LNC

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2005, for Lincoln National Corporation (LNC). LNC is a holding company operating multiple insurance and investment management businesses through four primary segments: Lincoln Retirement, Life Insurance, Investment Management, and Lincoln UK. The company markets its products under the "Lincoln Financial Group" identity.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue for the nine months ended September 30, 2005, increased 2% to $4.099 billion compared to $4.024 billion in the prior year period. Insurance fees and investment advisory fees grew due to increased assets under management and favorable equity market performance.
• Net Income Increase: Net income rose 17% to $605.7 million for the nine-month period, compared to $517.1 million in 2004. This increase was driven by lower realized investment losses and a reduction in federal income tax expense due to the release of a valuation allowance on foreign net operating losses.
• Realized Investment Gains/Losses: Net realized losses on investments and derivatives improved significantly, decreasing from a loss of $63.5 million in the prior year nine-month period to a loss of $8.2 million in 2005. This was primarily due to lower impairment losses.
• Segment Performance:
  • Lincoln Retirement: Income from operations increased 13% to $354.2 million, driven by fee income growth and favorable assumption reviews.
  • Life Insurance: Income from operations increased 6% to $218.7 million.
  • Investment Management: Income from operations decreased 44% to $21.4 million, largely due to the absence of income from the sold DIAL unit and increased expenses.
  • Lincoln UK: Income from operations increased 11% to $29.9 million.
• Divestitures: The company completed the sale of its London-based international investment unit (DIAL) in September 2004, resulting in a gain of $14.2 million in the first nine months of 2005 from the settlement of residual contingent payments.

Guidance, Outlook, Risks, and Unusual Items

• Merger with Jefferson-Pilot: On October 9, 2005, LNC entered into a merger agreement with Jefferson-Pilot Corporation. The transaction is expected to close by the end of the first quarter of 2006. The cash portion of the purchase price ($1.8 billion) will be financed through long-term debt, preferred stock, or other securities.
• Regulatory Risks:
  • Actuarial Guideline 38 (AXXX): New statutory reserve requirements for Universal Life products with secondary guarantees, effective July 1, 2005, could impact statutory surplus by up to $100 million in 2005. There is no impact on GAAP reserves.
  • UK Selling Practices: LNC increased reserves for UK selling practice matters by $4.9 million due to higher-than-expected customer complaints. Management believes future developments will not materially affect consolidated financial position.
• Interest Rate Risk: The company faces risk from falling interest rates on fixed annuity and interest-sensitive life insurance products. Management expects interest spreads to decrease by 2-3 basis points for the Lincoln Retirement segment and 1-2 basis points for the Life Insurance segment for the remainder of 2005.
• Investment Portfolio: Exposure to below-investment-grade securities increased to 7.4% of available-for-sale fixed maturity securities, primarily due to "fallen angels" (downgrades). Gross unrealized losses on these securities were $75.4 million.
• Restructuring: Pre-tax restructuring charges were $27.8 million for the nine months ended September 30, 2005, related to expense initiatives and realignment activities.

Important Facts for Investor Verification

• Merger Financing: Verify the terms and financing structure of the proposed merger with Jefferson-Pilot, including the potential impact on leverage and capital structure.
• Statutory Reserve Impact: Monitor the actual impact of the new Actuarial Guideline 38 on statutory surplus and dividend capacity from the Life Insurance segment.
• Investment Quality: Review the composition of the investment portfolio, specifically the exposure to below-investment-grade securities and the potential for further impairments in the airline and automotive sectors.
• UK Contingencies: Track developments regarding UK selling practice liabilities and potential VAT implications on the Capita outsourcing agreement.
• Interest Rate Margins: Assess the company's ability to maintain interest rate margins in a low-interest-rate environment, particularly for fixed annuity products.