Sub Filer Id
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 March 31, 2007.
|
|
|
¨
|
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.)
|
1500
Market Street, Suite 3900, Philadelphia,
Pennsylvania
|
19102-2112
|
(Address
of principal executive offices)
|
(Zip
Code)
|
(215)
448-1400
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 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 is a large accelerated filer, an
accelerated filer, or a non- accelerated filer. See definition of accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange
Act.
(Check
one): Large accelerated filer x
Accelerated filer ¨Non-
accelerated filer ¨
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 May
1, 2007, there were 270,773,385 shares of the registrant’s common stock
outstanding.
Item
1.
Financial Statements
LINCOLN
NATIONAL CORPORATION
CONSOLIDATED
BALANCE SHEETS
|
|
March
31,
|
|
December
31,
|
|
|
|
2007
|
|
2006
|
|
|
|
(Unaudited)
|
|
|
|
|
|
(in
millions)
|
|
ASSETS
|
|
|
|
|
|
|
|
Investments:
|
|
|
|
|
|
|
|
Securities
available-for-sale, at fair value:
|
|
|
|
|
|
|
|
Fixed
maturity (cost: 2007-$55,268; 2006-$54,960)
|
|
$
|
56,256
|
|
$
|
55,853
|
|
Equity
(cost: 2007-$682; 2006-$681)
|
|
|
714
|
|
|
701
|
|
Trading
securities
|
|
|
2,910
|
|
|
3,036
|
|
Mortgage
loans on real estate
|
|
|
7,416
|
|
|
7,384
|
|
Real
estate
|
|
|
406
|
|
|
421
|
|
Policy
loans
|
|
|
2,767
|
|
|
2,760
|
|
Derivative
investments
|
|
|
413
|
|
|
415
|
|
Other
investments
|
|
|
967
|
|
|
918
|
|
Total
investments
|
|
|
71,849
|
|
|
71,488
|
|
Cash
and invested cash
|
|
|
900
|
|
|
1,621
|
|
Deferred
acquisition costs and value of business acquired
|
|
|
8,535
|
|
|
8,420
|
|
Premiums
and fees receivable
|
|
|
375
|
|
|
356
|
|
Accrued
investment income
|
|
|
919
|
|
|
866
|
|
Amounts
recoverable from reinsurers
|
|
|
8,132
|
|
|
7,939
|
|
Goodwill
|
|
|
4,521
|
|
|
4,500
|
|
Other
assets
|
|
|
2,948
|
|
|
2,770
|
|
Assets
held in separate accounts
|
|
|
83,147
|
|
|
80,534
|
|
Total
assets
|
|
$
|
181,326
|
|
$
|
178,494
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
Insurance
and investment contract liabilities:
|
|
|
|
|
|
|
|
Insurance
policy and claim reserves
|
|
$
|
15,014
|
|
$
|
14,771
|
|
Investment
contract and policyholder funds
|
|
|
58,729
|
|
|
58,817
|
|
Total
insurance and investment contract liabilities
|
|
|
73,743
|
|
|
73,588
|
|
Short-term
debt
|
|
|
593
|
|
|
658
|
|
Long-term
debt:
|
|
|
|
|
|
|
|
Senior
notes
|
|
|
2,383
|
|
|
2,231
|
|
Junior
subordinated debentures issued to affiliated trusts
|
|
|
155
|
|
|
155
|
|
Capital
securities
|
|
|
1,571
|
|
|
1,072
|
|
Reinsurance
related derivative liability
|
|
|
230
|
|
|
229
|
|
Funds
withheld reinsurance liabilities
|
|
|
2,121
|
|
|
2,094
|
|
Deferred
gain on indemnity reinsurance
|
|
|
741
|
|
|
760
|
|
Other
liabilities
|
|
|
4,610
|
|
|
4,972
|
|
Liabilities
related to separate accounts
|
|
|
83,147
|
|
|
80,534
|
|
Total
liabilities
|
|
|
169,294
|
|
|
166,293
|
|
|
|
|
|
|
|
|
|
Commitments
and Contingencies (See Note 9)
|
|
|
|
|
|
|
|
Shareholders'
Equity
|
|
|
|
|
|
|
|
Series
A preferred stock-10,000,000 shares authorized (2007 liquidation
value-$1)
|
|
|
1
|
|
|
1
|
|
Common
stock-800,000,000 shares authorized (shares issued and
outstanding:
|
|
|
|
|
|
|
|
2007-
270,685,522; 2006- 275,752,668)
|
|
|
7,318
|
|
|
7,449
|
|
Retained
earnings
|
|
|
4,054
|
|
|
4,138
|
|
Accumulated
other comprehensive income:
|
|
|
|
|
|
|
|
Net
unrealized gain on securities available-for-sale
|
|
|
528
|
|
|
493
|
|
Net
unrealized gain on derivative instruments
|
|
|
47
|
|
|
39
|
|
Foreign
currency translation adjustment
|
|
|
168
|
|
|
165
|
|
Funded
status of employee benefit plans
|
|
|
(84
|
)
|
|
(84
|
)
|
Total
accumulated other comprehensive income
|
|
|
659
|
|
|
613
|
|
Total
shareholders' equity
|
|
|
12,032
|
|
|
12,201
|
|
Total
liabilities and shareholders' equity
|
|
$
|
181,326
|
|
$
|
178,494
|
|
See
accompanying Notes to Consolidated Financial Statements
LINCOLN
NATIONAL CORPORATION
CONSOLIDATED
STATEMENTS OF INCOME
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2007
|
|
2006
|
|
|
|
(Unaudited)
|
|
|
|
(in
millions, except per share amounts)
|
|
Revenue
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$
|
459
|
|
$
|
78
|
|
Insurance
fees
|
|
|
779
|
|
|
475
|
|
Investment
advisory fees
|
|
|
90
|
|
|
78
|
|
Communications
revenue (net)
|
|
|
67
|
|
|
-
|
|
Net
investment income
|
|
|
1,090
|
|
|
678
|
|
Realized
gain (loss)
|
|
|
26
|
|
|
(1
|
)
|
Amortization
of deferred gain on indemnity reinsurance
|
|
|
19
|
|
|
19
|
|
Other
revenue and fees
|
|
|
140
|
|
|
95
|
|
Total
revenue
|
|
|
2,670
|
|
|
1,422
|
|
Benefits
and Expenses
|
|
|
|
|
|
|
|
Benefits
|
|
|
1,194
|
|
|
582
|
|
Underwriting,
acquisition, insurance and other expenses
|
|
|
805
|
|
|
503
|
|
Communications
expense
|
|
|
41
|
|
|
-
|
|
Interest
and debt expense
|
|
|
61
|
|
|
22
|
|
Total
benefits and expenses
|
|
|
2,101
|
|
|
1,107
|
|
Income
before taxes
|
|
|
569
|
|
|
315
|
|
Federal
income taxes
|
|
|
173
|
|
|
94
|
|
Net
income
|
|
$
|
396
|
|
$
|
221
|
|
|
|
|
|
|
|
|
|
Net
Income Per Common Share
|
|
|
|
|
|
|
|
Basic
|
|
$
|
1.44
|
|
$
|
1.27
|
|
Diluted
|
|
$
|
1.42
|
|
$
|
1.24
|
|
See
accompanying Notes to Consolidated Financial Statements
LINCOLN
NATIONAL CORPORATION
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY
|
|
Three
Months Ended March 31,
|
|
|
|
2007
|
|
2006
|
|
|
|
(Unaudited)
|
|
|
|
(in
millions, except for share amounts)
|
|
Series
A Preferred Stock
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
$
|
1
|
|
$
|
1
|
|
Balance
at end-of-period
|
|
|
1
|
|
|
1
|
|
Common
Stock
|
|
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
|
7,449
|
|
|
1,775
|
|
Issued
for acquisition
|
|
|
20
|
|
|
-
|
|
Stock
compensation/issued for benefit plans
|
|
|
41
|
|
|
35
|
|
Deferred
compensation payable in stock
|
|
|
3
|
|
|
8
|
|
Retirement
of common stock
|
|
|
(195
|
)
|
|
-
|
|
Balance
at end-of-period
|
|
|
7,318
|
|
|
1,818
|
|
Retained
Earnings
|
|
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
|
4,138
|
|
|
4,082
|
|
Cumulative
effect of adoption of SOP 05-1
|
|
|
(41
|
)
|
|
-
|
|
Cumulative
effect of adoption of FIN 48
|
|
|
(15
|
)
|
|
-
|
|
Comprehensive
income (loss)
|
|
|
442
|
|
|
(23
|
)
|
Less
other comprehensive income (loss) (net of Federal income
tax):
|
|
|
|
|
|
|
|
Net
unrealized gain (loss) on securities available-for-sale, net
of
|
|
|
|
|
|
|
|
reclassification
adjustment
|
|
|
35
|
|
|
(278
|
)
|
Net
unrealized loss on derivative instruments
|
|
|
8
|
|
|
28
|
|
Foreign
currency translation adjustment
|
|
|
3
|
|
|
6
|
|
Net
income
|
|
|
396
|
|
|
221
|
|
Retirement
of common stock
|
|
|
(317
|
)
|
|
-
|
|
Dividends
declared:
|
|
|
|
|
|
|
|
Common
(2007-$.395; 2006-$.38)
|
|
|
(107
|
)
|
|
(67
|
)
|
Balance
at end-of-period
|
|
|
4,054
|
|
|
4,236
|
|
Net
Unrealized Gain on Securities Available-for-Sale
|
|
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
|
493
|
|
|
497
|
|
Change
during the period
|
|
|
35
|
|
|
(278
|
)
|
Balance
at end-of-period
|
|
|
528
|
|
|
219
|
|
Net
Unrealized Gain on Derivative Instruments
|
|
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
|
39
|
|
|
7
|
|
Change
during the period
|
|
|
8
|
|
|
28
|
|
Balance
at end-of-period
|
|
|
47
|
|
|
35
|
|
Foreign
Currency Translation Adjustment
|
|
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
|
165
|
|
|
83
|
|
Change
during the period
|
|
|
3
|
|
|
6
|
|
Balance
at end-of-period
|
|
|
168
|
|
|
89
|
|
Minimum
Pension Liability Adjustment
|
|
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
|
-
|
|
|
(60
|
)
|
Balance
at end-of-period
|
|
|
-
|
|
|
(60
|
)
|
Funded
Status of Employee Benefit Plans
|
|
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
|
(84
|
)
|
|
-
|
|
Balance
at end-of-period
|
|
|
(84
|
)
|
|
-
|
|
Total
shareholders' equity at end-of-period
|
|
$
|
12,032
|
|
$
|
6,338
|
|
See
accompanying Notes to Consolidated Financial Statements
LINCOLN
NATIONAL CORPORATION
CONSOLIDATED
STATEMENTS OF SHAREHOLDERS’ EQUITY
-CONTINUED-
|
|
Three
Months Ended March 31,
|
|
|
|
2007
|
|
2006
|
|
|
|
(Unaudited)
|
|
|
|
(Number
of Shares)
|
|
|
|
|
|
|
|
Series
A Preferred Stock
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
|
12,706
|
|
|
15,515
|
|
Conversion
into common stock
|
|
|
(180
|
)
|
|
(550
|
)
|
Balance
at end-of-period
|
|
|
12,526
|
|
|
14,965
|
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
|
|
|
|
|
|
Balance
at beginning-of-year
|
|
|
275,752,668
|
|
|
173,768,078
|
|
Conversion
of series A preferred stock
|
|
|
2,880
|
|
|
8,800
|
|
Stock
compensation/issued for benefit plans
|
|
|
2,144,891
|
|
|
2,107,311
|
|
Retirement
of common stock
|
|
|
(7,214,917
|
)
|
|
-
|
|
Balance
issued and outstanding at end-of-period
|
|
|
270,685,522
|
|
|
175,884,189
|
|
Common
stock at end-of-period:
|
|
|
|
|
|
|
|
Assuming
conversion of preferred stock
|
|
|
270,885,938
|
|
|
176,123,629
|
|
Diluted
basis
|
|
|
274,004,126
|
|
|
178,468,931
|
|
See
accompanying Notes to Consolidated Financial Statements
LINCOLN
NATIONAL CORPORATION
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2007
|
|
2006
|
|
|
|
(Unaudited)
|
|
|
|
(in
millions)
|
|
Cash
Flows from Operating Activities
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
396
|
|
$
|
221
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
Deferred
acquisition costs and value of business acquired
|
|
|
(206
|
)
|
|
(80
|
)
|
Premiums
and fees receivable
|
|
|
(19
|
)
|
|
(20
|
)
|
Accrued
investment income
|
|
|
(53
|
)
|
|
(6
|
)
|
Policy
liabilities and accruals
|
|
|
243
|
|
|
(9
|
)
|
Net
trading securities purchases, sales and maturities
|
|
|
126
|
|
|
(45
|
)
|
Gain
on reinsurance embedded derivative/trading securities
|
|
|
-
|
|
|
(6
|
)
|
Contractholder
funds
|
|
|
281
|
|
|
201
|
|
Pension
plan contribution
|
|
|
-
|
|
|
(1
|
)
|
Amounts
recoverable from reinsurers
|
|
|
(193
|
)
|
|
27
|
|
Federal
income taxes
|
|
|
(186
|
)
|
|
68
|
|
Stock-based
compensation expense
|
|
|
15
|
|
|
9
|
|
Depreciation
|
|
|
13
|
|
|
14
|
|
Increase
in funds withheld liability
|
|
|
27
|
|
|
46
|
|
Realized
loss (gain) on investments and derivative instruments
|
|
|
(26
|
)
|
|
7
|
|
Amortization
of deferred gain
|
|
|
(19
|
)
|
|
(19
|
)
|
Other
|
|
|
70
|
|
|
(82
|
)
|
Net
adjustments
|
|
|
73
|
|
|
104
|
|
Net
cash provided by operating activities
|
|
|
469
|
|
|
325
|
|
Cash
Flows from Investing Activities
|
|
|
|
|
|
|
|
Securities-available-for-sale:
|
|
|
|
|
|
|
|
Purchases
|
|
|
(5,017
|
)
|
|
(1,836
|
)
|
Sales
|
|
|
3,705
|
|
|
1,285
|
|
Maturities
|
|
|
972
|
|
|
494
|
|
Purchase
of other investments
|
|
|
(603
|
)
|
|
(529
|
)
|
Sale
or maturity of other investments
|
|
|
514
|
|
|
569
|
|
Increase
in cash collateral on loaned securities
|
|
|
(288
|
)
|
|
(35
|
)
|
Other
|
|
|
(124
|
)
|
|
(69
|
)
|
Net
cash used in investing activities
|
|
|
(841
|
)
|
|
(121
|
)
|
Cash
Flows from Financing Activities
|
|
|
|
|
|
|
|
Payment
of long-term debt
|
|
|
(314
|
)
|
|
-
|
|
Issuance
of long-term debt
|
|
|
749
|
|
|
-
|
|
Net
increase (decrease) in short-term debt
|
|
|
150
|
|
|
(109
|
)
|
Universal
life and investment contract deposits
|
|
|
2,177
|
|
|
1,179
|
|
Universal
life and investment contract withdrawals
|
|
|
(1,968
|
)
|
|
(1,139
|
)
|
Investment
contract transfers
|
|
|
(574
|
)
|
|
(432
|
)
|
Common
stock issued for benefit plans and excess tax benefits
|
|
|
52
|
|
|
26
|
|
Retirement
of common stock
|
|
|
(512
|
)
|
|
-
|
|
Dividends
paid to shareholders
|
|
|
(109
|
)
|
|
(67
|
)
|
Net
cash used in financing activities
|
|
|
(349
|
)
|
|
(542
|
)
|
Net
decrease in cash and invested cash
|
|
|
(721
|
)
|
|
(338
|
)
|
Cash
and invested cash at beginning-of-year
|
|
|
1,621
|
|
|
2,312
|
|
Cash
and invested cash at end-of-period
|
|
$
|
900
|
|
$
|
1,974
|
|
See
accompanying Notes to Consolidated Financial Statements
LINCOLN
NATIONAL CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
Basis of Presentation
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 and investment management businesses as well as a
broadcasting and sports programming business through seven business segments
(see Note 10). 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 and solutions.
These products include institutional and/or retail fixed and indexed annuities,
variable annuities, universal life insurance, variable universal life insurance,
term life insurance, mutual funds and managed accounts. We report less than
majority-owned entities in which we have at least a 20% interest on the equity
basis.
The
accompanying unaudited consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States
(“GAAP”) for interim financial information and with the instructions for the
Securities and Exchange Commission 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, 2006 (“2006 Form 10-K”) should be referred to in connection
with the reading of these interim unaudited consolidated financial statements.
On
April
3, 2006, we completed our merger with Jefferson-Pilot Corporation
(“Jefferson-Pilot”), and have included the results of operations and financial
condition of Jefferson-Pilot in our consolidated financial statements beginning
on April 3, 2006. The unaudited consolidated financial statements for the three
months ended March 31, 2006 exclude the results of operations and financial
condition of Jefferson-Pilot.
In
the
opinion of management, these statements include all normal recurring adjustments
necessary for a fair presentation of the results. Operating results for the
three month period ended March 31, 2007 are not necessarily indicative of the
results that may be expected for the full year ending December 31, 2007. All
material intercompany accounts and transactions have been eliminated in
consolidation.
Certain
amounts reported in prior periods’ unaudited consolidated financial statements
have been reclassified to conform to the 2007 presentation. These
reclassifications have no effect on net income or shareholders’ equity of the
prior periods.
2.
Changes in Accounting Principles and Changes in Estimates
Statement
of Position 05-1 - Accounting by Insurance Enterprises for Deferred Acquisition
Costs in Connection with Modifications or Exchanges of Insurance
Contracts.
In
September 2005, the American Institute of Certified Public Accountants (“AICPA”)
issued Statement of Position 05-1, “Accounting by Insurance Enterprises for
Deferred Acquisition Costs in Connection with Modifications or Exchanges of
Insurance Contracts” (“SOP 05-1”). SOP 05-1 provides guidance on accounting for
deferred acquisition costs (“DAC”) on internal replacements of insurance and
investment contracts. An internal replacement, defined by SOP 05-1, is a
modification in product benefits, features, rights or coverages that occurs
by
the exchange of a contract for a new contract, or by amendment, endorsement
or
rider to a contract, or by the election of a feature or coverage within a
contract. Contract modifications that result in a substantially unchanged
contract will be accounted for as a continuation of the replaced contract.
Contract modifications that result in a substantially changed contract should
be
accounted for as an extinguishment of the replaced contract. Unamortized DAC,
unearned revenue and deferred sales inducements from the replaced contract
must
be written-off. SOP 05-1 is effective for internal replacements occurring in
fiscal years beginning after December 15, 2006.
We
adopted SOP 05-1 effective January 1, 2007 by recording decreases to the
following categories in our Consolidated Balance Sheets:
(in
millions)
|
|
|
|
Assets
|
|
|
|
|
Deferred
acquisition costs
|
|
$
|
31
|
|
Value
of business acquired
|
|
|
35
|
|
Other
assets - deferred sales inducements
|
|
|
3
|
|
Total
assets
|
|
$
|
69
|
|
|
|
|
|
|
Liabilities
and Shareholders' Equity
|
|
|
|
|
Investment
contract and policyholder funds - deferred front end loads
|
|
$
|
2
|
|
Insurance
policy and claim reserves - guaranteed minimum death benefit annuity
reserves
|
|
|
4
|
|
Other
liabilities - income tax liabilities
|
|
|
22
|
|
Total
liabilities
|
|
|
28
|
|
|
|
|
|
|
Retained
earnings
|
|
|
41
|
|
|
|
|
|
|
Total
liabilities and shareholders' equity
|
|
$
|
69
|
|
The
adoption of this new guidance primarily impacts our Individual Markets Annuities
and Employer Markets Group Protection businesses, and our accounting policies
regarding the assumptions for lapsation used in the amortization of DAC and
value of business acquired (“VOBA”). In addition, the adoption of SOP 05-1
resulted in a $6 million pre-tax increase to underwriting, acquisition,
insurance and other expenses on our Consolidated Statements of Income in the
first three months of 2007, which was attributable to changes in DAC and VOBA
deferrals and amortization.
FASB
Interpretation No. 48 - Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement No. 109. In
July
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an
interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 requires an entity
to determine whether it is “more likely than not” that an individual tax
position will be sustained upon examination by the appropriate taxing authority
prior to any part of the benefit being recognized in the financial statements.
The amount recognized would be the largest amount of tax benefit that is greater
than fifty percent likely of being realized upon ultimate settlement, along
with
any related interest and penalties (if applicable). Upon adoption of FIN 48,
the
guidance will be applied to all tax positions, and only those tax positions
meeting the “more likely than not” threshold will be recognized or continue to
be recognized in the financial statements. In addition, FIN 48 expands
disclosure requirements to include additional information related to
unrecognized tax benefits, including accrued interest and penalties, and
uncertain tax positions where the estimate of the tax benefit may change
significantly in the next twelve months. FIN 48 is effective for fiscal years
beginning after December 15, 2006. We adopted FIN 48 effective January 1, 2007
by recording an increase in the liability for unrecognized tax benefits of
$15
million in our Consolidated Balance Sheets, offset by a reduction to the
beginning balance of retained earnings. See Note 4 for more information
regarding our adoption of FIN 48.
SFAS
No. 155 - Accounting for Certain Hybrid Financial Instruments - an amendment
of
FASB Statements No. 133 and 140.
In
February 2006, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments - an
amendment of FASB Statements No. 133 and 140” (“SFAS 155”), which permits fair
value remeasurement for a hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation. Under SFAS 155, an entity
may make an irrevocable election to measure a hybrid financial instrument at
fair value, in its entirety, with changes in fair value recognized in earnings.
SFAS 155 also: (a) clarifies which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities” (“SFAS 133”); (b) eliminates the
interim guidance in SFAS 133 Implementation Issue No. D1, “Application of
Statement 133 to Beneficial Interests in Securitized Financial Assets,” and
establishes a requirement to evaluate beneficial interests in securitized
financial assets to identify interests that are either freestanding derivatives
or hybrid financial instruments that contain an embedded derivative requiring
bifurcation; (c) clarifies that concentrations of credit risk in the form of
subordination are not embedded derivatives; and (d) eliminates restrictions
on a
qualifying special-purpose entity’s ability to hold passive derivative financial
instruments that pertain to beneficial interests that are or contain a
derivative financial instrument.
In
December 2006, the FASB issued Derivative
Implementation Group Statement 133 Implementation Issue No. B40,
“Embedded
Derivatives: Application of Paragraph 13(b) to Securitized Interests in
Prepayable Financial Assets” (“DIG B40”). Since SFAS 155 eliminated the interim
guidance related to securitized financial assets, DIG B40 provides a narrow
scope exception for securitized interests that contain only an embedded
derivative related to prepayment risk. Under DIG B40, a securitized interest
in
prepayable financial assets would not be subject to bifurcation if: (a) the
right to accelerate the settlement of the securitized interest cannot be
controlled by the investor and (b) the securitized interest itself does not
contain an embedded derivative for which bifurcation would be required other
than an embedded derivative that results solely from the embedded call options
in the underlying financial assets. Any other terms in the securitized financial
asset that may affect cash flow in a manner similar to a derivative instrument
would be subject to the requirements of paragraph 13(b) of SFAS 133. The
guidance in DIG B40 is to be applied upon the adoption of SFAS 155.
We
adopted the provisions SFAS 155 and DIG B40 on January 1, 2007. Prior period
restatement was not permitted. The adoption of SFAS 155 did not have a material
impact on our consolidated financial condition or results of operations.
SFAS
No. 157 - Fair Value Measurements.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
157”), which establishes a framework for measuring fair value under current
accounting pronouncements that require or permit fair value measurement. SFAS
157 retains the exchange price notion, but clarifies that exchange price is
the
price in an orderly transaction between market participants to sell the asset
or
transfer the liability in the most advantageous market for that asset or
liability. Fair value measurement 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 nonperformance risk which would
include the reporting entity’s own credit risk. SFAS 157 establishes a
three-level fair value hierarchy, which prioritizes the inputs to valuation
techniques used to measure fair value. The highest priority is given to quoted
prices in active markets for identical assets or liabilities and the lowest
priority to unobservable inputs in situations where there is little or no market
activity for the asset or liability. In addition, SFAS 157 expands the
disclosure requirements for annual and interim reporting to focus on the inputs
used to measure fair value, including those measurements using significant
unobservable inputs, and the effects of the measurements on earnings. SFAS
157
will be applied prospectively and is effective for fiscal years beginning after
November 15, 2007. Retrospective application is required for certain financial
instruments as a cumulative effect adjustment to the opening balance of retained
earnings. We expect to adopt SFAS 157 effective January 1, 2008, and are
currently evaluating the effects of SFAS 157 on our consolidated financial
condition and results of operations.
SFAS
No. 159 - The Fair Value Option for Financial Assets and Financial
Liabilities.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (“SFAS 159”), which allows an entity
to make an irrevocable election, on specific election dates, to measure eligible
items at fair value. The election to measure an item at fair value may be
determined on an instrument by instrument basis, with certain exceptions. If
the
fair value option is elected, unrealized gains and losses will be recognized
in
earnings at each subsequent reporting date, and any upfront costs and fees
related to the item will be recognized in earnings as incurred. In addition,
the
presentation and disclosure requirements of SFAS 159 are designed to assist
in
the comparison between entities that select different measurement attributes
for
similar types of assets and liabilities. SFAS 159 applies to fiscal years
beginning after November 15, 2007, with early adoption permitted for an entity
that has also elected to apply the provisions of SFAS 157. At the effective
date, the fair value option may be elected for eligible items that exist on
that
date. The effect of the first remeasurement to fair value shall be reported
as a
cumulative effect adjustment to the opening balance of retained earnings. We
expect to adopt SFAS 159 effective January 1, 2008, and are currently evaluating
the items to which we may apply the fair value option and the effect on our
consolidated financial condition and results of operations.
3.
Business Combination
On
April
3, 2006, we completed our merger with Jefferson-Pilot by acquiring 100% of
the
outstanding shares of Jefferson-Pilot in a transaction accounted for under
the
purchase method of accounting prescribed by SFAS No. 141, “Business
Combinations” (“SFAS 141”). Jefferson-Pilot’s results of operations are included
in our results of operations beginning April 3, 2006. As a result of the merger,
our product portfolio was expanded, and we now offer fixed and variable
universal life, fixed annuities, including indexed annuities, variable
annuities, mutual funds and institutional accounts, 401(k) and 403(b) offerings,
and group life, disability and dental insurance products. We also own and
operate television and radio stations in selected markets in the Southeastern
and Western United States and produce and distribute sports
programming.
SFAS
141
requires that the total purchase price be allocated to the assets acquired
and
liabilities assumed based on their fair values at the merger date.
The
aggregate consideration paid for the merger was as follows:
(in
millions, except share data)
|
|
Share
Amounts
|
|
|
|
LNC
common shares issued
|
|
|
112,301,906
|
|
|
|
|
Purchase
price per share of LNC common share (1)
|
|
$
|
48.98
|
|
|
|
|
Fair
value of common shares issued
|
|
|
|
|
$
|
5,501
|
|
Cash
paid to Jefferson-Pilot shareholders
|
|
|
|
|
|
1,800
|
|
Fair
value of Jefferson-Pilot stock options (2)
|
|
|
|
|
|
151
|
|
Transaction
costs
|
|
|
|
|
|
66
|
|
Total
purchase price
|
|
|
|
|
$
|
7,518
|
|
|
|
|
|
|
|
|
|
(1) |
The
value of the shares of LNC common stock exchanged with Jefferson-Pilot
shareholders was based upon the average of the closing prices of
LNC
common stock for the five day trading period ranging from two days
before,
to two days after, October 10, 2005, the date the merger was
announced.
|
(2) |
Includes
certain stock options that vested immediately upon the consummation
of the
merger. Any future income tax deduction related to these vested stock
options will be recognized on the option exercise date as an adjustment
to
the purchase price and recorded to goodwill.
|
The
fair
value of Jefferson-Pilot’s net assets assumed in the merger was $4.2 billion.
Goodwill of $3.3 billion resulted from the excess of purchase price over the
fair value of Jefferson-Pilot’s net assets. The amount of goodwill that is
expected to be deductible for tax purposes is approximately $24 million. We
paid
a premium over the fair value of Jefferson-Pilot’s net assets for a number of
potential strategic and financial benefits that are expected to be realized
as a
result of the merger including, but not limited to, the following:
· Greater
size and scale with improved earnings diversification and strong financial
flexibility;
· Broader,
more balanced product portfolio;
· Larger
distribution organization; and
· Value
creation opportunities through expense savings and revenue enhancements across
business units.
The
following table summarizes the fair values of the net assets acquired as of
the
acquisition date:
(in
millions)
|
|
Fair
Value
|
|
Investments
|
|
$
|
27,910
|
|
Due
from reinsurers
|
|
|
1,296
|
|
Value
of business acquired
|
|
|
2,486
|
|
Goodwill
|
|
|
3,324
|
|
Other
assets
|
|
|
1,693
|
|
Assets
held in separate accounts
|
|
|
2,574
|
|
Insurance
and investment contract liabilities
|
|
|
(26,641
|
)
|
Long-term
debt
|
|
|
(905
|
)
|
Income
tax liabilities
|
|
|
(782
|
)
|
Accounts
payable, accruals and other liabilities
|
|
|
(863
|
)
|
Liabilities
related to separate accounts
|
|
|
(2,574
|
)
|
Total
purchase price
|
|
$
|
7,518
|
|
The
goodwill resulting from the merger was allocated to the following
segments:
(in
millions)
|
|
|
|
Individual
Markets:
|
|
|
|
|
Life Insurance
|
|
$
|
1,318
|
|
Annuities
|
|
|
997
|
|
Total
Individual Markets
|
|
|
2,315
|
|
Employer
Markets: Group Protection
|
|
|
268
|
|
Lincoln
Financial Media
|
|
|
741
|
|
Total goodwill
|
|
$
|
3,324
|
|
|
|
|
|
|
The
following table summarizes the fair value of identifiable intangible assets
acquired in the merger and reported in other assets.
|
|
|
|
Weighted
|
|
|
|
|
|
Average
|
|
|
|
|
|
Amortization
|
|
(in
millions)
|
|
|
|
Period
|
|
Lincoln
Financial Media:
|
|
|
|
|
|
|
|
FCC
licenses
|
|
$
|
638
|
|
|
N/A
|
|
Sports
production rights
|
|
|
11
|
|
|
5
years
|
|
Network
affiliation agreements
|
|
|
10
|
|
|
21
years
|
|
Other
|
|
|
11
|
|
|
16
years
|
|
Total
Lincoln Financial Media
|
|
|
670
|
|
|
|
|
Individual
Markets - Life Insurance:
|
|
|
|
|
|
|
|
Sales
force
|
|
|
100
|
|
|
25
years
|
|
Total
indentifiable intangibles
|
|
$
|
770
|
|
|
|
|
|
|
|
|
|
|
|
|
Identifiable
intangibles not subject to amortization
|
|
$
|
638
|
|
|
N/A
|
|
Identifiable
intangibles subject to amortization
|
|
|
132
|
|
|
22
years
|
|
Total
identifiable intangibles
|
|
$
|
770
|
|
|
|
|
|
|
|
|
|
|
|
|
4.
Federal Income Taxes
The
effective tax rate was 30.4% and 29.7% for the first quarter of 2007 and
2006,
respectively. Differences in the effective rates and the U.S. statutory rate
of
35% are the result of certain tax preferred investment income, foreign tax
credits and other tax preference items.
We
are
required to establish a valuation allowance for any gross deferred tax assets
that are unlikely to reduce taxes payable in future years’ tax returns. At March
31, 2007, we believe that it is more likely than not that all gross deferred
tax
assets will reduce taxes payable in future years.
As
discussed in Note 2, we adopted FIN 48 on January 1, 2007, and as of this date
we had unrecognized tax benefits of $349 million of which $143 million, if
recognized, would impact the effective tax rate. Also, as of the adoption date,
we had accrued interest expense related to the unrecognized tax benefits of
$51
million. We recognize interest and penalties, if any, accrued related to
unrecognized tax benefits as a component of tax expense.
In
the
normal course of business we are subject to examination by taxing authorities
throughout the United States and the United Kingdom. At any given time, we
may
be under examination by state, local or non-U.S. income tax authorities.
We
are
currently under audit by the Internal Revenue Service (“IRS”). LNC is currently
under audit by the IRS for years 2003 and 2004. For the former Jefferson-Pilot
Corporation and its subsidiaries, the IRS is examining the years 2004 and 2005.
During the first quarter of 2006, the IRS completed its examination for the
tax
years 1999 through 2002 with assessments resulting in a payment that was not
material to our consolidated results of operations. In addition to taxes
assessed and interest, the payment included a deposit relating to a portion
of
the assessment, which we continue to challenge. We believe that this portion
of
the assessment is inconsistent with existing law and are protesting it through
the established IRS appeals process. We do not anticipate that any adjustments
that might result from such audits would be material to our consolidated results
of operations or financial condition. It is likely that the IRS appeals process
for the tax years 1996 to 1998 will conclude within the next twelve months.
It
is reasonably possible that a reduction in the unrecognized tax benefits may
occur; however, quantification of an estimated range cannot be made at this
time.
5.
Supplemental Financial Data
A
rollforward of DAC is as follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Balance
at beginning-of-year
|
|
$
|
5,116
|
|
$
|
4,164
|
|
Cumulative
effect of adoption of SOP 05-1
|
|
|
(31
|
)
|
|
-
|
|
Deferral
|
|
|
473
|
|
|
245
|
|
Amortization
|
|
|
(194
|
)
|
|
(148
|
)
|
Adjustment
related to realized gains on securities available-for-sale
|
|
|
|
|
|
|
|
and
derivatives
|
|
|
(13
|
)
|
|
(11
|
)
|
Adjustment
related to unrealized (gains) losses on securities
|
|
|
|
|
|
|
|
available-for-sale
and derivatives
|
|
|
(15
|
)
|
|
194
|
|
Foreign
currency translation adjustment
|
|
|
2
|
|
|
5
|
|
Balance
at end-of-period
|
|
$
|
5,338
|
|
$
|
4,449
|
|
|
|
|
|
|
|
|
|
A
rollforward of VOBA is as follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Balance
at beginning-of-year
|
|
$
|
3,304
|
|
$
|
999
|
|
Cumulative
effect of adoption of SOP 05-1
|
|
|
(35
|
)
|
|
-
|
|
Business
acquired
|
|
|
14
|
|
|
-
|
|
Deferral
of commissions and accretion of interest
|
|
|
15
|
|
|
-
|
|
Amortization
|
|
|
(88
|
)
|
|
(17
|
)
|
Adjustment
related to realized gains on securities
|
|
|
|
|
|
|
|
available-for-sale
and derivatives
|
|
|
(5
|
)
|
|
-
|
|
Adjustment
related to unrealized gains on securities
|
|
|
|
|
|
|
|
available-for-sale
and derivatives
|
|
|
(10
|
)
|
|
-
|
|
Foreign
currency translation adjustment
|
|
|
2
|
|
|
2
|
|
Balance
at end-of-period
|
|
$
|
3,197
|
|
$
|
984
|
|
Realized
gains and losses on investments and derivative instruments on the Consolidated
Statements of Income for the three months ended March 31, 2007 and 2006 are
net
of amounts amortized against DAC and VOBA of $18 million and $11 million,
respectively. In addition, realized gains and losses for both the three months
ended March 31, 2007 and 2006, are net of adjustments made to policyholder
reserves of $(2) million. We have either a contractual obligation or a
consistent historical practice of making allocations of investment gains or
losses to certain policyholders and to certain reinsurance
arrangements.
A
rollforward of deferred sales inducements, which is included in other assets
on
the Consolidated Balance Sheets, is as follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Balance
at beginning-of-year
|
|
$
|
194
|
|
$
|
129
|
|
Cumulative
effect of adoption of SOP 05-1
|
|
|
(3
|
)
|
|
-
|
|
Deferral
|
|
|
23
|
|
|
16
|
|
Amortization
|
|
|
(8
|
)
|
|
(5
|
)
|
Balance
at end-of-period
|
|
$
|
206
|
|
$
|
140
|
|
Details
underlying underwriting, acquisition, insurance and other expenses on the
Consolidated Statements of Income are as follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Commissions
|
|
$
|
515
|
|
$
|
242
|
|
General
and administrative expenses
|
|
|
422
|
|
|
305
|
|
DAC
and VOBA deferrals, net of amortization
|
|
|
(206
|
)
|
|
(80
|
)
|
Other
intangibles amortization
|
|
|
4
|
|
|
2
|
|
Taxes,
licenses and fees
|
|
|
66
|
|
|
34
|
|
Restructuring
charges
|
|
|
4
|
|
|
-
|
|
Total
|
|
$
|
805
|
|
$
|
503
|
|
As
discussed in Note 3, the excess of the purchase price for the Jefferson-Pilot
merger over the fair value of net assets acquired totaled $3.3
billion.
The
following summarizes the changes in the carrying amount of goodwill by
reportable segment for the three months ended March 31, 2007:
(in
millions)
|
|
Balance
at
December
31, 2006
|
|
Purchase
Accounting and Other Adjustments
|
|
Balance
at
March
31, 2007
|
|
Individual
Markets:
|
|
|
|
|
|
|
|
|
|
|
Life
Insurance
|
|
$
|
2,181
|
|
$
|
(9
|
)
|
$
|
2,172
|
|
Annuities
|
|
|
1,032
|
|
|
9
|
|
|
1,041
|
|
Employer
Markets:
|
|
|
|
|
|
|
|
|
|
|
Retirement
Products
|
|
|
20
|
|
|
-
|
|
|
20
|
|
Group
Protection
|
|
|
281
|
|
|
(13
|
)
|
|
268
|
|
Investment
Management
|
|
|
262
|
|
|
-
|
|
|
262
|
|
Lincoln
Financial Media
|
|
|
707
|
|
|
34
|
|
|
741
|
|
Lincoln
UK
|
|
|
17
|
|
|
-
|
|
|
17
|
|
Total
|
|
$
|
4,500
|
|
$
|
21
|
|
$
|
4,521
|
|
Details
of investment contract and policyholder funds on the Consolidated Balance Sheets
are as follows:
|
|
March
31,
|
|
December
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Premium
deposit funds
|
|
$
|
20,116
|
|
$
|
20,541
|
|
Other
policyholder funds
|
|
|
37,492
|
|
|
37,197
|
|
Deferred
front end loads
|
|
|
1,018
|
|
|
977
|
|
Undistributed
earnings on participating business
|
|
|
103
|
|
|
102
|
|
Total
|
|
$
|
58,729
|
|
$
|
58,817
|
|
|
|
|
|
|
|
|
|
6.
Insurance Benefit Reserves
We
issue
variable contracts through our separate accounts for which investment income
and
investment gains and losses accrue directly to, and investment risk is borne
by,
the contractholder (traditional variable annuities). We also issue variable
annuity and life contracts through separate accounts that include various types
of guaranteed minimum death benefit (“GMDB”), guaranteed minimum withdrawal
benefit and guaranteed income benefit features. The GMDB features include those
where we contractually guarantee to the contractholder either (a)
return
of no less than total deposits made to the contract less any partial
withdrawals, (b)
total
deposits made to the contract less any partial withdrawals plus a minimum
return, or (c)
the
highest contract value on any contract anniversary date through age 80 minus
any
payments or withdrawals following the contract anniversary.
The
following table provides information on the GMDB features outstanding at March
31, 2007 and December 31, 2006. (Note that our variable contracts with
guarantees may offer more than one type of guarantee in each contract;
therefore, the amounts listed are not mutually exclusive). The net amount at
risk is defined as the current guaranteed minimum death benefit in excess of
the
current account balance at the balance sheet date.
|
|
In
Event of Death
|
|
|
|
March
31,
|
|
December
31,
|
|
(dollars
in billions)
|
|
2007
|
|
2006
|
|
Return
of Net Deposit
|
|
|
|
|
|
Account
value
|
|
$
|
39.6
|
|
$
|
38.3
|
|
Net
amount at risk
|
|
|
0.1
|
|
|
0.1
|
|
Average
attained age of contractholders
|
|
|
54
|
|
|
54
|
|
Return
of Net Deposits Plus a Minimum Return
|
|
|
|
|
|
|
|
Account
value
|
|
$
|
0.4
|
|
$
|
0.4
|
|
Net
amount at risk
|
|
|
-
|
|
|
-
|
|
Average
attained age of contractholders
|
|
|
67
|
|
|
67
|
|
Guaranteed
minimum return
|
|
|
5
|
%
|
|
5
|
%
|
Highest
Specified Anniversary Account Value Minus
|
|
|
|
|
|
|
|
Withdrawals
Post Anniversary
|
|
|
|
|
|
|
|
Account
value
|
|
$
|
23.1
|
|
$
|
22.5
|
|
Net
amount at risk
|
|
|
0.2
|
|
|
0.2
|
|
Average
attained age of contractholders
|
|
|
64
|
|
|
64
|
|
The
determination of the GMDB 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 liabilities for GMDB, which is recorded in insurance
policy and claim reserves on our Consolidated Balance Sheets:
|
|
March
31,
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Balance
at beginning of year
|
|
$
|
23
|
|
$
|
15
|
|
Cumulative
effect of adoption of SOP 05-1
|
|
|
(4
|
)
|
|
-
|
|
Changes
in reserves
|
|
|
6
|
|
|
4
|
|
Benefits
paid
|
|
|
(2
|
)
|
|
(2
|
)
|
Balance
at end-of-period
|
|
$
|
23
|
|
$
|
17
|
|
|
|
|
|
|
|
|
|
The
changes to the benefit reserves amounts above are reflected in benefits in
the
Consolidated Statements of Income.
Also
included in benefits are the results of the hedging program, which included
losses of less than $1 million for GMDB for the three months ended March 31,
2007 and $2 million for the same period in 2006.
Separate
account balances attributable to variable annuity contracts with guarantees
are
as follows:
|
|
March
31,
|
|
December
31,
|
|
(in
billions)
|
|
2007
|
|
2006
|
|
Asset
Type
|
|
|
|
|
|
Domestic
equity
|
|
$
|
40.3
|
|
$
|
39.3
|
|
International
equity
|
|
|
6.3
|
|
|
5.9
|
|
Bonds
|
|
|
6.8
|
|
|
6.4
|
|
Total
|
|
|
53.4
|
|
|
51.6
|
|
Money
market
|
|
|
5.9
|
|
|
5.6
|
|
Total
|
|
$
|
59.3
|
|
$
|
57.2
|
|
Percent
of total variable annuity separate account values
|
|
|
87
|
%
|
|
87
|
%
|
7.
Employee Benefit Plans
Pension
and Other Postretirement Benefit Plans
As
a
result of our merger with Jefferson-Pilot, we maintain funded defined benefit
pension plans for the former U.S. employees and agents of Jefferson-Pilot.
The
components of net defined benefit pension plan and postretirement benefit plan
expense are as follows:
|
|
Pension
Benefits
|
|
Other
Postretirement Benefits
|
|
|
|
Three
Months Ended
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
U.S.
Plans
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$
|
9
|
|
$
|
5
|
|
$
|
1
|
|
$
|
1
|
|
Interest
cost
|
|
|
16
|
|
|
9
|
|
|
2
|
|
|
1
|
|
Expected
return on plan assets
|
|
|
(20
|
)
|
|
(11
|
)
|
|
(1
|
)
|
|
-
|
|
Recognized
net actuarial (gains) losses
|
|
|
-
|
|
|
1
|
|
|
-
|
|
|
-
|
|
Net
periodic benefit expense
|
|
$
|
5
|
|
$
|
4
|
|
$
|
2
|
|
$
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-U.S.
Plans
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
cost
|
|
|
5
|
|
|
4
|
|
|
|
|
|
|
|
Expected
return on plan assets
|
|
|
(5
|
)
|
|
(4
|
)
|
|
|
|
|
|
|
Recognized
net actuarial losses
|
|
|
1
|
|
|
1
|
|
|
|
|
|
|
|
Net
periodic benefit expense
|
|
$
|
1
|
|
$
|
1
|
|
|
|
|
|
|
|
See
Note
13 for information on a change to our retirement benefits.
See
Note
8 to the consolidated financial statements in our 2006 Form 10-K for a detailed
discussion of our other benefit plans.
8.
Stock-Based Incentive Compensation Plans
See
Note
9 to the consolidated financial statements in our 2006 Form 10-K for a detailed
discussion of stock and incentive compensation.
We
have
various incentive plans for our employees, agents and directors and our
subsidiaries that provide for the issuance of stock options, stock incentive
awards, stock appreciation rights, restricted stock awards, restricted stock
units (“performance shares”), and deferred stock units. Delaware Investments
U.S., Inc. (“DIUS”) has a separate stock option incentive plan.
In
the first quarter of 2007, a performance period from
2007-2009 was approved for our executive officers by the Compensation Committee.
Executive officers participating in this performance period received one-half
of
their award in 10-year
LNC
or
DIUS stock options, with the remainder of the award in a combination of either:
100% performance shares or 75% performance shares and 25% cash. LNC stock
options granted for this performance period vest ratably over the three-year
period, based solely on a service condition. DIUS stock options 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. Depending on
the
performance, the actual amount of performance shares could range from zero
to
200% of the granted amount. Under the 2007-2009 plan, a total of 725,161 LNC
stock options were granted; 12,237 DIUS stock options were granted; and 126,879
LNC performance shares were granted.
In
addition to the stock-based grants noted above, various other LNC stock-based
awards were granted in the first quarter of 2007, which are summarized in the
table below:
|
Three
Months Ended
March
31, 2007
|
|
Awards
|
|
|
10-year
LNC stock options
|
348,888
|
|
Non-employee
agent stock options
|
158,075
|
|
Restricted
stock units
|
222,656
|
|
Stock
appreciation rights
|
187,750
|
|
9.
Restrictions, Commitments and Contingencies
See
“Restrictions, Commitments and Contingencies” in Note 10 to the consolidated
financial statements in our 2006 Form 10-K for a discussion of restrictions,
commitments and contingencies, which information is incorporated herein by
reference.
Guaranteed
Investment Contracts
In
December 2006, we invested $400 million in a secured limited recourse note
issued by a third-party segregated portfolio company. In April 2007, we invested
$200 million in a secured limited recourse note issued by the same portfolio
company and $250 million in a secured limited recourse note issued by a second
portfolio company. These companies entered into a credit default swap with
a
third party providing credit protection in exchange for a fee. Defaults in
the
underlying reference portfolio will only affect the note if cumulative losses
of
a synthetic reference portfolio exceed the loss attachment point on the
portfolio. We have determined that we are not the primary beneficiary, as we
do
not hold the majority of the risk of loss. Our maximum exposure to loss as
a
result of our involvement with these entities is our recorded investment of
$400
million as of March 31, 2007, and $850 million as of April 2007.
10.
Segment Information
In
the
quarter ended June 30, 2006, we completed our merger with Jefferson-Pilot and
changed our management organization. We also realigned our reporting segments
to
reflect the current manner by which our chief operating decision makers view
and
manage the business. All segment data for reporting periods have been adjusted
to reflect the current segment reporting. As a result of these changes, we
provide products and services in five operating businesses: (1) Individual
Markets, (2) Employer Markets, (3) Investment Management, (4) Lincoln UK and
(5)
Lincoln Financial Media, and report results through seven business segments.
We
also
have “Other Operations,” which includes the financial data for operations that
are not directly related to the business segments, unallocated corporate items
(such as investment income on investments related to the amount of statutory
surplus in our insurance subsidiaries that is not allocated to our business
units and other corporate investments, interest expense on short-term and
long-term borrowings, and certain expenses, including restructuring and
merger-related expenses), along with the ongoing amortization of deferred gain
on the indemnity reinsurance portion of the transaction with Swiss Re. Other
Operations also includes the eliminations of intercompany transactions and
the
inter-segment elimination of the investment advisory fees for asset management
services the Investment Management segment provides to Individual Markets and
Employer Markets.
Segment
operating revenue 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. Operating revenue is GAAP revenue excluding realized gains and
losses on investments and derivative instruments, gains and losses on
reinsurance embedded derivative/trading securities, gains and losses on sale
of
subsidiaries/businesses and the amortization of deferred gain arising from
reserve development on business sold through reinsurance. Income (loss) from
operations is GAAP net income excluding net realized investment gains and
losses, losses on early retirement of debt, reserve development net of related
amortization on business sold through reinsurance and
cumulative
effect of accounting changes. Our management
and Board of Directors believe that operating revenue 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 net realized investment gains and losses, reserve development net of
related amortization on business sold through reinsurance and cumulative effect
of accounting changes 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. Operating revenue and income
(loss) from operations do not replace revenues and net income as the GAAP
measures of our consolidated results of operations.
The
following table shows financial data by segment:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Revenue
|
|
|
|
|
|
|
|
Segment
operating revenue
|
|
|
|
|
|
|
|
Individual
Markets:
|
|
|
|
|
|
|
|
Annuities
|
|
$
|
605
|
|
$
|
375
|
|
Life
Insurance
|
|
|
971
|
|
|
500
|
|
Total
Individual Markets
|
|
|
1,576
|
|
|
875
|
|
Employer
Markets:
|
|
|
|
|
|
|
|
Retirement
Products
|
|
|
359
|
|
|
306
|
|
Group
Protection
|
|
|
361
|
|
|
-
|
|
Total
Employer Markets
|
|
|
720
|
|
|
306
|
|
Investment
Management (1)
|
|
|
150
|
|
|
140
|
|
Lincoln
UK
|
|
|
91
|
|
|
70
|
|
Lincoln
Financial Media (2)
|
|
|
67
|
|
|
-
|
|
Other
Operations
|
|
|
75
|
|
|
61
|
|
Consolidating
adjustments
|
|
|
(35
|
)
|
|
(29
|
)
|
Net
realized investment results (3)
|
|
|
26
|
|
|
(1
|
)
|
Revenue
|
|
$
|
2,670
|
|
$
|
1,422
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
|
|
|
|
|
|
Segment
operating income
|
|
|
|
|
|
|
|
Individual
Markets:
|
|
|
|
|
|
|
|
Annuities
|
|
$
|
121
|
|
$
|
66
|
|
Life
Insurance
|
|
|
167
|
|
|
69
|
|
Total
Individual Markets
|
|
|
288
|
|
|
135
|
|
Employer
Markets:
|
|
|
|
|
|
|
|
Retirement
Products
|
|
|
64
|
|
|
60
|
|
Group
Protection
|
|
|
23
|
|
|
-
|
|
Total
Employer Markets
|
|
|
87
|
|
|
60
|
|
Investment
Management
|
|
|
16
|
|
|
15
|
|
Lincoln
UK
|
|
|
11
|
|
|
11
|
|
Lincoln
Financial Media
|
|
|
12
|
|
|
-
|
|
Other
Operations
|
|
|
(35
|
)
|
|
-
|
|
Net
realized investment results (4)
|
|
|
17
|
|
|
-
|
|
Net
income
|
|
$
|
396
|
|
$
|
221
|
|
|
|
|
|
|
|
|
|
(1) Revenues
for the Investment Management segment include inter-segment revenues for asset
management services provided to our other segments. These inter-segment revenues
totaled $25 million for both the three months ended March 31, 2007 and 2006.
(2)
Lincoln
Financial Media revenues are net of $8 million of commissions paid to agencies
for the three months ended March 31, 2007.
(3)
Includes
realized gains (losses) on investments of $26 million and $(11) million for
the
three months ended March 31, 2007 and 2006, respectively; realized gains on
derivative instruments of $4 million for the three months ended March 31, 2006;
and gains on reinsurance embedded derivative/trading securities of $6 million
for the three months ended March 31, 2006.
(4)
Includes
realized gains (losses) on investments of $17 million and $(6) million for
the
three months ended March 31, 2007 and 2006; realized gains on derivative
instruments of $2 million for the three months ended March 31, 2006; and gains
on reinsurance embedded derivative/trading securities of $4 million for the
three months ended March 31, 2006.
11.
Earnings Per Share
The
income used in the calculation of our diluted earnings per share is our income
before cumulative effect of accounting change and net income, reduced by
minority interest adjustments related to outstanding stock options under the
DIUS stock option incentive plan of less than $1 million for all periods
presented.
A
reconciliation of the denominator in the calculations of basic and diluted
net
income and income before cumulative effect of accounting change per share is
as
follows:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
2007
|
|
2006
|
|
Denominator:
[number of shares]
|
|
|
|
|
|
|
|
Weighted-average
shares, as used in basic calculation
|
|
|
274,889,645
|
|
|
174,577,421
|
|
Shares
to cover conversion of preferred stock
|
|
|
200,960
|
|
|
243,371
|
|
Shares
to cover non-vested stock
|
|
|
1,148,067
|
|
|
1,560,646
|
|
Average
stock options outstanding during the period
|
|
|
14,322,952
|
|
|
8,850,988
|
|
Assumed
acquisition of shares with assumed proceeds
|
|
|
|
|
|
|
|
and
benefits from exercising stock options (at average
|
|
|
|
|
|
|
|
market
price for the year).
|
|
|
(12,137,623
|
)
|
|
(7,778,439
|
)
|
Shares
repurchaseable from measured but unrecognized
|
|
|
|
|
|
|
|
stock
option expense
|
|
|
(255,647
|
)
|
|
(824,764
|
)
|
Average
deferred compensation shares
|
|
|
1,308,460
|
|
|
1,300,430
|
|
Weighted-average
shares, as used in diluted calculation
|
|
|
279,476,814
|
|
|
177,929,653
|
|
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 earnings per share 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.
12.
Restructuring Charges
2006
Restructuring Plan
Upon
completion of the merger with Jefferson-Pilot, we implemented a restructuring
plan relating to the integration of our legacy operations with those of
Jefferson-Pilot. The realignment will enhance productivity, efficiency and
scalability while positioning us for future growth.
The
following is the detail of the reserve for restructuring charges:
(in
millions)
|
|
Total
|
|
Restructuring
reserve at December 31, 2006
|
|
$
|
8
|
|
|
|
|
|
|
Amounts
incurred in the first three months of 2007
|
|
|
|
|
Employee
severance and termination benefits
|
|
|
1
|
|
Other
|
|
|
3
|
|
Total
2007 restructuring charges
|
|
|
4
|
|
Amounts
expended in the first three months of 2007
|
|
|
(6
|
)
|
Restructuring
reserve at March 31, 2007
|
|
$
|
6
|
|
|
|
|
|
|
Additional
amounts expended in the first three months of 2007
|
|
|
|
|
that
do not qualify as restructuring charges
|
|
$
|
10
|
|
Total
expected costs
|
|
|
180
|
|
|
|
|
|
|
Expected
completion date
|
|
|
4th
Quarter 2009
|
|
The
total
expected costs include both restructuring charges and additional expenses that
do not qualify as restructuring charges that are associated with the integration
activities. In addition, involuntary employee termination benefits were recorded
in goodwill as part of the purchase price allocation (see Note 3). Merger
integration costs relating to employee severance and termination benefits of
$13
million were included in other liabilities in the purchase price allocation
in
2006. The remaining liability balance at December 31, 2006 was $3 million.
In
the first quarter of 2007, an additional $8 million was recorded to goodwill
and
other liabilities as part of the final adjustment to the purchase price
allocation related to employee severance and termination benefits. Through
March
31, 2007 approximately $13 million of these costs were incurred and the
remaining liability balance at March 31, 2007 was $8 million.
Restructuring
charges for this plan in the first three months of 2007 were included in
underwriting, acquisition, insurance and other expenses within Other Operations
on the Consolidated Statements of Income.
13.
Subsequent Event
On
May 1,
2007, we announced plans to change the retirement benefits provided to
employees, which include replacing traditional pension retirement benefits
with
a new defined contribution plan beginning January 1, 2008. This prospective
change in benefits will not impact any of the pension retirement benefits that
have already accrued to employees. On January 1, 2008, retirement benefits
for
employees will begin accruing through the new defined contribution plan. This
change is not expected to be material to our future earnings, but will result
in
a one-time curtailment gain of $9 million ($6 million after-tax) in the second
quarter of 2007, which will be reported within Other Operations.
Item
2.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations
The
following is a discussion of the financial condition of Lincoln National
Corporation and its consolidated subsidiaries (“LNC” or the “Company” which also
may be referred to as “we” or “us”) as of March 31, 2007, compared with December
31, 2006, and the results of operations of LNC for the three months ended March
31, 2007 and 2006. On April 3, 2006, LNC completed its merger with
Jefferson-Pilot Corporation (Jefferson-Pilot). Beginning on April 3, 2006,
the
results of operations and financial condition of Jefferson-Pilot, after being
adjusted for the effects of purchase accounting, were consolidated with LNC’s.
As part of the merger, we realigned our businesses to conform to the way we
intend to manage and assess our business going forward. Accordingly, all prior
period segment results have been adjusted to reflect the new segmentation.
The
financial information presented herein for the three months ended March 31,
2006, reflects only the accounts of LNC. The
balance sheet information presented below is as of March 31, 2007 and December
31, 2006. The
statement of operations information is for the three months ended March 31
for
each respective year.
For
more
information regarding the completion of the merger, including the calculation
and allocation of the purchase price, see Note 3 to the consolidated financial
statements in this Form 10-Q.
This
discussion and analysis should be read in conjunction with our consolidated
financial statements and notes thereto presented in “Item 1” (“consolidated
financial statements”) and “Item 7 Management’s Discussion and Analysis of
Financial Condition, Results of Operations” (“MD&A”), “Item 1A Risk Factors”
and “Item 8 Consolidated Financial Statements” in our latest annual report on
Form 10-K for the year ended December 31, 2006 (“2006 Form 10-K”).
This
report contains certain financial information determined by methods other than
in conformity with accounting principles generally accepted in the United States
of America (“GAAP”). In addition to providing consolidated revenues and net
income (loss), we also provide segment operating revenue and income (loss)
from
operations because we believe they are meaningful measures of revenues and
the
profit or loss generated by our operating segments. Operating revenue is GAAP
revenue excluding realized gains and losses on investments and derivative
instruments, gains and losses on reinsurance embedded derivative/trading
securities, gains and losses on sale of subsidiaries/businesses and the
amortization of deferred gain arising from reserve development on business
sold
through reinsurance. Income (loss) from operations is GAAP net income excluding
net realized investment gains and losses, losses on early retirement of debt,
reserve development net of related amortization on business sold through
reinsurance and cumulative effect of accounting changes. Operating revenue
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 revenue and income (loss) from operations by segment in Note 10 to
our
unaudited consolidated financial statements. Our management and Board of
Directors believe that operating revenue 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
net realized investment gains and losses, reserve development net of related
amortization on business sold through reinsurance and cumulative effect of
accounting changes 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. Operating revenue and income (loss)
from
operations do not replace revenues and net income as the GAAP measures of our
consolidated results of operations.
Certain
reclassifications have been made to prior periods’ financial information to
conform to the 2007 presentation.
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, prospective services or products, future
performance or results of current and anticipated services or products, sales
efforts, expenses, the outcome of contingencies such as legal proceedings,
operations, trends or financial results. 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:
·
|
Problems
arising with
the ability to successfully integrate our and Jefferson-Pilot’s
businesses, which may affect our |
|
ability
to operate as effectively and efficiently as expected or to achieve
the
expected synergies from the merger or to achieve such synergies
within our
expected timeframe;
|
·
|
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 requirements
related to secondary guarantees under universal life and variable
annuity
products such as Actuarial Guideline 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: (a) adverse actions related to present or past business practices
common in businesses in which LNC and its subsidiaries compete;
(b) 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; (c) new decisions
that result in changes in law; and (d) 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 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 declines
in and volatility of the equity markets;
|
·
|
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
investor-owned life insurance business;
|
·
|
Changes
in accounting principles generally accepted in the United States
(“GAAP”)
that may result in unanticipated changes to LNC’s net income, including
the impact of adopting Statements of Financial Accounting Standard
157 and
159;
|
·
|
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, and profitability of its insurance
subsidiaries;
|
·
|
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, 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;
|
·
|
Loss
of key management, portfolio managers in the Investment Management
segment, financial planners or wholesalers; and
|
·
|
Changes
in general economic or business conditions, both domestic and foreign,
that may be less favorable than expected and may affect foreign
exchange
rates, premium levels, claims experience, the level of pension
benefit
costs and funding, and investment
results.
|
The
risks
included here are not exhaustive. Other sections of this report and LNC’s annual
report on Form 10-K, current reports on Form 8-K and other documents filed
with
the SEC include additional factors which could impact LNC’s business and
financial performance. Moreover, LNC operates in a rapidly changing and
competitive environment. New risk factors emerge from time to time and it is
not
possible for management to predict all such risk factors.
Further,
it is not possible to assess the impact of all risk factors on LNC’s business or
the extent to which any factor, or combination of factors, may cause actual
results to differ materially from those contained in any forward-looking
statements. Given these risks and uncertainties, investors should not place
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 and investment management
businesses as well as broadcasting and sports programming business 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, variable universal life insurance,
linked-benefit universal life, term life insurance, mutual funds and managed
accounts.
We
provide products and services in five operating businesses: (1) Individual
Markets, (2) Employer Markets, (3) Investment Management, (4) Lincoln UK and
(5)
Lincoln Financial Media, and are reporting results through seven business
segments. These operating businesses and their segments are described in “Part
I--Item 1--Business” of the 2006 Form 10-K.
Our
strategic intent is to be “The Retirement Income Security Company”. Retirement
income security represents all of the risks at various stages of the wealth
management cycle, not just the risk of outliving income during retirement.
We
believe
that the baby-boomer generation reaching retirement age will present an emerging
opportunity for companies like ours that offer products allowing baby-boomers
to
better manage their wealth accumulation, retirement income and wealth transfer
needs.
In
2007,
we are launching a larger, unified product suite available to our distribution
force. To this end and as discussed further below under “Recent Developments,”
we reorganized our insurance subsidiaries by merging several insurance
subsidiaries.
During
2007 we expect our major challenges to include:
·
|
The
continued, successful integration of the Jefferson-Pilot businesses
and
the success of our new unified product
portfolio.
|
|
|
·
|
While
recent increases in long-term rates have eased pressure on spreads,
a
continuation of the low interest rate environment creates a challenge
for
our products that generate investment margin profits, such as fixed
annuities and universal life insurance.
|
|
|
·
|
The
ability to generate tangible results from Retirement Income Security
Ventures (“RISV”).
|
|
|
·
|
The
continued, successful expansion of our wholesale distribution businesses.
|
|
|
·
|
The
ability to improve financial results and sales growth in Employer
Markets.
|
|
|
·
|
The
continuation of competitive pressures in the life insurance marketplace,
increased regulatory scrutiny of the life and annuity industry,
which may
lead to higher product costs and negative perceptions about the
industry.
|
|
|
·
|
Continued
focus by the government on tax reform, which may impact our
products.
|
In
the
face of these challenges, there are three key themes that will influence our
actions and decisions throughout 2007:
|
Taking
market share. We are making sizeable investments in distribution
throughout the organization, recognizing that sales growth is driven
by
our ability to maintain a strong presence in our key accounts and
distribution channels.
|
|
|
|
Jumpstarting
our RISV. The focus of this cadre of insurance professionals is
to rethink
the products, delivery systems and customer servicing that will
address
the emerging needs of the baby boomers.
|
|
|
|
Embedding
financial and execution discipline in our operations. We are making
significant investments in operating efficiencies while integrating
and
consolidating systems and processes across the organization. Investment
decisions will be evaluated based on a comprehensive metrics-based
approach.
|
Recent
Developments
On
March
8, 2007, we sold $500 million aggregate principal amount of our 6.05% Capital
Securities due April 20, 2067. Additionally, we sold $250 million aggregate
principal amount of our Floating Rate Senior Notes due March 12, 2010.
On
March
14, 2007, we entered into an agreement to purchase shares of our common stock
for an aggregate purchase price of $350 million under an accelerated stock
buyback program. Pursuant to the agreement, the minimum number of shares to
be
purchased has been set at approximately 4.8 million while the maximum is
approximately 5.9 million. On March 19, 2007, approximately 4.8 million shares
were delivered to us. Additional shares may be delivered to us at the end of
the
program, depending on the price of our shares during the remainder of the
program, which is expected to conclude in the third quarter of 2007.
As
part
of our continuing merger integration, on April 2, 2007, we completed the merger
of one of our wholly owned insurance subsidiaries, Jefferson-Pilot Life
Insurance Company, a North Carolina domiciled insurer, with and into The Lincoln
National Life Insurance Company ("LNL"), an Indiana domiciled insurer. LNL
remains an Indiana domiciled insurer. We also completed the merger of Jefferson
Pilot LifeAmerica Insurance Company ("JPLA"), a New Jersey domiciled insurer,
and Lincoln Life & Annuity Company of New York, a New York domiciled
insurer. JPLA has been redomiciled to New York and renamed Lincoln Life &
Annuity Company of New York ("LLANY").
On
April
2, 2007 we announced the introduction of our new Unified Product Portfolio
(UPP), a wide array of life insurance, annuity and linked benefit products.
We
expect to phase in UPP over the next few months, with fixed products being
the
first to market. These include universal life products and fixed and indexed
annuities. We expect to launch variable products, including variable annuities
and variable universal life, and term products during this summer. Our new
product portfolio will offer solutions to baby boomers no matter where they
may
be in the wealth management cycle.
On
May 1,
2007 we announced plans to change the retirement benefits provided to employees,
which include replacing traditional pension retirement benefits with a new
defined contribution plan beginning January 1, 2008. For additional details,
see
Note 13 of our consolidated financial statements.
During
the first quarter of 2007, we called for redemption $312 million in long-term
debt with interest rates ranging from 8.14% to 8.285%.
For
a
description of the sales and redemptions, see “Review of Consolidated Financial
Condition - Liquidity and Capital Resources” below.
Critical
Accounting Policies
The
MD&A included in our 2006 Form 10-K contains a detailed discussion of our
critical accounting policies. The following information updates the critical
accounting policies provided in the 2006 Form 10-K.
Deferred
Acquisition Costs, Value of Business Acquired, Deferred Sales Inducements and
Deferred Front-End Loads
In
September 2005, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants (“AICPA”) issued Statement of Position
(“SOP”) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition
Costs in Connection with Modifications or Exchanges of Insurance Contracts”
(“SOP 05-1”). SOP 05-1 addresses the accounting for DAC on internal replacements
other than those described in SFAS No. 97, “Accounting and Reporting by
Insurance Enterprises for Certain Long-Duration Contracts and for Realized
Gains
and Losses from the Sale of Investments.” An internal replacement is defined by
SOP 05-1 as a modification in product benefits, features, rights or coverages
that occurs by (a) exchanging the contract for a new contract, (b) amending,
endorsing or attaching a rider to the contract, or (c) electing a feature or
coverage within a contract. Contract modifications that result in a
substantially unchanged contract will be accounted for as a continuation of
the
replaced contract. Contract modifications that result in a substantially changed
contract should be accounted for as an extinguishment of the replaced contract,
and any unamortized DAC, unearned revenue and deferred sales charges must be
written-off. SOP 05-1 is to be applied prospectively and is effective for
internal replacements occurring in fiscal years beginning
after
December 15, 2006.
For
a
detailed discussion of the cumulative effect of adoption of SOP 05-1 recorded
to
our January 1, 2007 Consolidated Balance Sheets, see Note 2 of our consolidated
financial statements. The adoption of this new guidance primarily impacts our
Individual Markets Annuities and Employer Markets Group Protection businesses,
and our accounting policies regarding the assumptions for lapsation used in
the
amortization of DAC and VOBA. In addition, the adoption of SOP 05-1 resulted
in
a $6 million, pre-tax, increase to underwriting, acquisition, insurance and
other expenses in the first three months of 2007, which was attributable to
changes in DAC and VOBA deferrals and amortization.
The
impact is expected to be approximately $14 million, pre-tax, for the remainder
of 2007. In addition, due to the changes in our GMDB annuity reserves and DSI,
we expect benefits to increase by approximately $2 million, pre-tax, for the
twelve months ended December 31, 2007. The impact on amortization of DFEL is
expected to be less than $1 million.
As
equity
markets do not move in a systematic manner, we use a “reversion to the mean”
(“RTM”) process to compute our best estimate long-term gross growth rate
assumption. 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 each of the blocks of business. Because future equity
market returns are impossible to predict, the underlying premise of this
process
is that best estimate projections of future EGPs, as required by Statement
of
Financial Accounting Standards (“SFAS”) No. 97, “Accounting and Reporting by
Insurance Enterprises for Certain Long-Duration Contracts and for Realized
Gains
and Losses from the Sale of Investments”, 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 and DFEL. 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. For more information about the implications of declines
and advances in equity markets and our RTM process, see “Part II - Item 7 -
Critical Accounting Policies” in our 2006 Form 10-K.
The
table
below presents the balances by business segment as of March 31,
2007.
|
|
Individual
Markets
|
|
Employer
Markets
|
|
|
|
|
|
March
31, 2007 (in millions)
|
|
Annuities
|
|
Life
Insurance
|
|
Retirement
Products
|
|
Group
Protection
|
|
Lincoln
UK
|
|
Total
|
|
DAC
and VOBA
|
|
$
|
2,082
|
|
$
|
4,796
|
|
$
|
750
|
|
$
|
104
|
|
$
|
803
|
|
$
|
8,535
|
|
DSI
|
|
|
206
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
206
|
|
Total
DAC, VOBA and DSI
|
|
|
2,288
|
|
|
4,796
|
|
|
750
|
|
|
104
|
|
|
803
|
|
|
8,741
|
|
DFEL
|
|
|
105
|
|
|
491
|
|
|
22
|
|
|
-
|
|
|
400
|
|
|
1,018
|
|
Net
DAC, VOBA, DSI and DFEL
|
|
$
|
2,183
|
|
$
|
4,305
|
|
$
|
728
|
|
$
|
104
|
|
$
|
403
|
|
$
|
7,723
|
|
Derivatives
Guaranteed
Minimum Withdrawal and Guaranteed Income Benefits
The
Individual Markets Annuity segment has 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 the Lincoln Smart
SecuritySM
Advantage GMWB feature and our i4LIFE® Advantage GIB feature that is available
in our variable annuity products. The hedging strategy is designed such that
changes in the value of the hedge contracts move in the opposite direction
of
changes in the value of the embedded derivative of the GMWB and GIB. This
dynamic hedging strategy utilizes U.S.-based and international equity futures
and options 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 GMWB and GIB guarantees caused by those same
factors. At March 31, 2007, the embedded derivative for GMWB was an asset valued
at $63 million and the embedded derivative for i4LIFE® Advantage GIB was an
asset valued at $16 million.
Income
Taxes
Management
uses certain assumptions and estimates in determining income taxes payable
or
refundable for the current year, deferred income tax liabilities and assets
for
events recognized differently in its financial statements and income tax
returns, and federal income tax expense. Determining these amounts requires
analysis of certain transactions and interpretation of tax laws and regulations.
Management exercises considerable judgment in evaluating the amount and timing
of recognition of the resulting
income
tax liabilities and assets. These judgments and estimates are re-evaluated
on a
continual basis as regulatory and business factors change.
We
adopted FASB Interpretation No. 48, - “Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement 109” ("FIN 48") effective January 1,
2007 and recorded an increase in the liability for unrecognized tax benefits
of
$15 million in our Consolidated Balance Sheets, offset by a reduction to the
beginning balance of retained earnings with no impact on net income. FIN 48
established criteria for recognizing or continuing to recognize only
more-likely-than tax positions, which may result in federal income tax expense
volatility in future periods. While we believe we have adequately provided
for
all tax positions, amounts asserted by taxing authorities could be greater
than
our accrued position. Accordingly, additional provisions on federal and foreign
tax-related matters could be recorded in the future as revised estimates are
made or the underlying matters are settled or otherwise resolved. For a detailed
discussion of FIN 48, see Note 2 and Note 4 of our consolidated financial
statements.
RESULTS
OF CONSOLIDATED OPERATIONS
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Insurance
premiums
|
|
$
|
459
|
|
$
|
78
|
|
|
NM
|
|
Insurance
fees
|
|
|
779
|
|
|
475
|
|
|
64
|
%
|
Investment
advisory fees
|
|
|
90
|
|
|
78
|
|
|
15
|
%
|
Communications
revenue (net)
|
|
|
67
|
|
|
-
|
|
|
NM
|
|
Net
investment income
|
|
|
1,090
|
|
|
678
|
|
|
61
|
%
|
Amortization
of deferred gain on indemnity
|
|
|
|
|
|
|
|
|
|
|
reinsurance
|
|
|
19
|
|
|
19
|
|
|
0
|
%
|
Other
revenues and fees
|
|
|
140
|
|
|
95
|
|
|
47
|
%
|
Realized
gain (loss)
|
|
|
26
|
|
|
(1
|
)
|
|
NM
|
|
Total
revenue
|
|
|
2,670
|
|
|
1,422
|
|
|
88
|
%
|
Benefits
|
|
|
1,194
|
|
|
582
|
|
|
105
|
%
|
Underwriting,
acquisition, insurance and
|
|
|
|
|
|
|
|
|
|
|
other
expenses
|
|
|
805
|
|
|
503
|
|
|
60
|
%
|
Communications
expenses
|
|
|
41
|
|
|
-
|
|
|
NM
|
|
Interest
and debt expenses
|
|
|
61
|
|
|
22
|
|
|
177
|
%
|
Total
benefits and expenses
|
|
|
2,101
|
|
|
1,107
|
|
|
90
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Income
before taxes
|
|
|
569
|
|
|
315
|
|
|
81
|
%
|
Federal
income taxes
|
|
|
173
|
|
|
94
|
|
|
84
|
%
|
Net
income
|
|
$
|
396
|
|
$
|
221
|
|
|
79
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Items
included in net income (after-tax):
|
|
|
|
|
|
|
|
|
|
|
Realized
gain (loss) on investments and
|
|
|
|
|
|
|
|
|
|
|
derivative
instruments
|
|
$
|
17
|
|
$
|
(4
|
)
|
|
|
|
Net
gain on reinsurance embedded
|
|
|
|
|
|
|
|
|
|
|
derivative/trading
securities
|
|
|
-
|
|
|
4
|
|
|
|
|
Restructuring
charges
|
|
|
(3
|
)
|
|
-
|
|
|
|
|
The
table
below provides a detailed comparison of items included within net realized
investment gains (losses).
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Improvement
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
(Worsening)
|
|
Realized
gains on investments
|
|
$
|
66
|
|
$
|
25
|
|
|
164
|
%
|
Realized
losses on investments
|
|
|
(20
|
)
|
|
(21
|
)
|
|
5
|
%
|
Realized
gain (loss) on derivative instruments
|
|
|
-
|
|
|
4
|
|
|
-100
|
%
|
Amounts
amortized to balance sheet accounts
|
|
|
(18
|
)
|
|
(11
|
)
|
|
-64
|
%
|
Gain
on reinsurance embedded derivative/trading securities
|
|
|
-
|
|
|
6
|
|
|
-100
|
%
|
Investment
expenses
|
|
|
(2
|
)
|
|
(4
|
)
|
|
50
|
%
|
Net
gains (losses) on investments and derivative instruments
|
|
$
|
26
|
|
$
|
(1
|
)
|
|
NM
|
|
Write-downs
for other-than-temporary impairments included in
|
|
|
|
|
|
|
|
|
|
|
realized
losses on investments above
|
|
$
|
(4
|
)
|
$
|
(2
|
)
|
|
-100
|
%
|
Following
are deposits and net flows by business segment. For additional detail of deposit
and net flow information, see the discussion in “Results of Operations by
Segment” below.
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Improvement
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
(Worsening)
|
|
Deposits
|
|
|
|
|
|
|
|
Individual
Markets:
|
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$
|
2,821
|
|
$
|
2,136
|
|
|
32
|
%
|
Life
Insurance
|
|
|
1,039
|
|
|
488
|
|
|
113
|
%
|
Employer
Markets:
|
|
|
|
|
|
|
|
|
|
|
Retirement
Products - Defined Contributions
|
|
|
1,487
|
|
|
1,240
|
|
|
20
|
%
|
Retirement
Products - Executive Benefits
|
|
|
65
|
|
|
47
|
|
|
38
|
%
|
Investment
Management
|
|
|
6,033
|
|
|
9,064
|
|
|
-33
|
%
|
Consolidating
adjustments
(1)
|
|
|
(909
|
)
|
|
(739
|
)
|
|
-23
|
%
|
Total
Deposits
|
|
$
|
10,536
|
|
$
|
12,236
|
|
|
-14
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Net
Flows
|
|
|
|
|
|
|
|
|
|
|
Individual
Markets:
|
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$
|
754
|
|
$
|
770
|
|
|
-2
|
%
|
Life
Insurance
|
|
|
698
|
|
|
257
|
|
|
172
|
%
|
Employer
Markets:
|
|
|
|
|
|
|
|
|
|
|
Retirement
Products - Defined Contributions
|
|
|
221
|
|
|
180
|
|
|
23
|
%
|
Retirement
Products - Executive Benefits
|
|
|
(75
|
)
|
|
40
|
|
|
NM
|
|
Investment
Management
|
|
|
(89
|
)
|
|
4,899
|
|
|
NM
|
|
Consolidating
adjustments (1)
|
|
|
45
|
|
|
42
|
|
|
7
|
%
|
Total
Net Flows
|
|
$
|
1,554
|
|
$
|
6,188
|
|
|
-75
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of
|
|
|
|
|
|
|
|
As
of March 31,
|
|
December
31,
|
|
Increase
over
|
|
Increase
over
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
2006
|
|
Prior
year
|
|
Prior
quarter
|
|
Assets
Under Management by Advisor (2)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment
Management:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
External
Assets
|
|
$
|
98,146
|
|
$
|
86,428
|
|
$
|
97,306
|
|
|
14
|
%
|
|
1
|
%
|
Insurance-related
Assets
|
|
|
67,292
|
|
|
41,995
|
|
|
67,067
|
|
|
60
|
%
|
|
0
|
%
|
Lincoln
UK
|
|
|
10,255
|
|
|
8,986
|
|
|
10,108
|
|
|
14
|
%
|
|
1
|
%
|
Within
Business Units (Policy Loans)
|
|
|
2,767
|
|
|
1,860
|
|
|
2,760
|
|
|
49
|
%
|
|
0
|
%
|
By
Non-LNC Entities
|
|
|
58,571
|
|
|
43,726
|
|
|
56,282
|
|
|
34
|
%
|
|
4
|
%
|
|
|
$
|
237,031
|
|
$
|
182,995
|
|
$
|
233,523
|
|
|
30
|
%
|
|
2
|
%
|
(1)
|
Consolidating
adjustments represent the elimination of deposits and net flows
on
products affecting more than one segment.
|
(2)
|
Assets
under management by advisor provides a breakdown of assets that
we manage
or administer either directly or through unaffiliated third parties.
These
assets represent our investments, assets held in separate accounts
and
assets that we manage or administer for individuals or other companies.
We
earn insurance fees, investment advisory fees or investment income
on
these assets.
|
NM
- Not
Meaningful
Comparison
of the Three Months Ended March 31, 2007 to 2006
Revenues
The
merger with Jefferson-Pilot was the primary driver for the increase in insurance
premiums and fees for the three months ended March 31, 2007 compared to the
same
period in 2006. In addition to the merger, the increase in insurance fees and
investment advisory fees during the first quarter of 2007 reflects growth in
assets under management, as well as, the effects of favorable equity market
performance during the last twelve months. Assets under management increased
30%
as a result of the Jefferson-Pilot merger, positive net flows and equity market
gains. The average level of the equity markets was higher for the three months
ended March 31, 2007 compared to the same period in 2006, resulting in higher
fee income. Excluding the impact of dividends, the S&P 500 Index®
at March
31, 2007 was 9.7% higher than at March 31, 2006 and the average daily S&P
500 Index®
for the
first quarter of 2007 was 11.1% higher than the first quarter of 2006.
The
increase in net investment income for the first quarter of 2007 compared
to the
same period in 2006 primarily reflects the addition of Jefferson-Pilot
investment assets, higher portfolio yields and higher invested assets due
to the
favorable effect of asset growth from net flows. Negative fixed (including
the
fixed portion of variable annuity) net flows partially offset growth in our
indexed and variable annuity net flows. Fixed annuity net flows in the first
quarter of 2007 were unfavorably impacted by higher withdrawals driven by
the
expiration of multi-year crediting rate guarantees on certain products we
sold
three to five years ago.
Included
in revenues were net realized gains on investments of $26 million for the first
quarter of 2007 compared to losses of $1 million for the first quarter of 2006.
See “Consolidated Investments” below for additional information on our
investment performance.
Benefits
and Expenses
Consolidated
benefits
and
expenses
increased $994 million, or 90%, for the first quarter of 2007 compared to the
same period in 2006, primarily due to the merger with Jefferson-Pilot. See
“Results of Operations by Segment” below for further discussion by segment.
Expenses related to growth in our business were partially offset by the effect
of spread management through lower crediting rates on interest sensitive
business, the lower interest credited from lower fixed annuity account values
resulting from net outflows on fixed annuities and movements from fixed to
variable annuity products.
Consolidated
expenses for the first quarter of 2007 include $14 million for integration
costs, including restructuring charges that were the result of actions
undertaken by us to eliminate duplicate operations and functions as a result
of
the Jefferson-Pilot merger. These actions will be ongoing and are expected
to be
substantially complete by late 2008, with a total estimated cost of $180 million
pre-tax. In addition, the adoption of SOP 05-1 resulted in a $6 million,
pre-tax, increase to underwriting, acquisition, insurance and other expenses
in
the first three months of 2007, which was attributable to changes in DAC and
VOBA deferrals
We
expect
to record a one-time curtailment gain of $9 million ($6 million after-tax)
in
the second quarter of 2007 related to a change in our employee benefit plans,
for additional information on this change, see “Recent Developments”, “Other
Operations” and Note 13 to our consolidated financial statements.
For
additional information on restructuring charges, see Note 12 to our consolidated
financial statements.
RESULTS
OF OPERATIONS BY SEGMENT
Following
is a reconciliation of our income from operations to our consolidated net
income:
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Revenue
|
|
|
|
|
|
|
|
Segment
operating revenue
|
|
|
|
|
|
|
|
Individual
Markets:
|
|
|
|
|
|
|
|
Annuities
|
|
$
|
605
|
|
$
|
375
|
|
Life
Insurance
|
|
|
971
|
|
|
500
|
|
Total
Individual Markets
|
|
|
1,576
|
|
|
875
|
|
Employer
Markets:
|
|
|
|
|
|
|
|
Retirement
Products
|
|
|
359
|
|
|
306
|
|
Group
Protection
|
|
|
361
|
|
|
-
|
|
Total
Employer Markets
|
|
|
720
|
|
|
306
|
|
Investment
Management (1)
|
|
|
150
|
|
|
140
|
|
Lincoln
UK
|
|
|
91
|
|
|
70
|
|
Lincoln
Financial Media (2)
|
|
|
67
|
|
|
-
|
|
Other
Operations
|
|
|
75
|
|
|
61
|
|
Consolidating
adjustments
|
|
|
(35
|
)
|
|
(29
|
)
|
Net
realized investment results (3)
|
|
|
26
|
|
|
(1
|
)
|
Revenue
|
|
$
|
2,670
|
|
$
|
1,422
|
|
|
|
|
|
|
|
|
|
Net
Income
|
|
|
|
|
|
|
|
Segment
operating income
|
|
|
|
|
|
|
|
Individual
Markets:
|
|
|
|
|
|
|
|
Annuities
|
|
$
|
121
|
|
$
|
66
|
|
Life
Insurance
|
|
|
167
|
|
|
69
|
|
Total
Individual Markets
|
|
|
288
|
|
|
135
|
|
Employer
Markets:
|
|
|
|
|
|
|
|
Retirement
Products
|
|
|
64
|
|
|
60
|
|
Group
Protection
|
|
|
23
|
|
|
-
|
|
Total
Employer Markets
|
|
|
87
|
|
|
60
|
|
Investment
Management
|
|
|
16
|
|
|
15
|
|
Lincoln
UK
|
|
|
11
|
|
|
11
|
|
Lincoln
Financial Media
|
|
|
12
|
|
|
-
|
|
Other
Operations
|
|
|
(35
|
)
|
|
-
|
|
Net
realized investment results (4)
|
|
|
17
|
|
|
-
|
|
Net
income
|
|
$
|
396
|
|
$
|
221
|
|
(1)
|
Revenues
for the Investment Management segment include inter-segment revenues
for
asset management services provided to our other segments. These
inter-segment revenues totaled $25 million for both the three months
ended
March 31, 2007 and 2006.
|
(2)
|
Lincoln
Financial Media revenues are net of $8 million of commissions paid
to
agencies for the three months ended March 31, 2007.
|
(3)
|
Includes
realized gains (losses) on investments of $26 million and $(11)
million
for the three months ended March 31, 2007 and 2006, respectively;
realized
gains on derivative instruments of $4 million for the three months
ended
March 31, 2006; and gains on reinsurance embedded derivative/trading
securities of $6 million for the three months ended March 31,
2006.
|
(4)
|
Includes
realized gains (losses) on investments of $17 million and $(6)
million for
the three months ended March 31, 2007 and 2006; realized gains
on
derivative instruments of $2 million for the three months ended
March 31,
2006; and gains on reinsurance embedded derivative/trading securities
of
$4 million for the three months ended March 31, 2006.
|
RESULTS
OF INDIVIDUAL MARKETS
The
Individual Markets business provides its products through two segments -
Individual Annuities and Individual Life Insurance. Through its Individual
Annuities segment, Individual Markets provides tax-deferred investment growth
and lifetime income opportunities for its clients by offering individual fixed
annuities, including indexed annuities, and variable annuities. The Individual
Life Insurance segment offers wealth protection and transfer opportunities
through term insurance, a linked-benefit product, which is a universal life
insurance policy linked with riders that provide for long-term care costs,
and
both single and survivorship versions of universal life and variable universal
life.
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I - Item 1 - Risk Factors” in our 2006 Form
10-K and “Forward-looking Statements - Cautionary Language” in this
report.
Individual
Markets - Annuities
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
Operating
Summary (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$
|
13
|
|
$
|
9
|
|
|
44
|
%
|
Insurance
fees
|
|
|
236
|
|
|
174
|
|
|
36
|
%
|
Net
investment income
|
|
|
266
|
|
|
148
|
|
|
80
|
%
|
Other
revenues and fees
|
|
|
90
|
|
|
44
|
|
|
105
|
%
|
Total
operating revenues
|
|
|
605
|
|
|
375
|
|
|
61
|
%
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Insurance
benefits
|
|
|
188
|
|
|
115
|
|
|
63
|
%
|
Underwriting,
acquisition, insurance and other expenses
|
|
|
256
|
|
|
173
|
|
|
48
|
%
|
Total
operating expenses
|
|
|
444
|
|
|
288
|
|
|
54
|
%
|
Income
from operations before taxes
|
|
|
161
|
|
|
87
|
|
|
85
|
%
|
Federal
income taxes
|
|
|
40
|
|
|
21
|
|
|
90
|
%
|
Income
from operations
|
|
$
|
121
|
|
$
|
66
|
|
|
83
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Improvement
|
|
Net
Flows (in millions)
|
|
2007
|
|
2006
|
|
(Worsening)
|
|
Variable
portion of variable annuity deposits
|
|
$
|
2,000
|
|
$
|
1,666
|
|
|
20
|
%
|
Variable
portion of variable annuity withdrawals
|
|
|
(1,179
|
)
|
|
(959
|
)
|
|
-23
|
%
|
Variable
portion of variable annuity net flows
|
|
|
821
|
|
|
707
|
|
|
16
|
%
|
Fixed
portion of variable annuity deposits
|
|
|
535
|
|
|
449
|
|
|
19
|
%
|
Fixed
portion of variable annuity withdrawals
|
|
|
(151
|
)
|
|
(164
|
)
|
|
8
|
%
|
Fixed
portion of variable annuity net flows
|
|
|
384
|
|
|
285
|
|
|
35
|
%
|
Total
variable annuity deposits
|
|
|
2,535
|
|
|
2,115
|
|
|
20
|
%
|
Total
variable annuity withdrawals
|
|
|
(1,330
|
)
|
|
(1,123
|
)
|
|
-18
|
%
|
Total
variable annuity net flows
|
|
|
1,205
|
|
|
992
|
|
|
21
|
%
|
Indexed
annuity deposits
|
|
|
160
|
|
|
-
|
|
|
NM
|
|
Indexed
annuity withdrawals
|
|
|
(63
|
)
|
|
-
|
|
|
NM
|
|
Indexed
annuity net flows
|
|
|
97
|
|
|
-
|
|
|
NM
|
|
Fixed
annuity deposits
|
|
|
126
|
|
|
21
|
|
|
NM
|
|
Fixed
annuity withdrawals
|
|
|
(674
|
)
|
|
(243
|
)
|
|
NM
|
|
Fixed
annuity net flows
|
|
|
(548
|
)
|
|
(222
|
)
|
|
NM
|
|
Total
annuity deposits
|
|
|
2,821
|
|
|
2,136
|
|
|
32
|
%
|
Total
annuity withdrawals
|
|
|
(2,067
|
)
|
|
(1,366
|
)
|
|
-51
|
%
|
Total
annuity net flows
|
|
$
|
754
|
|
$
|
770
|
|
|
-2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Annuities
incremental deposits
|
|
$
|
2,794
|
|
$
|
2,111
|
|
|
32
|
%
|
|
|
As
of March 31,
|
|
Increase
|
|
Account
Values (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Variable
annuities
|
|
$
|
53,776
|
|
$
|
44,314
|
|
|
21
|
%
|
Fixed
annuities (including indexed annuities)
|
|
|
14,663
|
|
|
6,745
|
|
|
117
|
%
|
Fixed
annuities ceded to reinsurers
|
|
|
(1,689
|
)
|
|
(2,202
|
)
|
|
23
|
%
|
Total
fixed annuitites
|
|
|
12,974
|
|
|
4,543
|
|
|
186
|
%
|
Total
annuities
|
|
$
|
66,750
|
|
$
|
48,857
|
|
|
37
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
portion of variable annuities
|
|
$
|
3,476
|
|
$
|
3,819
|
|
|
-9
|
%
|
|
|
Three
Months Ended
|
|
Basis
Points
|
|
|
|
March
31,
|
|
Increase
|
|
Interest
Rate Spreads
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Net
investment income yield
|
|
|
5.87
|
%
|
|
5.84
|
%
|
|
3
|
|
Interest
rate credited to policyholders
|
|
|
3.75
|
%
|
|
3.93
|
%
|
|
(18
|
)
|
Interest
rate spread
|
|
|
2.12
|
%
|
|
1.91
|
%
|
|
21
|
|
Effect
on yield and interest rate spread:
|
|
|
|
|
|
|
|
|
|
|
Commercial
mortgage loan prepayment
|
|
|
|
|
|
|
|
|
|
|
and
bond makewhole premiums
|
|
|
0.05
|
%
|
|
0.09
|
%
|
|
(4
|
)
|
Interest
rate spread, excluding the above items
|
|
|
2.07
|
%
|
|
1.82
|
%
|
|
25
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
fixed annuity account values (in millions)
|
|
$
|
17,738
|
|
$
|
9,695
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
on income from operations (after-DAC,
|
|
|
|
|
|
|
|
|
|
|
after-tax)
(in millions):
|
|
|
|
|
|
|
|
|
|
|
Commercial
mortgage loan prepayment
|
|
|
|
|
|
|
|
|
|
|
and
bond makewhole premiums
|
|
$
|
1
|
|
$
|
1
|
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
March
31, (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Average
Daily Variable Account Values
|
|
$
|
49,284
|
|
$
|
39,947
|
|
|
23
|
%
|
Comparison
of the Three Months Ended March 31, 2007 to 2006
Income
from operations for this segment increased $55 million, or 83%, for the first
quarter of 2007 compared to the same period in 2006. The increase is due
primarily to growth in account values from positive net flows and favorable
market conditions, and the merger with Jefferson-Pilot. The
adoption of SOP 05-1 resulted in a cumulative effect reduction of $28 million
in
the segment’s DAC and VOBA balances. The adoption of SOP 05-1 also increased DAC
and VOBA amortization by $4 million for the first quarter of 2007. The impact
is
expected to be approximately $6 million, pre-tax, for the remainder of
2007.
Revenues
Insurance
fees increased 36% for the first quarter of 2007 compared to the same period
in
2006, due to increases in average daily variable annuity account values and
an
increase in expense assessment rates resulting primarily from increase in
account values with elective riders. The increase in account values reflects
cumulative positive net flows and improvement in the equity markets between
periods. Excluding the impact of dividends, the S&P 500 Index®
at March
31, 2007 was 9.7% higher than at March 31, 2006 and the average daily S&P
500 Index®
for the
first quarter of 2007 was 11.1% higher than the first quarter of 2006.
New
deposits are an important component of our effort to grow the annuity business.
Although deposits do not significantly impact current period income from
operations, they are an important indicator of future profitability. In the
past
several years, we have concentrated our efforts on both product and distribution
breadth. Annuity deposits increased 32% for the first quarter of 2007 compared
to the same period in 2006, primarily due to growth in the variable annuity
business. The
increase in fixed annuity deposits from the previous year includes
$160 million of deposits into indexed annuity products, which were added to
our
product portfolio as a result of the merger with Jefferson-Pilot.
The
growth in individual variable annuity deposits was primarily a result of
continued strong sales of products with the Lincoln SmartSecuritySM
Advantage and i4Life® Advantage features and the expansion of the wholesaling
force in LFD. Variable annuity gross deposits in our Lincoln
ChoicePlusSM
and
American Legacy products were up 20% for the first quarter of 2007 compared
to
the same period in 2006.
The
other
component of net flows relates to the retention of the business. One of the
key
assumptions in pricing a product is the account persistency, which we refer
to
as the lapse rate. The lapse rate compares the amount of withdrawals to the
retained account values. One way to measure a company’s success in retaining
assets is to look at the overall level of withdrawals from period to period.
Additionally, by comparing actual lapse rates to the rates assumed in designing
the annuity product, it is possible
to
gauge
the impact of persistency on profitability. The overall lapse rate for the
first
quarter of 2007 was 10.4%, compared to 9.2% for the same period in 2006. See
the
discussion below for the drivers of the increased lapse rates.
Included
in our suite of fixed annuity products are several multi-year guarantee
products. Our Step Five Fixed Annuity products have a 60-day window period
following each five-year fixed guarantee period during which there is no
surrender charge and where crediting rates are reset at the beginning of
the
window period. Account values for these products were $1.9 billion at March
31,
2007, with approximately $0.7 billion of account values entering the window
period throughout the remainder of 2007. Amounts after 2007 are not significant.
During the first quarter of 2007, approximately $0.2 billion of account values
entered the window period of which 38% lapsed. The after-DAC, after-tax effect
to the earnings of the segment is mitigated in part by a 50% coinsurance
arrangement on 89% of the account values. See “Reinsurance” for additional
information on this arrangement. Account values for our other multi-year
guaranteed products were $1.7 billion at March 31, 2007, with approximately
$0.3
billion of the account value entering the window period throughout the remainder
of 2007. During the first quarter of 2007, approximately $89 million of these
multi-year guarantee products reset with approximately 77% lapsing where
the
holder did not select another of our products. As multi-year guarantees expire,
policyholders have the opportunity to renew their annuities at rates in effect
at that time.
Our
fixed
annuity business also includes products with crediting rates that are reset
on
an annual basis and are not subject to surrender charges. Account values for
these products were $3.7 billion at March 31, 2007 with 40% already at their
minimum guaranteed rates. The average crediting rates for these products were
approximately 41 basis points in excess of average minimum guaranteed rates.
Our
ability to retain the multi-year guarantee and annual reset annuities will
be
subject to current competitive conditions at the time interest rates for these
products reset.
Net
investment income increased $118 million, or 80%, for the first quarter of
2007
compared to the same period in 2006. The increase in net investment income
is
due to the increase in fixed account values which were acquired in the
Jefferson-Pilot merger. Overall growth in net investment income has been
constrained due primarily to lower investment portfolio yields, lower average
fixed annuity account values and net outflows. Net investment income included
$2
million (5 basis points) and $3 million (9 basis points), pre-DAC, pre-tax,
from
commercial mortgage loan prepayment and bond makewhole premiums for the periods
ended March 31, 2007 and 2006, respectively. Net investment income for the
first
quarter of 2007 also includes an increase of $1 million (pre-DAC, pre-tax)
from
the mark-to-market adjustment for S&P 500 Index® call options supporting the
hedge program for the indexed annuity business. This adjustment, which is
largely offset by a $4 million ($1 million after-DAC, after-tax) related
adjustment in interest credited is included within insurance benefits expense
but is excluded from spread calculations.
When
analyzing the impact of net investment income, it is important to understand
that a portion of the investment income earned is credited to the policyholders
of our fixed annuity products. The interest credited to policyholders is
included in the segment’s insurance benefits. The annuity product interest rate
spread represents the excess of the yield on earning assets over the average
crediting rate. The yield on earning assets is calculated as net investment
income on fixed product investment portfolios divided by average earning assets.
The average crediting rate is calculated using interest credited on annuity
products less the mark-to-market adjustment on the indexed annuity business,
bonus credits and excess interest on policies with the dollar cost averaging
feature, divided by the average fixed account values net of coinsured account
values. Fixed account values reinsured under modified coinsurance agreements
are
included in account values for this calculation. Interest credited to
policyholder balances increased for the first quarter of 2007 compared to the
same period in 2006 as a result of the Jefferson-Pilot merger, partially offset
by lower average fixed account values and lower average crediting rates.
Interest credited for the first quarter of 2007 was also reduced by $4 million
($3 million after-tax) related to adjustments to the opening balance sheet
of
Jefferson-Pilot finalized in the first quarter of 2007. These adjustments
increased our interest rate spread by 9 basis points.
The
interest rate spread table above summarizes the effect of changes in the
portfolio yield and the rate credited to policyholders, as well as the impact
of
prepayment premiums on results on an after-DAC, after-tax basis. The adjusted
interest rate spread was 2.07% and 1.82% for the first quarter of 2007 and
2006,
respectively. The improvement is primarily due to a reduction in crediting
rates
year over year and the 9 basis point increase attributable to the opening
balance sheet adjustment.
We
expect
to manage the effect of spreads for near-term operating income through a
combination of 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” of this Form 10-Q.
Benefits
and Expenses
Insurance
benefits include interest credited to policyholders of $182 million and $106
million for the first quarter of 2007 and 2006, respectively. Increases from
the
merger with Jefferson-Pilot were partially offset by past actions taken to
lower
crediting
rates
commensurate with the reduction in the overall investment yield over the last
several years and lower fixed account values. See the table above for the
interest rate credited to policyholders. Interest credited decreased $1 million
from the unfavorable fair value adjustment on our indexed annuity product
liabilities, as discussed above. This fair value adjustment, which is influenced
by equity markets and interest rates used for discounting the calculation,
can
be volatile from period to period affecting the comparability of interest
credited.
Also
included in insurance benefits are the costs associated with guaranteed benefits
included within variable annuities with the GMDB, GMWB or GIB riders. For first
quarter of 2007, favorable market conditions resulted in decreased insurance
benefits for the GMDB, GMWB and GIB riders, which were offset by unfavorable
hedge results compared to 2006. The effect of changes in net reserve and benefit
payments and results of the hedge program attributable to these guaranteed
benefits was such that the period over period variances was a decrease to
benefits and expenses of $3 million ($1 million after-DAC, after-tax).
At
March
31, 2007, the segment’s net amount at risk (“NAR”) related to contracts with a
GMDB feature was $0.3 billion. The related GAAP and statutory reserves were
$22
million and $42 million, respectively. The comparable amounts at December 31,
2006, were a NAR of $0.3 billion, GAAP reserves of $23 million and statutory
reserves of $42 million. At any point in time, the NAR is the difference between
the potential death benefit payable and the total account value, with a floor
of
zero (when account values exceed the potential death benefit there is no amount
at risk). Accordingly, the NAR represents the maximum amount we would have
to
pay if all policyholders died. In evaluating the GMDB exposures that exist
within our variable annuity business relative to industry peers, it is important
to distinguish between the various types of GMDB features, and consider other
factors such as average account values, average amounts of NAR, and the age
of
contractholders. The following table and discussion provides this information
for our variable annuity business as of March 31, 2007:
|
|
Type
of GMDB Feature
|
|
|
|
Return
of
|
|
High
Water
|
|
|
|
|
|
|
|
|
|
Premium
|
|
Mark
|
|
Roll-up
|
|
No
GMDB
|
|
Total
|
|
Variable
Annuity Account Value (billions)
|
|
$
|
25.3
|
|
$
|
23.1
|
|
$
|
0.4
|
|
$
|
5.0
|
|
$
|
53.8
|
|
%
of Total Annuity Account Value
|
|
|
47.0
|
%
|
|
42.9
|
%
|
|
0.7
|
%
|
|
9.4
|
%
|
|
100.0
|
%
|
Average
Account Value (thousands)
|
|
$
|
109.0
|
|
$
|
108.3
|
|
$
|
82.5
|
|
$
|
75.8
|
|
$
|
104.3
|
|
Average
NAR (thousands)
|
|
|
5.0
|
|
|
6.4
|
|
|
12.3
|
|
|
N/A
|
|
|
6.4
|
|
NAR
(billions)
|
|
|
0.1
|
|
|
0.2
|
|
|
-
|
|
|
-
|
|
|
0.3
|
|
Average
Age of Contract Holder
|
|
|
64
|
|
|
64
|
|
|
67
|
|
|
62
|
|
|
57
|
|
%
of Contract Holders > 70 Years of Age
|
|
|
14.7
|
%
|
|
31.1
|
%
|
|
41.6
|
%
|
|
31.7
|
%
|
|
20.0
|
%
|
We
have
variable annuity contracts containing GMDBs that have a dollar-for-dollar
withdrawal feature. Under such a feature, withdrawals reduce both current
account value and the GMDB amount on a dollar-for-dollar basis. For contracts
containing this dollar-for-dollar feature, the account holder could withdraw
a
substantial portion of their account value resulting in a GMDB that is multiples
of the current account value. Our exposure to this dollar-for-dollar risk is
somewhat mitigated by the fact that we do not allow for partial 1035 exchanges
on non-qualified contracts. To take advantage of the dollar-for-dollar feature,
the contractholder must take constructive receipt of the withdrawal and pay
any
applicable surrender charges. We report the appropriate amount of the withdrawal
that is taxable to the Internal Revenue Service, as well as indicating whether
or not tax penalties apply under the premature distribution tax rules. We
closely monitor the dollar-for-dollar withdrawal GMDB exposure. Beginning in
2003, the GMDB feature offered on new contract sales is a pro-rata GMDB feature
whereby each dollar of withdrawal reduces the GMDB benefit in proportion to
the
current GMDB to account value ratio. As of March 31, 2007, there were 814
contracts for which the death benefit to account value ratio was greater than
ten to one. The NAR on these contracts was $52 million.
Underwriting,
acquisition, insurance and other expenses increased $83 million, or 48%, for
the
first quarter of 2007 compared to the same period in 2006. The increases were
driven by the merger with Jefferson-Pilot and account value growth from sales
and favorable equity markets, which resulted in higher commission expenses,
net
of deferrals and higher DAC amortization. Underwriting, acquisition, insurance
and other expenses for the first quarter of 2007 were increased by $2 million
($1 million after-tax) related to adjustments to the opening balance sheet
of
Jefferson-Pilot finalized in the first quarter of 2007.
Individual
Markets - Life Insurance
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
Operating
Summary (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$
|
88
|
|
$
|
51
|
|
|
73
|
%
|
Insurance
fees
|
|
|
419
|
|
|
200
|
|
|
110
|
%
|
Net
investment income
|
|
|
454
|
|
|
239
|
|
|
90
|
%
|
Other
revenues and fees
|
|
|
10
|
|
|
10
|
|
|
0
|
%
|
Total
operating revenues
|
|
|
971
|
|
|
500
|
|
|
94
|
%
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Insurance
benefits
|
|
|
498
|
|
|
262
|
|
|
90
|
%
|
Underwriting,
acquisition, insurance and other expenses
|
|
|
221
|
|
|
133
|
|
|
66
|
%
|
Total
operating expenses
|
|
|
719
|
|
|
395
|
|
|
82
|
%
|
Income
from operations before taxes
|
|
|
252
|
|
|
105
|
|
|
140
|
%
|
Federal
income taxes
|
|
|
85
|
|
|
36
|
|
|
136
|
%
|
Income
from operations
|
|
$
|
167
|
|
$
|
69
|
|
|
142
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
|
|
Basis
Points
|
|
|
|
March
31,
|
|
Increase
|
|
Interest
Rate Spreads
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Interest-Sensitive
Products
|
|
|
|
|
|
|
|
|
|
|
Net
investment income yield
|
|
|
6.48
|
%
|
|
6.48
|
%
|
|
-
|
|
Interest
rate credited to policyholders
|
|
|
4.46
|
%
|
|
4.60
|
%
|
|
(14
|
)
|
Interest
rate spread
|
|
|
2.02
|
%
|
|
1.88
|
%
|
|
14
|
|
Effect
on yield and interest rate spreads:
|
|
|
|
|
|
|
|
|
|
|
Commercial
mortgage loan prepayment
|
|
|
|
|
|
|
|
|
|
|
and
bond makewhole premiums
|
|
|
0.21
|
%
|
|
0.07
|
%
|
|
14
|
|
Interest
rate spread, excluding the above items
|
|
|
1.81
|
%
|
|
1.81
|
%
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
on income from operations (after-DAC,
|
|
|
|
|
|
|
|
|
|
|
after-tax)
(in millions):
|
|
|
|
|
|
|
|
|
|
|
Commercial
mortgage loan prepayment
|
|
|
|
|
|
|
|
|
|
|
and
bond makewhole premiums
|
|
$
|
4
|
|
$
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Traditional
Products
|
|
|
|
|
|
|
|
|
|
|
Net
investment income yield
|
|
|
6.41
|
%
|
|
6.72
|
%
|
|
(31
|
)
|
Effect
on yield:
|
|
|
|
|
|
|
|
|
|
|
Commercial
mortgage loan prepayment
|
|
|
|
|
|
|
|
|
|
|
and
bond makewhole premiums
|
|
|
0.02
|
%
|
|
0.15
|
%
|
|
(13
|
)
|
Net
investment income yield, excluding the above items
|
|
|
6.39
|
%
|
|
6.57
|
%
|
|
(18
|
)
|
Effect
on income from operations (after-tax) (in millions)
|
|
|
|
|
|
|
|
|
|
|
Commercial
mortgage loan prepayment
|
|
|
|
|
|
|
|
|
|
|
and
bond makewhole premiums
|
|
$
|
-
|
|
$
|
1
|
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Sales
by Product
|
|
|
|
|
|
|
|
|
|
|
Universal
Life ("UL")
|
|
|
|
|
|
|
|
|
|
|
Excluding
MoneyGuard®
|
|
$
|
166
|
|
$
|
41
|
|
|
NM
|
|
MoneyGuard®
|
|
|
7
|
|
|
8
|
|
|
-13
|
%
|
Total
Universal Life
|
|
|
173
|
|
|
49
|
|
|
253
|
%
|
Variable
Universal Life ("VUL")
|
|
|
21
|
|
|
10
|
|
|
110
|
%
|
Whole
Life
|
|
|
-
|
|
|
1
|
|
|
-100
|
%
|
Term
|
|
|
9
|
|
|
8
|
|
|
13
|
%
|
Total
|
|
$
|
203
|
|
$
|
68
|
|
|
199
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Net
Flows (in millions)
|
|
|
|
|
|
|
|
|
|
|
Deposits
|
|
$
|
1,039
|
|
$
|
488
|
|
|
113
|
%
|
Withdrawals
and Deaths
|
|
|
(341
|
)
|
|
(231
|
)
|
|
-48
|
%
|
Net
flows
|
|
$
|
698
|
|
$
|
257
|
|
|
172
|
%
|
Policyholder
Assessments
|
|
$
|
601
|
|
$
|
294
|
|
|
104
|
%
|
|
|
As
of March 31,
|
|
Increase
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Account
Values
|
|
|
|
|
|
|
|
|
|
|
Universal
Life
|
|
$
|
22,228
|
|
$
|
11,913
|
|
|
87
|
%
|
Variable
Universal Life
|
|
|
4,696
|
|
|
2,355
|
|
|
99
|
%
|
Total
life insurance account values
|
|
$
|
26,924
|
|
$
|
14,268
|
|
|
89
|
%
|
|
|
|
|
|
|
|
|
|
|
|
In-Force
Face Amount
|
|
|
|
|
|
|
|
|
|
|
Universal
Life and Other
|
|
$
|
272,920
|
|
$
|
129,584
|
|
|
111
|
%
|
Term
Insurance
|
|
|
235,491
|
|
|
191,825
|
|
|
23
|
%
|
Total
in-force
|
|
$
|
508,411
|
|
$
|
321,409
|
|
|
58
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Net
Amount at Risk
|
|
|
|
|
|
|
|
|
|
|
Universal
Life and Other
|
|
$
|
242,100
|
|
$
|
112,900
|
|
|
114
|
%
|
Term
Insurance
|
|
|
234,300
|
|
|
190,900
|
|
|
23
|
%
|
Total
net amount at risk
|
|
$
|
476,400
|
|
$
|
303,800
|
|
|
57
|
%
|
Comparison
of the Three Months Ended March 31, 2007 to 2006
Income
from operations for this segment increased $98 million, or 142%, for the first
quarter of 2007 compared to the same period in 2006. The increase was driven
by
the merger with Jefferson-Pilot. Excluding the increased operating results
from
the merger, income from operations during the first quarter of 2007 increased
over the same period in 2006 due to favorable investment results, insurance
fees
and growth of business in force, partially offset by higher amortization
expense.
Revenues
Revenues
for the first quarter of 2007 increased 94% compared to the same period in
2006
due to the inclusion of results from the Jefferson-Pilot companies beginning
in
April 2006. Revenues from insurance fees were up 110% for the three months
ended
March 31, 2007 compared to the same period in 2006 also due to the inclusion
of
results from the Jefferson-Pilot companies. Revenues for insurance fees for
the
first quarter of 2007 were reduced by $5 million ($2 million after-DAC,
after-tax) related to adjustments to the opening balance sheet of
Jefferson-Pilot finalized in the first quarter of 2007. Insurance fees include
mortality
assessments, expense assessments (net of DFEL
deferrals and amortization) and surrender charges. In addition to the effects
of
the merger, growth in mortality and expense assessments for the first quarter
of
2007 compared to the same period in 2006 was primarily related to higher sales
in the first quarter of 2007 compared to the same period in 2006 and increased
business in force due to new sales and favorable persistency. The improved
persistency results should positively affect future revenues.
During
the first quarter of 2007 compared to the same period in 2006, life insurance
in-force grew as a result of and in addition to the Jefferson-Pilot merger.
In-force growth should be considered independently with regard to term products
versus permanent products, as term products have a lower profitability in
relation to face amount compared to permanent products. Insurance premium
revenue relates primarily to whole life and term life insurance products.
Excluding the impact of the Jefferson-Pilot companies, insurance premiums for
term insurance increased 19% for the first quarter of 2007 compared to the
same
period in 2006, while insurance premiums for whole life decreased 10%. For
term
insurance, gross premiums grew 4% in the first quarter of 2007 from continued
growth in the term insurance book of business. Also contributing to the growth
in net term insurance premiums was a 5% reduction in premiums paid for
reinsurance coverage in the first quarter of 2007 compared to the same period
in
2006, primarily resulting from restructuring our reinsurance program in
September 2005. Under the restructured program, we reduced the percentage of
each new term policy reinsured and changed from using coinsurance to using
renewable term insurance. See “Reinsurance” below for additional information
regarding our reinsurance coverage.
Sales
in
the table above and as discussed below are reported as follows:
§ |
UL,
VUL, MoneyGuard® - 100% of annualized expected target premium plus 5% of
paid excess premium, including an adjustment for internal replacements
at
approximately 50% of target.
|
§ |
Whole
Life and Term - 100% of first year paid
premiums.
|
Sales
are
not part of revenues (other than for term products) and do not have a
significant impact on current quarter income from operations, but are an
indicator of future profitability. Total sales for the first quarter of 2007
compared to the same period in 2006 increased $135 million as a result of the
merger and strong performance by our distributors. Due to the first quarter
sales benefiting from a large case and the introduction of the UPP we may see
sales slow over the next two quarters. We believe that our sales of universal
life products include sales with investor-owned life insurance characteristics.
We have implemented procedures to identify sales believed to be associated
with
this type of business in order to prevent investor-owned life insurance policies
from being issued. However, accurate identification of these policies can be
difficult and we continue to modify our screening procedures. We cannot predict
whether or not these sales will ultimately impact our profitability, however,
returns on universal life business sold as part of investor-owned designs are
believed to be lower than traditional estate planning universal life sales
due
in part to zero-expected lapses.
UL
and
VUL products with secondary guarantees represented approximately 27% of
permanent life insurance in-force at March 31, 2007 and approximately 69% of
sales for these products during the first quarter of 2007. Actuarial Guideline
38 (“AXXX”) imposes additional reserve requirements for these products - See
“Review of Consolidated Financial Condition - Sources of Liquidity and Cash
Flow
- Financing Activities” for further information on the manner in which we
reinsure our AXXX reserves.
Net
investment income increased $215 million, or 90%, in the first quarter of 2007
compared to the same period in 2006, with the increase being driven by the
merger with Jefferson-Pilot. Excluding the effects of the merger, growth in
investment income was due to in-force growth, higher commercial mortgage loan
prepayments, and bond makewhole premiums and investment income from alternative
investments.
The
interest rate spread on interest-sensitive products is the difference between
the interest to be credited to policyholder accounts and the interest income
we
earn on the assets supporting the policyholder accounts. Traditional products
use interest income to build the policy reserves. At March 31, 2007 and 2006,
interest sensitive products represented approximately 81% and 78%, respectively,
of total invested assets. Interest rate spreads for interest sensitive
products increased 14 basis points in the first quarter of 2007 compared to
the
same period in 2006. Excluding the effects of commercial mortgage loan
prepayment and bond makewhole premiums, interest rate spreads for interest
sensitive products did not change in the first quarter of 2007, compared to
the
same period in 2006. The first quarter of 2007 interest rate spread on
interest-sensitive products was also positively impacted by 4 basis points
due
to an extension of our investment portfolio premium amortization period and
6
basis points due to reduced interest credited attributable to having one fewer
calendar day in the first quarter of 2007 than we will have in the second
quarter of 2007.
For
the
first quarter of 2007, spreads between new money rates and general account
yields remained steady. At March 31, 2007, 49% of interest sensitive account
values have crediting rates at contract guaranteed levels, and 41% have
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. This 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” of this Form 10-Q.
Benefits
and Expenses
Insurance
benefits include interest credited to policyholders of $252 million and $142
million for the periods ended March 31, 2007 and 2006, respectively, with the
increase primarily attributable to the merger. Also contributing to the increase
was growth in the book of business. Refer to the table above for the interest
rate credited to policyholders. Insurance benefits for the first quarter of
2007
were reduced by $14 million ($6 million after-DAC, after-tax) related to
adjustments to the opening balance sheet of Jefferson-Pilot finalized in the
first quarter of 2007.
During
2006, we undertook our annual comprehensive review of the assumptions underlying
the amortization of DAC, VOBA and DFEL. Insurance benefits in 2006 include
an
increase to the reserve for our products with secondary guarantees. The reserve
increase resulted from updating long-term assumptions, primarily investment
interest rates. The change in assumptions is estimated to result in an increase
in reserves in future quarters of approximately $2 million ($1 million
after-tax). The reserve increase for the first quarter of 2007 was $2 million
($1 million after-tax).
The
2006
review also resulted in a negative net prospective unlocking adjustment,
primarily reflecting the impact of the increased reserves related to the sale
of
life insurance products sold with secondary guarantees, partially offset by
improved mortality and expense assumptions. The 2006 review also resulted in
an
increase in the on-going amortization expense of approximately $4 million
pre-tax ($2 million after-tax) per quarter starting in the fourth quarter of
2006.
The
segment had favorable retrospective DAC, VOBA and DFEL unlocking of $9 million
pre-tax ($6 million after-tax) during the three months ended March 31, 2007,
primarily due to favorable investment results and favorable persistency, and
favorable retrospective DAC, VOBA and DFEL unlocking of $4 million pre-tax
($2
million after-tax) in the same period in 2006, primarily due to favorable
mortality and persistency. DAC and VOBA amortization for the first quarter
of
2007 was increased by $10 million ($6 million after-tax) related to adjustments
to the opening balance sheet of Jefferson-Pilot finalized in the first quarter
of 2007.
Underwriting,
acquisition, insurance and other expenses increased $88 million for the first
quarter of 2007 compared to the same period in 2006, with the increase being
driven primarily by the merger.
RESULTS
OF EMPLOYER MARKETS
The
Employer Markets business provides its products through two segments, Retirement
Products and Group Protection. The Retirement Products segment operates through
two lines of business - Defined Contribution, which provides employer-sponsored
variable and fixed annuities, mutual-fund based programs in the 401(k), 403(b),
and 457 marketplaces; and Executive Benefits, which provides corporate-owned
life insurance (“COLI”) and bank-owned life insurance (“BOLI”) and contains an
Institutional Pension business. The Group Protection segment of Employer Markets
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 1 - Risk Factors” in our 2006 Form 10-K and
“Forward-looking Statements - Cautionary Language” in this
report.
Employer
Markets - Retirement Products
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
Operating
Summary (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$
|
1
|
|
$
|
1
|
|
|
0
|
%
|
Insurance
fees
|
|
|
77
|
|
|
64
|
|
|
20
|
%
|
Net
investment income
|
|
|
275
|
|
|
235
|
|
|
17
|
%
|
Other
revenues and fees
|
|
|
6
|
|
|
6
|
|
|
0
|
%
|
Total
operating revenues
|
|
|
359
|
|
|
306
|
|
|
17
|
%
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Insurance
benefits
|
|
|
182
|
|
|
143
|
|
|
27
|
%
|
Underwriting,
acquisition, insurance and other expenses
|
|
|
85
|
|
|
77
|
|
|
10
|
%
|
Total
operating expenses
|
|
|
267
|
|
|
220
|
|
|
21
|
%
|
Income
from operations before taxes
|
|
|
92
|
|
|
86
|
|
|
7
|
%
|
Federal
income taxes
|
|
|
28
|
|
|
26
|
|
|
8
|
%
|
Income
from operations
|
|
$
|
64
|
|
$
|
60
|
|
|
7
|
%
|
Retirement
Products - Defined Contribution
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
Operating
Summary (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
Insurance
fees
|
|
$
|
62
|
|
$
|
58
|
|
|
7
|
%
|
Net
investment income
|
|
|
180
|
|
|
186
|
|
|
-3
|
%
|
Other
revenues and fees
|
|
|
5
|
|
|
5
|
|
|
0
|
%
|
Total
operating revenues
|
|
|
247
|
|
|
249
|
|
|
-1
|
%
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Insurance
benefits
|
|
|
104
|
|
|
101
|
|
|
3
|
%
|
Underwriting,
acquisition, insurance and other expenses
|
|
|
72
|
|
|
73
|
|
|
-1
|
%
|
Total
operating expenses
|
|
|
176
|
|
|
174
|
|
|
1
|
%
|
Income
from operations before taxes
|
|
|
71
|
|
|
75
|
|
|
-5
|
%
|
Federal
income taxes
|
|
|
21
|
|
|
23
|
|
|
-9
|
%
|
Income
from operations
|
|
$
|
50
|
|
$
|
52
|
|
|
-4
|
%
|
|
|
March
31,
|
|
Increase
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Account
Values
|
|
|
|
|
|
|
|
|
|
|
Variable
Annuities
|
|
$
|
17,676
|
|
$
|
16,454
|
|
|
7
|
%
|
Fixed
Annuities
|
|
|
10,993
|
|
|
11,033
|
|
|
0
|
%
|
Total
Annuities
|
|
|
28,669
|
|
|
27,487
|
|
|
4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Alliance
Mutual Funds
|
|
|
5,807
|
|
|
4,248
|
|
|
37
|
%
|
Total
Annuities and Alliance
|
|
$
|
34,476
|
|
$
|
31,735
|
|
|
9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
Portion of Variable Annuity
|
|
$
|
6,123
|
|
$
|
6,343
|
|
|
-3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Improvement
|
|
Net
Flows (in millions)
|
|
2007
|
|
2006
|
|
(Worsening)
|
|
Variable
Portion of Variable Annuity Deposits
|
|
$
|
655
|
|
$
|
669
|
|
|
-2
|
%
|
Variable
Portion of Variable Annuity Withdrawals
|
|
|
(813
|
)
|
|
(676
|
)
|
|
-20
|
%
|
Variable
Portion of Variable Annuity Net Flows
|
|
|
(158
|
)
|
|
(7
|
)
|
|
NM
|
|
Fixed
Portion of Variable Annuity Deposits
|
|
|
100
|
|
|
118
|
|
|
-15
|
%
|
Fixed
Portion of Variable Annuity Withdrawals
|
|
|
(233
|
)
|
|
(220
|
)
|
|
-6
|
%
|
Fixed
Portion of Variable Annuity Net Flows
|
|
|
(133
|
)
|
|
(102
|
)
|
|
-30
|
%
|
Total
Variable Annuity Deposits
|
|
|
755
|
|
|
787
|
|
|
-4
|
%
|
Total
Variable Annuity Withdrawals
|
|
|
(1,046
|
)
|
|
(896
|
)
|
|
-17
|
%
|
Total
Variable Annuity Net Flows
|
|
|
(291
|
)
|
|
(109
|
)
|
|
NM
|
|
Fixed
Annuity Deposits
|
|
|
198
|
|
|
135
|
|
|
47
|
%
|
Fixed
Annuity Withdrawals
|
|
|
(166
|
)
|
|
(108
|
)
|
|
-54
|
%
|
Fixed
Annuity Net Flows
|
|
|
32
|
|
|
27
|
|
|
19
|
%
|
Total
Annuity Deposits
|
|
|
953
|
|
|
922
|
|
|
3
|
%
|
Total
Annuity Withdrawals
|
|
|
(1,212
|
)
|
|
(1,004
|
)
|
|
-21
|
%
|
Total
Annuity Net Flows
|
|
|
(259
|
)
|
|
(82
|
)
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
Alliance
Mutual Fund Deposits
|
|
|
534
|
|
|
318
|
|
|
68
|
%
|
Alliance
Mutual Fund Withdrawals
|
|
|
(54
|
)
|
|
(56
|
)
|
|
4
|
%
|
Total
Alliance Mutual Fund Net Flows
|
|
|
480
|
|
|
262
|
|
|
83
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Total
Annuity and Alliance Deposits
|
|
|
1,487
|
|
|
1,240
|
|
|
20
|
%
|
Total
Annuity and Alliance Withdrawals
|
|
|
(1,266
|
)
|
|
(1,060
|
)
|
|
-19
|
%
|
Total
Annuity and Alliance Net Flows
|
|
$
|
221
|
|
$
|
180
|
|
|
23
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Annuities
Incremental Deposits
|
|
$
|
863
|
|
$
|
908
|
|
|
-5
|
%
|
Alliance
Mutual Fund Incremental Deposits
|
|
|
533
|
|
|
318
|
|
|
68
|
%
|
Total
Annuities and Alliance Incremental Deposits
(1)
|
|
$
|
1,396
|
|
$
|
1,226
|
|
|
14
|
%
|
(1)
Incremental
deposits represent gross deposits reduced by transfers from other segment
products.
|
|
Three
Months Ended
|
|
Basis
Points
|
|
|
|
March
31,
|
|
Increase
|
|
Interest
Rate Spread
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Net
investment income yield
|
|
|
6.20
|
%
|
|
6.35
|
%
|
|
(15
|
)
|
Interest
rate credited to policyholders
|
|
|
3.81
|
%
|
|
3.66
|
%
|
|
15
|
|
Interest
rate spread
|
|
|
2.39
|
%
|
|
2.69
|
%
|
|
(30
|
)
|
Effect
on yield and interest rate spread:
|
|
|
|
|
|
|
|
|
|
|
Commercial
mortgage loan prepayment
|
|
|
|
|
|
|
|
|
|
|
and
bond makewhole premiums
|
|
|
0.03
|
%
|
|
0.15
|
%
|
|
(12
|
)
|
Interest
rate spread adjusted for above items
|
|
|
2.36
|
%
|
|
2.54
|
%
|
|
(18
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Average
fixed annuity account values (in millions)
|
|
$
|
10,955
|
|
$
|
11,003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
on income from operations (after-DAC, after-tax)
|
|
|
|
|
|
|
|
|
|
|
(in
millions):
|
|
|
|
|
|
|
|
|
|
|
Commercial
mortgage loan prepayment
|
|
|
|
|
|
|
|
|
|
|
and
bond makewhole premiums
|
|
$
|
-
|
|
$
|
1
|
|
|
|
|
Comparison
of the Three Months Ended March 31, 2007 to 2006
Income
from operations for the Defined Contribution line of business within the
Retirement Products segment decreased $2 million, or 4%, for the first quarter
of 2007 compared to the same period in 2006, the net of higher insurance fees
on
higher average variable account values, more than offset by reductions in net
investment income and an increase interest credited to contractholder
funds.
Revenues
Insurance
fees increased 7% for the first quarter of 2007 compared to the same period
in
2006 as a result of increases in average daily variable annuity account values.
The increase in account values reflects cumulative positive net flows and
improvement in the equity markets between periods. Excluding the impact of
dividends, the S&P 500 Index®
at March
31, 2007 was 9.7% higher than at March 31, 2006 and the average daily S&P
500 Index®
for the
first quarter of 2007 was 11.1% higher than the first quarter of 2006.
New
deposits are an important component of our effort to grow the Defined
Contribution business. Although deposits do not significantly impact current
period income from operations, they are an important indicator of future
profitability. Deposits increased 20% in the first quarter of 2007 compared
to
the same period in 2006, primarily due to growth in the Alliance
program.
Employer
Markets serves the mid-large case 401(k) and 403(b) markets with our Alliance
program. Deposits (including Alliance program fixed annuity deposits of $177
million) were $710 million in the first quarter of 2007, an increase of 64%
from
the same period in 2006. The Alliance program bundles our fixed annuity products
with mutual funds, along with record keeping and employee education components.
We earn fees for the services that we provide to mutual fund accounts and
investment margins on fixed annuities of Alliance program accounts. The amounts
associated with the Alliance mutual fund program are not included in the assets
or liabilities reported in our Consolidated Balance Sheets.
The
distribution model for the small case 401(k) Market is focused on driving growth
through financial intermediaries. The two primary products we sell into this
market are Director and Lincoln American Legacy Retirement (LALR). As part
of
the strategic redesign of this model, in October 2006, we terminated the
relationship with the third-party wholesaler and committed resources to
developing our own external and internal sales force. During the first quarter
of 2007, 401(k) Director product sales were down 6% from the same period in
2006
due to the termination of the third-party wholesaler. We expect that the
benefits associated with our investment in a new wholesaling force will outweigh
any short-term consequences of terminating our third-party wholesaling
relationship.
The
other
component of net flows relates to the retention of our business as demonstrated
by our lapse rates. The overall lapse rate for our Defined Contribution annuity
products was 15.2% for the first quarter of 2007 compared to 13.4% for the
same
period in 2006. The period over period increase in annuity product lapses
occurred in the 401(k) Director product and several other aging product blocks.
Net
investment income decreased 3% for the first quarter of 2007 compared to the
same period in 2006 as a result of a net decrease in average fixed account
values. The decrease also includes a decrease in commercial mortgage loan
prepayment and bond makewhole premiums from $4 million for the first quarter
of
2006 to $1 million for the first quarter of 2007.
A
portion
of the net investment income in this segment is credited to our fixed annuity
policyholders. The interest credited to policyholders is included in the
segment’s expenses. Annuity product interest rate spreads represent the excess
of the yield on earning assets over the average crediting rate. The yield on
earning assets is calculated as net investment income on investment portfolios
supporting fixed products and the fixed portion of variable products divided
by
average earning assets. The average crediting rate is calculated using interest
credited on annuity products divided by the average fixed account values.
The
interest rate spread table above summarizes the effect on income from operations
of changes in the portfolio yield, the rate credited to policyholders, as well
as the impact of prepayment premiums on an after-DAC, after-tax basis. The
interest rate spread decreased to 2.39% for the first quarter of 2007 from
2.69%
for the same period in 2006. This was driven by a decrease in investment income
yield and an increase in crediting rates. After removing the effects of
prepayment premiums, the interest rate spread was 2.36% for the first quarter
of
2007 compared to 2.54% for the same period in 2006. In response to the
competitive environment, we increased crediting rates in April 2006 by 10 basis
points for a series of our fixed annuity products with approximately $6 billion
of account values. Effective October 1, 2006, we increased the crediting rates
for these products by an additional 10 basis points. We are currently evaluating
further crediting rate actions, with the expectation of maintaining stable
spreads over the near term, excluding the effects of prepayment premiums. 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” of this
Form
10-Q.
Benefits
and Expenses
Interest
credited to policyholders is included in insurance benefits and increased 4%
for
the first quarter of 2007 compared to the same period in 2006. The increase
is a
result of the increase in crediting rates discussed above. See the table above
for the interest rate credited to policyholders.
Underwriting,
acquisition, insurance and other expenses decreased 1% for the first quarter
of
2007 compared to the same period in 2006. This decrease was primarily the result
of less favorable DAC and VOBA adjustments, lower incentive compensation
accruals and a change in expense allocation methodology put into effect in
the
second quarter of 2006 as a result of the Jefferson-Pilot merger, which shifted
expenses to other business segments. The change in methodology was not material
to the other segments and did not affect consolidated expenses.
A
portion
of the variable annuity contracts in the segment contain GMDB’s in the form of a
Return of Premium (“ROP”) GMDB feature, which guarantees a return of premiums
adjusted for any withdrawals. At March 31, 2007, approximately $14.3 billion,
or
60%, of variable annuity contract account values contained an ROP death benefit
feature and the net amount at risk related to these contracts was $14 million.
The remaining variable annuity contract account values, including the 401(k)
Director product, contain no GMDB feature.
Retirement
Products - Executive Benefits
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
Operating
Summary (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$
|
1
|
|
$
|
1
|
|
|
0
|
%
|
Insurance
fees
|
|
|
15
|
|
|
6
|
|
|
150
|
%
|
Net
investment income
|
|
|
95
|
|
|
49
|
|
|
94
|
%
|
Other
revenues and fees
|
|
|
1
|
|
|
1
|
|
|
0
|
%
|
Total
operating revenues
|
|
|
112
|
|
|
57
|
|
|
96
|
%
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Insurance
benefits
|
|
|
78
|
|
|
42
|
|
|
86
|
%
|
Underwriting,
acquisition, insurance and other expenses
|
|
|
13
|
|
|
4
|
|
|
225
|
%
|
Total
Operating Expenses
|
|
|
91
|
|
|
46
|
|
|
98
|
%
|
Income
from operations before taxes
|
|
|
21
|
|
|
11
|
|
|
91
|
%
|
Federal
income taxes
|
|
|
7
|
|
|
3
|
|
|
133
|
%
|
Income
from operations
|
|
$
|
14
|
|
$
|
8
|
|
|
75
|
%
|
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Improvement
|
|
Operational
Data (in millions)
|
|
2007
|
|
2006
|
|
(Worsening)
|
|
COLI/BOLI
- Sales
|
|
$
|
20
|
|
$
|
17
|
|
|
18
|
%
|
|
|
|
|
|
|
|
|
|
|
|
COLI/BOLI-
Balance Beginning-of-Period
|
|
$
|
4,305
|
|
$
|
1,318
|
|
|
227
|
%
|
Business
acquired
|
|
|
-
|
|
|
-
|
|
|
NM
|
|
Deposits
|
|
|
65
|
|
|
47
|
|
|
38
|
%
|
Withdrawals
& deaths
|
|
|
(140
|
)
|
|
(7
|
)
|
|
NM
|
|
Net
flows
|
|
|
(75
|
)
|
|
40
|
|
|
NM
|
|
Policyholder
assessments
|
|
|
(18
|
)
|
|
(9
|
)
|
|
-100
|
%
|
Interest
credited and change in market value
|
|
|
52
|
|
|
38
|
|
|
37
|
%
|
COLI/BOLI-Balance
End-of-Period
|
|
$
|
4,264
|
|
$
|
1,387
|
|
|
207
|
%
|
|
|
March
31,
|
|
|
|
|
|
2007
|
|
2006
|
|
|
|
COLI/BOLI
In-Force
|
|
$
|
14,747
|
|
$
|
7,979
|
|
|
85
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Institutional
Pensions
|
|
$
|
2,734
|
|
$
|
2,753
|
|
|
-1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Comparison
of the Three Months Ended March 31, 2007 to 2006
Income
from operations for Executive Benefits business increased $6 million for the
first quarter of 2007 compared to the same period in 2006, due primarily to
the
April 2006 merger with Jefferson-Pilot. Excluding the effects of the merger,
results were down from the same period in 2006, as unfavorable mortality in
the
Institutional Pension business was offset in part by increases from growth
in
our COLI/BOLI in-force.
Revenues
Insurance
fees and premiums for this business increased 128% for the first quarter of
2007
compared to the same period in 2006, primarily as a result of the additions
of
the Jefferson-Pilot BOLI business.
Included
in the BOLI acquired with the Jefferson-Pilot companies are life insurance
products sold to community banks, which accounted for $1.9 billion in
policyholder fund balances. At March 31, 2007, VOBA balances, net of unearned
revenue reserves, related to these blocks were approximately $118 million.
These
policies, which are generally not subject to surrender charges, are owned by
several thousand policyholders. These policies were primarily originated
through, and continue to be serviced by, two marketing organizations. The
surrender rate for this product may increase beyond current experience due
to
the absence of surrender charges and rising interest rates that may result
in
returns available to policyholders on competitors’ products being more
attractive than on our policies in force.
Consistent
with the way we report UL sales, we report COLI/BOLI sales as 100% of annualized
expected target premium plus 5% of paid excess premium, including an adjustment
for internal replacements at approximately 50% of target. On this basis, sales
for the first quarter of 2007 increased 18% over the same period in 2006,
primarily in the historical Lincoln products, and include the impact of two
new
product launches in the second half of 2006.
Net
investment income increased 94% for the first quarter of 2007 compared to
the
same period in 2006. The increase was driven principally by the Jefferson-Pilot
merger, as higher investment income from the secured limited recourse note,
which was issued in December 2006, was offset by lower investment income
from
declining business in-force and investment yields on the Instiutional Pension
business. For more information on the secured limited recourse note see Note
9
to the Financial Statements.
Benefits
and Expenses
Insurance
benefits, which includes interest credited to policyholders, increased $36
million, or 86%, for the first quarter of 2007 compared to the same period
in
2006. The increase is primarily due to interest credited to Jefferson-Pilot
policyholders. On
July
1,
2006, we implemented a 25 basis point increase in crediting rates on our BOLI
business. Excluding the increase from Jefferson-Pilot companies, insurance
benefits for the first quarter of 2007 were essentially level with the same
period in 2006, as increased interest credited on the secured limited recourse
note was offset by a recovery on a reinsurance agreement.
Underwriting,
acquisition, insurance and other expenses increased $9 million, or 225% for
the
first quarter of 2007 compared to the same period in 2006. The increase was
primarily the result of inclusion of the Jefferson-Pilot BOLI business, and
also
reflects unfavorable retrospective unlocking in the first quarter of 2007,
resulting from surrender activity, and a change in expense allocation
methodology put into effect in the third quarter of 2006 as a result of the
April 2006 Jefferson-Pilot merger. The change in methodology did not affect
consolidated expenses. There are no systemic issues such as service or product
competitiveness driving the surrender activity in the first quarter of
2007.
Employer
Markets - Group Protection
The
Group
Protection segment offers group life, disability, and dental insurance to
employers. The segment’s 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. The Group Protection segment was added as a result of our merger
with Jefferson-Pilot. Therefore, its results are not included in our
consolidated results for the first quarter of 2006.
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
|
|
Operating
Summary (in millions)
|
|
2007
|
|
Operating
Revenues
|
|
|
|
|
Insurance
premiums
|
|
$
|
332
|
|
Net
investment income
|
|
|
28
|
|
Other
revenues and fees
|
|
|
1
|
|
Total
operating revenues
|
|
|
361
|
|
Operating
Expenses
|
|
|
|
|
Insurance
benefits
|
|
|
247
|
|
Underwriting,
acquisition, insurance and other expenses
|
|
|
78
|
|
Total
operating expenses
|
|
|
325
|
|
Income
from operations before taxes
|
|
|
36
|
|
Federal
income taxes
|
|
|
13
|
|
Income
from operations
|
|
$
|
23
|
|
|
|
|
|
|
Product
Line Data
|
|
Three
Months Ended March 31, 2007
|
|
|
|
Income
from
|
|
Earned
|
|
|
|
(in
millions)
|
|
Operations
|
|
Premiums
|
|
Loss
Ratios
|
|
|
|
|
|
|
|
|
|
Life
|
|
$
|
9
|
|
$
|
119
|
|
|
75.0
|
%
|
Disability
|
|
|
13
|
|
|
145
|
|
|
69.5
|
%
|
Dental
|
|
|
-
|
|
|
32
|
|
|
79.2
|
%
|
Total
Non-medical
|
|
|
22
|
|
|
296
|
|
|
72.7
|
%
|
Medical
|
|
|
1
|
|
|
35
|
|
|
|
|
Total
|
|
$
|
23
|
|
$
|
331
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expense
ratios:
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses
|
|
|
|
|
|
|
|
|
|
|
to
earned premiums
|
|
|
9.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
expenses to earned premiums
|
|
|
23.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
- annualized premium
|
|
|
|
|
|
|
|
|
|
|
Life,
disability and dental combined
|
|
$
|
61
|
|
|
|
|
|
|
|
Income
from operations for this segment benefited from solid claim experience on all
products. Because group underwriting risks may change over time, management
focuses on trends in loss ratios to compare actual experience with pricing
expectations. The level of expenses is also 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. Reported sales relate to
long-duration contracts sold to new policyholders and new programs sold to
existing policyholders. The trend in sales is an important indicator of
development of business in force over time.
The
adoption of SOP 05-1 resulted in a cumulative effect reduction of $38 million
in
the segment’s DAC and VOBA balances. The adoption of SOP 05-1 also increased DAC
and VOBA amortization by $2
million
for the first quarter of 2007. The total expected increase in expenses is
primarily from increased DAC and VOBA amortization for 2007 of $7
million.
For
additional information about the impact of SOP 05-1, refer to Note 2 of our
consolidated financial statements.
Revenues
After
the
merger, the operations of the Group Protection segment were substantially
unchanged from when it was part of Jefferson-Pilot. Insurance premiums for
the
first quarter of 2007 increased modestly compared to the same period in 2006
as
part of Jefferson-Pilot prior to the merger. Both the non-medical portion and
the medical portion of the business increased over comparable prior year
periods.
Sales
decreased for the first quarter of 2007 compared to the comparable period as
part of Jefferson-Pilot in 2006. Sales of larger cases (over 500 lives) were
the
primary contributor to this decrease,
which
are down 33%, reflective of an exceptionally competitive market. Sales showed
continued growth in the core under 200 lives segment, which were up 3% over
first quarter 2006 results. Sales in the voluntary lines, an area of focus
due
to favorable pricing characteristics, were up 6% over first quarter
2006.
Benefits
and Expenses
Policy
benefits reflect a total non-medical loss ratio of 72.7% for the first quarter
of 2007, reflecting loss ratios in line with expectations for all products.
The
discount rate used to calculate reserves for newly incurred long-term disability
and life waiver claims is 5.25%. Underwriting, acquisition, insurance and other
expenses for the first quarter of 2007 were at unit expense levels comparable
to
prior periods as part of Jefferson-Pilot. Excluding the effects of DAC and
VOBA,
these expenses decreased as a percentage of earned premiums compared to the
same
period in 2006 due to lower costs associated with general and administrative
expenses. Net of DAC and VOBA, and reflecting other expenses including
commissions, taxes, licenses and fees, total unit expenses decreased from prior
periods, principally due to lower VOBA amortization as a result of
implementation of SOP 05-1 and purchase accounting relative to DAC amortization
recorded as part of Jefferson-Pilot for the first quarter in 2006, partially
offset by an increase in commissions.
RESULTS
OF INVESTMENT MANAGEMENT
The
Investment Management segment, through Delaware Investments, provides a broad
range of managed account portfolios, mutual funds, subadvised funds, and other
investment products to individual investors and to institutional investors
such
as private and public pension funds, foundations, and endowment funds. Delaware
Investments is the marketing name for Delaware Management Holdings, Inc.
and its subsidiaries. For factors that could cause actual results to differ
materially from those set forth in this section, see “Part I - Item 1 - Risk
Factors” in our 2006 Form 10-K and “Forward-looking Statements - Cautionary
Language” in this report.
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
Operating
Summary (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
Investment
advisory fees
|
|
$
|
90
|
|
$
|
78
|
|
|
15
|
%
|
Investment
advisory fees - insurance-related
|
|
|
25
|
|
|
25
|
|
|
-
|
|
Other
revenues and fees
|
|
|
35
|
|
|
37
|
|
|
-5
|
%
|
Total
operating revenues
|
|
|
150
|
|
|
140
|
|
|
7
|
%
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Operating
and administrative expenses
|
|
|
125
|
|
|
116
|
|
|
8
|
%
|
Total
operating expenses
|
|
|
125
|
|
|
116
|
|
|
8
|
%
|
Income
from operations before taxes
|
|
|
25
|
|
|
24
|
|
|
4
|
%
|
Federal
income taxes
|
|
|
9
|
|
|
8
|
|
|
13
|
%
|
Income
from operations
|
|
$
|
16
|
|
$
|
15
|
|
|
7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Margin
Data
|
|
|
|
|
|
|
|
|
|
|
Pre-tax
operating margin
|
|
|
17.0
|
%
|
|
16.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
|
|
Assets
under management at March 31, (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Retail-equity
|
|
$
|
40,250
|
|
$
|
36,500
|
|
|
10
|
%
|
Retail-fixed
|
|
|
11,645
|
|
|
9,761
|
|
|
19
|
%
|
Total
retail
|
|
|
51,895
|
|
|
46,261
|
|
|
12
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Institutional-equity
|
|
|
22,782
|
|
|
22,905
|
|
|
-1
|
%
|
Institutional-fixed
|
|
|
23,469
|
|
|
17,262
|
|
|
36
|
%
|
Total
institutional
|
|
|
46,251
|
|
|
40,167
|
|
|
15
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Insurance-related
assets
|
|
|
67,292
|
|
|
41,995
|
|
|
60
|
%
|
Total
assets under management
|
|
$
|
165,438
|
|
$
|
128,423
|
|
|
29
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Total
Sub-advised Assets, included in above amounts
|
|
|
|
|
|
|
|
|
|
|
Retail
|
|
$
|
18,466
|
|
$
|
17,320
|
|
|
7
|
%
|
Institutional
|
|
|
4,645
|
|
|
5,608
|
|
|
-17
|
%
|
Total
sub-advised assets at the end of the period
|
|
$
|
23,111
|
|
$
|
22,928
|
|
|
1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Improvement
|
|
Net
flows (in millions)
|
|
2007
|
|
2006
|
|
(Worsening)
|
|
Retail
|
|
|
|
|
|
|
|
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
$
|
2,238
|
|
$
|
3,069
|
|
|
-27
|
%
|
Redemptions
and transfers
|
|
|
(2,475
|
)
|
|
(1,853
|
)
|
|
-34
|
%
|
Net
flows-equity
|
|
|
(237
|
)
|
|
1,216
|
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
income
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
|
1,365
|
|
|
951
|
|
|
44
|
%
|
Redemptions
and transfers
|
|
|
(895
|
)
|
|
(861
|
)
|
|
-4
|
%
|
Net
flows-fixed income
|
|
|
470
|
|
|
90
|
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
retail
|
|
|
|
|
|
|
|
|
|
|
Sales
|
|
|
3,603
|
|
|
4,020
|
|
|
-10
|
%
|
Redemptions
and transfers
|
|
|
(3,370
|
)
|
|
(2,714
|
)
|
|
-24
|
%
|
Net
flows-total retail
|
|
|
233
|
|
|
1,306
|
|
|
-82
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Institutional
|
|
|
|
|
|
|
|
|
|
|
Equity
|
|
|
|
|
|
|
|
|
|
|
Inflows
|
|
|
870
|
|
|
1,964
|
|
|
-56
|
%
|
Withdrawals
and transfers
|
|
|
(2,273
|
)
|
|
(1,007
|
)
|
|
NM
|
|
Net
flows-equity
|
|
|
(1,403
|
)
|
|
957
|
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
income
|
|
|
|
|
|
|
|
|
|
|
Inflows
|
|
|
1,560
|
|
|
3,080
|
|
|
-49
|
%
|
Withdrawals
and transfers
|
|
|
(479
|
)
|
|
(444
|
)
|
|
-8
|
%
|
Net
flows-fixed income
|
|
|
1,081
|
|
|
2,636
|
|
|
-59
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Total
institutional
|
|
|
|
|
|
|
|
|
|
|
Inflows
|
|
|
2,430
|
|
|
5,044
|
|
|
-52
|
%
|
Withdrawals
and transfers
|
|
|
(2,752
|
)
|
|
(1,451
|
)
|
|
-90
|
%
|
Net
flows-total institutional
|
|
|
(322
|
)
|
|
3,593
|
|
|
NM
|
|
|
|
|
|
|
|
|
|
|
|
|
Combined
Retail and Institutional
|
|
|
|
|
|
|
|
|
|
|
Sales/inflows
|
|
|
6,033
|
|
|
9,064
|
|
|
-33
|
%
|
Redemptions,
withdrawals and transfers
|
|
|
(6,122
|
)
|
|
(4,165
|
)
|
|
-47
|
%
|
Net
flows-combined retail and institutional
|
|
$
|
(89
|
)
|
$
|
4,899
|
|
|
NM
|
|
Note: Sales/inflows
include transfer in kind purchases, contributions and dividend reinvestment.
The
table above excludes the transfer of $780 million in assets to other
operations.
Comparison
of the Three Months Ended March 31, 2007 to 2006
Income
from operations for the first quarter of 2007 was $16 million compared to $15
million for the same period in 2006. The growth in earnings was primarily driven
by an increase in third-party assets under management and cost containment
initiatives. The segment’s pre-tax operating margin for the first quarter of
2007 was approximately 17%, slightly better than the first quarter of 2006.
Pre-tax operating margin is determined by dividing pre-tax income by operating
revenue.
Revenues,
Deposits and Net Flows
Investment
advisory fees increased 15% for the first quarter of 2007 compared to the
same
period in 2006 due to a higher average level of third-party assets under
management, changes in product mix and equity market returns. Aside from
the
assets acquired in the merger with Jefferson-Pilot, we believe that changes
in
the management of certain asset category offerings and the recognition in
the
marketplace of improving investment performance are drivers of the increase
in
the asset base. The average level of the equity markets was higher for the
first
quarter of 2007 compared to the same period in 2006, resulting in higher
fee
income. Excluding the impact of dividends, the S&P 500 Index® at March 31,
2007 was 9.7% higher than at March 31, 2006 and the average daily S&P 500
Index® for the first quarter 2007 was 11.1% higher than the first quarter of
2006.
Investment
advisory fees include amounts that are ultimately paid to sub-advisors for
managing the sub-advised assets. The amounts paid to sub-advisors are generally
included in the segment’s expenses. In addition, included in the investment
advisory fees—external are fees earned from managing funds included within our
variable annuity and life insurance products.
Investment
advisory fees - insurance-related consists of fees for asset management services
this segment provides for our general account assets supporting our fixed
products and surplus, including those of the Individual and Employer Markets
businesses. In the second quarter of 2006, we lowered the fees being charged
for
this service on assets managed to 9 basis points on assets managed from 16
basis
points. The effect on revenue was generally offset by an increase in general
account assets from the Jefferson-Pilot merger.
Net
flows
for the twelve months ended March 31, 2007, were $0.1 billion in retail and
$4.1
billion in institutional. Market value gains were $5.5 billion in retail and
$2.8 billion in institutional for the same period.
The
level
of net flows may vary considerably from period to period, and therefore results
in one period are not indicative of net flows in subsequent periods. While
we
expect investment performance to remain solid and look for positive net flows
in
2007, capacity constraints in certain investment strategies may limit growth
relative to the current year.
Expenses
Operating
and administrative expenses increased 8% for the first quarter of 2007 compared
to the same period in 2006, primarily reflecting the net effect of: increases
in
expenses that vary with levels of assets and revenues; modest increased spending
on technology and communications to further support the segment’s growing level
of assets; and cost containment initiatives.
Effective
May 1, 2007, the investment advisory role for the Lincoln Variable Insurance
Trust, a product within our Employer Markets business, transitioned from
Delaware to another internal advisor. In the role of investment advisor,
Delaware provided investment performance and compliance oversight on third-party
investment managers in exchange for a minimal fee. Delaware will continue
to manage certain of the assets as a sub-advisor. As a result of this
change, the Investment Management assets under management will decrease by
approximately $3 billion, with a related reduction in Investment advisory fees
-
insurance-related and associated expenses. The annual impact to the
segment’s income from operations is expected to be a reduction of approximately
$2 million after-tax. There is no impact to our consolidated assets under
management or net income.
RESULTS
OF LINCOLN UK
Lincoln
UK is headquartered in Barnwood, Gloucester, England, and is licensed to do
business throughout the United Kingdom. Lincoln UK primarily focuses on
protecting and enhancing the value of its existing customer base. The segment
accepts new deposits from existing relationships and markets a limited range
of
new products. Beginning in 2006 and continuing into 2007, Lincoln UK began
participating in our overall RISV initiative and we expect to introduce
retirement income product solutions into the U.K. marketplace. Lincoln UK’s
product portfolio principally consists of unit-linked life and pension
products, which are similar to U.S. produced variable life and annuity products,
where the risk associated with the underlying investments is borne by the
policyholders. For factors that could cause actual results to differ materially
from those set forth in this section, see “Part I - Item 1 - Risk Factors” in
our 2006 Form 10-K and “Forward-looking Statements - Cautionary Language” in
this report.
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
Operating
Summary (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$
|
24
|
|
$
|
17
|
|
|
41
|
%
|
Insurance
fees
|
|
|
47
|
|
|
36
|
|
|
31
|
%
|
Net
investment income
|
|
|
20
|
|
|
17
|
|
|
18
|
%
|
Total
operating revenues
|
|
|
91
|
|
|
70
|
|
|
30
|
%
|
|
|
|
|
|
|
|
|
|
|
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Insurance
benefits
|
|
|
36
|
|
|
25
|
|
|
44
|
%
|
Underwriting,
acquisition, insurance and other expenses
|
|
|
38
|
|
|
28
|
|
|
36
|
%
|
Total
operating expenses
|
|
|
74
|
|
|
53
|
|
|
40
|
%
|
Income
from operations before taxes
|
|
|
17
|
|
|
17
|
|
|
0
|
%
|
Federal
income taxes
|
|
|
6
|
|
|
6
|
|
|
0
|
%
|
Income
from operations
|
|
$
|
11
|
|
$
|
11
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
|
|
March
31, (in millions, except exchange rate)
|
|
|
2007
|
|
|
2006
|
|
|
(Decrease)
|
|
Unit-linked
assets
|
|
$
|
8,906
|
|
$
|
7,754
|
|
|
15
|
%
|
Individual
life insurance in-force
|
|
|
19,307
|
|
|
17,744
|
|
|
9
|
%
|
Exchange
rate ratio-U.S. dollars to pounds sterling:
|
|
|
|
|
|
|
|
|
|
|
Average
for the period
|
|
|
1.964
|
|
|
1.754
|
|
|
12
|
%
|
End
of period
|
|
|
1.968
|
|
|
1.737
|
|
|
13
|
%
|
Comparison
of the Three Months Ended March 31, 2007 to 2006
Revenues
For
the
first quarter of 2007, the average exchange rate for the U.S. dollar relative
to
the British pound sterling increased 12% compared to the same period in 2006.
Excluding the effect of the exchange rate, insurance premiums increased 26%
for
the first quarter of 2007 compared to the same period in 2006, reflecting an
increase in the annuitization of vesting pension policies. The receipt of these
premiums results in a corresponding increase in benefits. Our annualized policy
lapse rate for the first quarter in 2007 was 6.7% compared to 6.8% for the
same
period in 2006, as measured by the number of policies in-force. Excluding the
effects of exchange rates, insurance fees increased 17% for the first quarter
of
2007 compared to the same period in 2006.
The
segment is sensitive to changes in the foreign currency exchange rate between
the U.S. dollar and the British pound sterling. A significant increase/decrease
in the value of the U.S. dollar relative to the British pound has a significant
adverse effect on the segment’s operating results. Although the use of the
enhanced reversion to the mean process has lessened the impact of short-term
volatility of the equity markets, the segment also remains subject to volatility
in the equity markets on fee income.
Expenses
Operating
expenses were 40% higher for the first quarter of 2007 compared to the same
period in 2006. Excluding the effect of the exchange rate, operating expenses
were 25% higher for the first quarter of 2007 compared to the same period in
2006. Increased expenses were due to investment in developing our Retirement
Income strategy as well as an additional provision of $2 million before taxes
to
cover costs associated with the UK selling practice matters discussed
below.
Lincoln
UK maintains reserves established in 1997 and 1999 for mis-selling activities.
On an ongoing basis, Lincoln UK evaluates various assumptions underlying these
estimated liabilities, including the expected levels of future complaints and
the potential implications with respect to the adequacy of the aggregate
liability associated with UK selling practice matters. We increased our
provision by $2 million in the first quarter of 2007 due to remedial work that
we carried out following the Financial Services Authority (FSA) review of our
complaints handling process late in 2006. Future changes in complaint levels
could effect Lincoln UK’s ultimate exposure to mis-selling issues, although we
believe that any future change would not materially effect our consolidated
financial position.
The
services provided to the segment under the Capita agreement are currently deemed
to be exempt from value added tax (“VAT”), which is levied at the rate of 17.5%.
The European Commission is currently reviewing the application of VAT to
insurance and financial services. The timing of this review and how it will
impact our arrangement with Capita is uncertain and not likely to be resolved
in
the near future. Future changes in the application of VAT to Lincoln UK’s
outsourcing arrangement with Capita could impact the segment’s results, although
we believe that any future change would not materially affect our consolidated
financial position.
RESULTS
OF LINCOLN FINANCIAL MEDIA
The
Lincoln Financial Media segment consists of 18 radio and 3 television
broadcasting stations located in selected markets in the Southeastern and
Western United States and also produces and distributes syndicated collegiate
basketball and football sports programming. Operations of this segment were
acquired in the April 2006 merger with Jefferson-Pilot. Therefore, its results
are not included in our consolidated results for the first quarter of 2006.
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I - Item 1 - Risk Factors” in our 2006 Form
10-K and “Forward-looking Statements - Cautionary Language” in this
report.
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
|
|
|
|
Operating
Summary (in millions)
|
|
2007
|
|
Operating
Revenue
|
|
|
|
|
Communications
revenues (net)(1)
|
|
$
|
67
|
|
|
|
|
|
|
Operating
Expenses
|
|
|
|
|
Operating
expenses
|
|
|
48
|
|
|
|
|
|
|
Income
from operations before taxes
|
|
|
19
|
|
Federal
income taxes
|
|
|
7
|
|
Income
from Operations
|
|
$
|
12
|
|
(1)
Communications
revenues are net of commissions of $8 million paid to agencies.
Communications
revenues for the first quarter of 2007 increased 10% compared to the same period
in 2006, as part of Jefferson-Pilot prior to the merger. Income from operations
for this segment was $12 million for the first quarter of 2007. Profitability
for Lincoln Financial Media is seasonal and is principally influenced by such
factors as retail events, special and sporting events and political advertising.
RESULTS
OF OTHER OPERATIONS
Other
Operations includes investments related to the excess capital in our insurance
subsidiaries, other corporate investments, benefit plan net assets, and the
unamortized deferred gain on the indemnity reinsurance portion of the sales
transaction for our former reinsurance segment, which was sold to Swiss Re
Life
& Health America Inc. (“Swiss Re”) in 2001. Income (loss) from operations
for Other Operations includes earnings on invested excess capital and other
investments, amortization of the deferred gain on the indemnity reinsurance
portion of the transaction with Swiss Re, interest expense on corporate debt,
interest credited on
corporate reinsurance and
expenses that are corporate in nature such as merger-related expenses,
restructuring costs, branding, charitable contributions, certain litigation
reserves and other expenses not allocated to our business segments. Other
Operations also includes the eliminations of intercompany transactions and
the
inter-segment elimination of the investment advisory fees for asset management
services the Investment Management segment provides to Individual Markets and
Employer Markets.
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I - Item 1 - Risk Factors” in our 2006 Form
10-K and “Forward-looking Statements - Cautionary Language” in this
report.
|
|
Three
Months Ended
|
|
|
|
|
|
March
31,
|
|
Increase
|
|
Operating
Summary (in millions)
|
|
2007
|
|
2006
|
|
(Decrease)
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
|
Premiums
|
|
$
|
2
|
|
$
|
-
|
|
|
NM
|
|
Net
investment income
|
|
|
47
|
|
|
40
|
|
|
18
|
%
|
Amortization
of deferred gain on indemnity reinsurance
|
|
|
19
|
|
|
19
|
|
|
0
|
%
|
Other
revenue and fees
|
|
|
(3
|
)
|
|
(2
|
)
|
|
-50
|
%
|
Inter-segment
elimination of investment advisory fees
|
|
|
(25
|
)
|
|
(25
|
)
|
|
0
|
%
|
Total
operating revenues
|
|
|
40
|
|
|
32
|
|
|
25
|
%
|
Operating
Expenses
|
|
|
|
|
|
|
|
|
|
|
Insurance
benefits
|
|
|
6
|
|
|
2
|
|
|
200
|
%
|
Interest
credited to contractholder funds
|
|
|
37
|
|
|
34
|
|
|
9
|
%
|
Insurance
and other expenses
|
|
|
20
|
|
|
2
|
|
|
NM
|
|
Interest
and debt expense
|
|
|
61
|
|
|
21
|
|
|
190
|
%
|
Inter-segment
elimination of investment advisory fees
|
|
|
(25
|
)
|
|
(25
|
)
|
|
0
|
%
|
Total
operating expenses
|
|
|
99
|
|
|
34
|
|
|
191
|
%
|
Income
(loss) from operations before taxes
|
|
|
(59
|
)
|
|
(2
|
)
|
|
NM
|
|
Federal
income taxes
|
|
|
(24
|
)
|
|
(2
|
)
|
|
NM
|
|
Income
(loss) from operations
|
|
$
|
(35
|
)
|
$
|
-
|
|
|
NM
|
|
Comparison
of the Three Months Ended March 31, 2007 to 2006
Revenues
Net
investment income increased 18% for the first quarter of 2007 compared to
the
same period in 2006. The increase in net income for the first quarter of
2007 is
due primarily to the addition of Jefferson-Pilot companies. 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. Other Operations is impacted by
the
statutory surplus needs of our insurance segments and merger-related expenses.
If regulations require increases in our insurance segments’ statutory reserves
and surplus the Other Operations segment investment income will be negatively
impacted.
Operating
Expenses
Operating
expenses increased 191% for the first quarter of 2007 compared to the same
period in 2006 primarily due to the merger with Jefferson-Pilot. Operating
expenses for the first quarter of 2007 include $14 million in merger-related
integration costs, including restructuring charges. We expect our merger-related
integration costs will increase to approximately $24 million in the second
quarter of 2007. See Note 12 to the consolidated financial statements for
additional information.
On
May 1,
2007, we announced plans to change the retirement benefits provided to
employees, which include replacing traditional pension retirement benefits
with
a new defined contribution plan beginning January 1, 2008. For additional
details, see Note 13 of our consolidated financial statements.
Interest
credited to contractholder funds increased 9% for the first quarter of 2007
compared to the same period in 2006 with the increase primarily attributable
to
the merger with Jefferson-Pilot companies on business in run-off. The majority
of the interest credited to policyholders 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 financial statements. The interested credited corresponds
to
investment income earnings on the assets we continue to hold for this business.
There is no impact to the income or loss in Other Operations or to our
consolidated income.
Interest
on debt for the first quarter of 2007 increased 190% compared to the same period
in 2006. Corporate borrowings increased $3.4 billion, including approximately
$2.1 billion used to finance the $1.8 billion cash portion of the
Jefferson-Pilot
merger
consideration and the $1.0 billion stock repurchase. The increase also includes
$0.9 billion for the fair value of Jefferson-Pilot corporate debt. The timing
and/or discretionary nature of uses of cash for the repurchase of stock,
incentive compensation and the availability of funds from our cash management
account may result in changes in external financing and volatility in interest
expense. For additional information on our financing activities, see “Review of
Consolidated Financial Condition—Liquidity and Cash Flow—Sources of Liquidity
and Cash Flow—Financing Activities.”
The
effective tax rate was 39.7% for the three months ended March 31, 2007 compared
to 107.6% for the same period in 2006. The difference is primarily due to the
proportion of the affordable housing credits to the loss from operations before
taxes. In the first quarter of 2007, the credit was $1 million against a loss
of
$59 million verses a credit of $1 million against a loss of only $2 million
for
the same period of 2006, creating a proportionally higher effective tax
rate.
CONSOLIDATED
INVESTMENTS
The
following table presents consolidated invested assets, net investment income
and
investment yield.
|
|
March
31,
|
|
December
31,
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
2006
|
|
Total
consolidated investments (at fair value)
|
|
$
|
71,849
|
|
$
|
71,488
|
|
$
|
42,573
|
|
Average
invested assets at amortized cost (1)
|
|
|
69,906
|
|
|
64,099
|
|
|
44,364
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
Months Ended March 31,
|
|
|
Increase
|
|
(in
millions)
|
|
|
2007
|
|
|
2006
|
|
|
(Decrease)
|
|
Net
investment income
|
|
$
|
1,090
|
|
$
|
680
|
|
|
60
|
%
|
Investment
yield (ratio of net investment
|
|
|
|
|
|
|
|
|
|
|
income
to average invested assets)
|
|
|
6.24
|
%
|
|
6.13
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Items
included in net investment income:
|
|
|
|
|
|
|
|
|
|
|
Limited
partnership investment income
|
|
$
|
19
|
|
$
|
11
|
|
|
73
|
%
|
Prepayment
and makewhole premiums
|
|
|
15
|
|
|
10
|
|
|
50
|
%
|
Consent
fees
|
|
|
7
|
|
|
1
|
|
|
NM
|
|
Standby
real estate equity commitments
|
|
|
4
|
|
|
4
|
|
|
0
|
%
|
(1) Based
on
the average of invested asset balances at the beginning and ending of each
quarter within the year.
The
total
investment portfolio increased $362 million during the first quarter of 2007.
The increase was primarily the result of purchases of investments as a result
of
cash flow generated by our business segments.
The
quality of our available-for-sale fixed maturity securities portfolio, as
measured at fair value and by the percentage of fixed maturity securities
invested in various ratings categories, relative to the entire
available-for-sale fixed maturity security portfolio, as of March 31, 2007,
was
as follows:
(in
millions)
|
|
|
|
|
|
|
|
|
|
NAIC
Designation
|
|
Rating
Agency Equivalent Designation
|
|
Amortized
Cost
|
|
Estimated
Fair
Value
|
|
%
of Total
|
|
1
|
|
AAA
/ AA / A |
|
$
|
33,369
|
|
$
|
33,936
|
|
|
60.3
|
%
|
2
|
|
BBB |
|
|
18,634
|
|
|
18,945
|
|
|
33.7
|
%
|
3
|
|
BB |
|
|
2,121
|
|
|
2,172
|
|
|
3.9
|
%
|
4
|
|
B |
|
|
978
|
|
|
1,024
|
|
|
1.8
|
%
|
5
|
|
CCC
and lower |
|
|
148
|
|
|
162
|
|
|
0.3
|
%
|
6
|
|
In
or near default |
|
|
18
|
|
|
17
|
|
|
0.0
|
%
|
|
|
|
|
|
$
|
55,268
|
|
$
|
56,256
|
|
|
100.0
|
%
|
The
National Association of Insurance Commissioners (“NAIC”) assigns securities
quality ratings and uniform valuations called “NAIC Designations” which are used
by insurers when preparing their annual statements. The NAIC assigns
designations to publicly traded as well as privately placed securities. The
designations assigned by the NAIC range from class 1 to class 6, with
designations in classes 1 and 2 generally considered investment grade.
Fixed
maturity securities available-for-sale invested in below investment grade
securities (NAIC designations 3 through 6) were $3.4 billion, or 6.0% and $3.7
billion, or 6.6%, of all fixed maturity securities available-for-sale, as of
March 31, 2007 and December 31, 2006, respectively. This represents 4.7% of
the
total investment portfolio at March 31, 2007 compared to 5.2% at December 31,
2006. On an amortized cost basis, below investment grade securities represented
5.9% of available-for-sale fixed maturity securities at March 31, 2007 compared
to 6.5% at December 31, 2006.
Fixed
Maturity and Equity Securities Portfolios:
Fixed
maturity securities and equity securities consist of portfolios classified
as
available-for-sale and trading. Mortgage-backed and private securities are
included in both available-for-sale and trading portfolios.
Available-for-Sale:
Securities that are classified as available-for-sale are carried at fair value
in our Consolidated Balance Sheets and make up 95% of our fixed maturity and
equity securities portfolio. The fair value for all private securities was
$7.4
billion at March 31, 2007 compared to $7.1 billion at December 31, 2006,
representing approximately 10% of total invested assets, at the end of each
period.
Trading
Securities:
Trading
securities, which support certain funds withheld and modified coinsurance
arrangements (“Modco”), are carried at fair value and changes in fair value are
recorded in net income as they occur. Investment results for these portfolios,
including gains and losses from sales, are passed directly to the reinsurers
through the contractual terms of the reinsurance arrangements. Offsetting these
amounts are corresponding changes in the fair value of the embedded derivative
liability associated with the underlying reinsurance arrangement.
Mortgage-Backed
Securities: Our
fixed
maturity securities include mortgage-backed securities. These securities are
subject to risks associated with variable prepayments. This may result in
differences between the actual cash flow and maturity of these securities than
that expected at the time of purchase. We limit the extent of our risk on
mortgage-backed securities by prudently limiting exposure to the asset class,
by
generally avoiding the purchase of securities with a cost that significantly
exceeds par, by purchasing securities backed by stable collateral, and by
concentrating on securities with enhanced priority in their trust structure.
Such securities with reduced risk typically have a lower yield (but higher
liquidity) than higher-risk mortgage-backed securities. At selected times,
higher-risk securities may be purchased if they do not compromise the safety
of
the general portfolio. At March 31, 2007, we did not have a significant amount
of higher-risk mortgage-backed securities.
Mortgage
Loans on Real Estate: The
following summarizes key information on mortgage loans:
|
|
March
31,
|
|
December
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Total
portfolio (net of reserves)
|
|
$
|
7,416
|
|
$
|
7,384
|
|
Percentage
of total investment portfolio
|
|
|
10.3
|
%
|
|
10.3
|
%
|
Percentage
of investment by property type:
|
|
|
|
|
|
|
|
Commercial
office buildings
|
|
|
33.6
|
%
|
|
33.6
|
%
|
Retail
stores
|
|
|
24.2
|
%
|
|
24.7
|
%
|
Industrial
buildings
|
|
|
23.2
|
%
|
|
22.0
|
%
|
Apartments
|
|
|
10.8
|
%
|
|
11.1
|
%
|
Hotels/motels
|
|
|
6.1
|
%
|
|
6.4
|
%
|
Other
|
|
|
2.1
|
%
|
|
2.2
|
%
|
|
|
|
|
|
|
|
|
Impaired
mortgage loans
|
|
$
|
29
|
|
$
|
29
|
|
Impaired
mortgage loans as a percentage of total mortgage loans
|
|
|
0.4
|
%
|
|
0.4
|
%
|
Restructured
loans in good standing
|
|
$
|
58
|
|
$
|
59
|
|
Reserve
for mortgage loans
|
|
|
2
|
|
|
2
|
|
In
addition to the dispersion by property type, the mortgage loan portfolio is
geographically diversified throughout the United States.
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 current emphasis are the hotel, retail, office and industrial
properties that have deteriorating credits or have experienced debt coverage
reduction. Where warranted, we have established or increased loss reserves
based
upon this analysis. Impaired mortgage loans were 0.4% of total mortgage loans
as
of March 31, 2007 and December 31, 2006, respectively. As of March 31, 2007
we
had one commercial mortgage loan that was two or more payments delinquent
compared to two as of December 31, 2006. The total principal and interest due
on
these loans as of March 31, 2007 and December 31, 2006 was less than $1 million.
Limited
Partnership Investments:
As of
March 31, 2007 and December 31, 2006, our consolidated investments included
investments in limited partnership of $577 million and $529 million,
respectively. As of March 31, 2007 and December 31,2006, these include
investments in approximately 75 and 71 different partnerships, respectively,
that allow us to gain exposure to a broadly diversified portfolio of asset
classes such as venture capital, hedge funds, and oil and gas. The partnerships
do not represent off-balance sheet financing and generally involve several
third-party partners. Select 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 pose no threat to our liquidity. Limited partnership investments are
accounted for using the equity method of accounting and the majority of these
investments are included in other investments in our Consolidated Balance
Sheets.
Net
Investment Income: Net
investment income increased 60% for the first quarter of 2007 compared to the
same period in 2006. Excluding commercial mortgage loan prepayment, bond
makewhole premiums and fees received from the standby real estate equity
commitments financing program, the increase in net investment income primarily
reflects higher portfolio yields and higher invested assets due to the April
2006 Jefferson-Pilot merger, which added $27.9 billion in invested
assets.
As
of
March 31, 2007 and December 31, 2006, the carrying amount of fixed maturity
securities, mortgage loans on real estate and real estate that were non-income
producing was $29 million and $40 million, respectively.
The
following discussion addresses our invested assets excluding trading account
securities. As discussed above, investment results attributable to the trading
securities are passed to the reinsurers under the terms of the reinsurance
arrangements.
Realized
Gains and Losses on Investments and Derivative Instruments:
We had
net pre-tax realized gains (losses) on investments and derivatives of $26
million and $(7) million for the first quarter of 2007 and 2006, respectively.
Prior to the amortization of DAC, provision for policyholder commitments and
investment expenses, pre-tax realized gains were $46 million and $8 million
for
the first quarter of 2007 and 2006, respectively.
The
gross
realized gains on fixed maturity and equity securities were $57 million and
$24
million, for the first quarter of 2007 and 2006, respectively. Gross realized
losses on fixed maturity and equity securities were $11 million and $20 million,
respectively. Included in losses for fixed maturities and equity securities
are
write-downs for impairments of $4 million and $2 million for the first quarter
of 2007 and 2006, respectively.
For
additional information regarding our process for determining whether declines
in
fair value of securities available-for-sale are other than temporary, see
“Critical Accounting Policies - Write-Downs for Other-Than Temporary Impairments
and Allowance for Losses” in our 2006 Form 10-K.
Unrealized
Gains and Losses—Available-for-Sale Securities: When
considering unrealized gain and loss information, it is important to realize
that the information relates to the status of securities is at a particular
point in time, and may not be indicative of the status of our investment
portfolios subsequent to the balance sheet date. Further, since the timing
of
the recognition of realized investment gains and losses through the selection
of
which securities are sold is largely at management’s discretion, it is important
to consider the information provided below within the context of the overall
unrealized gain or loss position of our investment portfolios. These are
important considerations that should be included in any evaluation of the
potential impact of unrealized loss securities on our future earnings. At March
31, 2007 and December 31, 2006, gross unrealized gains on securities
available-for-sale were $1.3 billion and $1.3 billion, respectively, and gross
unrealized losses on securities available-for-sale were $328 million and $373
million, respectively. At March 31, 2007, gross unrealized gains and losses
on
fixed maturity securities available-for-sale were $1.3 billion and $328 million,
and gross unrealized gains and losses on equity securities available-for-sale
were $32 million and none. At December 31, 2006, gross unrealized gains and
losses on fixed maturity securities available-for-sale were $1.3 billion and
$371 million, and gross unrealized gains and losses on equity securities
available-for-sale were $22 million and $2 million. Changes in unrealized gains
and losses can be attributed to changes in interest rates and credit spreads,
which have created temporary price fluctuations.
For
total
publicly traded and private securities that we held at March 31, 2007 that
were
in an unrealized loss position, the fair value, amortized cost, unrealized
loss
and total time period that the security has been in an unrealized loss position
are presented in the table below:
|
|
Fair
|
|
%
Fair
|
|
Amortized
|
|
%
Amortized
|
|
Unrealized
|
|
%
Unrealized
|
|
(in
millions)
|
|
Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
<
= 90 days
|
|
$
|
6,186
|
|
|
37.2
|
%
|
$
|
6,272
|
|
|
37.0
|
%
|
$
|
(86
|
)
|
|
26.2
|
%
|
>
90 days but < 180 days
|
|
|
1,353
|
|
|
8.1
|
%
|
|
1,372
|
|
|
8.1
|
%
|
|
(19
|
)
|
|
5.8
|
%
|
>
180 days but < 270 days
|
|
|
289
|
|
|
1.7
|
%
|
|
301
|
|
|
1.8
|
%
|
|
(12
|
)
|
|
3.7
|
%
|
>
270 days but < 1 year
|
|
|
1,408
|
|
|
8.5
|
%
|
|
1,433
|
|
|
8.4
|
%
|
|
(25
|
)
|
|
7.6
|
%
|
>
1 year
|
|
|
7,410
|
|
|
44.5
|
%
|
|
7,596
|
|
|
44.7
|
%
|
|
(186
|
)
|
|
56.7
|
%
|
Total
|
|
$
|
16,646
|
|
|
100.0
|
%
|
$
|
16,974
|
|
|
100.0
|
%
|
$
|
(328
|
)
|
|
100.0
|
%
|
The
composition by industry categories of all securities in unrealized loss status,
which we held at March 31, 2007, is presented in the table below:
|
|
Fair
|
|
%
Fair
|
|
Amortized
|
|
%
Amortized
|
|
Unrealized
|
|
%
Unrealized
|
|
(in
millions)
|
|
Value
|
|
Value
|
|
Cost
|
|
Cost
|
|
Loss
|
|
Loss
|
|
Banking
|
|
$
|
1,555
|
|
|
9.3
|
%
|
$
|
1,592
|
|
|
9.4
|
%
|
$
|
(37
|
)
|
|
11.3
|
%
|
Collateralized
mortgage obligations ("CMO")
|
|
|
1,973
|
|
|
12.0
|
%
|
|
2,002
|
|
|
11.9
|
%
|
|
(29
|
)
|
|
8.9
|
%
|
Electric
|
|
|
1,172
|
|
|
7.0
|
%
|
|
1,193
|
|
|
7.0
|
%
|
|
(21
|
)
|
|
6.5
|
%
|
ABS
|
|
|
1,270
|
|
|
7.6
|
%
|
|
1,289
|
|
|
7.6
|
%
|
|
(19
|
)
|
|
5.8
|
%
|
CMBS
|
|
|
982
|
|
|
5.9
|
%
|
|
997
|
|
|
5.9
|
%
|
|
(15
|
)
|
|
4.6
|
%
|
Automotive
|
|
|
196
|
|
|
1.2
|
%
|
|
208
|
|
|
1.2
|
%
|
|
(12
|
)
|
|
3.7
|
%
|
Distributors
|
|
|
333
|
|
|
2.0
|
%
|
|
344
|
|
|
2.0
|
%
|
|
(11
|
)
|
|
3.4
|
%
|
Food
and Beverage
|
|
|
505
|
|
|
3.0
|
%
|
|
515
|
|
|
3.0
|
%
|
|
(10
|
)
|
|
3.0
|
%
|
Retailers
|
|
|
283
|
|
|
1.7
|
%
|
|
292
|
|
|
1.7
|
%
|
|
(9
|
)
|
|
2.7
|
%
|
Sovereigns
|
|
|
337
|
|
|
2.0
|
%
|
|
346
|
|
|
2.0
|
%
|
|
(9
|
)
|
|
2.7
|
%
|
Media
Non-cable
|
|
|
285
|
|
|
1.7
|
%
|
|
293
|
|
|
1.7
|
%
|
|
(8
|
)
|
|
2.4
|
%
|
Chemicals
|
|
|
215
|
|
|
1.3
|
%
|
|
223
|
|
|
1.3
|
%
|
|
(8
|
)
|
|
2.4
|
%
|
Paper
|
|
|
217
|
|
|
1.3
|
%
|
|
224
|
|
|
1.3
|
%
|
|
(7
|
)
|
|
2.1
|
%
|
Property
& Casualty insurers ("P&C")
|
|
|
472
|
|
|
2.8
|
%
|
|
479
|
|
|
2.8
|
%
|
|
(7
|
)
|
|
2.1
|
%
|
Technology
|
|
|
199
|
|
|
1.2
|
%
|
|
206
|
|
|
1.2
|
%
|
|
(7
|
)
|
|
2.1
|
%
|
Pipelines
|
|
|
349
|
|
|
2.2
|
%
|
|
355
|
|
|
2.1
|
%
|
|
(6
|
)
|
|
1.8
|
%
|
Gaming
|
|
|
141
|
|
|
0.8
|
%
|
|
147
|
|
|
0.9
|
%
|
|
(6
|
)
|
|
1.8
|
%
|
Metals
and Mining
|
|
|
286
|
|
|
1.7
|
%
|
|
292
|
|
|
1.7
|
%
|
|
(6
|
)
|
|
1.8
|
%
|
Government
Sponsored
|
|
|
393
|
|
|
2.4
|
%
|
|
398
|
|
|
2.3
|
%
|
|
(5
|
)
|
|
1.5
|
%
|
Entertainment
|
|
|
263
|
|
|
1.6
|
%
|
|
268
|
|
|
1.6
|
%
|
|
(5
|
)
|
|
1.5
|
%
|
Railroads
|
|
|
231
|
|
|
1.4
|
%
|
|
236
|
|
|
1.4
|
%
|
|
(5
|
)
|
|
1.5
|
%
|
Wirelines
|
|
|
204
|
|
|
1.2
|
%
|
|
208
|
|
|
1.2
|
%
|
|
(4
|
)
|
|
1.2
|
%
|
Real
Estate Investment Trusts ("REITS")
|
|
|
266
|
|
|
1.6
|
%
|
|
270
|
|
|
1.6
|
%
|
|
(4
|
)
|
|
1.2
|
%
|
Consumer
Products
|
|
|
158
|
|
|
0.9
|
%
|
|
162
|
|
|
1.0
|
%
|
|
(4
|
)
|
|
1.2
|
%
|
Industrial
Other
|
|
|
227
|
|
|
1.4
|
%
|
|
231
|
|
|
1.4
|
%
|
|
(4
|
)
|
|
1.2
|
%
|
Home
Construction
|
|
|
179
|
|
|
1.1
|
%
|
|
183
|
|
|
1.1
|
%
|
|
(4
|
)
|
|
1.2
|
%
|
Airlines
|
|
|
37
|
|
|
0.2
|
%
|
|
41
|
|
|
0.2
|
%
|
|
(4
|
)
|
|
1.2
|
%
|
Oil
Field Services
|
|
|
299
|
|
|
1.8
|
%
|
|
302
|
|
|
1.8
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Transportation
Services
|
|
|
173
|
|
|
1.0
|
%
|
|
176
|
|
|
1.0
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Financial
Other
|
|
|
185
|
|
|
1.1
|
%
|
|
188
|
|
|
1.1
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Wireless
|
|
|
112
|
|
|
0.7
|
%
|
|
115
|
|
|
0.7
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Building
Materials
|
|
|
167
|
|
|
1.0
|
%
|
|
170
|
|
|
1.0
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Independent
|
|
|
190
|
|
|
1.1
|
%
|
|
193
|
|
|
1.1
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Conventional
30yr
|
|
|
301
|
|
|
1.8
|
%
|
|
304
|
|
|
1.8
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Brokerage
|
|
|
190
|
|
|
1.1
|
%
|
|
193
|
|
|
1.1
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Owned
No Guarantee
|
|
|
122
|
|
|
0.7
|
%
|
|
125
|
|
|
0.7
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Packaging
|
|
|
134
|
|
|
0.8
|
%
|
|
137
|
|
|
0.8
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Diversified
Manufacturing
|
|
|
249
|
|
|
1.5
|
%
|
|
252
|
|
|
1.5
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Municipal
|
|
|
88
|
|
|
0.5
|
%
|
|
91
|
|
|
0.5
|
%
|
|
(3
|
)
|
|
0.9
|
%
|
Integrated
|
|
|
104
|
|
|
0.6
|
%
|
|
106
|
|
|
0.6
|
%
|
|
(2
|
)
|
|
0.7
|
%
|
Healthcare
|
|
|
185
|
|
|
1.1
|
%
|
|
187
|
|
|
1.1
|
%
|
|
(2
|
)
|
|
0.7
|
%
|
Pharmaceuticals
|
|
|
89
|
|
|
0.5
|
%
|
|
91
|
|
|
0.5
|
%
|
|
(2
|
)
|
|
0.7
|
%
|
Local
Authorities
|
|
|
61
|
|
|
0.4
|
%
|
|
63
|
|
|
0.4
|
%
|
|
(2
|
)
|
|
0.7
|
%
|
Non
Captive Consumer
|
|
|
201
|
|
|
1.2
|
%
|
|
203
|
|
|
1.2
|
%
|
|
(2
|
)
|
|
0.7
|
%
|
Consumer
Cyclical Services
|
|
|
30
|
|
|
0.2
|
%
|
|
32
|
|
|
0.3
|
%
|
|
(2
|
)
|
|
0.7
|
%
|
Non
Captive Diversified
|
|
|
113
|
|
|
0.7
|
%
|
|
114
|
|
|
0.7
|
%
|
|
(1
|
)
|
|
0.3
|
%
|
Non
Agency
|
|
|
65
|
|
|
0.4
|
%
|
|
66
|
|
|
0.4
|
%
|
|
(1
|
)
|
|
0.3
|
%
|
Lodging
|
|
|
127
|
|
|
0.8
|
%
|
|
128
|
|
|
0.8
|
%
|
|
(1
|
)
|
|
0.3
|
%
|
Restaurants
|
|
|
33
|
|
|
0.2
|
%
|
|
34
|
|
|
0.2
|
%
|
|
(1
|
)
|
|
0.3
|
%
|
Utility-Other
|
|
|
54
|
|
|
0.3
|
%
|
|
55
|
|
|
0.3
|
%
|
|
(1
|
)
|
|
0.3
|
%
|
Life
|
|
|
105
|
|
|
0.6
|
%
|
|
106
|
|
|
0.6
|
%
|
|
(1
|
)
|
|
0.3
|
%
|
Industries
with U/R Losses < $1MM
|
|
|
541
|
|
|
3.4
|
%
|
|
549
|
|
|
3.3
|
%
|
|
(8
|
)
|
|
2.4
|
%
|
Total
|
|
$
|
16,646
|
|
|
100.0
|
%
|
$
|
16,974
|
|
|
100.0
|
%
|
$
|
(328
|
)
|
|
100.0
|
%
|
Unrealized
Loss on All Below-Investment-Grade Available-for-Sale Fixed Maturity
Securities:
Gross
unrealized losses on all available-for-sale below-investment-grade securities
were $36 million at March 31, 2007, representing 11% of total gross unrealized
losses on all available-for-sale securities. Generally, below-investment-grade
fixed maturity securities are more likely than investment-grade securities
to
develop credit concerns. The remaining $292 million or 89% of the gross
unrealized losses relate to investment grade available-for-sale securities.
The
ratios of fair value to amortized cost reflected in the table below are not
necessarily indicative of the market value to amortized cost relationships
for
the securities throughout the entire time that the securities have been in
an
unrealized loss position nor are they necessarily indicative of these ratios
subsequent to March 31, 2007.
For
fixed
maturity securities that we held at March 31, 2007 that are below investment
grade and in an unrealized loss position, the fair value, amortized cost,
unrealized loss and the ratios of market value to amortized cost are presented
in the table below.
Aging
Category (in millions)
|
|
Ratio
of Amortized
Cost
to
Fair Value
|
|
Fair
Value
|
|
Amortized
Cost
|
|
Unrealized
Loss
|
|
<=90
days
|
|
|
70%
to 100%
|
|
$
|
197
|
|
$
|
201
|
|
$
|
(4
|
)
|
|
|
|
40%
to 70%
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
Below
40%
|
|
|
-
|
|
|
3
|
|
|
(3
|
)
|
<=90
days total
|
|
|
|
|
|
197
|
|
|
204
|
|
|
(7
|
)
|
>90
days but <=180 days
|
|
|
70%
to 100%
|
|
|
79
|
|
|
82
|
|
|
(3
|
)
|
|
|
|
40%
to 70%
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
Below
40%
|
|
|
-
|
|
|
-
|
|
|
-
|
|
>90
days but <=180 days total
|
|
|
|
|
|
79
|
|
|
82
|
|
|
(3
|
)
|
>180
days but <=270 days
|
|
|
70%
to 100%
|
|
|
54
|
|
|
58
|
|
|
(4
|
)
|
|
|
|
40%
to 70%
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
Below
40%
|
|
|
-
|
|
|
-
|
|
|
-
|
|
>180
days but <=270 days total
|
|
|
|
|
|
54
|
|
|
58
|
|
|
(4
|
)
|
>270
days but <=1 year
|
|
|
70%
to 100%
|
|
|
100
|
|
|
104
|
|
|
(4
|
)
|
|
|
|
40%
to 70%
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
Below
40%
|
|
|
-
|
|
|
-
|
|
|
-
|
|
>270
days but <=1 year total
|
|
|
|
|
|
100
|
|
|
104
|
|
|
(4
|
)
|
>1
year
|
|
|
70%
to 100%
|
|
|
278
|
|
|
296
|
|
|
(18
|
)
|
|
|
|
40%
to 70%
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
Below
40%
|
|
|
-
|
|
|
-
|
|
|
-
|
|
>1
year total
|
|
|
|
|
|
278
|
|
|
296
|
|
|
(18
|
)
|
Total below-investment-grade
|
|
|
|
|
$
|
708
|
|
$
|
744
|
|
$
|
(36
|
)
|
At
March
31, 2007 and December 31, 2006 there were $15 million and $16 million,
respectively, of the publicly traded and private securities held that were
subject to enhanced analysis and monitoring for potential changes in unrealized
loss status. At December 31, 2006, 7.4% of these were rated as investment grade.
There were none at March 31, 2007. At March 31, 2007, all of these securities
are maturing in one year or less. At December 31, 2006, the range of maturity
dates for these securities varied, with 7.4% of these securities maturing in
greater than 10 years and 92.6% maturing in one year or less. At March 31,
2007
and December 31, 2006, 95.7% of total publicly traded and private securities
in
unrealized loss status were rated as investment grade.
As
of
March 31, 2007, gross unrealized losses totaled $328 million compared to $373
million at December 31, 2006. We expect an ultimate recovery of full principal
and interest of our securities with unrealized losses.
Unrealized
Loss on Fixed Maturity Securities Available-for-Sale in Excess of $10
million:
At March
31, 2007, we had no investment grade or non-investment grade available-for-sale
fixed maturity securities with unrealized losses in excess of $10 million.
The
information presented above is subject to rapidly changing conditions. As such,
we expect that the level of securities with overall unrealized losses will
fluctuate, as will the level of unrealized loss securities that are subject
to
enhanced analysis and monitoring. The volatility of financial market conditions
results in increased recognition of both investment gains and losses, as
portfolio risks are adjusted through sales and purchases. As discussed below,
this is consistent with our classification of our investment portfolios as
available-for-sale.
Guaranteed
Investment Contracts: In
April
2007, we invested $450 million in secured limited recourse notes issued by
third-party segregated portfolio companies, in addition to the $400 million
invested in December 2006. These companies entered into a credit default swap
with a third party providing credit protection in exchange for a fee. Defaults
in the underlying reference portfolio will only affect the notes if cumulative
losses of a synthetic reference portfolio exceed the loss attachment point
on
the portfolio. We have determined we are not the primary beneficiary, as we
do
not hold the majority of the risk of loss. Our maximum exposure to loss as
a
result of our involvement with these entities is our recorded investment of
$400
million as of March 31, 2007, and $850 million as of April 2007.
REINSURANCE
Our
insurance companies cede insurance to other companies. The portion of risks
exceeding each of our insurance company’s retention limit 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.
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. At
March 31, 2007, the reserves associated with these reinsurance arrangements
totaled $1.7 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 accompanying financial statements 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. At March 31, 2007 the amounts recoverable from reinsurers
was $8.1 billion, compared to $7.9 billion at December 31, 2006. We obtain
reinsurance from a diverse group of reinsurers and we monitor concentration,
as
well as 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 contracts remain
on
our Consolidated Balance Sheets with a corresponding reinsurance receivable
from
the business sold to Swiss Re, which totaled $4.2 billion and $4.1 billion
at
March 31, 2007 and December 31, 2006, respectively. Swiss Re has funded a trust
with a balance of $1.8 billion at March 31, 2007 to support this business.
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 liabilities for funds withheld and embedded
derivatives included $2.1 billion and $0.2 billion, respectively, at March
31,
2007 related to the business sold to Swiss Re.
During
the third quarter of 2006 one of our reinsurers, Scottish Re Group Ltd
(“Scottish Re”), received rating downgrades from various rating agencies. Of the
$1.1 billion of fixed annuity business that we reinsure with Scottish Re,
approximately 76% is reinsured through the use of modified coinsurance treaties,
in which we possess the investments that support the reserves ceded to Scottish
Re. For our annuity business ceded on a coinsurance basis, Scottish Re had
previously established an irrevocable investment trust supporting the reserves
for the benefit of LNC. In addition to fixed annuities, we have approximately
$88 million of policy liabilities on the life insurance business we have
reinsured with Scottish Re. Scottish Re continues to perform under its
contractual responsibilities to us. We continue to evaluate the impact of these
ratings downgrades with respect to our existing exposures to Scottish Re. Based
on current information, we do not believe that Scottish Re’s ratings downgrades
will have a material adverse effect on our results of operations, liquidity
or
financial condition.
At
March
31, 2007, we had reinsurance receivables of $754 million and policy loans of
$52
million which are related to the businesses of Jefferson-Pilot that are
coinsured with Household International (HI) affiliates. HI has provided payment,
performance and capital maintenance guarantees with respect to the balances
receivable. We regularly evaluate the financial condition of our reinsurers
and
monitor concentrations of credit risk related to reinsurance activities.
For
factors that could cause actual results to differ materially from those set
forth in this section, see “Part I - Item 1 - Risk Factors” in our 2006 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, investment advisory 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 $469 million and $325 million for the first quarter of 2007
and
2006, 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 stock
dividends, interest and debt service, funding of callable securities, securities
repurchases, and acquisitions.
The
following table summarizes the primary sources of holding company cash flow.
The
table 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 intercompany cash management
account (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.
|
|
Three
Months Ended
|
|
Year
Ended
|
|
|
|
March
31,
|
|
December
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
2006
|
|
Dividends
from subsidiaries:
|
|
|
|
|
|
|
|
|
|
|
LNL
|
|
$
|
75
|
|
$
|
100
|
|
$
|
350
|
|
Jefferson
Pilot Life Insurance Company
|
|
|
-
|
|
|
-
|
|
|
2
|
|
Jefferson
Pilot Financial Insurance Company
|
|
|
71
|
|
|
-
|
|
|
217
|
|
Lincoln
Financial Media
|
|
|
17
|
|
|
-
|
|
|
39
|
|
Delaware
Investments
|
|
|
15
|
|
|
12
|
|
|
48
|
|
Other
non-regulated companies(1)
|
|
|
-
|
|
|
-
|
|
|
235
|
|
Lincoln
UK
|
|
|
16
|
|
|
19
|
|
|
85
|
|
Other
|
|
|
-
|
|
|
-
|
|
|
11
|
|
Subsidiary
loan repayments and interest:
|
|
|
|
|
|
|
|
|
|
|
LNL
interest on surplus notes
|
|
|
20
|
|
|
20
|
|
|
78
|
|
Jefferson
Pilot Financial Insurance Company
|
|
|
1
|
|
|
-
|
|
|
4
|
|
|
|
$
|
215
|
|
$
|
151
|
|
$
|
1,069
|
|
Other
cash flow and liquidity items:
|
|
|
|
|
|
|
|
|
|
|
Return
of seed capital
|
|
$
|
-
|
|
$
|
-
|
|
$
|
21
|
|
Net
capital received from stock option exercises
|
|
|
47
|
|
|
40
|
|
|
191
|
|
|
|
$
|
47
|
|
$
|
40
|
|
$
|
212
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Represents
dividend of proceeds from sale of equity securities used to repay borrowings
under the bridge facility.
Subsidiaries
Our
domestic insurance subsidiaries paid dividends of $146 million and $100 million
for the first quarter of 2007 and 2006, respectively. Based upon anticipated
ongoing positive statutory earnings and favorable credit markets, we expect
our
domestic insurance subsidiaries could pay dividends of approximately $666
million in 2007 without prior approval from the respective insurance
commissioners. The actual 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. Our
non-regulated subsidiaries have dividend capacity of over $500 million in
2007.
Financing
Activities
Although
our subsidiaries generate adequate cash flow to meet the needs of our normal
operations, periodically we may issue debt or equity securities 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,
and trust preferred securities of our affiliated trusts. Our Board of Directors
authorized us to issue up to $4 billion of such securities, and we have issued
$2.8 billion pursuant to that authorization.
The
following summarizes debt and financing activity during the first quarter of
2007.
· |
In
March 2007, LNC issued $500 million of 6.05% Capital Securities (callable
in year 10 at par) due April 20, 2067 and $250 million 3-year floating
rate senior notes at LIBOR plus 8 basis points due April 20, 2010
for
aggregate gross proceeds of $750
million.
|
We
have
also redeemed the following securities originally issued by Jefferson-Pilot
during the quarter:
· |
On
January 11, 2007, we redeemed all of the outstanding 8.14% Junior
Subordinated Deferrable Interest Debentures, Series A due 2046, which
were
held by Jefferson-Pilot Capital Trust A. The redemption price for
the
Capital Securities, Series A was $1,040.70 per security, for a total
principal amount of $206 million, plus $16 million for accrued interest
through the redemption date.
|
· |
On
March 1, 2007, we redeemed all of the outstanding 8.285% Junior
Subordinated Deferrable Interest Debentures, Series B due 2046, which
were
held by Jefferson-Pilot Capital Trust B. The redemption price for
the
Capital Securities, Series B was $1,041.43 per security, for a total
principal amount of $103 million, plus $8 million for accrued interest
through the redemption date.
|
At
March
31, 2007, we maintained three credit facilities with a group of domestic and
foreign banks:
· |
a
$1.6 billion five-year credit facility entered into in March 2006
and
maturing in March 2011, allowing for borrowing or issuances of letters
of
credit (“LOC”);
|
· |
a
$1 billion five-year credit facility entered into in February 2006
and
maturing in February 2011, allowing for borrowing or issuances of
LOCs;
and
|
· |
a
10 million pounds sterling ($20 million at March 31, 2007) one-year
U.K.
credit facility for use by our U.K. subsidiary renewed in December
2006
and maturing in December 2007.
|
At
March
31, 2007, there were approximately $1.2 billion in outstanding LOCs under the
various credit agreements. These LOCs support intercompany reinsurance
transactions and specific treaties associated with our former Reinsurance
segment. LOCs are primarily used to satisfy the U.S. regulatory requirements
of
domestic clients of the former Reinsurance segment who have contracted with
the
reinsurance subsidiaries not domiciled in the United States and, as discussed
below, for the reserve credit provided by our affiliated offshore reinsurance
company to our domestic insurance companies for ceded business.
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. At March 31,
2007,
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,
certain covenants of various contractual obligations may be triggered which
could negatively impact overall liquidity. 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. At March 31, 2007, we maintained adequate current financial strength
and senior debt ratings and do not anticipate any ratings-based impact to future
liquidity.
Included
in
the amounts outstanding at March 31, 2007 discussed above was approximately
$975
million of outstanding LOCs supporting the reinsurance obligations of our
non-U.S. domiciled subsidiary to LNL on universal life 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 AXXX and XXX needs. LOCs
and related capital market alternatives lower the RBC impact of the universal
life business with secondary guarantee products. An inability to obtain the
necessary LOC capacity or other capital market alternatives could impact our
returns on universal life business with secondary
guarantee
products. 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.
A
new
statutory reserving standard (commonly called “VACARVM”) is being developed by
the NAIC replacing current statutory reserve practices for variable annuities
with guaranteed benefits such as GMWBs. The timing for adoption of VACARVM
is not certain. Because the NAIC has not determined the final version of
VACARVM, we cannot estimate the ultimate impact that VACARVM will have on our
liquidity and capital resources. However, in its current draft form,
VACARVM has the potential to require statutory reserves well in excess of
current levels for certain variable annuity riders sold by Lincoln. We
plan to utilize existing captive reinsurance structures to lessen any negative
impact on statutory capital and dividend capacity in our life insurance
subsidiaries. However, additional statutory reserves could lead to lower
risk-based capital ratios and potentially reduce future dividend capacity from
our insurance subsidiaries.
We
have
commitments of $450 million relating to guaranteed investment contracts that,
as
of March 31, 2007, are not reflected as an asset or liability in our
Consolidated Balance Sheets. See “Consolidated Investments - Guaranteed
Investment Contracts” above for additional information.
Alternative
Sources of Liquidity
In
order
to maximize the use of available cash, the holding company maintains an
intercompany cash management account where subsidiaries can borrow from the
holding company to meet their short-term needs and can invest their short-term
funds with the holding company. The holding company finances this program from
its primary sources of cash flow discussed above. Depending on the overall
cash
availability or need, the holding company invests excess cash in short-term
investments or borrows funds in the financial markets.
The
holding company used $483 million of funds from the cash management account
on
average during the first quarter of 2007 to fund loans to its subsidiaries
and
for general corporate purposes. The holding company had a maximum amount of
$728
million of financing that it used from the cash management account during this
period and a minimum of $7 million.
Our
insurance subsidiaries, by virtue of their general account fixed income
investment holdings, can access liquidity through securities lending programs
and repurchase agreements. At March 31, 2007, our insurance subsidiaries had
securities with a carrying value of $710 million out on loan under the
securities lending program, and $499 million carrying value subject to
reverse-repurchase agreements.
LNC
has a
$1 billion commercial paper program that is rated A-1, P-2, F-1. The
commercial paper program is backed by a bank line of credit. During the
first quarter of 2007, LNC had an average of $171 million in commercial paper
outstanding with a maximum amount of $375 million outstanding at any time.
LNC had $150 million of commercial paper outstanding at March 31,
2007.
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
shareholders and to repurchase our stock and debt securities.
Return
of Capital to Shareholders
One
of
the holding company’s principal uses of cash is to provide a return to our
shareholders. Through dividends and stock repurchases, we have an established
record of providing significant cash returns to our shareholders. We have
increased our dividend in each of the last 24 years. In determining our dividend
payout, we balance the desire to increase the dividend against capital needs,
rating agency considerations and requirements for financial flexibility. The
following table summarizes this activity for 2007 and 2006.
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
(in
millions, except per share data)
|
|
2007
|
|
2006
|
|
Dividends
to shareholders
|
|
$
|
107
|
|
$
|
67
|
|
Repurchase
of common stock
|
|
|
512
|
|
|
-
|
|
Total
cash returned to shareholders
|
|
$
|
619
|
|
$
|
67
|
|
Number
of shares repurchased
|
|
|
7.215
|
|
|
-
|
|
Average
price per share
|
|
$
|
70.92
|
|
$
|
-
|
|
On
February 22, 2007, our Board of Directors approved an additional $2 billion
in
security repurchase authority. LNC also repurchased $512 million of its common
stock in the first quarter of 2007, $162 million through open market repurchases
and $350 million through an accelerated share repurchase transaction. Under
the
accelerated share repurchase program, LNC received approximately 4.8 million
shares of its common stock in exchange for $350 million. LNC may receive an
additional amount of shares at the end of the program depending upon the average
price of its common stock during the program. After the purchases under
the above-described programs, the remaining amount of authorized security
repurchases will be approximately $2.1 billion.
The
following table summarizes the primary uses of holding company cash flow. The
table focuses on significant and recurring cash flow items and excludes the
effects of certain financing activities, namely the periodic retirement of
debt
and cash flows related to our intercompany cash management account. 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.
|
|
Three
Months Ended
|
|
|
|
March
31,
|
|
(in
millions)
|
|
2007
|
|
2006
|
|
Debt
service (interest paid)
|
|
$
|
54
|
|
$
|
22
|
|
Common
dividends
|
|
|
109
|
|
|
67
|
|
Common
stock repurchase
|
|
|
514
|
|
|
-
|
|
Total
|
|
$
|
677
|
|
$
|
89
|
|
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 and surplus note interest payments of its insurance company
subsidiaries. The insurance company subsidiaries dividend capacity is impacted
by factors influencing their risk-based capital and statutory earnings
performance. In recent periods, Delaware Investments and our U.K. operations
have contributed significant free cash flow. Improved financial performance
at
Delaware, our decision to run-off significant blocks of business in the U.K.
and
cash flow from Lincoln Financial Media are responsible for the improved cash
flow and the return of capital to LNC in recent periods. Currently, we expect
to
have sufficient liquidity and capital resources to meet our obligations in
2007.
For factors that could effect our expectations for liquidity and capital, see
“Part I—Item 1—Business—Risk Factors” in the 2006 Form 10-K.
Shareholders’
Equity
Total
shareholders’ equity decreased $169 million during the three months ended March
31, 2007, primarily due to share repurchase activity and to a lesser extent
dividends declared, partially offset by net income and unrealized gains on
securities available-for-sale included in other comprehensive income resulting
from lower interest rates.
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, to make
permanent recent reductions in individual tax rates, to permanently repeal
the
estate tax and to increase regulation of our annuity and investment management
businesses. 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 1 - Risk Factors” in our 2006
Form
10-K
and “Forward-looking Statements - Cautionary Language” in this
report.
Recent
Accounting Pronouncements
See
Note
2 to our consolidated financial statements 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.
ACQUISITIONS
AND DIVESTITURES
Merger
with Jefferson-Pilot Corporation
See
“Introduction - Recent Developments” and “Liquidity and Capital Resources” of
the 2006 Form 10-K for discussion regarding the merger with
Jefferson-Pilot.
RESTRUCTURING
ACTIVITIES
See
Note
12 to the unaudited consolidated financial statements for the detail of our
restructuring activities.
Item
3.
Quantitative and Qualitative Disclosures About Market Risk
We
provided a discussion of our market risk in Item 7A of our 2006 Form 10-K.
During the first quarter of 2007, there was no substantive change in our market
risk except for the items noted below:
Interest
Rate Risk
Interest
Rate Risk—Falling Rates.
As
discussed in the Quantitative and Qualitative Disclosures About Market Risk
section of our 2006 Form 10-K, spreads on our fixed annuity and
interest-sensitive whole life, universal life and fixed portion of variable
universal life insurance policies, are at risk if interest rates decline and
remain low for a period of time.
See
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Results of Operations by Segment for the effects of interest rate
environments on interest rate margins.
Derivatives.
As
indicated in Note 10 of our 2006 Form 10-K, we have entered into derivative
transactions to reduce our exposure to rapid rises in interest rates, the risk
of changes in liabilities indexed to equity markets, credit risk, foreign
exchange risk and to increase our exposure to certain investments in exchange
for a premium. In addition, we are subject to risks associated with changes
in
the value of our derivatives; however, such changes in value are generally
offset by changes in the value of the items being hedged by such contracts.
Modifications to our derivative strategy are initiated periodically upon review
of our overall risk assessment. During the first quarter of 2007, the more
significant changes in our derivative positions are as follows:
· |
A
total of $27 million notional of interest rate swap agreements matured
or
was terminated, resulting in a remaining notional of $1.2 billion.
A loss
of $0.3 million was recognized on the terminations. These interest
rate
swap agreements convert floating rate bond coupon payments into a
fixed
rate of return.
|
· |
Entered
into $250 million notional of forward-starting interest rate swap
agreements. These swaps partially hedged the future cash flows of
a
forecasted debt issuance. The entire $250 million notional was terminated
resulting in a $2 million loss recorded in Other Comprehensive Income.
The
loss will be recognized into income over the life of the
debt.
|
· |
Terminated
0.3 million call options on LNC stock, resulting in a total of 0.6
million
call options remaining on an equal number of shares of LNC stock.
These
call options are hedging the increase in liabilities arising from
stock
appreciation rights granted on LNC
stock.
|
· |
We
had financial futures net purchase/termination activity in the amount
of
$0.2 billion notional resulting in a remaining notional of $3.3 billion.
These futures are hedging a portion of the liability exposure on
certain
options in variable annuity products. No gain or loss was recognized
as a
result of the expirations or
terminations.
|
· |
Entered
into $0.2 billion notional of put option agreements, resulting in
a total
notional of $2.4 billion. These put options are hedging a portion
of the
liability exposure on certain options in variable annuity products.
We
will receive a payment from the counterparty if the strike rate in
the
agreement is higher than the specified index rate at maturity. No
gain or
loss was recognized as a result of the
terminations.
|
· |
Entered
into foreign exchange forward contracts in the amount of $16 million
notional that are hedging dividends received from our Lincoln UK
subsidiary. The full amount expired resulting in no remaining
notional.
|
· |
Entered
into $156 million notional of foreign currency swaps, resulting in
a total
notional of $242 million. These
foreign currency swap agreements are part of a hedging strategy.
We own
various foreign issue securities. Interest payments from these securities
are received in a foreign currency and then swapped into U.S.
dollars.
|
· |
Entered
into $0.5 billion notional of S&P 500 call options. A total of $0.3
billion notional expired, resulting in a remaining notional of $2.5
billion. These call options are hedging the impact of the equity-index
interest credited to our equity indexed annuity
products.
|
We
are
exposed to credit loss in the event of non-performance by counterparties on
various derivative contracts. However, we do not anticipate non-performance
by
any of the counterparties. The credit risk associated with such agreements
is
minimized by purchasing such agreements from financial institutions with
long-standing superior performance records.
Item
4.
Controls and Procedures
(a)
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 defined in Rule
13a-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.
(b)
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 March 31, 2007 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
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 March 31, 2007:
Period
|
|
(a)
Total
Number
of
Shares
(or
Units)
Purchased
(1)
|
|
(b)
Average
Price
Paid
per
Share
(or
Unit)
|
|
(c)
Total Number
of
Shares (or Units)
Purchased
as Part of
Publicly
Announced
Plans
or Programs
(2)
|
|
(d)
Approximate Dollar
Value
of Shares that
May
Yet Be Purchased
Under
the Plans or
Programs
(in
millions)(3)
|
|
1/1/07
- 1/31/07
|
|
|
62,100
|
|
$
|
65.74
|
|
|
-
|
|
$
|
2,649.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2/1/07
- 2/28/07
|
|
|
19,246
|
|
|
69.69
|
|
|
-
|
|
|
2,649.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3/1/07
- 3/31/07
|
|
|
7,221,540
|
|
|
70.91
|
|
|
7,214,971
|
|
|
2,137.9
|
|
(1)
|
Of
the total number of shares purchased, 71,463 shares were received
in
connection with the exercise of stock options and related taxes
and 16,452
shares were withheld for taxes on the vesting of restricted stock.
For the
quarter ended March 31, 2007, 7,214,971 shares were purchased as
part of
publicly announced plans or programs.
|
(2)
|
On
February 23, 2007, we announced that our Board approved a $2 billion
increase in our securities repurchase authorization, bringing the
total
authorization to $2.6 billion. The 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.
|
(3)
|
As
of the last day of the applicable month.
|
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
Senior
Vice President and Chief Financial Officer
|
|
|
|
|
By:
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/s/ DOUGLAS
N. MILLER
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Douglas
N. Miller
Vice
President and Chief Accounting Officer
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Date:
May 10, 2007
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LINCOLN
NATIONAL CORPORATION
Exhibit
Index for the Report on Form 10-Q
For
the Quarter Ended March 31, 2007
4.1
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Fifth
Supplemental Junior Subordinated Indenture, dated as of March 13,
2007,
between Lincoln National Corporation and the Bank of New York Trust
Company, N.A., as trustee is incorporated by reference from Exhibit
4.1 of
LNC’s Form 8-K (File No. 1-6028) filed with the SEC on March 13,
2007.
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4.2
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Form
of 6.05% Capital Securities due 2067 is incorporated by reference
from
Exhibit 4.2 of LNC’s Form 8-K (File No. 1-6028) filed with the SEC on
March 13, 2007.
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4.3
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Form
of Floating Rate Senior Notes due 2010 is incorporated by reference
from
Exhibit 4.3 of LNC’s Form 8-K (File No. 1-6028) filed with the SEC on
March 13, 2007.
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4.4
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10.1
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10.2
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12
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31.1
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31.2
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32.1
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32.2
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*
Portions of the exhibit have been redacted and are subject to a confidential
treatment request filed with the Secretary of the Securities and Exchange
Commission (“SEC”) pursuant to Rule 24b-2 under the Securities Exchange Act of
1934, as amended.
E-1