-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, UcUsKq/WRPlZO5VdQK/qmhkqj2xQTCpX5sy5BPrzbFQUtC2a4KgtG4KB+onIgr+o /Y27k7YYoFBMZr/EVXwPLg== 0000059558-94-000043.txt : 19940804 0000059558-94-000043.hdr.sgml : 19940804 ACCESSION NUMBER: 0000059558-94-000043 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19940630 FILED AS OF DATE: 19940801 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LINCOLN NATIONAL CORP ET AL CENTRAL INDEX KEY: 0000059558 STANDARD INDUSTRIAL CLASSIFICATION: 6311 IRS NUMBER: 351140070 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-06028 FILM NUMBER: 94540983 BUSINESS ADDRESS: STREET 1: 1300 S CLINTON ST STREET 2: PO BOX 1110 CITY: FORT WAYNE STATE: IN ZIP: 46801 BUSINESS PHONE: 2194552000 10-Q 1 2ND QUARTER TEXT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended June 30, 1994 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 (I.R.S. Employer incorporation or organization) Identification No.) 200 East Berry Street, Fort Wayne, Indiana 46802-2706 (Address of Principal Executive Offices) Registrant's telephone number (219) 455-2000 Common Stock Outstanding July 28, 1994 94,951,076 Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter 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 [ ] The exhibit index to this report is located on page 17. Page 1 of 19 -2- PART I - FINANCIAL INFORMATION
Item 1 Financial Statements LINCOLN NATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS June 30 December 31 (000'S omitted) 1994 1993 ASSETS Investments: Securities available-for-sale, at fair value: Fixed maturity (cost 1994 - $21,438,155; 1993 - $22,219,285) ------------------ $21,362,749 $23,964,335 Equity (cost 1994 - $913,442; 1993 - $896,477) --------------------- 1,007,873 1,080,301 Mortgage loans on real estate ------------ 2,870,737 3,300,951 Real estate ------------------------------ 645,844 633,103 Policy loans ----------------------------- 536,956 595,085 Other investments ------------------------ 165,536 158,170 Total Investments ---------------------- 26,589,695 29,731,945 Investment in unconsolidated affiliates ---- 89,940 -- Cash and invested cash --------------------- 1,371,235 709,664 Property and equipment --------------------- 188,025 233,467 Deferred acquisition costs ----------------- 2,266,087 2,011,131 Premiums and fees receivable --------------- 711,003 601,883 Accrued investment income ------------------ 426,189 413,144 Assets held in separate accounts ----------- 13,094,929 12,430,577 Federal income taxes ----------------------- 389,145 -- Amounts recoverable from reinsurers -------- 1,857,692 1,460,038 Goodwill ----------------------------------- 148,753 228,530 Other assets ------------------------------- 689,171 559,982 Total Assets ----------------------------- $47,821,864 $48,380,361 See notes to consolidated financial statements on page 7.
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LINCOLN NATIONAL CORPORATION CONSOLIDATED BALANCE SHEETS -CONTINUED- June 30 December 31 (000's omitted) 1994 1993 LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Policy liabilities and accruals: Future policy benefits and losses, claims and loss expenses ------ $11,424,526 $12,652,036 Unearned premiums ----------------------- 829,490 858,805 Total Policy Liabilities and Accruals - 12,254,016 13,510,841 Contractholder funds ---------------------- 15,805,875 14,872,141 Liabilities related to separate accounts -- 13,094,929 12,430,577 Federal income taxes ---------------------- -- 150,951 Short-term debt --------------------------- 474,032 351,418 Long-term debt ---------------------------- 320,492 335,097 Other liabilities ------------------------- 2,523,544 2,657,015 Total Liabilities ----------------------- 44,472,888 44,308,040 Shareholders' Equity: Series A Preferred Stock (6/30/94 liquidation value - $3,645) ----- 1,496 1,553 Series E Preferred Stock (6/30/94 liquidation value - $151,569) --- 151,206 151,206 Series F Preferred Stock (6/30/94 liquidation value - $158,707) --- 158,707 158,707 Common Stock ------------------------------ 566,102 543,659 Earned surplus ---------------------------- 2,415,329 2,303,731 Foreign currency translation adjustment --- 4,550 (1,214) Net unrealized gain on securities available-for-sale ----------------------- 51,586 914,679 Total Shareholders' Equity -------------- 3,348,976 4,072,321 Total Liabilities and Shareholders' Equity -------------- $47,821,864 $48,380,361 See notes to consolidated financial statements on page 7.
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LINCOLN NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME Six Months Ended Three Months Ended June 30 June 30 (000's omitted) 1994 1993 1994 1993 Revenue: Insurance premiums ---------- $2,247,536 Insurance fees -------------- 216,866 225,903 111,033 114,805 Net investment income ------- 989,453 1,035,373 487,612 523,539 Equity in earnings of unconsolidated affiliates - 5,592 -- 4,938 -- Realized gain (loss) on investments --------------- (28,235) 55,356 (66,330) 45,990 Gain on sale of subsidiary -- 48,842 -- 4,784 -- Other ----------------------- 71,213 75,491 34,692 35,611 Total Revenue ----------- 3,551,267 3,840,917 1,544,431 1,901,910 Benefits and Expenses: Benefits and settlement expenses ------------------ 2,450,440 2,619,173 1,107,681 1,232,378 Underwriting, acquisition, insurance and other expenses 854,431 950,677 383,916 486,750 Interest expense ------------ 22,730 21,903 11,452 10,771 Total Benefits and Expenses ---------- 3,327,601 3,591,753 1,503,049 1,729,899 Income Before Federal Income Taxes and Cumulative Effect of Accounting Change --- 223,666 249,164 41,382 172,011 Federal Income Taxes ---------- 25,879 52,938 (5,420) 44,795 Income Before Cumulative Effect of Accounting Change ----- 197,787 196,226 46,802 127,216 Cumulative Effect of Accounting Change ----------- -- (96,431) -- -- Net Income -------------- $ 197,787 $ 99,795 $ 46,802 $ 127,216 Earnings Per Share: Income before cumulative effect of accounting change - $1.91 $1.94 $ .45 $1.23 Cumulative effect of accounting change ----------- -- (.95) -- -- Net Income -------------- $1.91 $ .99 $ .45 $1.23 Cash Dividends Per Share - Common Stock ---------------- $ .82 $ .76 $ .41 $ .38 See notes to consolidated financial statements on page 7.
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LINCOLN NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Six Months Ended June 30 Number of Shares Issued Amounts (000's omitted from dollar amounts) 1994 1993 1994 1993 Preferred Stock: (Shares authorized: 10,000,000) Series A Preferred Stock: Balance at beginning of year -------- 47,289 57,716 $ 1,553 $ 1,896 Conversion into Common Stock ------------- (1,723) (7,006) (57) (230) Balance at June 30 ------ 45,566 50,710 1,496 1,666 Series E and F Preferred Stock: Balance at beginning and end of period -------- 4,417,897 4,417,897 309,913 309,913 Common Stock: (Shares authorized: 1994 - 800,000,000; 1993 - 400,000,000) Balance at beginning of year - 94,183,190 84,142,458 543,659 200,986 Conversion of Series A Preferred Stock ------------ 13,784 56,048 57 230 Public offering of Common Stock --------------- -- 9,200,000 -- 316,100 Issued for benefit plans ---- 577,666 505,254 22,386 17,551 Balance at June 30 ------ 94,774,640 93,903,760 566,102 534,867 Earned Surplus: Balance at beginning of year - 2,303,731 2,147,691 Net income ------------------- 197,787 99,795 Cash dividends declared ------ (86,189) (79,936) Balance at June 30 ------ 2,415,329 2,167,550 Foreign Currency Translation Adjustment: Accumulated adjustment at beginning of year ---------- (1,214) 3,643 Change during period --------- 5,764 (3,203) Balance at June 30 ------ 4,550 440 Net Unrealized Gain (Loss) on Securities Available-for-Sale: Balance at beginning of year - 914,679 162,742 Change during period --------- (863,093) 62,260 Balance at June 30 ------ 51,586 225,002 Total Shareholders' Equity at June 30 ------------ $3,348,976 $3,239,438 Common Stock (assuming conversion of Series A, E & F Preferred Stock): End of Period ----------- 103,974,962 103,145,234 Average for the Period -- 103,749,231 101,312,000 See notes to consolidated financial statements on page 7.
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LINCOLN NATIONAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30 (000's omitted) 1994 1993 Operating Activities: Net Income----------------------------------------- $ 197,787 $ 99,795 Adjustments to reconcile net income to net cash provided by operating activities: Deferred acquisition costs -------------------- (83,551) (8,692) Premiums and fees receivable ------------------ (135,000) (94,511) Accrued investment income --------------------- (41,801) 26,383 Policy liabilities and accruals --------------- 227,980 220,939 Contractholder funds -------------------------- 820,774 589,188 Amounts recoverable from reinsurers ----------- (426,373) (368,442) Federal income taxes -------------------------- (46,112) (77,686) Provisions for depreciation ------------------- 28,442 28,152 Realized gain (loss) on investments ----------- 61,513 (55,356) Gain on sale of subsidiary -------------------- (48,842) -- Cumulative effect of accounting change -------- -- 96,431 Other ----------------------------------------- 28,428 (9,819) Net Adjustments ----------------------------- 385,458 346,587 Net Cash Provided by Operating Activities --- 583,245 446,382 Investing Activities: Securities-available-for-sale: Purchases -------------------------------------- (6,769,656) (4,886,344) Sales ------------------------------------------ 4,846,477 4,885,041 Maturities ------------------------------------- 719,355 4,300 Fixed maturity securities-held for investment: Purchases -------------------------------------- -- (3,193,672) Sales ------------------------------------------ -- 1,165,769 Maturities ------------------------------------- -- 850,223 Purchase of other investments -------------------- (595,307) (577,697) Sale or maturity of other investments ------------ 973,163 429,902 Sale of subsidiaries ----------------------------- 417,367 -- Increase in cash collateral on loaned securities ------------------------------ 108,417 104,068 Other -------------------------------------------- (48,151) (214,575) Net Cash Used in Investing Activities ------ (348,335) (1,432,985) Financing Activities: Principal payments on long-term debt ------------- (9,495) (1,387) Issuance of long-term debt ----------------------- 211 4,430 Net increase (decrease) in short-term debt ------- 123,567 (289,581) Universal life and investment contract deposits -- 1,203,505 1,320,931 Universal life and investment contract withdrawals --------------------------- (829,169) (676,355) Public offering of Common Stock ------------------ -- 316,100 Common Stock issued for benefit plans ------------ 22,386 17,551 Dividends paid to shareholders ------------------- (84,344) (76,234) Net Cash Provided by Financing Activities -- 426,661 615,455 Net Increase (Decrease) in Cash ------------ 661,571 (371,148) Cash at Beginning of Year -------------------------- 709,664 1,015,850 Cash at June 30 ---------------------------- $1,371,235 $ 644,702 See notes to consolidated financial statements on page 7.
-7- LINCOLN NATIONAL CORPORATION NOTES TO CONSOLIDATED STATEMENTS 1. Basis of Presentation The accompanying consolidated financial statements include Lincoln National Corporation ("LNC") and its majority-owned subsidiaries. Less than majority- owned entities in which LNC has at least a 20% interest are reported on the equity basis. These unaudited consolidated statements have been prepared in conformity with generally accepted accounting principles, except that they do not contain complete notes. However, in the opinion of management, these statements include all normal recurring adjustments necessary for a fair presentation of the results. For further information, refer to the consolidated financial statements included in LNC's annual report to shareholders or Form 10-K for the year ended December 31, 1993. Operating results for the six months ended June 30, 1994 are not necessarily indicative of the results that may be expected for the full year ending December 31, 1994. 2. Federal Income Taxes The effective tax rate on net income is lower than the prevailing corporate federal income tax rate. The difference for both 1993 and 1994 resulted principally from tax-exempt investment income. The six months ended June 30, 1994 also was affected by the fact that no income taxes were payable on the gain on sale of a subsidiary (see note 4). 3. Earnings Per Share Earnings per share are computed based on the average number of common shares outstanding (103,749,231 and 101,312,000 for the first six months of 1994 and 1993, respectively) after assuming conversion of the Series A, E and F Preferred Stock. 4. Sale of Subsidiaries On February 2, 1994, LNC completed the sale of Security-Connecticut Corporation through an initial public offering for cash, net of related expenses, totaling $172.7 million and a promissory note from Security- Connecticut Corporation for $65.0 million. The loss on sale and disposal expenses did not differ materially from the estimate recorded in the fourth quarter of 1993. The preliminary closing for the partial sale of a wholly owned subsidiary, EMPHESYS Financial Group, Inc. ("EMPHESYS"), through an initial public offering was completed on March 21, 1994. EMPHESYS is the parent company of Employers Health Insurance Company ("Employers Health"). As a result of this transaction, LNC exchanged 64% of the outstanding stock of EMPHESYS for cash, net of related expenses, totaling $220.1 million and a promissory note from EMPHESYS for $50.0 million. This transaction resulted in a gain on sale of $44.1 million (also $44.1 million pre-tax). The final closing of this partial sale was completed on April 15, 1994. The impact of the combined March 21st and April 15th transactions was that LNC exchanged 71% of the outstanding stock of EMPHESYS for cash, net of related expenses, totaling $244.7 million plus the $50.0 million promissory note. These transactions resulted in a gain on sale of $48.8 million (also $48.8 million pre-tax). For the January 1, 1994 through March 21, 1994 period, Employers Health had revenue of $314.9 million and net income of $14.4 million. For the six months and quarter ended June 30, 1993, Employers Health had revenues of $631.6 million and $318.0 million and net income of $24.0 million and $13.4 million, respectively. This revenue and net income was recorded within the Employee Life-Health Benefits segment. The gain on sale and the appropriate portion of the equity in the earnings of EMPHESYS after March 21, 1994, recognized in accordance with the equity method of accounting, were reported within "Other Operations". 5. Shareholders' Equity During the second quarter of 1994, LNC's Articles of Incorporation were amended to increase the number of authorized shares of Common Stock from 400,000,000 to 800,000,000. -8- LINCOLN NATIONAL CORPORATION ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION As indicated in the "Notes to Consolidated Statements" (see note 4 on page 7), LNC completed the sale and partial sale of two of its subsidiaries in the first six months of 1994. As noted in the following "Review of Consolidated Operations" and "Review of Consolidated Financial Condition," these sales have affected the comparability of select line items within the Consolidated Statements of Income and Consolidated Balance sheets. REVIEW OF CONSOLIDATED OPERATIONS The discussion that follows focuses on the results for the six months ended June 30, 1994 compared to the results for the six months ended June 30, 1993. The factors affecting the current quarter to prior year quarter comparisons are essentially the same as the year-to-date factors, except as noted. Insurance Premiums Property-Casualty premiums decreased by $74.4 million or 8% compared with the six months ended June 30, 1993 primarily as the result of implementing a more stringent underwriting policy to improve loss experience. Excluding the impact of the subsidiary sold in 1994 (see note 4 on page 7), health premiums were $350.7 million for the first six months of 1994 which is essentially the same as the first six months of 1993. Health premiums for the second half of 1994 are expected to be approximately the same as the first half number shown above. Life and annuity premiums increased by $165.7 million or 29% compared to the previous year. This increase resulted from an overall increase in the volume of transactions by the Life Insurance and Annuities and Life-Health Reinsurance segments. The increase in the Life Insurance and Annuities segment was the net result of increases in volume including premiums related to a company acquired by Lincoln National (UK) less the impact of the sale of Security-Connecticut Corporation (see note 4 on page 7). Insurance Fees Excluding the impact of the subsidiary sold in 1994 (see note 4 on page 7), insurance fees from the sale of universal life and other interest sensitive insurance contracts increased $41.8 million or 24% compared to the first six months of 1993 as the result of increases in the volume of transactions in the Life Insurance and Annuities segment. Net Investment Income Net investment income decreased $45.9 million or 4% when compared with the first six months of 1993. This is the net result of a 3% increase in mean invested assets less the impact of the overall yield on investments dropping from 7.84% to 7.12%. Equity in Earnings of Unconsolidated Affiliates This line was added to the statement of income in 1994 following LNC's partial sale of its direct writer of health coverages (see note 4 on page 7). The amount shown represents LNC's share of the total earnings of this company for the period after the closing of the sale on March 21, 1994. Gain on Sale of Subsidiary In the first six months of 1994 LNC recorded the sale of a portion of its interest in Employers Health Insurance Company (see note 4 on page 7). Realized Gain (Loss) on Investments The first six months of 1994 and 1993 had pre-tax realized gain (loss) on investments of $(28.2) million and $55.4 million, respectively. The gains for 1993 were the result of net gains on the sale of investments, less writedowns and provision for losses. The losses in 1994 were the result of net realized investment gains (losses) and some modest writedowns and -9- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION (continued) REVIEW OF CONSOLIDATED OPERATIONS (continued) provisions for losses. The investment losses, primarily from the second quarter, were the result of repositioning a portion of the investment portfolio during a period of rising interest rates. Fixed maturity and equity securities that were deemed to have declines in fair value that were other than temporary were written down. Provision for losses on mortgage loans on real estate, real estate investments and other investments were established where the underlying value of the property was deemed to be less than the carrying value. The pre-tax writedown of fixed maturity and equity securities for the first six months of 1994 and 1993 were $7.3 million and $45.2 million, respectively. In recognition of the current and expected interest rate environment, these writedowns include a second quarter 1993 writedown of $33.2 million related to interest only mortgage-backed securities. With the exception of interest only mortgage-backed securities, the fixed maturity securities to which these writedowns apply were generally of investment grade quality at the time of purchase, but were classified as "below investment grade" at the time of the writedowns. The pre-tax additions to provision for losses on mortgage loans on real estate and real estate for the first six months of 1994 and 1993 were $23.6 million and $111.3 million, respectively, including $64.1 million in 1993 for the adoption of FAS 114. The pre-tax addition to the provision for losses for other investments for the first six months of 1994 and 1993 were $5.6 million and $7.3 million, respectively. The gain (loss) on the sale of investments in the first six months of 1994 and 1993 were the result of gains and losses realized on equity securities and fixed maturity securities plus the release of mortgage loan reserves on select properties where the estimated fair value had increased since the prior quarter. In the second quarter of 1994, LNC completed a bulk sale of commercial real estate with a value of approximately $150 million. This sale did not result in any significant gain or loss as the proceeds received were approximately equal to the carrying value. Other Revenue Excluding the impact of the subsidiary sold, other revenue increased $1.4 million or 2% when compared to the first six months of 1993 as the result of an increase in the Life Insurance and Annuities segment. Insurance Benefits and Settlement Expenses Property-Casualty benefits decreased by $69.8 million or 9% when compared with the first six months of 1993. This decrease was the result of reduced volumes of insurance written. Catastrophe losses and weather related claims were essentially the same for both periods. Excluding the impact of the subsidiary sold in 1994 (see note 4 on page 7), health benefits increased by $17.3 million or 7% when compared to the first six months of 1993 as a result of increased claims in the Life Insurance and Annuity and Life-Health Reinsurance segment first six months of 1993 and 1994. Life and annuity benefits and settlement expenses increased $100.8 million or 8% when compared to the first six months of 1993. This increase is the result of increased volumes of business and poorer mortality in the Life Insurance and Annuities and Life-Health Reinsurance segments. Underwriting, Acquisition, Insurance and Other Expenses Excluding the impact of the various subsidiaries sold this expense increased $10.6 million or 1% for the six months ended June 30, 1994 as compared to the first six months of 1993. This increase was the result of inflation and increased volumes of business in the Life Insurance and Annuities segment being somewhat offset by lower expenses in the Property- Casualty segment. The Property-Casualty segment had a decrease in this expense as it continued to adjust staff levels to the current level of business. -10- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL I REVIEW OF CONSOLIDATED OPERATIONS (continued) Interest Expense Interest expense increased $800,000 or 4% when compared with the first six months of 1993. This was the net result of increases in the average debt outstanding and increases in short-term interest rates less the impact of changes in the composition of debt outstanding. Federal Income Taxes Federal income taxes decreased from $52.9 million in the first six months of 1993 to $25.9 million in the first six months of 1994 as a result of a decrease in pre-tax earnings and the lack of any tax expense on the gain on sale of subsidiary (see note 4 on page 7) less some effect of the continued movement from taxable securities to tax-exempt securities. Summary Net income for the first six months of 1994 was $197.8 million or $1.91 per share compared with $99.8 million or $0.99 per share in the first six months of 1993. Excluding realized gain (loss) on investments, gain on sale of subsidiary and the after-tax cumulative effect of implementing the postretirement benefit accounting change, LNC earned $170.9 million for the first six months of 1994 compared with $158.8 million for the first six months of 1993. This increase was due to increases in earnings from the Property- Casualty Insurance and Life Insurance and Annuity business segments being partially offset by a modest decrease in Life-Health Reinsurance segment earnings and the impact of the loss of earnings from subsidiaries sold not being offset by interest on the proceeds from the sales. REVIEW OF CONSOLIDATED FINANCIAL CONDITION Investments The total investment portfolio decreased $3.1 billion in the first six months of 1994. Most of this decrease related to fixed maturity securities. The removal of the investments of the two subsidiaries sold (see note 4 on page 7) accounted for $2.1 billion of this decrease. The remainder of the decrease is the result of new purchases of investments from cash flow being more than offset by the decrease in the fair value of existing investment securities during the first six months of 1994 due to rising interest rates during that period. The quality of LNC's fixed maturity securities portfolio as of June 30, 1994 was as follows: Treasuries and AAA 37.0% BBB 21.0% AA 11.0% BB 3.2% A 25.5% Less than BB 2.3% As of June 30, 1994, $1.178 billion or 5.5% of fixed maturity securities was invested in below investment grade securities (less than BBB). This represents 4.4% of the total investment portfolio. The interest rates available on these below investment grade securities are significantly higher than is available on other corporate debt securities. Also, the risk of loss due to default by the borrower is significantly greater with respect to such below investment grade securities, because these securities are generally unsecured, often subordinated to other creditors of the issuer and issued by companies that usually have high levels of indebtedness. LNC attempts to minimize the risks associated with these below investment grade securities by limiting the exposure to any one issuer and by closely monitoring the credit worthiness of such issuers. During the six months ended June 30, 1994, the aggregate cost of such investments purchased was $458.5 million. Aggregate proceeds from such investments sold were $266.4 million, resulting in a realized pre-tax gain of $3.4 million. -11- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION (continued) REVIEW OF CONSOLIDATED FINANCIAL CONDITION (continued) LNC's entire fixed maturity securities portfolio is classified as "available-for-sale" and is carried at fair value. Equity securities available-for-sale are also carried at fair value. Changes in fair value, net of related deferred acquisition costs, amounts required to satisfy policyholder commitments and taxes, are charged or credited directly to shareholders' equity. As of June 30, 1994, mortgage loans on real estate and real estate represented 10.8% and 2.4% of LNC's total investment portfolio. As of June 30, 1994, the underlying properties supporting the mortgage loans on real estate consisted of 27% in commercial office buildings, 29% in retail stores, 19% in apartments, 12% in industrial buildings, 2% in hotels/motels and 11% in other. In addition to the dispersion by property type, the mortgage loan portfolio is geographically diversified throughout the United States. Mortgage loans on real estate are actively monitored to identify problem loans. LNC classifies mortgage loans as problem loans if they are non-accrual loans (i.e., principal and interest are 60 days past due), restructured loans (i.e., the terms of the original loan have been modified) or loans not in the first two categories that are considered impaired. LNC considers a mortgage loan impaired when, based on current information and events, it is probable that LNC will be unable to collect all amounts due according to the contractual terms of the loan agreement. In addition, LNC also classifies loans as potential problem loans when available information causes management to be concerned about the borrowers' ability to comply with the present loan terms, including the repayment of outstanding interest and principal. When LNC determines that a loan is impaired as defined above, a provision for loss is established for the difference between the carrying value of the mortgage loan and the estimated value. Estimated value is based on either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral. Additional amounts were added to the mortgage loan provision for losses during 1993 due to the adoption of FAS 114 (see page 9). When a mortgage loan becomes 60 days past due, all existing accruals for interest due are reversed and interest is recorded on a cash basis until the mortgage loan is brought current. In the first six months of 1994, LNC continued to strengthen its provision for losses for mortgage loans on real estate. The reserve level and the ratio of reserves to impaired mortgages both decreased during this period as the modest increase in reserves was more than offset by the removal of amounts associated with the bulk sale of approximately $150 million in commercial real estate. A summary of LNC's problem mortgage loans on real estate before related provisions for losses and supplemental information with respect to such loans is as follows: June 30 December 31 (in millions) 1994 1993 Problem Loans: Non-accrual loans ----------------------------------- $182.6 $276.3 Restructured loans ---------------------------------- 30.0 59.8 Other problem loans --------------------------------- 354.1 445.2 Total Problem Loans ---------------------------- $566.7 $781.3 Potential problem loans ------------------------------- $ 61.5 $ 92.1 -12- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION (continued) REVIEW OF CONSOLIDATED FINANCIAL CONDITION (continued) Impaired loans included in the problem loans shown above along with the related provision for losses is as follows: June 30 December 31 (in millions) 1994 1993 Impaired loans ---------------------------------------- $506.5 $725.9 Provision for losses ---------------------------------- 138.3 226.6 Net Impaired loans --------------------------------- $368.2 $499.3 The dollar level of reserves and the ratio of impaired mortgages was lower at June 30, 1994 than at December 31, 1993 due to the sale of performing and non- performing mortgage loans and real estate in 1994 as described earlier. Net impaired loans were 1.4% of total investments at June 30, 1994. Six Months Ended June 30 (in millions) 1994 1993 Interest Income from Problem Loans: Amount that would have been recorded under original terms --------------------- $ 27.4 $41.3 Interest income actually recorded ------------------- 20.9 31.9 As of June 30, 1994, LNC has a commitment to lend $55,000 on a loan shown within other problem loans above. No other future commitments have been made on non-accrual or restructured loans. Investment in Unconsolidated Affiliates This line was added to the balance sheet in 1994 to accommodate LNC's 29% equity ownership in EMPHESYS, Financial Group, Inc., following LNC's partial sale of this company (see note 4 on page 7). Cash and Invested Cash Cash and invested cash increased by $661.6 million in the first six months of 1994. This increase is primarily the result of the receipt of proceeds from the sale of subsidiaries (see note 4 on page 7). These funds are pending application for general corporate purposes which may include additional investments in existing business or the financing of acquisitions. Assets Held in Separate Accounts Excluding the December 31, 1993 balance of the subsidiaries that were sold (see note 4 on page 7), this asset account as well as the corresponding liability account increased by $678.2 million, reflecting an increase in annuity and pension funds under management. Federal Income Taxes Federal income taxes recoverable at June 30, 1994 of $389.1 million represents a change of $540.1 million compared to the federal income taxes payable at December 31, 1993. This is the net result of increases related to recoverable deferred taxes resulting primarily from life insurance reserve differences, discounting of unpaid losses, additions to the investment reserves and postretirement obligations, and the decrease in deferred taxes payable primarily related to the reduction in unrealized gains on securities in the first six months of 1994. Amounts Recoverable from Reinsurers The increase in amounts recoverable from reinsurers was the result of an increased volume of business ceded in the life insurance and annuity segment. -13- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL INFORMATION (continued) REVIEW OF CONSOLIDATED FINANCIAL CONDITION (continued) Goodwill The decrease in goodwill of $79.7 million is primarily the result of the sale of subsidiaries during the first quarter of 1994 (see note 4 on page 7). Other Assets The increase in other assets of $129.2 million is the result of having a higher receivable related to the volume of investment security transactions sold in the last few days of the second quarter of 1994 versus such transactions at the end of 1993. Total Liabilities Excluding the December 31, 1993 liabilities of the subsidiaries that were sold (see note 4 on page 7) of $1.9 billion, total liabilities increased by $2.1 million in the first six months of 1994. This increase reflects 1) an increased level of business as evidenced by an increase of $990.4 million in contractholder funds, an increase of $678.2 million in the liabilities related to separate accounts, an increase in the policy liabilities and accruals of $374.1 million, 2) an increase in debt of $114.3 million and 3) a decrease in other liabilities of $76.3 million. Policyholder liabilities as of June 30, 1994 and December 31, 1993 included liabilities for environmental losses of approximately $215.0 million and $204.0 million respectively. Because of the limited coverages that have been written by LNC in this market, these reserves represent only 7-8% of LNC's total property-casualty reserves for both periods (3% based on claims counts of direct business). These percentages are at this level due to LNC's concentration of writing coverages for small to medium size companies rather than the larger companies that tend to incur most of the environmental and product liability claims. Establishing reserves for environmental losses is subject to significant uncertainties because of the long reporting delays, lack of historical data and the unresolved complex legal issues that are involved. However, based on available information, it is management's judgement that the appropriate level of reserves have been recorded and that any unrecorded liability would not be material to LNC's future results of operations, liquidity or financial condition. The decrease in other liabilities relates to a decrease in the expected payouts for security investments purchased in the last few days of the second quarter of 1994 versus a higher volume of such transactions at the end of 1993. Shareholders' Equity Total shareholders' equity decreased $723.3 million in the first six months of 1994. Excluding the decrease of $863.1 million related to unrealized gain on securities available-for-sale, shareholders' equity increased $139.8 million. This increase for the first six months of 1994 was the net result of $197.8 million from net income, $22.4 million from the issuance of Common Stock related to benefit plans, $5.8 million related to an increase in the accumulated foreign exchange gain and a decrease of $86.2 million related to the declaration of dividends to stockholders. Liquidity and Cash Flow In the insurance industry, liquidity generally refers to the ability of an enterprise to generate adequate amounts of cash from its normal operations, including activities in its investment portfolio, to meet its financial commitments. LNC manages its operations, including prudent investment portfolio structuring, to provide for appropriate liquidity levels. The portfolio structuring involves segregating LNC's investments by segments, sub-segments or type of product. The investments selected for each segregated portfolio are based on LNC's desire to match characteristics (e.g., duration and yield) of the underlying liabilities. -14- As indicated by the Consolidated Statements of Cash Flows on page 6, LNC's business operations generated $583.2 million of cash during the first six months of 1994. Although LNC generates adequate cash flow to meet the needs of its normal operations, periodically LNC may issue debt or equity securities to fund internal expansion, acquisitions, investment opportunities and the retirement of LNC's debt and equity. A transaction as described in the preceding sentence occurred during February 1993, when LNC received $316.1 million in proceeds from a public offering of 9.2 million shares of its Common Stock. In March 1994, LNC redeemed its $100 million 8% notes payable due in 1997. This redemption was funded with additional short-term debt. As indicated in note 7 to the consolidated financial statements for the year ended December 31, 1993 (see page 49 of LNC's Form 10-K), LNC has entered into derivative transactions to reduce its exposure to interest rate fluctuations. LNC has two significant programs in place primarily within its Life Insurance and Annuity segment. First, LNC uses interest rate cap agreements to hedge against the negative impact of a sustained and significant rise in interest rates. Interest rate caps are contracts that require counterparties to pay LNC at specified future dates the amount, if any, by which a specified market interest rate exceeds the fixed cap rate, applied to a notional principal amount. As of June 30, 1994 LNC had notional amounts of $4.2 billion with strike prices ranging from 93 to 343 basis points above prevailing interest rates. These agreements expire in 1997-2003. Secondly, LNC uses spread-lock agreements to hedge the value of corporate bonds against the risk of widening in their yield spreads over the yields of comparable maturity U.S. Government obligations. Under these agreements, LNC assumes the right and the obligation to enter into an interest rate swap at a future date in which LNC would pay a fixed rate equal to a contractually specified spread over the then prevailing U.S. Treasury rate and receive a floating rate. As of June 30, 1994, LNC had spread-lock agreements with an aggregate notional amount of $1.6 billion with 3 to 13 months remaining in the exercise periods. As of June 30, 1994, these contracts had unrealized gains of $107,000 and unrealized losses of $2.2 million. Both of these programs are designed to help ensure LNC's ability to be able to continue to provide competitive crediting rates to policyholders during periods when interest rates are rising or corporate bond spreads are widening. Failure to protect against these two possibilities could result in policyholders withdrawing their funds for placement in more competitive products. LNC purchases both types of derivative products from only highly credit-worthy financial institutions to minimize the possibility of non- performance. As indicated earlier LNC's primary derivative programs are designed to protect the company against interest rate fluctuations. LNC expects to continue to hedge against interest rate movements, as appropriate. -15- PART II - OTHER INFORMATION AND EXHIBITS Items 1, 3, 4 (b) and (d) and 5 of this Part II are either inapplicable or are answered in the negative and are omitted pursuant to the instructions to Part II. Item 4. Submission of Matters to a Vote to Securityholders (a) The matter discussed in (c) below was submitted to a vote at the Annual Meeting of Shareholders of the Registrant on May 12, 1994. (c) At the meeting referred to in (a) above, Shareholders of the Registrant were asked to approve an amendment to the Registrant's Articles of Incorporation that would increase the Registrant's authorized Common Stock from 400,000,000 shares to 800,000,000 shares. The results of the vote on this matter was 75,828,877 affirmative votes and 9,108,237 negative votes. Item 6. Exhibits and Reports on Form 8-K (a) The following Exhibit of the Registrant is included in this report. (Note: The number preceding the exhibit corresponds to the specific number within Item 601 of Regulation S-K.) 11 Computation of Per Share Earnings (b) No reports on Form 8-K were filed during the quarter ended June 30, 1994. -16- SIGNATURE PAGE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. LINCOLN NATIONAL CORPORATION By /S/ Richard C. Vaughan Richard C. Vaughan, Senior Vice President and Chief Financial Officer /S/ Donald L. Van Wyngarden Donald L. Van Wyngarden, Second Vice President and Controller Date July 29, 1994 -17- LINCOLN NATIONAL CORPORATION Exhibit Index for the Report on Form 10-Q for the Quarter Ended June 30, 1994 Exhibit Number Description Page Number 11 Computation of Per Share Earnings 17 EX-11 2 EXHIBIT
LINCOLN NATIONAL CORPORATION AND SUBSIDIARIES EXHIBIT (11) - COMPUTATION OF PER SHARE EARNINGS Six Months Three Months Ended June 30 Ended June 30 PRIMARY 1994 1993 1994 1993 Average shares outstanding (assuming conversion of Series A, E and F Preferred Stock) ------------- 103,749,231 101,312,000 103,954,236 103,127,193 Net effect of dilutive stock options (based on the treasury stock method using average market price) -- 696,669 789,304 663,047 739,596 Total shares outstanding ----------- 104,445,900 102,101,304 104,617,283 103,866,789 FULLY DILUTED Average shares outstanding (assuming conversion of Series A, E and F Preferred Stock) ------------- 103,749,231 101,312,000 103,954,236 103,127,193 Net effect of dilutive stock options (based on the treasury stock method using the end of period market price, if higher than average market price) -------- 761,544 807,840 747,263 739,596 Total shares outstanding ----------- 104,510,775 102,119,840 104,701,499 103,866,789 DOLLAR INFORMATION (000's omitted Income before the cumulative effect of accounting change ------------ $197,787 $196,226 $ 46,802 $127,216 Cumulative effect of accounting change ------------ -- (96,431) -- -- Net Income -------------- $197,787 $ 99,795 $ 46,802 $127,216 PER SHARE INFORMATION Primary: Income before the cumulative effect of accounting change ---------- $1.89 $1.92 $ .45 $1.22 Cumulative effect of accounting change ---------- -- (94) -- -- Net Income ---------- $1.89 $ .98 $ .45 $1.22 Fully Diluted: Income before the cumulative effect of accounting change ---------- $1.89 $1.92 $ .45 $1.22 Cumulative effect of accounting change ---------- -- (.94) -- -- Net Income ------------ $1.89 $ .98 $ .45 $1.22 Notes: 1. Earnings per share are computed based on the average number of common shares outstanding during each period after assuming conversion of the Series A, E and F Preferred Stock. 2. LNC does not include the dilutive effect of stock options in the computation of the earnings per share information appearing on the consolidated statements of income since it was immaterial.
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