ |
12,972 |
|
|
$ |
10,310 |
|
|
|
26 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Multi-Fund® and Other Variable
Annuities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at beginning-of-period
|
|
$ |
14,668 |
|
|
$ |
17,770 |
|
|
|
-17 |
% |
|
$ |
14,450 |
|
|
$ |
18,797 |
|
|
|
-23 |
% |
Gross
deposits
|
|
|
196 |
|
|
|
258 |
|
|
|
-24 |
% |
|
|
638 |
|
|
|
827 |
|
|
|
-23 |
% |
Withdrawals
and deaths
|
|
|
(381 |
) |
|
|
(554 |
) |
|
|
31 |
% |
|
|
(1,181 |
) |
|
|
(1,588 |
) |
|
|
26 |
% |
Net
flows
|
|
|
(185 |
) |
|
|
(296 |
) |
|
|
38 |
% |
|
|
(543 |
) |
|
|
(761 |
) |
|
|
29 |
% |
Transfers
between fixed and variable accounts
|
|
|
(1 |
) |
|
|
(1 |
) |
|
|
- |
|
|
|
- |
|
|
|
(1 |
) |
|
|
100 |
% |
Inter-segment
transfer
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
- |
|
|
|
295 |
|
|
|
-100 |
% |
Investment
increase and change in market value
|
|
|
1,083 |
|
|
|
(1,000 |
) |
|
|
208 |
% |
|
|
1,658 |
|
|
|
(1,857 |
) |
|
|
189 |
% |
Balance
at end-of-period
|
|
$ |
15,565 |
|
|
$ |
16,473 |
|
|
|
-6 |
% |
|
$ |
15,565 |
|
|
$ |
16,473 |
|
|
|
-6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Annuities and Mutual
Funds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
at beginning-of-period
|
|
$ |
31,327 |
|
|
$ |
35,041 |
|
|
|
-11 |
% |
|
$ |
28,878 |
|
|
$ |
36,058 |
|
|
|
-20 |
% |
Gross
deposits
|
|
|
1,103 |
|
|
|
1,334 |
|
|
|
-17 |
% |
|
|
3,794 |
|
|
|
4,306 |
|
|
|
-12 |
% |
Withdrawals
and deaths
|
|
|
(959 |
) |
|
|
(1,241 |
) |
|
|
23 |
% |
|
|
(2,737 |
) |
|
|
(3,696 |
) |
|
|
26 |
% |
Net
flows
|
|
|
144 |
|
|
|
93 |
|
|
|
55 |
% |
|
|
1,057 |
|
|
|
610 |
|
|
|
73 |
% |
Transfers
between fixed and variable accounts
|
|
|
15 |
|
|
|
(5 |
) |
|
NM
|
|
|
|
9 |
|
|
|
(57 |
) |
|
|
116 |
% |
Inter-segment
transfer
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
- |
|
|
|
295 |
|
|
|
-100 |
% |
Investment
increase and change in market value
|
|
|
2,836 |
|
|
|
(2,556 |
) |
|
|
211 |
% |
|
|
4,378 |
|
|
|
(4,333 |
) |
|
|
201 |
% |
Balance
at end-of-period (2)
|
|
$ |
34,322 |
|
|
$ |
32,573 |
|
|
|
5 |
% |
|
$ |
34,322 |
|
|
$ |
32,573 |
|
|
|
5 |
% |
(1)
|
On
September 30, 2008, $653 million relating to the Lincoln Employee 401(k)
Plan transferred from LINCOLN DIRECTORSM
to LINCOLN
ALLIANCE®.
|
(2)
|
Includes
mutual fund account values. Mutual funds are not included in
the separate accounts reported on our Consolidated Balance Sheets as we do
not have any ownership interest in
them.
|
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Net
Flows on Account Values
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable
portion of variable annuity deposits
|
|
$ |
387 |
|
|
$ |
532 |
|
|
|
-27 |
% |
|
$ |
1,173 |
|
|
$ |
1,767 |
|
|
|
-34 |
% |
Variable
portion of variable annuity withdrawals
|
|
|
(471 |
) |
|
|
(723 |
) |
|
|
35 |
% |
|
|
(1,299 |
) |
|
|
(2,202 |
) |
|
|
41 |
% |
Variable
portion of variable annuity net flows
|
|
|
(84 |
) |
|
|
(191 |
) |
|
|
56 |
% |
|
|
(126 |
) |
|
|
(435 |
) |
|
|
71 |
% |
Fixed
portion of variable annuity deposits
|
|
|
79 |
|
|
|
94 |
|
|
|
-16 |
% |
|
|
256 |
|
|
|
279 |
|
|
|
-8 |
% |
Fixed
portion of variable annuity withdrawals
|
|
|
(178 |
) |
|
|
(228 |
) |
|
|
22 |
% |
|
|
(570 |
) |
|
|
(620 |
) |
|
|
8 |
% |
Fixed
portion of variable annuity net flows
|
|
|
(99 |
) |
|
|
(134 |
) |
|
|
26 |
% |
|
|
(314 |
) |
|
|
(341 |
) |
|
|
8 |
% |
Total
variable annuity deposits
|
|
|
466 |
|
|
|
626 |
|
|
|
-26 |
% |
|
|
1,429 |
|
|
|
2,046 |
|
|
|
-30 |
% |
Total
variable annuity withdrawals
|
|
|
(649 |
) |
|
|
(951 |
) |
|
|
32 |
% |
|
|
(1,869 |
) |
|
|
(2,822 |
) |
|
|
34 |
% |
Total
variable annuity net flows
|
|
|
(183 |
) |
|
|
(325 |
) |
|
|
44 |
% |
|
|
(440 |
) |
|
|
(776 |
) |
|
|
43 |
% |
Fixed
annuity deposits
|
|
|
227 |
|
|
|
196 |
|
|
|
16 |
% |
|
|
787 |
|
|
|
623 |
|
|
|
26 |
% |
Fixed
annuity withdrawals
|
|
|
(149 |
) |
|
|
(183 |
) |
|
|
19 |
% |
|
|
(466 |
) |
|
|
(541 |
) |
|
|
14 |
% |
Fixed
annuity net flows
|
|
|
78 |
|
|
|
13 |
|
|
NM
|
|
|
|
321 |
|
|
|
82 |
|
|
|
291 |
% |
Total
annuity deposits
|
|
|
693 |
|
|
|
822 |
|
|
|
-16 |
% |
|
|
2,216 |
|
|
|
2,669 |
|
|
|
-17 |
% |
Total
annuity withdrawals
|
|
|
(798 |
) |
|
|
(1,134 |
) |
|
|
30 |
% |
|
|
(2,335 |
) |
|
|
(3,363 |
) |
|
|
31 |
% |
Total
annuity net flows
|
|
|
(105 |
) |
|
|
(312 |
) |
|
|
66 |
% |
|
|
(119 |
) |
|
|
(694 |
) |
|
|
83 |
% |
Mutual
fund deposits
|
|
|
410 |
|
|
|
512 |
|
|
|
-20 |
% |
|
|
1,578 |
|
|
|
1,637 |
|
|
|
-4 |
% |
Mutual
fund withdrawals
|
|
|
(161 |
) |
|
|
(107 |
) |
|
|
-50 |
% |
|
|
(402 |
) |
|
|
(333 |
) |
|
|
-21 |
% |
Mutual
fund net flows
|
|
|
249 |
|
|
|
405 |
|
|
|
-39 |
% |
|
|
1,176 |
|
|
|
1,304 |
|
|
|
-10 |
% |
Total
annuity and mutual fund deposits
|
|
|
1,103 |
|
|
|
1,334 |
|
|
|
-17 |
% |
|
|
3,794 |
|
|
|
4,306 |
|
|
|
-12 |
% |
Total
annuity and mutual fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
withdrawals
|
|
|
(959 |
) |
|
|
(1,241 |
) |
|
|
23 |
% |
|
|
(2,737 |
) |
|
|
(3,696 |
) |
|
|
26 |
% |
Total
annuity and mutual fund
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
flows
|
|
$ |
144 |
|
|
$ |
93 |
|
|
|
55 |
% |
|
$ |
1,057 |
|
|
$ |
610 |
|
|
|
73 |
% |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Other
Changes to Account Values
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
credited and change in market value on
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
variable,
excluding the fixed portion of variable
|
|
$ |
1,581 |
|
|
$ |
(1,854 |
) |
|
|
185 |
% |
|
$ |
2,322 |
|
|
$ |
(3,296 |
) |
|
|
170 |
% |
Transfers
from the fixed portion of variable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
annuity
products to the variable portion of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
variable
annuity products
|
|
|
21 |
|
|
|
(117 |
) |
|
|
118 |
% |
|
|
(164 |
) |
|
|
(318 |
) |
|
|
48 |
% |
We charge
expense assessments to cover insurance and administrative
expenses. Expense assessments are generally equal to a percentage of
the daily variable account values. Average daily account values are
driven by net flows and the equity markets. Our expense assessments
include fees we earn for the services that we provide to our mutual fund
programs. In addition, for both our fixed and variable annuity
contracts, we collect surrender charges when contract holders surrender their
contracts during the surrender charge periods to protect us from premature
withdrawals.
Net
Investment Income and Interest Credited
Details
underlying net investment income, interest credited (in millions) and our
interest rate spread were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Net
Investment Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities, mortgage loans on real
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
estate
and other, net of investment expenses
|
|
$ |
174 |
|
|
$ |
165 |
|
|
|
5 |
% |
|
$ |
510 |
|
|
$ |
489 |
|
|
|
4 |
% |
Commercial
mortgage loan prepayment and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
bond
makewhole premiums (1)
|
|
|
2 |
|
|
|
5 |
|
|
|
-60 |
% |
|
|
3 |
|
|
|
7 |
|
|
|
-57 |
% |
Alternative
investments (2)
|
|
|
1 |
|
|
|
- |
|
|
NM
|
|
|
|
- |
|
|
|
(2 |
) |
|
|
100 |
% |
Surplus
investments (3)
|
|
|
13 |
|
|
|
11 |
|
|
|
18 |
% |
|
|
28 |
|
|
|
33 |
|
|
|
-15 |
% |
Total
net investment income
|
|
$ |
190 |
|
|
$ |
181 |
|
|
|
5 |
% |
|
$ |
541 |
|
|
$ |
527 |
|
|
|
3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
Credited
|
|
$ |
111 |
|
|
$ |
107 |
|
|
|
4 |
% |
|
$ |
334 |
|
|
$ |
320 |
|
|
|
4 |
% |
(1)
|
See
“Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond
Makewhole Premiums” below for additional
information.
|
(2)
|
See
“Consolidated Investments – Alternative Investments” below for additional
information.
|
(3)
|
Represents
net investment income on the required statutory surplus for this segment
and includes the impact of investment income on alternative investments
for such assets that are held in the portfolios supporting statutory
surplus versus the portfolios supporting product
liabilities.
|
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
Basis
|
|
|
Months
Ended
|
|
|
Basis
|
|
|
|
September
30,
|
|
|
Point
|
|
|
September
30,
|
|
|
Point
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Interest
Rate Spread
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities, mortgage loans on real
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
estate
and other, net of investment expenses
|
|
|
5.85 |
% |
|
|
5.94 |
% |
|
|
(9 |
) |
|
|
5.78 |
% |
|
|
5.91 |
% |
|
|
(13 |
) |
Commercial
mortgage loan prepayment and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
bond
makewhole premiums
|
|
|
0.08 |
% |
|
|
0.17 |
% |
|
|
(9 |
) |
|
|
0.03 |
% |
|
|
0.08 |
% |
|
|
(5 |
) |
Alternative
investments
|
|
|
0.03 |
% |
|
|
-0.01 |
% |
|
|
4 |
|
|
|
0.00 |
% |
|
|
-0.02 |
% |
|
|
2 |
|
Net
investment income yield on reserves
|
|
|
5.96 |
% |
|
|
6.10 |
% |
|
|
(14 |
) |
|
|
5.81 |
% |
|
|
5.97 |
% |
|
|
(16 |
) |
Interest
rate credited to contract holders
|
|
|
3.66 |
% |
|
|
3.77 |
% |
|
|
(11 |
) |
|
|
3.73 |
% |
|
|
3.79 |
% |
|
|
(6 |
) |
Interest
rate spread
|
|
|
2.30 |
% |
|
|
2.33 |
% |
|
|
(3 |
) |
|
|
2.08 |
% |
|
|
2.18 |
% |
|
|
(10 |
) |
Note: The
yields, rates and spreads above are calculated using whole dollars instead of
dollars rounded to millions.
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Other
Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
invested assets on reserves
|
|
$ |
11,895 |
|
|
$ |
11,146 |
|
|
|
7 |
% |
|
$ |
11,762 |
|
|
$ |
11,034 |
|
|
|
7 |
% |
Average
fixed account values, including the
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
fixed
portion of variable
|
|
|
12,114 |
|
|
|
11,321 |
|
|
|
7 |
% |
|
|
11,960 |
|
|
|
11,233 |
|
|
|
6 |
% |
Transfers
from the fixed portion of variable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
annuity
products to the variable portion of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
variable
annuity products
|
|
|
(21 |
) |
|
|
117 |
|
|
NM
|
|
|
|
164 |
|
|
|
318 |
|
|
|
-48 |
% |
Net
flows for fixed annuities, including the
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
fixed
portion of variable
|
|
|
(21 |
) |
|
|
(121 |
) |
|
|
83 |
% |
|
|
7 |
|
|
|
(259 |
) |
|
|
103 |
% |
A portion
of our investment income earned is credited to the contract holders of our fixed
annuity products, including the fixed portion of variable annuity
contracts. We expect to earn a spread between what we earn on the
underlying general account investments supporting the fixed annuity product
line, including the fixed portion of variable annuity contracts, and what we
credit to our fixed annuity contract holders’ accounts, including the fixed
portion of variable annuity contracts. The interest rate spread for
this segment represents the excess of the yield on invested assets on reserves
over the average crediting rate. The yield on invested assets on
reserves is calculated as net investment income, excluding the amounts
attributable to our surplus investments, reverse repurchase agreement interest
expense, inter-segment cash management program interest expense and interest on
collateral, divided by average invested assets on reserves. The
average invested assets on reserves are calculated based upon total invested
assets, excluding hedge derivatives. The average crediting rate is
calculated as interest credited before DSI amortization, divided by the average
fixed account values, including the fixed portion of variable annuity
contracts. Commercial mortgage loan prepayments and bond makewhole
premiums, investment income on alternative investments and surplus investment
income can vary significantly from period to period due to a number of factors
and, therefore, may contribute to investment income results that are not
indicative of the underlying trends.
Benefits
Benefits
for this segment include changes in GDB and GLB benefit reserves.
The
changes in the GDB benefit ratio reserves for this segment are offset in
operating realized loss. See “Realized Loss – Operating Realized Gain
(Loss) – GDB” below for additional information.
Underwriting,
Acquisition, Insurance and Other Expenses
Details
underlying underwriting, acquisition, insurance and other expenses (in millions)
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Underwriting,
Acquisition, Insurance and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions
|
|
$ |
16 |
|
|
$ |
17 |
|
|
|
-6 |
% |
|
$ |
46 |
|
|
$ |
56 |
|
|
|
-18 |
% |
General
and administrative expenses
|
|
|
53 |
|
|
|
53 |
|
|
|
0 |
% |
|
|
161 |
|
|
|
158 |
|
|
|
2 |
% |
Taxes,
licenses and fees
|
|
|
3 |
|
|
|
3 |
|
|
|
0 |
% |
|
|
9 |
|
|
|
10 |
|
|
|
-10 |
% |
Total
expenses incurred
|
|
|
72 |
|
|
|
73 |
|
|
|
-1 |
% |
|
|
216 |
|
|
|
224 |
|
|
|
-4 |
% |
DAC
deferrals
|
|
|
(15 |
) |
|
|
(20 |
) |
|
|
25 |
% |
|
|
(51 |
) |
|
|
(66 |
) |
|
|
23 |
% |
Total
expenses recognized before amortization
|
|
|
57 |
|
|
|
53 |
|
|
|
8 |
% |
|
|
165 |
|
|
|
158 |
|
|
|
4 |
% |
DAC
and VOBA amortization, net of interest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prospective
unlocking - assumption changes
|
|
|
(8 |
) |
|
|
- |
|
|
NM
|
|
|
|
(8 |
) |
|
|
- |
|
|
NM
|
|
Retrospective
unlocking
|
|
|
(2 |
) |
|
|
3 |
|
|
NM
|
|
|
|
- |
|
|
|
5 |
|
|
|
-100 |
% |
Amortization,
net of interest, excluding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
unlocking
|
|
|
24 |
|
|
|
21 |
|
|
|
14 |
% |
|
|
63 |
|
|
|
66 |
|
|
|
-5 |
% |
Total
underwriting, acquisition, insurance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
other expenses
|
|
$ |
71 |
|
|
$ |
77 |
|
|
|
-8 |
% |
|
$ |
220 |
|
|
$ |
229 |
|
|
|
-4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DAC
Deferrals
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
a percentage of annuity sales/deposits
|
|
|
2.2 |
% |
|
|
2.4 |
% |
|
|
|
|
|
|
2.3 |
% |
|
|
2.5 |
% |
|
|
|
|
Commissions
and other costs, that vary with and are related primarily to the sale of annuity
contracts, are deferred to the extent recoverable and are amortized over the
lives of the contracts in relation to EGPs. For certain annuity
contracts, trail commissions that are based upon account values are expensed as
they are incurred rather than deferred and amortized. We do not pay
commissions on sales of our mutual fund products, and distribution expenses
associated with the sale of these mutual fund products are expensed as they are
incurred.
RESULTS
OF INSURANCE SOLUTIONS
The
Insurance Solutions business provides its products through two
segments: Life Insurance and Group Protection. The
Insurance Solutions – Life Insurance segment offers wealth protection and
transfer opportunities through term insurance, a linked-benefit product (which
is a UL policy linked with riders that provide for long-term care costs) and
both single and survivorship versions of UL and VUL, including corporate-owned
UL and VUL (“COLI”) and bank-owned UL and VUL (“BOLI”) products. The
Insurance Solutions – Group Protection segment offers group life, disability and
dental insurance to employers.
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I – Item 1A. Risk Factors” in our 2008 Form
10-K and “Forward-Looking Statements – Cautionary Language” in this
report.
Insurance
Solutions – Life Insurance
Income
from Operations
Details
underlying the results for Insurance Solutions – Life Insurance (in millions)
were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$ |
93 |
|
|
$ |
91 |
|
|
|
2 |
% |
|
$ |
277 |
|
|
$ |
267 |
|
|
|
4 |
% |
Insurance
fees
|
|
|
494 |
|
|
|
451 |
|
|
|
10 |
% |
|
|
1,426 |
|
|
|
1,386 |
|
|
|
3 |
% |
Net
investment income
|
|
|
495 |
|
|
|
522 |
|
|
|
-5 |
% |
|
|
1,446 |
|
|
|
1,541 |
|
|
|
-6 |
% |
Amortization
of deferred loss on business sold
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
through
reinsurance
|
|
|
(1 |
) |
|
|
- |
|
|
NM
|
|
|
|
(1 |
) |
|
|
- |
|
|
NM
|
|
Other
revenues and fees
|
|
|
8 |
|
|
|
10 |
|
|
|
-20 |
% |
|
|
20 |
|
|
|
22 |
|
|
|
-9 |
% |
Total
operating revenues
|
|
|
1,089 |
|
|
|
1,074 |
|
|
|
1 |
% |
|
|
3,168 |
|
|
|
3,216 |
|
|
|
-1 |
% |
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
credited
|
|
|
293 |
|
|
|
305 |
|
|
|
-4 |
% |
|
|
886 |
|
|
|
902 |
|
|
|
-2 |
% |
Benefits
|
|
|
320 |
|
|
|
400 |
|
|
|
-20 |
% |
|
|
1,000 |
|
|
|
1,006 |
|
|
|
-1 |
% |
Underwriting,
acquisition, insurance and other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
expenses
|
|
|
284 |
|
|
|
167 |
|
|
|
70 |
% |
|
|
700 |
|
|
|
621 |
|
|
|
13 |
% |
Total
operating expenses
|
|
|
897 |
|
|
|
872 |
|
|
|
3 |
% |
|
|
2,586 |
|
|
|
2,529 |
|
|
|
2 |
% |
Income
from operations before taxes
|
|
|
192 |
|
|
|
202 |
|
|
|
-5 |
% |
|
|
582 |
|
|
|
687 |
|
|
|
-15 |
% |
Federal
income tax expense
|
|
|
55 |
|
|
|
65 |
|
|
|
-15 |
% |
|
|
170 |
|
|
|
229 |
|
|
|
-26 |
% |
Income
from operations
|
|
$ |
137 |
|
|
$ |
137 |
|
|
|
0 |
% |
|
$ |
412 |
|
|
$ |
458 |
|
|
|
-10 |
% |
Comparison
of the Three Months Ended September 30, 2009 to 2008
Income
from operations for this segment remained flat due primarily to the
following:
·
|
Lower
net investment income due primarily to unfavorable results from our
investment income on alternative investments (see “Consolidated
Investments – Alternative Investments” below for additional information)
and the reinsurance transaction effective December 31, 2008, discussed in
“Additional Segment Information”
below;
|
·
|
A
$7 million unfavorable prospective unlocking of DAC, VOBA, DFEL and
secondary guarantee life insurance product reserves from assumption
changes due primarily to lower investment spreads and higher expenses,
mortality and lapse rates than our model projections assumed in 2009
compared to a $21 million unfavorable prospective unlocking (a $34 million
unfavorable unlocking from model refinements, net of a $13 million
favorable unlocking from assumption changes due primarily to higher
investment spreads and lower death claims, lapse rates and expenses than
our model projections assumed and adjustments to secondary guarantee life
insurance product reserves) in 2008 (see “Critical Accounting Policies and
Estimates – DAC, VOBA, DSI and DFEL” for more information);
and
|
·
|
The
impact of the coinsurance agreement discussed in “Additional Segment
Information” below, which resulted in reductions in insurance fees, net
investment income, interest credited, benefits and underwriting,
acquisition, insurance and other
expenses.
|
Comparison
of the Nine Months Ended September 30, 2009 to 2008
Income
from operations for this segment decreased due primarily to the
following:
·
|
Lower
net investment income due primarily to unfavorable results from our
investment income on alternative investments (see “Consolidated
Investments – Alternative Investments” below for additional information)
and the reinsurance transaction effective December 31, 2008, discussed in
“Additional Segment Information”
below;
|
·
|
An
increase in benefits, excluding unlocking, attributable primarily to an
increase in secondary guarantee life insurance product reserves from
continued growth in the business;
and
|
·
|
The
impact of the coinsurance agreement discussed in “Additional Segment
Information” below, which resulted in reductions in insurance fees, net
investment income, interest credited, benefits and underwriting,
acquisition, insurance and other
expenses.
|
The
decrease in income from operations was partially offset by the
following:
·
|
The
impact of prospective unlocking discussed
above;
|
·
|
Lower
underwriting, acquisition, insurance and other expenses, excluding
unlocking, due primarily to a decrease in DAC and VOBA amortization as a
result of lower gross margins in the first and second quarters of 2009,
attributable primarily to lower investment income on alternative
investments; and
|
·
|
A
reduction in federal income tax expense due primarily to favorable tax
return true-ups in the first quarter of
2009.
|
Additional
Segment Information
The
coinsurance agreement that we entered into on March 31, 2009, resulted in a
pre-tax deferred loss of $53 million, and approximately $2 million annually will
be amortized into income from operations prospectively over 20
years. Effective October 1, 2009, we executed an additional agreement
whereby we assumed the mortality risk on this block of business through yearly
renewable term reinsurance. As a result of these agreements, this
segment’s income from operations will be reduced by approximately $6 million per
quarter as a result of reductions in insurance fees, net investment income,
interest credited and benefits that we had not experienced prior to these
agreements. This unfavorable impact will be partially offset by an
approximate $2 million increase to income from operations in Other Operations,
as a result of having higher net investment income due to the transfer of assets
from Insurance Solutions – Life Insurance attributable to its reduction in
capital as a result of these coinsurance agreements; therefore, we expect our
net impact from this transaction to our consolidated net income will be a
reduction of $4 million per quarter. See “Reinsurance” below for more
information.
As of
December 31, 2008, we released approximately $240 million of capital that had
previously supported our UL products with secondary guarantees as a result of
executing on a reinsurance transaction that resulted in the release of statutory
reserves related to the Application of the Valuation of Life Insurance Policies
Model Regulation (“AG38”). This reduction in capital lowered the
level of assets supporting this business, as assets were transferred to Other
Operations, and caused an approximate $4 million per quarter ongoing reduction
in this segment’s net investment income.
A portion
of the retrospective and prospective unlocking of DAC, VOBA, DFEL and secondary
guarantee life insurance product reserves in 2008 resulted in an unfavorable
recurring earnings impact of $7 million per quarter that began in the third
quarter of 2008.
On March
1, 2009, we implemented a 15 basis point decrease in crediting rates on most
interest-sensitive products not already at contractual guarantees, which has
increased spreads by approximately 5 basis points. On June 1, 2008,
we implemented a 10 basis point decrease in crediting rates on most
interest-sensitive products not already at contractual guarantees, which has
increased spreads by approximately 5 basis points.
As of
September 30, 2009, 73% of interest-sensitive account values had crediting rates
at contract guaranteed levels, and 14% had crediting rates within 50 basis
points of contractual guarantees. Going forward, we expect to be able
to manage the effects of spreads on near-term income from operations through a
combination of rate actions and portfolio management, which assumes no
significant changes in net flows into or out of our fixed accounts or other
changes that may cause interest rate spreads to differ from our
expectations. For information on interest rate spreads and the
interest rate risk due to falling interest rates, see “Item 3. Quantitative and
Qualitative Disclosures About Market Risk.”
Sales are
not recorded as a component of revenues (other than for traditional products)
and do not have a significant impact on current quarter income from operations
but are indicators of future profitability. Generally, we have higher
sales during the second half of the year with the fourth quarter being our
strongest; however, results for 2008 were muted given the economic
conditions.
We
experienced higher expenses attributable to our U.S. pension plans (see
“Critical Accounting Policies and Estimates – Pension and Other Postretirement
Benefit Plans” in our 2008 Form 10-K) during the first nine months of 2009, and
the fourth quarter of 2009 will continue this unfavorable trend when compared to
the corresponding period in 2008.
We
provide information about this segment’s operating revenue and operating expense
line items, the period in which amounts are recognized, key drivers of changes
and historical details underlying the line items and their associated drivers
below.
Insurance
Premiums
Insurance
premiums relate to traditional products and are a function of the rates priced
into the product and the level of insurance in force. Insurance in
force, in turn, is driven by sales, persistency and mortality
experience.
Insurance
Fees
Details
underlying insurance fees, sales, net flows, account values and in-force face
amount (in millions) were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Insurance
Fees
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortality
assessments
|
|
$ |
317 |
|
|
$ |
332 |
|
|
|
-5 |
% |
|
$ |
981 |
|
|
$ |
982 |
|
|
|
0 |
% |
Expense
assessments
|
|
|
186 |
|
|
|
178 |
|
|
|
4 |
% |
|
|
538 |
|
|
|
520 |
|
|
|
3 |
% |
Surrender
charges
|
|
|
33 |
|
|
|
18 |
|
|
|
83 |
% |
|
|
81 |
|
|
|
52 |
|
|
|
56 |
% |
DFEL:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferrals
|
|
|
(108 |
) |
|
|
(97 |
) |
|
|
-11 |
% |
|
|
(305 |
) |
|
|
(276 |
) |
|
|
-11 |
% |
Amortization,
net of interest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prospective
unlocking - assumption changes
|
|
|
20 |
|
|
|
(4 |
) |
|
NM
|
|
|
|
20 |
|
|
|
(4 |
) |
|
NM
|
|
Prospective
unlocking - model refinements
|
|
|
- |
|
|
|
(25 |
) |
|
|
100 |
% |
|
|
- |
|
|
|
(25 |
) |
|
|
100 |
% |
Retrospective
unlocking
|
|
|
8 |
|
|
|
12 |
|
|
|
-33 |
% |
|
|
12 |
|
|
|
27 |
|
|
|
-56 |
% |
Amortization,
net of interest, excluding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
unlocking
|
|
|
38 |
|
|
|
37 |
|
|
|
3 |
% |
|
|
99 |
|
|
|
110 |
|
|
|
-10 |
% |
Total
insurance fees
|
|
$ |
494 |
|
|
$ |
451 |
|
|
|
10 |
% |
|
$ |
1,426 |
|
|
$ |
1,386 |
|
|
|
3 |
% |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Sales
by Product
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
UL:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Excluding
MoneyGuard®
|
|
$ |
91 |
|
|
$ |
144 |
|
|
|
-37 |
% |
|
$ |
278 |
|
|
$ |
382 |
|
|
|
-27 |
% |
MoneyGuard®
|
|
|
18 |
|
|
|
14 |
|
|
|
29 |
% |
|
|
44 |
|
|
|
37 |
|
|
|
19 |
% |
Total
UL
|
|
|
109 |
|
|
|
158 |
|
|
|
-31 |
% |
|
|
322 |
|
|
|
419 |
|
|
|
-23 |
% |
VUL
|
|
|
7 |
|
|
|
12 |
|
|
|
-42 |
% |
|
|
23 |
|
|
|
39 |
|
|
|
-41 |
% |
COLI
and BOLI
|
|
|
14 |
|
|
|
13 |
|
|
|
8 |
% |
|
|
31 |
|
|
|
54 |
|
|
|
-43 |
% |
Term/whole
life
|
|
|
16 |
|
|
|
7 |
|
|
|
129 |
% |
|
|
39 |
|
|
|
18 |
|
|
|
117 |
% |
Total
sales
|
|
$ |
146 |
|
|
$ |
190 |
|
|
|
-23 |
% |
|
$ |
415 |
|
|
$ |
530 |
|
|
|
-22 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Flows
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
$ |
1,074 |
|
|
$ |
1,082 |
|
|
|
-1 |
% |
|
$ |
3,151 |
|
|
$ |
3,276 |
|
|
|
-4 |
% |
Withdrawals
and deaths
|
|
|
(512 |
) |
|
|
(392 |
) |
|
|
-31 |
% |
|
|
(1,492 |
) |
|
|
(1,258 |
) |
|
|
-19 |
% |
Net
flows
|
|
$ |
562 |
|
|
$ |
690 |
|
|
|
-19 |
% |
|
$ |
1,659 |
|
|
$ |
2,018 |
|
|
|
-18 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
holder assessments
|
|
$ |
747 |
|
|
$ |
705 |
|
|
|
6 |
% |
|
$ |
2,205 |
|
|
$ |
2,060 |
|
|
|
7 |
% |
|
|
As
of September 30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Account
Values
|
|
|
|
|
|
|
|
|
|
UL
(1)
|
|
$ |
24,631 |
|
|
$ |
24,951 |
|
|
|
-1 |
% |
VUL
(1)
|
|
|
4,369 |
|
|
|
5,056 |
|
|
|
-14 |
% |
Interest-sensitive
whole life
|
|
|
2,272 |
|
|
|
2,276 |
|
|
|
0 |
% |
Total
account values
|
|
$ |
31,272 |
|
|
$ |
32,283 |
|
|
|
-3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
In-Force
Face Amount
|
|
|
|
|
|
|
|
|
|
|
|
|
UL
and other (1)
|
|
$ |
289,124 |
|
|
$ |
306,293 |
|
|
|
-6 |
% |
Term
insurance
|
|
|
242,889 |
|
|
|
233,671 |
|
|
|
4 |
% |
Total
in-force face amount
|
|
$ |
532,013 |
|
|
$ |
539,964 |
|
|
|
-1 |
% |
(1)
|
Effective
with the March 31, 2009, coinsurance agreement, UL and VUL account values
were reduced by $938 million and $640 million, respectively, and UL and
other face amount in force was reduced by $20.9
billion.
|
Insurance
fees relate only to interest-sensitive products and include mortality
assessments, expense assessments (net of deferrals and amortization related to
DFEL) and surrender charges. Mortality and expense assessments are
deducted from our contract holders’ account values. These amounts are
a function of the rates priced into the product and premiums received, face
amount in force and account values. Insurance in force, in turn, is
driven by sales, persistency and mortality experience. In-force
growth should be considered independently with respect to term products versus
UL and other products, as term products have a lower profitability relative to
face amount compared to whole life and interest-sensitive products.
Sales in
the table above and as discussed above were reported as follows:
·
|
UL
(excluding linked-benefit products) and VUL (including COLI and BOLI) –
first year commissionable premiums plus 5% of excess premiums received,
including an adjustment for internal replacements of approximately 50% of
commissionable premiums;
|
·
|
MoneyGuard® (our
linked-benefit product) – 15% of premium deposits;
and
|
·
|
Whole
life and term – 100% of first year paid
premiums.
|
UL and
VUL products with secondary guarantees represented approximately 39% of
interest-sensitive life insurance in force as of September 30, 2009, and
approximately 58% and 66% of sales for the three and nine months ended September
30, 2009. AG38 imposes additional statutory reserve requirements for
these products.
Net
Investment Income and Interest Credited
Details
underlying net investment income, interest credited (in millions) and our
interest rate spread were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Net
Investment Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities, mortgage loans on real
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
estate
and other, net of investment expenses
|
|
$ |
487 |
|
|
$ |
478 |
|
|
|
2 |
% |
|
$ |
1,454 |
|
|
$ |
1,425 |
|
|
|
2 |
% |
Commercial
mortgage loan prepayment and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
bond
makewhole premiums
(1)
|
|
|
3 |
|
|
|
1 |
|
|
|
200 |
% |
|
|
7 |
|
|
|
14 |
|
|
|
-50 |
% |
Alternative
investments (2)
|
|
|
(20 |
) |
|
|
21 |
|
|
NM
|
|
|
|
(73 |
) |
|
|
35 |
|
|
NM
|
|
Surplus
investments (3)
|
|
|
25 |
|
|
|
22 |
|
|
|
14 |
% |
|
|
58 |
|
|
|
67 |
|
|
|
-13 |
% |
Total
net investment income
|
|
$ |
495 |
|
|
$ |
522 |
|
|
|
-5 |
% |
|
$ |
1,446 |
|
|
$ |
1,541 |
|
|
|
-6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
Credited
|
|
$ |
293 |
|
|
$ |
305 |
|
|
|
-4 |
% |
|
$ |
886 |
|
|
$ |
902 |
|
|
|
-2 |
% |
(1)
|
See
“Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond
Makewhole Premiums” below for additional
information.
|
(2)
|
See
“Consolidated Investments – Alternative Investments” below for additional
information.
|
(3)
|
Represents
net investment income on the required statutory surplus for this segment
and includes the impact of investment income on alternative investments
for such assets that are held in the portfolios supporting statutory
surplus versus the portfolios supporting product
liabilities.
|
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
Basis
|
|
|
Months
Ended
|
|
|
Basis
|
|
|
|
September
30,
|
|
|
Point
|
|
|
September
30,
|
|
|
Point
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Interest
Rate Yields and Spread
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to interest-sensitive
products:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities, mortgage loans on real
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
estate
and other, net of investment expenses
|
|
|
5.97 |
% |
|
|
5.92 |
% |
|
|
5 |
|
|
|
5.95 |
% |
|
|
5.94 |
% |
|
|
1 |
|
Commercial
mortgage loan prepayment and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
bond
makewhole premiums
|
|
|
0.04 |
% |
|
|
0.02 |
% |
|
|
2 |
|
|
|
0.03 |
% |
|
|
0.06 |
% |
|
|
(3 |
) |
Alternative
investments
|
|
|
-0.29 |
% |
|
|
0.31 |
% |
|
|
(60 |
) |
|
|
-0.35 |
% |
|
|
0.18 |
% |
|
|
(53 |
) |
Net
investment income yield on reserves
|
|
|
5.72 |
% |
|
|
6.25 |
% |
|
|
(53 |
) |
|
|
5.63 |
% |
|
|
6.18 |
% |
|
|
(55 |
) |
Interest
rate credited to contract holders
|
|
|
4.22 |
% |
|
|
4.35 |
% |
|
|
(13 |
) |
|
|
4.22 |
% |
|
|
4.36 |
% |
|
|
(14 |
) |
Interest
rate spread
|
|
|
1.50 |
% |
|
|
1.90 |
% |
|
|
(40 |
) |
|
|
1.41 |
% |
|
|
1.82 |
% |
|
|
(41 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to traditional
products:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities, mortgage loans on real
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
estate
and other, net of investment expenses
|
|
|
5.98 |
% |
|
|
6.06 |
% |
|
|
(8 |
) |
|
|
5.98 |
% |
|
|
6.13 |
% |
|
|
(15 |
) |
Commercial
mortgage loan prepayment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
bond makewhole premiums
|
|
|
0.01 |
% |
|
|
0.00 |
% |
|
|
1 |
|
|
|
0.01 |
% |
|
|
0.04 |
% |
|
|
(3 |
) |
Alternative
investments
|
|
|
0.02 |
% |
|
|
-0.01 |
% |
|
|
3 |
|
|
|
0.00 |
% |
|
|
-0.01 |
% |
|
|
1 |
|
Net
investment income yield on reserves
|
|
|
6.01 |
% |
|
|
6.05 |
% |
|
|
(4 |
) |
|
|
5.99 |
% |
|
|
6.16 |
% |
|
|
(17 |
) |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Averages
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to interest-sensitive
products:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Invested
assets on reserves (1)
|
|
$ |
27,734 |
|
|
$ |
27,398 |
|
|
|
1 |
% |
|
$ |
27,721 |
|
|
$ |
26,773 |
|
|
|
4 |
% |
Account
values - universal and whole life (1)
|
|
|
27,465 |
|
|
|
27,713 |
|
|
|
-1 |
% |
|
|
27,660 |
|
|
|
27,063 |
|
|
|
2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to traditional
products:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Invested
assets on reserves
|
|
|
4,916 |
|
|
|
4,814 |
|
|
|
2 |
% |
|
|
4,873 |
|
|
|
5,137 |
|
|
|
-5 |
% |
(1)
|
We
experienced declines in our average calculations for invested assets on
reserves and account values attributable to interest-sensitive products
during the second quarter of 2009 as a result of the coinsurance agreement
effective March 31, 2009, which reduced these balances by $927 million and
$938 million, respectively, on that
date.
|
A portion
of the investment income earned for this segment is credited to contract holder
accounts. Invested assets will typically grow at a faster rate than
account values because of the AG38 reserve requirements, which cause statutory
reserves to grow at an accelerated rate. Invested assets are based
upon the statutory reserve liabilities and are therefore affected by various
reserve adjustments, including capital transactions providing relief from AG38
reserve requirements, which leads to a transfer of invested assets from this
segment to Other Operations for use in other corporate purposes. We
expect to earn a spread between what we earn on the underlying general account
investments and what we credit to our contract holders’ accounts. The
interest rate spread for this segment represents the excess of the yield on
invested assets on reserves over the average crediting rate on
interest-sensitive products. The yield on invested assets on reserves
is calculated as net investment income, excluding amounts attributable to our
surplus investments and reverse repurchase agreement interest expense, divided
by average invested assets on reserves. In addition, we exclude the
impact of earnings from affordable housing tax credit securities, which is
reflected as a reduction to federal income tax expense, from our spread
calculations. Traditional products use interest income to build the
policy reserves. Commercial mortgage loan prepayments and bond
makewhole premiums and investment income on alternative investments can vary
significantly from period to period due to a number of factors, and, therefore,
may contribute to investment income results that are not indicative of the
underlying trends.
Benefits
Details
underlying benefits (dollars in millions) were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Benefits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Death
claims direct and assumed
|
|
$ |
541 |
|
|
$ |
536 |
|
|
|
1 |
% |
|
$ |
1,643 |
|
|
$ |
1,612 |
|
|
|
2 |
% |
Death
claims ceded
|
|
|
(231 |
) |
|
|
(249 |
) |
|
|
7 |
% |
|
|
(719 |
) |
|
|
(722 |
) |
|
|
0 |
% |
Reserves
released on death
|
|
|
(99 |
) |
|
|
(80 |
) |
|
|
-24 |
% |
|
|
(294 |
) |
|
|
(271 |
) |
|
|
-8 |
% |
Net
death benefits
|
|
|
211 |
|
|
|
207 |
|
|
|
2 |
% |
|
|
630 |
|
|
|
619 |
|
|
|
2 |
% |
Change
in secondary guarantee life insurance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
product
reserves:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prospective
unlocking - assumption changes
|
|
|
(2 |
) |
|
|
8 |
|
|
NM
|
|
|
|
(2 |
) |
|
|
8 |
|
|
NM
|
|
Prospective
unlocking - model refinements
|
|
|
- |
|
|
|
76 |
|
|
|
-100 |
% |
|
|
- |
|
|
|
76 |
|
|
|
-100 |
% |
Other
|
|
|
57 |
|
|
|
32 |
|
|
|
78 |
% |
|
|
168 |
|
|
|
86 |
|
|
|
95 |
% |
Change
in secondary guarantee life insurance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
product
reserves - reinsurance
|
|
|
(4 |
) |
|
|
6 |
|
|
NM
|
|
|
|
29 |
|
|
|
6 |
|
|
NM
|
|
Other
benefits (1)
|
|
|
58 |
|
|
|
71 |
|
|
|
-18 |
% |
|
|
175 |
|
|
|
211 |
|
|
|
-17 |
% |
Total
benefits
|
|
$ |
320 |
|
|
$ |
400 |
|
|
|
-20 |
% |
|
$ |
1,000 |
|
|
$ |
1,006 |
|
|
|
-1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Death
claims per $1,000 of inforce
|
|
|
1.61 |
|
|
|
1.55 |
|
|
|
4 |
% |
|
|
1.59 |
|
|
|
1.55 |
|
|
|
3 |
% |
(1)
|
Other
benefits includes primarily traditional product changes in reserves and
dividends.
|
Benefits
for this segment includes claims incurred during the period in excess of the
associated reserves for its interest-sensitive and traditional
products. In addition, benefits includes the change in secondary
guarantee life insurance product reserves. The reserve for secondary
guarantees is impacted by changes in expected future trends of expense
assessments causing unlocking adjustments to this liability similar to DAC, VOBA
and DFEL. Additionally, we establish a reserve for reinsurance margin
(reinsurance premiums paid less death benefit recoveries) and amortize this
margin over the life of the expected insurance assessments for certain blocks of
secondary guarantee UL business. When we experience unfavorable
mortality, particularly on higher face amount claims, our reinsurance recoveries
can increase significantly and are deferred, which reduces the amount by which
the expense for the direct claims are offset by reinsurance. The
reinsurance on our secondary guarantee UL business is excess of loss
reinsurance, and this block has a large range of face amounts, both of which
contribute to volatility in our actual experience of reinsurance recoveries as
compared to our expectations.
Underwriting,
Acquisition, Insurance and Other Expenses
Details
underlying underwriting, acquisition, insurance and other expenses (in millions)
were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Underwriting,
Acquisition, Insurance and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions
|
|
$ |
159 |
|
|
$ |
209 |
|
|
|
-24 |
% |
|
$ |
478 |
|
|
$ |
584 |
|
|
|
-18 |
% |
General
and administrative expenses
|
|
|
112 |
|
|
|
102 |
|
|
|
10 |
% |
|
|
332 |
|
|
|
308 |
|
|
|
8 |
% |
Taxes,
licenses and fees
|
|
|
31 |
|
|
|
36 |
|
|
|
-14 |
% |
|
|
87 |
|
|
|
95 |
|
|
|
-8 |
% |
Total
expenses incurred
|
|
|
302 |
|
|
|
347 |
|
|
|
-13 |
% |
|
|
897 |
|
|
|
987 |
|
|
|
-9 |
% |
DAC
and VOBA deferrals
|
|
|
(213 |
) |
|
|
(261 |
) |
|
|
18 |
% |
|
|
(635 |
) |
|
|
(744 |
) |
|
|
15 |
% |
Total
expenses recognized before amortization
|
|
|
89 |
|
|
|
86 |
|
|
|
3 |
% |
|
|
262 |
|
|
|
243 |
|
|
|
8 |
% |
DAC
and VOBA amortization, net of interest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prospective
unlocking - assumption changes
|
|
|
33 |
|
|
|
(32 |
) |
|
|
203 |
% |
|
|
33 |
|
|
|
(32 |
) |
|
|
203 |
% |
Prospective
unlocking - model refinements
|
|
|
- |
|
|
|
(49 |
) |
|
|
100 |
% |
|
|
- |
|
|
|
(49 |
) |
|
|
100 |
% |
Retrospective
unlocking
|
|
|
20 |
|
|
|
26 |
|
|
|
-23 |
% |
|
|
38 |
|
|
|
53 |
|
|
|
-28 |
% |
Amortization,
net of interest, excluding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
unlocking
|
|
|
141 |
|
|
|
135 |
|
|
|
4 |
% |
|
|
364 |
|
|
|
403 |
|
|
|
-10 |
% |
Other
intangible amortization
|
|
|
1 |
|
|
|
1 |
|
|
|
0 |
% |
|
|
3 |
|
|
|
3 |
|
|
|
0 |
% |
Total
underwriting, acquisition, insurance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
other expenses
|
|
$ |
284 |
|
|
$ |
167 |
|
|
|
70 |
% |
|
$ |
700 |
|
|
$ |
621 |
|
|
|
13 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DAC
and VOBA Deferrals
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
a percentage of sales
|
|
|
145.9 |
% |
|
|
137.4 |
% |
|
|
|
|
|
|
153.0 |
% |
|
|
140.4 |
% |
|
|
|
|
Commissions
and other general and administrative expenses that vary with and are related
primarily to the production of new business are deferred to the extent
recoverable and for our interest-sensitive products are generally amortized over
the lives of the contracts in relation to EGPs. For our traditional
products, DAC and VOBA are amortized on either a straight-line basis or as a
level percent of premium of the related contracts, depending on the block of
business.
When
comparing DAC and VOBA deferrals as a percentage of sales for the three and nine
months ended September 30, 2009 and 2008, the increase is a result of incurred
deferrable general and administrative expenses declining at a rate lower than
sales.
Insurance Solutions – Group Protection
Income
from Operations
Details
underlying the results for Insurance Solutions – Group Protection (in millions)
were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$ |
379 |
|
|
$ |
371 |
|
|
|
2 |
% |
|
$ |
1,183 |
|
|
$ |
1,134 |
|
|
|
4 |
% |
Net
investment income
|
|
|
34 |
|
|
|
31 |
|
|
|
10 |
% |
|
|
92 |
|
|
|
89 |
|
|
|
3 |
% |
Other
revenues and fees
|
|
|
1 |
|
|
|
1 |
|
|
|
0 |
% |
|
|
4 |
|
|
|
4 |
|
|
|
0 |
% |
Total
operating revenues
|
|
|
414 |
|
|
|
403 |
|
|
|
3 |
% |
|
|
1,279 |
|
|
|
1,227 |
|
|
|
4 |
% |
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
credited
|
|
|
1 |
|
|
|
1 |
|
|
|
0 |
% |
|
|
2 |
|
|
|
1 |
|
|
|
100 |
% |
Benefits
|
|
|
261 |
|
|
|
268 |
|
|
|
-3 |
% |
|
|
836 |
|
|
|
823 |
|
|
|
2 |
% |
Underwriting,
acquisition, insurance and other
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
expenses
|
|
|
99 |
|
|
|
92 |
|
|
|
8 |
% |
|
|
297 |
|
|
|
271 |
|
|
|
10 |
% |
Total
operating expenses
|
|
|
361 |
|
|
|
361 |
|
|
|
0 |
% |
|
|
1,135 |
|
|
|
1,095 |
|
|
|
4 |
% |
Income
from operations before taxes
|
|
|
53 |
|
|
|
42 |
|
|
|
26 |
% |
|
|
144 |
|
|
|
132 |
|
|
|
9 |
% |
Federal
income tax expense
|
|
|
18 |
|
|
|
15 |
|
|
|
20 |
% |
|
|
50 |
|
|
|
46 |
|
|
|
9 |
% |
Income
from operations
|
|
$ |
35 |
|
|
$ |
27 |
|
|
|
30 |
% |
|
$ |
94 |
|
|
$ |
86 |
|
|
|
9 |
% |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Income
from Operations by Product Line
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
|
|
$ |
16 |
|
|
$ |
9 |
|
|
|
78 |
% |
|
$ |
29 |
|
|
$ |
30 |
|
|
|
-3 |
% |
Disability
|
|
|
18 |
|
|
|
16 |
|
|
|
13 |
% |
|
|
63 |
|
|
|
51 |
|
|
|
24 |
% |
Dental
|
|
|
(1 |
) |
|
|
1 |
|
|
NM
|
|
|
|
(3 |
) |
|
|
1 |
|
|
NM
|
|
Total
non-medical
|
|
|
33 |
|
|
|
26 |
|
|
|
27 |
% |
|
|
89 |
|
|
|
82 |
|
|
|
9 |
% |
Medical
|
|
|
2 |
|
|
|
1 |
|
|
|
100 |
% |
|
|
5 |
|
|
|
4 |
|
|
|
25 |
% |
Total
income from operations
|
|
$ |
35 |
|
|
$ |
27 |
|
|
|
30 |
% |
|
$ |
94 |
|
|
$ |
86 |
|
|
|
9 |
% |
Comparison
of the Three and Nine Months Ended September 30, 2009 to 2008
Income
from operations for this segment increased due to the following:
·
|
More
favorable total non-medical loss ratio experience, slightly below the low
end of our expected range; and
|
·
|
Growth
in insurance premiums driven by normal, organic business growth in our
non-medical products.
|
The
increase in income from operations was partially offset by an increase to
underwriting, acquisition, insurance and other expenses due primarily to higher
expenses attributable to our U.S. pension plans (see “Critical Accounting
Policies and Estimates – Pension and Other Postretirement Benefit Plans” in our
2008 Form 10-K for additional information) and the increase in paid premiums,
partially offset by higher costs of investments in strategic initiatives
associated with realigning our marketing and distribution structure in
2008.
During
the first nine months of 2009, we experienced exceptional short- and long-term
disability loss ratios due primarily to favorable claims incidence and
termination experience. We attribute the recent favorable incidence
and termination experience in our long-term disability line of business to be
related, at least in part, to the impact of the challenging economic environment
on our insureds. Consequently, we expect to experience non-medical
loss ratios over the remainder of this year around the low end of our historical
expected range of 71% to 74%. In addition, we experienced unfavorable
life loss ratios in the first quarter of 2009 due primarily to adverse mortality
experience, the one-time adjustment noted below and the downward effects of
whole-case pricing on premium rates, all of which we do not expect to recur in
future quarters.
During
the third quarter of 2009, certain reserving methodology changes contributed to
a decrease in life loss ratios and an increase in long-term disability loss
ratios, but had effectively no impact on total non-medical loss
ratios.
Benefits
included a one-time adjustment of $3 million in the first quarter of 2009
relating to unfavorable waiver claim reserves.
We
experienced higher expenses attributable to our U.S. pension plans (see
“Critical Accounting Policies and Estimates – Pension and Other Postretirement
Benefit Plans” in our 2008 Form 10-K) during the first nine months of 2009, and
the fourth quarter of 2009 will continue this unfavorable trend when compared to
the corresponding period in 2008.
Sales
relate to long-duration contracts sold to new contract holders and new programs
sold to existing contract holders. We believe that the trend in sales
is an important indicator of development of business in force over
time.
Management
focuses on trends in loss ratios to compare actual experience with pricing
expectations because group-underwriting risks change over time. We
expect normal fluctuations in our composite non-medical loss ratios of this
segment, as claim experience is inherently uncertain. As discussed
further above, we expect favorable loss ratio experience over the remainder of
this year.
Insurance
Premiums
Details
underlying insurance premiums (in millions) were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Insurance
Premiums by Product Line
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
|
|
$ |
142 |
|
|
$ |
136 |
|
|
|
4 |
% |
|
$ |
432 |
|
|
$ |
402 |
|
|
|
7 |
% |
Disability
|
|
|
173 |
|
|
|
168 |
|
|
|
3 |
% |
|
|
518 |
|
|
|
499 |
|
|
|
4 |
% |
Dental
|
|
|
36 |
|
|
|
38 |
|
|
|
-5 |
% |
|
|
111 |
|
|
|
112 |
|
|
|
-1 |
% |
Total
non-medical
|
|
|
351 |
|
|
|
342 |
|
|
|
3 |
% |
|
|
1,061 |
|
|
|
1,013 |
|
|
|
5 |
% |
Medical
|
|
|
28 |
|
|
|
29 |
|
|
|
-3 |
% |
|
|
122 |
|
|
|
121 |
|
|
|
1 |
% |
Total
insurance premiums
|
|
$ |
379 |
|
|
$ |
371 |
|
|
|
2 |
% |
|
$ |
1,183 |
|
|
$ |
1,134 |
|
|
|
4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$ |
80 |
|
|
$ |
68 |
|
|
|
18 |
% |
|
$ |
194 |
|
|
$ |
187 |
|
|
|
4 |
% |
Our cost
of insurance and policy administration charges are embedded in the premiums
charged to our customers. The premiums are a function of the rates
priced into the product and our business in force. Business in force,
in turn, is driven by sales and persistency experience. Sales in the
table above are the combined annualized premiums for our life, disability and
dental products.
The
business represented as “medical” consists primarily of our non-core
EXEC-U-CARE® product. This product provides an insured medical
expense reimbursement vehicle to executives for non-covered health plan
costs. This product produces significant revenues and benefits
expenses for this segment but only a limited amount of
income. Discontinuance of this product would significantly impact
segment revenues, but not income from operations.
Net
Investment Income
We use
our interest income to build the associated policy reserves, which are a
function of our insurance premiums and the yields on our invested
assets.
Benefits
and Interest Credited
Details
underlying benefits and interest credited (in millions) were as
follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Benefits
and Interest Credited by Product Line
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
|
|
$ |
95 |
|
|
$ |
100 |
|
|
|
-5 |
% |
|
$ |
314 |
|
|
$ |
293 |
|
|
|
7 |
% |
Disability
|
|
|
115 |
|
|
|
116 |
|
|
|
-1 |
% |
|
|
326 |
|
|
|
337 |
|
|
|
-3 |
% |
Dental
|
|
|
29 |
|
|
|
29 |
|
|
|
0 |
% |
|
|
92 |
|
|
|
89 |
|
|
|
3 |
% |
Total
non-medical
|
|
|
239 |
|
|
|
245 |
|
|
|
-2 |
% |
|
|
732 |
|
|
|
719 |
|
|
|
2 |
% |
Medical
|
|
|
23 |
|
|
|
24 |
|
|
|
-4 |
% |
|
|
106 |
|
|
|
105 |
|
|
|
1 |
% |
Total
benefits and interest credited
|
|
$ |
262 |
|
|
$ |
269 |
|
|
|
-3 |
% |
|
$ |
838 |
|
|
$ |
824 |
|
|
|
2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
Ratios by Product Line
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
|
|
|
66.6 |
% |
|
|
74.0 |
% |
|
|
|
|
|
|
72.8 |
% |
|
|
72.7 |
% |
|
|
|
|
Disability
|
|
|
66.8 |
% |
|
|
68.6 |
% |
|
|
|
|
|
|
62.8 |
% |
|
|
67.6 |
% |
|
|
|
|
Dental
|
|
|
79.7 |
% |
|
|
75.9 |
% |
|
|
|
|
|
|
83.4 |
% |
|
|
79.2 |
% |
|
|
|
|
Total
non-medical
|
|
|
68.1 |
% |
|
|
71.6 |
% |
|
|
|
|
|
|
69.0 |
% |
|
|
70.9 |
% |
|
|
|
|
Medical
|
|
|
82.0 |
% |
|
|
86.2 |
% |
|
|
|
|
|
|
86.9 |
% |
|
|
87.7 |
% |
|
|
|
|
Note: Loss
ratios presented above are calculated using whole dollars instead of dollars
rounded to millions.
Underwriting,
Acquisition, Insurance and Other Expenses
Details
underlying underwriting, acquisition, insurance and other expenses (in millions)
were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Underwriting,
Acquisition, Insurance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
Other Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commissions
|
|
$ |
44 |
|
|
$ |
42 |
|
|
|
5 |
% |
|
$ |
131 |
|
|
$ |
123 |
|
|
|
7 |
% |
General
and administrative expenses
|
|
|
48 |
|
|
|
45 |
|
|
|
7 |
% |
|
|
144 |
|
|
|
134 |
|
|
|
7 |
% |
Taxes,
licenses and fees
|
|
|
9 |
|
|
|
9 |
|
|
|
0 |
% |
|
|
27 |
|
|
|
28 |
|
|
|
-4 |
% |
Total
expenses incurred
|
|
|
101 |
|
|
|
96 |
|
|
|
5 |
% |
|
|
302 |
|
|
|
285 |
|
|
|
6 |
% |
DAC
and VOBA deferrals
|
|
|
(13 |
) |
|
|
(13 |
) |
|
|
0 |
% |
|
|
(38 |
) |
|
|
(40 |
) |
|
|
5 |
% |
Total
expenses recognized before amortization
|
|
|
88 |
|
|
|
83 |
|
|
|
6 |
% |
|
|
264 |
|
|
|
245 |
|
|
|
8 |
% |
DAC
and VOBA amortization, net of interest
|
|
|
11 |
|
|
|
9 |
|
|
|
22 |
% |
|
|
33 |
|
|
|
26 |
|
|
|
27 |
% |
Total
underwriting, acquisition, insurance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
other expenses
|
|
$ |
99 |
|
|
$ |
92 |
|
|
|
8 |
% |
|
$ |
297 |
|
|
$ |
271 |
|
|
|
10 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DAC
and VOBA Deferrals
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
a percentage of insurance premiums
|
|
|
3.4 |
% |
|
|
3.5 |
% |
|
|
|
|
|
|
3.2 |
% |
|
|
3.5 |
% |
|
|
|
|
Expenses,
excluding broker commissions, that vary with and are related primarily to the
production of new business are deferred to the extent recoverable and are
amortized on either a straight-line basis or as a level percent of premium of
the related contracts depending on the block of business. Broker
commissions, which vary with and are related to paid premiums, are expensed as
incurred. The level of expenses is an important driver of
profitability for this segment as group insurance contracts are offered within
an environment that competes on the basis of price and service.
RESULTS
OF OTHER OPERATIONS
Other
Operations includes investments related to the excess capital in our insurance
subsidiaries, investments in media properties and other corporate investments,
benefit plan net assets, the unamortized deferred gain on indemnity reinsurance,
which was sold to Swiss Re in 2001, external debt and business sold through
reinsurance. We are actively managing our remaining radio station
clusters to maximize performance and future value. Other Operations
also includes the Institutional Pension business, which is a closed block of
pension business, the majority of which was sold on a group annuity basis, and
is currently in run-off, and the results of certain disability income business
due to the rescission of this business previously sold to Swiss Re.
Loss
from Operations
Details
underlying the results for Other Operations (in millions) were as
follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$ |
- |
|
|
$ |
1 |
|
|
|
-100 |
% |
|
$ |
4 |
|
|
$ |
4 |
|
|
|
0 |
% |
Net
investment income
|
|
|
81 |
|
|
|
90 |
|
|
|
-10 |
% |
|
|
221 |
|
|
|
277 |
|
|
|
-20 |
% |
Amortization
of deferred gain on business
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
sold
through reinsurance
|
|
|
18 |
|
|
|
18 |
|
|
|
0 |
% |
|
|
55 |
|
|
|
55 |
|
|
|
0 |
% |
Media
revenues (net)
|
|
|
17 |
|
|
|
21 |
|
|
|
-19 |
% |
|
|
51 |
|
|
|
66 |
|
|
|
-23 |
% |
Other
revenues and fees
|
|
|
4 |
|
|
|
5 |
|
|
|
-20 |
% |
|
|
9 |
|
|
|
10 |
|
|
|
-10 |
% |
Total
operating revenues
|
|
|
120 |
|
|
|
135 |
|
|
|
-11 |
% |
|
|
340 |
|
|
|
412 |
|
|
|
-17 |
% |
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
credited
|
|
|
33 |
|
|
|
43 |
|
|
|
-23 |
% |
|
|
115 |
|
|
|
130 |
|
|
|
-12 |
% |
Benefits
|
|
|
38 |
|
|
|
29 |
|
|
|
31 |
% |
|
|
178 |
|
|
|
87 |
|
|
|
105 |
% |
Media
expenses
|
|
|
13 |
|
|
|
14 |
|
|
|
-7 |
% |
|
|
40 |
|
|
|
45 |
|
|
|
-11 |
% |
Other
expenses
|
|
|
23 |
|
|
|
39 |
|
|
|
-41 |
% |
|
|
120 |
|
|
|
132 |
|
|
|
-9 |
% |
Interest
and debt expenses
|
|
|
68 |
|
|
|
69 |
|
|
|
-1 |
% |
|
|
194 |
|
|
|
209 |
|
|
|
-7 |
% |
Total
operating expenses
|
|
|
175 |
|
|
|
194 |
|
|
|
-10 |
% |
|
|
647 |
|
|
|
603 |
|
|
|
7 |
% |
Loss
from operations before taxes
|
|
|
(55 |
) |
|
|
(59 |
) |
|
|
7 |
% |
|
|
(307 |
) |
|
|
(191 |
) |
|
|
-61 |
% |
Federal
income tax benefit
|
|
|
(21 |
) |
|
|
(20 |
) |
|
|
-5 |
% |
|
|
(112 |
) |
|
|
(63 |
) |
|
|
-78 |
% |
Loss
from operations
|
|
$ |
(34 |
) |
|
$ |
(39 |
) |
|
|
13 |
% |
|
$ |
(195 |
) |
|
$ |
(128 |
) |
|
|
-52 |
% |
Comparison
of the Three Months Ended September 30, 2009 to 2008
Loss from
operations for this segment decreased due primarily to the
following:
·
|
Lower
other expenses attributable primarily to higher merger-related expenses in
the third quarter of 2008 as a result of higher system integration work
related to our administrative systems and lower branding expenses in the
third quarter of 2009 due to cost save initiatives;
and
|
·
|
More
favorable tax items that impacted the effective tax rate related primarily
to changes in tax preferred
investments.
|
The
decrease in loss from operations was partially offset by the
following:
·
|
Lower
net investment income related to our short-term liquidity strategy during
the recent volatile markets that has reduced our portfolio yield and lower
dividend income from our holdings of Bank of America common stock due to
dividend rate cuts, partially offset by higher invested assets driven by
distributable earnings received from our insurance segments, dividends
received from our other segments and issuances of common stock, preferred
stock and debt, partially offset by transfers to other segments for
other-than-temporary impairments;
|
·
|
Unfavorable
results of our run-off disability income business due primarily to the
rescission of the Swiss Re reinsurance agreement discussed below;
and
|
·
|
Lower
media earnings related primarily to the general weakening of the U.S
economy causing substantial declines in revenues throughout the radio
market.
|
Comparison
of the Nine Months Ended September 30, 2009 to 2008
Loss from
operations for this segment increased due primarily to the
following:
·
|
The
$64 million unfavorable impact in the first quarter of 2009 of the
rescission of the reinsurance agreement on certain disability income
business sold to Swiss Re as discussed in “Reinsurance” below, which
resulted in pre-tax increases in benefits of $78 million, interest
credited of $15 million and other expenses of $5 million, partially offset
by a $34 million tax benefit;
|
·
|
Lower
net investment income related to our short-term liquidity strategy during
the recent volatile markets that has reduced our portfolio yield and lower
dividend income from our holdings of Bank of America common stock due to
dividend rate cuts, partially offset by higher invested assets driven by
distributable earnings received from our insurance segments, dividends
received from our other segments and issuances of common stock, preferred
stock and debt, partially offset by transfers to other segments for
other-than-temporary impairments;
|
·
|
Lower
media earnings related primarily to the general weakening of the U.S
economy causing substantial declines in revenues throughout the radio
market; and
|
·
|
Unfavorable
results of our run-off disability income business due primarily to
the rescission discussed above.
|
The
increase in loss from operations was partially offset by the
following:
·
|
Lower
other expenses attributable primarily to higher merger-related expenses as
a result of higher system integration work related to our administrative
systems and relocation costs associated with the move of our corporate
office in 2008 and lower branding expenses in 2009 due to cost save
initiatives, partially offset by restructuring charges of $22 million in
2009 related to expense reduction initiatives that are discussed further
below;
|
·
|
Lower
interest and debt expenses as a result of a decline in interest rates that
affect our variable rate borrowings and lower average balances of
outstanding debt in 2009; and
|
·
|
More
favorable tax items that impacted the effective tax rate related primarily
to changes in tax preferred
investments.
|
Additional
Segment Information
We expect
lower media earnings in 2009 than was experienced in 2008, as our customers have
reduced their advertising expenses in response to the economic
conditions.
We expect
lower investment income in 2009 as compared to 2008 due to lower dividend income
from our holdings of Bank of America common stock as it announced dividend rate
cuts during the latter part of 2008 and early 2009, partially offset by higher
investment income of $2 million per quarter prospectively related to the
coinsurance agreement that we entered into on March 31, 2009 (see “Results of
Insurance Solutions – Insurance Solutions – Life Insurance” and “Reinsurance”
for more information) and by the net investment income earned on the proceeds
received from the issuance of common stock and debt during the second quarter of
2009 and preferred stock and a common stock warrant during the third quarter of
2009, which is discussed in more detail below in “Review of Consolidated
Financial Condition – Liquidity and Capital Resources – Financing
Activities.”
The
inclusion of run-off disability income business results within Other Operations
due to the rescission of the Swiss Re reinsurance agreement mentioned above may
create volatility in earnings going forward. As part of our
transition plan related to the rescission, we are conducting a reserve study to
determine whether or not reserves are adequate to cover contract holder
obligations. This study, which we expect to complete during the
fourth quarter of 2009, could result in an adjustment to the reserves that we
have assumed from Swiss Re pursuant to the rescission
agreement.
Sustained
market volatility and the challenging economic environment continue to put
pressure on many industries and companies, including our own. After
reviewing the impact of this difficult economy on our anticipated sales and
business activities, we initiated actions in the fourth quarter of 2008 to
streamline operations, reduce expenses and ensure that staffing levels were
aligned with expected business activity. Additionally, we initiated a
second expense reduction initiative in the second quarter of 2009, as discussed
below. We focused on reducing the workforce, reducing capital
spending and addressing corporate-wide discretionary spending.
As a
result of shrinking revenues due to the impact of unfavorable equity markets on
our asset management businesses and a reduction in sales volumes caused by the
unfavorable economic environment, we launched further initiatives to reduce
expenses, including a 12% workforce reduction that was substantially completed
in the second quarter of 2009, that we believe will improve our capital position
and preserve profits. The restructuring costs associated with these
layoffs are included in other expenses within Other Operations.
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I – Item 1A. Risk Factors” in our 2008 Form
10-K and “Forward-Looking Statements – Cautionary Language” in this
report.
We
provide information about this segment’s operating revenue and operating expense
line items, the period in which amounts are recognized, key drivers of changes
and historical details underlying the line items and their associated drivers
below.
Net
Investment Income and Interest Credited
We
utilize an internal formula to determine the amount of capital that is allocated
to our business segments. Investment income on capital in excess of
the calculated amounts is reported in Other Operations. If
regulations require increases in our insurance segments’ statutory reserves and
surplus, the amount of capital allocated to Other Operations would decrease and
net investment income would be negatively impacted. In addition, as
discussed below in “Review of Consolidated Financial Condition –
Alternative
Sources of Liquidity,” we maintain an inter-segment cash management program
where certain subsidiaries can borrow from or lend money to the holding company
to meet short-term borrowing needs. The inter-segment cash management
program affects net investment income for Other Operations, as all inter-segment
eliminations are reported within Other Operations.
Write-downs
for other-than-temporary impairments decrease the recorded value of our invested
assets owned by our business segments. These write-downs are not
included in the income from operations of our operating
segments. When impairment occurs, assets are transferred to the
business segments’ portfolios and will reduce the future net investment income
for Other Operations, but should not have an impact on a consolidated basis
unless the impairments are related to defaulted securities. Statutory
reserve adjustments for our business segments can also cause allocations of
invested assets between the affected segments and Other Operations.
The
majority of our interest credited relates to our reinsurance operations sold to
Swiss Re in 2001. A substantial amount of the business was sold
through indemnity reinsurance transactions resulting in some of the business
still flowing through our consolidated financial statements. The
interest credited corresponds to investment income earnings on the assets we
continue to hold for this business. There is no impact to income or
loss in Other Operations or on a consolidated basis for these
amounts.
Benefits
Benefits
are recognized when incurred for Institutional Pension products and disability
income business.
Other
Expenses
Details
underlying other expenses (in millions) were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Other
Expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Merger-related
expenses
|
|
$ |
3 |
|
|
$ |
13 |
|
|
|
-77 |
% |
|
$ |
14 |
|
|
$ |
44 |
|
|
|
-68 |
% |
Restructuring
charges for expense initiatives
|
|
|
1 |
|
|
|
- |
|
|
NM
|
|
|
|
34 |
|
|
|
- |
|
|
NM
|
|
Branding
|
|
|
4 |
|
|
|
8 |
|
|
|
-50 |
% |
|
|
13 |
|
|
|
27 |
|
|
|
-52 |
% |
Retirement
Income Security Ventures
|
|
|
2 |
|
|
|
4 |
|
|
|
-50 |
% |
|
|
6 |
|
|
|
9 |
|
|
|
-33 |
% |
Taxes,
licenses and fees
|
|
|
(1 |
) |
|
|
2 |
|
|
NM
|
|
|
|
4 |
|
|
|
5 |
|
|
|
-20 |
% |
Other
|
|
|
14 |
|
|
|
12 |
|
|
|
17 |
% |
|
|
49 |
|
|
|
47 |
|
|
|
4 |
% |
Total
other expenses
|
|
$ |
23 |
|
|
$ |
39 |
|
|
|
-41 |
% |
|
$ |
120 |
|
|
$ |
132 |
|
|
|
-9 |
% |
Other in
the table above includes expenses that are corporate in nature including
charitable contributions, certain litigation reserves, amortization of media
intangible assets with a definite life, other expenses not allocated to our
business segments and inter-segment expense eliminations.
Merger-related
expenses were the result of actions undertaken by us to eliminate duplicate
operations and functions as a result of the Jefferson-Pilot merger along with
costs related to the implementation of our new unified product portfolio and
other initiatives. Although these actions were substantially
completed in the first nine months of 2009, we expect to incur up to $6 million
of merger-related expenses during the remainder of 2009. Our current
estimate of the cumulative integration expenses is approximately $215 million to
$225 million, pre-tax, and excludes amounts capitalized or recorded as
goodwill.
Starting
in December 2008, we implemented a restructuring plan in response to the current
economic downturn and sustained market volatility, which focused on reducing
expenses. During the fourth quarter of 2008, we recorded a pre-tax
charge of $8 million. The expenses associated with this initiative
are reported in restructuring charges for expense initiatives
above. We expect our cumulative pre-tax charges to amount to $43
million for severance, benefits and related costs associated with the plan for
workforce reduction and other restructuring actions.
Interest
and Debt Expenses
Our
current level of interest expense may not be indicative of the future due to,
among other things, the timing of the use of cash, the availability of funds
from our inter-company cash management program and the future cost of
capital. For additional information on our financing activities, see
“Review of Consolidated Financial Condition – Liquidity and Capital Resources –
Sources of Liquidity and Cash Flow – Financing Activities”
below.
REALIZED
LOSS
Details
underlying realized loss, after-DAC (1) (in
millions) were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
Pre-Tax
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Operating
realized gain (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indexed
annuity net derivatives results
|
|
$ |
- |
|
|
$ |
2 |
|
|
|
-100 |
% |
|
$ |
- |
|
|
$ |
- |
|
|
NM
|
|
GLB
|
|
|
8 |
|
|
|
11 |
|
|
|
-27 |
% |
|
|
28 |
|
|
|
27 |
|
|
|
4 |
% |
GDB
|
|
|
(74 |
) |
|
|
39 |
|
|
NM
|
|
|
|
(107 |
) |
|
|
47 |
|
|
NM
|
|
Total
operating realized gain (loss)
|
|
|
(66 |
) |
|
|
52 |
|
|
NM
|
|
|
|
(79 |
) |
|
|
74 |
|
|
NM
|
|
Realized
loss related to certain investments
|
|
|
(136 |
) |
|
|
(315 |
) |
|
|
57 |
% |
|
|
(444 |
) |
|
|
(473 |
) |
|
|
6 |
% |
Gain
(loss) on certain reinsurance derivative/
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
trading
securities
|
|
|
71 |
|
|
|
(2 |
) |
|
NM
|
|
|
|
83 |
|
|
|
- |
|
|
NM
|
|
GLB
net derivatives results
|
|
|
(222 |
) |
|
|
89 |
|
|
NM
|
|
|
|
(494 |
) |
|
|
85 |
|
|
NM
|
|
GDB
derivatives results
|
|
|
(11 |
) |
|
|
(33 |
) |
|
|
67 |
% |
|
|
(70 |
) |
|
|
(41 |
) |
|
|
-71 |
% |
Indexed
annuity forward-starting option
|
|
|
(4 |
) |
|
|
2 |
|
|
NM
|
|
|
|
- |
|
|
|
9 |
|
|
|
-100 |
% |
Gain
on sale of subsidiaries/businesses
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
1 |
|
|
|
- |
|
|
NM
|
|
Total
excluded realized loss
|
|
|
(302 |
) |
|
|
(259 |
) |
|
|
-17 |
% |
|
|
(924 |
) |
|
|
(420 |
) |
|
NM
|
|
Total
realized loss
|
|
$ |
(368 |
) |
|
$ |
(207 |
) |
|
|
-78 |
% |
|
$ |
(1,003 |
) |
|
$ |
(346 |
) |
|
NM
|
|
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
After-Tax
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Operating
realized gain (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Indexed
annuity net derivatives results
|
|
$ |
- |
|
|
$ |
1 |
|
|
|
-100 |
% |
|
$ |
- |
|
|
$ |
- |
|
|
NM
|
|
GLB
|
|
|
5 |
|
|
|
7 |
|
|
|
-29 |
% |
|
|
18 |
|
|
|
18 |
|
|
|
0 |
% |
GDB
|
|
|
(48 |
) |
|
|
25 |
|
|
NM
|
|
|
|
(70 |
) |
|
|
31 |
|
|
NM
|
|
Total
operating realized gain (loss)
|
|
|
(43 |
) |
|
|
33 |
|
|
NM
|
|
|
|
(52 |
) |
|
|
49 |
|
|
NM
|
|
Realized
loss related to certain investments
|
|
|
(88 |
) |
|
|
(205 |
) |
|
|
57 |
% |
|
|
(288 |
) |
|
|
(307 |
) |
|
|
6 |
% |
Gain
(loss) on certain reinsurance derivative/
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
trading
securities
|
|
|
46 |
|
|
|
(1 |
) |
|
NM
|
|
|
|
54 |
|
|
|
- |
|
|
NM
|
|
GLB
net derivatives results
|
|
|
(144 |
) |
|
|
58 |
|
|
NM
|
|
|
|
(321 |
) |
|
|
54 |
|
|
NM
|
|
GDB
derivative results
|
|
|
(7 |
) |
|
|
(22 |
) |
|
|
68 |
% |
|
|
(46 |
) |
|
|
(27 |
) |
|
|
-70 |
% |
Indexed
annuity forward-starting option
|
|
|
(3 |
) |
|
|
1 |
|
|
NM
|
|
|
|
- |
|
|
|
6 |
|
|
|
-100 |
% |
Gain
on sale of subsidiaries/businesses
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
1 |
|
|
|
- |
|
|
NM
|
|
Total
excluded realized loss
|
|
|
(196 |
) |
|
|
(169 |
) |
|
|
-16 |
% |
|
|
(600 |
) |
|
|
(274 |
) |
|
NM
|
|
Total
realized loss
|
|
$ |
(239 |
) |
|
$ |
(136 |
) |
|
|
-76 |
% |
|
$ |
(652 |
) |
|
$ |
(225 |
) |
|
NM
|
|
(1)
|
DAC
refers to the associated amortization of DAC, VOBA, DSI and DFEL and
changes in other contract holder funds and funds withheld reinsurance
liabilities.
|
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I – Item 1A. Risk Factors” in our 2008 Form
10-K and “Forward-Looking Statements – Cautionary Language” in this
report.
For
information on our counterparty exposure see “Item 3. Quantitative and
Qualitative Disclosures About Market Risk.”
Comparison
of the Three and Nine Months Ended September 30, 2009 to 2008
GLB net
derivatives results declined due primarily to the NPR component of the liability
being unfavorable in 2009 attributable to a narrowing of credit
spreads. See “GLB Net Derivatives Results” below for a discussion of
how our NPR adjustment is determined. This decline was partially
offset by significantly more favorable GLB hedge program performance in 2009
relative to 2008. In 2008, the result was largely driven by extremely
volatile capital markets. At the end of the second quarter of 2009,
we made a strategic decision to reduce our interest rate coverage as we prepare
for the adoption of VACARVM, which is effective for statutory accounting on
December 31, 2009. The reduced coverage on rates may create some GAAP
earnings volatility going forward. Also, as a result of this reduction in
coverage of interest rate changes, we estimate that for every one basis point
increase in interest rates, we will experience an immediate $1 million
unfavorable impact to earnings.
The third
quarter of 2009 had unfavorable prospective unlocking of assumptions associated
with the GLB reserves reflecting primarily updates to our lapse
assumption. The third quarter of 2008 had favorable unlocking of
assumptions associated with the GLB reserves reflecting primarily updates to
implied ultimate volatility.
The third
quarter of 2008 had unfavorable prospective DAC, VOBA, DSI and DFEL unlocking
related to the GLB reserves reflecting the impact of incorporating the change in
EGPs resulting from the change in assumptions for the reserves discussed above
into the DAC, VOBA, DSI and DFEL models.
The
decline in the realized loss related to certain investments was attributable
primarily to the lower OTTI. This is due to some improvement in
the credit markets and the change in the accounting for impairments under the
Investments – Debt and Equity Securities Topic of the FASB ASC that is effective
for impairments recorded after January 1, 2009. For a further
explanation of this change, see Note 2. For more information on
realized losses on certain investments, see “Consolidated Investments – Realized
Loss Related to Investments” below.
The gain
on certain reinsurance derivative/trading securities in 2009 was due primarily
to the rescission of the Swiss Re indemnity reinsurance agreement covering
certain disability income business, whereby we released the embedded derivative
liability related to the funds withheld nature of the reinsurance
agreement. Prior to the rescission of the Swiss Re indemnity
reinsurance agreement, the fluctuations in the fair value of the trading
securities mostly offset the fair value fluctuations in the embedded derivative
of the reinsurance agreement with the net difference reported as a realized gain
or loss. The release of this embedded derivative liability increased
net income by approximately $31 million in the first quarter of
2009. Since the rescission, this line item is impacted by market
conditions as we now have trading securities that are no longer supporting an
embedded derivative liability due to the rescission causing us to release that
liability. Consequently, we may experience more volatility in the
fluctuation of this component of realized gain or loss in the
future. During the third quarter of 2009, the value of these trading
securities increased due to changes in interest rates. For more
information, see “Reinsurance” below and Note 11.
Operating
Realized Gain (Loss)
Details
underlying operating realized gain (loss) (dollars in millions) were as
follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Indexed
Annuity Net Derivatives Results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in fair value of S&P 500 call options
|
|
$ |
(47 |
) |
|
$ |
42 |
|
|
NM
|
|
|
$ |
(49 |
) |
|
$ |
167 |
|
|
NM
|
|
Change
in fair value of embedded derivatives
|
|
|
48 |
|
|
|
(37 |
) |
|
|
230 |
% |
|
|
50 |
|
|
|
(167 |
) |
|
|
130 |
% |
Associated
amortization expense of DAC,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
VOBA,
DSI and DFEL
|
|
|
(1 |
) |
|
|
(3 |
) |
|
|
67 |
% |
|
|
(1 |
) |
|
|
- |
|
|
NM
|
|
Total
indexed annuity net derivatives
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
results
|
|
|
- |
|
|
|
2 |
|
|
|
-100 |
% |
|
|
- |
|
|
|
- |
|
|
NM
|
|
GLB
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-DAC
(1) amount
|
|
|
10 |
|
|
|
18 |
|
|
|
-44 |
% |
|
|
37 |
|
|
|
51 |
|
|
|
-27 |
% |
Associated
amortization expense of DAC,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
VOBA,
DSI and DFEL:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retrospective
unlocking (2)
|
|
|
3 |
|
|
|
4 |
|
|
|
-25 |
% |
|
|
13 |
|
|
|
7 |
|
|
|
86 |
% |
Amortization,
excluding unlocking
|
|
|
(5 |
) |
|
|
(11 |
) |
|
|
55 |
% |
|
|
(22 |
) |
|
|
(31 |
) |
|
|
29 |
% |
Total
GLB
|
|
|
8 |
|
|
|
11 |
|
|
|
-27 |
% |
|
|
28 |
|
|
|
27 |
|
|
|
4 |
% |
GDB
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-DAC
(1)
amount
|
|
|
(84 |
) |
|
|
51 |
|
|
NM
|
|
|
|
(120 |
) |
|
|
66 |
|
|
NM
|
|
Associated
amortization expense of DAC,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
VOBA,
DSI and DFEL:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retrospective
unlocking (2)
|
|
|
(38 |
) |
|
|
18 |
|
|
NM
|
|
|
|
(59 |
) |
|
|
19 |
|
|
NM
|
|
Amortization,
excluding unlocking
|
|
|
48 |
|
|
|
(30 |
) |
|
|
260 |
% |
|
|
72 |
|
|
|
(38 |
) |
|
|
289 |
% |
Total
GDB
|
|
|
(74 |
) |
|
|
39 |
|
|
NM
|
|
|
|
(107 |
) |
|
|
47 |
|
|
NM
|
|
Total
Operating Realized Gain (Loss)
|
|
$ |
(66 |
) |
|
$ |
52 |
|
|
NM
|
|
|
$ |
(79 |
) |
|
$ |
74 |
|
|
NM
|
|
(1)
|
DAC
refers to the associated amortization of DAC, VOBA, DSI and
DFEL.
|
(2)
|
Related
primarily to the emergence of gross
profits.
|
Operating
realized gain (loss) includes the following:
Indexed Annuity Net Derivative
Results
Indexed
annuity net derivatives results represent the net difference between the change
in the fair value of the S&P 500 Index® (“S&P 500”) call options that we
hold and the change in the fair value of the embedded derivative liabilities of
our indexed annuity products. The change in the fair value of the
liability for the embedded derivative represents the amount that is credited to
the indexed annuity contract.
GLB
Our GWB,
GIB and 4LATER® features have elements of both benefit reserves and embedded
derivative reserves. We calculate the value of the embedded
derivative reserve and the benefit reserve based on the specific characteristics
of each GLB feature. For our GLBs that meet the definition of an
embedded derivative under the Derivatives and Hedging Topic of the FASB ASC, we
record them at fair value with changes in fair value recorded in realized loss
on our Consolidated Statements of Income (Loss). In bifurcating the
embedded derivative, we attribute to the embedded derivative the portion of
total fees collected from the contract holder that relates to the GLB riders
(the “attributed fees”). These attributed fees represent the present
value of future claims expected to be paid for the GLB at the inception of the
contract (the “net valuation premium”) plus a margin that a theoretical market
participant would include for risk/profit (the “risk/profit
margin”).
Our
methodology for calculating the NPR component of the embedded derivative reserve
utilizes an extrapolated 30-year NPR spread curve applied to a series of
expected cash flows over the expected life of the embedded
derivative. Our cash flows consist of both expected fees to be
received from contract holders and benefits to be paid, and these cash flows are
different on a pre- and post- NPR basis are different. The difference
in the cash flows this quarter resulted in an increase to the GLB reserve
liability in excess of the liability that we hedge. We utilize a
model based on our holding company’s CDS spreads adjusted for items, such as the
liquidity of our holding company CDS. Because the guaranteed benefit
liabilities are contained within our insurance subsidiaries, we apply items,
such as the impact of our insurance subsidiaries’ claims-paying ratings compared
to holding company credit risk and the over-collateralization of insurance
liabilities, in order to determine factors that are representative of a
theoretical market participant’s view of the NPR of the specific liability
within our insurance subsidiaries. Details underlying the NPR
component and associated impact to our GLB embedded derivative reserves (dollars
in millions) were as follows:
|
|
As
of
|
|
|
As
of
|
|
|
As
of
|
|
|
As
of
|
|
|
|
September
30,
|
|
|
June
30,
|
|
|
March
31,
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2009
|
|
|
2009
|
|
|
2008
|
|
10-year
CDS spread
|
|
|
2.49 |
% |
|
|
5.52 |
% |
|
|
23.25 |
% |
|
|
6.34 |
% |
NPR
factor related to 10-year CDS spread
|
|
|
0.20 |
% |
|
|
0.82 |
% |
|
|
1.49 |
% |
|
|
1.23 |
% |
Unadjusted
embedded derivative liability
|
|
$ |
1,014 |
|
|
$ |
1,197 |
|
|
$ |
3,064 |
|
|
$ |
3,416 |
|
We
experienced significant widening of our CDS spreads during the first quarter of
2009. We compared our CDS spreads to those of our peer companies with
similar holding company ratings and determined that our company specific spreads
were significantly wider due to the market’s concerns over our holding company
liquidity. As a result, we reduced the spreads used in the
calculation of our NPR factors to be in line with our
peers. Therefore, the starting point for our spreads was reduced over
the entire term structure with the 10-year at 8.45%.
The $212
million change in the NPR component of the liability from June 30, 2009, to
September 30, 2009, was attributable primarily to change in the NPR
factors. Estimating what the absolute amount of the NPR effect will
be period to period is difficult due to the utilization of all cash flows and
the shape of the spread curve. For the third quarter of 2009, the
spread curve flattened significantly relative to prior
quarters. Currently, we estimate that if the NPR factors as of
September 30, 2009, were to have been zero along all points on the spread curve,
then the NPR offset to the unadjusted liability would have resulted in an
unfavorable impact to net income of approximately $100 million, pre-DAC* and
tax. Alternatively, if the NPR factors were 20 basis points higher
along all points on the spread curve as of September 30, 2009, then there would
have been a favorable impact to net income of approximately $100 million,
pre-DAC* and tax. Changing market conditions could cause this
relationship to deviate significantly in future periods. Sensitivity
within this range is primarily a result of volatility in our CDS spreads and the
slope of the CDS spread term structure.
*
|
DAC
refers to the associated amortization of DAC, VOBA, DSI and
DFEL.
|
We
include the risk/profit margin portion of the GLB attributed rider fees in
operating realized gain and include the net valuation premium of the GLB
attributed rider fees in excluded realized (loss). For our Retirement
Solutions – Annuities and Retirement Solutions – Defined Contribution segments,
the excess of total fees collected from the contract holders over the GLB
attributed rider fees is reported in insurance fees.
We also
include the change in the fair value of the derivatives that offsets the change
in GLB benefit ratio reserves. The change in GLB benefit ratio
reserves attributable to the Retirement Solutions business is offset in benefits
within income from operations. This approach excludes the change in
benefit ratio reserves from income from operations according to our definition
of income from operations and instead reflects it within GLB net derivatives
results, a component of excluded realized (loss). On our Consolidated
Statements of Income (Loss), the change in benefit ratio reserves is reported
within benefits.
GDB
GDB
represents the change in the fair value of the derivatives that offsets the
change in GDB benefit ratio reserves, including our expected cost of the hedging
instruments. The change in GDB benefit ratio reserves attributable to
the Retirement Solutions business is offset in benefits within income from
operations. This approach excludes the change in benefit ratio
reserves from income from operations according to our definition of income from
operations and instead reflects it within GDB derivatives results, a component
of excluded realized (loss). On our Consolidated Statements of Income
(Loss), the change in benefit ratio reserves is reported within
benefits.
Realized
Loss Related to Certain Investments
See
“Consolidated Investments – Realized Loss Related to Investments”
below.
Gain
(Loss) on Certain Reinsurance Derivative/Trading Securities
Gain
(loss) on certain reinsurance derivative/trading securities represents changes
in the fair values of total return swaps (embedded derivatives) theoretically
included in our various modified coinsurance and coinsurance with funds withheld
reinsurance arrangements that have contractual returns related to various assets
and liabilities associated with these arrangements.
GLB
Net Derivatives Results and GDB Derivatives Results
Details
underlying GLB net derivatives results and GDB derivative results (in millions)
were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
GLB
Net Derivatives Results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
valuation premium, net of reinsurance
|
|
$ |
31 |
|
|
$ |
21 |
|
|
|
48 |
% |
|
$ |
81 |
|
|
$ |
58 |
|
|
|
40 |
% |
Change
in reserves hedged:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prospective
unlocking - assumption changes
|
|
|
(17 |
) |
|
|
80 |
|
|
NM
|
|
|
|
(17 |
) |
|
|
80 |
|
|
NM
|
|
Prospective
unlocking - model refinements
|
|
|
(9 |
) |
|
|
- |
|
|
NM
|
|
|
|
(9 |
) |
|
|
- |
|
|
NM
|
|
Other
|
|
|
210 |
|
|
|
(651 |
) |
|
|
132 |
% |
|
|
2,419 |
|
|
|
(812 |
) |
|
NM
|
|
Change
in market value of derivative assets
|
|
|
(241 |
) |
|
|
319 |
|
|
NM
|
|
|
|
(2,385 |
) |
|
|
388 |
|
|
NM
|
|
Hedge
program effectiveness
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(ineffectiveness)
|
|
|
(57 |
) |
|
|
(252 |
) |
|
|
77 |
% |
|
|
8 |
|
|
|
(344 |
) |
|
|
102 |
% |
Change
in reserves not hedged (NPR
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
component)
|
|
|
(212 |
) |
|
|
372 |
|
|
NM
|
|
|
|
(600 |
) |
|
|
481 |
|
|
NM
|
|
Change
in derivative assets not hedged (NPR
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
component)
|
|
|
5 |
|
|
|
- |
|
|
NM
|
|
|
|
10 |
|
|
|
- |
|
|
NM
|
|
Change
in benefit ratio reserves not hedged
|
|
|
7 |
|
|
|
- |
|
|
NM
|
|
|
|
14 |
|
|
|
- |
|
|
NM
|
|
Associated
amortization expense of DAC,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
VOBA,
DSI and DFEL:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prospective
unlocking - assumption changes
|
|
|
- |
|
|
|
(31 |
) |
|
|
100 |
% |
|
|
- |
|
|
|
(31 |
) |
|
|
100 |
% |
Retrospective
unlocking (1)
|
|
|
(75 |
) |
|
|
(69 |
) |
|
|
-9 |
% |
|
|
(216 |
) |
|
|
(59 |
) |
|
NM
|
|
Amortization,
excluding unlocking
|
|
|
79 |
|
|
|
48 |
|
|
|
65 |
% |
|
|
209 |
|
|
|
14 |
|
|
NM
|
|
Loss
from the initial adoption of new accounting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
standard,
after-DAC (2)
(3)
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
- |
|
|
|
(34 |
) |
|
|
100 |
% |
Total
GLB net derivatives results
|
|
$ |
(222 |
) |
|
$ |
89 |
|
|
NM
|
|
|
$ |
(494 |
) |
|
$ |
85 |
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
GDB
Derivatives Results
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
in benefit ratio reserves
|
|
$ |
84 |
|
|
$ |
(51 |
) |
|
|
265 |
% |
|
$ |
120 |
|
|
$ |
(66 |
) |
|
|
282 |
% |
Change
in fair value of derivatives, excluding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
expected
cost of hedging instruments
|
|
|
(97 |
) |
|
|
8 |
|
|
NM
|
|
|
|
(203 |
) |
|
|
10 |
|
|
NM
|
|
Associated
amortization expense of DAC,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
VOBA,
DSI and DFEL:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retrospective
unlocking (1)
|
|
|
(5 |
) |
|
|
(16 |
) |
|
|
69 |
% |
|
|
(36 |
) |
|
|
(17 |
) |
|
NM
|
|
Amortization,
excluding unlocking
|
|
|
7 |
|
|
|
26 |
|
|
|
-73 |
% |
|
|
49 |
|
|
|
32 |
|
|
|
53 |
% |
Total
GDB derivatives results
|
|
$ |
(11 |
) |
|
$ |
(33 |
) |
|
|
67 |
% |
|
$ |
(70 |
) |
|
$ |
(41 |
) |
|
|
-71 |
% |
|
(1)
|
Related
primarily to the emergence of gross
profits.
|
|
(2)
|
This
new accounting standard was the Fair Value Measurements and Disclosures
Topic of the FASB ASC.
|
|
(3)
|
DAC
refers to the associated amortization of DAC, VOBA, DSI and
DFEL.
|
GLB
Net Derivatives Results
Our GLB
net derivatives results are comprised of the net valuation premium, the change
in the GLB embedded derivative reserves and the change in the fair value of the
derivative instruments we own to hedge them, including the cost of purchasing
the hedging instruments.
Our GWB,
GIB and 4LATER® features have elements of both benefit reserves and embedded
derivative reserves. The benefit ratio reserve component is
calculated in a manner consistent with our GDB benefit ratio
reserves. We calculate the value of the embedded derivative reserve
and the benefit reserve based on the specific characteristics of each GLB
feature. We record the embedded derivative reserve on our GLBs at
fair value on our Consolidated Balance Sheets. We use derivative
instruments to hedge our exposure to the risks and earnings volatility that
result from changes in the GLB embedded derivatives reserves. The
change in fair value of these derivative instruments is designed to generally
offset the change in embedded derivative reserves. In the table
above, we have presented the components of our GLB results, which can be
volatile especially when sudden and significant changes in equity markets and/or
interest rates occur. When we assess the effectiveness of our hedge
program, we exclude the impact of the change in the component of the embedded
derivative reserves related to the required NPR. We do not attempt to
hedge the change in the NPR component of the liability. As of
September 30, 2009, the net effect of the NPR resulted in an $87 million
increase in the liability for our GLB embedded derivative
reserves. See above for information regarding the effect of the NPR
on the GLB net derivatives results for the three and nine months ended September
30, 2009 and 2008. For additional information on our guaranteed
benefits, see “Critical Accounting Policies and Estimates – Derivatives –
Guaranteed Living Benefits” above. For additional information on our
hedge program see “Reinsurance” below.
Our GLB
net derivatives results also include the change in GLB benefit ratio
reserves. The change in GLB benefit ratio reserves is offset in GLB
operating realized gain (loss). See “GLB” above for additional
information.
GDB
Derivatives Results
Our GDB
derivatives results represent the net difference between the change in GDB
benefit ratio reserves and the change in the fair value of the derivative
instruments we own to hedge the change in our benefit ratio reserves, excluding
our expected cost of the hedging instruments. The change in GDB
benefit ratio reserves is offset in GDB operating realized gain
(loss). See “GDB” above for additional
information.
Indexed
Annuity Forward-Starting Option
Details
underlying indexed annuity forward-starting option (dollars in millions) were as
follows:
|
|
For
the Three
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
Change
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Indexed
Annuity Forward-Starting Option
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pre-DAC
(1)
amounts
|
|
$ |
(11 |
) |
|
$ |
4 |
|
NM
|
|
$ |
(1 |
) |
|
$ |
(2 |
) |
|
|
50 |
% |
Associated
amortization expense of DAC,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
VOBA,
DSI and DFEL
|
|
|
7 |
|
|
|
(2 |
) |
NM
|
|
|
1 |
|
|
|
1 |
|
|
|
0 |
% |
Gain
from the initial adoption of new accounting
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
standard,
after-DAC (1)
(2)
|
|
|
- |
|
|
|
- |
|
NM
|
|
|
- |
|
|
|
10 |
|
|
|
-100 |
% |
Total
|
|
$ |
(4 |
) |
|
$ |
2 |
|
NM
|
|
$ |
- |
|
|
$ |
9 |
|
|
|
-100 |
% |
(1)
|
This
new accounting standard was the Fair Value Measurements and Disclosures
Topic of the FASB ASC.
|
(2)
|
DAC
refers to the associated amortization of DAC, VOBA, DSI and
DFEL.
|
The
liability for the forward-starting option reflects changes in the fair value of
embedded derivative liabilities related to index call options we may purchase in
the future to hedge contract holder index allocations applicable to future reset
periods for our indexed annuity products accounted for under the Derivatives and
Hedging and the Fair Value Measurements and Disclosures Topics of the FASB
ASC. These fair values represent an estimate of the cost of the
options we will purchase in the future, discounted back to the date of the
balance sheet, using current market indications of volatility and interest
rates, which can vary significantly from period to period due to a number of
factors and therefore can provide results that are not indicative of the
underlying trends.
CONSOLIDATED
INVESTMENTS
The
MD&A included in our 2008 Form 10-K contains detailed information and
discussion of our consolidated investments. The following
updates "Consolidated Investments" provided in our 2008 Form 10-K and,
accordingly, should be read in conjunction with the "Consolidated
Investments" in our Form 10-K. See Note 5 for more information
related to our consolidated investments. For a discussion on our risk management
process, see “Item 3. Quantitative and Qualitative Disclosures About
Market Risk.”
Residential
Mortgage-Baked Securities (“RMBS”)
Our AFS
fixed maturity securities include RMBS, which are backed by residential
mortgages. These securities are backed by loans that are
characterized by borrowers of differing levels of
creditworthiness: prime, Alt-A and subprime. Prime lending
is the origination of residential mortgage loans to customers with excellent
credit profiles. Alt-A lending is the origination of residential
mortgage loans to customers who have prime credit profiles but lack
documentation to substantiate income. Subprime lending is the
origination of loans to customers with weak or impaired credit
profiles.
The
slowing U.S. housing market, increased interest rates for non-prime
borrowers and relaxed underwriting standards over the last several years
have led to higher delinquency rates for residential mortgage loans and home
equity loans. We expect delinquency rates and loss rates on
residential mortgages and home equity loans to increase in the future; however,
we continue to expect to receive payments in accordance with contractual terms
for a significant amount of our securities, largely due to the seniority of the
claims on the collateral of the securities that we own. The tranches
of the securities will experience losses according to their seniority level with
the least senior (or most junior), typically the unrated residual tranche,
taking the initial loss. The credit ratings of our securities reflect
the seniority of the securities that we own. Our RMBS had a market
value of $9.6 billion and an unrealized loss of $642 million, or 7%, as of
September 30, 2009. The unrealized loss was due primarily
to deteriorating fundamentals and a general level of illiquidity in the market
resulting in price declines in many structured products.
The
market value of investments backed by subprime loans was $417 million and
represented less than 1% of our total investment portfolio as of September 30,
2009. Investments rated A or above represented 65% of the subprime
investments and $202 million in market value of our subprime investments was
backed by loans originating in 2005 and forward. AFS securities
represent $405 million, or 97%, of the subprime exposure and trading securities
represent $12 million, or 3%, as of September 30, 2009. The tables
below summarize our investments in AFS securities backed by pools of residential
mortgages (in millions):
|
|
|
Fair
Value as of September 30, 2009
|
|
|
|
|
|
|
|
Prime/
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime
|
|
|
Non
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency
|
|
|
Agency
|
|
|
Alt-A
|
|
|
Subprime
|
|
|
Total
|
|
Type
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateralized
mortgage obligations ("CMOs") and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage
pass-throughs ("MPTS")
|
$ |
7,320 |
|
|
$ |
919 |
|
|
$ |
478 |
|
|
$ |
- |
|
|
$ |
8,717 |
|
Asset-backed
securities ("ABS") home equity
|
|
|
|
- |
|
|
|
- |
|
|
|
240 |
|
|
|
405 |
|
|
|
645 |
|
Total
by type (1)
|
|
|
$ |
7,320 |
|
|
$ |
919 |
|
|
$ |
718 |
|
|
$ |
405 |
|
|
$ |
9,362 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AAA
|
|
|
$ |
7,298 |
|
|
$ |
304 |
|
|
$ |
158 |
|
|
$ |
215 |
|
|
$ |
7,975 |
|
AA
|
|
|
|
5 |
|
|
|
37 |
|
|
|
117 |
|
|
|
23 |
|
|
|
182 |
|
A |
|
|
|
17 |
|
|
|
48 |
|
|
|
50 |
|
|
|
25 |
|
|
|
140 |
|
BBB
|
|
|
|
- |
|
|
|
36 |
|
|
|
16 |
|
|
|
27 |
|
|
|
79 |
|
BB
and below
|
|
|
|
- |
|
|
|
494 |
|
|
|
377 |
|
|
|
115 |
|
|
|
986 |
|
Total
by rating (1)(2)
|
|
|
$ |
7,320 |
|
|
$ |
919 |
|
|
$ |
718 |
|
|
$ |
405 |
|
|
$ |
9,362 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Origination
Year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
and prior
|
|
|
$ |
2,970 |
|
|
$ |
317 |
|
|
$ |
277 |
|
|
$ |
206 |
|
|
$ |
3,770 |
|
2005 |
|
|
|
919 |
|
|
|
187 |
|
|
|
209 |
|
|
|
142 |
|
|
|
1,457 |
|
2006 |
|
|
|
331 |
|
|
|
143 |
|
|
|
189 |
|
|
|
52 |
|
|
|
715 |
|
2007 |
|
|
|
1,311 |
|
|
|
272 |
|
|
|
43 |
|
|
|
- |
|
|
|
1,626 |
|
2008 |
|
|
|
372 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
372 |
|
2009 |
|
|
|
1,417 |
|
|
|
- |
|
|
|
- |
|
|
|
5 |
|
|
|
1,422 |
|
Total
by origination year (1)
|
|
|
$ |
7,320 |
|
|
$ |
919 |
|
|
$ |
718 |
|
|
$ |
405 |
|
|
$ |
9,362 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
AFS securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
60,949 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by origination year as a percentage of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
total
AFS securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-agency, Alt-A & subprime as a
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
percentage
of total AFS securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3.4 |
% |
|
(1)
|
Does
not include the fair value of trading securities totaling $220 million,
which support our Modco reinsurance agreements because investment results
for these agreements are passed directly to the reinsurers. The
$220 million in trading securities consisted of $192 million prime, $16
million Alt-A and $12 million
subprime.
|
|
(2)
|
For
the table above, credit ratings shown in the document are based on ratings
provided by the major credit rating agencies (Fitch Ratings, Moody’s and
S&P) or are based on internal ratings for those securities where
external ratings are not available. For securities where the
ratings assigned by the major rating agencies are not equivalent, the
second highest of the three ratings assigned is
used.
|
|
|
|
Amortized
Cost as of September 30, 2009
|
|
|
|
|
|
|
|
Prime/
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prime
|
|
|
Non
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agency
|
|
|
Agency
|
|
|
Alt-A
|
|
|
Subprime
|
|
|
Total
|
|
Type
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
and MPTS
|
|
|
$ |
6,939 |
|
|
$ |
1,261 |
|
|
$ |
663 |
|
|
$ |
- |
|
|
$ |
8,863 |
|
ABS
home equity
|
|
|
|
- |
|
|
|
- |
|
|
|
394 |
|
|
|
732 |
|
|
|
1,126 |
|
Total
by type (1)
|
|
|
$ |
6,939 |
|
|
$ |
1,261 |
|
|
$ |
1,057 |
|
|
$ |
732 |
|
|
$ |
9,989 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rating
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
AAA
|
|
|
$ |
6,917 |
|
|
$ |
333 |
|
|
$ |
190 |
|
|
$ |
291 |
|
|
$ |
7,731 |
|
AA
|
|
|
|
5 |
|
|
|
46 |
|
|
|
157 |
|
|
|
34 |
|
|
|
242 |
|
A |
|
|
|
16 |
|
|
|
53 |
|
|
|
68 |
|
|
|
54 |
|
|
|
191 |
|
BBB
|
|
|
|
- |
|
|
|
53 |
|
|
|
30 |
|
|
|
52 |
|
|
|
135 |
|
BB
and below
|
|
|
|
1 |
|
|
|
776 |
|
|
|
612 |
|
|
|
301 |
|
|
|
1,690 |
|
Total
by rating (1)(2)
|
|
|
$ |
6,939 |
|
|
$ |
1,261 |
|
|
$ |
1,057 |
|
|
$ |
732 |
|
|
$ |
9,989 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Origination
Year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2004
and prior
|
|
|
$ |
2,802 |
|
|
$ |
367 |
|
|
$ |
363 |
|
|
$ |
312 |
|
|
$ |
3,844 |
|
2005 |
|
|
|
866 |
|
|
|
254 |
|
|
|
296 |
|
|
|
264 |
|
|
|
1,680 |
|
2006 |
|
|
|
309 |
|
|
|
213 |
|
|
|
315 |
|
|
|
151 |
|
|
|
988 |
|
2007 |
|
|
|
1,213 |
|
|
|
427 |
|
|
|
83 |
|
|
|
- |
|
|
|
1,723 |
|
2008 |
|
|
|
351 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
351 |
|
2009 |
|
|
|
1,398 |
|
|
|
- |
|
|
|
- |
|
|
|
5 |
|
|
|
1,403 |
|
Total
by origination year (1)
|
|
|
$ |
6,939 |
|
|
$ |
1,261 |
|
|
$ |
1,057 |
|
|
$ |
732 |
|
|
$ |
9,989 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
AFS securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
60,835 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by origination year as a percentage of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
total
AFS securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-agency, Alt-A & subprime as a
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
percentage
of total AFS securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5.0 |
% |
|
(1)
|
Does
not include the amortized cost of trading securities totaling $235
million, which support our Modco reinsurance agreements because investment
results for these agreements are passed directly to the
reinsurers. The $235 million in trading securities consisted of
$195 million prime, $23 million Alt-A and $17 million
subprime.
|
|
(2)
|
For
the table above, credit ratings shown in the document are based on ratings
provided by the major credit rating agencies (Fitch Ratings, Moody’s and
S&P) or are based on internal ratings for those securities where
external ratings are not available. For securities where the
ratings assigned by the major rating agencies are not equivalent, the
second highest of the three ratings assigned is
used.
|
None of
these investments include any direct investments in subprime lenders or
mortgages. We are not aware of material exposure to subprime loans in
our alternative asset portfolio.
See Note
5 for information on our commercial mortgage-backed securities.
Mortgage
Loans on Real Estate
The
following summarizes key information on mortgage loans (in
millions):
|
|
As
of September 30, 2009
|
|
|
|
As
of September 30, 2009
|
|
|
|
Amount
|
|
|
%
|
|
|
|
Amount
|
|
|
%
|
|
Property
Type
|
|
|
|
|
|
|
State
Exposure
|
|
|
|
|
|
|
Office
building
|
|
$ |
2,511 |
|
|
|
35 |
% |
CA
|
|
$ |
1,493 |
|
|
|
21 |
% |
Industrial
|
|
|
1,929 |
|
|
|
26 |
% |
TX
|
|
|
627 |
|
|
|
9 |
% |
Retail
|
|
|
1,726 |
|
|
|
24 |
% |
MD
|
|
|
430 |
|
|
|
6 |
% |
Apartment
|
|
|
665 |
|
|
|
9 |
% |
FL
|
|
|
329 |
|
|
|
5 |
% |
Hotel/Motel
|
|
|
215 |
|
|
|
3 |
% |
VA
|
|
|
315 |
|
|
|
4 |
% |
Mixed
use
|
|
|
133 |
|
|
|
2 |
% |
TN
|
|
|
311 |
|
|
|
4 |
% |
Other
commercial
|
|
|
98 |
|
|
|
1 |
% |
AZ
|
|
|
303 |
|
|
|
4 |
% |
|
|
$ |
7,277 |
|
|
|
100 |
% |
WA
|
|
|
289 |
|
|
|
4 |
% |
|
|
|
|
|
|
|
|
|
IL
|
|
|
268 |
|
|
|
4 |
% |
|
|
|
|
|
|
|
|
|
NC
|
|
|
264 |
|
|
|
4 |
% |
|
|
|
|
|
|
|
|
|
GA
|
|
|
244 |
|
|
|
3 |
% |
Geographic
Region
|
|
|
|
|
|
|
|
|
PA
|
|
|
211 |
|
|
|
3 |
% |
Pacific
|
|
$ |
1,890 |
|
|
|
26 |
% |
NV
|
|
|
205 |
|
|
|
3 |
% |
South
Atlantic
|
|
|
1,728 |
|
|
|
24 |
% |
OH
|
|
|
195 |
|
|
|
2 |
% |
East
North Central
|
|
|
750 |
|
|
|
10 |
% |
IN
|
|
|
174 |
|
|
|
2 |
% |
Mountain
|
|
|
711 |
|
|
|
10 |
% |
MA
|
|
|
156 |
|
|
|
2 |
% |
West
South Central
|
|
|
667 |
|
|
|
9 |
% |
MN
|
|
|
155 |
|
|
|
2 |
% |
Middle
Atlantic
|
|
|
482 |
|
|
|
7 |
% |
NJ
|
|
|
142 |
|
|
|
2 |
% |
East
South Central
|
|
|
442 |
|
|
|
6 |
% |
SC
|
|
|
131 |
|
|
|
2 |
% |
West
North Central
|
|
|
396 |
|
|
|
5 |
% |
NY
|
|
|
129 |
|
|
|
2 |
% |
New
England
|
|
|
211 |
|
|
|
3 |
% |
Other
states under 2%
|
|
|
906 |
|
|
|
12 |
% |
|
|
$ |
7,277 |
|
|
|
100 |
% |
|
|
$ |
7,277 |
|
|
|
100 |
% |
All
mortgage loans that are impaired have an established allowance for credit
loss. Changing economic conditions impact our valuation of mortgage
loans. Changing vacancies and rents are incorporated into the
discounted cash flow analysis that we perform for monitored loans and may
contribute to the establishment of (or an increase or decrease in) an allowance
for credit losses. In addition, we continue to monitor the entire
commercial mortgage loan portfolio to identify risk. Areas of
emphasis are properties that have deteriorating credits or have experienced debt
coverage reduction. Where warranted, we have established or increased
loss reserves based upon this analysis. There were nine impaired
mortgage loans as of September 30, 2009, or less than 1% of the total dollar
amount of mortgage loans, and no impaired mortgage loans as of December 31,
2008. As of September 30, 2009, there were seven commercial mortgage
loans that were two or more payments delinquent. As of December 31,
2008, there were no commercial mortgage loans that were two or more payments
delinquent. The carrying value on the mortgage loans that were two or
more payments delinquent as of September 30, 2009, was $45 million, or less than
1%, of total mortgage loans. The total principal and interest past
due on the mortgage loans that were two or more payments delinquent as of
September 30, 2009, was $2 million. See Note 1 in our 2008 Form 10-K
for more information regarding our accounting policy relating to the impairment
of mortgage loans.
Alternative
Investments
The
carrying value of our consolidated alternative investments by business segment
(in millions), which consists primarily of investments in limited partnerships,
was as follows:
|
|
As
of
|
|
|
As
of
|
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
Retirement
Solutions:
|
|
|
|
|
|
|
Annuities
|
|
$ |
77 |
|
|
$ |
89 |
|
Defined
Contribution
|
|
|
61 |
|
|
|
72 |
|
Insurance
Solutions:
|
|
|
|
|
|
|
|
|
Life
Insurance
|
|
|
480 |
|
|
|
603 |
|
Group
Protection
|
|
|
29 |
|
|
|
8 |
|
Other
Operations
|
|
|
33 |
|
|
|
4 |
|
Total
alternative investments
|
|
$ |
680 |
|
|
$ |
776 |
|
Income
(loss) derived from our consolidated alternative investments by business segment
(in millions) was as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Retirement
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$ |
2 |
|
|
$ |
2 |
|
|
|
0 |
% |
|
$ |
(6 |
) |
|
$ |
1 |
|
|
NM
|
|
Defined
Contribution
|
|
|
2 |
|
|
|
1 |
|
|
|
100 |
% |
|
|
(3 |
) |
|
|
(2 |
) |
|
|
-50 |
% |
Insurance
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
Insurance
|
|
|
(17 |
) |
|
|
23 |
|
|
NM
|
|
|
|
(79 |
) |
|
|
36 |
|
|
NM
|
|
Group
Protection
|
|
|
1 |
|
|
|
1 |
|
|
|
0 |
% |
|
|
(2 |
) |
|
|
1 |
|
|
NM
|
|
Other
Operations
|
|
|
1 |
|
|
|
- |
|
|
NM
|
|
|
|
2 |
|
|
|
- |
|
|
NM
|
|
Total
alternative investments
(1)
|
|
$ |
(11 |
) |
|
$ |
27 |
|
|
NM
|
|
|
$ |
(88 |
) |
|
$ |
36 |
|
|
NM
|
|
(1)
|
Includes
net investment income on the alternative investments supporting the
required statutory surplus of our insurance
businesses.
|
The
decline in our investment income on alternative investments in the nine months
ended September 30, 2009, as compared to the same period in 2008 presented in
the table above was due to the impact of audit adjustments related to completion
of calendar-year financial statement audits of the investments within our
portfolio and deterioration of the financial markets. The nature of
these adjustments is discussed further below. This weakness was
concentrated primarily in our energy, domestic venture capital and real estate
limited partnership holdings.
As of
September 30, 2009, and December 31, 2008, alternative investments included
investments in approximately 100 different partnerships. The
partnerships represent a broadly diversified portfolio of asset
classes. The investment strategy of the alternative investment
portfolio is to provide incremental investment income compared to the
traditional fixed-income and equity markets over a long term investment
horizon. In addition, the portfolio represents less than 1% of our
overall invested assets. The portfolio is actively monitored to
minimize the likelihood of material investment income losses.
The
carrying value of our consolidated alternative investments by asset class (in
millions) was as follows:
|
|
As
of
|
|
|
As
of
|
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
|
|
|
|
|
Venture
capital
|
|
$ |
308 |
|
|
$ |
341 |
|
Hedge
funds
|
|
|
182 |
|
|
|
223 |
|
Real
estate
|
|
|
90 |
|
|
|
110 |
|
Oil
and gas
|
|
|
100 |
|
|
|
102 |
|
Total
alternative investments
|
|
$ |
680 |
|
|
$ |
776 |
|
The
partnerships do not represent off-balance sheet financing and generally involve
several third-party partners. Some of our partnerships contain
capital calls, which require us to contribute capital upon notification by the
general partner. These capital calls are contemplated during the
initial investment decision and are planned for well in advance of the call
date. The capital calls are not material in size and are not material
to our liquidity. The capital calls are included on the table of
contingent commitments in “Review of Consolidated Financial Condition –
Liquidity and Capital Resources” in our 2008 Form 10-K. Alternative
investments are accounted for using the equity method of accounting and are
included in other investments on our Consolidated Balance Sheets.
Our
venture capital portfolio is mainly comprised of private equity investments in
various leveraged buyout and venture capital limited partnerships, which in
turn, invest in a well-diversified portfolio across various industry sectors,
geographies, and investment stages. The objective of making such
investments is to achieve an excess long-term risk-adjusted return.
The hedge
fund portfolio is broadly diversified and contains exposure to the strategies
which we believe will have the best long-term risk-adjusted
returns.
The real
estate limited partnership portfolio tries to capture value-added returns in
both equity and mezzanine positions in both traditional and specialized areas of
the commercial and residential real estate markets including workforce
housing.
Similar
to our venture capital portfolio, we invest in various oil and gas limited
partnerships that target a well diversified energy sector including exploration
and production, storage and distribution (midstream), oil field services, and
other energy-related services.
We
account for our investments in limited partnerships (“LPs”) using the equity
method to determine the GAAP carrying value. The LPs where LNC is a
participant generally report their assets at fair value. Since the
assets of the LPs are measured at fair value and the values of the LPs’
liabilities would generally approximate fair value according to the audited
financial statements received from the partnerships, the GAAP carrying value on
our consolidated balance sheet would approximate a fair value for our LP
investments.
Recognition
of alternative investment income is delayed due to the availability of the
related financial statements, as our venture capital, real estate and oil and
gas portfolios are generally on a three-month delay and our hedge funds are on a
one-month delay and are generally obtained from the partnerships’ general
partners. In addition, the impact of audit adjustments related to
completion of calendar-year financial statement audits of the investees are
typically received after the filing of Form 10-K during the second quarter of
each calendar year. Accordingly, our investment income from
alternative investments for any calendar year period may not include the
complete impact of the change in the underlying net assets for the partnership
for that calendar year period.
Annually,
typically during the first or second quarter, we obtain audited financial
statements for our alternative investment partnerships for the preceding
calendar year and recognize adjustments to the extent that audited equity of the
investee differs from the equity used for reporting in prior
quarters. Accordingly, our investment income from alternative
investments for any calendar year period may not include the complete impact of
the change in the underlying net assets for the partnership for that calendar
year period. When we record audit adjustments, it impacts our
investment income from alternative investments in the period that the
adjustments are recorded. Our investment income from alternative
investments for the second quarter of 2009 included a pre-tax loss of $71
million, of which $57 million of the losses
were attributable to audit adjustments to partnerships’ 2008 financial
statements. The breakdown of these audit adjustments by segment were
as follows: $50 million for Insurance Solutions – Life Insurance; $1
million for Insurance Solutions – Group Protection; $3 million for Retirement
Solutions – Annuities; and $3 million for Retirement Solutions – Defined
Contribution. Our investment income from alternative
investments for the third quarter of 2009 included a $12 million, pre-tax, loss
which was attributable to audit adjustments to partnerships’ 2008 financial
statements for our Insurance Solutions – Life Insurance segment.
Non-Income
Producing Investments
As of
September 30, 2009, and December 31, 2008, the carrying amount of fixed maturity
securities, mortgage loans on real estate and real estate that were non-income
producing was $28 million and $15 million, respectively.
Net
Investment Income
Details
underlying net investment income (loss) (in millions) and our investment yield
were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Net
Investment Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity AFS securities
|
|
$ |
899 |
|
|
$ |
833 |
|
|
|
8 |
% |
|
$ |
2,577 |
|
|
$ |
2,510 |
|
|
|
3 |
% |
Equity
AFS securities
|
|
|
2 |
|
|
|
6 |
|
|
|
-67 |
% |
|
|
5 |
|
|
|
22 |
|
|
|
-77 |
% |
Trading
securities
|
|
|
40 |
|
|
|
41 |
|
|
|
-2 |
% |
|
|
119 |
|
|
|
126 |
|
|
|
-6 |
% |
Mortgage
loans on real estate
|
|
|
114 |
|
|
|
120 |
|
|
|
-5 |
% |
|
|
349 |
|
|
|
354 |
|
|
|
-1 |
% |
Real
estate
|
|
|
4 |
|
|
|
4 |
|
|
|
0 |
% |
|
|
10 |
|
|
|
15 |
|
|
|
-33 |
% |
Standby
real estate equity commitments
|
|
|
- |
|
|
|
1 |
|
|
|
-100 |
% |
|
|
1 |
|
|
|
3 |
|
|
|
-67 |
% |
Policy
loans
|
|
|
42 |
|
|
|
46 |
|
|
|
-9 |
% |
|
|
128 |
|
|
|
133 |
|
|
|
-4 |
% |
Invested
cash
|
|
|
1 |
|
|
|
9 |
|
|
|
-89 |
% |
|
|
13 |
|
|
|
39 |
|
|
|
-67 |
% |
Commercial
mortgage loan prepayment and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
bond
makewhole premiums (1)
|
|
|
6 |
|
|
|
8 |
|
|
|
-25 |
% |
|
|
11 |
|
|
|
28 |
|
|
|
-61 |
% |
Alternative
investments
(2)
|
|
|
(11 |
) |
|
|
27 |
|
|
NM
|
|
|
|
(88 |
) |
|
|
36 |
|
|
NM
|
|
Consent
fees
|
|
|
1 |
|
|
|
2 |
|
|
|
-50 |
% |
|
|
4 |
|
|
|
4 |
|
|
|
0 |
% |
Other
investments
|
|
|
3 |
|
|
|
- |
|
|
NM
|
|
|
|
8 |
|
|
|
(3 |
) |
|
NM
|
|
Investment
income
|
|
|
1,101 |
|
|
|
1,097 |
|
|
|
0 |
% |
|
|
3,137 |
|
|
|
3,267 |
|
|
|
-4 |
% |
Investment
expense
|
|
|
(30 |
) |
|
|
(29 |
) |
|
|
-3 |
% |
|
|
(82 |
) |
|
|
(96 |
) |
|
|
15 |
% |
Net
investment income
|
|
$ |
1,071 |
|
|
$ |
1,068 |
|
|
|
0 |
% |
|
$ |
3,055 |
|
|
$ |
3,171 |
|
|
|
-4 |
% |
(1)
|
See
“Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums” below
for additional information.
|
(2)
|
See
“Alternative Investments” above for additional
information.
|
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
Basis
|
|
|
Months
Ended
|
|
|
Basis
|
|
|
|
September
30,
|
|
|
Point
|
|
|
September
30,
|
|
|
Point
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Interest
Rate Yield
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
maturity securities, mortgage loans on
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
real
estate and other, net of investment expenses
|
5.82 |
% |
|
|
5.87 |
% |
|
|
(5 |
) |
|
|
5.82 |
% |
|
|
5.89 |
% |
|
|
(7 |
) |
Commercial
mortgage loan prepayment and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
bond
makewhole premiums
|
|
|
0.03 |
% |
|
|
0.05 |
% |
|
|
(2 |
) |
|
|
0.02 |
% |
|
|
0.05 |
% |
|
|
(3 |
) |
Alternative
investments
|
|
|
-0.06 |
% |
|
|
0.15 |
% |
|
|
(21 |
) |
|
|
-0.16 |
% |
|
|
0.07 |
% |
|
|
(23 |
) |
Consent
fees
|
|
|
0.01 |
% |
|
|
0.01 |
% |
|
|
- |
|
|
|
0.01 |
% |
|
|
0.01 |
% |
|
|
- |
|
Standby
real estate equity commitments
|
|
|
0.00 |
% |
|
|
0.01 |
% |
|
|
(1 |
) |
|
|
0.00 |
% |
|
|
0.01 |
% |
|
|
(1 |
) |
Net
investment income yield on invested assets
|
|
5.80 |
% |
|
|
6.09 |
% |
|
|
(29 |
) |
|
|
5.69 |
% |
|
|
6.03 |
% |
|
|
(34 |
) |
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Average
invested assets at amortized cost
|
|
$ |
73,805 |
|
|
$ |
70,150 |
|
|
|
5.2 |
% |
|
$ |
71,573 |
|
|
$ |
70,121 |
|
|
|
2.1 |
% |
We earn
investment income on our general account assets supporting fixed annuity, term
life, whole life, UL and interest-sensitive whole life insurance
products. The profitability of our fixed annuity and life insurance
products is affected by our ability to achieve target spreads, or margins,
between the interest income earned on the general account assets and the
interest credited to the contract holder on our average fixed account values,
including the fixed portion of variable. Net investment income and
the interest rate yield table each include commercial mortgage loan prepayments
and bond makewhole premiums, alternative investments and contingent interest and
standby real estate equity commitments. These items can vary
significantly from period to period due to a number of factors and therefore can
provide results that are not indicative of the underlying trends.
The
decline in net investment income when comparing the first nine months of 2009 to
the same period in 2008 was attributable to a decline in investment income on
alternative investments in conjunction with our liquidity strategy of
maintaining higher cash balances in the first half of the year during the more
volatile markets reducing portfolio yield. We expect to continue to
reduce this excess liquidity in future quarters as a result of the recent
improvement in the capital markets.
Standby
Real Estate Equity Commitments
Periodically,
we enter into standby commitments, which obligate us to purchase real estate at
a specified cost if a third-party sale does not occur within approximately one
year after construction is completed. These commitments are used by a
developer to obtain a construction loan from an outside lender on favorable
terms. In return for issuing the commitment, we receive an annual fee
and a percentage of the profit when the property is sold. Our
long-term expectation is that we will be obligated to fund a small portion of
these commitments. However, due to the current economic environment,
we may experience increased funding obligations.
As of
September 30, 2009, and December 31, 2008, we had standby real estate equity
commitments totaling $220 million and $267 million,
respectively. During the nine months ended September 30, 2009, we
funded commitments of $46 million and the fair value of the associated real
estate of $32 million is included on our Consolidated Balance Sheets, which
resulted in the recognition of $14 million in realized losses. In
addition, we recorded an estimated loss of $20 million in the second quarter of
2009 on one project due to our belief that our requirement to fund the project
in accordance with the Standby Contingent Equity Acquisition Program (“CAP”)
agreement is probable.
Commercial
Mortgage Loan Prepayment and Bond Makewhole Premiums
Prepayment
and makewhole premiums are collected when borrowers elect to call or prepay
their debt prior to the stated maturity. A prepayment or makewhole
premium allows investors to attain the same yield as if the borrower made all
scheduled interest payments until maturity. These premiums are
designed to make investors indifferent to prepayment.
The
decline in prepayment and makewhole premiums when comparing the nine months
ended September 30, 2009 to 2008 was attributable primarily to the continued
tightening of credit conditions in the market resulting in less refinancing
activity and less prepayment income.
Realized
Loss Related to Investments
The
detail of the realized loss related to investments (in millions) was as
follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Fixed
maturity AFS securities:
|
|
|
|
|
|
|
|
Gross
gains
|
|
$ |
23 |
|
|
$ |
19 |
|
|
|
21 |
% |
|
$ |
110 |
|
|
$ |
44 |
|
|
|
150 |
% |
Gross
losses
|
|
|
(166 |
) |
|
|
(372 |
) |
|
|
55 |
% |
|
|
(579 |
) |
|
|
(592 |
) |
|
|
2 |
% |
Equity
AFS securities:
|
|
|
|
|
|
|
|
|
|
Gross
gains
|
|
|
- |
|
|
|
1 |
|
|
|
-100 |
% |
|
|
4 |
|
|
|
1 |
|
|
NM
|
|
Gross
losses
|
|
|
(8 |
) |
|
|
(25 |
) |
|
|
68 |
% |
|
|
(16 |
) |
|
|
(32 |
) |
|
|
50 |
% |
Gain
on other investments
|
|
|
2 |
|
|
|
1 |
|
|
|
100 |
% |
|
|
(58 |
) |
|
|
29 |
|
|
NM
|
|
Associated
amortization expense of DAC, VOBA,
|
|
|
|
|
|
|
|
|
|
DSI
and DFEL and changes in other contract
|
|
|
|
|
|
|
|
|
|
holder
funds and funds withheld
|
|
|
|
|
|
|
|
|
|
reinsurance
liabilities
|
|
|
25 |
|
|
|
91 |
|
|
|
-73 |
% |
|
|
128 |
|
|
|
139 |
|
|
|
-8 |
% |
Total
realized loss on investments, excluding
|
|
(124 |
) |
|
|
(285 |
) |
|
|
56 |
% |
|
|
(411 |
) |
|
|
(411 |
) |
|
|
0 |
% |
trading
securities
|
|
|
|
|
|
|
|
|
|
Loss
on certain derivative instruments
|
|
|
(12 |
) |
|
|
(30 |
) |
|
|
60 |
% |
|
|
(33 |
) |
|
|
(62 |
) |
|
|
47 |
% |
Total
realized loss on investments and
|
|
|
|
|
|
|
|
|
|
certain
derivative instruments,
|
|
|
|
|
|
|
|
|
|
excluding
trading securities
|
|
$ |
(136 |
) |
|
$ |
(315 |
) |
|
|
57 |
% |
|
$ |
(444 |
) |
|
$ |
(473 |
) |
|
|
6 |
% |
Amortization
expense of DAC, VOBA, DSI, DFEL and changes in other contract holder funds
reflects an assumption for an expected level of credit-related investment
losses. When actual credit-related investment losses are realized, we
recognize a true up to our DAC, VOBA, DSI and DFEL amortization and changes in
other contract holder funds within realized loss reflecting the incremental
impact of actual versus expected credit-related investment
losses. These actual to expected amortization adjustments could
create volatility in net realized gains and losses. The write-down
for impairments includes both credit-related and interest-rate related
impairments.
Realized
gains and losses generally originate from asset sales to reposition the
portfolio or to respond to product experience. During the first nine
months of 2009 and 2008, we sold securities for gains and losses. In
the process of evaluating whether a security with an unrealized loss reflects
declines that are other-than-temporary, we consider our ability and intent to
sell the security prior to a recovery of value. 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 our 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 our investment portfolio as
AFS. We expect to continue to manage all non-trading invested assets
within our portfolios in a manner that is consistent with the AFS
classification.
We
consider economic factors and circumstances within countries and industries
where recent write-downs have occurred in our assessment of the status of
securities we own of similarly situated issuers. While it is possible
for realized or unrealized losses on a particular investment to affect other
investments, our risk management has been designed to identify correlation risks
and other risks inherent in managing an investment portfolio. Once
identified, strategies and procedures are developed to effectively monitor and
manage these risks. The areas of risk correlation that we pay
particular attention to are risks that may be correlated within specific
financial and business markets, risks within specific industries and risks
associated with related parties.
When the
detailed analysis by our 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 estimated recovery
value. In instances where declines are considered temporary, the
security will continue to be carefully monitored. See “Item
7. Management’s Discussion and Analysis – Introduction – Critical
Accounting Policies and Estimates” in our 2008 Form 10-K for additional
information on our portfolio management strategy.
Details
underlying write-downs taken as a result of OTTIs (in millions) that were
recognized in net income (loss) were as follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
Fixed
Maturity Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
bonds
|
|
$ |
29 |
|
|
$ |
205 |
|
|
|
-86 |
% |
|
$ |
187 |
|
|
$ |
331 |
|
|
|
-44 |
% |
Mortgage-backed
securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CMOs
|
|
|
70 |
|
|
|
76 |
|
|
|
-8 |
% |
|
|
213 |
|
|
|
153 |
|
|
|
39 |
% |
ABS:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CDOs
|
|
|
10 |
|
|
|
- |
|
|
NM
|
|
|
|
39 |
|
|
|
1 |
|
|
NM
|
|
Hybrid
and redeemable preferred securities
|
|
|
17 |
|
|
|
1 |
|
|
NM
|
|
|
|
18 |
|
|
|
1 |
|
|
NM
|
|
Total
fixed maturity securities
|
|
|
126 |
|
|
|
282 |
|
|
|
-55 |
% |
|
|
457 |
|
|
|
486 |
|
|
|
-6 |
% |
Equity
Securities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
securities
|
|
|
- |
|
|
|
1 |
|
|
|
-100 |
% |
|
|
- |
|
|
|
1 |
|
|
|
-100 |
% |
Other
financial services securities
|
|
|
8 |
|
|
|
24 |
|
|
|
-67 |
% |
|
|
10 |
|
|
|
24 |
|
|
|
-58 |
% |
Other
securities
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
6 |
|
|
|
7 |
|
|
|
-14 |
% |
Total
equity securities
|
|
|
8 |
|
|
|
25 |
|
|
|
-68 |
% |
|
|
16 |
|
|
|
32 |
|
|
|
-50 |
% |
Gross
OTTI recognized in
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
income (loss)
|
|
|
134 |
|
|
|
307 |
|
|
|
-56 |
% |
|
|
473 |
|
|
|
518 |
|
|
|
-9 |
% |
Associated
amortization expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of
DAC, VOBA, DSI and DFEL
|
|
|
(54 |
) |
|
|
(70 |
) |
|
|
23 |
% |
|
|
(154 |
) |
|
|
(123 |
) |
|
|
-25 |
% |
Net
OTTI recognized in
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net
income (loss), pre-tax
|
|
$ |
80 |
|
|
$ |
237 |
|
|
|
-66 |
% |
|
$ |
319 |
|
|
$ |
395 |
|
|
|
-19 |
% |
When
comparing the first nine months of 2009 to 2008, the decrease in write-downs for
OTTIs on our AFS securities were attributable primarily to overall improvement
in the credit markets as compared to the same period in prior
year. Losses in the first nine months of 2009 were primarily
attributable to certain corporate bond holdings within the Financial, Automotive
and Gaming sectors, as well as deteriorating fundamentals within the housing
market which affected select RMBS holdings.
The $134
million of impairments taken during the third quarter of 2009 relates to credit
related impairments. The credit related impairments are largely
attributable to our RMBS and mortgage-related ABS holdings that have suffered
from continued deterioration in housing fundamentals. The non-credit
related impairments were incurred due to declines in values of securities for
which we have an intent to sell.
We have
investments in Royal Bank of Scotland (“RBS”) and Lloyds Banking Group.
These investments consist primarily of hybrid and redeemable preferred
stocks and are reported in fixed maturity AFS securities on our
Consolidated Balance Sheets. On November 3, 2009, both RBS and Lloyds
Banking Group received U.K. government infusion and agreed to certain terms,
related primarily to asset sales, cash bonus limitations and deferral of
dividends. As of October 30, 2009, our amortized cost and fair value for
both of these investments totaled approximately $300 million and $200 million,
respectively. We are evaluating the impact of these agreed upon terms and
what if any impact they have on the present value of the cash flows expected to
be collected on our investments.
REINSURANCE
Our
insurance companies cede insurance to other companies. The portion of
risks exceeding each of our insurance companies’ retention limits is reinsured
with other insurers. We seek reinsurance coverage within the
businesses that sell life insurance to limit our exposure to mortality losses
and enhance our capital management. We utilize inter-company
reinsurance agreements to manage our statutory capital position as well as our
hedge program for variable annuity guarantees. These inter-company
agreements do not have an impact on our consolidated financial
statements.
Portions
of our deferred annuity business have been reinsured on a modified coinsurance
basis with other companies to limit our exposure to interest rate
risks. As of September 30, 2009, the reserves associated with these
reinsurance arrangements totaled $1.0 billion. To cover products
other than life insurance, we acquire other insurance coverage with retentions
and limits that management believes are appropriate for the
circumstances. The consolidated financial statements included in Item
1 reflect premiums, benefits and DAC, net of insurance ceded. Our
insurance companies remain liable if their reinsurers are unable to meet
contractual obligations under applicable reinsurance agreements.
Our
amounts recoverable from reinsurers represent receivables from and reserves
ceded to reinsurers. As of September 30, 2009, and December 31, 2008,
the amounts recoverable from reinsurers were $7.7 billion and $8.4 billion,
respectively. We obtain reinsurance from a diverse group of
reinsurers, and we monitor concentration and financial strength ratings of our
principal reinsurers. Swiss Re represents our largest
exposure. In 2001, we sold our reinsurance business to Swiss Re
primarily through indemnity reinsurance arrangements. Because we are
not relieved of our liability to the ceding companies for this business, the
liabilities and obligations associated with the reinsured policies remain on our
Consolidated Balance Sheets with a corresponding reinsurance receivable from the
business sold to Swiss Re, which totaled $3.2 billion and $4.5 billion as of
September 30, 2009, and December 31, 2008, respectively. Swiss Re has
funded a trust with a balance of $2.0 billion as of September 30, 2009, to
support this business. As a result of Swiss Re’s S&P financial
strength rating dropping below AA-, Swiss Re was required to fund an additional
trust of approximately $1.8 billion as of September 30, 2009, to support this
business. Swiss Re funded the new trust in October of
2009. In addition to various remedies that we would have in the event
of a default by Swiss Re, we continue to hold assets in support of certain of
the transferred reserves. These assets consist of those reported as
trading securities and certain mortgage loans. Our liability for
funds withheld and our asset for embedded derivatives included $1.2 billion and
$44 million, respectively, as of September 30, 2009, related to the business
sold to Swiss Re.
We sold a
block of disability income business to Swiss Re as part of several indemnity
reinsurance transactions executed in 2001, as discussed above. On
January 24, 2009, an award of rescission was declared related to an ongoing
dispute between us and Swiss Re for this treaty, which requires us to be fully
responsible for all claims incurred and liabilities supporting this block as if
the reinsurance treaty never existed. We are conducting a review of the
adequacy of the reserves supporting the liabilities. We expect to
evaluate the results of this review during our reporting for the fourth quarter
of 2009. Any increase in reserves will result in a charge to our
earnings. See Note 11 for a discussion of the effects of the
rescission.
On March
31, 2009, we entered into a 55% coinsurance agreement whereby we ceded a closed
block of business consisting of certain UL and VUL insurance products to a third
party reinsurer. Effective October 1, 2009, we executed an additional
agreement whereby we assumed the mortality risk on this block of business
through yearly renewable term reinsurance. See “Results of Insurance
Solutions – Insurance Solutions – Life Insurance” and “Review of Consolidated
Financial Condition” for more information.
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I – Item 1A. Risk Factors” in our 2008 Form
10-K and “Forward-Looking Statements – Cautionary Language” in this
report.
REVIEW
OF CONSOLIDATED FINANCIAL CONDITION
Liquidity
and Capital Resources
Sources
of Liquidity and Cash Flow
Liquidity
refers to the ability of an enterprise to generate adequate amounts of cash from
its normal operations to meet cash requirements with a prudent margin of
safety. Our principal sources of cash flow from operating activities
are insurance premiums and fees and investment income, while sources of cash
flows from investing activities result from maturities and sales of invested
assets. Our operating activities provided cash of $552 million and
$811 million for the first nine months of 2009 and 2008,
respectively. When considering our liquidity and cash flow, it is
important to distinguish between the needs of our insurance subsidiaries and the
needs of the holding company, LNC. As a holding company with no
operations of its own, LNC derives its cash primarily from its operating
subsidiaries.
The
sources of liquidity of the holding company are principally comprised of
dividends and interest payments from subsidiaries, augmented by holding company
short-term investments, bank lines of credit, a commercial paper program and the
ongoing availability of long-term public financing under an SEC-filed shelf
registration statement. These sources of liquidity and cash flow
support the general corporate needs of the holding company, including its common
and preferred stock dividends, interest and debt service, funding of callable
securities, securities repurchases, repayment of preferred stock, acquisitions
and investment in core businesses.
The
disruptions in the capital markets experienced in the second half of 2008
continued into the first part of 2009. During this extraordinary
market environment, management continually monitored and adjusted its liquidity
and capital plans for LNC and its subsidiaries in light of changing needs and
opportunities. To strengthen the capital position of our principal
insurance subsidiaries and provide holding company liquidity during this period
of volatility in the capital and credit markets, we issued common stock and debt
during the second quarter of 2009 and issued preferred stock and a common stock
warrant through the TARP CPP during the third quarter of 2009, which is
discussed in more detail below in “Financing Activities.”
We
believe that the rating agencies have heightened the level of scrutiny that they
apply to the U.S. life insurance sector and may adjust upward the capital and
other requirements employed in the rating agency models for maintenance of
certain ratings levels. In addition, actions we take to access third
party financing may in turn cause rating agencies to reevaluate our
ratings. For more information about ratings, see “Part I – Item 1.
Business – Ratings” in our 2008 Form 10-K.
Details
underlying the primary sources of our holding company cash flows (in millions)
were as follows:
|
|
For
the Three
|
|
|
For
the Nine
|
|
|
For
the
|
|
|
|
Months
Ended
|
|
|
Months
Ended
|
|
|
Year
Ended
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2009
|
|
|
2008
|
|
|
2008
|
|
Dividends
from Subsidiaries
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LNL,
excluding Lincoln Financial Media
|
|
$ |
- |
|
|
$ |
100 |
|
|
$ |
403 |
|
|
$ |
400 |
|
|
$ |
400 |
|
Lincoln
Financial Media (1)
|
|
|
- |
|
|
|
3 |
|
|
|
4 |
|
|
|
656 |
|
|
|
659 |
|
First
Penn-Pacific
|
|
|
- |
|
|
|
- |
|
|
|
50 |
|
|
|
50 |
|
|
|
50 |
|
Delaware
Investments
|
|
|
3 |
|
|
|
15 |
|
|
|
8 |
|
|
|
43 |
|
|
|
51 |
|
Lincoln
Barbados
|
|
|
- |
|
|
|
- |
|
|
|
300 |
|
|
|
- |
|
|
|
- |
|
Lincoln
UK
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
24 |
|
|
|
24 |
|
Other
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
54 |
|
Loan
Repayments and Interest from
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subsidiary
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LNL
interest on intercompany notes (2)
|
|
|
22 |
|
|
|
22 |
|
|
|
63 |
|
|
|
63 |
|
|
|
83 |
|
|
|
$ |
25 |
|
|
$ |
140 |
|
|
$ |
828 |
|
|
$ |
1,236 |
|
|
$ |
1,321 |
|
Other
Cash Flow and Liquidity Items
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
proceeds on common stock issuance
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
652 |
|
|
$ |
- |
|
|
$ |
- |
|
TARP
CPP proceeds
|
|
|
950 |
|
|
|
- |
|
|
|
950 |
|
|
|
- |
|
|
|
- |
|
Net
capital received from (paid for taxes on) stock
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
option
exercises and restricted stock
|
|
|
(1 |
) |
|
|
1 |
|
|
|
(1 |
) |
|
|
15 |
|
|
|
15 |
|
|
|
$ |
949 |
|
|
$ |
1 |
|
|
$ |
1,601 |
|
|
$ |
15 |
|
|
$ |
15 |
|
(1)
|
For
2008, amount includes proceeds on the sale of certain discontinued media
operations.
|
(2)
|
Primarily
represents interest on the holding company’s $1.3 billion in surplus note
investments in LNL.
|
The table
above focuses on significant and recurring cash flow items and excludes the
effects of certain financing activities, namely the periodic issuance and
retirement of debt and cash flows related to our inter-company cash management
program (discussed below). Taxes have been eliminated from the
analysis due to a tax sharing agreement among our primary subsidiaries resulting
in a modest impact on net cash flows at the holding company. Also
excluded from this analysis is the modest amount of investment income on
short-term investments of the holding company.
Dividends
from Subsidiaries
Our
insurance subsidiaries are subject to certain insurance department regulatory
restrictions as to the transfer of funds and payment of dividends to the holding
company. Under Indiana laws and regulations, our Indiana insurance
subsidiaries, including our primary insurance subsidiary, LNL, may pay dividends
to LNC without prior approval of the Indiana Insurance Commissioner (the
“Commissioner”) up to a certain threshold, or must receive prior approval of the
Commissioner to pay a dividend if such dividend, along with all other dividends
paid within the preceding twelve consecutive months exceed the statutory
limitation. The current statutory limitation is the greater of 10% of
the insurer’s contract holders’ surplus, as shown on its last annual statement
on file with the Commissioner or the insurer’s statutory net gain from
operations for the prior calendar year. As discussed in “Part I –
Item 1. Business – Regulatory – Insurance Regulation” in our 2008 Form 10-K, we
may not consider the benefit from the permitted practice to the prescribed
statutory accounting principles relating to our insurance subsidiaries’ deferred
tax assets in calculating available dividends. Indiana law gives the
Commissioner broad discretion to disapprove requests for dividends in excess of
these limits. New York, the state of domicile of our other major
insurance subsidiary, Lincoln Life & Annuity Co. of New York, has similar
restrictions, except that in New York it is the lesser of 10% of surplus to
contract holders as of the immediately preceding calendar year or net gain from
operations for the immediately preceding calendar year, not including realized
capital gains.
We expect
our domestic insurance subsidiaries could pay dividends of approximately $550
million in 2009 without prior approval from the respective state
commissioners. The amount of surplus that our insurance subsidiaries
could pay as dividends is constrained by the amount of surplus we hold to
maintain our ratings, to provide an additional layer of margin for risk
protection and for future investment in our businesses.
We
maintain an investment portfolio of various holdings, types and
maturities. These investments are subject to general credit,
liquidity, market and interest rate risks. An extended disruption in
the credit and capital markets could adversely affect LNC and its subsidiaries’
ability to access sources of liquidity, and there can be no assurance that
additional financing will be available to us on favorable terms, or at all, in
the current market environment. In addition, further
other-than-temporary impairments could reduce our statutory surplus, leading to
lower RBC ratios and potentially reducing future dividend capacity from our
insurance subsidiaries.
Subsidiaries’
Statutory Reserving and Surplus
Our
insurance subsidiaries have statutory surplus and RBC levels above current
regulatory required levels. As mentioned earlier in “Results of
Insurance Solutions – Insurance Solutions – Life Insurance,” approximately 58%
and 66% of our life sales for the three and nine months ended September 30,
2009, respectively, consisted of products containing secondary guarantees, which
require reserving practices under AG38. Our insurance subsidiaries
are employing strategies to lessen the burden of increased AG38 and Valuation of
Life Insurance Policies Model Regulation (“XXX”) statutory reserves associated
with certain UL products and other products with secondary guarantees subject to
these statutory reserving requirements.
Included
in the letters of credit (“LOCs”) issued as of September 30, 2009, reported in
the revolving credit facilities table below in “Financing Activities,” was
approximately $1.5 billion of LOCs supporting the reinsurance obligations of
Lincoln National Reinsurance Company (Barbados) Limited (“LNBAR”) on UL business
with secondary guarantees. Recognizing that LOCs are generally one to
five years in duration, it is likely that our insurance companies will apply a
mix of LOCs, reinsurance and capital market strategies in addressing long-term
AG38 and XXX needs. LOCs and related capital market alternatives
lower the RBC impact of the UL business with secondary guarantee
products. An inability to obtain the necessary LOC capacity or other
capital market alternatives could impact our returns on UL business with
secondary guarantee products. Our strategy to address the statutory
reserve strain from UL products with secondary guarantees uses a mix of
retaining a portion of the statutory reserve strain, implementing long-term
capital financing solutions and leveraging short-term LOCs. We
previously executed a long-term structured solution of approximately $400
million in 2007. It is our plan to replace the $1.5 billion of LOCs
that mature in 2012 with a mix of more permanent long-term structures and new
LOCs.
We are
continuing to pursue capital management strategies related to our AG38 reserves
involving reinsurance and securitizations. As mentioned above in
“Reinsurance,” we entered into a coinsurance agreement on March 31,
2009. The transaction resulted in the release of approximately $240
million of statutory capital previously supporting a closed block of business of
certain UL and VUL insurance products and an RBC benefit of approximately 20
percentage points in 2009. Effective October 1, 2009, we executed an
additional agreement whereby we assumed the mortality risk on this block of
business, which resulted in a capital outlay of approximately $14
million. See “Part I – Item 1A. Risk Factors – Attempts to mitigate
the impact of Regulation XXX and Actuarial Guideline 38 may fail in whole or in
part resulting in an adverse effect on our financial condition and results of
operations” in our 2008 Form 10-K for further information on XXX
reserves. In addition, a portion of our term life insurance business
is reinsured with a domestic reinsurance captive as part of our overall strategy
of managing the statutory capital of our insurance
subsidiaries. There are no outstanding LOCs related to this
business.
As a
result of recent financing activities discussed below and upon the closing of
the TARP CPP, we contributed $1.0 billion to our principal life insurance
subsidiary during the third quarter of 2009. In addition, we
contributed media assets to our principal life insurance subsidiary during the
second quarter of 2009, which increased our statutory capital by $285
million.
In
September of 2008, the National Association of Insurance Commissioners adopted a
new statutory reserving standard, VACARVM, which will be effective as of
December 31, 2009. We are currently in the process of evaluating the
impact of adopting VACARVM. This reserving requirement will replace
current statutory reserving practices for variable annuities with guaranteed
benefits and has the potential to require statutory reserves well in excess of
current levels for certain variable annuity riders sold by us. The
actual impact of the adoption will be dependent upon several factors including
account values and market conditions that exist as of December 31, 2009, the
value of derivative and other assets supporting reserves whose change in value
may be uncorrelated with the new reserving requirements and the use of captive
or third-party reinsurance. Our current capital plan assumes a $500
million impact related to VACARVM, recognizing that this is a preliminary
estimate, and contemplates actions to better manage the capital requirements as
we move towards implementation. Markets will greatly influence the
ultimate capital required due to their impact on the valuation of reserves and
derivative assets hedging these reserves. We continue to evaluate the
impact of VACARVM requirements on our capital position and reserving
assumptions. Our estimates of the expected impact may change as we
conduct further analysis prior to implementation. We
are analyzing the current use of existing captive reinsurance structures, as
well as additional third-party reinsurance arrangements, and hedging strategies
relative to managing the negative impact on the level and volatility of
statutory capital and dividend capacity in our life insurance
subsidiaries. Depending on market conditions, reinsurance solutions
and hedging strategies, additional statutory reserves could lead to lower RBC
ratios and potentially reduce future dividend capacity of our insurance
subsidiaries.
As a
result of the equity market impacts in the third quarter of 2009, we experienced
an increase in the statutory reserve adjustment under the Commissioners Annuity
Reserve Valuation Method (“CARVM”) for our annuity products and lower net
reserves for GDB riders. CARVM is the current statutory actuarial
method used for determining reserves for the base annuity
contract. The impact of these items increased statutory surplus of
our statutory insurance companies by approximately $100 million in the third
quarter of 2009. We estimate that an S&P 500 level of 900, a 15%
drop from the September 30, 2009, level, would result in a decrease in the CARVM
statutory reserve adjustment and an increase in statutory net GDB reserves, and
thereby, reduce statutory surplus of LNL by $80 million to $100 million at the
end of 2009. As a result, the estimated RBC ratio on a consolidated
basis as of December 31, 2009, under this scenario would be reduced by
approximately five to seven percentage points. The estimated
capital impact is based on the current statutory reserve formulas and does not
take into account the reserve and asset adequacy analysis performed by our
actuaries on an annual basis to determine appropriateness of the reserves at
year end. This analysis incorporates the adequacy of assets in LNBAR, our
captive reinsurance company, supporting the liabilities that it assumes from
LNL. The outcome of this analysis may result in an additional reserve
increase and could further reduce the RBC ratio.
The sensitivity of our statutory reserves and surplus established for
our variable annuity base contracts and riders to changes in the equity markets
will vary depending on the magnitude of the decline. The
sensitivity will be affected by the level of account values relative to the
level of guaranteed amounts, product design and
reinsurance. Statutory reserves for variable annuities depend upon
the cumulative equity market impacts on the business in force and therefore
result in non-linear relationships with respect to the level of equity market
performance within any reporting period. The RBC ratio is also
affected by the product mix of the in-force book of business (i.e., the
amount of business without guarantees is not subject to the same level of
reserves as the business with guarantees). The RBC ratio of LNL is an
important factor in the determination of the credit and financial strength
ratings of LNC and its subsidiaries. The market value of our separate
account assets increased during the first nine months of 2009, resulting in a
$95 million increase in statutory surplus. The separate accounts
include the impact of our variable annuities and also our credit-linked
notes. However, future declines in the market values of our separate
account assets could cause reductions in the surplus of LNL, which may impact
its RBC ratio and dividend capacity.
Financing
Activities
Although
our subsidiaries currently generate adequate cash flow to meet the needs of our
normal operations, periodically we may issue debt or equity securities to
maintain ratings and increase liquidity, as well as to fund internal growth,
acquisitions and the retirement of our debt and equity securities.
We
currently have an effective shelf registration statement, which allows us to
issue, in unlimited amounts, securities, including debt securities, preferred
stock, common stock, warrants, stock purchase contracts, stock purchase units,
depository shares and trust preferred securities of our affiliated
trusts.
We
entered into a purchase agreement to sell Delaware on August 18,
2009. We expect this transaction to close on or around December 31,
2009, and we expect that the after-tax proceeds of approximately $400 million
will be used for general corporate purposes.
On July
10, 2009, we issued and sold to the U.S. Treasury 950,000 shares of Series B
preferred stock together with a related warrant to purchase up to 13,049,451
shares of our common stock at an exercise price of $10.92 per share, in
accordance with the terms of the TARP CPP, for an aggregate purchase price of
$950 million. Holders of this Series B preferred stock are entitled
to a cumulative cash dividend at the annual rate per share of 5% of the
liquidation preference, $1,000 per share, or $48 million annually, for the first
five years from issuance. After July 10, 2014, if the preferred
shares are still outstanding, the annual dividend rate will increase to 9% per
year. We intend to repay this financing prior to the increase in the
dividend rate, taking into consideration appropriate balance sheet strength and
capital market conditions. The Series B non-voting preferred stock
has no maturity date and ranks senior to our common stock. The Series
B preferred stock dividends and related accretion of discount is recorded as a
direct reduction to retained earnings and deducted from income available to
common stockholders in the calculation of earnings per share. See
Note 12 for additional details.
On June
22, 2009, we closed on the issuance and sale of 40 million shares of our common
stock at a price to the public of $15.00 per share, and we also completed the
issuance and sale of $500 million aggregate principal amount of our 8.75% senior
notes due 2019. On June 25, 2009, we closed on the issuance and sale
of 6 million additional shares of our common stock at a price of $15.00 per
share to the underwriters who exercised their over-allotment
option. The net proceeds from these offerings were approximately $1.1
billion.
As
mentioned above, we contributed $1.0 billion of the proceeds of these recent
financing activities to our principal insurance subsidiary during the third
quarter of 2009, and we retained the remaining $1.1 billion at the holding
company for general corporate purposes.
We
announced on June 15, 2009, that we entered into a share purchase agreement to
sell Lincoln UK. The transaction closed on October 1, 2009, and we
received proceeds of approximately $305 million, after-tax, that will be used
for general corporate purposes. There could be post-closing
adjustments, some of which are beyond our control, and no assurance can be given
as to the timing of its completion as an extension beyond 120 days is allowed in
the share purchase agreement if there is disagreement during this
period.
Details
underlying debt and financing activities (in millions) were as
follows:
|
|
For
the Nine Months Ended September 30, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Maturities
|
|
|
in
Fair
|
|
|
|
|
|
|
|
|
|
Beginning
|
|
|
|
|
|
and
|
|
|
Value
|
|
|
Other
|
|
|
Ending
|
|
|
|
Balance
|
|
|
Issuance
|
|
|
Repayments
|
|
|
Hedges
|
|
|
Changes
(1)
|
|
|
Balance
|
|
Short-Term
Debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
paper
|
|
$ |
315 |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
(166 |
) |
|
$ |
149 |
|
Current
maturities of long-term debt
|
|
|
500 |
|
|
|
- |
|
|
|
(500 |
) |
|
|
- |
|
|
|
250 |
|
|
|
250 |
|
Other
short-term debt
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1 |
|
|
|
1 |
|
Total
short-term debt
|
|
$ |
815 |
|
|
$ |
- |
|
|
$ |
(500 |
) |
|
$ |
- |
|
|
$ |
85 |
|
|
$ |
400 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-Term
Debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior
notes
|
|
$ |
2,555 |
|
|
$ |
495 |
|
|
$ |
- |
|
|
$ |
(104 |
) |
|
$ |
(247 |
) |
|
$ |
2,699 |
|
Bank
borrowing
|
|
|
200 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
200 |
|
Federal
Home Loan Bank
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of
Indianapolis ("FHLBI") advance
|
|
|
250 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
250 |
|
Junior
subordinated debentures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
issued
to affiliated trusts
|
|
|
155 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
155 |
|
Capital
securities
|
|
|
1,571 |
|
|
|
- |
|
|
|
(87 |
) |
|
|
- |
|
|
|
1 |
|
|
|
1,485 |
|
Total
long-term debt
|
|
$ |
4,731 |
|
|
$ |
495 |
|
|
$ |
(87 |
) |
|
$ |
(104 |
) |
|
$ |
(246 |
) |
|
$ |
4,789 |
|
(1)
|
Includes
the net increase (decrease) in commercial paper, non-cash reclassification
of long-term debt to current maturities of long-term debt, accretion of
discounts and (amortization) of
premiums.
|
On April
6, 2009, we funded the maturity of a $500 million floating rate senior note
through dividends received during the second quarter of 2009 from LNL and LNBAR
and internal borrowings. Borrowings that are scheduled to mature
within two years include a $250 million floating rate senior note due on March
12, 2010, and a $250 million 6.2% fixed rate senior note due on December 15,
2011. We are currently considering refinancing alternatives to, among
other things, pre-fund the debt maturing in March 2010. The specific
resources or combination of resources that we will use to meet the maturities
will depend upon, among other things, the financial market conditions present at
the time of maturity. As of September 30, 2009, the holding company
had $820 million in cash and cash equivalents.
In March
of 2009, we repurchased $87 million of our capital securities and recognized a
gain of $64 million, pre-tax. See Note 10 for additional information
on the gain recognized on the early extinguishment of debt.
Details
underlying our credit facilities with a group of domestic and foreign banks (in
millions) were as follows:
|
|
|
As
of September 30, 2009
|
|
|
Expiration
|
|
Maximum
|
|
|
Borrowings
|
|
|
Date
|
|
Available
|
|
|
Outstanding
|
|
Revolving
Credit Facilities
|
|
|
|
|
|
|
|
Credit
facility with the FHLBI (1)
|
Not
Applicable
|
|
$ |
411 |
|
|
$ |
350 |
|
Five-year
revolving credit facility
|
March
2011
|
|
|
1,750 |
|
|
|
- |
|
Five-year
revolving credit facility
|
February
2011
|
|
|
1,350 |
|
|
|
- |
|
Total
|
|
|
$ |
3,511 |
|
|
$ |
350 |
|
|
|
|
|
|
|
|
|
|
|
Letters
of credit issued
|
|
|
|
|
|
|
$ |
2,095 |
|
(1)
|
Our
borrowing capacity under this credit facility does not have an expiration
date and continues while our investment in the FHLBI common stock remains
outstanding as long as LNL maintains a satisfactory level of
creditworthiness and does not incur a material adverse change in its
financial, business, regulatory or other areas that would materially
affect its operations and viability. Of the borrowings
outstanding as of September 30, 2009, $250 million is classified within
long-term debt and $100 million is classified within payables for
collateral under securities loaned and derivatives on our Consolidated
Balance Sheets. The maturity dates of the borrowings are
discussed below.
|
The LOCs
support inter-company reinsurance transactions and specific treaties associated
with our business sold through reinsurance. LOCs are used primarily
to satisfy the U.S. regulatory requirements of our domestic insurance companies
for which reserve credit is provided by our affiliated offshore reinsurance
company, as discussed above, and our domestic clients of the business sold
through reinsurance.
Under the
credit agreements, we must maintain a minimum consolidated net worth
level. In addition, the agreements contain covenants restricting our
ability to incur liens, merge or consolidate with another entity where we are
not the surviving entity and dispose of all or substantially all of our
assets. As of September 30, 2009, we were in compliance with all such
covenants. All of our credit agreements are unsecured.
If
current debt ratings and claims-paying ratings were downgraded in the future,
terms in our derivative agreements may be triggered, which could negatively
impact overall liquidity. For the majority of our counterparties,
there is a termination event should long-term debt ratings of LNC drop below
BBB-/Baa3. Our long-term debt currently holds a rating of
BBB/Baa2. In addition, contractual selling agreements with
intermediaries could be negatively impacted, which could have an adverse impact
on overall sales of annuities, life insurance and investment
products. See “Part I – Item 1A. Risk Factors – A decrease in the
capital and surplus of our insurance subsidiaries may result in a downgrade to
our insurer financial strength ratings” and “Part I – Item 1A. Risk Factors
– A downgrade in
our financial strength or credit ratings could limit our ability to market
products, increase the number or value of policies being surrendered and/or hurt
our relationships with creditors” in our 2008 Form 10-K for more
information. See “Part I – Item 1. Business – Ratings” in our 2008
Form 10-K for additional information on our current bond
ratings.
In the
third quarter of 2008, LNL made an investment of $19 million in the FHLBI, a
AAA-rated entity, and made an additional investment of $2 million in the second
quarter of 2009. We are allowed to borrow up to 20 times the amount
of our common stock investment in the FHLBI. All borrowings from the
FHLBI are required to be secured by certain investments owned by
LNL. On December 4, 2008, the LNC and LNL Boards of Directors
approved an additional common stock investment of $56 million, which would
increase our total borrowing capacity up to $1.5 billion upon completion of that
incremental investment. As of September 30, 2009, based on our actual
common stock investment, we had borrowing capacity of up to approximately $411
million from the FHLBI. We had a $250 million floating-rate term loan
outstanding under the facility due June 20, 2017, which may be prepaid beginning
June 20, 2010. In June 2009, we also borrowed $100 million at a rate
of 0.8% that is due June 3, 2010.
Management
is monitoring the covenants associated with LNC’s capital securities. If
we fail to meet capital adequacy or net income and shareholders’ equity levels
(also referred to as “trigger events”), terms in the agreements may be
triggered, which would require us to make interest payments in accordance with
an alternative coupon satisfaction mechanism (“ACSM”).
The ACSM
would require us to use commercially reasonable efforts to pay interest in full
on the capital securities with the net proceeds from sales of our common stock
and warrants on our common stock with an exercise price greater than the market
price. We would have to utilize the ACSM until the trigger events above no
longer existed. If we were required to utilize the ACSM and were
successful in selling sufficient common shares or warrants to satisfy the
interest payment, we would dilute the current holders of our common stock.
Furthermore, while a trigger event is occurring and if we do not pay
accrued interest in full, we may not, among other things, pay dividends on
or repurchase our capital stock. We have designated the proceeds from
our June 2009 common stock offering as being available to satisfy the ACSM;
therefore, the proceeds can be used for such purpose for 180 days after June 22,
2009.
In recent
quarters, we have triggered the net income test as a result of quarterly
consolidated net losses, and we may continue to trigger the net income test
looking forward to future quarters. However, our capital raise in the
form of equity in the second and third quarters of 2009 resulted in avoiding the
overall shareholders’ equity trigger looking forward to the quarters ending
December 31, 2009, and March 31, 2010.
For more
information, see “Part I – Item 1A. Risk Factors – We will be required to pay
interest on our capital securities with proceeds from the issuance of qualifying
securities if we fail to achieve capital adequacy or net income and
shareholders’ equity levels” and Note 13 in our 2008 Form 10-K.
Alternative
Sources of Liquidity
In order
to manage our capital more efficiently, we have an inter-company cash management
program where certain subsidiaries can lend to or borrow from the holding
company to meet short-term borrowing needs. The cash management
program is essentially a series of demand loans, which are permitted under
applicable insurance laws, among LNC and its affiliates that reduces overall
borrowing costs by allowing LNC and its subsidiaries to access internal
resources instead of incurring third-party transaction costs. For our
Indiana-domiciled insurance subsidiaries, the borrowing and lending limit is
currently the lesser of 3% of the insurance company’s admitted assets and 25% of
its surplus, in both cases, as of its most recent year end.
The
holding company did not borrow from the cash management program during the third
quarter of 2009, and there was no balance as of September 30,
2009. In addition, the holding company had an outstanding payable of
$130 million to certain subsidiaries resulting from amounts placed by the
subsidiaries in the inter-company cash management account in excess of funds
borrowed by those subsidiaries as of September 30, 2009. Any increase
(decrease) in either of these holding company cash management program payable
balances results in an immediate and equal increase (decrease) to holding
company cash and cash equivalents.
Our
insurance subsidiaries, by virtue of their general account fixed income
investment holdings, can access liquidity through securities lending programs
and repurchase agreements. As of September 30, 2009, our insurance
subsidiaries had securities with a carrying value of $694 million out on loan
under the securities lending program and $344 million carrying value subject to
reverse-repurchase agreements. The cash received in our securities
lending program is typically invested in cash equivalents, short-term
investments or fixed maturity securities.
LNC has a
$1.0 billion commercial paper program that is rated A-2, P-2 and
F2. The commercial paper program is backed by a bank line of
credit. During the third quarter of 2009, LNC had an average of $191
million in commercial paper outstanding with a maximum amount of $220 million
outstanding at any time. LNC had $149 million of commercial paper
outstanding as of September 30, 2009.
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I – Item 1A. Risk Factors” in our 2008 Form
10-K and “Forward-Looking Statements – Cautionary Language” in this
report.
Divestitures
For a
discussion of our divestitures, see Note 3.
Uses
of Capital
Our
principal uses of cash are to pay policy claims and benefits, operating
expenses, commissions and taxes, to purchase new investments, to purchase
reinsurance, to fund policy surrenders and withdrawals, to pay dividends to our
stockholders and to repurchase our stock and debt securities.
Return
of Capital to Common Stockholders
One of
the holding company’s primary goals is to provide a return to our common
stockholders through dividends and stock repurchases. In determining
dividends, the Board takes into consideration items such as current and expected
earnings, capital needs, rating agency considerations and requirements for
financial flexibility. As a result of our participation in the TARP
CPP, we are subject to limits on increasing the dividend on our common stock
(unless the U.S. Treasury consents), which applies until the third anniversary
of the U.S. Treasury’s investment unless we redeem the Series B preferred shares
in whole or the U.S. Treasury transfers all of the Series B preferred stock to
third parties.
Details
underlying this activity (in millions, except per share data) were as
follows:
|
|
For
the Three
|
|
|
|
|
|
For
the Nine
|
|
|
|
|
|
For
the
|
|
|
|
Months
Ended
|
|
|
|
|
|
Months
Ended
|
|
|
|
|
|
Year
Ended
|
|
|
|
September
30,
|
|
|
|
|
|
September
30,
|
|
|
|
|
|
December
31,
|
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2009
|
|
|
2008
|
|
|
Change
|
|
|
2008
|
|
Common
dividends to stockholders
|
|
$ |
3 |
|
|
$ |
106 |
|
|
|
-97 |
% |
|
$ |
59 |
|
|
$ |
323 |
|
|
|
-82 |
% |
|
$ |
429 |
|
Repurchase
of common stock
|
|
|
- |
|
|
|
50 |
|
|
|
-100 |
% |
|
|
- |
|
|
|
476 |
|
|
|
-100 |
% |
|
|
476 |
|
Total
cash returned to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
stockholders
|
|
$ |
3 |
|
|
$ |
156 |
|
|
|
-98 |
% |
|
$ |
59 |
|
|
$ |
799 |
|
|
|
-93 |
% |
|
$ |
905 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number
of shares issued
|
|
|
- |
|
|
|
- |
|
|
NM
|
|
|
|
46.000 |
|
|
|
- |
|
|
NM
|
|
|
|
- |
|
Average
price per share
|
|
$ |
- |
|
|
$ |
- |
|
|
NM
|
|
|
$ |
14.34 |
|
|
$ |
- |
|
|
NM
|
|
|
$ |
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number
of shares repurchased
|
|
|
- |
|
|
|
1.010 |
|
|
|
-100 |
% |
|
|
- |
|
|
|
9.091 |
|
|
|
-100 |
% |
|
|
9.091 |
|
Average
price per share
|
|
$ |
- |
|
|
$ |
49.55 |
|
|
|
-100 |
% |
|
$ |
- |
|
|
$ |
52.31 |
|
|
|
-100 |
% |
|
$ |
52.31 |
|
Note: Average
price per share is calculated using whole dollars instead of dollars rounded to
millions.
On
February 24, 2009, the Board of Directors approved a reduction of the dividend
on our common stock from $0.21 to $0.01 per share, which, along with a prior
reduction, is expected to add approximately $100 million to capital each
quarter. Additionally, we have suspended stock repurchase
activity. We expect that both of these changes will favorably impact
our capital position prospectively in light of the recent market volatility and
extraordinary events and developments affecting financial markets.
Significant
Trends in Sources and Uses of Cash Flow
As stated
above, LNC’s cash flow, as a holding company, is largely dependent upon the
dividend capacity of its insurance company subsidiaries as well as their ability
to advance funds to it through inter-company borrowing arrangements, which may
be impacted by factors influencing the insurance subsidiaries’ RBC and statutory
earnings performance. As a result of the raising of $2.1 billion as
part of our capital plan, discussed in “Financing Activities” above, we
currently expect to be able to meet the holding company’s ongoing cash needs and
to have sufficient capital to offer downside protection in the event that the
capital and credit markets experience another period of extreme volatility and
disruption. These actions compliment the previously mentioned
dividend reductions, suspension of share repurchases and enterprise-wide
restructuring program that is expected to generate $250 million, pre-tax, in
annual savings to further strengthen our capital and liquidity
positions. In addition, we are exploring our options with regard to
protecting and building capital at the insurance company subsidiaries, which may
include, depending on then current market conditions and other factors,
potential securitizations of reserves, reinsurance transactions and sales of
corporate assets. Note, a continuation of or an acceleration of poor
capital market conditions, which reduces our insurance subsidiaries’ statutory
surplus and RBC, may require them to retain more capital and may pressure our
subsidiaries’ dividends to the holding company, which may lead us to take steps
to preserve or raise additional capital. For factors that could
affect our expectations for liquidity and capital, see “Part I – Item 1A. Risk
Factors” in our 2008 Form 10-K.
OTHER
MATTERS
Other
Factors Affecting Our Business
In
general, our businesses are subject to a changing social, economic, legal,
legislative and regulatory environment. Some of the changes include
initiatives to require more reserves to be carried by our insurance
subsidiaries. Although the eventual effect on us of the changing
environment in which we operate remains uncertain, these factors and others
could have a material effect on our results of operations, liquidity and capital
resources. For factors that could cause actual results to differ
materially from those set forth in this section, see “Part I – Item 1A. Risk
Factors” in our 2008 Form 10-K, as updated in “Forward-Looking Statements –
Cautionary Language” in this report.
Recent
Accounting Pronouncements
See Note
2 for a discussion of recent accounting pronouncements that have been
implemented during the periods presented or that have been issued and are to be
implemented in the future.
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
We
analyze and manage the risks arising from market exposures of financial
instruments, as well as other risks, in an integrated asset-liability management
process that takes diversification into account. By aggregating the
potential effect of market and other risks on the entire enterprise, we
estimate, review and in some cases manage the risk to our earnings and
shareholder value. We have exposures to several market risks
including interest rate, foreign currency exchange, equity market, default,
basis and credit. The exposure of financial instruments to market
risks, and the related risk management process, are most important to our
Retirement Solutions and Insurance Solutions businesses, where most of the
invested assets support accumulation and investment-oriented insurance
products. As an important element of our integrated asset-liability
management process, we use derivatives to minimize the effects of changes in
interest levels, the shape of the yield curve, currency movements and
volatility. In this context, derivatives are designated as a hedge and
serve to minimize interest rate risk by mitigating the effect of significant
increases in interest rates on our earnings. Additional market
exposures exist in our other general account insurance products and in our debt
structure and derivatives positions. Our primary sources of market
risk are: substantial, relatively rapid and sustained increases or
decreases in interest rates; fluctuations in currency exchange rates; or a sharp
drop in equity market values. These market risks are discussed in
detail in the following pages and should be read in conjunction with, our
consolidated financial statements and the accompanying notes to the consolidated
financial statements (“Notes”) presented in “Item 1. Financial Statements and
Supplementary Data,” as well as “Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations (“MD&A”).
Derivatives
We have
entered into derivative transactions to hedge our exposure to rapid changes in
interest rates. The derivative programs are used to help us achieve
somewhat stable margins while providing competitive crediting rates to contract
holders during periods when interest rates are changing. Such
derivatives include interest rate swaps, interest rate futures, interest rate
caps and treasury locks. See Note 6 for additional information on our
derivatives used to hedge our exposure to changes in interest
rates.
In
addition to continuing existing programs, we may use derivative instruments in
other strategies to limit risk and enhance returns, particularly in the
management of investment spread businesses. We have established
policies, guidelines and internal control procedures for the use of derivatives
as tools to enhance management of the overall portfolio of risks assumed in our
operations. Annually, our Board of Directors reviews our derivatives
policy.
Impact
of Equity Market Sensitivity
Due to
the use of our reversion to the mean (“RTM”) process and our hedging strategies
as described in “MD&A – Critical Accounting Policies and Estimates” in Item
2 above and in Item 7 of our 2008 Form 10-K, we expect that, in general,
short-term fluctuations in the equity markets should not have a significant
impact on our quarterly earnings from unlocking of assumptions for deferred
acquisition costs, value of business acquired, deferred sales inducements and
deferred front-end loads, as we do not unlock our long-term equity market
assumptions based upon short-term fluctuations in the equity
markets. However, there is an impact to earnings from the effects of
equity market movements on account values and assets under management and the
related asset-based fees we earn on those assets net of related expenses we
incur based upon the level of assets. The following table presents
our estimate of the impact on income from operations (in millions), from the
change in asset-based fees and related expenses, if the level of the S&P 500
Index® (“S&P 500”) were to drop to 800 immediately after September 30, 2009,
and remaining at that level through the next twelve months or dropped to 700
immediately after September 30, 2009, and remain at that level through the next
twelve months, excluding any impact related to sales, prospective unlocking,
persistency, hedge program performance or customer behavior caused by the equity
market change:
|
|
S&P
500
|
|
|
S&P
500
|
|
|
|
at
700 (2)
|
|
|
at
800 (2)
|
|
Segment
|
|
|
|
|
|
|
Retirement
Solutions – Annuities
(1)
|
|
$ |
(110 |
) |
|
$ |
(80 |
) |
Retirement
Solutions – Defined Contribution
(1)
|
|
|
(25 |
) |
|
|
(20 |
) |
(1)
|
If
the level of the S&P 500 dropped to 700 immediately after September
30, 2009, and remained at that level in subsequent periods we project that
we would have a RTM prospective unlocking of approximately $250 million to
$310 million, after-tax, for Retirement Solutions late in
2011. If the level of the S&P 500 dropped to 800
immediately after September 30, 2009, and remained at that
level in subsequent periods we project that we would have a RTM
prospective unlocking of approximately $200 million to $240 million,
after-tax, for Retirement Solutions late in
2012.
|
(2)
|
The
baseline for these impacts assumes 9% annual equity market growth
beginning on October 1, 2009. The baseline is then compared to
scenarios of S&P 500 at the 700 and 800 levels, which assume the index
stays at those levels for the next twelve months and grows at 9% annually
thereafter. The difference between the baseline and S&P 500
at the 700 and 800 level scenarios is presented in the
table.
|
The
impact on earnings summarized above is an expected effect for the next twelve
months. The effect of quarterly equity market changes upon fee
revenues and asset-based expenses will not be fully recognized in the current
quarter because fee revenues are earned and related expenses are incurred based
upon daily variable account values. The difference between the
current period average daily variable account values compared to the end of
period variable account values impacts fee revenues in subsequent
periods. Additionally, the impact on earnings may not necessarily be
symmetrical with comparable increases in the equity markets. This
discussion concerning the estimated effects of ongoing equity market volatility
on the fees we earn from account values and assets under management is intended
to be illustrative. Actual effects may vary depending on a variety of
factors, many of which are outside of our control, such as changing customer
behaviors that might result in changes in the mix of our business between
variable and fixed annuity contracts, switching among investment alternatives
available within variable products, changes in sales production levels or
changes in policy persistency. For purposes of this guidance, the
change in account values is assumed to correlate with the change in the relevant
index.
Credit-Related
Derivatives
We use
credit-related derivatives to minimize our exposure to credit-related events and
we also sell credit default swaps to offer credit protection to our contract
holders. For additional information see Note 6.
Credit Risk
Through
the use of derivative instruments, we are exposed to both credit risk (our
counterparty fails to make payment) and market risk (the value of the instrument
falls). When the fair value of a derivative contract is positive,
this generally indicates that the counterparty owes us and, therefore, creates a
credit risk for us equal to the extent of the fair value gain in the
derivative. When the fair value of a derivative contract is negative,
this generally indicates we owe the counterparty and therefore we have no credit
risk, but have been affected by market risk. We minimize the credit
risk in derivative instruments by entering into transactions with high quality
counterparties with minimum credit ratings that are reviewed regularly by us, by
limiting the amount of credit exposure to any one counterparty, and by requiring
certain counterparties to post collateral if our credit risk exceeds certain
limits. We also maintain a policy of requiring all derivative
contracts to be governed by an International Swaps and Derivatives Association
(“ISDA”) Master Agreement. We do not believe that the credit or
market risks associated with derivative instruments are material to any
insurance subsidiary or to us.
We have
derivative positions with counterparties. Assuming zero recovery
value, our exposure is the positive market value of the derivative positions
with a counterparty, less collateral, that would be lost if the counterparty
were to default. As of September 30, 2009, and December 31, 2008, our
counterparty risk exposure, net of collateral, was $426 million and $562
million, respectively. Of this exposure, $144 million and $145
million, respectively was related to our program to hedge our variable annuity
guaranteed benefits. As of September 30, 2009, we have exposure to 16
counterparties, with a maximum exposure of $148 million, net of collateral, to a
single counterparty. The credit risk associated with such agreements
is minimized by purchasing such agreements from financial institutions with
long-standing, superior performance records. For the majority of
Lincoln National Corporation (“LNC”) counterparties, there is a termination
event should long-term debt ratings of LNC rating drop below
BBB-/Baa3. Additionally, we maintain a policy of requiring all
derivative contracts to be governed by an ISDA Master Agreement.
As of
September 30, 2009, and December 31, 2008, our fair value of counterparty
exposure (in millions) was as follows:
|
|
|
As
of
|
|
|
As
of
|
|
|
|
|
September
30,
|
|
|
December
31,
|
|
|
|
|
2009
|
|
|
2008
|
|
Rating
|
|
|
|
|
|
|
|
AAA
|
|
|
$ |
4 |
|
|
$ |
20 |
|
AA
|
|
|
|
290 |
|
|
|
333 |
|
A |
|
|
|
|
125 |
|
|
|
209 |
|
BBB
|
|
|
|
7 |
|
|
|
- |
|
Total
|
|
|
$ |
426 |
|
|
$ |
562 |
|
Item 4. Controls
and Procedures
Conclusions
Regarding Disclosure Controls and Procedures
We
maintain disclosure controls and procedures, which are designed to ensure that
information required to be disclosed in the reports we file or submit under the
Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission’s rules and forms, and that such information
is accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure. As of the end of the period covered by this
report, we, under the supervision and with the participation of our Chief
Executive Officer and Chief Financial Officer, conducted an evaluation of the
effectiveness of our disclosure controls and procedures (as that term is defined
in Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are effective in timely
alerting them to material information relating to us and our consolidated
subsidiaries required to be disclosed in our periodic reports under the Exchange
Act.
Changes
in Internal Control Over Financial Reporting
There was
no change in our internal control over financial reporting (as that term is
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
that occurred during the quarter ended September 30, 2009, that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
A control
system, no matter how well designed and operated, can provide only reasonable
assurance that the control system’s objectives will be met. Further,
because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that misstatements due to error or fraud
will not occur or that all control issues and instances of fraud, if any, within
the company have been detected. Projections of any evaluation of
controls effectiveness to future periods are subject to risks. Over
time, controls may become inadequate because of changes in conditions or
deterioration in the degree of compliance with policies or
procedures.
PART
II – OTHER INFORMATION
Item 1. Legal
Proceedings
Information
regarding reportable legal proceedings is contained in Note 11 to the
consolidated financial statements in “Part I – Item 1.”
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
(c) The
following table summarizes purchases of equity securities by the issuer during
the quarter ended September 30, 2009 (dollars in millions, except per share
data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
Total
|
|
|
|
|
|
(c)
Total Number
|
|
|
(d)
Approximate Dollar
|
|
|
|
Number
|
|
|
(b)
Average
|
|
|
of
Shares (or Units)
|
|
|
Value
of Shares (or
|
|
|
|
of
Shares
|
|
|
Price
Paid
|
|
|
Purchased
as Part of
|
|
|
Units)
that May Yet Be
|
|
|
|
(or
Units)
|
|
|
per
Share
|
|
|
Publicly
Announced
|
|
|
Purchased
Under the
|
|
Period
|
|
Purchased
(1)
|
|
|
(or
Unit)
|
|
|
Plans
or Programs (2)
|
|
|
Plans
or Programs (3)
|
|
7/1/09
- 7/31/09
|
|
|
433 |
|
|
$ |
15.06 |
|
|
|
- |
|
|
$ |
1,204 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8/1/09
- 8/31/09
|
|
|
11,636 |
|
|
|
23.22 |
|
|
|
- |
|
|
|
1,204 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9/1/09
- 9/30/09
|
|
|
18,855 |
|
|
|
23.97 |
|
|
|
- |
|
|
|
1,204 |
|
(1)
|
Of
the total number of shares purchased, no shares were received in
connection with the exercise of stock options and related taxes and 30,924
shares were withheld for taxes on the vesting of restricted
stock. For the quarter ended September 30, 2009, there were no
shares purchased as part of publicly announced plans or
programs.
|
(2)
|
On
February 23, 2007, our Board approved a $2.0 billion increase to our
securities repurchase authorization, bringing the total authorization at
that time to $2.6 billion. As of September 30, 2009, our
security repurchase authorization was $1.2 billion. The
security repurchase authorization does not have an expiration
date. The amount and timing of share repurchase depends on key
capital ratios, rating agency expectations, the generation of free cash
flow and an evaluation of the costs and benefits associated with
alternative uses of capital. The shares repurchased in
connection with the awards described in Note 15 are not included in our
security repurchase. As required under the Troubled Asset
Relief Program (“TARP”) Capital Purchase Program (“CPP”), repurchases of
the Company’s outstanding preferred and common stock are subject to
certain restrictions (unless the U.S. Treasury consents). In
addition to these restrictions, in connection with this arrangement, the
Company will comply with enhanced compensation restrictions for certain
executives and
employees.
|
(3)
|
As
of the last day of the applicable
month.
|
On July
10, 2009, in connection with the TARP CPP, established as part of the Emergency
Economic Stabilization Act of 2008, we issued and sold to the U.S. Treasury,
under an exemption from registration pursuant to Rule 144A of the
Securities Act of 1933, 950,000 shares of Series B preferred stock together with
a related warrant to purchase up to 13,049,451 shares of our common stock at an
exercise price of $10.92 per share, in accordance with the terms of the TARP
CPP, for an aggregate purchase price of $950 million.
Item
6. Exhibits
The
Exhibits included in this report are listed in the Exhibit Index beginning on
page E-1, which is incorporated herein by reference.
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
|
|
|
LINCOLN
NATIONAL CORPORATION
|
|
|
|
|
By:
|
/s/ FREDERICK J.
CRAWFORD
|
|
|
Frederick
J. Crawford
Executive
Vice President and Chief Financial Officer
|
|
|
|
|
By:
|
/s/ DOUGLAS N.
MILLER
|
|
|
Douglas
N. Miller
Vice
President and Chief Accounting Officer
|
Date: November
6, 2009
|
|
|
LINCOLN
NATIONAL CORPORATION
Exhibit
Index for the Report on Form 10-Q
For
the Quarter Ended September 30, 2009
2.1
|
Purchase
And Sale Agreement By And Among Lincoln National Corporation, Lincoln
National Investment Companies, Inc. And Macquarie Bank Limited, dated as
of August 18, 2009 is filed herewith.*
|
4.1
|
Warrant
for the Purchase of Shares of Common Stock is incorporated by reference to
Exhibit 3.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on July
10, 2009.
|
10.1
|
Form
of Indemnification between LNC and each director filed
herewith.
|
10.2
|
Letter
Agreement, dated July 10, 2009, between LNC and the U.S. Department of the
Treasury is incorporated by reference to Exhibit 10.1 to LNC’s Form 8-K
(File No. 1-6028) filed with the SEC on July 10, 2009.
|
10.3
|
Side
Letter, dated July 10, 2009, between LNC and the U.S. Department of the
Treasury is incorporated by reference to Exhibit 10.2 to LNC’s Form 8-K
(File No. 1-6028) filed with the SEC on July 10, 2009.
|
10.4
|
Form
of Waiver, is incorporated by reference to Exhibit 10.3 to LNC’s Form 8-K
(File No. 1-6028) filed with the SEC on July 10, 2009.
|
12.1
|
Historical
Ratio of Earnings to Fixed Charges.
|
31.1
|
Certification
of the Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
31.2
|
Certification
of the Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
32.1
|
Certification
of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
32.2
|
Certification
of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
101
|
Attached
as Exhibit 101 to this report are the following Interactive Data Files
formatted in XBRL (Extensible Business Reporting Language): (i)
Consolidated Balance Sheets for the quarter ended September 30, 2009 and
period ended December 31, 2008, (ii) Consolidated Statements of Income for
the three and nine months ended September 30, 2009 and 2008; (iii)
Consolidated Statements of Stockholders’ Equity for the nine months ended
September 30, 2009 and 2008; and (iv) the Consolidated Statements of Cash
Flow for the nine months ended September 30, 2009 and
2008. Users of this data are advised pursuant to Rule 401 of
Regulation S-T that the information contained in the XBRL documents is
unaudited and these are not the official publicly filed financial
statements of Lincoln National
Corporation.
|
In
accordance with Rule 402 of Regulation S-T, the XBRL related information in this
report shall not be deemed filed for purposes of Section18 of the Securities
Exchange Act of 1934, as amended, or otherwise subject to the liability of that
section, and shall not be incorporated by reference into any registration
statement or other document filed under the Securities Act of 1933, as amended,
except as shall be expressly set forth by specific reference in such
filing.
* The
contents of the schedules to the Purchase and Sale Agreement and its exhibits
have been omitted pursuant to Item 601(b)(2) of Regulation S-K. LNC
will furnish supplementally a copy of the exhibits and schedules to the Purchase
and Sale Agreement to the SEC upon request. The Purchase and Sale
Agreement contains representations and warranties that the parties to the
Agreement made to and solely for the benefit of each other. The assertions
embodied in such representations and warranties are qualified by information
contained in confidential schedules that the parties exchanged in connection
with signing the Purchase and Sale Agreement. Accordingly, investors and
shareholders should not rely on such representations and warranties as
characterizations of the actual state of facts or circumstances, since they were
only made as of the date of the Purchase and Sale Agreement and are modified in
important part by the underlying disclosure schedules. Moreover, information
concerning the subject matter of such representations and warranties may change
after the date of the Purchase and Sale Agreement, which subsequent information
may or may not be fully reflected in our public disclosures.