Lincoln National Corporation
2008 Annual Report to Shareholders
To Our Shareholders:
The Year in Review
2008 was a year of intensifying challenges for our industry. Along with many of our peers, Lincoln National Corporation
(“Lincoln”) faced elevated investment losses, earnings pressure brought on by a sharp decline in the equity markets, and
disappointing actions by the independent ratings agencies. In all, it was an unsatisfactory year in terms of Lincoln’s share price
performance and earnings results, and in addition, we made the necessary move to preserve capital by reducing the dividend.
As we took actions to deal with the extraordinary capital and investment markets, we also focused on our operations to uphold our
industry franchise position. Highlights of this included:
(cid:120) Realigning our businesses into Insurance Solutions and Retirement Solutions, a move that clarified our ongoing strategic focus
(cid:120)
and effectiveness;
Strengthening our senior management with the hiring of two experienced executives to lead Lincoln Financial Distributors and
Human Resources;
(cid:120) Taking difficult but prudent steps to lower our costs through reductions in our operating expenses and in our workforce;
(cid:120) Adding new products and modifying our annuity income products to mitigate risk and increase profitability; and
(cid:120)
Substantially increasing our communications with our business partners to help maintain these important relationships.
It is likely that the external conditions will continue to be difficult throughout 2009. However, we are confident in our competitive
position and our ability to adapt and manage through these volatile markets.
Here is a snapshot of our full year 2008 financial results:
(cid:120) Net income of $57 million, or $0.22 per diluted share;
(cid:120) $28.8 billion of consolidated retail deposits;
(cid:120) $2.5 billion of consolidated net retail flows;
(cid:120) $178.0 billion consolidated assets under management;
(cid:120) Life Insurance in force of $545.2 billion;
(cid:120) Group Protection sales of $316 million, premiums up 10%;
(cid:120) Individual variable annuities deposits of $10 billion, positive net flows; and
(cid:120) Defined Contribution deposits of $5.5 billion, net flows up 132%.
Keeping our Business Moving Forward
Despite the weakening economy, Lincoln experienced pockets of relative strength, specifically in the areas of Group Protection
and Lincoln Financial Network (“LFN”), our retail distribution organization. In addition, Lincoln maintained its market leadership
position within many of our distribution partner firms. We achieved positive net flows in Retirement Solutions and Insurance
Solutions for the fourth quarter and full year, reflecting retail and wholesale distribution strength and a comprehensive product
line-up.
In an increasingly uncertain world, our business model, the products we manufacture and the advice we deliver are even more
relevant in helping our customers secure their financial futures. Leveraging our powerful wholesale and retail distribution
organizations, we are undertaking even greater efforts to help clients make sense of the challenges of this economic environment
and how our products can assist them now and in the future. We are also continuing to develop new solutions and services, such
as our Lincoln AssetEdgeSM variable life insurance product and our industry-leading underwriting capabilities that differentiate
Lincoln as an essential partner in this industry.
Powerful Advice-Focused Distribution
Our powerful wholesale and retail distribution expertise provided a strong defense against the external economic climate in 2008.
Lincoln Financial Distributors
Lincoln Financial Distributors (“LFD”), our wholesaling organization, continued to focus on positioning our firm for growth by
leveraging our strong wholesaler presence and delivering comprehensive Lincoln solutions to our strategic partner intermediary
firms and financial advisor clients. LFD successfully retained top talent and continued to empower its effective sales force of
wholesalers and sales managers.
Despite pressure from an increasingly challenging economic environment, LFD maintained leading market share positions in
variable annuity and life sales in many of our top strategic partner firms. LFD grew sales of MoneyGuard®, a universal life
insurance/long-term care product, by 24% and maintained a strong market presence in the Defined Contribution space, doubling
our 403(b) activity in 2008. As part of our strategy to gain deeper penetration in the Independent Planner channel, LFD launched
the Business Development Desk, which successfully drove incremental sales to the organization.
Lincoln Financial Network
LFN, our retail distribution group, enjoyed record profitability in 2008, driven by strong recruiting and life insurance sales. LFN’s
recruiting results were impressive, attracting experienced life insurance and financial planning advisors with over $50 million of
annual production. As of December 31, 2008, there were approximately 7,400 active advisors within the LFN system.
Most importantly, LFN’s growth and recruiting strategy remained sharply focused on not just growing the overall advisor
headcount, but on leveraging LFN’s compelling life insurance and financial planning platforms that enable us to attract and retain
high-quality, productive advisors. In 2008, the Lincoln Financial Advisors division led all Lincoln channels in life production,
growing its sales by more than 9%. This is a solid measure of the quality of LFN planners and producers, even during the
challenging financial backdrop of last year.
Transforming into Retirement and Insurance Solutions
In July 2008, Lincoln Financial realigned Employer Markets and Individual Markets into two new operating businesses –
Retirement Solutions and Insurance Solutions – a move that brought us closer to focusing on, understanding and effectively
meeting the needs of our customers. This realignment optimized our resources and reinforced our commitment to our clients’
needs of retirement accumulation and income as well as wealth protection and transfer.
Retirement Solutions
With a strategic focus on accumulation and income, our Retirement Solutions business continued to gain market share. In the
Defined Contribution segment, overall deposits were flat with the prior year, while net flows more than doubled to almost $800
million. In the Annuities segment, gross deposits were down 13%; however, this was partially offset by a 10% reduction in
outflows.
Due to the volatile financial markets and deteriorating economy, Retirement Solutions has taken steps to reduce the risk profile of
our variable annuity products. As we look forward to 2009, we remain confident in the division’s ability to make necessary changes
and remain competitive.
Insurance Solutions
Production remained strong in the Insurance Solutions business, which focuses on individual life insurance and group protection,
as many clients re-assessed their wealth protection needs in light of market turmoil. We further refined our individual life
insurance product line-up to be the most innovative and responsive on the market. For example, we introduced our new Lincoln
AssetEdgeSM variable universal life product and our LINCOLN CORPORATE COMMITMENT® series of corporate-owned and
bank-owned life insurance products.
As part of our strategy to competitively differentiate Lincoln through industry-leading underwriting capabilities, we fully
implemented a comprehensive, cross-functional service approach to Underwriting and New Business, as well as technology
enhancements to support our service goals and distribution partners. Underwriting is now clearly a differentiator for Lincoln with
our advisor clients.
In our Group Protection segment, a new, national PPO dental network, branded with the Lincoln Financial name, provided
broader nationwide coverage and streamlined administration and customer service for our policyholders. A new Group Protection
sales model helped contribute to solid results and a record-setting sales month in December.
Investment Management
Despite the impact of a very difficult investing environment, Delaware Investments continues to be well-positioned within the
asset management industry. Its investment performance has been solid and its fixed income business has helped to mitigate the
financial impact of the volatile equity markets. Delaware’s institutional advisory new client fundings, while down overall from 2007
levels, picked up in 2008 as our fixed income team continued to deliver good performance relative to their key competitors. In
addition, all of Delaware’s fixed income retail mutual funds (with a five-year track record) ended the year in the top half of their
Lipper peer groups for five-year performance.
Retail fund performance improved across all timeframes in 2008 with nine of the top 10 largest retail funds beating their Lipper
average for one-year performance for the year ended December 31, 2008. At year-end, more than half of Delaware’s retail mutual
funds carried either a 4- or 5-star rating from Morningstar.*
Focused on Capital and Risk Management
With market conditions depressing our overall performance, during the second half of the year our priorities increasingly focused
on capital preservation and risk mitigation. To preserve and strengthen the company’s capital position, Lincoln took a number of
actions, such as engaging in expense reduction initiatives, suspending share buy-back programs and reducing its dividend.
Although the decision to reduce the dividend was a very difficult one, on balance, our Board of Directors believes that preserving
capital in this environment is in the long-term best interests of shareholders.
While it would be inaccurate to say that we anticipated the depth and severity of the market disruption, we put our investment
portfolio in a defensive position heading into 2008 by reducing our real estate and high-yield bond exposures. Prolonged weakness
in the economy will hurt even well-positioned and diversified bond portfolios, and therefore, we anticipate elevated levels of
impairments relative to historical default rates throughout 2009. We are continuing to hold more cash and focusing new purchases
on higher quality assets, as well as leveraging the fixed income expertise of Delaware Investments, Lincoln’s investment
management subsidiary which also manages our general account assets.
Responding to the extreme pressures in the economy, the major independent rating agencies have taken ratings actions designed to
reflect the impact of the severe equity market declines on life insurer’s earnings and capital. Currently, the ratings on our primary
insurance subsidiary for financial strength remain at strong “AA-” levels with several of the major rating agencies. However, given
the negative outlook on the industry and, in some cases, on Lincoln specifically, and overall market volatility, it is difficult to
predict the future actions of ratings agencies. This makes it even more vital that we continue to protect our capital base and reduce
risk.
Benefiting Others through Corporate Citizenship
During times like these, it is especially important to recognize that our commitment to corporate citizenship benefits all
stakeholders: shareholders, communities and employees.
In 2008, Lincoln Financial Foundation contributed more than $11 million to support nonprofit organizations in the communities
where our employees live and work, with a focus on supporting education and workforce development, providing for basic needs
and increasing access to the arts. Lincoln Foundation also contributed nearly $1 million to United Way agencies, and our
employees donated nearly $1 million to the United Way in workplace campaigns.
Lincoln remains committed to supporting volunteerism in three ways: participation on nonprofit boards; activities such as drives
for local charities, including food banks and blood drives; and through LIVE, Lincoln Invests in Volunteer Experiences, which
awarded nearly $40,000 to nonprofits in 2008 in recognition of employees donating 50 hours of personal volunteer time.
Our People are Leading the Charge
As part of our commitment to providing excellent products and service to our customers, Lincoln continued its commitment to
developing and retaining top talent in the insurance and financial services industry.
In 2008, we strengthened our culture by implementing a new performance management system designed to effectively help
managers and employees assess their career paths and goals and enhanced our leadership development through new programs that
reinforce our Leadership Expectations. Employees also had access to new resources to help them achieve their personal and
professional goals. In addition, we confirmed employees’ engagement in our strategic direction and our company through an
enterprise-wide survey, where we outperformed industry benchmarks for employee advocacy and passion for our brand.
Overall, our people strategy is to provide a rewarding environment where employees can grow both personally and professionally,
while offering tools that empower them to embrace their financial futures.
Making Progress in the Year Ahead
Recognizing the serious challenges facing us and our industry, and with a healthy respect for the unknown, we are nonetheless
confident that our business model, product solutions and advice will position us to make progress during this difficult period and
enable us to seize the opportunities that will emerge from this environment. With this in mind, our company is embracing the
following goals:
(cid:120) Adhere to our Retirement Solutions, Insurance Solutions, and Investment Management strategies for growth;
(cid:120) Continue to take market share by deepening our relationships with intermediaries and making sure clients understand and take
advantage of the innovative products and solutions we offer;
(cid:120) Work to exceed customers’ expectations by delivering a distinct experience that differentiates Lincoln as an essential partner in
this industry;
(cid:120) Continue our disciplined approach to product design, pricing and risk transfer;
(cid:120) Manage costs prudently, find ways to improve efficiencies and eliminate redundant and costly processes;
(cid:120) Continue our long-standing practices of investing in risk management; and
(cid:120) Take action as necessary to preserve our long-term financial flexibility and to communicate to all key constituencies in the face
of unprecedented market conditions.
In closing, let me emphasize that we will take action to improve shareholder performance in 2009. We are confident in our people,
our businesses and our strategies, and, as this economic situation evolves, we will continue to do our absolute best to deliver value
for our customers and our shareholders. We thank you again for your confidence, trust and continued commitment.
Sincerely,
Dennis R. Glass
President and CEO
March 18, 2009
*Lipper rankings reflect each fund’s historical total return performance relative to its peers. Although a fund may outperform
peers within the peer group, its returns for that time period may still be negative. The Overall Morningstar Rating™ is derived
from a weighted average of the performance figures associated with a fund's 3-, 5- and 10-year (as applicable) Morningstar
Rating™ metrics. The top 10% of funds in each Morningstar category receive 5 stars and the next 22.5% receive 4 stars. Past
performance is no guarantee of future results.
Forward-Looking Statements – Cautionary Language – Statements in this letter that are not historical facts are forward-
looking statements. Actual results may differ materially from those projected in the forward-looking statements. See “Forward-
Looking Statements – Cautionary Language” beginning on page 47 and “Risk Factors” beginning on page 28.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Mark One)
(cid:95)
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2008
(cid:133)
OR
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to .
Commission File Number 1-6028
LINCOLN NATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
Indiana
(State or other jurisdiction of
incorporation or organization)
150 N. Radnor Chester Road, Suite A305, Radnor, Pennsylvania
(Address of principal executive offices)
35-1140070
(I.R.S. Employer
Identification No.)
19087
(Zip Code)
Registrant’s telephone number, including area code: (484) 583-1400
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock
$3.00 Cumulative Convertible Preferred Stock, Series A
6.75% Capital Securities
6.75% Trust Preferred Securities, Series F (1)
Name of each exchange on which registered
New York and Chicago
New York and Chicago
New York
New York
(1)
Issued by Lincoln National Capital VI. Payments of distributions and payments on liquidation or redemption are guaranteed by
Lincoln National Corporation.
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes (cid:95) No (cid:133)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes (cid:133) No (cid:95)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes (cid:95) No (cid:133)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will
not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. (cid:133)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one) Large accelerated filer (cid:95) Accelerated filer (cid:133)(cid:3)Non-accelerated filer (cid:133) Smaller reporting company (cid:133)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes (cid:133) No (cid:95)
The aggregate market value of the shares of the registrant’s common stock held by non-affiliates (based upon the closing price
of these shares on the New York Stock Exchange) as of the last business day of the registrant’s most recently completed second fiscal
quarter was $11.6 billion.
As of February 20, 2009, 256,042,499 shares of common stock of the registrant were outstanding.
Selected portions of the Proxy Statement for the Annual Meeting of Shareholders, scheduled for May 14, 2009, have been
incorporated by reference into Part III of this Form 10-K.
Documents Incorporated by Reference:
(cid:3)
(cid:3)
(cid:3)
Lincoln National Corporation
Table of Contents
PART I
Page
Item
1.
Business
Overview
Business Segments and Other Operations
Retirement Solutions
Retirement Solutions – Annuities
Retirement Solutions – Defined Contribution
Insurance Solutions
Insurance Solutions – Life Insurance
Insurance Solutions – Group Protection
Investment Management
Lincoln UK
Other Operations
Reinsurance
Reserves
Investments
Ratings
Regulatory
Employees
Available Information
1A. Risk Factors
1B. Unresolved Staff Comments
2.
3.
4.
Properties
Legal Proceedings
Submission of Matters to a Vote of Security Holders
Executive Officers of the Registrant
PART II
5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
6.
Selected Financial Data
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements – Cautionary Language
Introduction
Executive Summary
Critical Accounting Policies and Estimates
Acquisitions and Dispositions
Results of Consolidated Operations
Results of Retirement Solutions
Retirement Solutions – Annuities
Retirement Solutions – Defined Contribution
Results of Insurance Solutions
Insurance Solutions – Life Insurance
Insurance Solutions – Group Protection
i
1
1
3
3
4
8
9
10
13
14
17
18
19
19
19
20
22
27
27
28
42
42
42
42
43
44
45
46
47
48
48
53
68
69
73
73
81
88
88
95
Item
Results of Investment Management
Results of Lincoln UK
Results of Other Operations
Realized Gain (Loss)
Consolidated Investments
Reinsurance
Review of Consolidated Financial Condition
Liquidity and Capital Resources
Other Matters
Other Factors Affecting Our Business
Recent Accounting Pronouncements
Acquisitions and Divestitures
Restructuring Activities
7A. Quantitative and Qualitative Disclosures About Market Risk
8.
9.
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
9A. Controls and Procedures
9B. Other Information
10. Directors, Executive Officers and Corporate Governance
11. Executive Compensation
PART III
12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
13. Certain Relationships and Related Transactions, and Director Independence
14. Principal Accountant Fees and Services
PART IV
15. Exhibits and Financial Statement Schedules
Signatures
Index to Financial Statement Schedules
Index to Exhibits
Page
98
101
105
108
114
139
141
141
150
150
150
150
150
151
159
245
245
246
247
247
247
247
247
248
249
FS-1
E-1
ii
PART I
The “Business” section and other parts of this Form 10-K contain forward-looking statements that involve inherent risks and
uncertainties. Statements that are not historical facts, including statements about our beliefs and expectations, and containing
words such as “believes,” “estimates,” “anticipates,” “expects” or similar words are forward-looking statements. Our actual results
may differ materially from the projected results discussed in the forward-looking statements. Factors that could cause such
differences include, but are not limited to, those discussed in “Item 1A. Risk Factors” and in the “Forward-Looking Statements –
Cautionary Language” in “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations” (“MD&A”) of the Form 10-K. Our consolidated financial statements and the accompanying notes to the
consolidated financial statements (“Notes”) are presented in “Part II – Item 8. Financial Statements and Supplementary Data.”
Item 1. Business
OVERVIEW
Lincoln National Corporation (“LNC,” which also may be referred to as “Lincoln,” “we,” “our” or “us”) is a holding company,
which operates multiple insurance and investment management businesses through subsidiary companies. Through our business
segments, we sell a wide range of wealth protection, accumulation and retirement income products and solutions. These products
include institutional and/or retail fixed and indexed annuities, variable annuities, universal life insurance (“UL”), variable universal
life insurance (“VUL”), term life insurance, mutual funds and managed accounts. LNC was organized under the laws of the state
of Indiana in 1968. We currently maintain our principal executive offices in Radnor, Pennsylvania, which were previously located
in Philadelphia, Pennsylvania. “Lincoln Financial Group” is the marketing name for LNC and its subsidiary companies. As of
December 31, 2008, LNC had consolidated assets of $163.1 billion and consolidated stockholders’ equity of $8.0 billion.
Prior to our realignment discussed below, we provided products and services in four operating businesses: Individual Markets;
Employer Markets; Investment Management; and Lincoln UK. We reported results through six business segments: Individual
Markets – Annuities; Individual Markets – Life Insurance; Employer Markets – Retirement Products; Employer Markets – Group
Protection; Investment Management; and Lincoln UK.
On July 21, 2008, we announced the realignment of our segments under our former Employer Markets and Individual Markets
operating businesses into two new operating businesses – Retirement Solutions and Insurance Solutions. We believe the new
structure more closely aligns with consumer needs and should lead to more coordinated product development and greater
effectiveness across the enterprise. The only change to our prior segment reporting was to report the results of the Executive
Benefits business, which was previously part of the Retirement Products segment, in the Life Insurance segment for all periods
presented. These changes are in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No.
131, “Disclosures about Segments of an Enterprise and Related Information,” and reflect the manner in which we are organized
for purposes of making operating decisions and assessing performance. We view the changes to the existing segments as
immaterial. Accordingly, we provide products and services in four operating businesses and report results through six segments as
follows:
Business
Retirement Solutions
Insurance Solutions
Corresponding Segments
Annuities
Defined Contribution (formerly Retirement Products)
Life Insurance (including Executive Benefits business)
Group Protection
Investment Management
Investment Management
Lincoln UK
Lincoln UK
In addition, the results of our run-off Institutional Pension business, formerly reported in Employer Markets – Retirement
Products – Executive Benefits, are included in Other Operations for all periods presented. Other Operations also includes the
financial data for operations that are not directly related to the business segments, unallocated corporate items and the ongoing
amortization of deferred gain on the indemnity reinsurance portion of the sale of our former reinsurance segment to Swiss Re Life
& Health America Inc. (“Swiss Re”) in the fourth quarter of 2001. Unallocated corporate items include 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.
1
On November 12, 2007, we signed agreements to sell the television stations, sports programming business and certain radio
properties of our former Lincoln Financial Media segment. The sales closed during the fourth quarter of 2007 and the first quarter
of 2008. Accordingly, we have reported the results of these businesses as discontinued operations on our Consolidated Statements
of Income and the assets and liabilities as held for sale on our Consolidated Balance Sheets for all periods presented. The results of
the remaining radio properties, which are included in Other Operations, do not qualify as discontinued operations. For further
information, see “Acquisitions and Dispositions” below.
The results of Lincoln Financial Network (“LFN”) and Lincoln Financial Distributors (“LFD”), our retail and wholesale
distributors, respectively, are included in the segments for which they distribute products. LFD distributes our individual as well as
Defined Contribution and Executive Benefits (which includes corporate-owned UL and VUL (“COLI”) and bank-owned UL and
VUL (“BOLI”)) products and services. The distribution occurs primarily through brokers, planners, agents, financial advisors,
third party administrators (“TPAs”) and other intermediaries. Group Protection distributes its products and services primarily
through employee benefit brokers, TPAs and other employee benefit firms. As of December 31, 2008, LFD had approximately
830 internal and external wholesalers (including sales managers). As of December 31, 2008, LFN offered LNC and non-
proprietary products and advisory services through a national network of approximately 7,400 active producers who placed
business with us within the last twelve months.
On July 16, 2008, we announced our change in definitions of segment operating revenues and income from operations to better
reflect the underlying economics of our variable and indexed annuities that employ derivative instruments to hedge policy benefits
and the manner in which management evaluates that business. For more information regarding this change, see the “MD&A”
below.
Financial information in the tables that follow is presented in conformity with accounting principles generally accepted in the
United States of America (“GAAP”), unless otherwise indicated. We provide revenues, income (loss) from operations and assets
attributable to each of our business segments and Other Operations, as well as revenues derived inside and outside the U.S. for the
last three fiscal years, in Note 23.
Revenues by segment (in millions) were as follows:
Revenues
Operating revenues:
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Excluded realized gain (loss), pre-tax
Amortization of deferred gain arising from
reserve changes on business sold through
reinsurance, pre-tax
Total revenues
Acquisitions and Dispositions
For the Years Ended December 31,
2008
2006
2007
$
2,610
936
3,546
$
2,533
986
3,519
$
2,060
988
3,048
4,250
1,640
5,890
438
327
439
(760)
4,189
1,500
5,689
590
370
473
(175)
3,470
1,032
4,502
564
308
444
12
3
9,883
$
9
10,475
$
1
8,879
$
On January 8, 2009, the Office of Thrift Supervision approved our application to become a savings and loan holding company and
our acquisition of Newton County Loan & Savings, FSB, a federally regulated savings bank, located in Indiana. We agreed to
contribute $10 million to the capital of Newton County Loan & Savings, FSB. We closed on our purchase of Newton County
Loan & Savings, FSB on January 15, 2009. We also filed an application with the U.S. Treasury to participate in the Troubled
Assets Relief Program (“TARP”) Capital Purchase Program (“CPP”). We have also applied to participate in the Federal Deposit
2
Insurance Corporation’s (“FDIC”) Temporary Liquidity Guarantee Program (the “TLGP”). Our applications to participate in the
CPP and the TLGP are subject to approval from the U.S. Treasury and FDIC, respectively. Accordingly, there can be no
assurance that we will participate in the CPP or the TLGP. These programs are discussed further below in “Regulatory.”
On November 12, 2007, Lincoln Financial Media Company (“LFMC”), our wholly-owned subsidiary, entered into two stock
purchase agreements with Raycom Holdings, LLC (“Raycom”). Pursuant to one of the agreements, LFMC agreed to sell to
Raycom all of the outstanding capital stock of three of LFMC’s wholly-owned subsidiaries: WBTV, Inc., the owner and operator
of television station WBTV, Charlotte, North Carolina; WCSC, Inc., the owner and operator of television station WCSC,
Charleston, South Carolina; and WWBT, Inc., the owner and operator of television station WWBT, Richmond, Virginia. The
transaction closed on March 31, 2008, and LFMC received proceeds of $546 million. Pursuant to the other agreement, LFMC
agreed to sell to Raycom all of the outstanding capital stock of Lincoln Financial Sports, Inc., a wholly-owned subsidiary of LFMC.
This transaction closed on November 30, 2007, and LFMC received $42 million of proceeds.
On November 12, 2007, LFMC also entered into a stock purchase agreement with Greater Media, Inc., to sell all of the
outstanding capital stock of Lincoln Financial Media Company of North Carolina, the owner and operator of radio stations
WBT(AM), Charlotte, North Carolina; WBT-FM, Chester, South Carolina; and WLNK(FM), Charlotte, North Carolina. This
transaction closed on January 31, 2008, and LFMC received proceeds of $100 million. More information on these LFMC
transactions can be found in our Form 8-K filed on November 14, 2007, and in Note 3.
During the fourth quarter of 2007, we sold certain institutional taxable fixed income business to an unaffiliated investment
management company. Investment Management transferred $12.3 billion of assets under management as part of this transaction.
Based upon the assets transferred as of October 31, 2007, the purchase price is expected to be approximately $49 million. During
the fourth quarter of 2007, we received $25 million of the purchase price, with additional scheduled payments over the next three
years. During 2007, we recorded an after-tax loss of $2 million in realized gain (loss) on our Consolidated Statements of Income as
a result of the goodwill we attributed to this business. During 2008, we recorded an after-tax gain of $5 million in realized gain
(loss) on our Consolidated Statements of Income related to this transaction, for additional cash received toward the purchase price.
Investment Management manages approximately $90.7 billion of fixed income assets with a team of 100 fixed income investment
professionals. The transaction did not impact the fixed income team that manages our fixed income mutual funds or general
account assets.
On April 3, 2006, we completed our merger with Jefferson-Pilot Corporation (“Jefferson-Pilot”), pursuant to which Jefferson-Pilot
merged into one of our wholly-owned subsidiaries. Prior to the merger, Jefferson-Pilot, through its subsidiaries, offered full lines
of individual life, annuity and investment products, and group life insurance products, disability income and dental contracts, and it
operated television and radio stations and a sports broadcasting network.
In September 2004, we completed the sale of our London-based international investment unit, Delaware International Advisors
Ltd. (“DIAL”), to a newly-formed company associated with DIAL’s management and a private-equity firm. At closing, we
received $181 million in cash and relief of certain obligations of approximately $19 million. We had an after-tax gain from the
transaction of $46 million. DIAL, which has since been renamed Mondrian Investment Partners (“Mondrian”), continues to
provide sub-advisory services with respect to certain international asset classes for our Investment Management segment and LNC.
For further inform tion about acquisitions and divestitures, see Note 3.
BUSINESS SEGMENTS AND OTHER OPERATIONS
RETIREMENT SOLUTIONS
Overview
The Retirement Solutions business, with principal operations in Radnor, Pennsylvania; Fort Wayne, Indiana; Hartford,
Connecticut; and Greensboro, North Carolina and additional operations in Concord, New Hampshire and Arlington Heights,
Illinois, provides its products through two segments: Annuities and Defined Contribution. The Annuities segment provides tax-
deferred growth and lifetime income opportunities for its clients by offering individual fixed annuities, including indexed annuities,
and variable annuities. The Defined Contribution segment provides employer-sponsored fixed and variable annuities and mutual
fund-based programs in the 401(k), 403(b) and 457 plan marketplaces. Products for both segments are distributed through a wide
range of intermediaries including both affiliated and unaffiliated channels including advisors, consultants, brokers, banks and
wirehouses.
3
Overview
Retirement Solutions – Annuities
The Annuities segment provides tax-deferred growth and lifetime income opportunities for its clients by offering fixed and variable
annuities. As a result of a broad product portfolio and a strong and diverse distribution network, Annuities ranked 5th in assets and
5th in variable annuity flows for the year ended December 31, 2008, in the U.S., according to Morningstar Annuity Research Center.
The Annuities segment offers non-qualified and qualified fixed and variable annuities to individuals. The “fixed” and “variable”
classification describes whether we or the contract holders bear the investment risk of the assets supporting the contract. This also
determines the manner in which we earn investment margin profits from these products, either as investment spreads for fixed
products or as asset-based fees charged to variable products.
Annuities have several features that are attractive to customers. First, they provide tax-deferred growth in the underlying principal,
thereby deferring the tax consequences of the growth in value until withdrawals are made from the accumulation values, often at
lower tax rates occurring during retirement. Second, annuities are unique in that contract holders can select a variety of payout
alternatives to help provide an income flow for life. Many annuity contracts include guarantee features (living and death benefits)
that are not found in any other investment vehicle and, we believe, make annuities attractive especially in times of economic
uncertainty. Over the last several years, the individual annuities market has seen an increase in competition with respect to
guarantee features.
Products
In general, an annuity is a contract between an insurance company and an individual or group in which the insurance company,
after receipt of one or more premium payments, agrees to pay an amount of money either in one lump sum or on a periodic basis
(i.e. annually, semi-annually, quarterly or monthly), beginning on a certain date and continuing for a period of time as specified in
the contract. Periodic payments can begin within twelve months after the premium is received (referred to as an immediate
annuity) or at a future date in time (referred to as a deferred annuity). This retirement vehicle helps protect an individual from
outliving his or her money and can be either a fixed annuity or a variable annuity.
The Annuities segment’s deposits (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Deposits
Variable portion of variable annuity
Fixed portion of variable annuity
Total variable annuity
Fixed indexed annuity
Other fixed annuity
Total deposits
Variable Annuities
$
$
$
6,690
3,433
10,123
1,078
529
11,730
9,135
2,795
11,930
755
772
13,457
$
$
$
7,251
2,090
9,341
717
698
10,756
A variable annuity provides the contract holder the ability to direct the investment of premium deposits into one or more sub-
accounts offered through the product (“variable portion”) or into a fixed account with a guaranteed return (“fixed portion”). The
value of the variable portion of the contract holder’s account varies with the performance of the underlying sub-accounts chosen
by the contract holder. The underlying assets of the sub-accounts are managed within a special insurance series of mutual funds.
The contract holder’s return is tied to the performance of the segregated assets underlying the variable annuity (i.e. the contract
holder bears the investment risk associated with these investments). The value of the fixed portion is guaranteed by us and
recorded in our general account liabilities. Variable annuity account values were $44.5 billion, $62.1 billion and $51.8 billion for the
years ended December 31, 2008, 2007 and 2006, respectively, including the fixed portions of variable accounts of $3.6 billion, $3.5
billion and $3.6 billion, for the years ended December 31, 2008, 2007 and 2006, respectively.
We charge mortality and expense assessments and administrative fees on variable annuity accounts to cover insurance and
administrative expenses. These assessments are built into accumulation unit values, which when multiplied by the number of units
owned for any sub-account equals the contract holder’s account value for that sub-account. The fees that we earn from these
contracts are reported as insurance fees on our Consolidated Statements of Income. In addition, for some contracts, we collect
surrender charges that range from 0% to 10% of withdrawals when contract holders surrender their contracts during the surrender
4
charge period, which is generally higher during the early years of a contract. Our individual variable annuity products have a
maximum surrender charge period of ten years.
We offer A-share, B-share, C-share, L-share and bonus variable annuities, although not with every annuity product. The
differences in these relate to the sales charge and fee structure associated with the contract.
(cid:120) An A-share has a front-end sales charge and no back-end contingent deferred sales charge, also known as a surrender charge.
The net premium (premium less front-end charge) is invested in the contract, resulting in full liquidity and lower mortality and
expense assessments over the long term than those in other share classes.
(cid:120) A B-share has a seven-year surrender charge that is only paid if the account is surrendered or withdrawals are in excess of
contractual free withdrawals within the contract’s specified surrender charge period. The entire premium is invested in the
contract, but it offers limited liquidity during the surrender charge period.
(cid:120) A C-share has no front-end sales charge or back-end surrender charge. Accordingly, it offers maximum liquidity but mortality
and expense assessments are higher than those for A-share or B-share during the surrender charge period. A persistency credit
is applied beginning in year eight so that the total charge to the customer is consistent with B-share levels.
(cid:120) An L-share has a four to five year surrender charge that is only paid if the account is surrendered or withdrawals are in excess
of contractual free withdrawals within the contract’s specified surrender charge period. The differences between the L-share
and the B-share are the length of the surrender charge period and the fee structure. L-shares have a shorter surrender charge
period, so for the added liquidity, mortality and expense assessments are higher. We offer L-share annuity products with
persistency credits that are applied in all years after surrender charges are no longer applicable so that the total charge to the
customer is consistent with B-share levels.
(cid:120) A bonus annuity is a variable annuity contract that offers a bonus credit to a contract based on a specified percentage (typically
ranging from 2% to 5%) of each deposit. The entire premium plus the bonus are invested in the sub-accounts supporting the
contract. It has a seven to nine-year surrender charge. The expenses are slightly more than those for a B-share. We offer
bonus annuity products with persistency credits that are applied in all years after surrender charges are no longer applicable so
that the total charge to the customer is consistent with B-share levels.
We offer guaranteed benefit riders with certain of our variable annuity products, such as a guaranteed death benefit (“GDB”), a
guaranteed withdrawal benefit (“GWB”), a guaranteed income benefit (“GIB”) and a combination of such benefits. Most of our
variable annuity products also offer the choice of a fixed option that provides for guaranteed interest credited to the account value.
Approximately 91% of variable annuity separate account values had a GDB rider as of December 31, 2008, 2007 and 2006. The
GDB features currently offered include those where we contractually guarantee to the contract holder that upon death, we will
return no less than: the total deposits made to the contract, adjusted to reflect any partial withdrawals; the total deposits made to
the contract, adjusted to reflect any partial withdrawals, plus a minimum return; or the highest contract value on a specified
anniversary date adjusted to reflect any partial withdrawals following the contract anniversary.
Approximately 28%, 31% and 26% of variable annuity account values as of December 31, 2008, 2007 and 2006, respectively, had a
GWB rider. The Lincoln SmartSecurity® Advantage benefit is a GWB rider that offers the contract holder a guarantee equal to the
initial deposit (or contract value, if elected after issue), adjusted for any subsequent purchase payments or withdrawals. There are
two elective step-up options: a one-year option and a five-year option. In general, the one-year option allows an owner to step up
the guarantee amount automatically on the benefit anniversary to the current contract value, and the five-year option allows the
owner to step up the guarantee amount to the current contract value on or after the fifth anniversary of the election or of the most
recent step up. In each case, the contract value must be greater than the guarantee amount at the time of step up. To receive the
full amount of the guarantee, annual withdrawals are limited to either 5% of the guaranteed amount for the one-year option or 7%
of the guaranteed amount for the five-year option. Under the one-year option, withdrawals will continue for the rest of the
owner’s life (“single life version”) or the life of the owner or owner’s spouse (“joint life version”) as long as withdrawals begin after
attained age 65 and are limited to 5% of the guaranteed amount. Withdrawals in excess of the applicable maximum in any contract
year are assessed any applicable surrender charges, and the guaranteed amount is recalculated.
We offer other product riders including i4LIFE® Advantage and 4LATER® Advantage. The i4LIFE® rider, on which we have
received a U.S. patent, allows variable annuity contract holders access and control during the income distribution phase of their
contract. This added flexibility allows the contract holder to access the account value for transfers, additional withdrawals and
other service features like portfolio rebalancing. Approximately 11%, 9% and 6% of variable annuity account values as of
December 31, 2008, 2007 and 2006, respectively, have elected an i4LIFE® Advantage feature. In general, GIB is an optional
feature available with i4LIFE® Advantage that guarantees regular income payments will not fall below 75% of the highest income
payment on a specified anniversary date (reduced for any subsequent withdrawals). Approximately 92%, 88% and 83% of
i4LIFE® Advantage account values elected the GIB feature as of December 31, 2008, 2007 and 2006, respectively. 4LATER®
Advantage provides a minimum income base used to determine the GIB floor when a client begins income payments under
i4LIFE® Advantage. The income base is equal to the initial deposit (or contract value, if elected after issue) and increases by 15%
5
every three years (subject to a 200% cap). The owner may step up the income base on or after the third anniversary of rider
election or of the most recent step-up (which also resets the 200% cap).
The Lincoln Lifetime IncomeSM Advantage and Lincoln Lifetime IncomeSM Advantage Plus are hybrid benefit riders combining aspects of
GWB and GIB. Both benefit riders allow the contract holder the ability to take income at a maximum rate of 5% of the
guaranteed amount when they are above the lifetime income age or income through i4LIFE® Advantage with the GIB. Lincoln
Lifetime IncomeSM Advantage and Lincoln Lifetime IncomeSM Advantage Plus provide higher income if the contract holder delays
withdrawals, including both a 5% enhancement to the guaranteed amount each year a withdrawal is not taken for a specified period
of time and a doubling of the initial guaranteed amount at the later of ten years or age seventy, subject to withdrawal limits. The
Lincoln Lifetime IncomeSM Advantage Plus provides an additional benefit, which is a return of principal at the end of the seventh year
if the customer has not taken any withdrawals. Contract holders under both the Lincoln Lifetime IncomeSM Advantage and Lincoln
Lifetime IncomeSM Advantage Plus are subject to restrictions on the allocation of their account value within the various investment
choices. Approximately 8% of variable annuity account values as of December 31, 2008, had a Lincoln Lifetime IncomeSM Advantage
or Lincoln Lifetime IncomeSM Advantage Plus rider.
To mitigate the increased risks associated with guaranteed benefits, we developed a dynamic hedging program. The customized
dynamic hedging program uses equity and interest rate futures positions, interest rate and variance swaps, as well as equity-based
options depending upon the risks underlying the guarantees. Our program is designed to offset both positive and negative changes
in the carrying value of the guarantees. However, while we actively manage these hedge positions, the hedge positions may not be
effective to exactly offset the changes in the carrying value of the guarantees due to, among other things, the time lag between
changes in their values and corresponding changes in the hedge positions, high levels of volatility in the equity markets, contract
holder behavior and divergence between the performance of the underlying funds and hedging indices, which is referred to as basis
risk. For more information on our hedging program, see “Critical Accounting Policies and Estimates – Derivatives” and “Realized
Gain (Loss)” in the MD&A. For information regarding risks related to guaranteed benefits, see “Item 1A. Risk Factors – Changes
in the equity markets, interest rates and/or volatility affect the profitability of our products with guaranteed benefits; therefore,
such changes may have a material adverse effect on our business and profitability.”
We design and actively manage the features and structure of our guaranteed benefit riders to maintain a competitive suite of
products consistent with profitability and risk management goals. In late 2008 and early 2009, in light of changes in the variable
annuity market place driven by financial market conditions, we made changes to our rider designs that are expected to reduce the
risk of these benefits. The changes include, but are not limited to, implementing investment restrictions for all new rider sales and
for the majority of in force policies with guaranteed riders, raising the charge for guaranteed benefit riders and eliminating certain
features. We plan to make further rider design changes in 2009 that we expect will reduce the risk of our guaranteed benefit riders.
The changes will take into account the rapidly evolving competitive environment for guaranteed benefit annuities.
Fixed Annuities
A fixed annuity preserves the principal value of the contract while guaranteeing a minimum interest rate to be credited to the
accumulation value. We offer single and flexible premium fixed deferred annuities to the individual annuities market. Single
premium fixed deferred annuities are contracts that allow only a single premium to be paid. Flexible premium fixed deferred
annuities are contracts that allow multiple premium payments on either a scheduled or non-scheduled basis. Our fixed annuities
include both traditional fixed-rate and fixed indexed annuities. With fixed deferred annuities, the contract holder has the right to
surrender the contract and receive the current accumulation value less any applicable surrender charge and, if applicable, a market
value adjustment (“MVA”). Depending on market conditions, MVAs can, for some products, be less than zero, which means the
MVA results in an increase to the amount received by the contract holder.
Fixed indexed annuities allow the contract holder to elect an interest rate linked to the performance of the Standard & Poor’s
(“S&P”) 500 Index® (“S&P 500”). The indexed interest rate is guaranteed never to be less than zero. Our fixed indexed annuities
provide contract holders a choice of a traditional fixed-rate account and one or more different indexed accounts. A contract
holder may elect to change allocations at renewal dates, either annually or biannually. At each renewal date, we have the
opportunity to re-price the indexed component (i.e. reset the caps, spreads or participation rates), subject to guarantees.
Fixed annuity contracts are general account obligations. We bear the investment risk for fixed annuity contracts. To protect from
premature withdrawals, we impose surrender charges. Surrender charges are typically applicable during the early years of the
annuity contract, with a declining level of surrender charges over time. We expect to earn a spread between what we earn on the
underlying general account investments supporting the fixed annuity product line and what we credit to our fixed annuity contract
holders’ accounts. In addition, with respect to fixed indexed annuities, we purchase options that are highly correlated to the
indexed account allocation decisions of our contract holders, such that we are closely hedged with respect to indexed interest for
the current reset period. For more information on our hedging program for fixed indexed annuities, see “Critical Accounting
Policies and Estimates – Derivatives” and “Realized Gain (Loss)” in the MD&A.
6
Individual fixed annuity account values were $14.0 billion, $14.4 billion and $14.9 billion as of December 31, 2008, 2007 and 2006,
respectively. Approximately $10.1 billion of individual fixed annuity account values as of December 31, 2008, were still within the
surrender charge period.
Our fixed annuity product offerings as of December 31, 2008, consisted of traditional fixed-rate and fixed indexed deferred
annuities, as well as fixed-rate immediate annuities with various payment options, including lifetime incomes. In addition to
traditional fixed-rate immediate annuities, in 2007 we introduced Lincoln SmartIncomeSM Inflation Annuity. This product provides
lifetime income with annual adjustments to keep pace with inflation. It uses a patent-pending design to preserve access to
remaining principal, also adjusted annually for inflation, for premature death or unexpected needs. The traditional fixed-rate
deferred annuity products include the Lincoln ClassicSM (Single and Flexible Premium), Lincoln SelectSM and Lincoln ChoicePlusSM Fixed
annuities. The fixed indexed deferred annuity products include the Lincoln OptiPoint®, Lincoln OptiChoiceSM, Lincoln New Directions®
and Lincoln Future Point® annuities. The fixed indexed annuities offer one or more of the following indexed accounts:
(cid:120) The Performance Triggered Indexed Account pays a specified rate, declared at the beginning of the indexed term, if the S&P
500 value at the end of the indexed term is the same or greater than the S&P 500 value at the beginning of the indexed term;
(cid:120) The Point to Point Indexed Account compares the value of the S&P 500 at the end of the indexed term to the S&P 500 value
at the beginning of the term. If the S&P 500 at the end of the indexed term is higher than the S&P 500 value at the beginning
of the term, then the percentage change, up to the declared indexed interest cap, is credited to the indexed account;
(cid:120) The Monthly Cap Indexed Account reflects the monthly changes in the S&P 500 value over the course of the indexed term.
Each month, the percentage change in the S&P 500 value is calculated, subject to a monthly indexed cap that is declared at the
beginning of the indexed term. At the end of the indexed term, all of the monthly change percentages are summed to
determine the rate of indexed interest that will be credited to the account; and
(cid:120) The Monthly Average Indexed Account compares the average monthly value of the S&P 500 to the S&P 500 value at the
beginning of the term. The average of the S&P 500 values at the end of each of the twelve months in the indexed term is
calculated. The percentage change of the average S&P 500 value to the starting S&P 500 value is calculated. From that
amount, the indexed interest spread, which is declared at the beginning of the indexed term, is subtracted. The resulting rate is
used to calculate the indexed interest that will be credited to the account.
If the S&P 500 values produce a negative indexed interest rate, no indexed interest is credited to the indexed account.
We introduced the Lincoln Living IncomeSM Advantage in 2007. Available with certain of our fixed indexed annuities, it provides the
contract holder a guaranteed lifetime withdrawal benefit. Withdrawals in excess of the free amount are assessed any applicable
surrender charges, and the guaranteed withdrawal amount is recalculated.
Many of our fixed annuities have an MVA. If a contract with an MVA is surrendered during the surrender charge period, both a
surrender charge and an MVA may be applied. The MVA feature increases or decreases the contract value of the annuity based on
a decrease or increase in interest rates. Individual fixed annuities with an MVA feature constituted 46%, 40% and 24% of total
fixed annuity account values as of December 31, 2008, 2007 and 2006, respectively.
Distribution
The Annuities segment distributes its individual fixed and variable annuity products through LFD, our wholesaling distribution
organization. LFD’s distribution channels give the Annuities segment access to its target markets. LFD distributes the segment’s
products to a large number of financial intermediaries, including LFN. The financial intermediaries include wire/regional firms,
independent financial planners, financial institutions and managing general agents.
Competition
The annuities market is very competitive and consists of many companies – with no one company dominating the market for all
products. The Annuities segment competes with numerous other financial services companies. The main factors upon which
entities in this market compete are distribution channel access and the quality of wholesalers, investment performance, cost,
product features, speed to market, brand recognition, financial strength ratings, crediting rates and client service.
7
Overview
Retirement Solutions – Defined Contribution
The Defined Contribution segment provides employers the ability to offer tax-deferred retirement savings plans to their
employees, primarily through 403(b) and 401(k) retirement savings plans. We provide a variety of plan investment vehicles,
including individual and group variable annuities, group fixed annuities and mutual funds. We also offer a broad array of plan
services including plan recordkeeping, compliance testing, participant education and other related services.
Defined contribution (“DC”) plans are a popular employee benefit offered by many employers across a wide spectrum of
industries and by employers large and small. Some plans include employer matching of contributions, which can increase
participation by employees. Growth in the number of DC plans has occurred as these plans have been used as replacements for
frozen or eliminated defined benefit retirement plans. In general, DC plans offer tax-deferred contributions and investment
growth, thereby deferring the tax consequences of both the contributions and investment growth until withdrawals are made from
the accumulated values, often at lower tax rates occurring during retirement.
Lincoln’s 403(b) assets accounted for 60% of total assets under management in this segment as of December 31, 2008. The 401(k)
business accounted for 46% of our new deposits during 2008 for this segment.
Products and Services
The Defined Contribution segment currently offers four primary offerings to the employer-sponsored market: LINCOLN
DIRECTORSM group variable annuity, LINCOLN ALLIANCE® program, Lincoln SmartFuture® program and Multi-Fund®
variable annuity.
The Defined Contribution segment’s deposits (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Deposits
Variable portion of variable annuity
Fixed portion of variable annuity
Total variable annuity
Fixed annuity
Mutual funds
Total deposits
$
$
$
2,170
369
2,539
812
2,196
5,547
2,355
351
2,706
754
2,090
5,550
2,525
441
2,966
506
1,113
4,585
$
$
$
LINCOLN DIRECTORSM and Multi-Fund® products are variable annuities. LINCOLN ALLIANCE® and Lincoln SmartFuture®
programs are mutual fund-based programs. This suite of products covers both the 403(b) and 401(k) marketplace. Both 403(b)
and 401(k) plans are tax-deferred, defined contribution plans offered to employees of an entity to enable them to save for
retirement. The 403(b) plans are available to employees of educational institutions, not-for-profit healthcare organizations and
certain other not-for-profit entities, while 401(k) plans are generally available to employees of for-profit entities. The investment
options for our annuities encompass the spectrum of asset classes with varying levels of risk and include both equity and fixed
income. As of December 31, 2008 and 2007, healthcare clients accounted for 45% and 43% of account values for these products,
respectively.
LINCOLN DIRECTORSM group variable annuity is a 401(k) DC retirement plan solution available to micro- to small-sized
businesses, typically those that have DC plans with less than $3 million in account values. The LINCOLN DIRECTORSM product
offers participants a broad array of investment options from several fund families. In 2008, the investment options were
significantly enhanced with the addition of the funds that had been offered only through the Lincoln American Legacy Retirement®
group variable annuity. Lincoln American Legacy Retirement® was merged into LINCOLN DIRECTORSM group variable annuity in
2008 and is no longer offered as a standalone product for new sales. LINCOLN DIRECTORSM group variable annuity has the
option of being serviced through a TPA or fully serviced by Lincoln. As of December 31, 2008, approximately 90% of LINCOLN
DIRECTORSM clients were serviced through TPAs. The Defined Contribution segment earns revenue through asset charges,
investment income, surrender charges and recordkeeping fees from this product. Account values for LINCOLN DIRECTORSM
group variable annuity were $4.9 billion, $7.8 billion and $7.5 billion as of December 31, 2008, 2007 and 2006, respectively.
Deposits for LINCOLN DIRECTORSM group variable annuity were $1.5 billion, $1.6 billion and $1.8 billion during 2008, 2007
and 2006, respectively.
8
The LINCOLN ALLIANCE® program is a 401(k) or 403(b) DC retirement plan solution aimed at mid to large employers,
typically those that have DC plans with $15 million or more in account value. The target market is primarily for-profit
corporations, educational institutions and healthcare providers. The program bundles our traditional fixed annuity products with
the employer’s choice of retail mutual funds, along with recordkeeping, plan compliance services and customized employee
education services. Included in the product offering is the LIFESPAN® learning program, which provides participants with
educational materials and one-on-one guidance for retirement planning assistance. The program allows the use of any retail mutual
fund. We earn fees for our recordkeeping and educational services and the services we provide to mutual fund accounts. We also
earn investment margins on fixed annuities. The retail mutual funds associated with this program are not included in the separate
accounts reported on our Consolidated Balance Sheets, as we do not have any ownership interest in them. LINCOLN
ALLIANCE® program account values were $9.4 billion, $9.5 billion and $7.0 billion as of December 31, 2008, 2007 and 2006,
respectively.
The Lincoln SmartFuture® program is a 401(k) or 403(b) DC retirement plan solution aimed at small to mid to large employers,
typically those that have DC plans with between $3 million to $15 million or more in account value. The target market is primarily
for-profit corporations, educational institutions and healthcare providers. The Lincoln SmartFuture® program was introduced in
2008 and is built on the LINCOLN ALLIANCE® platform. Like LINCOLN ALLIANCE®, the program bundles our
traditional fixed annuity products with retail mutual funds, recordkeeping, plan compliance services and employee education
services using the LIFESPAN® learning program, which is described further above. However, the Lincoln SmartFuture® program
allows the employer to choose from a list of over 100 retail mutual funds chosen by us, which consists of a broad range of low-cost
funds. Services for this program are typically not customized for each employer. We earn fees for our recordkeeping and
educational services and the services we provide to mutual fund accounts. We also earn investment margins on fixed annuities.
The retail mutual funds associated with this program are not included in the separate accounts reported on our Consolidated
Balance Sheets, as we do not have any ownership interest in them. Lincoln SmartFuture® program account values were $104 million
as of December 31, 2008.
Multi-Fund® Variable Annuity is a defined contribution retirement plan solution with full-bundled administrative services and high
quality investment choices marketed to small- to mid-sized healthcare, education, governmental and not-for-profit plans. The
product can be sold either to the employer through the Multi-Fund® group variable annuity contract or directly to the individual
through the Multi-Fund® select variable annuity contract. Included in the product offering is the LIFESPAN® learning program,
which is described further above. We earn mortality and expense charges, investment income and surrender charges from this
product. The Multi-Fund® variable annuity is currently available in all states except New York. Account values for the Multi-
Fund® variable annuity were $9.7 billion, $13.3 billion and $13.5 billion as of December 31, 2008, 2007 and 2006, respectively.
Multi-Fund® program deposits represented 15%, 17% and 20% of the segment’s deposits in 2008, 2007 and 2006, respectively.
Distribution
Defined contribution products are distributed by LFD, which has approximately 80 internal and external wholesalers (including
sales managers). The wholesalers distribute the defined contribution products through advisors, consultants, banks, wirehouses,
TPAs and individual planners. The Multi-Fund® program is sold primarily by affiliated advisors; certain non-affiliated advisors can
also distribute the product. The LINCOLN ALLIANCE® program and the Lincoln SmartFuture® program are sold primarily
through consultants and affiliated advisors. LINCOLN DIRECTORSM group variable annuity is sold primarily by TPAs and
individual planners and is in the early stages of introduction to wirehouses and banks.
Competition
The defined contribution marketplace is very competitive and is comprised of many providers – with no one company dominating
the market for all products. We compete with numerous other financial services companies. The main factors upon which entities
in this market compete are distribution channel access and the quality of wholesalers, investment performance, cost, product
features, speed to market, brand recognition, financial strength ratings, crediting rates and client service.
Overview
INSURANCE SOLUTIONS
The Insurance Solutions business provides its products through two segments: Life Insurance and Group Protection. The Life
Insurance segment offers wealth protection and transfer opportunities through both individual and survivorship versions of UL
and VUL, as well as term insurance and the MoneyGuard® product, a linked-benefit product (which is a UL policy linked with riders
that provide for long-term care costs). The Group Protection segment focuses on offering group term life, disability income and
dental insurance primarily in the small to mid-sized employer marketplace for their eligible employees.
9
Overview
Insurance Solutions – Life Insurance
The Life Insurance segment, with principal operations in Greensboro, North Carolina and Hartford, Connecticut and additional
operations in Concord, New Hampshire and Fort Wayne, Indiana, focuses on the creation and protection of wealth for its clients
through the manufacturing of life insurance products. The Life Insurance segment offers wealth protection and transfer
opportunities through term insurance, a linked-benefit product (which is a UL policy linked with riders that provide for long-term
care costs) and both single and survivorship versions of UL and VUL, including COLI and BOLI products.
The Life Insurance segment primarily targets the affluent to high net worth markets, defined as households with at least $250,000
of financial assets. For those individual policies we sold in 2008, the average face amount (excluding term and MoneyGuard®
products) was $1 million and average first year premiums paid were approximately $60,000.
The Life Insurance segment also offers COLI and BOLI products and services to small- to mid-sized banks and mid- to large-sized
corporations, mostly through executive benefit brokers.
Products
The Life Insurance segment sells primarily interest/market-sensitive products (UL and VUL), including COLI and BOLI products,
and term products. The segment’s sales (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Sales by Product
UL:
Excluding MoneyGuard ®
MoneyGuard ®
Total UL
VUL
COLI and BOLI
Term/whole life
Total sales
$
$
$
525
50
575
54
84
28
741
597
40
637
77
91
32
837
436
31
467
61
83
43
654
$
$
$
UL, VUL and COLI and BOLI sales represent target premium plus 5% of excess premium (including adjustments for internal
replacements at 50%); whole life and term sales represent 100% of first year paid premium; and linked-benefit sales represent 15%
of premium deposits.
The segment generally has higher sales in the second half of the year than in the first half of the year. Approximately 46% and
41% of total sales were in the first half of 2008 and 2006, respectively; however, in 2007, approximately 50% of total sales were in
the first half of the year. In 2007, this was due to the transition of our product portfolio to the new unified product portfolio.
In addition, the following table shows life policies’ face amount in force (in millions):
As of December 31,
2007
2008
2006
In-Force Face Amount
UL and other
Term insurance
Total in-force face amount
$
$
310,198
235,023
545,221
$
$
299,598
235,919
535,517
$
$
282,874
234,148
517,022
Mortality margins, morbidity margins (for linked-benefit products), investment margins (through spreads or fees), net expense
charges (expense charges assessed to the contract holder less expenses incurred to manage the business) and surrender fees drive
life insurance profits. Mortality margins represent the difference between amounts charged to the customer to cover the mortality
risk and the actual cost of reinsurance and death benefits paid. Mortality charges are either specifically deducted from the contract
holder’s policy account value (i.e. cost of insurance assessments or “COIs”) or are embedded in the premiums charged to the
10
customer. In either case, these amounts are a function of the rates priced into the product and level of insurance in force (less
reserves previously set aside to fund benefits). Insurance in force, in turn, is driven by sales, persistency and mortality experience.
Similar to the annuity product classifications described above, life products can be classified as “fixed” or “variable” contracts.
This classification describes whether we or the policy holders bear the investment risk of the assets supporting the policy. This
also determines the manner in which we earn investment margin profits from these products, either as investment spreads for fixed
products or as asset-based fees charged to variable products.
We offer four categories of life insurance products consisting of:
Interest-sensitive Life Insurance (Primarily UL)
Interest-sensitive life insurance products provide life insurance with account (cash) values that earn rates of return based on
company-declared interest rates. Contract holder account values are invested in our general account investment portfolio, so we
bear the risk of investment performance. Some of our UL contracts include secondary guarantees, which are explained more fully
below.
In a UL contract, contract holders have flexibility in the timing and amount of premium payments and the amount of death
benefit, provided there is sufficient account value to cover all policy charges for mortality and expenses for the coming period.
Under certain contract holder options and market conditions, the death benefit amount may increase or decrease. Premiums
received on a UL product, net of expense loads and charges, are added to the contract holder’s account value. The client has
access to their account value (or a portion thereof) through contractual liquidity features such as loans, partial withdrawals and full
surrenders. Loans and withdrawals reduce the death benefit amount payable and are limited to certain contractual maximums
(some of which are required under state law), and interest is charged on all loans. Our UL contracts assess surrender charges
against the policies’ account values for full or partial face amount surrenders that occur during the contractual surrender charge
period. Depending on the product selected, surrender charge periods can range from 0 to 20 years.
We also offer a fixed indexed UL product that functions similarly to a traditional UL policy, with the added flexibility of allowing
contract holders to have portions of their account value earn interest credits linked to the performance of the S&P 500. The
indexed interest rate is guaranteed never to be less than 1%. Our fixed indexed UL policy provides contract holders a choice of a
traditional fixed rate account and several different indexed accounts. A contract holder may elect to change allocations annually for
amounts in the indexed accounts and quarterly for new premiums into the policy. Prior to each new allocation we have the
opportunity to re-price the indexed components, subject to minimum guarantees.
As mentioned previously, we offer survivorship versions of our individual UL products. These products insure two lives with a
single policy and pay death benefits upon the second death.
Sales results are heavily influenced by the series of UL products with secondary guarantees. A UL policy with a secondary
guarantee can stay in force, even if the base policy account value is zero, as long as secondary guarantee requirements have been
met. The secondary guarantee requirement is based on the evaluation of a reference value within the policy, calculated in a manner
similar to the base policy account value, but using different assumptions as to expense charges, COI charges and credited interest.
The assumptions for the secondary guarantee requirement are listed in the contract. As long as the contract holder funds the
policy to a level that keeps this calculated reference value positive, the death benefit will be guaranteed. The reference value has no
actual monetary value to the contract holder; it is only a calculated value used to determine whether or not the policy will lapse
should the base policy account value be less than zero.
Unlike other guaranteed death benefit designs, our secondary guarantee benefits maintain the flexibility of a traditional UL policy,
which allows a contract holder to take loans or withdrawals. Although loans and withdrawals are likely to shorten the time period
of the guaranteed death benefit, the guarantee is not automatically or completely forfeited, as is sometimes the case with other
death benefit guarantee designs. The length of the guarantee may be increased at any time through additional excess premium
deposits. Secondary guarantee UL face amount in force was $99.0 billion, $83.9 billion and $65.5 billion as of December 31, 2008,
2007 and 2006, respectively. For information on the reserving requirements for this business, see “Regulatory” below and “Review
of Consolidated Financial Condition” in the MD&A.
We manage investment margins (i.e. the difference between the amount the portfolio earns compared to the amount that is
credited to the customer) by seeking to maximize current yields, in line with asset/liability and risk management targets, while
crediting a competitive rate to the customer. Crediting rates are typically subject to guaranteed minimums specified in the
underlying life insurance contract. Interest-sensitive life account values (including MoneyGuard® and the fixed portion of VUL)
were $27.5 billion, $26.5 billion and $25.4 billion as of December 31, 2008, 2007 and 2006, respectively.
11
Linked-benefit Life Products
Linked-benefit life products combine UL with long-term care insurance through the use of riders. The first rider allows the
contract holder to accelerate death benefits on a tax-free basis in the event of a qualified long-term care need. The second rider
extends the long-term care insurance benefits for an additional period of time if the death benefit is fully depleted for the purposes
of long-term care. If the long-term care benefits are never used, the policy provides a tax-free death benefit to the contract
holder’s heirs. Linked-benefit life products generate earnings through investment, mortality and morbidity margins. MoneyGuard®
products are linked-benefit life products.
VUL
VUL products are UL products that provide a return on account values linked to an underlying investment portfolio of sub-
accounts offered through the product. The value of the contract holder’s account varies with the performance of the sub-accounts
chosen by the contract holder. The underlying assets of the sub-accounts are managed within a special insurance series of mutual
funds. Premiums, net of expense loads and charges for mortality and expenses, received on VUL products are invested according
to the contract holder’s investment option selection. As the return on the investment portfolio increases or decreases, the account
value of the VUL policy will increase or decrease. As with fixed UL products, contract holders have access, within contractual
maximums, to account values through loans, withdrawals and surrenders. Surrender charges are assessed during the surrender
charge period, ranging from 0 to 20 years depending on the product. The investment choices we offer in VUL products are the
same, in most cases, as the investment choices offered in our individual variable annuity contracts.
In addition, VUL products offer a fixed account option that is managed by us. Investment risk is borne by the customer on all but
the fixed account option. We charge fees for mortality costs and administrative expenses as well as asset-based investment
management fees. VUL account values (excluding the fixed portion of VUL) were $4.3 billion, $6.0 billion and $5.4 billion as of
December 31, 2008, 2007 and 2006, respectively.
We also offer survivorship versions of our individual VUL products. These products insure two lives with a single policy and pay
death benefits upon the second death.
We also offer an enhanced single life version of our secondary guarantee VUL products with a survivorship option. These
products combine the lapse protection elements of UL with the upside potential of a traditional VUL product, giving clients the
flexibility to choose the appropriate balance between protection and market risk that meets their individual needs. The combined
single life and survivorship face amount in force of these products was $4.9 billion, $4.0 billion and $2.9 billion as of December 31,
2008, 2007 and 2006, respectively.
Term Life Insurance
Term life insurance provides a fixed death benefit for a scheduled period of time. It usually does not offer cash values. Scheduled
policy premiums are required to be paid at least annually. Products offering a return of premium benefit payable at the end of a
specified period are also available.
Distribution
The Life Insurance segment’s products are sold through LFD. LFD provides the Life Insurance segment with access to financial
intermediaries in the following primary distribution channels – wire/regional firms, independent planner firms (including LFN),
financial institutions and managing general agents/independent marketing organizations. LFD distributes COLI/BOLI products
to approximately 15 intermediaries who specialize in the executive benefits market and are serviced through a network of internal
and external sales professionals
Competition
The life insurance industry is very competitive and consists of many companies with no one company dominating the market for
all products. As of the end of 2007, the latest year for which data is available, there were 1,009 life insurance companies in the
U.S., according to the American Council of Life Insurers.
The Life Insurance segment competes on product design and customer service. The Life Insurance segment designs products
specifically for the high net worth and affluent markets. In addition to the growth opportunity offered by its target market, our
product breadth, design innovation, competitiveness, speed to market, customer service, underwriting and risk management and
extensive distribution network all contribute to the strength of the Life Insurance segment. On average, the development of
products takes approximately six months. The Life Insurance segment implemented several major product upgrades and/or new
features, including important UL, VUL, linked-benefit and term product enhancements in 2008. With respect to customer service,
12
management tracks the speed, accuracy and responsiveness of service to customers’ calls and transaction requests. Further, the
Life Insurance segment tracks the turnaround time and quality for various client services such as processing of applications.
Underwriting
In the context of life insurance, underwriting is the process of evaluating medical and non-medical information about an individual
and determining the effect these factors statistically have on life expectancy or mortality. This process of evaluation is often
referred to as risk classification. Of course, no one can accurately predict how long any individual will live, but certain risk factors
can affect life expectancy and are evaluated during the underwriting process.
Claims Administration
Claims services are delivered to customers from the Greensboro, North Carolina and Concord, New Hampshire home offices.
Claims examiners are assigned to each claim notification based on coverage amount, type of claim and the experience of the
examiner. Claims meeting certain criteria are referred to senior claim examiners. A formal quality assurance program is carried out
to ensure the consistency and effectiveness of claims examining activities. A network of in-house legal counsel, compliance
officers, medical personnel and an anti-fraud investigative unit also support claim examiners. A special team of claims examiners,
in conjunction with claims management, focus on more complex claims matters such as long-term care claims, claims incurred
during the contestable period, beneficiary disputes, litigated claims and the few invalid claims that are encountered.
The Life Insurance segment maintains a centralized claim service center in order to minimize the volume of clerical and repetitive
administrative demands on its claims examiners while providing convenient service to policy owners and beneficiaries.
Overview
Insurance Solutions – Group Protection
The Group Protection segment offers group non-medical insurance products, principally term life, disability and dental, to the
employer marketplace through various forms of contributory and noncontributory plans. Most of the segment’s group contracts
are sold to employers with fewer than 500 employees.
The Group Protection segment was added as a result of the merger with Jefferson-Pilot and was then known as Benefit Partners.
Accordingly, the insurance premium product line data (in millions) for this segment, provided in the following table, only include
nine months during 2006:
For the Years Ended December 31,
2008
2006
2007
Insurance Premiums by Product Line
Life
Disability
Dental
Total non-medical
Medical
Total insurance premiums
Products
Group Life Insurance
$
$
$
541
672
150
1,363
154
1,517
494
601
136
1,231
149
1,380
$
$
$
334
407
95
836
113
949
We offer employer-sponsored group term life insurance products including basic, optional and voluntary term life insurance to
employees and their dependents. Additional benefits may be provided in the event of a covered individual’s accidental death or
dismemberment.
13
Group Disability Insurance
We offer short- and long-term employer-sponsored group disability insurance, which protects an employee against loss of wages
due to illness or injury. Short-term disability generally provides benefits for up to 26 weeks following a short waiting period,
ranging from one to 30 days. Long-term disability provides benefits following a longer waiting period, usually between 30 and 180
days and provides benefits for a longer period, at least two years and typically extending to normal (Social Security) retirement age.
Group Dental
We offer employer-sponsored group dental insurance, which covers a portion of the cost of eligible dental procedures for
employees and their dependents. Products offered include indemnity coverage, which does not distinguish benefits based on a
dental provider’s participation in a network arrangement, and a Preferred Provider Organization (“PPO”) product that does reflect
the dental provider’s participation in the PPO network arrangement, including agreement with network fee schedules.
Distribution
The segment’s products are marketed primarily through a national distribution system, including 143 managers and marketing
representatives. The managers and marketing representatives develop business through employee benefit brokers, TPAs and other
employee benefit firms.
Competition
The group protection marketplace is very competitive. Principal competitive factors include particular product features, price,
quality of customer service and claims management, technological capabilities, financial strength and claims-paying ratings. In the
group insurance market, the Group Protection segment competes with a limited number of major companies and selected other
companies that focus on these products.
Underwriting
The Group Protection segment’s underwriters evaluate the risk characteristics of each employee group. Generally, the relevant
characteristics evaluated include employee census information (such as age, gender, income and occupation), employer industry
classification, geographic location, benefit design elements and other factors. The segment employs detailed underwriting policies,
guidelines and procedures designed to assist the underwriter to properly assess and quantify risks. The segment uses technology to
efficiently review, price and issue smaller cases, utilizing its underwriting staff on larger, more complex cases. Individual
underwriting techniques (including evaluation of individual medical history information) may be used on certain covered
individuals selecting larger benefit amounts. For voluntary and other forms of employee paid coverages, minimum participation
requirements are used to obtain a better spread of risk and minimize the risk of anti-selection.
Claims Administration
Claims for the Group Protection segment are managed by a staff of experienced claim specialists. Disability claims management is
especially important to segment results, as results depend on both the incidence and the length of approved disability claims. The
segment employs nurses and rehabilitation specialists to help evaluate medical conditions and develop return to work plans.
Independent medical reviews are routinely performed by external medical professionals to further evaluate conditions as part of the
claim management process.
Overview
INVESTMENT MANAGEMENT
The Investment Management segment, with principal operations in Philadelphia, Pennsylvania, provides investment products and
services to both individual and institutional investors through Delaware Management Holdings, Inc. and its affiliates, (“Delaware
Investments”). Delaware Investments offers a broad line of mutual funds and other investment products to retail investors
(including managed accounts).
Delaware Investments also offers investment advisory services and products to institutional clients, such as corporate and public
retirement plans, endowments and foundations, nuclear decommissioning trusts, Taft-Hartley plans and sub-advisory separate
accounts for which Delaware Investments acts as a sub-advisor. As of December 31, 2008, Delaware Investments served as an
investment advisor to approximately 190 institutional accounts, acted as investment manager and performed additional services for
81 open-end funds and for 7 closed-end funds. The Investment Management segment also provides investment advisory services
14
for the general account of LNC’s insurance subsidiaries, including separate accounts and mutual funds, and acts as an investment
advisor to collateralized debt obligations (“CDOs”).
Products
Investment Management products include U.S. and international equity and fixed-income retail mutual funds, institutional separate
accounts, institutional mutual funds and managed accounts.
The Investment Management segment’s assets under management (including assets under administration) (in millions) were as
follows:
Assets Under Management
Retail – equity
Retail – fixed
Total retail
Institutional – equity
Institutional – fixed (1)
Total institutional
Inter-segment assets
Total assets under management
Total sub-advised assets, included above (2)
As of December 31,
2007
2006
2008
$
15,222
10,453
25,675
11,203
9,696
20,899
73,648
120,222
$
$
31,598
10,801
42,399
21,751
11,536
33,287
77,088
152,774
$
$
31,705
8,790
40,495
21,977
21,105
43,082
81,166
164,743
$
$
10,227
$
20,789
$
22,671
(1)
In the fourth quarter of 2007, the Investment Management segment sold a portion of our institutional fixed-income business
to an unaffiliated investment management company.
(2) Effective May 1, 2007, the investment advisory role for the Lincoln Variable Insurance Trust, a product within our Retirement
Solutions segment, transitioned from Investment Management to another internal advisor. In the role of investment advisor,
Investment Management provided investment performance and compliance oversight on third-party investment managers in
exchange for a fee. Investment Management is continuing to manage certain of the assets as a sub-advisor. As a result of this
change, the Investment Management assets under management decreased by $3.2 billion, with a corresponding reduction in
investment advisory fees – inter-segment and associated expenses.
Retail Products and Services
The Investment Management segment offers various retail products including mutual funds to individual investors, as well as
investment services to high net worth and small institutional investors through managed accounts. The external retail assets under
management were $25.7 billion, $42.4 billion and $40.5 billion as of December 31, 2008, 2007 and 2006, respectively. These assets
include $8.0 billion, $16.2 billion and $18.0 billion of sub-advised assets as of December 31, 2008, 2007 and 2006, respectively. We
pay fees to the third-party sub-advisors to manage the assets. See “Results of Investments Management” in the MD&A for
discussion of the decline in retail assets under management.
The Investment Management segment, through Delaware Investments, offers open-end and closed-end mutual funds to suit an
array of investment needs. Delaware Investments’ mutual funds are grouped by asset class, with each investment management
team focused on a specific investment discipline. This structure of distinct investment teams allows for a style-specific research
effort tailored for each asset class. The mutual funds are owned by the shareholders of those funds and not by Delaware
Investments. Delaware Investments manages the funds pursuant to an agreement with the separate funds’ boards. Accordingly,
the mutual fund assets and liabilities, as well as related investment returns, are not reflected in our consolidated financial
statements. Instead, Delaware Investments earns fees for providing the management and other services to the funds. However,
Delaware’s assets under management do include seed capital investments in new products, which are included on our Consolidated
Balance Sheets and are marked-to-market through net income on our Consolidated Statements of Income.
Delaware Investments manages both open-end and closed-end funds. An open-end mutual fund does not have a fixed number of
shares and will normally offer as many shares as investors are willing to buy. Investors sell their shares by requesting the fund to
redeem the shares. The open-end funds are available with various pricing structures, such as A-class with a front end sales charge
and C-class with a contingent deferred sales charge, as well as R-class and Institutional class, which are sold without a front end or
contingent deferred sales charge and are designed for certain retirement plans and/or institutional investors. Effective May 2007,
no new or subsequent investments are allowed in the B-class except through a reinvestment of dividends or capital gains by
15
existing shareholders. A-, B-, C- and R-classes are generally subject to Rule 12b-1 fees. A closed-end fund offers a fixed number
of shares and is usually sold through a brokerage firm. After the initial offering, shares normally trade on a major stock exchange.
The Investment Management segment also provides investment advisory services to clients through separately managed accounts,
commonly referred to as wrap accounts. These products are offered by a sponsor, typically a broker-dealer, to higher net worth
individuals with a minimum investment of approximately $250,000. During 2006, the Investment Management segment closed the
International American Depository Receipt (“ADR”) separately managed account product, which is sub-advised by Mondrian, and
the Delaware Large Cap Growth Equity separately managed account to new investors. During 2008, both of these products were
reopened to new investors. An ADR is a security that trades in the U.S., but represents a specified number of shares in a foreign
corporation. ADRs are bought and sold on U.S. markets just like traditional stocks and are issued or sponsored in the U.S. by a
bank or brokerage firm.
Institutional Products and Services
For institutional clients, the Investment Management segment offers Delaware Pooled Trust and institutional separate accounts
and manages CDOs. External institutional assets under management were $20.9 billion, $33.3 billion and $43.1 billion as of
December 31, 2008, 2007 and 2006, respectively.
Delaware Pooled Trust is a registered investment company that offers a series of mutual funds managed in styles that are similar to
institutional separate account offerings and are best suited for smaller- to medium-sized institutional investment mandates.
Delaware Pooled Trust’s minimum initial investment is typically $1 million. The funds included in Delaware Pooled Trust are
offered without a sales charge directly through Delaware Investments’ institutional marketing and client services group.
The Investment Management segment provides investment advisory services through individually managed accounts to a broad
range of institutional clients, such as corporate and public retirement plans, endowments and foundations, nuclear
decommissioning trusts, sub-advisory clients and Taft-Hartley plans, among others. Included among sub-advisory clients are
mutual funds and other commingled vehicles offered by institutional parties. Most clients utilize individually managed separate
accounts, which means clients have the opportunity to customize the management of their portfolio by including or excluding
certain types of securities, sectors or segments within a given asset class. Because of their individually managed nature, these
separate accounts are best suited for larger investment mandates. Currently, the minimum account size is typically $25 million.
The Investment Management segment also provides investment advisory services for CDOs. CDOs are pools of debt instruments
that are securitized and sold to investors through a sponsor, typically an investment bank. The Investment Management segment
does not invest in these securities, but the insurance portfolios of LNC’s insurance subsidiaries are invested in certain of these
securities. The Investment Management segment provides investment advisory services at a fee. As of December 31, 2008, 2007
and 2006, the Investment Management segment provided advisory services for $5.0 billion, $6.1 billion and $3.7 billion,
respectively, of CDOs.
As stated in “Acquisitions and Dispositions” above, during the fourth quarter of 2007, we completed the sale of certain
institutional taxable fixed income business with an unaffiliated investment management company involving certain members of our
fixed income team and related institutional taxable fixed income business.
The Investment Management segment also provides investment management services for LNC’s general account assets for which
it earns advisory revenue.
Distribution
The businesses in the Investment Management segment deliver their broad range of products through multiple distribution
channels, enabling them to reach an expanding community of retail and institutional investors. Investment Management
distributes retail mutual funds and managed accounts through intermediaries, including LFN, which are serviced by the LFD
wholesaling distribution network. Delaware Distributors, L.P. is the principal underwriter for the Delaware Investments mutual
funds and serves as a liaison between the funds and LFD.
Delaware Investments’ institutional marketing group, working closely with manager selection consultants, markets substantially all
of the institutional products.
16
Competition
The Investment Management segment primarily competes with mutual fund complexes that are broker sold, and other asset
managers offering managed accounts, institutional accounts and sub-advisory services. Competitive factors impacting the
Investment Management segment include investment performance, breadth of investment styles offered, distribution capabilities
and customer service.
Investment performance is a key driver of the Investment Management segment’s ability to attract new sales, retain existing assets
and improve net flows. The following table summarizes the performance of institutional and managed accounts composites
relative to their respective benchmarks for the one-, three- and five-year periods ended December 31, 2008:
Number of institutional composites
outperforming their respective benchmarks (1)
Number of managed account styles
outperforming their respective benchmarks (2)
One Year
Three Year
Five Year
4 of 8
3 of 7
3 of 8
2 of 7
4 of 7
3 of 5
(1) Represents the largest composites based on assets under management. The returns for these composites are Global
Investment Performance Standards (GIPS®) compliant and the benchmarks are industry standards.
(2) Represents Delaware Investments’ managed account styles that have associated benchmarks for the respective length of time.
Delaware Investments closely monitors the relative performance of individual funds. Fund performance is compared to a
benchmark group of peer funds that have similar investment characteristics and objectives. Performance in various key categories,
as reported to Lipper, one of the leading providers of mutual fund research, is used by Delaware Investments in measuring its
funds’ performance. The following table summarizes the performance for the 25 largest mutual funds and for all of the mutual
funds in the Delaware Investments’ family of funds for the one-, three- and five-year periods ended December 31, 2008:
Number of funds out of Delaware's top 25
retail mutual funds in top half of their
Lipper category (1)
One Year
Three Year
Five Year
19 of 25
16 of 25
15 of 25
Number of all retail mutual funds in top half of
their Lipper category (1)
28 of 41
25 of 41
27 of 40
(1) For these purposes, Delaware Investments’ family of funds does not include variable insurance product funds or mutual funds
managed by Delaware Investments for certain of our affiliates or other third parties.
Overview
LINCOLN UK
Lincoln UK is headquartered in Barnwood, Gloucester, England and is licensed to do business throughout the United Kingdom
(“U.K.”). Lincoln UK is primarily focused on protecting and enhancing the value of its existing customer base. The segment
accepts new deposits on the existing block of business and markets a limited range of life and retirement income products.
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 contract holders.
These products have largely been issued to individuals, and benefits, premium levels and charges can often be varied within limits.
Certain contract holders have chosen to contract out of the U.K. government’s pension scheme through a Lincoln personal
pension arrangement for which Lincoln UK receives rebate premiums from the government.
17
The Lincoln UK segment’s product revenues (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Product Revenues
Life products
Pension products
Other products
Total product revenues
$
$
$
106
136
6
248
121
160
8
289
$
$
$
95
131
11
237
Product revenues include premiums, fees and assessments for Lincoln UK’s products.
Our subsidiary in the U.K. has its balance sheets and income statements translated at the current spot exchange rate as of the year-
end and average spot exchange rate for the year, respectively.
Lincoln UK has an evergreen agreement to outsource its customer service and policy administration functions to Capita Life &
Pensions Services Limited, a subsidiary of Capita Group Plc (“Capita”). The purpose of the outsourcing is to reduce the
operational risk and variability of future costs associated with administering the business by taking advantage of Capita’s proven
expertise in providing outsourcing solutions to a variety of industries including insurance companies. To date, the relationship has
provided the segment with results in line with expectations.
Competition
The U.K. life insurance market is very competitive and consists of many companies, with no one company dominating the market
for all products. Lincoln UK markets a limited range of new unit-linked life and pension products through independent
intermediaries. The main factors upon which entities in this market compete are distribution access, product features, investment
choice, cost, customer service, brand recognition and financial strength.
OTHER OPERATIONS
Other Operations includes the results of operations that are not directly related to the business segments, unallocated corporate
items and the ongoing amortization of deferred gain on the indemnity reinsurance portion of the sale of our former reinsurance
segment to Swiss Re in the fourth quarter of 2001. Unallocated corporate items include 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, such as our remaining radio properties, interest expense on short-term and long-term borrowings, our closed block of
run-off pension business in the form of group annuity and insured funding-type of contracts with assets under management of
approximately $1.9 billion as of December 31, 2008, and certain expenses, including restructuring and merger-related expenses.
Other Operations also includes the eliminations of inter-company transactions and the inter-segment elimination of the investment
advisory fees for asset management services the Investment Management segment provides to Retirement Solutions and Insurance
Solutions.
Revenues (in millions) from Other Operations were as follows:
Operating Revenues
Insurance premiums
Net investment income
Amortization of deferred gain on business
sold through reinsurance
Media revenues (net)
Other revenues and fees
Inter-segment elimination of investment
advisory fees
Total operating revenues
For the Years Ended December 31,
2008
2006
2007
4
$
358
$
3
372
9
$
373
74
85
-
74
107
4
75
85
(1)
(82)
439
$
(87)
473
$
(97)
444
$
18
REINSURANCE
We follow the industry practice of reinsuring a portion of our life insurance and annuity risks with unaffiliated reinsurers. In a
reinsurance transaction, a reinsurer agrees to indemnify another insurer for part or all of its liability under a policy or policies it has
issued for an agreed upon premium. We use reinsurance to protect our insurance subsidiaries against the severity of losses on
individual claims and unusually serious occurrences in which a number of claims produce an aggregate extraordinary loss. We also
use reinsurance to improve our results by leveraging favorable reinsurance pricing. Although reinsurance does not discharge the
insurance subsidiaries from their primary liabilities to their contract holders for losses insured under the insurance policies, it does
make the assuming reinsurer liable to the insurance subsidiaries for the reinsured portion of the risk. Because we bear the risk of
nonpayment by one or more of our reinsurers, we primarily cede reinsurance to well-capitalized, highly rated reinsurers.
We reinsure approximately 50% to 55% of the mortality risk on newly issued non-term life insurance contracts and approximately
40% to 45% of total mortality risk including term insurance contracts. Our policy for this program is to retain no more than $10
million on a single insured life issued on fixed and VUL insurance contracts. Additionally, the retention per single insured life for
term life insurance and for COLI is $2 million for each type of insurance.
From July 2007 until June 2008, we reinsured our Lincoln SmartSecurity® Advantage rider related to our variable annuities. Swiss Re
provided 50% quota share coinsurance of our lifetime GWB, Lincoln SmartSecurity® Advantage, for business written in 2007 and
2008, up to a total of $3.8 billion in deposits.
Portions of our deferred annuity business have been reinsured on a modified coinsurance (“Modco”) basis with other companies
to limit our exposure to interest rate risks. In a Modco program, the reinsurer shares proportionally in all financial terms of the
reinsured policies (i.e. premiums, expenses, claims, etc.) based on their respective quota share of the risk.
In addition, we acquire other reinsurance to cover products other than as discussed above with retentions and limits that
management believes are appropriate for the circumstances.
We obtain reinsurance from a diverse group of reinsurers and we monitor concentration and financial strength ratings of our
principal reinsurers. Swiss Re represents our largest exposure. As of December 31, 2008 and 2007, the amounts recoverable from
reinsurers were $8.5 billion and $8.2 billion, respectively, of which $4.5 billion and $4.3 billion was recoverable from Swiss Re for
the same periods, respectively.
For more information regarding reinsurance, see “Reinsurance” in the MD&A and Note 9. For risks involving reinsurance, see
“Item 1A. Risk Factors – We face a risk of non-collectibility of reinsurance, which could materially affect our results of
operations.”
RESERVES
The applicable insurance laws under which insurance companies operate require that they report, as liabilities, policy reserves to
meet future obligations on their outstanding policies. These reserves are the amounts that, with the additional premiums to be
received and interest thereon compounded annually at certain assumed rates, are calculated to be sufficient to meet the various
policy and contract obligations as they mature. These laws specify that the reserves shall not be less than reserves calculated using
certain specified mortality and morbidity tables, interest rates and methods of valuation.
For more information on reserves, see “Critical Accounting Policies and Estimates – Derivatives” and “Critical Accounting
Policies and Estimates – Future Contract Benefits and Other Contract Holder Obligations” in the MD&A.
See “Regulatory” below for information on permitted practices and proposed regulations that may impact the amount of statutory
reserves necessary to support our current insurance liabilities.
For risks related to reserves, see “Item 1A. Risk Factors – Changes in interest rates may cause interest rate spreads to decrease and
may result in increased contract withdrawals.”
INVESTMENTS
An important component of our financial results is the return on invested assets. Our investment strategy is to balance the need
for current income with prudent risk management, with an emphasis on generating sufficient current income to meet our
obligations. This approach requires the evaluation of risk and expected return of each asset class utilized, while still meeting our
income objectives. This approach also permits us to be more effective in our asset-liability management because decisions can be
made based upon both the economic and current investment income considerations affecting assets and liabilities. Investments by
our insurance subsidiaries must comply with the insurance laws and regulations of the states of domicile.
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We do not use derivatives for speculative purposes. Derivatives are used for hedging purposes and income generation. Hedging
strategies are employed for a number of reasons including, but not limited to, hedging certain portions of our exposure to changes
in our GDB, GWB and GIB liabilities, interest rate fluctuations, the widening of bond yield spreads over comparable maturity U.S.
Government obligations and credit, foreign exchange and equity risks. Income generation strategies include credit default swaps
through replication synthetic asset transactions. These derivatives synthetically create exposure in the general account to corporate
debt, similar to investing in the credit markets. Our investment portfolio does not contain any significant concentrations in single
issuers. As of December 31, 2008, we had investments in the collateralized mortgage obligation industry with a fair value of $6.8
billion, or 10% of the invested assets portfolio totaling $67.3 billion. We did not have a concentration of financial instruments in a
single industry as of December 31, 2007.
For additional information on our investments, including carrying values by category, quality ratings and net investment income,
see “Consolidated Investments” in the MD&A, as well as Notes 1 and 5.
RATINGS
The Nationally Recognized Statistical Ratings Organizations rate the financial strength of our principal insurance subsidiaries and
the debt of LNC. Ratings are not recommendations to buy our securities.
Rating agencies rate insurance companies based on financial strength and the ability to pay claims, factors more relevant to contract
holders than investors. We believe that the ratings assigned by nationally recognized, independent rating agencies are material to
our operations. There may be other rating agencies that also rate our securities, which we do not disclose in our reports.
Insurer Financial Strength Ratings
The insurer financial strength rating scales of A.M. Best, Fitch Ratings (“Fitch”), Moody’s Investors Service (“Moody’s”) and S&P
are characterized as follows:
(cid:120) A.M. Best – A++ to S
(cid:120) Fitch – AAA to C
(cid:120) Moody’s – Aaa to C
(cid:120)
S&P – AAA to R
As of February 26, 2009, the financial strength ratings of our principal insurance subsidiaries, as published by the principal rating
agencies that rate our securities, or us, were as follows:
The Lincoln National Life Insurance Co.
("LNL")
Lincoln Life & Annuity Co. of New York
("LLANY")
First Penn-Pacific Life Insurance Co. ("FPP")
A. M. Best
A+
(2nd of 16)
A+
(2nd of 16)
A+
(2nd of 16)
Fitch
AA
(3rd of 21)
AA
(3rd of 21)
AA
(3rd of 21)
Moody's
Aa3
(4th of 21)
Aa3
(4th of 21)
A1
(5th of 21)
S&P
AA-
(4th of 21)
AA-
(4th of 21)
A+
(5th of 21)
A downgrade of the financial strength rating of one of our principal insurance subsidiaries could affect our competitive position in
the insurance industry and make it more difficult for us to market our products, as potential customers may select companies with
higher financial strength ratings.
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Debt Ratings
The long-term credit rating scales of A.M. Best, Fitch, Moody’s and S&P are characterized as follows:
(cid:120) A.M. Best – aaa to rs
(cid:120) Fitch – AAA to D
(cid:120) Moody’s – Aaa to C
(cid:120)
S&P – AAA to D
As of February 26, 2009, our long-term credit ratings, as published by the principal rating agencies that rate our long-term credit,
were as follows:
A. M. Best
a-
(7th of 23)
Fitch
A
(6th of 21)
Moody's
A3
(7th of 21)
S&P
A-
(7th of 22)
The short-term credit rating scales of A.M. Best, Fitch Ratings, Moody’s and S&P are characterized as follows:
(cid:120) A.M. Best – AMB-1+ to d
(cid:120) Fitch – F1+ to D
(cid:120) Moody’s – P-1 to NP
(cid:120)
S&P – A-1+ to D
As of February 26, 2009, our short-term credit ratings, as published by the principal rating agencies that rate our short-term credit,
were as follows:
A. M. Best
AMB-1
(2nd of 6)
Fitch
F1
(2nd of 7)
Moody's
P-2
(2nd of 4)
S&P
A-2
(3rd of 10)
A downgrade of our debt ratings could affect our ability to raise additional debt with terms and conditions similar to our current
debt, and accordingly, likely increase our cost of capital. In addition, a downgrade of these ratings could make it more difficult to
raise capital to refinance any maturing debt obligations, to support business growth at our insurance subsidiaries and to maintain or
improve the current financial strength ratings of our principal insurance subsidiaries described above.
On February 10, 2009, Moody’s placed LNC’s senior debt rating and the insurance financial strength ratings of the insurance
subsidiaries under review for possible downgrade, but affirmed its stable outlook for LNC’s short-term credit rating. Placing the
company’s ratings under review for possible downgrade indicates that Lincoln’s ratings could be affirmed or lowered in the near
term based on developments in financial market conditions, and/or Lincoln’s business performance or financial measures. On
February 20, 2009, A.M. Best downgraded our long-term credit rating to “a-” from “a,” and affirmed the financial strength ratings
of our insurance subsidiaries. Additionally, A.M. Best revised its ratings outlook to negative from stable. On February 26, 2009,
S&P downgraded our long-term credit rating to “A-” from “A+,” our short-term credit rating to “A-2” from “A-1” and the
insurance financial strength ratings of the insurance subsidiaries to “AA-” from “AA.” S&P revised its outlook for the holding
company to stable from negative and maintained its stable outlook for the insurance subsidiaries.
In late September and early October of 2008, A.M. Best, Fitch, Moody’s and S&P each revised their outlook for the U.S. life
insurance sector to negative from stable. We believe that the rating agencies may heighten the level of scrutiny that they apply to
such institutions, may increase the frequency and scope of their credit reviews, may request additional information from the
companies that they rate and may adjust upward the capital and other requirements employed in the rating agency models for
maintenance of certain ratings levels. In addition, actions we take to access third-party financing may in turn cause rating agencies
to reevaluate our ratings.
All of our ratings are subject to revision or withdrawal at any time by the rating agencies, and therefore, no assurance can be given
that our principal insurance subsidiaries or LNC can maintain these ratings. Each rating should be evaluated independently of any
other rating.
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Insurance Regulation
REGULATORY
Our insurance subsidiaries, like other insurance companies, are subject to regulation and supervision by the states, territories and
countries in which they are licensed to do business. The extent of such regulation varies, but generally has its source in statutes
that delegate regulatory, supervisory and administrative authority to supervisory agencies. In the U.S., this power is vested in state
insurance departments.
In supervising and regulating insurance companies, state insurance departments, charged primarily with protecting contract holders
and the public rather than investors, enjoy broad authority and discretion in applying applicable insurance laws and regulation for
that purpose. Our principal insurance subsidiaries, LNL, LLANY and FPP, are domiciled in the states of Indiana, New York and
Indiana, respectively.
The insurance departments of the domiciliary states exercise principal regulatory jurisdiction over our insurance subsidiaries. The
extent of regulation by the states varies, but in general, most jurisdictions have laws and regulations governing standards of
solvency, adequacy of reserves, reinsurance, capital adequacy, licensing of companies and agents to transact business, prescribing
and approving policy forms, regulating premium rates for some lines of business, prescribing the form and content of financial
statements and reports, regulating the type and amount of investments permitted and standards of business conduct. Insurance
company regulation is discussed further under “Insurance Holding Company Regulation” and “Restrictions on Subsidiaries’
Dividends and Other Payments.”
As part of their regulatory oversight process, state insurance departments conduct periodic, generally once every three to five years,
examinations of the books, records, accounts, and business practices of insurers domiciled in their states. During the three-year
period ended December 31, 2008, we have not received any material adverse findings resulting from state insurance department
examinations of our insurance subsidiaries conducted during this three-year period.
State insurance laws and regulations require our U.S. insurance companies to file financial statements with state insurance
departments everywhere they do business, and the operations of our U.S. insurance companies and accounts are subject to
examination by those departments at any time. Our U.S. insurance companies prepare statutory financial statements in accordance
with accounting practices and procedures prescribed or permitted by these departments. The National Association of Insurance
Commissioners (“NAIC”) has approved a series of statutory accounting principles that have been adopted, in some cases with
minor modifications, by virtually all state insurance departments.
We received approval from the Indiana Department of Insurance for a permitted practice to the prescribed NAIC statutory
accounting principles for our Indiana-domiciled insurance subsidiaries as of December 31, 2008. The permitted practice modifies
the statutory accounting for deferred income taxes prescribed by the NAIC by increasing the realization period for deferred tax
assets from one to three years and increasing the asset recognition limit from 10% to 15% of statutory capital and surplus. This
permitted practice is expected to benefit the statutory capital and surplus of our Indiana-domiciled insurance subsidiaries by
approximately $300 million, but may not be considered when calculating the dividends available from the insurance subsidiaries.
We also received approval from the Department for two more permitted practices for LNL relating to the application of specified
mortality tables for life insurance. These are expected to benefit the statutory capital and surplus of LNL by approximately $16
million.
A new statutory reserving standard, Actuarial Guideline 43, Commissioners Annuity Reserve Valuation Method for Variable
Annuities (“VACARVM”), replaces current statutory reserve practices for variable annuities with guaranteed benefits, such as
GWBs. VACARVM was adopted by the NAIC in September 2008 and will be effective as of December 31, 2009. Based upon the
level of variable annuity account values as of December 31, 2008, we estimate that VACARVM would have decreased our statutory
capital by $125 million to $175 million. The actual impact of the adoption will be dependent upon account values and conditions
that exist as of December 31, 2009. We plan to utilize existing captive reinsurance structures, as well as pursue additional third-
party reinsurance arrangements, 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 (“RBC”) ratios and potentially reduce
future dividend capacity from our insurance subsidiaries. For more information on VACARVM and our use of captive reinsurance
structures, see “Review of Consolidated Financial Condition – Liquidity and Capital Resources” in the MD&A.
Insurance Holding Company Regulation
LNC and its primary insurance subsidiaries are subject to regulation pursuant to the insurance holding company laws of the states
of Indiana and New York. These insurance holding company laws generally require an insurance holding company and insurers
that are members of such insurance holding company’s system to register with the insurance department authorities, to file with it
certain reports disclosing information including their capital structure, ownership, management, financial condition, and certain
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inter-company transactions, including material transfers of assets and inter-company business agreements and to report material
changes in that information. These laws also require that inter-company transactions be fair and reasonable and, under certain
circumstances, prior approval of the insurance departments must be received before entering into an inter-company transaction.
Further, these laws require that an insurer’s contract holders’ surplus following any dividends or distributions to shareholder
affiliates is reasonable in relation to the insurer’s outstanding liabilities and adequate for its financial needs.
In general, under state holding company regulations, no person may acquire, directly or indirectly, a controlling interest in our
capital stock unless such person, corporation or other entity has obtained prior approval from the applicable insurance
commissioner for such acquisition of control. Pursuant to such laws, in general, any person acquiring, controlling or holding the
power to vote, directly or indirectly, ten percent or more of the voting securities of an insurance company, is presumed to have
“control” of such company. This presumption may be rebutted by a showing that control does not exist in fact. The insurance
commissioner, however, may find that “control” exists in circumstances in which a person owns or controls a smaller amount of
voting securities. To obtain approval from the insurance commissioner of any acquisition of control of an insurance company, the
proposed acquirer must file with the applicable commissioner an application containing information regarding: the identity and
background of the acquirer and its affiliates; the nature, source and amount of funds to be used to carry out the acquisition; the
financial statements of the acquirer and its affiliates; any potential plans for disposition of the securities or business of the insurer;
the number and type of securities to be acquired; any contracts with respect to the securities to be acquired; any agreements with
broker-dealers; and other matters.
Other jurisdictions in which our insurance subsidiaries are licensed to transact business may have similar or additional requirements
for prior approval of any acquisition of control of an insurance or reinsurance company licensed or authorized to transact business
in those jurisdictions. Additional requirements in those jurisdictions may include re-licensing or subsequent approval for renewal
of existing licenses upon an acquisition of control. As further described below, laws that govern the holding company structure
also govern payment of dividends to us by our insurance subsidiaries.
Restrictions on Subsidiaries’ Dividends and Other Payments
We are a holding company that transacts substantially all of our business directly and indirectly through subsidiaries. Our primary
assets are the stock of our operating subsidiaries. Our ability to meet our obligations on our outstanding debt and to pay dividends
and our general and administrative expenses depends on the surplus and earnings of our subsidiaries and the ability of our
subsidiaries to pay dividends or to advance or repay funds to us.
Our insurance subsidiaries are subject to certain insurance department regulatory restrictions as to the transfer of funds and
payment of dividends to the holding company. Under Indiana laws and regulations, our Indiana insurance subsidiaries, including
our primary insurance subsidiary, LNL, may pay dividends to LNC without prior approval of the Indiana Insurance Commissioner
(the “Commissioner”), only from unassigned surplus or must receive prior approval of the Commissioner to pay a dividend if such
dividend, along with all other dividends paid within the preceding twelve consecutive months, would exceed the statutory
limitation. The current statutory limitation is the greater of 10% of the insurer’s contract holders’ surplus, as shown on its last
annual statement on file with the Commissioner or the insurer’s statutory net gain from operations for the previous twelve months,
but in no event to exceed statutory unassigned surplus. As discussed above, we may not consider the permitted practice to the
prescribed statutory accounting principles relating to the deferred tax asset in calculating available dividends. Indiana law gives the
Commissioner broad discretion to disapprove requests for dividends in excess of these limits. New York, the state of domicile of
our other major insurance subsidiary, LLANY, has similar restrictions, except that in New York it is the lesser of 10% of surplus to
contract holders as of the immediately preceding calendar year or net gain from operations for the immediately preceding calendar
year, not including realized capital gains.
Indiana law also provides that following the payment of any dividend, the insurer’s contract holders’ surplus must be reasonable in
relation to its outstanding liabilities and adequate for its financial needs, and permits the Indiana Insurance Commissioner to bring
an action to rescind a dividend which violates these standards. In the event that the Indiana Insurance Commissioner determines
that the contract holders’ surplus of one subsidiary is inadequate, the Commissioner could use his or her broad discretionary
authority to seek to require us to apply payments received from another subsidiary for the benefit of that insurance subsidiary. For
information regarding dividends paid to us during 2008 from our insurance subsidiaries, see “Review of Consolidated Financial
Condition – Liquidity and Capital Resources – Sources of Liquidity and Cash Flow” in the MD&A.
Lincoln UK’s insurance subsidiaries are regulated by the U.K. Financial Services Authority (“FSA”) and are subject to capital
requirements as defined by the U.K. Capital Resources Requirement. Lincoln UK maintains a target of approximately 1.5 to 2.0
times the required capital as prescribed by the regulatory resource requirement. Effective January 1, 2005, all insurance companies
operating in the U.K. also have to complete an RBC assessment to demonstrate to the FSA that they hold sufficient capital to
cover their risks. RBC requirements in the U.K. are different than the NAIC requirements. In addition, the FSA imposes certain
minimum capital requirements for the combined U.K. subsidiaries. As is the case with regulated insurance companies in the U.S.,
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future changes to regulatory capital requirements could impact the dividend capacity of our U.K. insurance subsidiaries and cash
flow to the holding company.
Risk-Based Capital
The NAIC has adopted RBC requirements for life insurance companies to evaluate the adequacy of statutory capital and surplus in
relation to investment and insurance risks. The requirements provide a means of measuring the minimum amount of statutory
surplus appropriate for an insurance company to support its overall business operations based on its size and risk profile. There
are five major risks involved in determining the requirements:
Category
Name
Description
Asset risk - affiliates
Asset risk - other
Insurance risk
Interest rate risk, health credit
risk and market risk
Business risk
C-0
C-1
C-2
C-3
C-4
Risk of assets' default for certain affiliated investments
Risk of assets' default of principal and interest or
fluctuation in fair value
Risk of underestimating liabilities from business already
written or inadequately pricing business to be written in
the future
Risk of losses due to changes in interest rate levels, risk
that health benefits prepaid to providers become the
obligation of the health insurer once again and risk of
loss due to changes in market levels associated with
variable products with guarantees
Risk of general business
A company’s risk-based statutory surplus is calculated by applying factors and performing calculations relating to various asset,
premium, claim, expense and reserve items. Regulators can then measure adequacy of a company’s statutory surplus by comparing
it to the RBC determined by the formula. Under RBC requirements, regulatory compliance is determined by the ratio of a
company’s total adjusted capital, as defined by the NAIC, to its company action level of RBC (known as the RBC ratio), also as
defined by the NAIC. Accordingly, factors that have an impact on the total adjusted capital of our insurance subsidiaries, such as
the permitted practices discussed above, will also affect their RBC levels.
Four levels of regulatory attention may be triggered if the RBC ratio is insufficient:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
“Company action level” – If the RBC ratio is between 75% and 100%, then the insurer must submit a plan to the regulator
detailing corrective action it proposes to undertake;
“Regulatory action level” – If the RBC ratio is between 50% and 75%, then the insurer must submit a plan, but a regulator
may also issue a corrective order requiring the insurer to comply within a specified period;
“Authorized control level” – If the RBC ratio is between 35% and 50%, then the regulatory response is the same as at the
“Regulatory action level,” but in addition, the regulator may take action to rehabilitate or liquidate the insurer; and
“Mandatory control level” – If the RBC ratio is less than 35%, then the regulator must rehabilitate or liquidate the insurer.
As of December 31, 2008, the RBC ratios of LNL, LLANY and FPP reported to their respective states of domicile and the NAIC
all exceeded the “company action level.” We believe that we will be able to maintain the RBC ratios of our insurance subsidiaries
in excess of “company action level” through prudent underwriting, claims handling, investing and capital management. However,
no assurances can be given that developments affecting the insurance subsidiaries, many of which could be outside of our control,
will not cause the RBC ratios to fall below our targeted levels. These developments may include, but may not be limited to:
changes to the manner in which the RBC ratio is calculated; new regulatory requirements for calculating reserves such as
VACARVM and principles based reserving; economic conditions leading to higher levels of impairments of securities in our
insurance subsidiaries' general accounts; and an inability to securitize life reserves including the issuing of letters of credit
supporting captive reinsurance structures.
See “Item 1A. Risk Factors – A decrease in the capital and surplus of our insurance subsidiaries may result in a downgrade to our
credit and insurer financial strength ratings.”
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Federal Initiatives
The U.S. federal government does not directly regulate the insurance industry; however, federal initiatives from time to time can
impact the insurance industry. In reaction to the current credit market illiquidity and global financial crisis, Congress enacted the
Emergency Economic Stabilization Act of 2008 (“EESA”) on October 3, 2008, and enacted the American Recovery and
Reinvestment Act of 2009 (“ARRA”) on February 17, 2009, in an effort to restore liquidity to the U.S. credit markets. The EESA
defines financial institutions to include insurance companies. The EESA contains the TARP. The TARP authorized the U.S.
Treasury to purchase “troubled assets” (as defined in the TARP) from financial institutions, including insurance companies.
Pursuant to the authority granted under the TARP, the U.S. Treasury has adopted the CPP, the Generally Available Capital Access
Program (“GACAP”) and the Exceptional Financial Recovery Assistance (“EFRA”). The ARRA contains provisions impacting
participants in these various capital assistance programs, such as limits imposed on executive compensation. Under the CPP, as
currently adopted, bank and thrift holding companies may apply to the U.S. Treasury for the direct sale of preferred stock and
warrants to the U.S. Treasury. We filed an application with the U.S. Treasury to participate in the CPP, but there are no assurances
that the U.S. Treasury will approve our application, or that we will participate in the GACAP or the EFRA. It remains unclear at
this point if or when the EESA and the ARRA will restore sustained liquidity and confidence in the markets and its affect on the
fair value of our invested assets.
In June 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) was enacted. The EGTRRA
contains provisions that have and will continue, near term, to significantly lower individual tax rates. These may have the effect of
reducing the benefits of tax deferral on the inside build-up of annuities and life insurance products. The EGTRRA also includes
provisions that will eliminate, over time, the estate, gift and generation-skipping taxes and partially eliminates the step-up in basis
rule applicable to property held in a decedent’s estate. Some of these changes might hinder our sales and result in the increased
surrender of insurance and annuity products. These provisions expire after 2010, unless extended.
In May 2003, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (“JGTRRA”) was enacted. Individual taxpayers are the
principal beneficiaries of the JGTRRA, which includes an acceleration of certain of the income tax rate reductions enacted
originally under the EGTRRA, as well as capital gains and dividend tax rate reductions. On May 17, 2006, the Tax Increase
Prevention and Reconciliation Act of 2006 (“TIPRA”) was signed into law. TIPRA extends the lower capital gains and dividends
rates through the end of 2010. Although most of these rate reductions expire after 2010, these reductions have the effect of
reducing the benefits of tax deferral on the build-up of value of annuities and life insurance products. Like the EGTRRA changes,
the JGTRRA changes may hinder our sales and result in increased surrender of insurance and annuity products.
On August 17, 2006, the Pension Protection Act of 2006 (“PPA”) was signed into law. The PPA makes numerous changes to
pension and other tax laws including: permanence for the EGTRRA enacted pension provisions including higher annual
contribution limits for defined contribution plans and IRAs as well as catch-up contributions for persons over age 50; clarification
of the safest available annuity standard for the selection of an annuity as a distribution option for defined contribution plans;
expansion of investment advice options for defined contribution plan participants and IRA owners; more stringent funding
requirements for defined benefit pension plans and clarification of the legal status of hybrid (cash balance) pension plans; non-
pension related tax changes, such as the codification of COLI best practices, bringing more certainty to this market segment;
permanence for EGTRRA enacted tax benefits for Section 529 college savings plans; and favorable tax treatment for long-term
care insurance included as a rider to or on annuity products. We expect many of these changes to have a beneficial effect upon
various segments of our business lines.
The USA PATRIOT Act of 2001 (the “Patriot Act”), enacted in response to the terrorist attacks on September 11, 2001, contains
anti-money laundering and financial transparency laws and mandates the implementation of various new regulations applicable to
broker-dealers and other financial services companies, including insurance companies. The Patriot Act seeks to promote
cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in
terrorism or money laundering. Anti-money laundering laws outside of the U.S. contain provisions that may be different,
conflicting or more rigorous. The increased obligations of financial institutions to identify their customers, watch for and report
suspicious transactions, respond to requests for information by regulatory authorities and law enforcement agencies, and share
information with other financial institutions require the implementation and maintenance of internal practices, procedures and
controls.
Employee Retirement Income Security Act (“ERISA”) Considerations
ERISA is a comprehensive federal statute that applies to U.S. employee benefit plans sponsored by private employers and labor
unions. Plans subject to ERISA include pension and profit sharing plans and welfare plans, including health, life and disability
plans. ERISA provisions include reporting and disclosure rules, standards of conduct that apply to plan fiduciaries and
prohibitions on transactions known as “prohibited transactions,” such as conflict-of-interest transactions and certain transactions
between a benefit plan and a party in interest. ERISA also provides for a scheme of civil and criminal penalties and enforcement.
Our insurance, asset management, plan administrative services and other businesses provide services to employee benefit plans
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subject to ERISA, including services where we may act as an ERISA fiduciary. In addition to ERISA regulation of businesses
providing products and services to ERISA plans, we become subject to ERISA’s prohibited transaction rules for transactions with
those plans, which may affect our ability to enter transactions, or the terms on which transactions may be entered, with those plans,
even in businesses unrelated to those giving rise to party in interest status.
Broker-Dealer, Securities and Savings and Loan Regulation
Some of our separate accounts as well as mutual funds that we sponsor, in addition to being registered under the Securities Act of
1933, are registered as investment companies under the Investment Company Act of 1940, and the shares of certain of these
entities are qualified for sale in some or all states and the District of Columbia. We also have several subsidiaries that are registered
as broker-dealers under the Securities Exchange Act of 1934 (“Exchange Act”) and are subject to federal and state regulation,
including but not limited to the Financial Industry Regulation Authority’s (“FINRA”) net capital rules. In addition, we have several
subsidiaries that are investment advisors registered under the Investment Advisers Act of 1940. LFN’s registered representatives
and our employees, insofar as they are involved in the sale or marketing of products that are securities, are subject to the Exchange
Act and to examination requirements and regulation by the U.S. Securities and Exchange Commission (“SEC”), FINRA and state
securities commissioners. Regulation also extends to various LNC entities that employ or control those individuals. The SEC and
other governmental agencies and self-regulatory organizations, as well as state securities commissions in the U.S., have the power
to conduct administrative proceedings that can result in censure, fines, the issuance of cease-and-desist orders or suspension,
termination or limitation of the activities of the regulated entity or its employees.
Our U.S. banking operations are subject to federal and state regulation. As a result of its ownership of Newton County Loan &
Savings, FSB, which was approved on January 8, 2009, LNC is considered to be a savings and loan holding company and, along
with Newton County Loan & Savings, FSB, is subject to annual examination by the Office of Thrift Supervision of the U.S.
Department of Treasury. Federal and state banking laws generally provide that no person may acquire control of LNC, and gain
indirect control of Newton County Loan & Savings, FSB, without prior regulatory approval. Generally, beneficial ownership of
10% or more of the voting securities of LNC would be presumed to constitute control.
As a savings and loan holding company, we have applied to participate in the FDIC’s TLGP. Under the TLGP, the FDIC will
guarantee newly issued senior unsecured debt issued on or before June 30, 2009. The amount guaranteed may not exceed 125% of
the par or face value of senior unsecured debt outstanding as of September 30, 2008, that is scheduled to mature on or before June
30, 2009. This means only debt maturing before June 30, 2009, can be included in calculating the cap. The FDIC can vary the cap.
The debt guarantee expires June 30, 2012, regardless if the debt matures later. The proceeds of guaranteed debt cannot be used to
prepay debt that is not guaranteed. Entities participating in the TLGP are subject to enhanced supervisory oversight to prevent
rapid growth or excessive risk taking, including additional reporting and on-site reviews to determine compliance with the TLGP.
There can be assurance that the FDIC will approve our participation in the TLGP.
Environmental Considerations
Federal, state and local environmental laws and regulations apply to our ownership and operation of real property. Inherent in
owning and operating real property are the risk of hidden environmental liabilities and the costs of any required clean-up. Under
the laws of certain states, contamination of a property may give rise to a lien on the property to secure recovery of the costs of
clean-up, which could adversely affect our commercial mortgage lending. In several states, this lien has priority over the lien of an
existing mortgage against such property. In addition, in some states and under the federal Comprehensive Environmental
Response, Compensation, and Liability Act of 1980 (“CERCLA”), we may be liable, as an “owner” or “operator,” for costs of
cleaning-up releases or threatened releases of hazardous substances at a property mortgaged to us. We also risk environmental
liability when we foreclose on a property mortgaged to us. Federal legislation provides for a safe harbor from CERCLA liability
for secured lenders that foreclose and sell the mortgaged real estate, provided that certain requirements are met. However, there
are circumstances in which actions taken could still expose us to CERCLA liability. Application of various other federal and state
environmental laws could also result in the imposition of liability on us for costs associated with environmental hazards.
We routinely conduct environmental assessments for real estate we acquire for investment and before taking title through
foreclosure to real property collateralizing mortgages that we hold. Although unexpected environmental liabilities can always arise,
based on these environmental assessments and compliance with our internal procedures, we believe that any costs associated with
compliance with environmental laws and regulations or any clean-up of properties would not have a material adverse effect on our
results of operations.
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Intellectual Property
We rely on a combination of copyright, trademark, patent and trade secret laws to establish and protect our intellectual property.
We have implemented a patent strategy designed to protect innovative aspects of our products and processes which we believe
distinguish us from competitors. We currently own four issued U.S. patents and have additional patent applications pending in the
U.S. Patent and Trademark Office. Our currently issued U.S. patents will expire between 2015 and 2021. We intend to continue to
file patent applications as we develop new products, technologies and patentable enhancements.
We regard our patents as valuable assets and intend to vigorously protect them against infringement. However, complex legal and
factual determinations and evolving laws make patent protection uncertain, and while we believe our patents provide us with a
competitive advantage, we cannot be certain that patents will be issued from any of our pending patent applications or that any
issued patents will have sufficient breadth to offer meaningful protection. In addition, our issued patents may be successfully
challenged, invalidated, circumvented or found unenforceable so that our patent rights would not create an effective competitive
barrier. We have in the past instituted litigation against competitors to enforce our intellectual property rights with success. For
example, we recently won a $13 million judgment that upheld the validity of one of our patents and found infringement by the
defendants. We are currently reviewing the judgment and its applicability in relation to other potentially infringing parties.
Finally, we have an extensive portfolio of trademarks and service marks that we consider important in the marketing of our
products and services, including, among others, the trademarks of the Lincoln National and Lincoln Financial names, the Lincoln
silhouette logo and the combination of these marks. Trademark registrations may be renewed indefinitely subject to continued use
and registration requirements. We regard our trademarks as valuable assets in marketing our products and services and protect
them against infringement.
EMPLOYEES
As of December 31, 2008, we had a total of 9,696 employees. In addition, we had a total of 1,486 planners and agents who had
active sales contracts with one of our insurance subsidiaries. None of our employees are represented by a labor union, and we are
not a party to any collective bargaining agreements. We consider our employee relations to be good.
AVAILABLE INFORMATION
We file annual, quarterly and current reports, proxy statements and other documents with the SEC under the Exchange Act. The
public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE,
Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. Also, the SEC maintains an Internet website that contains reports, proxy and information statements, and other
information regarding issuers, including LNC, that file electronically with the SEC. The public can obtain any documents that we
file with the SEC at http://www.sec.gov.
We also make available, free of charge, on or through our Internet website http://www.lincolnfinancial.com, our Annual Report
on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the SEC.
The information on the website listed above is not, and should not, be considered part of this annual report on Form 10-K and is
not incorporated by reference in this document. This website is, and is only intended to be, an inactive textual reference.
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Item 1A. Risk Factors
You should carefully consider the risks described below before investing in our securities. The risks and uncertainties described
below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently
deem immaterial may also impair our business operations. If any of these risks actually occur, our business, financial condition and
results of operations could be materially affected. In that case, the value of our securities could decline substantially.
Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs, access to capital
and cost of capital.
The capital and credit markets have been experiencing extreme volatility and disruption for more than twelve months. In some
cases, the markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers.
We maintain an investment portfolio of various holdings, types and maturities. These investments are subject to general credit,
liquidity, market and interest rate risks. An extended disruption in the credit and capital markets could adversely affect LNC and
its subsidiaries’ ability to access sources of liquidity, and there can be no assurance that additional financing will be available to us
on favorable terms, or at all, in the current market environment. In addition, further other-than-temporary impairments could
reduce our statutory surplus, leading to lower RBC ratios and potentially reducing future dividend capacity from our insurance
subsidiaries.
We need liquidity to pay our operating expenses, interest on our debt and dividends on our capital stock, to maintain our securities
lending activities and to replace certain maturing liabilities. Without sufficient liquidity, we will be forced to curtail our operations,
and our business will suffer. As a holding company with no direct operations, our principal asset is the capital stock of our
insurance and investment management subsidiaries. Our ability to meet our obligations for payment of interest and principal on
outstanding debt obligations, including the $500 million of senior securities due in April 2009, and to pay dividends to shareholders
and corporate expenses depends significantly upon the surplus and earnings of our subsidiaries and the ability of our subsidiaries to
pay dividends or to advance or repay funds to us. Payments of dividends and advances or repayment of funds to us by our
insurance subsidiaries are restricted by the applicable laws and regulations of their respective jurisdictions, including laws
establishing minimum solvency and liquidity thresholds. Changes in these laws can constrain the ability of our subsidiaries to pay
dividends or to advance or repay funds to us in sufficient amounts and at times necessary to meet our debt obligations and
corporate expenses. For our insurance and other subsidiaries, the principal sources of our liquidity are insurance premiums and
fees, annuity considerations, investment advisory fees, and cash flow from our investment portfolio and assets, consisting mainly of
cash or assets that are readily convertible into cash. At the holding company level, sources of liquidity in normal markets also
include a variety of short- and long-term instruments, including credit facilities, commercial paper and medium- and long-term
debt.
In the event that current resources do not satisfy our needs, we may have to seek additional financing. The availability of
additional financing will depend on a variety of factors such as market conditions, the general availability of credit, the volume of
trading activities, the overall availability of credit to the financial services industry, our credit ratings and credit capacity, as well as
the possibility that customers or lenders could develop a negative perception of our long- or short-term financial prospects if we
incur large investment losses or if the level of our business activity decreases due to a market downturn. Similarly, our access to
funds may be impaired if regulatory authorities or rating agencies take negative actions against us as has happened recently. See
“Item 1. Business – Ratings” for a complete description of our ratings and ratings outlook. Our internal sources of liquidity may
prove to be insufficient, and in such case, we may not be able to successfully obtain additional financing on favorable terms, or at
all.
Disruptions, uncertainty or volatility in the capital and credit markets may also limit our access to capital required to operate our
business, most significantly our insurance operations. Such market conditions may limit our ability to replace, in a timely manner,
maturing liabilities; satisfy statutory capital requirements; generate fee income and market-related revenue to meet liquidity needs;
and access the capital necessary to grow our business. As such, we may be forced to delay raising capital, issue shorter term
securities than we prefer, or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our
financial flexibility. Recently, our credit spreads have widened considerably, which increases the interest rate we must pay on any
new debt obligation we may issue. Our results of operations, financial condition, cash flows and statutory capital position could be
materially adversely affected by disruptions in the financial markets.
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Difficult conditions in the global capital markets and the economy generally may materially adversely affect our
business and results of operations and we do not expect these conditions to improve in the near future.
Our results of operations are materially affected by conditions in the global capital markets and the economy generally, both in the
U.S. and elsewhere around the world. The stress experienced by global capital markets that began in the second half of 2007
continued and substantially increased during the second half of 2008, particularly in the fourth quarter of 2008. Recently, concerns
over unemployment, the availability and cost of credit, the U.S. mortgage market and a declining real estate market in the U.S. have
contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors,
combined with volatile oil prices and declining business and consumer confidence, have precipitated a recession. In addition, the
fixed-income markets are experiencing a period of extreme volatility, which has negatively impacted market liquidity conditions.
Initially, the concerns on the part of market participants were focused on the subprime segment of the mortgage-backed securities
market. However, these concerns have since expanded to include a broad range of mortgage- and asset-backed and other fixed
income securities, including those rated investment grade, the U.S. and international credit and interbank money markets generally,
and a wide range of financial institutions and markets, asset classes and sectors. As a result, the market for fixed income
instruments has experienced decreased liquidity, increased price volatility, credit downgrade events and increased probability of
default. Securities that are less liquid are more difficult to value and may be hard to sell, if desired. Domestic and international
equity markets have also been experiencing heightened volatility and turmoil, with issuers (such as our company) that have
exposure to the real estate, mortgage and credit markets particularly affected. These events and the continuing market upheavals
may have an adverse effect on us, in part because we have a large investment portfolio and are also dependent upon customer
behavior. Our revenues are likely to decline in such circumstances and our profit margins could erode. In addition, in the event of
extreme prolonged market events, such as the global credit crisis, we could incur significant losses. Even in the absence of a
market downturn, we are exposed to substantial risk of loss due to market volatility.
Factors such as consumer spending, business investment, government spending, the volatility and strength of the capital markets
and inflation all affect the business and economic environment and, ultimately, the amount and profitability of our business. In an
economic downturn characterized by higher unemployment, lower family income, lower corporate earnings, lower business
investment and lower consumer spending, the demand for our financial and insurance products could be adversely affected. In
addition, we may experience an elevated incidence of claims and lapses or surrenders of policies. Our policyholders may choose to
defer paying insurance premiums or stop paying insurance premiums altogether. Adverse changes in the economy could affect
earnings negatively and could have a material adverse effect on our business, results of operations and financial condition. The
current mortgage crisis has also raised the possibility of future legislative and regulatory actions in addition to the recent
enactments of the EESA and the ARRA that could further impact our business. We cannot predict whether or when such actions
may occur, or what impact, if any, such actions could have on our business, results of operations and financial condition. A
continuation of current economic conditions may require us to raise additional capital or consider other transactions to manage our
capital position or our liquidity.
If our businesses do not perform well and/or the price of our common stock does not increase, we may be required to
recognize an impairment of our goodwill or to establish a valuation allowance against the deferred income tax asset,
which could have a material adverse effect on our results of operations and financial condition.
Goodwill represents the excess of the amounts we paid to acquire subsidiaries and other businesses over the fair value of their net
assets at the date of acquisition. As of December 31, 2008, we had a total of $3.9 billion of goodwill on our Consolidated Balance
Sheets, of which $2.2 billion related to our Insurance Solutions – Life Insurance segment and $1.0 billion related to our Retirement
Solutions – Annuities segment. We test goodwill at least annually for impairment. Impairment testing is performed based upon
estimates of the fair value of the “reporting unit” to which the goodwill relates. The reporting unit is the operating segment or a
business one level below that operating segment if discrete financial information is prepared and regularly reviewed by management
at that level. The fair value of the reporting unit is impacted by the performance of the business. If it is determined that the
goodwill has been impaired, i.e. when the fair value of the “reporting unit” is not expected to recover in a reasonable amount of
time, we must write down the goodwill by the amount of the impairment, with a corresponding charge to net income. For the year
ended December 31, 2008, we took total pre-tax impairment charges of $176 million, primarily related to our media assets.
If current market conditions persist during 2009, in particular, if our share price remains below book value per share, or if we take
actions to limit risk associated with our products or investments that causes a significant change in any one reporting unit’s fair
value, this may trigger goodwill impairment testing at the end of each quarter as part of an annual or interim impairment test. We
expect to perform interim tests of goodwill impairment in addition to our annual test during 2009, especially if our market
capitalization remains below our book value. Subsequent reviews of goodwill could result in impairment of goodwill during 2009,
as early as the first quarter. These subsequent reviews of goodwill could result in additional impairment of goodwill during 2009,
and such write downs could have a material adverse effect on our results of operations or financial position, but will not affect the
statutory capital of our insurance subsidiaries. For more information on goodwill, see Note 8 and the MD&A.
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Deferred income tax represents the tax effect of the differences between the book and tax basis of assets and liabilities. Deferred
tax assets are assessed periodically by management to determine if they are realizable. Factors in management’s determination
include the performance of the business, including the ability to generate capital gains from a variety of sources and tax planning
strategies. If, based on available information, it is more likely than not that the deferred income tax asset will not be realized, then
a valuation allowance must be established with a corresponding charge to net income. Such valuation allowance could have a
material adverse effect on our results of operations and financial position, but will not affect the statutory capital of our insurance
subsidiaries.
There can be no assurance that actions of the U.S. Government, Federal Reserve and other governmental and regulatory
bodies for the purpose of stabilizing the financial markets will achieve the intended effect.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment
banks and other financial institutions, on October 3, 2008, the EESA was signed into law and on February 17, 2009, the ARRA
was signed into law. The federal government, Federal Reserve and other governmental and regulatory bodies have taken or are
considering taking other actions to address the financial crisis. There can be no assurance as to what impact such actions will have
on the financial markets, including the extreme levels of volatility currently being experienced.
The difficulties faced by other financial institutions could adversely affect us.
We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the
financial services industry, including brokers and dealers, commercial banks, investment banks and other institutions. Many of
these transactions expose us to credit risk in the event of default of our counterparty. In addition, with respect to secured
transactions, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not
sufficient to recover the full amount of the loan or derivative exposure due to it. We also may have exposure to these financial
institutions in the form of unsecured debt instruments, derivative transactions and/or equity investments. There can be no
assurance that any such losses or impairments to the carrying value of these assets would not materially and adversely affect our
business and results of operations.
Furthermore, we distribute a significant amount of our insurance, annuity and mutual fund products through large financial
institutions. We believe that the mergers of several of these entities, as well as the negative impact of the markets on these entities,
has disrupted and may lead to further disruption of their businesses, which may have a negative effect on our production levels.
Our participation in a securities lending program and a reverse repurchase program subjects us to potential liquidity
and other risks.
We participate in a securities lending program for our general account whereby fixed income securities are loaned by our agent
bank to third parties, primarily major brokerage firms and commercial banks. The borrowers of our securities provide us with
collateral, typically in cash, which we separately maintain. We invest such cash collateral in other securities, primarily in commercial
paper and money market or other short term funds. Securities with a cost or amortized cost of $430 million and a fair value of
$410 million were on loan under the program as of December 31, 2008. Securities loaned under such transactions may be sold or
repledged by the transferee. We were liable for cash collateral under our control of $427 million as of December 31, 2008.
We participate in a reverse repurchase program for our general account whereby we sell fixed income securities to third parties,
primarily major brokerage firms, with a concurrent agreement to repurchase those same securities at a determined future date. The
borrowers of our securities provide us with cash collateral which is typically invested in fixed maturity securities. The fair value of
securities pledged under reverse repurchase agreements was $496 million as of December 31, 2008.
As of December 31, 2008, substantially all of the securities on loan under the program could be returned to us by the borrowers at
any time. Collateral received under the reverse repurchase program cannot be returned prior to maturity, however, market
conditions on the repurchase date may limit our ability to enter into new agreements. The return of loaned securities or our
inability to enter into new reverse repurchase agreements would require us to return the cash collateral associated with such
securities. In addition, in some cases, the maturity of the securities held as invested collateral (i.e. securities that we have purchased
with cash received from the third parties) may exceed the term of the related securities and the market value may fall below the
amount of cash received as collateral and invested. If we are required to return significant amounts of cash collateral on short
notice and we are forced to sell securities to meet the return obligation, we may have difficulty selling such collateral that is
invested in securities in a timely manner, be forced to sell securities in a volatile or illiquid market for less than we otherwise would
have been able to realize under normal market conditions, or both. In addition, under stressful capital market and economic
conditions, such as those conditions we have experienced recently, liquidity broadly deteriorates, which may further restrict our
ability to sell securities.
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Our reserves for future policy benefits and claims related to our current and future business as well as businesses we
may acquire in the future may prove to be inadequate.
We establish and carry, as a liability, reserves based on estimates of how much we will need to pay for future benefits and claims.
For our life insurance and annuity products, we calculate these reserves based on many assumptions and estimates, including
estimated premiums we will receive over the assumed life of the policy, the timing of the event covered by the insurance policy, the
lapse rate of the policies, the amount of benefits or claims to be paid and the investment returns on the assets we purchase with the
premiums we receive. The assumptions and estimates we use in connection with establishing and carrying our reserves are
inherently uncertain. In addition, the sensitivity of our statutory reserves and surplus established for our variable annuity base
contracts and riders to changes in the equity markets will vary depending on the magnitude of the decline. The sensitivity will be
affected by the level of account values relative to the level of guaranteed amounts, product design and reinsurance. Statutory
reserves for variable annuities depend upon the cumulative equity market impacts on the business in force, and therefore, result in
non-linear relationships with respect to the level of equity market performance within any reporting period. Accordingly, we
cannot determine with precision the ultimate amount or the timing of the payment of actual benefits and claims or whether the
assets supporting the policy liabilities will grow to the level we assume prior to payment of benefits or claims. If our actual
experience is different from our assumptions or estimates, our reserves may prove to be inadequate in relation to our estimated
future benefits and claims. As a result, we would incur a charge to our earnings in the quarter in which we increase our reserves.
Because the equity markets and other factors impact the profitability and expected profitability of many of our products,
changes in equity markets and other factors may significantly affect our business and profitability.
The fee revenue that we earn on equity-based variable annuities, unit-linked accounts, VUL insurance policies and investment
advisory business is based upon account values. Because strong equity markets result in higher account values, strong equity
markets positively affect our net income through increased fee revenue. Conversely, a weakening of the equity markets results in
lower fee income and may have a material adverse effect on our results of operations and capital resources.
The increased fee revenue resulting from strong equity markets increases the expected gross profits (“EGPs”) from variable
insurance products as do better than expected lapses, mortality rates and expenses. As a result, higher EGPs may result in lower
net amortized costs related to deferred acquisition costs (“DAC”), deferred sales inducements (“DSI”), value of business acquired
(“VOBA”), deferred front-end loads (“DFEL”) and changes in future contract benefits. However, a decrease in the equity
markets, as well as worse than expected increases in lapses, mortality rates and expenses, depending upon their significance, may
result in higher net amortized costs associated with DAC, DSI, VOBA, DFEL and changes in future contract benefits and may
have a material adverse effect on our results of operations and capital resources. For example, in the fourth quarter of 2008, we
reset the baseline of account values from which EGPs are projected. As a result of this and the impact of the volatile capital
market conditions on our annuity reserves, we had a cumulative unfavorable prospective unlocking of $223 million, after-tax.
Changes in the equity markets, interest rates and/or volatility affect the profitability of our products with guaranteed
benefits; therefore, such changes may have a material adverse effect on our business and profitability.
Certain of our variable annuity products include guaranteed benefit riders. These include GDB, GWB and GIB riders. Our GWB,
GIB and 4LATER® features have elements of both insurance benefits accounted for under Statement of Position 03-1 (“SOP 03-
1”) and embedded derivatives accounted for under SFAS No. 133 “Accounting for Derivative Instruments and Hedging
Activities” and SFAS No. 157, “Fair Value Measurements, (“SFAS 157”). The SOP 03-1 component is calculated in a manner
consistent with our GDB, as described below. We weight the reserves based on the significance of their features. The amount of
reserves related to GDB for variable annuities is tied to the difference between the value of the underlying accounts and the GDB,
calculated using a benefit ratio approach. The GDB reserves take into account the present value of total expected GDB payments,
the present value of total expected GDB assessments over the life of the contract, claims paid to date and assessments to date.
Reserves for our GIB and certain GWB with lifetime benefits are based on a combination of fair value of the underlying benefit
and a benefit ratio approach that is based on the projected future payments in excess of projected future account values. The
benefit ratio approach takes into account the present value of total expected GIB payments, the present value of total expected
GIB assessments over the life of the contract, claims paid to date and assessments to date. The amount of reserves related to those
GWB that do not have lifetime benefits is based on the fair value of the underlying benefit.
Both the level of expected payments and expected total assessments used in calculating the benefit ratio are affected by the equity
markets. The liabilities related to fair value are impacted by changes in equity markets, interest rates and volatility. Accordingly,
strong equity markets will decrease the amount of reserves that we must carry, and strong equity markets, increases in interest rates
and decreases in volatility will generally decrease the reserves calculated using fair value. Conversely, a decrease in the equity
markets will increase the expected future payments used in the benefit ratio approach, which has the effect of increasing the
amount of reserves. Also, a decrease in the equity market along with a decrease in interest rates and an increase in volatility will
generally result in an increase in the reserves calculated using fair value, which are the conditions we have experienced recently.
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Increases in reserves would result in a charge to our earnings in the quarter in which the increase occurs. Therefore, we maintain a
customized dynamic hedge program that is designed to mitigate the risks associated with income volatility around the change in
reserves on guaranteed benefits. However, the hedge positions may not be effective to exactly offset the changes in the carrying
value of the guarantees due to, among other things, the time lag between changes in their values and corresponding changes in the
hedge positions, high levels of volatility in the equity markets and derivatives markets, extreme swings in interest rates, contract
holder behavior different than expected and divergence between the performance of the underlying funds and hedging indices.
For example, for the years ended December 31, 2008 and 2007, we experienced a breakage on our guaranteed living benefits net
derivatives results of $51 million and $(136) million, pre-DAC, pre-tax. Breakage is defined as the difference between the change
in the value of the liabilities, excluding the amount related to the non-performance risk component, and the change in the fair value
of the derivatives. The non-performance risk factor is required under SFAS 157, which requires us to consider our own credit
standing, which is not hedged, in the valuation of certain of these liabilities. A decrease in our own credit spread could cause the
value of these liabilities to increase, resulting in a reduction to net income. Conversely, an increase in our own credit spread could
cause the value of these liabilities to decrease, resulting in an increase to net income. See “Realized Gain (Loss)” in the MD&A for
further discussion.
In addition, we remain liable for the guaranteed benefits in the event that derivative counterparties are unable or unwilling to pay,
and we are also subject to the risk that the cost of hedging these guaranteed benefits increases, resulting in a reduction to net
income. These, individually or collectively, may have a material adverse effect on net income, financial condition or liquidity.
Changes in interest rates may cause interest rate spreads to decrease and may result in increased contract withdrawals.
Because the profitability of our fixed annuity and interest-sensitive whole life, UL and fixed portion of VUL insurance business
depends in part on interest rate spreads, interest rate fluctuations could negatively affect our profitability. Changes in interest rates
may reduce both our profitability from spread businesses and our return on invested capital. Some of our products, principally
fixed annuities, interest-sensitive whole life, UL and the fixed portion of VUL insurance, have interest rate guarantees that expose
us to the risk that changes in interest rates will reduce our “spread,” or the difference between the amounts that we are required to
pay under the contracts and the amounts we are able to earn on our general account investments intended to support our
obligations under the contracts. Declines in our spread or instances where the returns on our general account investments are not
enough to support the interest rate guarantees on these products could have a material adverse effect on our businesses or results
of operations.
In periods of increasing interest rates, we may not be able to replace the assets in our general account with higher yielding assets
needed to fund the higher crediting rates necessary to keep our interest-sensitive products competitive. We therefore may have to
accept a lower spread and thus lower profitability or face a decline in sales and greater loss of existing contracts and related assets.
In periods of declining interest rates, we have to reinvest the cash we receive as interest or return of principal on our investments
in lower yielding instruments then available. Moreover, borrowers may prepay fixed-income securities, commercial mortgages and
mortgage-backed securities in our general account in order to borrow at lower market rates, which exacerbates this risk. Because
we are entitled to reset the interest rates on our fixed rate annuities only at limited, pre-established intervals, and since many of our
contracts have guaranteed minimum interest or crediting rates, our spreads could decrease and potentially become negative.
Increases in interest rates may cause increased surrenders and withdrawals of insurance products. In periods of increasing interest
rates, policy loans and surrenders and withdrawals of life insurance policies and annuity contracts may increase as contract holders
seek to buy products with perceived higher returns. This process may lead to a flow of cash out of our businesses. These outflows
may require investment assets to be sold at a time when the prices of those assets are lower because of the increase in market
interest rates, which may result in realized investment losses. A sudden demand among consumers to change product types or
withdraw funds could lead us to sell assets at a loss to meet the demand for funds.
Our requirements to post collateral or make payments related to declines in market value of specified assets may
adversely affect our liquidity and expose us to counterparty credit risk.
Many of our transactions with financial and other institutions, including settling futures positions, specify the circumstances under
which the parties are required to post collateral. The amount of collateral we may be required to post under these agreements may
increase under certain circumstances, which could adversely affect our liquidity. In addition, under the terms of some of our
transactions, we may be required to make payment to our counterparties related to any decline in the market value of the specified
assets.
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Losses due to defaults by others could reduce our profitability or negatively affect the value of our investments.
Third parties that owe us money, securities or other assets may not pay or perform their obligations. These parties include the
issuers whose securities we hold, borrowers under the mortgage loans we make, customers, trading counterparties, counterparties
under swaps and other derivative contracts, reinsurers and other financial intermediaries. These parties may default on their
obligations to us due to bankruptcy, lack of liquidity, downturns in the economy or real estate values, operational failure, corporate
governance issues or other reasons. A further downturn in the U.S. and other economies could result in increased impairments.
Defaults on our mortgage loans and volatility in performance may adversely affect our profitability.
Our mortgage loans face default risk and are principally collateralized by commercial properties. Mortgage loans are stated on our
balance sheet at unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, and are
net of valuation allowances. We establish valuation allowances for estimated impairments as of the balance sheet date based on
information, such as the market value of the underlying real estate securing the loan, any third party guarantees on the loan balance
or any cross collateral agreements and their impact on expected recovery rates. As of December 31, 2008, no loans were in default
for our mortgage loan investments. The performance of our mortgage loan investments, however, may fluctuate in the future. In
addition, some of our mortgage loan investments have balloon payment maturities. An increase in the default rate of our mortgage
loan investments could have a material adverse effect on our business, results of operations and financial condition.
Further, any geographic or sector exposure in our mortgage loans may have adverse effects on our investment portfolios and
consequently on our consolidated results of operations or financial condition. While we seek to mitigate this risk by having a
broadly diversified portfolio, events or developments that have a negative effect on any particular geographic region or sector may
have a greater adverse effect on the investment portfolios to the extent that the portfolios are exposed.
Our investments are reflected within our consolidated financial statements utilizing different accounting bases, and,
accordingly, we may not have recognized differences, which may be significant, between cost and fair value in our
consolidated financial statements.
Our principal investments are in fixed maturity and equity securities, mortgage loans on real estate, policy loans, short-term
investments, derivative instruments, limited partnerships and other invested assets. The carrying value of such investments is as
follows:
(cid:120) Fixed maturity and equity securities are classified as available-for-sale, except for those designated as trading securities, and are
reported at their estimated fair value. The difference between the estimated fair value and amortized cost of such securities
(i.e. unrealized investment gains and losses) are recorded as a separate component of other comprehensive income or loss, net
of adjustments to DAC, policyholder related amounts and deferred income taxes;
(cid:120) Fixed maturity and equity securities designated as trading securities, which support certain reinsurance arrangements, are
recorded at fair value with subsequent changes in fair value recognized in realized gain (loss). However, offsetting the changes
to fair value of the trading securities are corresponding changes in the fair value of the embedded derivative liability associated
with the underlying reinsurance arrangement. In other words, the investment results for the trading securities, including gains
and losses from sales, are passed directly to the reinsurers through the contractual terms of the reinsurance arrangements;
Short-term investments include investments with remaining maturities of one year or less, but greater than three months, at
the time of acquisition and are stated at amortized cost, which approximates fair value;
(cid:120)
(cid:120) Mortgage loans are stated at unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or
expenses, net of valuation allowances;
(cid:120) Policy loans are stated at unpaid principal balances;
(cid:120) Real estate joint ventures and other limited partnership interests are carried using the equity method of accounting; and
(cid:120) Other invested assets consist principally of derivatives with positive fair values. Derivatives are carried at fair value with
changes in fair value reflected in income from non-qualifying derivatives and derivatives in fair value hedging relationships.
Derivatives in cash flow hedging relationships are reflected as a separate component of other comprehensive income or loss.
Investments not carried at fair value in our consolidated financial statements – principally, mortgage loans, policy loans and real
estate – may have fair values which are substantially higher or lower than the carrying value reflected in our consolidated financial
statements. In addition, unrealized losses are not reflected in net income unless we realize the losses by either selling the security at
below amortized cost or determine that the decline in fair value is deemed to be other-than-temporary (i.e. impaired). Each of
such asset classes is regularly evaluated for impairment under the accounting guidance appropriate to the respective asset class.
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Our valuation of fixed maturity, equity and trading securities may include methodologies, estimations and assumptions
which are subject to differing interpretations and could result in changes to investment valuations that may materially
adversely affect our results of operations or financial condition.
Fixed maturity, equity and trading securities and short-term investments, which are reported at fair value on our Consolidated
Balance Sheets, represented the majority of our total cash and invested assets. Pursuant to SFAS 157, we have categorized these
securities into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value
hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest
priority to unobservable inputs (Level 3).
The determination of fair values in the absence of quoted market prices is based on: valuation methodologies; securities we deem
to be comparable; and assumptions deemed appropriate given the circumstances. The fair value estimates are made at a specific
point in time, based on available market information and judgments about financial instruments, including estimates of the timing
and amounts of expected future cash flows and the credit standing of the issuer or counterparty. Factors considered in estimating
fair value include coupon rate, maturity, estimated duration, call provisions, sinking fund requirements, credit rating, industry sector
of the issuer and quoted market prices of comparable securities. The use of different methodologies and assumptions may have a
material effect on the estimated fair value amounts.
During periods of market disruption, including periods of significantly increasing/decreasing or high/low interest rates, rapidly
widening credit spreads or illiquidity, it may be difficult to value certain of our securities, if trading becomes less frequent and/or
market data becomes less observable. There may be certain asset classes that were in active markets with significant observable
data that become illiquid due to the current financial environment. In such cases, more securities may fall to Level 3 and thus
require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less
observable or require greater estimation, as well as valuation methods which are more sophisticated or require greater estimation,
thereby resulting in values which may be less than the value at which the investments may be ultimately sold. Further, rapidly
changing and unprecedented credit and equity market conditions could materially impact the valuation of securities as reported
within our consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value
may have a material adverse effect on our results of operations or financial condition.
See Note 2 for further information about SFAS 157.
Some of our investments are relatively illiquid and are in asset classes that have been experiencing significant market
valuation fluctuations.
We hold certain investments that may lack liquidity, such as privately placed fixed maturity securities, mortgage loans, policy loans
and other limited partnership interests. These asset classes represented 25% of the carrying value of our total cash and invested
assets as of December 31, 2008. Even some of our very high quality assets have been more illiquid as a result of the recent
challenging market conditions.
If we require significant amounts of cash on short notice in excess of normal cash requirements or are required to post or return
collateral in connection with our investment portfolio, derivatives transactions or securities lending activities, we may have
difficulty selling these investments in a timely manner, be forced to sell them for less than we otherwise would have been able to
realize, or both.
The reported value of our relatively illiquid types of investments, our investments in the asset classes described in the paragraph
above and, at times, our high quality, generally liquid asset classes, do not necessarily reflect the lowest current market price for the
asset. If we were forced to sell certain of our assets in the current market, there can be no assurance that we would be able to sell
them for the prices at which we have recorded them and we might be forced to sell them at significantly lower prices.
We invest a portion of our invested assets in investment funds, many of which make private equity investments. The amount and
timing of income from such investment funds tends to be uneven as a result of the performance of the underlying investments,
including private equity investments. The timing of distributions from the funds, which depends on particular events relating to
the underlying investments, as well as the funds’ schedules for making distributions and their needs for cash, can be difficult to
predict. As a result, the amount of income that we record from these investments can vary substantially from quarter to quarter.
Recent equity and credit market volatility may reduce investment income for these types of investments.
In addition, other external factors may cause a drop in value of investments, such as ratings downgrades on asset classes. For
example, Congress has proposed legislation to amends the U.S. Bankruptcy Code to permit bankruptcy courts to modify mortgages
on primary residences, including an ability to reduce outstanding mortgage balances. Such actions by bankruptcy courts may
impact the ratings and valuation of our residential mortgage-backed investment securities.
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The determination of the amount of allowances and impairments taken on our investments is highly subjective and
could materially impact our results of operations or financial position.
The determination of the amount of allowances and impairments varies by investment type and is based upon our periodic
evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments
are revised as conditions change and new information becomes available. Management updates its evaluations regularly and
reflects changes in allowances and impairments in operations as such evaluations are revised. There can be no assurance that our
management has accurately assessed the level of impairments taken and allowances reflected in our financial statements.
Furthermore, additional impairments may need to be taken or allowances provided for in the future. Historical trends may not be
indicative of future impairments or allowances.
For example, the cost of our fixed maturity and equity securities is adjusted for impairments in value deemed to be other-than-
temporary in the period in which the determination is made. The assessment of whether impairments have occurred is based on
management’s case-by-case evaluation of the underlying reasons for the decline in fair value. In evaluating whether a decline in
value is other-than-temporary, we consider several factors including, but not limited to: our ability and intent to hold the security
for a sufficient period of time to allow for a recovery in value; the cause of the decline; fundamental analysis of the liquidity,
business prospects and overall financial condition of the issuer; and severity of the decline in value.
Additionally, our management considers a wide range of factors about the security issuer and uses its best judgment in evaluating
the cause of the decline in the estimated fair value of the security and in assessing the prospects for recovery. Inherent in
management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings
potential. Another key factor in whether determining an “other-than-temporary impairment” has occurred is our intent or ability
to hold to recovery or maturity. In the event that we determine that we do not have the intent or ability to hold to recovery or
maturity, we are required to write down the security. A write-down is necessary even in situations where the unrealized loss is not
due to an underlying credit issue, but may be solely related to the impact of changes in interest rates on the fair value of the
security. Where such analysis results in a conclusion that declines in fair values are other-than-temporary, the security is written
down to fair value.
Our gross unrealized losses on securities available-for-sale as of December 31, 2008, were $7.5 billion, pre-tax, and the component
of gross unrealized losses for securities with a decline of 20% or more for at least six months was $5.0 billion, pre-tax. Related to
our unrealized losses, we establish deferred tax assets for the tax benefit we may receive in the event that losses are realized. The
realization of significant realized losses could result in an inability to recover the tax benefits and may result in the establishment of
valuation allowances against our deferred tax assets. Realized losses or impairments may have a material adverse impact on our
results of operation and financial position.
We will be required to pay interest on our capital securities with proceeds from the issuance of qualifying securities if we
fail to achieve capital adequacy or net income and stockholders’ equity levels.
We have approximately $1.6 billion in principal amount of capital securities outstanding. All of the capital securities contain
covenants that require us to make interest payments in accordance with an alternative coupon satisfaction mechanism (“ACSM”) if
we determine that one of the following triggers exists as of the 30th day prior to an interest payment date (“determination date”):
1. LNL’s RBC ratio is less than 175% (based on the most recent annual financial statement filed with the State of Indiana); or
2.
(i) The sum of our consolidated net income for the four trailing fiscal quarters ending on the quarter that is two quarters prior
to the most recently completed quarter prior to the determination date is zero or negative, and (ii) our consolidated
stockholders’ equity (excluding accumulated other comprehensive income and any increase in stockholders’ equity resulting
from the issuance of preferred stock during a quarter) (“adjusted stockholders’ equity”) as of (x) the most recently completed
quarter and (y) the end of the quarter that is two quarters before the most recently completed quarter, has declined by 10% or
more as compared to the quarter that is ten fiscal quarters prior to the last completed quarter (the “benchmark quarter”).
The ACSM would generally require us to use commercially reasonable efforts to satisfy our obligation to pay interest in full on the
capital securities with the net proceeds from sales of our common stock and warrants to purchase our common stock with an
exercise price greater than the market price. We would have to utilize the ACSM until the trigger events above no longer existed,
and, in the case of test 2 above, our adjusted stockholders’ equity amount has increased or has declined by less than 10% as
compared to the adjusted stockholders’ equity at the end of the benchmark quarter for each interest payment date as to which
interest payment restrictions were imposed by test 2 above.
As a result of our net loss of $505 million in the quarter ended December 31, 2008, if we have net income of $232 million or less
for the quarter ended March 31, 2009, we would trigger test 2(i) above with respect to the quarter ended September 30, 2009. If
our adjusted stockholders’ equity at each of the quarters ended March 31 and September 30, 2009, as compared to the benchmark
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quarter (March 31, 2007) declines by 10% or more, we would trigger tests 2(ii)(x) and (y) above. In such a case, we would trigger
the ACSM for at least our interest payments on November 17, 2009, of $28 million and January 20, 2010, of $5 million.
If we were required to utilize the ACSM and were successful in selling sufficient common shares or warrants to satisfy the interest
payment, we would dilute the current holders of our common stock. Furthermore, while a trigger event is occurring and if we do
not pay accrued interest in full, we may not, among other things, pay dividends on or repurchase our capital stock. Our failure to
pay interest pursuant to the ACSM will not result in an event of default with respect to the capital securities, nor will a nonpayment
of interest, unless it lasts for ten consecutive years, although such breaches may result in monetary damages to the holders of the
capital securities.
The calculations of RBC, net income (loss) and adjusted stockholders’ equity are subject to adjustments and the capital securities
are subject to additional terms and conditions as further described in supplemental indentures filed as exhibits to our Forms 8-K
filed on March 13, 2007, May 17, 2006, and April 20, 2006.
A decrease in the capital and surplus of our insurance subsidiaries may result in a downgrade to our credit and insurer
financial strength ratings.
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending on a variety of factors – the
amount of statutory income or losses generated by our insurance subsidiaries (which itself is sensitive to equity market and credit
market conditions), the amount of additional capital our insurance subsidiaries must hold to support business growth, changes in
reserving requirements, such as VACARVM and principles based reserving, our inability to secure capital market solutions to
provide reserve relief, such as issuing letters of credit to support captive reinsurance structures, changes in equity market levels, the
value of certain fixed-income and equity securities in our investment portfolio, the value of certain derivative instruments that do
not get hedge accounting, changes in interest rates and foreign currency exchange rates, as well as changes to the NAIC RBC
formulas. The RBC ratio is also affected by the product mix of the in-force book of business (i.e. the amount of business without
guarantees is not subject to the same level of reserves as the business with guarantees). Most of these factors are outside of our
control. Our credit and insurer financial strength ratings are significantly influenced by the statutory surplus amounts and RBC
ratios of our insurance company subsidiaries. The RBC ratio of LNL is an important factor in the determination of the credit and
financial strength ratings of LNC and its subsidiaries. In addition, rating agencies may implement changes to their internal models
that have the effect of increasing or decreasing the amount of statutory capital we must hold in order to maintain our current
ratings. In addition, in extreme scenarios of equity market declines, the amount of additional statutory reserves that we are
required to hold for our variable annuity guarantees may increase at a rate greater than the rate of change of the markets. Increases
in reserves reduce the statutory surplus used in calculating our RBC ratios. To the extent that our statutory capital resources are
deemed to be insufficient to maintain a particular rating by one or more rating agencies, we may seek to raise additional capital
through public or private equity or debt financing, which may be on terms not as favorable as in the past. Alternatively, if we were
not to raise additional capital in such a scenario, either at our discretion or because we were unable to do so, our financial strength
and credit ratings might be downgraded by one or more rating agencies. For more information on risks regarding our ratings, see
“A downgrade in our financial strength or credit ratings could limit our ability to market products, increase the number or value of
policies being surrendered and/or hurt our relationships with creditors” below.
A downgrade in our financial strength or credit ratings could limit our ability to market products, increase the number
or value of policies being surrendered and/or hurt our relationships with creditors.
Nationally recognized rating agencies rate the financial strength of our principal insurance subsidiaries and rate our debt. Ratings
are not recommendations to buy our securities. Each of the rating agencies reviews its ratings periodically, and our current ratings
may not be maintained in the future. In late September and early October of 2008, A.M. Best, Fitch, Moody’s and S&P each
revised their outlook for the U.S. life insurance sector from stable to negative. We believe that the rating agencies may heighten the
level of scrutiny that they apply to such institutions, may increase the frequency and scope of their credit reviews, may request
additional information from the companies that they rate and may adjust upward the capital and other requirements employed in
the rating agency models for maintenance of certain ratings levels. In addition, actions we take to access third-party financing may
in turn cause rating agencies to reevaluate our ratings.
Our financial strength ratings, which are intended to measure our ability to meet contract holder obligations, are an important
factor affecting public confidence in most of our products and, as a result, our competitiveness. A downgrade of the financial
strength rating of one of our principal insurance subsidiaries could affect our competitive position in the insurance industry by
making it more difficult for us to market our products as potential customers may select companies with higher financial strength
ratings and by leading to increased withdrawals by current customers seeking companies with higher financial strength ratings.
This could lead to a decrease in fees as net outflows of assets increase, and therefore, result in lower fee income. Furthermore,
sales of assets to meet customer withdrawal demands could also result in losses, depending on market conditions. The interest
rates we pay on our borrowings are largely dependent on our credit ratings. The recent downgrades and future downgrades of our
debt ratings could affect our ability to raise additional debt, including bank lines of credit, with terms and conditions similar to our
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current debt, and accordingly, likely increase our cost of capital. In addition, the recent downgrades and future downgrades of
these ratings could make it more difficult to raise capital to refinance any maturing debt obligations, to support business growth at
our insurance subsidiaries and to maintain or improve the current financial strength ratings of our principal insurance subsidiaries.
Additional future downgrades of one or more of our ratings have become more likely as several of the ratings agencies have
negative outlooks on our credit and insurer financial strength ratings. See “Item 1. Business – Ratings” for a complete description
of our ratings and ratings outlook.
As a result of S&P’s recent downgrade of LNC’s short-term credit rating to A-2, we are not currently eligible to issue new
commercial paper under the Federal Reserve’s Commercial Paper Funding Facility (“CPFF”), which we believe will make it more
expensive to sell additional commercial paper, and it may make it more likely that we will have to utilize other sources of liquidity,
including our credit facilities, for liquidity purposes. Prior to the downgrade, we were eligible to sell up to a maximum of $575
million to the CPFF. See “Review of Consolidated Financial Condition – Liquidity and Capital Resources – Sources of Liquidity
and Cash Flow – Alternative Sources of Liquidity” in the MD&A for more information regarding our participation in the CPFF.
Certain blocks of our insurance business purchased from third-party insurers under indemnity reinsurance agreements
may require us to place assets in trust, secure letters of credit or return the business, if the financial strength ratings
and/or capital ratios of certain insurance subsidiaries are not maintained at specified levels.
Under certain indemnity reinsurance agreements, one of our insurance subsidiaries, LLANY, provides 100% indemnity reinsurance
for the business assumed, however, the third-party insurer (the “cedent”) remains primarily liable on the underlying insurance
business. Under these types of agreements, at December 31, 2008, we held statutory reserves of approximately $3.5 billion. These
indemnity reinsurance arrangements require that our subsidiary, as the reinsurer, maintain certain insurer financial strength ratings
and capital ratios. If these ratings or capital ratios are not maintained, depending upon the reinsurance agreement, the cedent may
recapture the business, or require us to place assets in trust or provide letters of credit at least equal to the relevant statutory
reserves. Under the largest indemnity reinsurance arrangement, we held approximately $2.4 billion of statutory reserves at
December 31, 2008. LLANY must maintain an A.M. Best financial strength rating of at least B+, an S&P financial strength rating
of at least BB+ and a Moody’s financial strength rating of at least Ba1, as well as maintain a RBC ratio of at least 160% or an S&P
capital adequacy ratio of 100%, or the cedent may recapture the business. Under two other arrangements, by which we established
approximately $1 billion of statutory reserves, LLANY must maintain an A.M. Best financial strength rating of at least B++, an
S&P financial strength rating of at least BBB- and a Moody’s financial strength rating of at least Baa3. One of these arrangements
also requires LLANY to maintain an RBC ratio of at least 185% or an S&P capital adequacy ratio of 115%. Each of these
arrangements may require LLANY to place assets in trust equal to the relevant statutory reserves. As of December 31, 2008,
LLANY’s RBC ratio exceeded 500%. See “Item 1. Business – Ratings” for a complete description of LLANY’s ratings.
If the cedent recaptured the business, LLANY would be required to release reserves and transfer assets to the cedent. Such a
recapture could adversely impact our future profits. Alternatively, if LLANY established a security trust for the cedent, the ability
to transfer assets out of the trust could be severely restricted, thus negatively impacting our liquidity.
Our businesses are heavily regulated and changes in regulation may reduce our profitability.
Our insurance subsidiaries are subject to extensive supervision and regulation in the states in which we do business. The
supervision and regulation relate to numerous aspects of our business and financial condition. The primary purpose of the
supervision and regulation is the protection of our insurance contract holders, and not our investors. The extent of regulation
varies, but generally is governed by state statutes. These statutes delegate regulatory, supervisory and administrative authority to
state insurance departments. This system of supervision and regulation covers, among other things:
(cid:120)
Standards of minimum capital requirements and solvency, including RBC measurements;
(cid:120) Restrictions of certain transactions between our insurance subsidiaries and their affiliates;
(cid:120) Restrictions on the nature, quality and concentration of investments;
(cid:120) Restrictions on the types of terms and conditions that we can include in the insurance policies offered by our primary
insurance operations;
(cid:120) Limitations on the amount of dividends that insurance subsidiaries can pay;
(cid:120) The existence and licensing status of the company under circumstances where it is not writing new or renewal business;
(cid:120) Certain required methods of accounting;
(cid:120) Reserves for unearned premiums, losses and other purposes; and
(cid:120) Assignment of residual market business and potential assessments for the provision of funds necessary for the settlement of
covered claims under certain policies provided by impaired, insolvent or failed insurance companies.
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We may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of
applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations, which may change from time
to time. Also, regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not
have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory
authorities could preclude or temporarily suspend us from carrying on some or all of our activities or impose substantial fines.
Further, insurance regulatory authorities have relatively broad discretion to issue orders of supervision, which permit such
authorities to supervise the business and operations of an insurance company. As of December 31, 2008, no state insurance
regulatory authority had imposed on us any substantial fines or revoked or suspended any of our licenses to conduct insurance
business in any state or issued an order of supervision with respect to our insurance subsidiaries, which would have a material
adverse effect on our results of operations or financial condition.
In addition, Lincoln Financial Network and Lincoln Financial Distributors, as well as our variable annuities and variable life
insurance products, are subject to regulation and supervision by the SEC and the FINRA. Our Investment Management segment
is subject to regulation and supervision by the SEC, the FINRA, the Municipal Securities Rulemaking Board, the Pennsylvania
Department of Banking and jurisdictions of the states, territories and foreign countries in which they are licensed to do business.
Lincoln UK is subject to regulation by the FSA in the U.K. LNC, as a savings and loan holding company and Newton County
Loan and Savings, FSB, are subject to regulation and supervision by the Office of Thrift Supervision. These laws and regulations
generally grant supervisory agencies and self-regulatory organizations broad administrative powers, including the power to limit or
restrict the subsidiaries from carrying on their businesses in the event that they fail to comply with such laws and regulations.
Finally, our radio operations require a license, subject to periodic renewal, from the Federal Communications Commission to
operate. While management considers the likelihood of a failure to renew remote, any station that fails to receive renewal would be
forced to cease operations.
Many of the foregoing regulatory or governmental bodies have the authority to review our products and business practices and
those of our agents and employees. In recent years, there has been increased scrutiny of our businesses by these bodies, which has
included more extensive examinations, regular “sweep” inquiries and more detailed review of disclosure documents. These
regulatory or governmental bodies may bring regulatory or other legal actions against us if, in their view, our practices, or those of
our agents or employees, are improper. These actions can result in substantial fines, penalties or prohibitions or restrictions on our
business activities and could have a material adverse effect on our business, results of operations or financial condition.
Attempts to mitigate the impact of Regulation XXX and Actuarial Guideline 38 may fail in whole or in part resulting in
an adverse effect on our financial condition and results of operations.
The Model Regulation entitled “Valuation of Life Insurance Policies,” commonly known as “Regulation XXX” or “XXX,”
requires insurers to establish additional statutory reserves for term life insurance policies with long-term premium guarantees and
UL policies with secondary guarantees. In addition, Actuarial Guideline 38 (“AG38”) clarifies the application of XXX with respect
to certain UL insurance policies with secondary guarantees. Virtually all of our newly issued term and the great majority of our
newly issued UL insurance products are now affected by XXX and AG38.
As a result of this regulation, we have established higher statutory reserves for term and UL insurance products and changed our
premium rates for term life insurance products. We also have implemented reinsurance and capital management actions to
mitigate the capital impact of XXX and AG38, including the use of letters of credit to support the reinsurance provided by a
captive reinsurance subsidiary. However, we cannot provide assurance that there will not be regulatory, rating agency or other
challenges to the actions we have taken to date. The result of those potential challenges could require us to increase statutory
reserves or incur higher operating and/or tax costs. Any change to or repeal of XXX or AG38 could reduce the competitive
advantage of our reinsurance and capital management actions and could adversely affect our market position in the life insurance
market. In addition, as a result of current capital market conditions and disruption in the credit markets, our ability to secure
additional letters of credit or to secure them at current costs may impact the profitability of term and UL insurance products. See
“Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital
Resources – Sources of Liquidity and Cash Flow – Subsidiaries” for a further discussion of our capital management in connection
with XXX.
In light of the current downturn in the credit markets and the increased spreads on asset-backed debt securities, we also cannot
provide assurance that we will be able to continue to implement actions to mitigate the impact of XXX or AG38 on future sales of
term and UL insurance products. If we are unable to continue to implement those actions, we may be required to increase
statutory reserves, incur higher operating costs and lower returns on products sold than we currently anticipate or reduce our sales
of these products. We also may have to implement measures that may be disruptive to our business. For example, because term
and UL insurance are particularly price-sensitive products, any increase in premiums charged on these products in order to
compensate us for the increased statutory reserve requirements or higher costs of reinsurance may result in a significant loss of
volume and adversely affect our life insurance operations.
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A drop in the rankings of the mutual funds that we manage, as well as a loss of key portfolio managers, could result in
lower advisory fees.
While mutual funds are not rated, per se, many industry periodicals and services, such as Lipper, provide rankings of mutual fund
performance. These rankings often have an impact on the decisions of customers regarding which mutual funds to invest in. If
the rankings of the mutual funds for which we provide advisory services decrease materially, the funds’ assets may decrease as
customers leave for funds with higher performance rankings. Similarly, a loss of our key portfolio managers who manage mutual
fund investments could result in poorer fund performance, as well as customers leaving these mutual funds for new mutual funds
managed by the portfolio managers. Any loss of fund assets would decrease the advisory fees that we earn from such mutual
funds, which are generally tied to the amount of fund assets and performance. This would have an adverse effect on our results of
operations.
Changes in accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies
may adversely affect our financial statements.
Our financial statements are subject to the application of GAAP, which is periodically revised and/or expanded. Accordingly,
from time to time we are required to adopt new or revised accounting standards or guidance issued by recognized authoritative
bodies, including the Financial Accounting Standards Board. It is possible that future accounting standards we are required to
adopt could change the current accounting treatment that we apply to our consolidated financial statements and that such changes
could have a material adverse effect on our financial condition and results of operations.
Legal and regulatory actions are inherent in our businesses and could result in financial losses or harm our businesses.
We are, and in the future may be, subject to legal actions in the ordinary course of our insurance and investment management
operations, both domestically and internationally. Pending legal actions include proceedings relating to aspects of our businesses
and operations that are specific to us and proceedings that are typical of the businesses in which we operate. Some of these
proceedings have been brought on behalf of various alleged classes of complainants. In certain of these matters, the plaintiffs are
seeking large and/or indeterminate amounts, including punitive or exemplary damages. Substantial legal liability in these or future
legal or regulatory actions could have a material financial effect or cause significant harm to our reputation, which in turn could
materially harm our business prospects. For more information on pending material legal proceedings, see “Regulatory and
Litigation Matters” in Note 14 for a description of our reportable litigation.
Changes in U.S. federal income tax law could increase our tax costs.
Changes to the Internal Revenue Code, administrative rulings or court decisions could increase our effective tax rate and lower our
net income. In this regard, on August 16, 2007, the Internal Revenue Service (“IRS”) issued a revenue ruling which purports,
among other things, to modify the calculation of separate account deduction for dividends received by life insurance companies.
Subsequently, the IRS issued another revenue ruling that suspended the August 16, 2007, ruling and announced a new regulation
project on the issue. Our income tax provision for the year ended December 31, 2008, included a separate account dividend
received deduction benefit of $81 million.
Our risk management policies and procedures may leave us exposed to unidentified or unanticipated risk, which could
negatively affect our businesses or result in losses.
We have devoted significant resources to develop our risk management policies and procedures and expect to continue to do so in
the future. Nonetheless, our policies and procedures to identify, monitor and manage risks may not be fully effective. Many of our
methods of managing risk and exposures are based upon our use of observed historical market behavior or statistics based on
historical models. As a result, these methods may not predict future exposures, which could be significantly greater than the
historical measures indicate, such as the risk of pandemics causing a large number of deaths. Other risk management methods
depend upon the evaluation of information regarding markets, clients, catastrophe occurrence or other matters that is publicly
available or otherwise accessible to us, which may not always be accurate, complete, up-to-date or properly evaluated. Management
of operational, legal and regulatory risks requires, among other things, policies and procedures to record properly and verify a large
number of transactions and events, and these policies and procedures may not be fully effective.
We face a risk of non-collectibility of reinsurance, which could materially affect our results of operations.
We follow the insurance practice of reinsuring with other insurance and reinsurance companies a portion of the risks under the
policies written by our insurance subsidiaries (known as ceding). As of December 31, 2008, we have ceded approximately $347
billion of life insurance in force to reinsurers for reinsurance protection. Although reinsurance does not discharge our subsidiaries
from their primary obligation to pay contract holders for losses insured under the policies we issue, reinsurance does make the
assuming reinsurer liable to the insurance subsidiaries for the reinsured portion of the risk. As of December 31, 2008, we had $8.5
39
billion of reinsurance receivables from reinsurers for paid and unpaid losses, for which they are obligated to reimburse us under
our reinsurance contracts. Of this amount, $4.5 billion relates to the sale of our reinsurance business to Swiss Re in 2001 through
an indemnity reinsurance agreement. Swiss Re has funded a trust to support this business. The balance in the trust changes as a
result of ongoing reinsurance activity and was $1.9 billion as of December 31, 2008. In addition, should Swiss Re’s financial
strength ratings drop below either S&P AA- or A.M. Best A, or their NAIC RBC ratio fall below 250%, assets equal to the reserves
supporting business reinsured must be placed into a trust according to pre-established asset quality guidelines. Furthermore,
approximately $2.0 billion of the Swiss Re treaties are funds withheld structures where we have a right of offset on assets backing
the reinsurance receivables.
Included in the business sold to Swiss Re through indemnity reinsurance in 2001 was disability income business. See further
discussion of this business in “Reinsurance” in the MD&A.
The balance of the reinsurance is due from a diverse group of reinsurers. The collectibility of reinsurance is largely a function of
the solvency of the individual reinsurers. We perform annual credit reviews on our reinsurers, focusing on, among other things,
financial capacity, stability, trends and commitment to the reinsurance business. We also require assets in trust, letters of credit or
other acceptable collateral to support balances due from reinsurers not authorized to transact business in the applicable
jurisdictions. Despite these measures, a reinsurer’s insolvency, inability or unwillingness to make payments under the terms of a
reinsurance contract, especially Swiss Re, could have a material adverse effect on our results of operations and financial condition.
Significant adverse mortality experience may result in the loss of, or higher prices for, reinsurance.
We reinsure a significant amount of the mortality risk on fully underwritten, newly issued, individual life insurance contracts. We
regularly review retention limits for continued appropriateness and they may be changed in the future. If we were to experience
adverse mortality or morbidity experience, a significant portion of that would be reimbursed by our reinsurers. Prolonged or
severe adverse mortality or morbidity experience could result in increased reinsurance costs, and ultimately, reinsurers not willing to
offer coverage. If we are unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts
that we consider sufficient, we would either have to be willing to accept an increase in our net exposures or revise our pricing to
reflect higher reinsurance premiums. If this were to occur, we may be exposed to reduced profitability and cash flow strain or we
may not be able to price new business at competitive rates.
Catastrophes may adversely impact liabilities for contract holder claims and the availability of reinsurance.
Our insurance operations are exposed to the risk of catastrophic mortality, such as a pandemic, an act of terrorism or other event
that causes a large number of deaths or injuries. Significant influenza pandemics have occurred three times in the last century, but
the likelihood, timing or severity of a future pandemic cannot be predicted. In our group insurance operations, a localized event
that affects the workplace of one or more of our group insurance customers could cause a significant loss due to mortality or
morbidity claims. These events could cause a material adverse effect on our results of operations in any period and, depending on
their severity, could also materially and adversely affect our financial condition.
The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event
and the severity of the event. Pandemics, hurricanes, earthquakes and man-made catastrophes, including terrorism, may produce
significant damage in larger areas, especially those that are heavily populated. Claims resulting from natural or man-made
catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could materially reduce
our profitability or harm our financial condition. Also, catastrophic events could harm the financial condition of our reinsurers and
thereby increase the probability of default on reinsurance recoveries. Accordingly, our ability to write new business could also be
affected.
Consistent with industry practice and accounting standards, we establish liabilities for claims arising from a catastrophe only after
assessing the probable losses arising from the event. We cannot be certain that the liabilities we have established or applicable
reinsurance will be adequate to cover actual claim liabilities, and a catastrophic event or multiple catastrophic events could have a
material adverse effect on our business, results of operations and financial condition.
We may be unable to attract and retain sales representatives and other employees and independent contractors,
particularly financial advisors.
We compete to attract and retain financial advisors, wholesalers, portfolio managers and other employees and independent
contractors, as well as independent distributors of our products. Intense competition exists for persons and independent
distributors with demonstrated ability. We compete with other financial institutions primarily on the basis of our products,
compensation, support services and financial position. Sales in our businesses and our results of operations and financial condition
could be materially adversely affected if we are unsuccessful in attracting and retaining financial advisors, wholesalers, portfolio
managers and other employees, as well as independent distributors of our products.
40
Our sales representatives are not captive and may sell products of our competitors.
We sell our annuity and life insurance products through independent sales representatives. These representatives are not captive,
which means they may also sell our competitors’ products. If our competitors offer products that are more attractive than ours, or
pay higher commission rates to the sales representatives than we do, these representatives may concentrate their efforts in selling
our competitors’ products instead of ours.
We may not be able to protect our intellectual property and may be subject to infringement claims.
We rely on a combination of contractual rights and copyright, trademark, patent and trade secret laws to establish and protect our
intellectual property. Although we use a broad range of measures to protect our intellectual property rights, third parties may
infringe or misappropriate our intellectual property. We may have to litigate to enforce and protect our copyrights, trademarks,
patents, trade secrets and know-how or to determine their scope, validity or enforceability, which represents a diversion of
resources that may be significant in amount and may not prove successful. The loss of intellectual property protection or the
inability to secure or enforce the protection of our intellectual property assets could have a material adverse effect on our business
and our ability to compete.
We also may be subject to costly litigation in the event that another party alleges our operations or activities infringe upon another
party’s intellectual property rights. Third parties may have, or may eventually be issued, patents that could be infringed by our
products, methods, processes or services. Any party that holds such a patent could make a claim of infringement against us. We
may also be subject to claims by third parties for breach of copyright, trademark, trade secret or license usage rights. Any such
claims and any resulting litigation could result in significant liability for damages. If we were found to have infringed a third-party
patent or other intellectual property rights, we could incur substantial liability, and in some circumstances could be enjoined from
providing certain products or services to our customers or utilizing and benefiting from certain methods, processes, copyrights,
trademarks, trade secrets or licenses, or alternatively could be required to enter into costly licensing arrangements with third parties,
all of which could have a material adverse effect on our business, results of operations and financial condition.
Intense competition could negatively affect our ability to maintain or increase our profitability.
Our businesses are intensely competitive. We compete based on a number of factors, including name recognition, service, the
quality of investment advice, investment performance, product features, price, perceived financial strength and claims-paying and
credit ratings. Our competitors include insurers, broker-dealers, financial advisors, asset managers and other financial institutions.
A number of our business units face competitors that have greater market share, offer a broader range of products or have higher
financial strength or credit ratings than we do.
In recent years, there has been substantial consolidation and convergence among companies in the financial services industry
resulting in increased competition from large, well-capitalized financial services firms. Many of these firms also have been able to
increase their distribution systems through mergers or contractual arrangements. Furthermore, larger competitors may have lower
operating costs and an ability to absorb greater risk while maintaining their financial strength ratings, thereby allowing them to
price their products more competitively. We expect consolidation to continue and perhaps accelerate in the future, thereby
increasing competitive pressure on us.
Anti-takeover provisions could delay, deter or prevent our change in control, even if the change in control would be
beneficial to LNC shareholders.
We are an Indiana corporation subject to Indiana state law. Certain provisions of Indiana law could interfere with or restrict
takeover bids or other change in control events affecting us. Also, provisions in our articles of incorporation, bylaws and other
agreements to which we are a party could delay, deter or prevent our change in control, even if a change in control would be
beneficial to shareholders. In addition, under Indiana law, directors may, in considering the best interests of a corporation,
consider the effects of any action on stockholders, employees, suppliers and customers of the corporation and the communities in
which offices and other facilities are located, and other factors the directors consider pertinent. One statutory provision prohibits,
except under specified circumstances, LNC from engaging in any business combination with any shareholder who owns 10% or
more of our common stock (which shareholder, under the statute, would be considered an “interested shareholder”) for a period
of five years following the time that such shareholder became an interested shareholder, unless such business combination is
approved by the board of directors prior to such person becoming an interested shareholder. In addition, our articles of
incorporation contain a provision requiring holders of at least three-fourths of our voting shares then outstanding and entitled to
vote at an election of directors, voting together, to approve a transaction with an interested shareholder rather than the simple
majority required under Indiana law.
41
In addition to the anti-takeover provisions of Indiana law, there are other factors that may delay, deter or prevent our change in
control. As an insurance holding company, we are regulated as an insurance holding company and are subject to the insurance
holding company acts of the states in which our insurance company subsidiaries are domiciled. The insurance holding company
acts and regulations restrict the ability of any person to obtain control of an insurance company without prior regulatory approval.
Under those statutes and regulations, without such approval (or an exemption), no person may acquire any voting security of a
domestic insurance company, or an insurance holding company which controls an insurance company, or merge with such a
holding company, if as a result of such transaction such person would “control” the insurance holding company or insurance
company. “Control” is generally defined as the direct or indirect power to direct or cause the direction of the management and
policies of a person and is presumed to exist if a person directly or indirectly owns or controls 10% or more of the voting securities
of another person. Similarly, as a result of its ownership of Newton County Loan & Savings, FSB, LNC is considered to be a
savings and loan holding company. Federal banking laws generally provide that no person may acquire control of LNC, and gain
indirect control of Newton County Loan & Savings, FSB, without prior regulatory approval. Generally, beneficial ownership of
10% or more of the voting securities of LNC would be presumed to constitute control.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
As of December 31, 2008, LNC and our subsidiaries owned or leased approximately 3.9 million square feet of office space. As of
December 31, 2008, we leased 0.4 million square feet of office space in Philadelphia, Pennsylvania for the Investment Management
segment and for LFN. Beginning in the second quarter of 2008, we leased 0.2 million square feet of office space in Radnor,
Pennsylvania for our corporate center and for LFD. We owned or leased 0.8 million square feet of office space in Fort Wayne,
Indiana, primarily for our Retirement Solutions – Annuities and Retirements Solutions – Defined Contribution segments. We
owned or leased 0.8 million square feet of office space in Greensboro, North Carolina, primarily for our Insurance Solutions – Life
Insurance segment. We owned or leased 0.3 million square feet of office space in Omaha, Nebraska, primarily for our Insurance
Solutions – Group Protection segment. An additional 1.4 million square feet of office space is owned or leased in other U.S. cities
and the U.K. for branch offices and other operations. As provided in Note 14, the rental expense on operating leases for office
space and equipment totaled $63 million for 2008. This discussion regarding properties does not include information on
investment properties.
Item 3. Legal Proceedings
For information regarding legal proceedings, see “Regulatory and Litigation Matters” in Note 14, which is incorporated herein by
reference.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of 2008, no matters were submitted to security holders for a vote.
42
Executive Officers of the Registrant
Executive Officers of the Registrant as of February 20, 2009, were as follows:
Name
Age (2)
Position with LNC and Business Experience During the Past Five Years
Dennis R. Glass
59
Lisa M. Buckingham
43
Charles C. Cornelio
49
Patrick P. Coyne
45
President, Chief Executive Officer and Director (since July 2007). President, Chief
Operating Officer and Director (April 2006 - July 2007). President and Chief Executive
Officer, Jefferson-Pilot (2004 - April 2006). President and Chief Operating Officer,
Jefferson-Pilot (2001 - April 2006).
Senior Vice President, Chief Human Resources Officer (since December 2008). Senior
Vice President, Global Talent, Thomson Reuters, a provider of information and services
for businesses and professionals (April 2008 - November 2008). Senior Vice President,
Human Resources, Thomson Corporation (2002 - April 2008).
Executive Vice President, Chief Administrative Officer (since November 2008). Senior
Vice President, Shared Services and Chief Information Officer (April 2006 - November
2008). Executive Vice President, Technology and Insurance Services, Jefferson-Pilot
(2004 - April 2006). Senior Vice President, Jefferson-Pilot (1997 - 2004).
President of Lincoln National Investment Companies, Inc. (1) and Delaware Management
Holdings, Inc. (1) (since July 2006). Executive Vice President and Chief Investment
Officer, Lincoln National Investment Company, Inc. and Delaware Management
Holdings, Inc. (2003 - July 2006).
Frederick J. Crawford
45
Executive Vice President and Chief Financial Officer (since November 2008). Senior
Vice President and Chief Financial Officer (2005 - November 2008). Vice President and
Treasurer (2001 - 2004).
Robert W. Dineen
59
Chairman and CEO, Lincoln Financial Advisors (1) (since 2002). Senior Vice President,
Managed Asset Group, Merrill Lynch & Co., a diversified financial services company
(2001 - 2002).
Heather C. Dzielak
40
Wilford H. Fuller
38
Mark E. Konen
49
Senior Vice President, Chief Marketing Officer (since January 2009). Senior Vice
President, Retirement Income Security Ventures (September 2006 - January 2009). Vice
President, Lincoln National Life Insurance Company (1) (December 2003 - September
2006).
President and CEO of Lincoln Financial Distributors (1) (since February 2009). Head,
Distribution, Global Wealth Management, Merrill Lynch & Co., a diversified financial
services company (2007-2009). Head, Distribution, Managed Solutions Group, Merrill
Lynch & Co. (2005-2007). National Sales Manager, Merrill Lynch & Co. (2000-2005).
President, Insurance Solutions (since July 2008). President, Individual Markets (April
2006 - July 2008). Executive Vice President, Life and Annuity Manufacturing, Jefferson-
Pilot (2004 - April 2006). Executive Vice President, Product/Financial Management,
Jefferson-Pilot (2002 - 2004).
Dennis L. Schoff
49
Senior Vice President, LNC and General Counsel (since 2002). Vice President and
Deputy General Counsel (2001 - 2002).
Michael Tallett-
Williams
55
President and Managing Director, Lincoln National (UK) (1) (since 2000).
(1) Denotes an affiliate of LNC.
(2) Age shown is based on the officer’s age as of February 20, 2009.
43
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
(a) Stock Market and Dividend Information
Our common stock is traded on the New York and Chicago stock exchanges under the symbol LNC. As of January 30, 2009, the
number of shareholders of record of our common stock was 11,425. The dividend on our common stock is declared each quarter
by our Board of Directors if we are eligible to pay dividends and the Board determines that we will pay dividends. In determining
dividends, the Board takes into consideration items such as our financial condition, including current and expected earnings,
projected cash flows and anticipated financing needs. On February 24, 2009, the Board of Directors approved a reduction in the
dividend on our common stock from $0.210 to $0.01 per share. For potential restrictions on our ability to pay dividends, see “Part
I – Item 1A. Risk Factors – We will be required to pay interest on our capital securities with proceeds from the issuance of
qualifying securities if we fail to achieve capital adequacy or net income and stockholders’ equity levels,” “Item 7. Management’s
Discussion and Analysis (“MD&A”) – Review of Consolidated Financial Condition” and Note 21 to our consolidated financial
statements and the accompanying notes to the consolidated financial statements (“Notes”) presented in “Item 8. Financial
Statements and Supplementary Data.” The following presents the high and low prices for our common stock on the New York
Stock Exchange during the periods indicated and the dividends declared per share during such periods:
2008
High
Low
Dividend declared
2007
High
Low
Dividend declared
(b) Not Applicable
(c) Issuer Purchases of Equity Securities
1st Qtr
2nd Qtr
3rd Qtr
4th Qtr
$
58.11
45.50
0.415
$
56.80
45.18
0.415
$
59.99
39.83
0.415
$
45.50
4.76
0.210
$
71.18
64.29
0.395
$
74.72
66.90
0.395
$
72.28
54.40
0.395
$
70.66
55.84
0.415
The following summarizes our stock repurchases during the quarter ended December 31, 2008 (dollars in millions, except per share
data):
(a) Total
Number
of Shares
(or Units)
Purchased
-
-
Period
10/1/08 - 10/31/08
11/1/08 - 11/30/08
12/1/08 - 12/31/08
1,741 (1)
(b) Average
Price Paid
per Share
(or Unit)
$
-
-
17.45
(c) Total Number
of Shares (or Units)
Purchased as Part of
Publicly Announced
Plans or Programs (2)
(d) Approximate Dollar
Value of Shares (or
Units) that May Yet Be
Purchased Under the
Plans or Programs (3)
$
1,204
1,204
1,204
-
-
-
Represents shares withheld for taxes on the vesting of restricted stock.
(1)
(2) On February 23, 2007, our Board approved a $2 billion increase to our existing securities repurchase authorization, bringing
the total authorization at that time to $2.6 billion. At December 31, 2008, our security repurchase authorization was $1.2
billion. The security repurchase authorization does not have an expiration date. However, 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. In the fourth quarter of 2008, we announced a suspension
of share repurchases under this program. The shares repurchased in connection with the awards described in footnote (1)
are not included in our security repurchase.
As of the last day of the applicable month.
(3)
44
Item 6. Selected Financial Data
The following selected financial data (in millions, except per share data) should be read in conjunction with the MD&A and the
Notes of this report. Some previously reported amounts have been reclassified to conform to the presentation as of and for the
year ended December 31, 2008.
Total revenues
Income from continuing operations
Net income
Per share data (1):
Income from continuing operations - basic
Income from continuing operations - diluted
Net income - basic
Net income - diluted
Common stock dividends
Assets
Long-term debt
Stockholders' equity
Per share data (1):
Stockholders' equity including accumulated
other comprehensive income (2)
Stockholders' equity excluding accumulated
other comprehensive income (2)
Market value of common stock
2008
$
9,883
62
57
$
0.24
0.24
0.22
0.22
1.455
$
2008
163,136
4,731
7,977
$
For the Years Ended December 31,
2007
2005
2006
10,475
1,321
1,215
8,879
1,295
1,316
5,459
831
831
$
$
$
4.89
4.82
4.50
4.43
1.600
$
5.13
5.05
5.21
5.13
1.535
$
4.80
4.72
4.80
4.72
1.475
$
2007
191,435
4,618
11,718
As of December 31,
2006
178,495
3,458
12,201
$
$
2005
124,860
1,333
6,384
2004
$
5,351
732
707
$
4.15
4.09
4.01
3.95
1.415
$
2004
116,219
1,389
6,176
$
31.15
$
44.32
$
44.21
$
36.69
$
35.53
42.10
18.84
43.46
58.22
41.99
66.40
33.66
53.03
30.17
46.68
(1) Per share amounts were affected by the issuance of 112.3 million shares for the acquisition of Jefferson-Pilot in 2006 and the
retirement of 9.3 million, 15.4 million, 16.9 million, 2.3 million and 7.6 million shares of common stock during the years ended
December 31, 2008, 2007, 2006, 2005 and 2004, respectively.
(2) Per share amounts are calculated under the assumption that preferred stock has been converted to common stock.
45
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis (“MD&A”) is intended to help the reader understand the results of
operations and financial condition of Lincoln National Corporation and its consolidated subsidiaries (“LNC,” “Lincoln” or the
“Company” which also may be referred to as “we,” “our” or “us”) as of December 31, 2008, compared with December 31, 2007,
and the results of operations of LNC in 2008 and 2007, compared with the immediately preceding year. 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.
The financial information presented herein for the year ended December 31, 2006, reflects the accounts of LNC for the three
months ended March 31, 2006, and the consolidated accounts of LNC and Jefferson-Pilot for the remainder of 2006. The MD&A
is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the
accompanying notes to the consolidated financial statements (“Notes”) presented in “Item 8. Financial Statements and
Supplementary Data,” as well as “Item 1A. Risk Factors” above.
In this report, in addition to providing consolidated revenues and net income (loss), we also provide segment operating revenues
and income (loss) from operations because we believe they are meaningful measures of revenues and the profitability of our
operating segments. Income (loss) from operations is net income recorded in accordance with United States of America generally
accepted accounting principles (“GAAP”) excluding the after-tax effects of the following items, as applicable:
(cid:120) Realized gains and losses associated with the following (“excluded realized gain (loss)”):
Sale or disposal of securities;
Impairments of securities;
(cid:131)
(cid:131)
(cid:131) Change in the fair value of embedded derivatives within certain reinsurance arrangements and the change in the fair value
of related trading securities;
(cid:131) Change in the fair value of the embedded derivatives of our guaranteed living benefits (“GLB”) within our variable
annuities net of the change in the fair value of the derivatives we own to hedge the changes in the embedded derivative;
(cid:131) Net difference between the benefit ratio unlocking of Statement of Position (“SOP”) No. 03-1, “Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts”
(“SOP 03-1”) reserves on our guaranteed death benefit (“GDB”) riders within our variable annuities and the change in the
fair value of the derivatives excluding our expected cost of purchasing the hedging instruments; and
(cid:131) Changes in the fair value of the embedded derivative liabilities related to index call options we may purchase in the future
to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products as required
under Statements of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and
Hedging Activities” (“SFAS 133”) and SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).
Income (loss) from the initial adoption of changes in accounting principles;
Income (loss) from reserve changes (net of related amortization) on business sold through reinsurance;
(cid:120)
(cid:120)
(cid:120) Losses on early retirement of debt, including subordinated debt;
(cid:120) Losses from the impairment of intangible assets; and
(cid:120)
Income (loss) from discontinued operations.
Operating revenues represent GAAP revenues excluding the pre-tax effects of the following items, as applicable:
(cid:120) Excluded realized gain (loss);
(cid:120) Amortization of deferred gains arising from the reserve changes on business sold through reinsurance; and
(cid:120) Revenue adjustments from the initial impact of the adoption of changes in accounting principles.
Operating revenues and income (loss) from operations are the financial performance measures we use to evaluate and assess the
results of our segments. Accordingly, we report operating revenues and income (loss) from operations by segment in Note 23.
Our management and Board of Directors believe that operating revenues and income (loss) from operations explain the results of
our ongoing businesses in a manner that allows for a better understanding of the underlying trends in our current businesses
because the excluded items are unpredictable and not necessarily indicative of current operating fundamentals or future
performance of the business segments, and, in many instances, decisions regarding these items do not necessarily relate to the
operations of the individual segments. Operating revenues and income (loss) from operations do not replace revenues and net
income as the GAAP measures of our consolidated results of operations.
Beginning with the quarter ended June 30, 2008, we changed our definitions of segment operating revenues and income from
operations to better reflect: the underlying economics of our variable and indexed annuities that employ derivative instruments to
hedge policy benefits; and the manner in which management evaluates that business. Our change in the definition of income from
operations is primarily the result of our adoption of SFAS 157 during the first quarter of 2008 (See Note 2). Under the fair value
46
measurement provisions of SFAS 157, we are required to measure the fair value of these annuities from an “exit price” perspective,
(i.e., the exchange price between market participants to transfer the liability). We, therefore, must include margins that a market
participant buyer would require as well as a factor for non-performance risk (“NPR”) related to our credit quality. We do not
believe that these factors relate to the economics of the underlying business and do not reflect the manner in which management
evaluates the business. The items that are now excluded from our operating results that were previously included are as follows:
GLB net derivatives results; indexed annuity forward-starting option; and GDB derivatives results. For more information
regarding this change, see our current report on Form 8-K dated July 16, 2008.
We continue to exclude the effects of any realized gain (loss) on investments from segment operating revenues and income from
operations as we believe that such items are 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.
We believe that our new definitions of operating revenues and income (loss) from operations will provide investors with a more
valuable measure of our performance because it better reveals trends in our business. See “Realized Gain (Loss)” below for more
information about these items.
Certain reclassifications have been made to prior periods’ financial information. Included in these reclassifications is the change in
our definition of segment operating revenues and income (loss) from operations as discussed above. In addition, we have
reclassified the results of certain derivatives and embedded derivatives to realized gain (loss), which were previously reported within
insurance fees, net investment income, interest credited or benefits. The associated amortization expense of deferred acquisition
costs (“DAC”) and value of business acquired (“VOBA”) (previously reported within underwriting, acquisition, insurance and
other expenses), deferred sales inducements (“DSI”) (previously reported within interest credited), deferred front-end loads
(“DFEL”) (previously reported within insurance fees) and changes in contract holder funds (previously reported within benefits)
have also been reclassified to realized gain (loss). See “Basis of Presentation” in Note 1 for details.
FORWARD-LOOKING STATEMENTS – CAUTIONARY LANGUAGE
Certain statements made in this report and in other written or oral statements made by LNC or on LNC’s behalf are “forward-
looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”). A forward-looking
statement is a statement that is not a historical fact and, without limitation, includes any statement that may predict, forecast,
indicate or imply future results, performance or achievements, and may contain words like: “believe,” “anticipate,” “expect,”
“estimate,” “project,” “will,” “shall” and other words or phrases with similar meaning in connection with a discussion of future
operating or financial performance. In particular, these include statements relating to future actions, trends in our businesses,
prospective services or products, future performance or financial results and the outcome of contingencies, such as legal
proceedings. LNC claims the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the results
contained in the forward-looking statements. Risks and uncertainties that may cause actual results to vary materially, some of
which are described within the forward-looking statements, include, among others:
(cid:120) Continued deterioration in general economic and business conditions, both domestic and foreign, that may affect foreign
exchange rates, premium levels, claims experience, the level of pension benefit costs and funding and investment results;
(cid:120) Continued economic declines and credit market illiquidity could cause us to realize additional impairments on investments and
certain intangible assets, including goodwill and a valuation allowance against deferred tax assets, which may reduce future
earnings and/or affect our financial condition and ability to raise additional capital or refinance existing debt as it matures;
(cid:120) Uncertainty about the impact of the U.S. Treasury’s Troubled Asset Relief Program (“TARP”) on the economy, and LNC’s
ability to participate in the program;
(cid:120) Legislative, regulatory or tax changes, both domestic and foreign, that affect the cost of, or demand for, LNC’s products, the
required amount of reserves and/or surplus, or otherwise affect our ability to conduct business, including changes to statutory
reserves and/or risk-based capital (“RBC”) requirements related to secondary guarantees under universal life and variable
annuity products such as Actuarial Guideline 43 (also known as “VACARVM”); restrictions on revenue sharing and 12b-1
payments; and the potential for U.S. Federal tax reform;
(cid:120) The initiation of legal or regulatory proceedings against LNC or its subsidiaries, and the outcome of any legal or regulatory
proceedings, such as: adverse actions related to present or past business practices common in businesses in which LNC and
its subsidiaries compete; adverse decisions in significant actions including, but not limited to, actions brought by federal and
state authorities and extra-contractual and class action damage cases; new decisions that result in changes in law; and
unexpected trial court rulings;
(cid:120) 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;
47
(cid:120) A decline in the equity markets causing a reduction in the sales of LNC’s products, a reduction of asset-based fees that LNC
charges on various investment and insurance products, an acceleration of amortization of DAC, VOBA, DSI and DFEL and
an increase in liabilities related to guaranteed benefit features of LNC’s variable annuity products;
Ineffectiveness of LNC’s various hedging strategies used to offset the impact of changes in the value of liabilities due to
changes in the level and volatility of the equity markets and interest rates;
(cid:120)
(cid:120) A deviation in actual experience regarding future persistency, mortality, morbidity, interest rates or equity market returns from
LNC’s assumptions used in pricing its products, in establishing related insurance reserves and in the amortization of
intangibles that may result in an increase in reserves and a decrease in net income, including as a result of stranger-originated
life insurance business;
(cid:120) Changes in GAAP that may result in unanticipated changes to LNC’s net income;
(cid:120) 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;
(cid:120) Lowering of one or more of the insurer financial strength ratings of LNC’s insurance subsidiaries and the adverse impact such
(cid:120)
action may have on the premium writings, policy retention, profitability of its insurance subsidiaries and liquidity;
Significant credit, accounting, fraud or corporate governance issues that may adversely affect the value of certain investments
in the portfolios of LNC’s companies requiring that LNC realize losses on such investments;
(cid:120) 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;
(cid:120) The adequacy and collectibility of reinsurance that LNC has purchased;
(cid:120) 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;
(cid:120) 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;
(cid:120) The unknown impact on LNC’s business resulting from changes in the demographics of LNC’s client base, as aging baby-
boomers move from the asset-accumulation stage to the asset-distribution stage of life; and
(cid:120) Loss of key management, portfolio managers in the Investment Management segment, financial planners or wholesalers.
The risks included here are not exhaustive. Other sections of this report, LNC’s quarterly reports on Form 10-Q, current reports
on Form 8-K and other documents filed with the Securities and Exchange Commission (“SEC”) include additional factors that
could impact LNC’s business and financial performance, including “Item 1A. Risk Factors,” “Item 7A. Quantitative and
Qualitative Disclosures About Market Risk” and the risk discussions included in this section under “Critical Accounting Policies
and Estimates,” “Consolidated Investments” and “Reinsurance,” which are incorporated herein by reference. Moreover, LNC
operates in a rapidly changing and competitive environment. New risk factors emerge from time to time, and it is not possible for
management to predict all such risk factors.
Further, it is not possible to assess the impact of all risk factors on LNC’s business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of
actual results. In addition, LNC disclaims any obligation to update any forward-looking statements to reflect events or
circumstances that occur after the date of this report.
INTRODUCTION
Executive Summary
We are a holding company that operates multiple insurance and investment management businesses through subsidiary companies.
Through our business segments, we sell a wide range of wealth protection, accumulation and retirement income products and
solutions. These products include institutional and/or retail fixed and indexed annuities, variable annuities, universal life insurance
(“UL”), variable universal life insurance (“VUL”), linked-benefit UL, term life insurance, mutual funds and managed accounts.
On July 21, 2008, we announced the realignment of our segments under our former Employer Markets and Individual Markets
businesses into two new businesses – Retirement Solutions and Insurance Solutions. For information on our 2008 segment
realignment, see “Part I – Item 1. Business – Overview.”
Our individual products and services are distributed primarily through brokers, planners, agents and other intermediaries with sales
and marketing support provided by approximately 750 wholesalers within Lincoln Financial Distributors (“LFD”), our wholesaling
distributor. Our Insurance Solutions – Group Protection segment distributes its products and services primarily through employee
benefit brokers, third party administrators (“TPAs”) and other employee benefit firms with sales support provided by its group and
retirement sales specialists. Our retail distributor, Lincoln Financial Network, offers proprietary and non-proprietary products and
48
advisory services through a national network of approximately 7,400 active producers who placed business with us within the last
twelve months.
Within our Retirement Solutions – Annuities segment, our Lincoln SmartSecurity® Advantage, with its one-year reset feature,
including the Lifetime withdrawal benefit introduced in 2006, and five-year reset feature, contributed to our growth with elections
of these riders totaling 21% of deposits in 2008. We also offer a patented annuity product feature, i4LIFE®, which we introduced
a few years ago to meet the needs of baby-boomers for retirement income as they enter the retirement phase of their life cycle.
The i4LIFE® Advantage product offers a guaranteed income benefit (“GIB”) rider, which can be elected to provide a floor to the
amount of income available from the annuity during retirement. In 2008, elections of i4LIFE® were $2.3 billion, a decrease of
$177 million over 2007. Additionally, in 2006, we introduced 4LATER® to meet the needs of baby-boomers who are not ready
for retirement but are ready to plan for it. In 2008, deposits of 4LATER® were approximately $774 million. We also offer a fixed
indexed annuity, which offers upside growth from equity markets with fixed return protection.
Our Retirement Solutions – Defined Contribution segment provides us the platform to benefit from the movement in the
marketplace by employees away from the traditional defined benefit pension plans towards voluntary defined contribution plans,
such as 401(k)s and 403(b)s, and the increase in voluntary group life and disability has also provided for a convergence of
distribution strategies. We also believe that the Pension Protection Act of 2006 (“PPA”) will benefit the Retirement Solutions
business. Our oldest block of business in our Retirement Solutions – Defined Contribution segment is experiencing significant
negative net flows, and a substantial increase in new deposit production will be necessary to maintain earnings at current levels.
In our Insurance Solutions – Life Insurance segment, we are in a competitive marketplace, especially related to life insurance
products with secondary guarantees. This product requires us to maintain risk management and pricing discipline, which is
especially important in the competitive environment. Sales of insurance products with such guarantees comprised 68% of our life
insurance sales in 2008. The statutory reserving requirements for these products are such that it is necessary for us to utilize capital
market solutions to manage the level of reserves held in our domestic life insurance companies. As a result, as discussed in
“Review of Consolidated Financial Condition – Liquidity and Capital Resources – Sources of Liquidity and Cash Flow” below, we
completed transactions that enabled us to release approximately $300 million of capital in 2007 and approximately $240 million in
the fourth quarter of 2008 from one of our insurance subsidiaries under Actuarial Guideline 38 (“AG38”).
As our businesses and products are complex, so is the manner in which we derive income. For a discussion on how we derive our
revenues, see our discussion in results of operations by segment below.
Current Market Conditions
During 2008, the capital markets continued to experience high volatility that affected both equity market returns and interest rates.
In addition, credit spreads widened across asset classes and reduced liquidity in the credit markets. October 2008 marked the worst
equity market returns in 21 years. The price of our common stock declined during the fourth quarter of 2008 to close at $18.84 on
December 31, 2008, as compared to $42.81 on September 30, 2008, and during that time it traded at a low of $4.76. The National
Bureau of Economic Research, a panel of economists charged with officially designating business cycles, announced that a U.S.
recession began in December of 2007. Analysts expect the downturn to last through the first half of 2009 and unemployment to
continue to increase until early 2010. Earnings in 2009 will continue to be unfavorably impacted by the significant decline in the
equity markets during 2008. Due to these challenges, the capital markets had a significant effect on our segment income (loss)
from operations and consolidated net income for 2008. Furthermore, although the fourth quarter is normally the strongest in
terms of sales for our Insurance Solutions – Life Insurance segment, it was somewhat muted in 2008. In the face of these capital
market challenges, we continue to focus on building our businesses through these difficult markets and beyond by developing and
introducing high quality products, expanding distribution in new and existing key accounts and channels and targeting market
segments that have high growth potential while maintaining a disciplined approach to managing our expenses. The markets
impacted primarily the following areas:
Earnings from Assets Under Management
Our asset-gathering segments – Retirement Solutions – Annuities, Retirement Solutions – Defined Contribution and Investment
Management – are the most sensitive to the equity markets. We discuss the earnings impact of the equity markets on account
values, assets under management and the related asset-based fees below in “Item 7A. Quantitative and Qualitative Disclosures
About Market Risk – Equity Market Risk – Impact of Equity Market Sensitivity.” From the end of 2007 to December 31, 2008,
the daily average value of the Standard & Poor’s (“S&P”) 500 Index® (“S&P 500”) decreased 17%. Solely as a result of the equity
markets, our assets under management as of December 31, 2008, were down $52 billion from December 31, 2007. Strong deposits
over the last year have only helped to partially offset this impact for 2008, compared to 2007. The effect of the negative equity
markets on our assets under management in 2008 will continue to dampen our earnings throughout 2009 even if the equity market
returns become consistent with our long-term assumptions. Accordingly, we may continue to report lower asset-based fees relative
to expectations or prior periods.
49
Investment Income on Alternative Investments
We believe that overall market conditions in both the equity and credit markets caused our alternative investments portfolio, which
consists mostly of hedge funds and various limited partnership investments, to under-perform relative to our long-term
expectations, and we expect these assets to under-perform at least in the short term. These investments impact primarily our
Insurance Solutions – Life Insurance, Retirement Solutions – Annuities and Retirement Solutions – Defined Contribution
segments. See “Consolidated Investments – Alternative Investments” for additional information on our investment portfolio.
Variable Annuity Hedge Program Results
We offer variable annuity products with living benefit guarantees. As described below in “Critical Accounting Policies and
Estimates – Derivatives – Guaranteed Living Benefits,” we use derivative instruments to hedge our exposure to the risks and
earnings volatility that result from the embedded derivatives for living benefits in certain of our variable annuity products. The
change in fair value of these instruments tends to move in the opposite direction of the change in fair value of the embedded
derivatives. For 2008, the market conditions noted above negatively affected the net result of the change in the fair value of the
living benefit embedded derivative, excluding the effect of our NPR factor, and the change in fair value of the hedging derivatives.
The NPR factor used in the calculation of the embedded derivative liability relates to the change in the spreads of our credit default
swaps and had a favorable effect on the overall result. These results are excluded from operating revenues and income (loss) from
operations.
We also offer variable products with death benefit guarantees. As described below in “Critical Accounting Policies and Estimates
– Future Contract Benefits and Other Contract Holder Obligations – Guaranteed Death Benefits,” we use derivative instruments
to attempt to hedge in the opposite direction of the impact to our associated reserves for movements in equity markets. These
results are excluded from income (loss) from operations.
Credit Losses, Impairments and Unrealized Losses
Related to our investments in fixed income and equity securities, we experienced net realized losses of $1.0 billion for 2008, which
included gross write-downs of securities for other-than-temporary impairments of $1.1 billion. Widening spreads during 2008 was
the primary cause of a $6.1 billion increase in gross unrealized losses on the available-for-sale fixed maturity securities in our
general account. These unrealized losses were concentrated in the investment grade category of investments and demonstrate how
reduced liquidity in the credit markets have resulted in a decline in asset values as investors shift their investments to safer
government securities, such as U.S. Treasuries. In addition, continued weakness in the economic environment could lead to
increased credit defaults, resulting in additional write-downs of securities for other-than-temporary impairments.
Capital Preservation
On October 10, 2008, the Board of Directors approved a decrease in the quarterly dividend on our common stock from $0.415 per
share to $0.21 per share for the dividend payable February 1, 2009. On February 24, 2009, the Board of Directors approved a
further reduction of the dividend on our common stock from $0.21 to $0.01 per share, which, along with the prior reduction, is
expected to add approximately $100 million to capital each quarter. Additionally, we have suspended stock repurchase activity.
Both of these changes will favorably impact our capital position prospectively.
As a result of shrinking revenues due to the impact of unfavorable equity markets on our asset management businesses and a
reduction in sales volumes caused by the unfavorable economic environment, we have launched initiatives to reduce expenses,
including layoffs of staff, that we believe will improve our capital position and preserve profits. See “Results of Other Operations”
below for more information on our expense actions.
Stimulus Legislation
In reaction to the recession, credit market illiquidity and global financial crisis experienced during the latter part of 2008 and into
2009, Congress enacted the Emergency Economic Stabilization Act of 2008 (“EESA”) on October 3, 2008, and the American
Recovery and Reinvestment Act of 2009 (“ARRA”) which was signed into law on February 17, 2009, in an effort to restore
liquidity to the U.S. credit markets and stimulate the U.S. economy. The EESA defines financial institutions to include insurance
companies and contains the TARP. The ARRA and TARP authorized the purchase of “troubled assets” from financial
institutions, including insurance companies. Pursuant to the authority granted under the TARP, the U.S. Treasury also adopted the
Capital Purchase Program (“CPP”), the Generally Available Capital Access Program and the Exceptional Financial Recovery
Assistance Program. Under the CPP, as currently adopted, bank and thrift holding companies may apply to the U.S. Treasury for
the direct sale of preferred stock and warrants to the U.S. Treasury. It remains unclear at this point, if and when the EESA and
ARRA will restore sustained liquidity and confidence in the markets and its affect on the fair value of our invested assets.
50
On January 8, 2009, the Office of Thrift Supervision approved our application to become a savings and loan holding company and
our acquisition of Newton County Loan & Savings, FSB, a federally regulated savings bank, located in Indiana. We agreed to
contribute $10 million to the capital of Newton County Loan & Savings, FSB, and closed on the purchase on January 15, 2009.
We also previously filed an application to participate in the CPP. Our application to participate in the CPP is subject to approval
from the U.S. Treasury. Accordingly, there can be no assurance that we will participate in the CPP or any of the other programs.
New Products and Distribution Channels
Product development and strong distribution are important to our ability to meet the challenges of the competitive marketplace.
In the third quarter of 2008, our Insurance Solutions – Life Insurance segment launched Lincoln AssetEdgeSM VUL, a variable life
insurance product offering clients the ability to align their portfolio to match investment goals, while retaining the flexibility to
change allocations as needs change. In February 2008, our Retirement Solutions – Annuities segment launched a new guaranteed
withdrawal benefit (“GWB”), Lincoln Lifetime IncomeSM Advantage, which includes features such as: a reduced minimum age for
lifetime income eligibility; a 5% benefit enhancement in each year an owner does not take a withdrawal; a health care benefit; and a
guaranteed minimum accumulation benefit. Due to this and other activities, we were able to expand our distribution breadth for
variable annuities into three large banks during 2008. Within the mid-sized market of our Retirement Solutions – Defined
Contribution segment, we launched our Lincoln SmartFutureSM retirement program in the first quarter of 2008 to fill the gap between
our LINCOLN ALLIANCE® program and our group variable annuities.
In the third quarter of 2008, we updated our LINCOLN DIRECTORSM product that now offers more than 80 investment options
and will be positioned as our primary product in the micro-to small 401(k) plan marketplace. This product includes fiduciary
support for plan sponsors, accumulation strategies and tools for plan participants and will also offer our patented distribution
option, i4LIFE® Advantage.
Industry Trends
We continue to be influenced by a variety of trends that affect the industry.
Financial Environment
The level of long-term interest rates and the shape of the yield curve can have a negative impact on the demand for and the
profitability of spread-based products such as fixed annuities and UL. A flat or inverted yield curve and low long-term interest
rates will be a concern if new money rates on corporate bonds are lower than overall life insurer investment portfolio yields.
Equity market performance can also impact the profitability of life insurers, as product demand and fee revenue from variable
annuities and fee revenue from pension products tied to separate account balances often reflect equity market performance. A
steady economy is important as it provides for continuing demand for insurance and investment-type products. Insurance
premium growth, with respect to life and disability products, for example, is closely tied to employers’ total payroll growth.
Additionally, the potential market for these products is expanded by new business creation. See “Current Market Conditions”
above for further discussion of the current impact of volatility in the capital markets.
Economic Environment
The National Bureau of Economic Research, a panel of economists charged with officially designating business cycles, announced
that a U.S. recession began in December of 2007. Analysts expect the downturn to last through the first half of 2009 and
unemployment to continue to increase until early 2010. The deterioration of the U.S. economy is likely to result in businesses and
consumers spending less, including the products the insurance industry markets and sells.
Demographics
In the coming decade, a key driver shaping the actions of the insurance industry will be the escalation of income protection and
wealth accumulation goals and needs of the retiring baby-boomers. As a result of increasing longevity, retirees will need to
accumulate sufficient savings to finance retirements that may span 30 or more years. Helping the baby-boomers to accumulate
assets for retirement and subsequently to convert these assets into retirement income represents an opportunity for the insurance
industry.
Insurers are well positioned to address the baby-boomers’ rapidly increasing need for savings tools and for income protection. We
believe that, among insurers, those with strong brands, high financial strength ratings and broad distribution, are best positioned to
capitalize on the opportunity to offer income protection products to baby-boomers.
Moreover, the insurance industry’s products and the needs they are designed to address are complex. We believe that individuals
approaching retirement age will need to seek information to plan for and manage their retirements. In the workplace, as employees
51
take greater responsibility for their benefit options and retirement planning, they will need information about their possible
individual needs. One of the challenges for the insurance industry will be the delivery of this information in a cost effective
manner.
Competitive Pressures
The insurance industry remains highly competitive, especially in this recessionary environment. The product development and
product life cycles have shortened in many product segments, leading to more intense competition with respect to product
features. Larger companies have the ability to invest in brand equity, product development, technology and risk management,
which are among the fundamentals for sustained profitable growth in the life insurance industry. In addition, several of the
industry’s products can be quite homogeneous and subject to intense price competition. Sufficient scale, financial strength and
financial flexibility are becoming prerequisites for sustainable growth in the life insurance industry. Larger market participants tend
to have the capacity to invest in additional distribution capability and the information technology needed to offer the superior
customer service demanded by an increasingly sophisticated industry client base.
Regulatory Changes
The insurance industry is regulated at the state level, with some products and services also subject to federal regulation. As life
insurers introduce new and often more complex products, regulators refine capital requirements and introduce new reserving
standards for the life insurance industry. Regulations recently adopted or currently under review can potentially impact the reserve
and capital requirements of the industry.
Challenges and Outlook
Going into 2009, we expect major challenges to include:
(cid:120) Continuation of volatility in the equity markets, resulting in hedge breakage and possible additional erosion in variable account
values;
(cid:120) Continuation of illiquid credit markets and impact on spreads and on other-than-temporary securities impairments;
(cid:120) Continuation of the current credit and capital markets, restricting our ability to access capital;
(cid:120) Continuation of the low interest rate environment, which creates a challenge for our products that generate investment margin
profits, such as fixed annuities and UL;
(cid:120) Possible additional intangible asset impairments, such as goodwill, if the financial performance of our reporting units does not
improve, our market capitalization remains below book value for a prolonged period of time or business valuation
assumptions (such as discount rates and equity market volatility) deteriorate further;
(cid:120) Continuation of the recession and other challenges in the economy;
(cid:120) Achieving success in our portfolio of products, marketplace acceptance of new variable annuity features and maintaining
management and wholesalers that will help maintain our competitive position; and
(cid:120) Continuation of focus by the government on tax reform including potential changes in company dividends-received deduction
(“DRD”) calculations, which may impact our products and overall earnings.
In the face of these challenges, we expect to focus on the following throughout 2009:
(cid:120) Continue near term product development in our manufacturing units and future product development initiatives, with
particular focus on further reducing risk related to guaranteed benefit riders offered with certain variable annuities;
(cid:120) Evaluate and potentially pursue the sale of non-core businesses and other options to raise additional capital;
(cid:120) Manage our expenses aggressively and utilize cost reduction initiatives and continue embedding financial and execution
discipline throughout our operations by using technology and making other investments to improve operating effectiveness
and lower unit costs; and
Substantially complete the remaining platform and system consolidations necessary to achieve the final portion of integration
cost saves as well as prepare us for more effective customer interaction in the future.
(cid:120)
For additional factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk
Factors” and “Forward-Looking Statements – Cautionary Language” above.
52
Critical Accounting Policies and Estimates
We have identified the accounting policies below as critical to the understanding of our results of operations and our financial
position. In applying these critical accounting policies in preparing our financial statements, management must use significant
assumptions, estimates and judgments concerning future results or other developments, including the likelihood, timing or amount
of one or more future events. Actual results may differ from these estimates under different assumptions or conditions. On an
ongoing basis, we evaluate our assumptions, estimates and judgments based upon historical experience and various other
information that we believe to be reasonable under the circumstances. For a detailed discussion of other significant accounting
policies, see Note 1.
DAC, VOBA, DSI and DFEL
Accounting for intangible assets requires numerous assumptions, such as estimates of expected future profitability for our
operations and our ability to retain existing blocks of life and annuity business in force. Our accounting policies for DAC, VOBA,
DSI and DFEL impact the Retirement Solutions – Annuities, Retirement Solutions – Defined Contribution, Insurance Solutions –
Life Insurance, Insurance Solutions – Group Protection and Lincoln UK segments.
Acquisition costs for variable annuity and deferred fixed annuity contracts and UL and VUL policies, which are accounted for
under 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” (“SFAS 97”), are amortized over the lives of the contracts in relation to the
incidence of estimated gross profits (“EGPs”) derived from the contracts. Acquisition costs are those costs that vary with and are
related primarily to new or renewal business. These costs include commissions and other expenses that vary with new business
volume. The costs that we defer are recorded as an asset on our Consolidated Balance Sheets as DAC for products we sold or
VOBA for books of business we acquired. In addition, we defer costs associated with DSI and revenues associated with DFEL.
DSI is included within other assets on our Consolidated Balance Sheets and, when amortized, increases interest credited and
reduces income. DFEL is a liability included within other contract holder funds on our Consolidated Balance Sheets, and when
amortized, increases product expense charge revenues and income.
EGPs vary based on a number of sources including policy persistency, mortality, fee income, investment margins, expense margins
and realized gains and losses on investments, including assumptions about the expected level of credit-related losses. Each of these
sources of profit is, in turn, driven by other factors. For example, assets under management and the spread between earned and
credited rates drive investment margins; net amount at risk (“NAR”) drives the level of cost of insurance (“COI”) charges and
reinsurance premiums. The level of separate account assets under management is driven by changes in the financial markets
(equity and bond markets, hereafter referred to collectively as “equity markets”) and net flows. Realized gains and losses on
investments include amounts resulting from differences in the actual level of impairments and the levels assumed in calculating
EGPs.
Our DAC, VOBA, DSI and DFEL balances (in millions) by business segment as of December 31, 2008, were as follows:
Retirement Solutions
Defined
Contribution
Annuities
2,977
$
261
3,238
130
$
883
2
885
-
Insurance Solutions
Life
Group
Protection
Insurance
146
7,383
$
$
-
-
146
7,383
-
890
Lincoln
UK
$
534
-
534
262
Other
Operations
13
$
-
13
-
Total
$
11,936
263
12,199
1,282
DAC and VOBA
DSI
Total
DFEL
Net total
$
3,108
$
885
$
6,493
$
146
$
272
$
13
$
10,917
Note: The above table includes DAC and VOBA amortized in accordance with SFAS No. 60, “Accounting and Reporting by
Insurance Enterprises (“SFAS 60”).” Under SFAS 60, acquisition costs for traditional life insurance and Insurance
Solutions – Group Protection’s products, which include whole life and term life insurance policies and group life, dental
and disability policies, are amortized over periods of 10 to 30 years for life products and up to 15 years for group products
on either a straight-line basis or as a level percent of premium of the related policies depending on the block of business.
No DAC is being amortized under SFAS 60 for fixed and variable payout annuities.
The adoption of SOP 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with
Modifications or Exchanges of Insurance Contracts” (“SOP 05-1”) on January 1, 2007, increased DAC and VOBA amortization,
net of deferrals by approximately $11 million. The adoption of this new guidance impacted primarily our Retirement Solutions –
53
Annuities and Insurance Solutions – Group Protection segments and our accounting policies regarding the assumptions for
lapsation used in the amortization of DAC and VOBA. For a detailed discussion of SOP 05-1, see Note 2.
On a quarterly basis, we may record an adjustment to the amounts included within our Consolidated Balance Sheets for DAC,
VOBA, DSI and DFEL with an offsetting benefit or charge to revenue or expense for the impact of the difference between the
estimates of future gross profits used in the prior quarter and the emergence of actual and updated estimates of future gross profits
in the current quarter (“retrospective unlocking”). In addition, in the third quarter of each year, we conduct our annual
comprehensive review of the assumptions and the projection models used for our estimates of future gross profits underlying the
amortization of DAC, VOBA, DSI and DFEL and the calculations of the embedded derivatives and reserves for annuity and life
insurance products with living benefit and death benefit guarantees. These assumptions include investment margins, mortality,
retention, rider utilization and maintenance expenses (costs associated with maintaining records relating to insurance and individual
and group annuity contracts and with the processing of premium collections, deposits, withdrawals and commissions). Based on
our review, the cumulative balances of DAC, VOBA, DSI and DFEL, included on our Consolidated Balance Sheets, are adjusted
with an offsetting benefit or charge to revenue or amortization expense to reflect such change (“prospective unlocking –
assumption changes”). We may also identify and implement actuarial modeling refinements (“prospective unlocking – model
refinements”) that result in increases or decreases to the carrying values of DAC, VOBA, DSI, DFEL, embedded derivatives and
reserves for annuity and life insurance products with living benefit and death benefit guarantees. The primary distinction between
retrospective and prospective unlocking is that retrospective unlocking is driven by the emerging experience period-over-period,
while prospective unlocking is driven by changes in assumptions or projection models related to estimated future gross profits.
In discussing our results of operations below in this MD&A, we refer to favorable and unfavorable unlocking. With respect to
DAC, VOBA and DSI, favorable unlocking refers to an increase in the carrying value of the asset on our Consolidated Balance
Sheets and an equal and offsetting decrease to expenses on our Consolidated Statements of Income. With respect to DFEL,
favorable unlocking refers to a decrease in the carrying value of the liability on our Consolidated Balance Sheets and an equal and
offsetting increase to revenue on our Consolidated Statements of Income. With respect to the calculations of the embedded
derivatives and reserves for annuity and life insurance products with living benefit and death benefit guarantees, favorable
unlocking refers to a decrease in future contract benefits on our Consolidated Balance Sheets and an equal and offsetting decrease
to benefit expense on our Consolidated Statements of Income. Unfavorable unlocking has the opposite impacts on our
consolidated financial statements of what is described above.
54
Details underlying our prospective unlocking as a result of our annual comprehensive review (in millions) were as follows:
Insurance fees:
Retirement Solutions - Annuities
Insurance Solutions - Life Insurance
Lincoln UK
Total insurance fees
Realized gain (loss):
Indexed annuity forward-starting option
GLB
Total realized gain (loss)
Total revenues
Interest credited:
Retirement Solutions - Annuities
Total interest credited
Benefits:
Retirement Solutions - Annuities
Insurance Solutions - Life Insurance
Total benefits
Underwriting, acquisition, insurance and other expenses:
Retirement Solutions - Annuities
Retirement Solutions - Defined Contribution
Insurance Solutions - Life Insurance
Lincoln UK
Total underwriting, acquisition, insurance and other expenses
Total benefits and expenses
Income (loss) from continuing operations before taxes
Federal income taxes
Income (loss) from continuing operations
For the Years Ended December 31,
2008
2006
2007
$
(1)
(28)
(1)
(30)
$
(1)
26
5
30
$
(3)
(1)
(12)
(16)
-
48
48
18
-
-
-
85
85
1
2
3
33
(1)
(1)
2
-
2
-
-
-
(16)
(1)
(1)
(3)
15
12
(2)
-
(81)
4
(79)
6
12
4
$
8
(12)
3
21
2
14
15
18
6
12
$
(1)
(7)
14
(3)
3
14
(30)
(11)
(20)
$
Note: The 2006 amounts reflect our harmonization of several assumptions and related processes as a result of our merger with
Jefferson-Pilot. The effects varied by segment and are discussed further in the respective segment discussions below.
Because equity market movements have a significant impact on the value of variable annuity, VUL and unit-linked accounts
(contracts written in the U.K. similar to U.S. produced variable life and annuity products) and the fees earned on these accounts,
EGPs could increase or decrease with movements in the equity markets; therefore, significant and sustained changes in equity
markets have had and could in the future have an impact on DAC, VOBA, DSI and DFEL amortization for our variable annuity,
annuity-based 401(k) business, VUL and unit-linked business. The table above excludes the impact of our prospective unlocking
that we recognized in the fourth quarter of 2008, which is described below.
As equity markets do not move in a systematic manner, we reset the baseline of account values from which EGPs are projected,
which we refer to as our “reversion to the mean” (“RTM”) process. Under our current RTM process, on each valuation date,
future EGPs are projected using stochastic modeling of a large number of future equity market scenarios in conjunction with best
estimates of lapse rates, interest rate spreads and mortality to develop a statistical distribution of the present value of future EGPs
for our variable annuity, annuity-based 401(k), VUL and unit-linked product blocks of business. Because future equity market
returns are unpredictable, the underlying premise of this process is that best estimate projections of future EGPs, as required by
SFAS 97, need not be affected by random short-term and insignificant deviations from expectations in equity market returns.
However, long-term or significant deviations from expected equity market returns require a change to best estimate projections of
EGPs and prospective unlocking of DAC, VOBA, DSI, DFEL and changes in future contract benefits. The statistical distribution
is designed to identify when the equity market return deviations from expected returns have become significant enough to warrant
a change of the future equity return EGP assumption.
55
The stochastic modeling performed for our variable annuity blocks of business as described above is used to develop a range of
reasonably possible future EGPs. We compare the range of the present value of the future EGPs from the stochastic modeling to
that used in our amortization model. A set of intervals around the mean of these scenarios is utilized to calculate two separate
statistical ranges of reasonably possible EGPs. These intervals are then compared again to the present value of the EGPs used in
the amortization model. If the present value of EGP assumptions utilized for amortization were to exceed the margin of the
reasonable range of statistically calculated EGPs, a revision of the EGPs used to calculate amortization would occur. If a revision
is deemed necessary, future EGPs would be re-projected using the current account values at the end of the period during which the
revision occurred along with a revised long-term annual equity market gross return assumption such that the reprojected EGPs
would be our best estimate of EGPs.
Notwithstanding these intervals, if a severe decline or advance in equity markets were to occur or should other circumstances,
including contract holder behavior, suggest that the present value of future EGPs no longer represents our best estimate, we could
determine that a revision of the EGPs is necessary.
Our practice is not necessarily to unlock immediately after exceeding the first of the two statistical ranges, but, rather, if we stay
between the first and second statistical range for several quarters, we would likely unlock. Additionally, if we exceed the ranges as a
result of a short-term market reaction, we would not necessarily unlock. However, if the second statistical range is exceeded for
more than one quarter, it is likely that we would unlock. While this approach reduces adjustments to DAC, VOBA, DSI and
DFEL due to short-term equity market fluctuations, significant changes in the equity markets that extend beyond one or two
quarters could result in a significant favorable or unfavorable unlocking.
Our long-term equity market growth assumption rate is 9%, which is used in the determination of DAC, VOBA, DSI and DFEL
amortization for the variable component of our variable annuity and VUL products, as this component is related primarily to
underlying investments in equity funds within the separate accounts. This variable appreciation rate is before the deduction of our
contract fees. The actual variable appreciation rate in 2008 was significantly lower than the assumed rate with October of 2008
representing the worst returns in 21 years. The negative returns in the fourth quarter of 2008 resulted in the piercing of the outer
corridor in our Retirement Solutions businesses and our Insurance Solutions – Life Insurance segment. Although the piercing of
the outer corridor does not automatically result in a resetting of our RTM assumption, we determined that the significance of
unfavorable equity markets experienced during 2008 and the recessionary economic environment required a prospective unlocking
related to RTM in the fourth quarter. If unfavorable economic conditions persist and the equity markets trend down further from
the December 31, 2008, levels, additional unlocking of our RTM assumptions is possible in future periods.
As we did not pierce the corridor in our Lincoln UK segment in relation to our unit-linked accounts, we did not record prospective
unlocking related to RTM in the fourth quarter of 2008. If the Financial Time Stock Exchange (“FTSE”) declines by
approximately 31% from its level as of December 31, 2008, we believe it would result in approximately $50 million, after-tax,
unfavorable RTM prospective unlocking.
56
Details underlying our fourth quarter prospective unlocking related to RTM and the impact of the volatile capital market
conditions on our annuity reserves (in millions) were as follows:
Insurance fees:
Retirement Solutions - Annuities
Insurance Solutions - Life Insurance
Total insurance fees
Realized gain (loss):
GLB
Total realized gain (loss)
Total revenues
Interest credited:
Retirement Solutions - Annuities
Total interest credited
Benefits:
Retirement Solutions - Annuities
Retirement Solutions - Defined Contribution
Total benefits
Underwriting, acquisition, insurance and other expenses:
Retirement Solutions - Annuities
Retirement Solutions - Defined Contribution
Insurance Solutions - Life Insurance
Total underwriting, acquisition, insurance and other expenses
Total benefits and expenses
Income (loss) from continuing operations before taxes
Federal income taxes
Income (loss) from continuing operations
For the Three
Months Ended
December 31,
2008
$
26
16
42
70
70
112
37
37
8
1
9
305
39
65
409
455
(343)
(120)
(223)
$
57
For illustrative purposes, the following presents the hypothetical impacts to EGPs and DAC (1) amortization attributable to
changes in assumptions from those our model projections assume:
Actual Experience Differs
From Those Our Model
Projections Assume
Higher equity markets
Hypothetical
Impact to
Net Income
for EGPs
Favorable
Hypothetical
Impact to
Net Income
for DAC (1)
Amortization Description of Expected Impact
Favorable
Increase to fee income and decrease to changes in
reserves.
Lower equity markets
Unfavorable Unfavorable
Decrease to fee income and increase to changes in
reserves.
Higher investment margins
Favorable
Favorable
Increase to interest rate spread on our fixed product
line, including fixed portion of variable.
Lower investment margins
Unfavorable Unfavorable
Decrease to interest rate spread on our fixed product
Higher credit losses
Lower credit losses
Higher lapses
line, including fixed portion of variable.
Unfavorable Unfavorable
Decrease to realized gains on investments.
Favorable
Favorable
Increase to realized gains on investments.
Unfavorable Unfavorable
Decrease to fee income, partially offset by decrease to
benefits due to shorter contract life.
Lower lapses
Favorable
Favorable
Increase to fee income, partially offset by increase to
benefits due to longer contract life.
Higher death claims
Unfavorable Unfavorable
Decrease to fee income and increase to changes in
reserves due to shorter contract life.
Lower death claims
Favorable
Favorable
Increase to fee income and decrease to changes in
reserves due to longer contract life.
(1) DAC refers to the associated amortization of expense of DAC, VOBA, DSI and DFEL and changes in future contract
benefits.
Goodwill and Other Intangible Assets
Under SFAS No. 142, “Goodwill and Other Intangible Assets,” (“SFAS 142”) goodwill and intangible assets with indefinite lives
are not amortized, but are subject to impairment tests conducted at least annually. Intangibles that do not have indefinite lives are
amortized over their estimated useful lives. SFAS 142 requires that we perform a two-step test in our evaluation of the carrying
value of goodwill. In Step 1 of the evaluation, the fair value of each reporting unit is determined and compared to the carrying
value of the reporting unit. If the fair value is greater than the carrying value, then the carrying value is deemed to be sufficient and
Step 2 is not required. If the fair value estimate is less than the carrying value, it is an indicator that impairment may exist and Step
2 is required to be performed. In Step 2, the implied fair value of the reporting unit’s goodwill is determined by allocating the
reporting unit’s fair value as determined in Step 1 to all of its net assets (recognized and unrecognized) as if the reporting unit had
been acquired in a business combination at the date of the impairment test. If the implied fair value of the reporting unit’s
goodwill is lower than its carrying amount, goodwill is impaired and written down to its fair value. Refer to Note 10 of our
consolidated financial statements for a table of our goodwill and intangible assets by reporting unit.
The valuation techniques we have historically used to estimate the fair value of the group of assets comprising the different
reporting units has varied based on the characteristics of each reporting unit’s business and operations. A market-based valuation
technique that focused on a price-to-earnings multiplier and segment-level operating income was used prior to 2008 for our
Retirement Solutions and Insurance Solutions businesses and the remaining media business that is now reported in Other
Operations. For the Lincoln UK segment, a discounted cash flow model has been historically utilized to determine the fair value.
A valuation technique combining multiples of revenues, earnings before interest, taxes, depreciation and amortization and assets
under management has been historically used to assess the goodwill in our Investment Management segment. We use October 1
as the annual review date for goodwill and other intangible assets impairment testing. The results of the tests performed as of
October 1, 2007 and 2006, indicated that we did not have impaired goodwill or other intangibles.
58
For our tests performed as of October 1, 2008, we did not limit our analysis to reviewing market-based valuation information such
as price-to-earnings multiples or recent transactions. There have been very few merger or acquisition transactions in the life
insurance industry for the prior 18 months. Additionally, stock prices for the broad market, especially the insurance sector,
declined dramatically in the fourth quarter reducing our market capitalization and that of our peers below book value. Therefore, a
more thorough analysis was required to determine the fair value of our businesses.
We performed a Step 1 goodwill impairment analysis on all of our reporting units. The Step 1 analysis for our Insurance Solutions
and Retirement Solutions segments utilized primarily a discounted cash flow valuation technique. The discounted cash flow
analysis required us to make judgments about revenues, earnings projections, growth rates and discount rates. We also considered
other valuation techniques such as an analysis of peer companies and market participants. The key assumptions used in the
analysis to determine the fair value of the reporting units reported within our Insurance Solutions and Retirement Solutions
businesses included: cash flow periods of 10 years; terminal values based upon terminal growth rates ranging from 3.0% to 4.6%;
and discount rates ranging from 10.5% to 14.0%, which were based on the weighted average cost of capital for each of our
reporting units adjusted for the risks associated with the operations. Assumptions about revenues, earnings and growth rates were
based on our budgets and financial plans. Assumptions were also made for varying perpetual growth rates for periods beyond the
long-term business plan period. For our other reporting units, we used other available information including market data obtained
through strategic reviews and other analysis to support our Step 1 conclusions. All of our reporting units passed the Step 1
analysis, except for our Media and Lincoln UK reporting units, which required a Step 2 analysis to be completed. Additionally,
while the Step 1 analysis of our Insurance Solutions – Life reporting unit indicated that its fair value exceeded its carrying value, the
margin above carrying value was relatively small. Therefore, we concluded that we should perform additional analysis for our
Insurance Solutions – Life reporting unit under the Step 2 requirements of SFAS 142.
In the valuation process, we gave consideration to the current economic and market conditions, which are discussed above in
“Introduction – Executive Summary – Current Market Conditions.” We also updated our October 1 analysis of goodwill
impairment to reflect fourth quarter results and forecasts as of December 31, 2008, due to sharp declines in the equity markets and
our stock price in the fourth quarter. In determining the estimated fair value of our reporting units, we incorporated consideration
of discounted cash flow calculations, peer company price-to-earnings multiples, the level of our own share price and assumptions
that market participants would make in valuing our reporting units. Our fair value estimations were based primarily on an in-depth
analysis of future cash flows and relevant discount rates, which considered market participant inputs (“income approach”). In our
Step 2 analysis, we estimated the implied fair value of the reporting units’ goodwill as determined by allocating the reporting units’
fair value determined in Step 1 to all of its net assets (recognized and unrecognized) as if the reporting unit had been acquired in a
business combination at the date of the impairment test. We utilized forecasts of cash flows and market observable inputs in
determining a fair value for each of these reporting units similar to what would be estimated in a business combination between
market participants.
Based upon our annual analysis, we recorded goodwill impairment of $81 million and Federal Communications Commission
(“FCC”) license intangible impairment of $125 million for our Media reporting unit, which was attributable primarily to rapid
deterioration in the radio market from declines in advertising revenues for the entire radio market that was above what we
expected. In addition, we also recorded goodwill impairment on our Lincoln UK segment of $12 million, which was primarily the
result of the deterioration of the economic and business conditions for the insurance industry in the United Kingdom. The
implied fair value for our goodwill impairment of Lincoln UK was based upon market observable data about the industry and
previous transactions.
After consideration of the analysis performed, management concluded that the goodwill of the reporting units within our
Retirement Solutions and Insurance Solutions businesses as of October 1, 2008, and December 31, 2008, was not impaired. The
estimated fair value of each reporting unit based upon future earnings and cash flows continued to be in excess of the respective
reporting unit’s carrying value.
If current market conditions persist during 2009, and, in particular, if our share price remains below book value per share, we will
need to reassess goodwill impairment at the end of each quarter. We expect to perform interim tests of goodwill impairment in
addition to our annual test during 2009, especially if our market capitalization remains below our book value. Subsequent reviews
of goodwill could result in impairment of goodwill during 2009, as early as the first quarter. Factors that could result in an
impairment include, but are not limited to, the following:
(cid:120) Prolonged period of our book value exceeding our market capitalization;
(cid:120) Valuations of mergers or acquisitions of companies or blocks of business that would provide relevant market-based inputs for
our impairment assessment that could support different conclusions than our income approach;
(cid:120) Deterioration in key assumptions used in our income approach estimates of fair value, such as higher discount rates from
higher stock market volatility, widening credit spreads or a further decline in interest rates;
59
(cid:120) Lower earnings projections due to spread compression, lower account values from unfavorable equity markets and
significantly lower expectations for future sales which would reduce future earnings expectations;
(cid:120) Higher than expected impairments of invested assets; and
(cid:120) Prolonged inability to execute future Valuation of Life Insurance Policies Model Regulation (“XXX”) or AG38 reinsurance
transactions for our life insurance business due to unavailability of financing resulting in higher capital requirements.
To illustrate the impact that changes in valuation assumptions could have on our estimated of our reporting units’ fair values, the
following presents the hypothetical impact to segment implied fair value (in millions, except where otherwise noted) associated
with specified sensitivities:
Carrying value as of December 31, 2008:
Goodwill
Net assets (1)
Estimated fair value as of December 31, 2008 (in billions)
Hypothetical estimated reduction in implied fair value attributable to:
100 basis point increase in discount rate
100 basis point decline in long term growth rate
10% decline in forecasted operating earnings growth rate
Retirement
Solutions -
Annuities
Insurance Solutions
Group
Life
Protection
Insurance
$
1,040
$
2,188
$
274
4,043
4.5 to 5.0
7,395
8.4 to 9.3
894
1.3 to 1.5
600
300
100
1,000
400
300
200
100
100
(1)
Includes unrealized gains and losses included in accumulated other comprehensive income.
During the second quarter of 2008, as a result of declines in current and forecasted advertising revenues for the radio market, we
performed an impairment review outside of our annual process for our media business. This review resulted in $83 million of
goodwill impairment and $92 million of FCC licenses impairment.
Investments
Our primary investments are in fixed maturity securities, including corporate and government bonds, asset and mortgage-backed
securities and redeemable preferred stock, and equity securities, mortgage loans and policy loans. All our fixed maturity and equity
securities are classified as available-for-sale as defined in SFAS No. 115, “Accounting for Certain Investments in Debt and Equity
Securities,” except for those securities supporting certain reinsurance transactions that are classified as trading securities. Available-
for-sale securities are carried at fair value with the difference from amortized cost included in stockholders’ equity as a component
of accumulated other comprehensive income. The difference is net of related DAC, VOBA, DSI and DFEL and amounts that
would be credited to contract holders, if realized, and taxes.
Investment Valuation
We adopted SFAS 157 for all our financial instruments effective January 1, 2008. For detailed discussions of the methodologies
and assumptions used to determine the fair value of our financial instruments and a summary of our financial instruments carried
at fair value as of December 31, 2008, see Notes 1, 2 and 22 of this report.
Subsequent to the adoption of SFAS 157, we did not make any material changes to the valuation techniques or models used to
determine the fair value of the assets we carry at fair value. As part of our on-going valuation process, we assess the reasonableness
of all our valuation techniques or models and make adjustments as necessary.
60
Fixed maturity, equity, trading securities and short-term investments, which are reported at fair value on the Consolidated Balance
Sheets, represented the majority of our total cash and invested assets. The fair value of a financial instrument is the amount at
which the instrument could be exchanged in a current transaction between knowledgeable, unrelated willing parties using inputs,
including assumptions and estimates, a market participant would use. Pursuant to SFAS 157, we have categorized these securities
into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives
the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to
unobservable inputs (Level 3). An asset or liability’s classification within the fair value hierarchy is based of the lowest level of
significant input to its valuation. SFAS 157 defines the input levels as follows:
(cid:120) Level 1 – inputs to the valuation methodology are quoted prices available in active markets for identical investments as of the
reporting date. “Blockage discounts” for large holdings of unrestricted financial instruments where quoted prices are readily
and regularly available for an identical asset or liability in an active market are prohibited;
(cid:120) Level 2 – inputs to the valuation methodology are other than quoted prices in active markets, which are either directly or
indirectly observable as of the reporting date, and fair value can be determined through the use of models or other valuation
methodologies; and
(cid:120) Level 3 – inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity
for the asset or liability and the reporting entity makes estimates and assumptions related to the pricing of the asset or liability,
including assumptions regarding risk.
The following summarizes our investments carried at fair value by pricing source and SFAS 157 hierarchy level (in millions):
Priced by third party pricing services
Priced by independent broker quotations
Priced by matrices
Priced by other methods (1)
Total
Percent of total
Level 1
317
$
-
-
-
317
$
As of December 31, 2008
Level 2
42,550
$
-
6,497
-
49,047
$
Level 3
-
$
3,750
-
1,839
5,589
$
Total
42,867
3,750
6,497
1,839
54,953
$
$
1%
89%
10%
100%
(1) Represents primarily securities for which pricing models were used to compute the fair values.
The Level 1 securities primarily consist of certain U.S. Treasury and agency fixed maturity securities and exchange-traded common
stock.
The Level 2 assets include fixed maturity securities priced principally through independent pricing services including most U.S.
Treasury and agency securities as well as the majority of U.S. and foreign corporate securities, residential mortgage-backed
securities, commercial mortgage-backed securities, state and political subdivision securities, foreign government securities, and
asset-backed securities as well as equity securities, including non-redeemable preferred stock, priced by independent pricing
services. Management reviews the valuation methodologies used by the pricing services on an ongoing basis and ensures that any
valuation methodologies are justified.
Level 3 assets include fixed maturity securities priced principally through independent broker quotes or market standard valuation
methodologies. This level consists of less liquid fixed maturity securities with very limited trading activity or where less price
transparency exists around the inputs to the valuation methodologies including: U.S. and foreign corporate securities (including
below investment grade private placements); residential mortgage-backed securities; asset-backed securities; and other fixed
maturity securities such as structured securities. Equity securities classified as Level 3 securities consist principally of common
stock of privately held companies and non-redeemable preferred stock where there has been very limited trading activity or where
less price transparency exists around the inputs to the valuation. For the categories and associated fair value of our available-for-
sale fixed maturity securities classified within Level 3 of the fair value hierarchy as of December 31, 2008 and 2007, see Note 22.
Our investment securities are valued using market inputs, including benchmark yields, reported trades, broker/dealer quotes, issuer
spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators and industry and
economic events are monitored, and further market data is acquired if certain triggers are met. Credit risk is also incorporated and
considered in the valuation of our investment securities as we incorporate the issuer’s credit rating and a risk premium, if
warranted, due to the issuer’s industry and the security’s time to maturity. The credit rating is based upon internal and external
analysis of the issuer’s financial strength. For certain security types, additional inputs may be used, or some of the inputs described
above may not be applicable. For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from
61
sources recognized to be market participants. In order to validate the pricing information and broker/dealer quotes, we employ,
where possible, procedures that include comparisons with similar observable positions, comparisons with subsequent sales,
discussions with senior business leaders and brokers as well as observations of general market movements for those asset classes.
The broker/dealer quotes are non-binding. Our broker-quoted only securities are generally classified as Level 3 in the SFAS 157
hierarchy. It is possible that different valuation techniques and models, other than those described above, could produce materially
different estimates of fair values.
Changes of our investments carried at fair value and classified within Level 3 of the fair value hierarchy result from changes in
market conditions, as well as changes in our portfolio mix and increases and decreases in fair values as a result of those
classifications. During 2008, there were no material changes in investments classified as Level 3 of the fair value hierarchy. For
further detail, see Note 22.
See “Consolidated Investments” below for a summary of our investments in available-for-sale securities backed by pools of
residential mortgages.
Write-Downs for Other-Than-Temporary Impairments and Allowance for Losses
The criteria for determining whether a security is impaired is based upon an other-than-temporary impairment standard. Under the
other-than-temporary criteria, we could have a security that we believe is likely to recover its value over time, but we would still be
required to record an impairment write-down under GAAP. Determining whether or not a decline in current fair values for
securities classified as available-for-sale is other-than-temporary can frequently involve a variety of assumptions and estimates,
particularly for investments that are not actively traded on established markets. For instance, assessing the value of some
investments requires an analysis of expected future cash flows. Some investment structures, such as collateralized debt obligations,
often represent selected tranches collateralized by underlying investments in a wide variety of issuers and security types.
Factors we consider in determining whether declines in the fair value of fixed maturity securities are other-than-temporary include:
the significance of the decline; our ability and intent to retain the investment for a sufficient period of time for it to recover to an
amount at least equal to its carrying value; the time period during which there has been a significant decline in value; and
fundamental analysis of the liquidity, business prospects and overall financial condition of the issuer. Based upon these factors,
securities that have indications of potential impairment are subject to intensive review. Where such analysis results in a conclusion
that declines in fair values are other-than-temporary, the security is written down to fair value. The fixed maturity securities to
which these write-downs apply were generally of investment grade at the time of purchase, but were subsequently downgraded by
rating agencies to “below-investment grade.” Another key factor in whether a write-down for impairment is necessary is our
“intent or ability to hold to recovery or maturity.” In the event that we determine that we do not have the intent or ability to hold
to recovery or maturity, we are required to write down the security. A write-down is necessary even in situations where the
unrealized loss is not due to an underlying credit issue, but may be solely related to the impact of changes in interest rates on the
fair value of the security. See Note 22 for a general discussion of the methodologies and assumptions used to determine estimated
fair values. Each quarter, the Company asserts its intent and ability to retain until recovery those securities judged to be
temporarily impaired. Upon making this assertion we are limited in our ability to sell these securities as it could raise concerns over
the validity of our assertion and our ability to use such assertion in the future. Subsequent to making the assertion, we may
authorize the sale of these securities if facts and circumstances change that relate to events that could not have been reasonably
foreseen. Examples of such changes include, but are not limited to, the deterioration of the issuer’s creditworthiness, a change in
regulatory requirements or a major business combination or disposition.
For certain securitized fixed maturity securities with contractual cash flows, including asset-backed securities, we use our best
estimate of cash flows for the life of the security to determine whether there is an other-than-temporary impairment of the security
as required under Emerging Issues Task Force (“EITF”) Issue No. 99-20, “Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial Assets” and Financial Accounting Standards Board (“FASB”)
Staff Position (“FSP”) EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20.” In addition, we
review for other indicators of impairment as required by FSP FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments.”
Based on our evaluation of securities with an unrealized loss as of December 31, 2008, we do not believe that any additional other-
than-temporary impairment losses, other than those already reflected in the financial statements, are necessary. As of December
31, 2008, there were available-for-sale securities with unrealized losses totaling $7.3 billion, pre-tax, and prior to the impact on
DAC, VOBA, DSI and other contract holder funds.
As the discussion above indicates, there are risks and uncertainties associated with determining whether declines in the fair value of
investments are other-than-temporary. These include subsequent significant changes in general overall economic conditions, as
well as specific business conditions affecting particular issuers, future financial market effects such as interest rate spreads, stability
of foreign governments and economies, future rating agency actions and significant accounting, fraud or corporate governance
62
issues that may adversely affect certain investments. In addition, there are often significant estimates and assumptions that we use
to estimate the fair values of securities, including projections of expected future cash flows and pricing of private securities. We
continually monitor developments and update underlying assumptions and financial models based upon new information.
Write-downs and allowances for losses on select mortgage loans, real estate and other investments are established when the
underlying value of the property is deemed to be less than the carrying value. All mortgage loans that are impaired have an
established allowance for credit loss. Changing economic conditions impact our valuation of mortgage loans. Increasing
vacancies, declining rents and the like are incorporated into the discounted cash flow analysis that we perform for monitored loans
and may contribute to the establishment of (or an increase 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 mortgage loan portfolio and
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.
Derivatives
To protect us from a variety of equity market and interest rate risks that are inherent in many of our life insurance and annuity
products, we use various derivative instruments. Assessing the effectiveness of these hedging programs and evaluating the carrying
values of the related derivatives often involve a variety of assumptions and estimates. We use derivatives to hedge equity market
risks, interest rate risk and foreign currency exposures that are embedded in our annuity and life insurance product liabilities or
investment portfolios. Derivatives held as of December 31, 2008, contain industry standard terms. Our accounting policies for
derivatives and the potential impact on interest spreads in a falling rate environment are discussed in “Item 7A. Quantitative and
Qualitative Disclosures About Market Risk.” See Note 6 for additional information on our accounting for derivatives.
The adoption of SFAS 157 decreased income from continuing operations by $16 million. The impact to revenue is reported in
realized gain (loss) and such amount along with the associated federal income taxes is excluded from income (loss) from operations
of our segments. For a detailed description of the impact of adoption of SFAS 157 on our consolidated financial statements, see
Note 2.
Subsequent to the adoption of SFAS 157, we did not make any material changes to valuation techniques or models used to
determine the fair value of the liabilities we carry at fair value. As part of our on-going valuation process, we assess the
reasonableness of all our valuation techniques or models and make adjustments as necessary.
Our insurance liabilities that contain embedded derivatives are valued based on a stochastic projection of scenarios of the
embedded derivative fees, benefits and expenses. The scenario assumptions, at each valuation date, are those we view to be
appropriate for a hypothetical market participant and include assumptions for capital markets, actuarial lapse, benefit utilization,
mortality, risk margin, administrative expenses and a margin for profit. In addition, an NPR component is determined at each
valuation date that reflects our risk of not fulfilling the obligations of the underlying liability. The spread for the NPR is added to
the discount rates used in determining the fair value from the net cash flows. We believe these assumptions are consistent with
those that would be used by a market participant; however, as the related markets develop we will continue to reassess our
assumptions. It is possible that different valuation techniques and assumptions could produce a materially different estimate of fair
value.
The adoption of SFAS 157 increased our exposure to earnings fluctuations from period to period due to volatility of the fair value
inputs in the current economic environment, including the inclusion of the NPR into the calculation of the GLB embedded
derivative liability. For additional information, see our discussion in “Realized Gain (Loss)” below and “Item 7A. Quantitative and
Qualitative Disclosures About Market Risk.”
The following summarizes the percentages of our future contract benefits (embedded derivatives) carried at fair value on a
recurring basis by the SFAS 157 hierarchy levels:
As of December 31, 2008
Future contract benefits (embedded derivatives)
Level 1
0%
Level 2
0%
Level 3
100%
Total
Fair
Value
100%
Changes of our future contract benefits carried at fair value and classified within Level 3 of the fair value hierarchy result from
changes in market conditions, as well as changes in mix and increases and decreases in fair values as a result of those classifications.
During 2008, there were no material changes in future contract benefits classified as Level 3 of the fair value hierarchy. For further
detail, see Note 22.
63
Guaranteed Living Benefits
We have a dynamic hedging strategy designed to mitigate selected risk and income statement volatility caused by changes in the
equity markets, interest rates and market implied volatilities associated with the Lincoln SmartSecurity® Advantage GWB feature and
our i4LIFE® Advantage and 4LATER® Advantage GIB features that are available in our variable annuity products. In early
January 2008, we added the GLB features that are available in our variable annuity products in our New York insurance subsidiary,
Lincoln Life & Annuity Company of New York (“LLANY”), to our hedge program. In February 2008, we also added our new
GWB Lincoln Lifetime IncomeSM Advantage to our hedging program. Our GIB and 4LATER® features have elements of both
insurance benefits accounted for under SOP 03-1 and embedded derivatives accounted for under SFAS 133 and SFAS 157. We
weight these features and their associated reserves accordingly based on their hybrid nature. In addition to mitigating selected risk
and income statement volatility, the hedge program is also focused on a long-term goal of accumulating assets that could be used
to pay claims under these benefits, recognizing that such claims are likely to begin no earlier than approximately a decade in the
future.
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 portion of the GLB features. This dynamic hedging strategy utilizes options on U.S.-based
equity indices, futures on U.S.-based and international equity indices and variance swaps on U.S.-based equity indices, as well as
interest rate futures and swaps. The notional amounts of the underlying hedge instruments are such that the magnitude of the
change in the value of the hedge instruments due to changes in equity markets, interest rates and implied volatilities is designed to
offset the magnitude of the change in the fair value of the GLB guarantees caused by those same factors. As of December 31,
2008, the fair value of the embedded derivative liability, before adjustment for the NPR factor required by SFAS 157, for GWB,
the i4LIFE® Advantage GIB and the 4LATER® Advantage GIB were valued at $2.6 billion, $745 million and $233 million,
respectively.
As part of our current hedging program, equity market, interest rate and market implied volatility conditions are monitored on a
daily basis. We rebalance our hedge positions based upon changes in these factors as needed. While we actively manage our hedge
positions, our hedge positions may not be totally effective to offset changes in the fair value embedded derivative liability caused by
movements in these factors due to, among other things, differences in timing between when a market exposure changes and
corresponding changes to the hedge positions, extreme swings in the equity markets, interest rates and market implied volatilities,
realized market volatility, contract holder behavior, divergence between the performance of the underlying funds and the hedging
indices, divergence between the actual and expected performance of the hedge instruments or our ability to purchase hedging
instruments at prices consistent with our desired risk and return trade-off. This hedging strategy is managed on a combined basis
with the hedge for our GDB features.
For more information on our GDB hedging strategy, see the discussion in “Future Contract Benefits and Other Contract Holder
Obligations” below.
As of December 31, 2008, the fair value of our derivative assets, which hedge both our GLB and GDB features, and including
margins generated by futures contracts, was $4.0 billion. As of December 31, 2008, the sum of all GLB liabilities at fair value and
GDB reserves was $3.9 billion, comprised of $3.6 billion for GLB liabilities and $0.3 billion for the GDB reserves. The fair value
of the hedge assets exceeded the liabilities by $0.1 billion, which we believe indicates that the hedge strategy has performed well by
providing funding for our best estimate of the present value of the liabilities related to our GLB and GDB features. However, the
relationship of hedge assets to the liabilities for the guarantees may vary in any given reporting period due to market conditions,
hedge performance and/or changes to the hedging strategy.
Approximately 36% of our variable annuity account values contain a GWB rider. Declines in the equity markets increase our
exposure to potential benefits under the GWB contracts, leading to an increase in our existing liability for those benefits. For
example, a GWB contract is “in the money” if the contract holder’s account balance falls below the guaranteed amount. As of
December 31, 2008, and December 31, 2007, 88% and 20%, respectively, of all GWB in-force contracts were “in the money,” and
our exposure to the guaranteed amounts, after reinsurance, as of December 31, 2008, and December 31, 2007, was $5.0 billion and
$84 million respectively. However, the only way the GWB contract holder can monetize the excess of the guaranteed amount over
the account value of the contract is upon death or through a series of withdrawals that do not exceed a specific percentage of the
premiums paid per year. If, after the series of withdrawals, the account value is exhausted, the contract holder will receive a series
of annuity payments equal to the remaining guaranteed amount, and, for our lifetime GWB products, the annuity payments can
continue beyond the guaranteed amount. The account value can also fluctuate with equity market returns on a daily basis resulting
in increases or decreases in the excess of the guaranteed amount over account value.
As a result of these factors, the ultimate amount to be paid by us related to GWB guarantees is uncertain and could be significantly
more or less than $5.0 billion. Our fair value estimates of the GWB liabilities, which are based on detailed models of future cash
flows under a wide range of market-consistent scenarios, reflect a more comprehensive view of the related factors and represent
our best estimate of the present value of these potential liabilities.
64
For information on our GLB hedging results, see our discussion in “Realized Gain (Loss)” below.
The following table presents our estimates of the potential instantaneous impact to excluded realized gain (loss), which could result
from sudden changes that may occur in equity markets, interest rates and implied market volatilities (in millions) at the levels
indicated in the table and excludes the net cost of operating the hedging program. The amounts represent the estimated difference
between the change in the portion of GLB reserves that is calculated on a fair value basis and the change in the value of the
underlying hedge instruments after the amortization of DAC, VOBA, DSI and DFEL and taxes. These impacts do not include any
estimate of retrospective or prospective unlocking that could occur. These estimates are based upon the recorded reserves as of
January 8, 2009, and the related hedge instruments in place as of that date, along with additional implied volatility (vega) hedges
that have been implemented to further close the vega shortfall that existed as of January 8, 2009. The impacts presented below are
not representative of the aggregate impacts that could result if a combination of such changes to equity market returns, interest
rates and implied volatilities occurred.
Equity market return
Interest rates
Implied volatilities
-20%
$
(36)
-50 bps
$
(4)
-4%
$
-
In-Force Sensitivities
-10%
$
-5%
$
(8)
(2)
-25 bps
$
-
-2%
$
-
+25 bps
$
(3)
2%
$
-
5%
$
(2)
+50 bps
$
(10)
4%
$
(1)
The following table shows the effect (dollars in millions) of indicated changes in instantaneous shifts in equity market returns,
interest rate scenarios and market implied volatilities:
Scenario 1
Scenario 2
Scenario 3
Equity
Market
Return
Assumptions of Changes In
Interest
Rate
Yields
-12.5 bps
-25.0 bps
-50.0 bps
Market
Implied
Volatilities
+1%
+2%
+4%
-5%
-10%
-20%
Hypothetical
Impact to
Net
Income
$
(3)
(13)
(60)
The actual effects of the results illustrated in the two tables above could vary depending on a variety of factors, many of which are
out of our control and consideration should be given to the following:
(cid:120) The analysis is only valid as of this particular business day, due to changing market conditions, contract holder activity, hedge
positions and other factors;
(cid:120) The analysis assumes instantaneous shifts in the capital market factors and no ability to rebalance hedge positions prior to the
market changes;
(cid:120) Assumptions regarding shifts in the market factors, such as assuming parallel shifts in interest rate and implied volatility term
(cid:120)
structures, may be overly simplistic and not indicative of actual market behavior in stress scenarios;
It is very unlikely that one capital market sector (e.g. equity markets) will sustain such a large instantaneous movement without
affecting other capital market sectors; and
(cid:120) The analysis assumes that there is no tracking or basis risk between the funds and/or indices affecting the GLBs and the
instruments utilized to hedge these exposures.
S&P 500 Benefits
We also have in place a hedging program for our indexed annuities and indexed UL. These contracts permit the holder to elect a
fixed interest rate return or a return where interest credited to the contracts is linked to the performance of the S&P 500. Contract
holders may elect to rebalance among the various accounts within the product at renewal dates, either annually or biannually. At
the end of each 1-year or 2-year indexed term we have the opportunity to re-price the indexed component by establishing different
caps, spreads or specified rates, subject to contractual guarantees. We purchase options that are highly correlated to the portfolio
allocation decisions of our contract holders, such that we are economically hedged with respect to equity returns for the current
reset period. The mark-to-market of the options held generally offsets the change in value of the embedded derivative within the
indexed annuity, both of which are recorded as a component of realized gain (loss) on our Consolidated Statements of Income.
SFAS 133 requires that we calculate fair values of index options we may purchase in the future to hedge contract holder index
65
allocations in future reset periods. These fair values represent an estimate of the cost of the options we will purchase in the future,
discounted back to the date of the balance sheet, using current market indicators of volatility and interest rates. Changes in the fair
values of these liabilities are included as a component of realized gain (loss) on our Consolidated Statements of Income.
For information on our S&P 500 benefits hedging results, see our discussion in “Realized Gain (Loss)” below.
Future Contract Benefits and Other Contract Holder Obligations
Reserves
Reserves are the amounts that, with the additional premiums to be received and interest thereon compounded annually at certain
assumed rates, are calculated to be sufficient to meet the various policy and contract obligations as they mature. Establishing
adequate reserves for our obligations to contract holders requires assumptions to be made regarding mortality and morbidity. The
applicable insurance laws under which insurance companies operate require that they report, as liabilities, policy reserves to meet
future obligations on their outstanding contracts. These laws specify that the reserves shall not be less than reserves calculated
using certain specified mortality and morbidity tables, interest rates, and methods of valuation.
The reserves reported in our financial statements contained herein are calculated in accordance with GAAP and differ from those
specified by the laws of the various states and carried in the statutory financial statements of the life insurance subsidiaries. These
differences arise from the use of mortality and morbidity tables, interest, persistency and other assumptions that we believe to be
more representative of the expected experience for these contracts than those required for statutory accounting purposes and from
differences in actuarial reserving methods.
The assumptions on which reserves are based are intended to represent an estimation of experience for the period that policy
benefits are payable. If actual experience is better than or equal to the assumptions, then reserves should be adequate to provide
for future benefits and expenses. If experience is worse than the assumptions, additional reserves may be required. This would
result in a charge to our net income during the period the increase in reserves occurred. The key experience assumptions include
mortality rates, policy persistency and interest rates. We periodically review our experience and update our policy reserves for new
issues and reserve for all claims incurred, as we believe appropriate.
Guaranteed Death Benefits
The reserves related to the GDB features available in our variable annuity products are based on the application of a “benefit ratio”
(the present value of total expected benefit payments over the life of the contract divided by the present value of total expected
assessments over the life of the contract) to total variable annuity assessments received in the period. The level and direction of
the change in reserves will vary over time based on the emergence of the benefit ratio and the level of assessments associated with
the variable annuity.
We utilize a delta hedging strategy for variable annuity products with a GDB feature, which uses futures on U.S.-based equity
market indices to hedge against movements in equity markets. The hedging strategy is designed such that changes in the value of
the hedge contracts move in the opposite direction of equity market driven changes in the reserve for GDB contracts subject to
the hedging strategy. Because the GDB reserves are based upon projected long-term equity market return assumptions, and
because the value of the hedging contracts will reflect current capital market conditions, the quarterly changes in values for the
GDB reserves and the hedging contracts may not offset each other on an exact basis. Despite these short-term fluctuations in
values, we intend to continue to hedge our long-term GDB exposure in order to mitigate the risk associated with falling equity
markets. Account balances covered in this hedging program represent approximately 93% of total account balances for variable
annuities with a guaranteed death benefit other than account value at time of death. As of December 31, 2008, the GDB reserves
were $277 million.
For information on our GDB hedging results, see our discussion in “Realized Gain (Loss)” below.
Deferred Gain on Sale of the Reinsurance Segment
In 2001, we sold our reinsurance operation to Swiss Re Life & Health America Inc. (“Swiss Re”). The transaction involved a series
of indemnity reinsurance transactions combined with the sale of certain stock companies that comprised our reinsurance operation.
The gain related to the indemnity reinsurance transactions was recorded as deferred gain in the liability section of our Consolidated
Balance Sheets in accordance with the requirements of SFAS No. 113, “Accounting and Reporting for Reinsurance of Short-
Duration and Long-Duration Contracts” (“SFAS 113”). The deferred gain is being amortized into income at the rate that earnings
on the reinsured business are expected to emerge, over a period of 15 years. In addition, because we have not been relieved of our
legal liabilities to the underlying ceding companies with respect to the portion of the business indemnity reinsured by Swiss Re,
under SFAS 113, the reserves for the underlying reinsurance contracts as well as a corresponding reinsurance recoverable from
Swiss Re will continue to be carried on our Consolidated Balance Sheets during the run-off period of the underlying reinsurance
66
business. This is particularly relevant in the case of the exited personal accident reinsurance lines of business where the underlying
reserves are based upon various estimates that are subject to considerable uncertainty.
Because of ongoing uncertainty related to the personal accident business, the reserves related to these exited business lines carried
on our Consolidated Balance Sheets as of December 31, 2008, may ultimately prove to be either excessive or deficient. For
instance, in the event that future developments indicate that these reserves should be increased, we would record a current period
non-cash charge to record the increase in reserves. Because Swiss Re is responsible for paying the underlying claims to the ceding
companies, we would record a corresponding increase in reinsurance recoverable from Swiss Re. However, SFAS 113 does not
permit us to take the full benefit in earnings for the recording of the increase in the reinsurance recoverable in the period of the
change. Rather, we would increase the deferred gain recognized upon the closing of the indemnity reinsurance transaction with
Swiss Re and would report a cumulative amortization “catch-up” adjustment to the deferred gain balance as increased earnings
recognized in the period of change. Any amount of additional increase to the deferred gain above the cumulative amortization
“catch-up” adjustment must continue to be deferred and will be amortized into income in future periods over the remaining period
of expected run-off of the underlying business. No cash would be transferred between Swiss Re and us as a result of these
developments.
Pension and Other Postretirement Benefit Plans
Pursuant to the accounting rules for our obligations to employees under our various pension and other postretirement benefit
plans, we are required to make a number of assumptions to estimate related liabilities and expenses. Our most significant
assumptions are those for the weighted-average discount rate on our benefit obligation liability and expected return on plan assets.
The discount rate assumptions are determined using an analysis of current market information and the projected benefit flows
associated with these plans. The expected long-term rate of return on plan assets is initially established at the beginning of the plan
year based on historical and projected future rates of return and is the average rate of earnings expected on the funds invested or to
be invested in the plan. See Note 1 and Note 18 for more information on our accounting for employee benefit plans.
The following presents our estimates of the hypothetical impact to net income (in millions) for the year ended December 31, 2008,
associated with sensitivities related to these significant assumptions:
The Effect of Changes in the Rate of Return on Plan Assets
Increase (decrease) by 100 basis points
U.S.
U.S. Other
Pension Postretirement
Plans
Benefits
$
6
$
-
The Effect of Changes in the Discount Rate on Net Periodic Benefit Expense
Increase (decrease) by 100 basis points
3
1
Due to the unfavorable equity markets experienced during 2008, especially during the fourth quarter of 2008, as well as a decrease
in our discount rate assumption on benefit obligations for 2009, we expect the U.S. net periodic pension benefit recovery we
experienced in 2008 will be replaced by an expense in 2009. To illustrate the potential unfavorable impact, the following provides
our actual benefit recovery for 2008 and our current assumption for expense (in millions) for 2009 by segment:
Retirement Solutions
Defined
Annuities Contribution Insurance
(3)
(3)
$
$
$
12
11
(1)
7
Insurance Solutions
Life
Group
Investment
Protection Management Operations
(2)
$
$
1
$
Other
(1)
(1)
(1)
7
Total
$
(11)
37
2008
2009
Expected increase
$
14
$
8
$
15
$
8
$
-
$
3
$
48
See “Review of Consolidated Financial Condition – Liquidity and Capital Resources – Uses of Capital – Pension Contributions”
below for discussion of the PPA and the law’s effect on required future contributions.
67
Contingencies
Management establishes separate reserves for each contingent matter when it is deemed probable and can be reasonably estimated.
The outcomes of contingencies, which relate to corporate litigation and regulatory matters, are inherently difficult to predict, and
the reserves that have been established for the estimated settlement are subject to significant changes. It is possible that the
ultimate cost to LNC, including the tax-deductibility of payments, could exceed the reserve by an amount that would have a
material adverse effect on our consolidated results of operations or cash flows in a particular quarterly or annual period. See Note
14 for more information on our contingencies.
Stock-Based Incentive Compensation
Determining the fair value of stock options at the grant date requires judgment, including estimates for the average risk-free
interest rate, expected volatility, expected exercise behavior, expected dividend yield and expected forfeitures. If any of those
assumptions differ significantly from actual, stock-based compensation expense could be impacted, which could have a material
effect on our consolidated results of operations in a particular quarterly or annual period. See Note 20 for more information on
our stock-based incentive compensation plans.
Because of the volatility of our share price in the second half of 2008, the historical volatility that we will use to calculate future
stock option values for new awards will increase, partially offsetting the decline in our stock price.
Income Taxes
Management uses certain assumptions and estimates in determining the income taxes payable or refundable for the current year,
the deferred income tax liabilities and assets for items recognized differently in its financial statements from amounts shown on its
income tax returns, and the federal income tax expense. Determining these amounts requires analysis and interpretation of current
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.
Changes to the Internal Revenue Code of 1986, as amended, administrative rulings or court decisions could increase our effective
tax rate. In this regard, on August 16, 2007, the Internal Revenue Service (“IRS”) issued a revenue ruling that purports, among
other things, to modify the calculation of separate account deduction for dividends received by life insurance companies.
Subsequently, the IRS issued another revenue ruling that suspended the August 16 ruling and announced a new regulation project
on the issue.
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-not 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 Notes 2 and 7.
For information about acquisitions and divestitures, see “Part I – Item 1. Business – Acquisitions and Dispositions” and Note 3.
Acquisitions and Dispositions
68
RESULTS OF CONSOLIDATED OPERATIONS
Net Income
Details underlying the consolidated results and assets under management (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Revenues
Insurance premiums
Insurance fees
Investment advisory fees
Net investment income
Realized gain (loss)
Amortization of deferred gain on business sold
through reinsurance
Other revenues and fees
Total revenues
Benefits and Expenses
Interest credited
Benefits
Underwriting, acquisition, insurance and
other expenses
Interest and debt expense
Impairment of intangibles
Total benefits and expenses
Income from continuing operations before taxes
Federal income tax expense (benefit)
Income from continuing operations
Income (loss) from discontinued operations,
net of federal income tax expense (benefit)
Net income
$
2,096
3,229
268
4,208
(537)
$
1,947
3,190
360
4,378
(169)
$
1,406
2,564
328
3,923
13
76
543
9,883
2,501
3,157
3,576
281
393
9,908
(25)
(87)
62
83
686
10,475
2,435
2,562
3,320
284
-
8,601
1,874
553
1,321
76
569
8,879
2,191
1,906
2,776
228
-
7,101
1,778
483
1,295
(5)
57
$
(106)
1,215
$
21
1,316
$
8%
1%
-26%
-4%
NM
-8%
-21%
-6%
3%
23%
8%
-1%
NM
15%
NM
NM
-95%
95%
-95%
38%
24%
10%
12%
NM
9%
21%
18%
11%
34%
20%
25%
NM
21%
5%
14%
2%
NM
-8%
69
Revenues
Operating revenues:
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Excluded realized gain (loss), pre-tax
Amortization of deferred gain arising from
reserve changes on business sold through
reinsurance, pre-tax
Total revenues
Net Income
Income (loss) from operations:
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Excluded realized gain (loss), after-tax
Early extinguishment of debt
Income (loss) from reserve changes (net of related
amortization) on business sold through
reinsurance, after-tax
Impairment of intangibles, after-tax
Income from continuing operations, after-tax
Income (loss) from discontinued
operations, after-tax
Net income
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
2,610
936
3,546
$
2,533
986
3,519
$
2,060
988
3,048
4,250
1,640
5,890
438
327
439
(760)
4,189
1,500
5,689
590
370
473
(175)
3,470
1,032
4,502
564
308
444
12
3
9,883
$
9
10,475
$
1
8,879
$
3%
-5%
1%
1%
9%
4%
-26%
-12%
-7%
NM
-67%
-6%
23%
0%
15%
21%
45%
26%
5%
20%
7%
NM
NM
18%
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
193
123
316
$
485
181
666
$
399
204
603
541
104
645
28
50
(180)
(494)
-
2
(305)
62
719
114
833
76
46
(173)
(120)
-
(7)
-
1,321
531
99
630
55
39
(38)
9
(4)
1
-
1,295
(5)
57
$
(106)
1,215
$
21
1,316
$
-60%
-32%
-53%
-25%
-9%
-23%
-63%
9%
-4%
NM
NM
129%
NM
-95%
95%
-95%
22%
-11%
10%
35%
15%
32%
38%
18%
NM
NM
100%
NM
NM
2%
NM
-8%
70
Deposits
Retirement Solutions:
Annuities
Defined Contribution
Insurance Solutions - Life Insurance
Investment Management
Consolidating adjustments (1)
Total deposits
Net Flows
Retirement Solutions:
Annuities
Defined Contribution
Insurance Solutions - Life Insurance
Investment Management
Consolidating adjustments (1)
Total net flows
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
11,730
5,547
4,493
15,997
$
13,457
5,550
4,413
23,752
$
10,756
4,585
3,632
28,094
(4,637)
33,130
$
(4,015)
43,157
$
(3,838)
43,229
$
$
4,090
781
2,822
(9,270)
$
4,991
337
2,645
(1,372)
$
2,665
342
2,080
9,368
338
(1,239)
$
820
7,421
$
114
14,569
$
-13%
0%
2%
-33%
-15%
-23%
-18%
132%
7%
NM
-59%
NM
25%
21%
22%
-15%
-5%
0%
87%
-1%
27%
NM
NM
-49%
(1) Consolidating adjustments represents the elimination of deposits and net flows on products affecting more than one segment.
Assets Under Management by Advisor
Investment Management:
External assets
Inter-segment assets
Lincoln UK (excluding policy loans)
Policy loans
Assets administered through unaffiliated
third parties
Total assets under management
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2007
2006
$
46,574
73,648
5,978
2,923
$
75,686
77,088
10,243
2,886
$
83,577
81,166
10,104
2,811
48,885
178,008
$
70,824
236,727
$
55,916
233,574
$
-38%
-4%
-42%
1%
-31%
-25%
-9%
-5%
1%
3%
27%
1%
Comparison of 2008 to 2007
Net income decreased due primarily to the following:
(cid:120) Write-downs for other-than-temporary impairments on our available-for-sale securities increased by $411 million and were
(cid:120)(cid:3)
attributable primarily to unfavorable changes in credit quality and increases in credit spreads;
Impairment of goodwill and our FCC license intangible assets on our media business attributable primarily to declines in
advertising revenues for the entire radio market and impairment of our Lincoln UK goodwill due to deterioration in the
market; however, these non-cash impairments will not impact our future liquidity;
(cid:120)(cid:3) A $215 million unfavorable prospective unlocking (a $168 million decrease from assumption changes and a $47 million
decrease from model refinements) of DAC, VOBA, DSI, DFEL and the reserves for annuity and life insurance products with
living benefit and death benefit guarantees due primarily to significantly unfavorable equity markets in 2008 compared to a $12
million favorable prospective unlocking (a $28 million increase from assumption changes due primarily to lower lapses and
expenses and higher interest rates than our model projections assumed net of a $16 million decrease from model refinements)
in 2007 (see “Critical Accounting Policies and Estimates – DAC, VOBA, DSI and DFEL” for more information);
(cid:120)(cid:3) A $108 million unfavorable retrospective unlocking of DAC, VOBA, DSI, DFEL and the reserves for annuity and life
insurance products with living benefit and death benefit guarantees in 2008 due primarily to the impact of lower equity market
performance and premiums received and higher death claims and future GDB claims than our model projections assumed
compared to a $40 million favorable retrospective unlocking in 2007 due primarily to the impact of higher equity market
performance and persistency and lower expenses than our model projections assumed;
(cid:120) Higher benefits due primarily to an increase in the change in GDB reserves from an increase in our expected GDB benefit
payments attributable primarily to the decline in account values from the unfavorable equity markets and the increase in
71
reserves for products with secondary guarantees from continued growth of business in force and the effects of model
refinements along with higher mortality experience due to an increase in the average attained age of the in-force block and
lower benefits in the first quarter of 2007 related to a purchase accounting adjustment to the opening balance sheet of
Jefferson-Pilot;
(cid:120)(cid:3) Lower earnings from our variable annuity and mutual fund products as a result of declines in assets under management caused
by decreases in the equity markets;
(cid:120)(cid:3) Lower net investment income attributable primarily to less favorable investment income on surplus and alternative
investments and prepayment and bond makewhole premiums due primarily to deterioration of the capital markets (see
“Consolidated Investments – Alternative Investments” below for additional information on our alternative investments); and
(cid:120)(cid:3) A $16 million impact of the initial adoption of SFAS 157 on January 1, 2008.
The decrease in net income was partially offset by the following:
(cid:120)(cid:3) Favorable GLB net derivatives results due primarily to the inclusion in 2008 of an NPR adjustment as required under SFAS
157 attributable primarily to our widening credit spreads;
(cid:120)(cid:3) Lower DAC and VOBA amortization, net of interest and excluding unlocking, due primarily to declines in variable account
values from unfavorable equity markets during 2008;
(cid:120)(cid:3) The loss on disposition of our discontinued operations in 2007;
(cid:120)(cid:3) Growth in insurance fees driven by increases in life insurance in force as a result of new sales and favorable persistency
partially offset by unfavorable equity markets and adjustments during the second quarter of 2007 resulting from adjusting
account values for certain of our life insurance policies and modifying the accounting for certain of our life insurance policies;
(cid:120) A reduction in federal income tax expense due primarily to lower income from continuing operations, favorable tax audit
adjustments, and favorable tax return true-ups driven primarily by the separate account DRD and other items; and
(cid:120)(cid:3) Lower broker-dealer expenses due primarily to lower sales of non-proprietary products, lower merger expenses as many of our
integration efforts related to our acquisition of Jefferson-Pilot have been completed and lower incentive compensation
accruals as a result of lower earnings and production performance relative to planned goals.
Comparison of 2007 to 2006
Net income decreased due primarily to the following:
(cid:120)(cid:3) Write-downs for other-than-temporary impairments on our available-for-sale securities attributable primarily to unfavorable
changes in credit quality and interest rates;
(cid:120)(cid:3) An increase to realized loss due to the ineffectiveness of our GLB hedge program driven by significant volatility in the capital
markets along with a modification of the structure of some of our hedges in an effort to better match the sensitivities of the
embedded derivative liability going forward;
(cid:120)(cid:3) The loss on disposition of our discontinued operations in 2007;
(cid:120)(cid:3) An increase to underwriting, acquisition, insurance and other expenses due primarily to growth in account values from sales
and favorable equity markets and an increase in broker-dealer expenses, driven by an increase in incentive compensation
attributable to stronger sales performance and an increase in legal expenses for pending cases;
(cid:120)(cid:3) An increase in the effective tax rate to 30% from 27% attributable to a $25 million favorable tax return true-up in 2006
associated primarily with the separate account DRD;
(cid:120)(cid:3) The impact of adjustments during the second quarter of 2007 resulting from account value adjustments for certain of our life
insurance policies and modifying the accounting for certain of our life insurance policies; and
(cid:120)(cid:3) The adoption of SOP 05-1 on January 1, 2007, which increased DAC and VOBA amortization, net of deferrals by
approximately $11 million.
The decrease in net income was partially offset by the following:
(cid:120)(cid:3)
Including the results of operations from Jefferson-Pilot for twelve months in 2007 compared to only nine months in 2006;
(cid:120)(cid:3) Growth in insurance fees driven by increases in life insurance in force as a result of new sales and favorable persistency along
with increases in variable account values from favorable equity markets and positive net flows;
(cid:120)(cid:3) Growth in insurance premiums driven by increases in our Insurance Solutions – Group Protection non-medical group
business in force as a result of new sales and favorable persistency;
(cid:120)(cid:3) Higher investment income from stronger results from our alternative investments and growth in fixed account values,
including fixed portion of variable, driven by positive net flows and favorable equity markets (see “Consolidated Investments –
Alternative Investments” below for additional information on our alternative investments);
72
(cid:120)(cid:3) A $12 million favorable prospective unlocking (a $28 million increase from assumption changes net of a $16 million decrease
from model refinements) of DAC, VOBA, DSI, DFEL and the reserves for annuity and life insurance products with living
benefit and death benefit guarantees (discussed above) in 2007 compared to a $19 million unfavorable prospective unlocking
(an $18 million decrease from assumption changes due primarily to higher increase in reserves on products with secondary
guarantees, partially offset by improved mortality experience and expenses than our model projections assumed and a $1
million decrease from model refinements) in 2006 (see “Critical Accounting Policies and Estimates – DAC, VOBA, DSI and
DFEL” for more information); and
(cid:120)(cid:3)(cid:3)(cid:3)(cid:3)Growth in investment advisory fees driven by higher external average assets under management and favorable equity markets.
The foregoing items are discussed in further detail in results of operations by segment discussions and “Realized Gain (Loss)”
below. In addition, for a discussion of the earnings impact of the equity markets, see “Item 7A. Quantitative and Qualitative
Disclosures About Market Risk – Equity Market Risk – Impact of Equity Market Sensitivity.”
RESULTS OF RETIREMENT SOLUTIONS
The Retirement Solutions business provides its products through two segments: Annuities and Defined Contribution. The
Retirement Solutions – Annuities segment provides tax-deferred investment growth and lifetime income opportunities for its
clients by offering individual fixed annuities, including indexed annuities, and variable annuities. The Retirement Solutions –
Defined Contribution segment provides employer-sponsored variable and fixed annuities and mutual-fund based programs in the
401(k), 403(b) and 457 marketplaces.
Retirement Solutions – Annuities
Income from Operations
Details underlying the results for Retirement Solutions – Annuities (in millions) were as follows:
Operating Revenues
Insurance premiums
Insurance fees
Net investment income
Operating realized gain
Other revenues and fees (1)
Total operating revenues
Operating Expenses
Interest credited
Benefits
Underwriting, acquisition, insurance and other
expenses
Total operating expenses
Income from operations before taxes
Federal income tax expense (benefit)
Income from operations
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
136
963
972
219
$
118
998
1,032
6
$
47
751
976
1
320
2,610
698
452
1,322
2,472
379
2,533
659
170
1,060
1,889
285
2,060
624
92
855
1,571
138
(55)
193
$
644
159
485
$
489
90
399
$
15%
-4%
-6%
NM
-16%
3%
6%
166%
25%
31%
-79%
NM
-60%
151%
33%
6%
NM
33%
23%
6%
85%
24%
20%
32%
77%
22%
(1) Other revenues and fees consists primarily of broker-dealer earnings that are subject to market volatility.
73
Comparison of 2008 to 2007
Income from operations for this segment decreased due primarily to the following:
(cid:120) A $210 million unfavorable prospective unlocking from assumption changes of DAC, VOBA, DSI, DFEL and reserves for
our GDB riders in 2008 due primarily to significantly unfavorable equity markets, compared to a $7 million favorable
prospective unlocking (an $18 million favorable unlocking from assumption changes due primarily to favorable interest rates,
maintenance expenses and persistency, partially offset by less favorable asset-based fees than our model projections assumed,
net of an $11 million unfavorable unlocking from model refinements) in 2007 (see “Critical Accounting Policies and Estimates
– DAC, VOBA, DSI and DFEL” for more information);
(cid:120) A $50 million unfavorable retrospective unlocking of DAC, VOBA, DSI, DFEL and reserves for our guarantee riders in 2008
due primarily to the impact of lower equity market performance than our model projections assumed, compared to a $21
million favorable retrospective unlocking in 2007 due primarily to lower lapses and higher equity market performance than our
model projections assumed;
(cid:120) Higher benefits from an increase in the change in GDB reserves due to an increase in our expected GDB benefit payments
attributable primarily to the decline in account values due to the unfavorable equity markets;
(cid:120) Lower net investment income attributable primarily to less favorable investment income on surplus and alternative
investments due to deterioration of the capital markets (see “Consolidated Investments – Alternative Investments” below for
additional information on our alternative investments);
(cid:120) Lower insurance fees driven primarily by lower average daily variable account values due to unfavorable equity markets,
partially offset by increased surrender charges and higher average expense assessment rates due to continued growth in rider
elections that have incremental charges associated with them; and
(cid:120) A less favorable net broker-dealer margin attributable primarily to lower sales of non-proprietary products and lower earnings
due to the unfavorable equity markets.
The decrease in income from operations was partially offset by the following:
(cid:120) Lower underwriting, acquisition, insurance and other expenses, excluding unlocking, due primarily to lower DAC and VOBA
amortization, net of interest, driven by the declines in our variable account values from unfavorable equity markets during
2008 and lower incentive compensation accruals as a result of lower earnings and production performance relative to planned
goals; and
(cid:120) A reduction in federal income tax expense related to a $21 million favorable tax return true-up driven primarily by the separate
account DRD and other items in 2008, compared to a $2 million unfavorable tax return true-up and other items in 2007.
Future Expectations
We expect lower earnings for this segment in 2009 than we experienced in 2008, when excluding the impact of unlocking. The
expected decline is attributable to the following:
(cid:120) Lower expense assessments and higher changes in reserves related to our GDB features, partially offset by lower asset-based
expenses, due to the variable account value erosion from unfavorable equity market returns experienced during the fourth
quarter of 2008 resulting in lower account values at the end of 2008;
(cid:120) Lower investment income on the segment’s alternative investments due to the market conditions in both the equity and credit
markets (see “Consolidated Investments – Alternative Investments” below for additional information on our alternative
investments); and
(cid:120) Higher expenses attributable to our U.S. pension plans (see “Critical Accounting Policies and Estimates – Pension and Other
Postretirement Benefit Plans” above for additional information).
Although the segment’s results in 2008 were unfavorably impacted by declining account values and the economic environment, its
overall net flows were relatively strong in a challenging economic environment. New deposits are an important component of net
flows and key to our efforts to grow our business. Although deposits do not significantly impact current period income from
operations, they are an important indicator of future profitability.
The other component of net flows relates to the retention of the business. An important measure of retention is the lapse rate,
which compares the amount of withdrawals to the average account values. The overall lapse rate for our annuity products was 9%,
10% and 12% for 2008, 2007 and 2006, respectively. The segment’s lapse rates remained relatively flat when comparing 2008 to
2007 during a time of increasingly negative customer sentiment.
See Note 11 below for information on contractual guarantees to contract holders related to GDB features.
74
We expect to manage the effect of changing market investment returns by managing interest rate spreads for near-term income
from operations through a combination of crediting rate actions and portfolio management. Our expectation includes the
assumption that there are no significant changes in net flows in or out of our fixed accounts or other changes that may cause
interest rate spreads to differ from our expectation. For information on interest rate spreads and the interest rate risk due to falling
interest rates, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”
Our fixed annuity business includes products with crediting rates that are reset on an annual basis and are not subject to surrender
charges. Account values for these products were $4.9 billion as of December 31, 2008, with 41% already at their minimum
guaranteed rates. The average crediting rates for these products were approximately 51 basis points in excess of average minimum
guaranteed rates. Our ability to retain annual reset annuities will be subject to current competitive conditions at the time interest
rates for these products reset.
For factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk Factors” and
“Forward-Looking Statements – Cautionary Language” above.
Comparison of 2007 to 2006
Income from operations for this segment increased due primarily to the following:
(cid:120)
Including the results of operations from Jefferson-Pilot for twelve months in 2007 compared to only nine months in 2006;
(cid:120) Growth in insurance fees driven by higher average daily variable account values from favorable equity markets and positive net
flows and an increase in average expense assessment rates driven by the increase in account values with our guarantee riders
that have incremental charges associated with them; and
(cid:120) A $7 million favorable prospective unlocking of DAC, VOBA, DSI, DFEL and reserves for our GDB riders (discussed above)
in 2007 compared to a $1 million favorable prospective unlocking from assumption changes for 2006.
The increase in income from operations was partially offset by the following:
(cid:120)
Increases to underwriting, acquisition, insurance and other expenses attributable primarily to growth in account values from
sales and favorable equity markets and an increase in our broker-dealer expenses, driven by increases in incentive
compensation attributable to the strong sales performance and increases in legal expenses for pending cases;
(cid:120) The adoption of SOP 05-1 on January 1, 2007, which increased DAC and VOBA amortization, net of deferrals, by
approximately $6 million; and
(cid:120) An increase in the effective tax rate to 25% from 18% attributable to a $2 million unfavorable tax return true-up and other
items in 2007, compared to a $33 million favorable tax return true-up associated primarily with the separate account DRD in
2006.
We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are
recognized, key drivers of changes and historical details underlying the line items and their associated drivers below. For detail on
the operating realized gain, see “Realized Gain (Loss)” below.
75
Insurance Fees
Details underlying insurance fees, account values and net flows (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Insurance Fees
Mortality, expense and other assessments
Surrender charges
DFEL:
$
935
45
$
989
39
$
747
35
Deferrals
Prospective unlocking - assumption changes
Retrospective unlocking
Other amortization, net of interest
Total insurance fees
(50)
25
13
(5)
963
$
(45)
(1)
-
16
998
$
(40)
(3)
(1)
13
751
$
-5%
15%
-11%
NM
NM
NM
-4%
32%
11%
-13%
67%
100%
23%
33%
As of December 31,
2007
2008
Change Over Prior Year
2006
2008
2007
Account Values
Variable portion of variable annuities
Fixed portion of variable annuities
Total variable annuities
Fixed annuities, including indexed
Fixed annuities ceded to reinsurers
Total fixed annuities
Total account values
$
$
$
40,925
3,617
44,542
14,038
(1,125)
12,913
57,455
58,643
3,470
62,113
14,352
(1,352)
13,000
75,113
48,169
3,613
51,782
14,932
(1,812)
13,120
64,902
$
$
$
-30%
4%
-28%
-2%
17%
-1%
-24%
22%
-4%
20%
-4%
25%
-1%
16%
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Averages
Daily variable account values, excluding the fixed
portion of variable
Daily S&P 500
$
52,111
$
54,210
$
42,359
1,220.72
1,476.71
1,310.58
-4%
-17%
28%
13%
76
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
$
$
Net Flows on Account Values
Variable portion of variable annuity deposits
Variable portion of variable annuity withdrawals
Variable portion of variable annuity net flows
Fixed portion of variable annuity deposits
Fixed portion of variable annuity withdrawals
Fixed portion of variable annuity net flows
Total variable annuity deposits
Total variable annuity withdrawals
Total variable annuity net flows
Fixed indexed annuity deposits
Fixed indexed annuity withdrawals
Fixed indexed annuity net flows
Other fixed annuity deposits
Other fixed annuity withdrawals
Other fixed annuity net flows
Total annuity deposits
Total annuity withdrawals
Total annuity net flows
6,690
(4,813)
1,877
3,433
(549)
2,884
10,123
(5,362)
4,761
1,078
(441)
637
529
(1,837)
(1,308)
11,730
(7,640)
4,090
9,135
(5,089)
4,046
2,795
(644)
2,151
11,930
(5,733)
6,197
755
(245)
510
772
(2,488)
(1,716)
13,457
(8,466)
4,991
7,251
(4,080)
3,171
2,090
(697)
1,393
9,341
(4,777)
4,564
717
(175)
542
698
(3,139)
(2,441)
10,756
(8,091)
2,665
$
$
$
-27%
5%
-54%
23%
15%
34%
-15%
6%
-23%
43%
-80%
25%
-31%
26%
24%
-13%
10%
-18%
26%
-25%
28%
34%
8%
54%
28%
-20%
36%
5%
-40%
-6%
11%
21%
30%
25%
-5%
87%
Other Changes to Account Values
Interest credited and change in market value on
variable, excluding the fixed portion of variable
Transfers from the fixed portion of variable
annuity products to the variable portion of
variable annuity products
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
(22,187)
$
3,988
$
5,203
NM
-23%
2,798
2,440
1,890
15%
29%
We charge contract holders mortality and expense assessments on variable annuity accounts to cover insurance and administrative
expenses. These assessments are a function of the rates priced into the product and the average daily variable account values.
Average daily account values are driven by net flows and the equity markets. In addition, for our fixed annuity contracts and for
some variable contracts, we collect surrender charges when contract holders surrender their contracts during their surrender charge
periods to protect us from premature withdrawals. Insurance fees include charges on both our variable and fixed annuity products,
but exclude the attributed fees on our GLB products; see “Realized Gain (Loss) – Operating Realized Gain – GLB” below for
discussion of these attributed fees.
77
Net Investment Income and Interest Credited
Details underlying net investment income, interest credited (in millions) and our interest rate spread were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Net Investment Income
Fixed maturity securities, mortgage loans on real
estate and other, net of investment expenses
Commercial mortgage loan prepayment and bond
makewhole premiums (1)
Alternative investments (2)
Surplus investments (3)
Internal default charges (4)
Broker-dealer
Total net investment income
Interest Credited
Amount provided to contract holders
Opening balance sheet adjustment (5)
DSI deferrals
Interest credited before DSI amortization
DSI amortization:
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization
Total interest credited
$
901
$
914
$
886
3
(2)
67
10
1
101
7
2
81
-
3
972
$
-
6
1,032
$
(4)
4
976
$
$
727
$
746
$
691
-
(95)
632
(4)
(116)
626
-
(86)
605
37
-
13
16
698
$
(2)
1
(1)
35
659
$
(1)
-
(3)
23
624
$
-1%
-70%
NM
-34%
NM
-50%
-6%
-3%
100%
18%
1%
NM
-100%
NM
-54%
6%
3%
43%
-50%
25%
100%
50%
6%
8%
NM
-35%
3%
-100%
NM
67%
52%
6%
(1) See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums” below for
additional information.
(2) See “Consolidated Investments – Alternative Investments” below for additional information.
(3) Represents net investment income on the required statutory surplus for this segment.
(4) See “Results of Other Operations” below for information on this methodology discontinued in the third quarter of 2006.
(5) Net adjustment to the opening balance sheet of Jefferson-Pilot finalized in 2007.
78
Interest Rate Spread
Fixed maturity securities, mortgage loans on real
estate and other, net of investment expenses
Commercial mortgage loan prepayment and
bond make whole premiums
Alternative investments
Internal default charges
Net investment income yield on reserves
Amount provided to contract holders
Opening balance sheet adjustment
Interest rate credited to contract holders
Interest rate spread
For the Years Ended December 31,
2008
2006
2007
Basis Point Change
Over Prior Year
2008
2007
5.79%
5.87%
5.82%
0.02%
-0.01%
0.00%
5.80%
3.84%
0.00%
3.84%
1.96%
0.06%
0.00%
0.00%
5.93%
3.74%
-0.02%
3.72%
2.21%
0.05%
0.01%
-0.03%
5.85%
3.82%
0.00%
3.82%
2.03%
(8)
(4)
(1)
-
(13)
10
2
12
(25)
5
1
(1)
3
8
(8)
(2)
(10)
18
Note: The yields, rates and spreads above are calculated using whole dollars instead of dollars rounded to millions.
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Other Information
Average invested assets on reserves
Average fixed account values, including the
$
15,784
$
15,924
$
15,386
fixed portion of variable
17,263
17,560
16,525
Transfers from the fixed portion of variable
annuity products to the variable portion of
variable annuity products
Net flows for fixed annuities, including the
(2,798)
(2,440)
(1,890)
fixed portion of variable
2,213
945
(506)
-1%
-2%
-15%
134%
3%
6%
-29%
287%
A portion of our investment income earned is credited to the contract holders of our fixed annuity products, including the fixed
portion of variable annuity contracts. We expect to earn a spread between what we earn on the underlying general account
investments supporting the fixed annuity product line, including the fixed portion of variable annuity contracts, and what we credit
to our fixed annuity contract holders’ accounts, including the fixed portion of variable annuity contracts. The interest rate spread
for this segment represents the excess of the yield on invested assets on reserves over the average crediting rate. The yield on
invested assets on reserves is calculated as net investment income, excluding the amounts attributable to our surplus investments,
reverse repurchase agreement interest expense, inter-segment cash management account interest expense and interest on collateral
divided by average invested assets on reserves. The average invested assets on reserves is calculated based upon total invested
assets, excluding hedge derivatives and collateral. The average crediting rate is calculated as interest credited before DSI
amortization, plus the immediate annuity reserve change (included within benefits) divided by the average fixed account values,
including the fixed portion of variable annuity contracts, net of coinsured account values. Fixed account values reinsured under
modified coinsurance agreements are included in account values for this calculation. Changes in commercial mortgage loan
prepayments and bond makewhole premiums, investment income on alternative investments and surplus investment income can
vary significantly from period to period due to a number of factors and, therefore, may contribute to investment income results
that are not indicative of the underlying trends.
Benefits
Benefits for this segment include changes in reserves on immediate annuity account values driven by premiums, death benefits paid
and changes in reserves on GDBs.
The changes in reserves attributable to the segment’s benefit ratio unlocking of its SOP 03-1 reserves for GDB riders is offset in
operating realized gain. See “Realized Gain (Loss) – Operating Realized Gain – GDB” below for additional information.
79
Underwriting, Acquisition, Insurance and Other Expenses
Details underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Underwriting, Acquisition, Insurance and
Other Expenses
Total expenses incurred, excluding
broker-dealer
DAC and VOBA deferrals
Total pre-broker-dealer expenses incurred,
excluding amortization, net of interest
DAC and VOBA amortization, net of interest:
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization, net of interest
Broker-dealer expenses incurred
Total underwriting, acquisition, insurance
$
1,002
(686)
$
1,083
(774)
$
878
(612)
316
303
-
154
218
331
309
(28)
16
(32)
417
378
266
(1)
-
(19)
322
287
-7%
11%
2%
NM
-100%
NM
-48%
-12%
and other expenses
$
1,322
$
1,060
$
855
25%
DAC and VOBA Deferrals
As a percentage of sales/deposits
5.8%
5.8%
5.7%
23%
-26%
16%
NM
NM
-68%
30%
32%
24%
Commissions and other costs that vary with and are related primarily to the production of new business are deferred to the extent
recoverable and are amortized over the lives of the contracts in relation to EGPs. We have certain trail commissions that are based
upon account values that are expensed as incurred rather than deferred and amortized.
Broker-dealer expenses that vary with and are related to sales are expensed as incurred and not deferred and amortized. These
expenses are more than offset by increases to other income.
80
Retirement Solutions – Defined Contribution
Income from Operations
Details underlying the results for Retirement Solutions – Defined Contribution (in millions) were as follows:
Operating Revenues
Insurance fees
Net investment income
Operating realized gain
Other revenues and fees
Total operating revenues
Operating Expenses
Interest credited
Benefits
Underwriting, acquisition, insurance and other
expenses
Total operating expenses
Income from operations before taxes
Federal income taxes
Income from operations
Comparison of 2008 to 2007
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
222
695
4
15
936
$
259
709
-
18
986
$
230
738
-
20
988
430
14
418
-
411
-
340
784
152
29
123
$
315
733
253
72
181
$
297
708
280
76
204
$
-14%
-2%
NM
-17%
-5%
3%
NM
8%
7%
-40%
-60%
-32%
13%
-4%
NM
-10%
0%
2%
NM
6%
4%
-10%
-5%
-11%
Income from operations for this segment decreased due primarily to the following:
(cid:120) A $26 million unfavorable prospective unlocking from assumption changes of DAC, VOBA, DSI and reserves for our GDB
riders in 2008 due primarily to continued significantly unfavorable equity markets, compared to a $2 million unfavorable
prospective unlocking from assumption changes in 2007 due primarily to higher lapse rates and lower asset-based fees,
partially offset by lower expenses than our model projections assumed (see “Critical Accounting Policies and Estimates –
DAC, VOBA, DSI and DFEL” for more information);
(cid:120) Lower insurance fees driven primarily by lower average daily variable account values resulting from the unfavorable equity
markets and an overall shift in business mix toward products with lower expense assessment rates;
(cid:120) Lower net investment income attributable primarily to less favorable investment income on surplus and alternative
investments due to deterioration of the capital markets partially offset by higher average fixed account values (see
“Consolidated Investments – Alternative Investments” below for additional information on our alternative investments);
(cid:120) Higher interest credited driven primarily by higher average fixed account values, including the fixed portion of variable annuity
contracts, driven by transfers from variable to fixed;
(cid:120) Higher benefits from an increase in the change in GDB reserves due to an increase in our expected GDB benefit payments
attributable primarily to the decline in account values due to the unfavorable equity markets; and
(cid:120) A $9 million unfavorable retrospective unlocking of DAC, VOBA and DSI in 2008 due primarily to higher lapses,
maintenance expenses and future GDB claims than our model projections assumed compared to a $4 million unfavorable
retrospective unlocking in 2007 due primarily to higher lapses and less favorable asset-based fees than our model projections
assumed.
The decrease in income from operations was partially offset by the following:
(cid:120) Lower underwriting, acquisition, insurance and other expenses, excluding unlocking, due primarily to lower DAC and VOBA
amortization, net of interest, driven by the declines in our variable account values from unfavorable equity markets during
2008, the implementation of several expense management controls and practices that are focused on aggressively managing
expenses and lower incentive compensation accruals as a result of lower earnings and production performance relative to
planned goals; and
(cid:120) A reduction in federal income tax expense related to a favorable tax return true up in 2008.
81
Future Expectations
We expect lower earnings for this segment in 2009 than we experienced in 2008, when excluding the impacts of unlocking. The
expected decline is attributable to the following:
(cid:120) Lower expense assessments and higher changes in reserves related to our GDB features, partially offset by lower asset-based
expenses, due to the variable account value erosion from unfavorable equity market returns experienced during the fourth
quarter of 2008 resulting in lower account values at the end of 2008;
(cid:120) Lower investment income on the segment’s alternative investments due to the market conditions in both the equity and credit
markets (see “Consolidated Investments – Alternative Investments” below for additional information on our alternative
investments);
(cid:120) Lower insurance fees driven by a continuing overall shift in business mix toward products with lower expense assessments and
lower margins.; and
(cid:120) Higher expenses attributable to our U.S. pension plans (see “Critical Accounting Policies and Estimates – Pension and Other
Postretirement Benefit Plans” above for additional information).
Although the segment’s results in 2008 were unfavorably impacted by declining account values and the economic environment, its
overall net flows were relatively strong in a challenging economic environment.
New deposits are an important component of net flows and key to our efforts to grow our business. Although deposits do not
significantly impact current period income from operations, they are an important indicator of future profitability.
The other component of net flows relates to the retention of the business. An important measure of retention is the lapse rate,
which compares the amount of withdrawals to the average account values. The overall lapse rate for our annuity products was
15%, 15% and 13% for 2008, 2007 and 2006, respectively. The segment’s lapse rates remained flat when comparing 2008 to 2007.
Due to an expected overall shift in business mix towards products with lower expense assessment rates, a substantial increase in
new deposit production will be necessary to maintain earnings at current levels.
See Note 11 below for information on contractual guarantees to contract holders related to GDB features.
We expect to manage the effect of changing market investment returns by managing interest rate spreads for near-term income
from operations through a combination of crediting rate actions and portfolio management. Our expectation includes the
assumption that there are no significant changes in net flows in or out of our fixed accounts or other changes that may cause
interest rate spreads to differ from our expectation. For information on interest rate spreads and the interest rate risk due to falling
interest rates, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”
For factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk Factors” and
“Forward-Looking Statements – Cautionary Language” above.
Comparison of 2007 to 2006
Income from operations for this segment decreased due primarily to the following:
(cid:120) Lower net investment income driven by net outflows for fixed annuities, including the fixed portion of variable annuity
contracts and less favorable results from our investment income on alternative investments and prepayment and bond
makewhole premiums (see “Consolidated Investments – Alternative Investments” below for additional information on our
alternative investments);
(cid:120) Higher interest credited to contract holders attributable to an increase in crediting rates;
(cid:120) A $2 million unfavorable prospective unlocking of DAC, VOBA and DSI from assumption changes (discussed above) in 2007
compared to a $4 million favorable prospective unlocking from assumption changes in 2006 due primarily to lower long-term
interest rates and favorable margins, partially offset by lower persistency than our model projections assumed; and
(cid:120) Higher costs of investments in strategic initiatives associated with changes to and expansion of our wholesaling structure in
2007.
The decrease in income from operations was partially offset by growth in insurance fees driven by higher average daily variable
account values from favorable equity markets and positive net flows.
82
We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are
recognized, key drivers of changes and historical details underlying the line items and their associated drivers below. For detail on
the operating realized gain, see “Realized Gain (Loss)” below.
Insurance Fees
Details underlying insurance fees, account values and net flows (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Insurance Fees
Annuity expense assessments
Mutual fund fees
Total expense assessments
Surrender charges
Total insurance fees
$
$
$
197
19
216
6
222
234
17
251
8
259
210
12
222
8
230
-16%
12%
-14%
-25%
-14%
11%
42%
13%
0%
13%
$
$
$
Averages
Daily variable account values, excluding the fixed
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
portion of variable
Daily S&P 500
$
14,935
$
18,043
$
16,432
1,220.72
1,476.71
1,310.58
-17%
-17%
10%
13%
As of December 31,
2007
2008
Change Over Prior Year
2006
2008
2007
Account Values
Variable portion of variable annuities
Fixed portion of variable annuities
Total variable annuities
Fixed annuities
Total annuities
Mutual funds
Total annuities and mutual funds
$
$
$
10,588
6,037
16,625
5,601
22,226
6,652
28,878
17,876
5,893
23,769
4,996
28,765
7,293
36,058
17,476
6,210
23,686
4,796
28,482
5,174
33,656
$
$
$
-41%
2%
-30%
12%
-23%
-9%
-20%
2%
-5%
0%
4%
1%
41%
7%
83
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
$
$
Account Value Roll Forward – By Product
Total Micro – Small Segment:
Balance at beginning-of-period
Gross deposits
Withdrawals and deaths
Net flows
Transfers between fixed and variable accounts
Inter-product transfer (1)
Investment increase and change in market value
Balance at end-of-period
Total Mid – Large Segment:
Balance at beginning-of-period
Gross deposits
Withdrawals and deaths
Net flows
Transfers between fixed and variable accounts
Inter-product transfer (1)
Investment increase and change in market value
Balance at end-of-period
Total Multi-Fund ® and Other Variable Annuities:
Balance at beginning-of-period
Gross deposits
Withdrawals and deaths
Net flows
Transfers between fixed and variable accounts
Inter-segment transfer
Investment increase and change in market value
Balance at end-of-period
Total Annuities and Mutual Funds:
Balance at beginning-of-period
Gross deposits
Withdrawals and deaths
Net flows
Transfers between fixed and variable accounts
Inter-segment transfer
Investment increase and change in market value
Balance at end-of-period (2)
7,798
1,531
(1,740)
(209)
(8)
(653)
(2,040)
4,888
9,463
2,933
(871)
2,062
(55)
653
(2,583)
9,540
-
18,797
1,083
(2,155)
(1,072)
(2)
295
(3,568)
14,450
36,058
5,547
(4,766)
781
(65)
295
(8,191)
28,878
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
7,535
1,594
(1,931)
(337)
(5)
-
605
7,798
-
6,975
2,771
(724)
2,047
(17)
-
458
9,463
-
19,146
1,185
(2,558)
(1,373)
(6)
-
1,030
18,797
-
33,656
5,550
(5,213)
337
(28)
-
2,093
36,058
6,506
1,840
(1,540)
300
-
-
729
7,535
5,271
1,544
(434)
1,110
(4)
-
598
6,975
18,697
1,201
(2,269)
(1,068)
(6)
-
1,523
19,146
30,474
4,585
(4,243)
342
(10)
-
2,850
33,656
3%
-4%
10%
38%
-60%
NM
NM
-37%
36%
6%
-20%
1%
NM
NM
NM
1%
-2%
-9%
16%
22%
67%
NM
NM
-23%
7%
0%
9%
132%
NM
NM
NM
-20%
16%
-13%
-25%
NM
NM
NM
-17%
3%
32%
79%
-67%
84%
NM
NM
-23%
36%
2%
-1%
-13%
-29%
0%
NM
-32%
-2%
10%
21%
-23%
-1%
NM
NM
-27%
7%
(1) The Lincoln Employee 401(k) Plan transferred from LINCOLN DIRECTORSM to LINCOLN ALLIANCE® effective
(2)
September 30, 2008.
Includes mutual fund account values. Mutual funds are not included in the separate accounts reported on our Consolidated
Balance Sheets as we do not have any ownership interest in them.
84
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
$
$
Net Flows on Account Values
Variable portion of variable annuity deposits
Variable portion of variable annuity withdrawals
Variable portion of variable annuity net flows
Fixed portion of variable annuity deposits
Fixed portion of variable annuity withdrawals
Fixed portion of variable annuity net flows
Total variable annuity deposits
Total variable annuity withdrawals
Total variable annuity net flows
Fixed annuity deposits
Fixed annuity withdrawals
Fixed annuity net flows
Total annuity deposits
Total annuity withdrawals
Total annuity net flows
Mutual fund deposits
Mutual fund withdrawals
Mutual fund net flows
Total annuity and mutual fund deposits
Total annuity and mutual fund withdrawals
Total annuity and mutual fund net flows
2,170
(2,708)
(538)
369
(991)
(622)
2,539
(3,699)
(1,160)
812
(557)
255
3,351
(4,256)
(905)
2,196
(510)
1,686
5,547
(4,766)
781
2,355
(3,212)
(857)
351
(912)
(561)
2,706
(4,124)
(1,418)
754
(724)
30
3,460
(4,848)
(1,388)
2,090
(365)
1,725
5,550
(5,213)
337
2,525
(2,557)
(32)
441
(938)
(497)
2,966
(3,495)
(529)
506
(501)
5
3,472
(3,996)
(524)
1,113
(247)
866
4,585
(4,243)
342
-8%
16%
37%
5%
-9%
-11%
-6%
10%
18%
8%
23%
NM
-3%
12%
35%
5%
-40%
-2%
0%
9%
132%
-7%
-26%
NM
-20%
3%
-13%
-9%
-18%
NM
49%
-45%
NM
0%
-21%
NM
88%
-48%
99%
21%
-23%
-1%
$
$
$
Other Changes to Account Values
Interest credited and change in market value on
variable, excluding the fixed portion of variable
Transfers from the fixed portion of variable
annuity products to the variable portion of
variable annuity products
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
(5,942)
$
1,287
$
1,899
NM
-32%
(461)
(29)
(84)
NM
65%
We charge expense assessments to cover insurance and administrative expenses. Expense assessments are generally equal to a
percentage of the daily variable account values. Average daily account values are driven by net flows and the equity markets. Our
expense assessments include fees we earn for the services that we provide to our mutual fund programs. In addition, for both our
fixed and variable annuity contracts, we collect surrender charges when contract holders surrender their contracts during the
surrender charge periods to protect us from premature withdrawals.
85
Net Investment Income and Interest Credited
Details underlying net investment income, interest credited (in millions) and our interest rate spread were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Net Investment Income
Fixed maturity securities, mortgage loans on real
estate and other, net of investment expenses
Commercial mortgage loan prepayment and bond
makewhole premiums (1)
Alternative investments (2)
Surplus investments (3)
Total net investment income
$
655
$
646
$
659
7
(6)
6
2
17
8
39
695
$
55
709
$
54
738
$
Interest Credited
$
430
$
418
$
411
1%
17%
NM
-29%
-2%
3%
-2%
-65%
-75%
2%
-4%
2%
(1) See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums” below for
additional information.
(2) See “Consolidated Investments – Alternative Investments” below for additional information.
(3) Represents net investment income on the required statutory surplus for this segment.
Interest Rate Spread
Fixed maturity securities, mortgage loans on real
estate and other, net of investment expenses
Commercial mortgage loan prepayment and
bond makewhole premiums
Alternative investments
Net investment income yield on reserves
Interest rate credited to contract holders
Interest rate spread
For the Years Ended December 31,
2008
2006
2007
Basis Point Change
Over Prior Year
2008
2007
5.89%
6.03%
6.11%
0.06%
-0.05%
5.90%
3.79%
2.11%
0.06%
0.02%
6.11%
3.83%
2.28%
0.16%
0.07%
6.34%
3.73%
2.61%
(14)
-
(7)
(21)
(4)
(17)
(8)
(10)
(5)
(23)
10
(33)
Note: The yields, rates and spreads above are calculated using whole dollars instead of dollars rounded to millions.
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Other Information
Average invested assets on reserves
Average fixed account values, including the
$
11,113
$
10,712
$
10,785
fixed portion of variable
11,330
10,935
11,016
Transfers from the fixed portion of variable
annuity products to the variable portion of
variable annuity products
Net flows for fixed annuities, including the
fixed portion of variable
461
(367)
29
(531)
84
(492)
4%
4%
NM
31%
-1%
-1%
-65%
-8%
A portion of our investment income earned is credited to the contract holders of our fixed annuity products, including the fixed
portion of variable annuity contracts. We expect to earn a spread between what we earn on the underlying general account
investments supporting the fixed annuity product line, including the fixed portion of variable annuity contracts, and what we credit
to our fixed annuity contract holders’ accounts, including the fixed portion of variable annuity contracts. The interest rate spread
86
for this segment represents the excess of the yield on invested assets on reserves over the average crediting rate. The yield on
invested assets on reserves is calculated as net investment income, excluding the amounts attributable to our surplus investments,
reverse repurchase agreement interest expense, inter-segment cash management account interest expense and interest on collateral,
divided by average invested assets on reserves. The average invested assets on reserves are calculated based upon total invested
assets, excluding hedge derivatives. The average crediting rate is calculated as interest credited before DSI amortization, divided by
the average fixed account values, including the fixed portion of variable annuity contracts. Commercial mortgage loan
prepayments and bond makewhole premiums, investment income on alternative investments and surplus investment income can
vary significantly from period to period due to a number of factors and, therefore, may contribute to investment income results
that are not indicative of the underlying trends.
Benefits
Benefits for this segment include changes in reserves on GDBs and death benefits paid.
The changes in reserves attributable to the segment’s benefit ratio unlocking of its SOP 03-1 reserves for GDB riders is offset in
operating realized gain. See “Realized Gain (Loss) – Operating Realized Gain – GDB” below for additional information.
Underwriting, Acquisition, Insurance and Other Expenses
Details underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Underwriting, Acquisition, Insurance and
Other Expenses
Total expenses incurred
DAC deferrals
Total expenses recognized before amortization
DAC and VOBA amortization, net of interest:
Prospective unlocking - assumption changes
Retrospective unlocking
Other amortization, net of interest
Total underwriting, acquisition, insurance and
$
305
(94)
211
$
313
(92)
221
$
311
(88)
223
39
15
75
3
6
85
(7)
6
75
other expenses
$
340
$
315
$
297
DAC Deferrals
As a percentage of annuity sales/deposits
2.8%
2.7%
2.5%
-3%
-2%
-5%
NM
150%
-12%
8%
1%
-5%
-1%
143%
0%
13%
6%
Commissions and other costs, that vary with and are related primarily to the sale of annuity contracts, are deferred to the extent
recoverable and are amortized over the lives of the contracts in relation to EGPs. For certain annuity contracts, trail commissions
that are based upon account values are expensed as incurred rather than deferred and amortized. We do not pay commissions on
sales of our mutual fund products, and distribution expenses associated with the sale of these mutual fund products are not
deferred and amortized.
87
RESULTS OF INSURANCE SOLUTIONS
The Insurance Solutions business provides its products through two segments: Life Insurance and Group Protection. The
Insurance Solutions – Life Insurance segment offers wealth protection and transfer opportunities through term insurance, a linked-
benefit product (which is a UL policy linked with riders that provide for long-term care costs) and both single and survivorship
versions of UL and VUL, including corporate-owned UL and VUL (“COLI”) and bank-owned UL and VUL (“BOLI”) products.
The Insurance Solutions – Group Protection segment offers group life, disability and dental insurance to employers, and its
products are marketed primarily through a national distribution system of regional group offices. These offices develop business
through employee benefit brokers, TPAs and other employee benefit firms.
For factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk Factors” and
“Forward-Looking Statements – Cautionary Language” above.
Insurance Solutions – Life Insurance
Income from Operations
Details underlying the results for Insurance Solutions – Life Insurance (in millions) were as follows:
Operating Revenues
Insurance premiums
Insurance fees
Net investment income
Other revenues and fees
Total operating revenues
Operating Expenses
Interest credited
Benefits
Underwriting, acquisition, insurance and other
expenses
Total operating expenses
Income from operations before taxes
Federal income tax expense
Income from operations
Comparison of 2008 to 2007
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
360
1,871
1,988
31
4,250
$
351
1,734
2,069
35
4,189
$
322
1,421
1,685
42
3,470
1,202
1,363
877
3,442
1,173
1,089
842
3,104
1,007
901
765
2,673
808
267
541
$
1,085
366
719
$
797
266
531
$
3%
8%
-4%
-11%
1%
2%
25%
4%
11%
-26%
-27%
-25%
9%
22%
23%
-17%
21%
16%
21%
10%
16%
36%
38%
35%
Income from operations for this segment decreased due primarily to the following:
(cid:120) A $53 million unfavorable prospective unlocking of DAC, VOBA, DFEL and secondary guarantee life insurance product
reserves (a $34 million unfavorable unlocking from model refinements and a $19 million unfavorable unlocking from
assumption changes due primarily to the impact of significantly unfavorable equity markets on our VUL block of business,
partially offset by adjustments to reserves for products with secondary guarantees) in 2008 compared to a $4 million favorable
prospective unlocking (a $12 million favorable unlocking from assumption changes due primarily to lower lapses and expenses
and higher interest rates than our model projections assumed, net of an $8 million unfavorable unlocking from model
refinements) in 2007 (see “Critical Accounting Policies and Estimates – DAC, VOBA, DSI and DFEL” for more
information);
(cid:120) A $24 million unfavorable retrospective unlocking of DAC, VOBA, and DFEL in 2008 due primarily to lower premiums
received, higher death claims and lower investment income on alternative investments and prepayment and bond makewhole
premiums than our model projections assumed, compared to a $28 million favorable retrospective unlocking in 2007 due
primarily to higher persistency, higher investment income on alternative investments and prepayment and bond makewhole
premiums and lower expenses than our model projections assumed, partially offset by the impact of a correction to account
values;
(cid:120) An increase in benefits due primarily to an increase in reserves for products with secondary guarantees from continued growth
of business in force and the effects of model refinements along with higher mortality due to an increase in the average attained
88
age of the in-force block (discussed below) and lower benefits in the first quarter of 2007 related to a purchase accounting
adjustment to the opening balance sheet of Jefferson-Pilot, discussed below; and
(cid:120) Lower net investment income due primarily to unfavorable results from our investment income on alternative investments (see
“Consolidated Investments – Alternative Investments” below for additional information on our alternative investments) and
prepayment and bond makewhole premiums due to deterioration of the financial markets and reductions in statutory reserves
for products with secondary guarantees as a result of executing on a capital transaction to provide AG38 relief (see “Review of
Consolidated Financial Condition – Liquidity and Capital Resources – Sources of Liquidity and Cash Flow” for details), the
merger of several of our insurance subsidiaries and certain assumption changes in the fourth quarter of 2007.
The decrease in income from operations was partially offset by growth in insurance fees driven by an increase in business in force
as a result of new sales and favorable persistency and an increase in the average attained age of the in-force block (discussed below)
and the correction in the second quarter of 2007 discussed below.
A portion of the retrospective and prospective unlocking of DAC, VOBA, DFEL and secondary guarantee life insurance product
reserves in 2008 discussed above resulted in an additional unfavorable earnings impact of $7 million in both the third and fourth
quarters of 2008 that will recur in future quarters.
UL and VUL products with secondary guarantees represented approximately 34% of interest-sensitive life insurance in force as of
December 31, 2008, and approximately 68% of sales for these products for 2008. AG38 imposes additional statutory reserve
requirements for these products.
At June 30, 2007, we reduced statutory reserves related to our secondary guarantee UL products by approximately $150 million,
which has reduced the amount of net investment income allocated to this segment by $2 million per quarter. This statutory reserve
reduction related to modifying the accounting for certain of our life insurance policies. In October 2007, we released
approximately $300 million of capital that had previously supported our UL products with secondary guarantees as a result of
executing on a reinsurance transaction to release statutory reserves related to AG38. This reduction in capital lowered the level of
assets supporting this business, as assets were transferred to Other Operations, and has reduced net investment income by
approximately $5 million per quarter. As of December 31, 2007, we reduced statutory reserves related primarily to legal entity
consolidation by $344 million, which has reduced the amount of net investment income allocated to this segment by approximately
$5 million per quarter in 2008. This reduction in statutory reserves was primarily a result of the merger of several of our insurance
subsidiaries. As of December 31, 2008, we released approximately $240 million of capital that had previously supported our UL
products with secondary guarantees as a result of executing on a reinsurance transaction to release statutory reserves related to
AG38. This reduction in capital will lower the level of assets supporting this business, as assets were transferred to Other
Operations, and will reduce net investment income by approximately $4 million per quarter beginning in 2009.
On June 1, 2007, we implemented a 10 basis point decrease in crediting rates on most interest-sensitive products not already at
contractual guarantees, which has increased spreads approximately 5 basis points. On June 1, 2008, we implemented a 10 basis
point decrease in crediting rates on most interest-sensitive products not already at contractual guarantees, which has increased
spreads approximately 5 basis points. On March 1, 2009, we expect to implement a 15 basis point decrease in crediting rates on
most interest-sensitive products not already at contractual guarantees, which is expected to increase spreads approximately 5 basis
points.
At the end of 2008, the portfolio rate exceeded new money rates by roughly 15 basis points. We significantly reduced our level of
investment activity at year end in response to volatile capital markets and instead held higher levels of cash and short-term
investments. At the end of 2007, the portfolio rates exceeded new money rates by roughly 28 basis points. As of December 31,
2008, 47% of interest-sensitive account values have crediting rates at contract guaranteed levels, and 37% 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, which assumes no significant
changes in net flows into or out of our fixed accounts or other changes that may cause interest rate spreads to differ from our
expectations. For information on interest rate spreads and the interest rate risk due to falling interest rates, see “Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.”
Although the segment’s results in 2008 were unfavorably impacted by the U.S. recession, which began in December of 2007, its
new business products, as represented by sales, deposits and in-force face amount, were relatively strong.
Sales are not recorded as a component of revenues (other than for traditional products) and do not have a significant impact on
current quarter income from operations but are indicators of future profitability. Generally, we have higher sales during the second
half of the year with the fourth quarter being our strongest; however, results for 2008 were muted given the economic conditions.
The average issue age on new policies has increased in recent years as a result of targeting higher net worth individuals, which has
increased the average attained age of the in-force block. We have screening procedures to identify sales that we believe have
characteristics associated with stranger-originated life insurance in order to prevent policies with these characteristics from being
89
issued. However, accurate identification of these policies can be difficult, and we continue to modify our screening procedures.
We believe that our sales of UL products include some sales with stranger-originated life insurance characteristics. We expect no
significant impact to our profitability; however, returns on UL business sold as part of stranger-originated designs are believed to
be lower than traditional estate planning UL sales due in part to no expected lapses.
We expect higher expenses attributable to our U.S. pension plans (see “Critical Accounting Policies and Estimates – Pension and
Other Postretirement Benefit Plans” above for additional information) during 2009.
Comparison of 2007 to 2006
Income from operations for this segment increased due primarily to the following:
(cid:120)
Including the results of operations from Jefferson-Pilot for twelve months in 2007 compared to only nine months in 2006;
(cid:120) Growth in insurance fees driven by increase in business in force as a result of new sales and favorable persistency, partially
offset by a $41 million reduction related to the impact of the correction to account values and modifications of accounting
related to certain insurance contracts during the second quarter of 2007;
(cid:120) Higher investment income from growth in fixed product account values driven by positive net flows, higher statutory reserves
on products with secondary guarantees and stronger results from our investment income on alternative investments (see
“Consolidated Investments – Alternative Investments” below for additional information on our alternative investments);
(cid:120) A $28 million favorable retrospective unlocking of DAC, VOBA, and DFEL (discussed above) in 2007 compared to an $11
million favorable retrospective unlocking in 2006 due primarily to higher persistency, higher investment income on alternative
investments and prepayment and bond makewhole premiums and lower expenses than our model projections assumed,
partially offset by the impact of a correction to account values; and
(cid:120) A $4 million favorable prospective unlocking of DAC, VOBA, DFEL and secondary guarantee life insurance product reserves
(discussed above) in 2007 compared to a $20 million unfavorable prospective unlocking (a $19 million decrease from
assumption changes due primarily to higher increases in reserves on products with secondary guarantees, partially offset by
lower mortality and expenses than our model projections assumed and a $1 million decrease from model refinements) in 2006.
The increase in income from operations was partially offset by the following:
(cid:120) The adjustments to account values and modification of accounting related to certain life insurance policies with secondary
guarantees during the second quarter of 2007; and
(cid:120) Other increases to benefits due to growth in business in force, higher mortality and an increase in reserves for products with
secondary guarantees, partially offset by $14 million in the first quarter of 2007 related to adjustments to the opening balance
sheet of Jefferson-Pilot.
We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are
recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.
Insurance Premiums
Insurance premiums relate to traditional products and are a function of the rates priced into the product and the level of insurance
in force. Insurance in force, in turn, is driven by sales, persistency and mortality experience.
90
Insurance Fees
Details underlying insurance fees, sales, net flows, account values and in-force face amount (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Insurance Fees
Mortality assessments
Expense assessments
Surrender charges
DFEL:
Deferrals
Amortization, net of interest:
$
1,321
707
60
$
1,223
653
59
$
998
474
60
(379)
(364)
(206)
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization, net of interest
Total insurance fees
12
(25)
35
140
1,871
$
-
26
(9)
146
1,734
$
(2)
1
(7)
103
1,421
$
8%
8%
2%
-4%
NM
NM
NM
-4%
8%
23%
38%
-2%
-77%
100%
NM
-29%
3%
22%
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Sales by Product
UL:
Excluding MoneyGuard ®
MoneyGuard ®
Total UL
VUL
COLI and BOLI
Term/whole life
Total sales
Net Flows
Deposits
Withdrawals and deaths
Net flows
$
$
$
525
50
575
54
84
28
741
597
40
637
77
91
32
837
436
31
467
61
83
43
654
$
$
$
$
$
4,493
(1,671)
2,822
$
$
4,413
(1,768)
2,645
$
$
3,632
(1,552)
2,080
Contract holder assessments
$
2,791
$
2,521
$
2,037
-12%
25%
-10%
-30%
-8%
-13%
-11%
2%
5%
7%
11%
37%
29%
36%
26%
10%
-26%
28%
22%
-14%
27%
24%
Account Values
UL
VUL
Interest-sensitive whole life
Total account values
In-Force Face Amount
UL and other
Term insurance
Total in-force face amount
As of December 31,
2007
2008
Change Over Prior Year
2006
2008
2007
$
$
$
25,199
4,251
2,303
31,753
24,223
6,040
2,295
32,558
$
$
$
23,106
5,432
2,257
30,795
$
$
282,874
234,148
517,022
$
$
310,198
235,023
545,221
$
$
299,598
235,919
535,517
91
4%
-30%
0%
-2%
4%
0%
2%
5%
11%
2%
6%
6%
1%
4%
Insurance fees relate only to interest-sensitive products and include mortality assessments, expense assessments (net of deferrals
and amortization related to DFEL) and surrender charges. Mortality and expense assessments are deducted from our contract
holders’ account values. These amounts are a function of the rates priced into the product and premiums received, face amount in
force and account values. Insurance in force, in turn, is driven by sales, persistency and mortality experience. In-force growth
should be considered independently with respect to term products versus UL and other products, as term products have a lower
profitability relative to face amount compared to whole life and interest-sensitive products.
Sales in the table above and as discussed above were reported as follows:
(cid:120) UL (excluding linked-benefit products) and VUL (including COLI and BOLI) – first year commissionable premiums plus 5%
of excess premiums received, including an adjustment for internal replacements at approximately 50% of target;
(cid:120) MoneyGuard® (our linked-benefit product) – 15% of premium deposits; and
(cid:120) Whole life and term – 100% of first year paid premiums.
Net Investment Income and Interest Credited
Details underlying net investment income, interest credited (in millions) and our interest rate spread were as follows:
Net Investment Income
Fixed maturity securities, mortgage loans on real
estate and other, net of investment expenses
Commercial mortgage loan prepayment and
bond makewhole premiums (1)
Alternative investments (2)
Surplus investments (3)
Internal default charges (4)
Total net investment income
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
1,902
$
1,873
$
1,583
2%
18%
16
(11)
81
36
54
106
25
6
77
-
1,988
$
-
2,069
$
(6)
1,685
$
-56%
NM
-24%
NM
-4%
2%
44%
NM
38%
100%
23%
16%
Interest Credited
$
1,202
$
1,173
$
1,007
(1) See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums” below for
additional information.
(2) See “Consolidated Investments – Alternative Investments” below for additional information.
(3) Represents net investment income on the required statutory surplus for this segment and includes the impact of investment
income on alternative investments for such assets that are held in the surplus portfolios versus the product portfolios.
(4) See “Results of Other Operations” below for information on this methodology, which was discontinued in the third quarter of
2006.
92
Interest Rate Yields and Spread
Attributable to interest-sensitive products:
Fixed maturity securities, mortgage loans on real
estate and other, net of investment expenses
Commercial mortgage loan prepayment and
bond makewhole premiums
Alternative investments
Internal default charges
Net investment income yield on reserves
Interest rate credited to contract holders
Interest rate spread
Attributable to traditional products:
Fixed maturity securities, mortgage loans on real
estate and other, net of investment expenses
Commercial mortgage loan prepayment
and bond makewhole premiums
Alternative investments
Net investment income yield on reserves
For the Years Ended December 31,
2008
2006
2007
Basis Point Change
Over Prior Year
2008
2007
5.91%
6.06%
6.15%
0.05%
-0.03%
0.00%
5.93%
4.35%
1.58%
0.13%
0.21%
0.00%
6.40%
4.44%
1.96%
0.09%
0.02%
-0.03%
6.23%
4.51%
1.72%
6.13%
6.25%
6.45%
0.03%
-0.03%
6.13%
0.07%
0.01%
6.33%
0.11%
0.04%
6.60%
(15)
(8)
(24)
-
(47)
(9)
(38)
(12)
(4)
(4)
(20)
(9)
4
19
3
17
(7)
24
(20)
(4)
(3)
(27)
Averages
Attributable to interest-sensitive products:
Invested assets on reserves
Account values - universal and whole life
Attributable to traditional products:
Invested assets on reserves
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
27,003
27,136
$
25,787
25,900
$
21,202
21,838
5,058
5,063
4,446
5%
5%
0%
22%
19%
14%
A portion of the investment income earned for this segment is credited to contract holder accounts. Invested assets will typically
grow at a faster rate than account values because of the AG38 reserve requirements, which cause statutory reserves to grow at an
accelerated rate. Invested assets are based upon the statutory reserve liabilities and are therefore affected by various reserve
adjustments, primarily the result of the merger of several of our insurance subsidiaries, the modification of accounting for certain
of our life insurance policies, and by capital transactions providing relief from AG38 reserve requirements, which leads to a transfer
of invested assets from this segment to Other Operations for use in other corporate purposes. We expect to earn a spread
between what we earn on the underlying general account investments and what we credit to our contract holders’ accounts. The
interest rate spread for this segment represents the excess of the yield on invested assets on reserves over the average crediting rate
on interest-sensitive products. The yield on invested assets on reserves is calculated as net investment income, excluding amounts
attributable to our surplus investments and reverse repurchase agreement interest expense, divided by average invested assets on
reserves. In addition, we exclude the impact of earnings from affordable housing tax credit securities, which is reflected as a
reduction to federal income tax expense, from our spread calculations. Traditional products use interest income to build the policy
reserves. Commercial mortgage loan prepayments and bond makewhole premiums and investment income on alternative
investments can vary significantly from period to period due to a number of factors, and, therefore, may contribute to investment
income results that are not indicative of the underlying trends.
93
Benefits
Details underlying benefits (dollars in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Benefits
Death claims direct and assumed
Death claims ceded
Reserves released on death
Net death benefits
Change in reserves for products with
secondary guarantees:
$
2,177
(966)
(357)
854
$
1,944
(810)
(339)
795
$
1,644
(714)
(312)
618
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Other
Other benefits (1)
Total benefits
8
76
134
(3)
3
60
15
-
39
291
1,363
$
234
1,089
$
229
901
$
Death claims per $1,000 of inforce
1.59
1.52
1.31
(1) Other benefits includes primarily traditional product changes in reserves and dividends.
12%
-19%
-5%
7%
NM
NM
123%
24%
25%
5%
18%
-13%
-9%
29%
NM
NM
54%
2%
21%
16%
Benefits for this segment include claims incurred during the period in excess of the associated reserves for its interest-sensitive and
traditional products. In addition, benefits include the change in reserves for our products with secondary guarantees. The reserve
for secondary guarantees is impacted by changes in expected future trends of expense assessments causing unlocking adjustments
to this liability similar to DAC, VOBA and DFEL.
Underwriting, Acquisition, Insurance and Other Expenses
Details underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Underwriting, Acquisition, Insurance and
Other Expenses
Total expenses incurred
DAC and VOBA deferrals
Total expenses recognized before amortization
DAC and VOBA amortization, net of interest:
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization, net of interest
Other intangible amortization
Total underwriting, acquisition, insurance
$
1,338
(1,016)
322
$
1,458
(1,134)
324
$
1,154
(839)
315
34
(49)
71
495
4
(15)
36
(51)
544
4
12
2
(25)
458
3
and other expenses
$
877
$
842
$
765
DAC and VOBA Deferrals
As a percentage of sales
137.1%
135.5%
128.3%
-8%
10%
-1%
NM
NM
239%
-9%
0%
4%
26%
-35%
3%
NM
NM
NM
19%
33%
10%
Commissions and other general and administrative expenses that vary with and are related primarily to the production of new
business are deferred to the extent recoverable and for our interest-sensitive products are generally amortized over the lives of the
contracts in relation to EGPs. For our traditional products, DAC and VOBA are amortized on either a straight-line basis or as a
level percent of premium of the related contracts, depending on the block of business.
94
Insurance Solutions – Group Protection
Income from Operations
Details underlying the results for Insurance Solutions – Group Protection (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Operating Revenues
Insurance premiums
Net investment income
Other revenues and fees
Total operating revenues
Operating Expenses
Interest credited
Benefits
Underwriting, acquisition, insurance and other
expenses
Total operating expenses
Income from operations before taxes
Federal income taxes
Income from operations
$
1,517
117
6
1,640
2
1,107
371
1,480
160
56
104
$
$
1,380
115
5
1,500
$
949
80
3
1,032
-
999
-
663
326
1,325
175
61
114
$
217
880
152
53
99
$
10%
2%
20%
9%
NM
11%
14%
12%
-9%
-8%
-9%
45%
44%
67%
45%
NM
51%
50%
51%
15%
15%
15%
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Income from Operations by Product Line
Life
Disability
Dental
Total non-medical
Medical
Total income from operations
Comparison of 2008 to 2007
$
$
$
34
64
2
100
4
104
41
64
4
109
5
114
37
53
6
96
3
99
-17%
0%
-50%
-8%
-20%
-9%
11%
21%
-33%
14%
67%
15%
$
$
$
Income from operations for this segment decreased due to the following:
(cid:120) Less favorable total non-medical loss ratio experience, although still on the low end of our expected range; and
(cid:120) An increase to underwriting, acquisition, insurance and other expenses due primarily to growth in our business in force, higher
401(k) expenses, higher costs of investments in strategic initiatives associated with realigning our marketing and distribution
structure and an increase in the allocation of expenses to this segment.
The decrease in income from operations was partially offset by a growth in insurance premiums driven by normal, organic business
growth in our non-medical products and favorable persistency.
Although results for this segment were less favorable, new business production for this segment, as measured by sales, was
relatively strong. Sales relate to long-duration contracts sold to new contract holders and new programs sold to existing contract
holders. We believe that the trend in sales is an important indicator of development of business in force over time.
Management focuses on trends in loss ratios to compare actual experience with pricing expectations because group-underwriting
risks change over time. We believe that loss ratios in the 71-74% range are more representative of longer-term expectations for the
composite non-medical portion of this segment. We expect normal fluctuations in this range, as claim experience is inherently
uncertain, and there can be no assurance that experience will fall inside this expected range.
95
We expect higher expenses attributable to our U.S. pension plans during 2009. See “Critical Accounting Policies and Estimates –
Pension and Other Postretirement Benefit Plans” above for additional information.
Comparison of 2007 to 2006
Income from operations for this segment increased due to the following:
(cid:120) Growth in sales as a result of sales strength in our core, small case markets; and
(cid:120) This segment was added as a result of the merger with Jefferson-Pilot; therefore, the results of operations reflect twelve
months of activity in 2007 compared to only nine months in 2006.
The increase in income from operations was partially offset by the following:
(cid:120) Loss ratios in 2007 were not as favorable as the loss ratios in 2006 due primarily to the exceptional claims experience on all our
non-medical products during 2006; and
(cid:120) The adoption of SOP 05-1 on January 1, 2007, which increased DAC and VOBA amortization, net of deferrals, by
approximately $5 million.
We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are
recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.
Insurance Premiums
Details underlying insurance premiums (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Insurance Premiums by Product Line
Life
Disability
Dental
Total non-medical
Medical
Total insurance premiums
$
$
$
541
672
150
1,363
154
1,517
494
601
136
1,231
149
1,380
$
$
$
334
407
95
836
113
949
Sales
$
316
$
326
$
209
10%
12%
10%
11%
3%
10%
-3%
48%
48%
43%
47%
32%
45%
56%
Our cost of insurance and policy administration charges are embedded in the premiums charged to our customers. The premiums
are a function of the rates priced into the product and our business in force. Business in force, in turn, is driven by sales and
persistency experience. Sales in the table above are the combined annualized premiums for our life, disability and dental products.
The business represented as “medical” consists primarily of our non-core EXEC-U-CARE® product. This product provides an
insured medical expense reimbursement vehicle to executives for non-covered health plan costs. This product produces significant
revenues and benefits expenses for this segment but only a limited amount of income. Discontinuance of this product would
significantly impact segment revenues, but not income from operations.
Net Investment Income
We use our interest income to build the associated policy reserves, which is a function of our insurance premiums and the yields on
our invested assets.
96
Benefits and Interest Credited
Details underlying benefits and interest credited (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Benefits and Interest Credited by Product Line
Life
Disability
Dental
Total non-medical
Medical
Total benefits and interest credited
Loss Ratios by Product Line
Life
Disability
Dental
Total non-medical
Medical
$
$
$
401
456
117
974
135
1,109
360
406
104
870
129
999
$
$
$
233
262
68
563
100
663
11%
12%
13%
12%
5%
11%
55%
55%
53%
55%
29%
51%
73.9%
67.9%
78.3%
71.4%
87.6%
73.0%
67.5%
76.6%
70.7%
87.0%
69.7%
64.4%
72.2%
67.4%
88.2%
Note: Loss ratios presented above are calculated using whole dollars instead of dollars rounded to millions.
Underwriting, Acquisition, Insurance and Other Expenses
Details underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows:
For the Years Ended December 31,
2007
2006
2008
Underwriting, Acquisition, Insurance
and Other Expenses
Total expenses incurred
DAC and VOBA deferrals
Total expenses recognized before amortization
DAC and VOBA amortization, net of interest
Total underwriting, acquisition, insurance
$
393
(58)
335
36
$
349
(54)
295
31
$
238
(37)
201
16
and other expenses
$
371
$
326
$
217
DAC and VOBA Deferrals
As a percentage of insurance premiums
3.8%
3.9%
3.9%
Change Over Prior Year
2008
2007
13%
-7%
14%
16%
14%
47%
-46%
47%
94%
50%
Expenses, excluding broker commissions, that vary with and are related primarily to the production of new business are deferred to
the extent recoverable and are amortized on either a straight-line basis or as a level percent of premium of the related contracts
depending on the block of business. Broker commissions, which vary with and are related to paid premiums, are expensed as
incurred. The level of expenses is an important driver of profitability for this segment as group insurance contracts are offered
within an environment that competes on the basis of price and service.
97
RESULTS OF INVESTMENT MANAGEMENT
The Investment Management segment, through Delaware Investments, provides a broad range of managed account portfolios,
mutual funds, sub-advised 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 affiliates.
Income from Operations
Details underlying the results for Investment Management (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Operating Revenues
Investment advisory fees – external
Investment advisory fees – inter-segment
Other revenues and fees
Total operating revenues
Operating Expenses
Underwriting, acquisition, insurance and other
expenses
Income from operations before taxes
Federal income taxes
Income from operations
Pre-tax operating margin (1)
$
268
82
88
438
$
360
87
143
590
$
328
97
139
564
393
45
17
28
$
471
119
43
76
$
480
84
29
55
$
10%
20%
15%
-26%
-6%
-38%
-26%
-17%
-62%
-60%
-63%
10%
-10%
3%
5%
-2%
42%
48%
38%
(1) The pre-tax operating margin is determined by dividing pre-tax income from operations by operating revenues.
Comparison of 2008 to 2007
Income from operations decreased due primarily to the following:
(cid:120) A reduction in investment advisory fees due to lower assets under management resulting primarily from continued significant
unfavorable equity markets, an increase in negative net flows, the sale of certain institutional fixed income business in 2007
(discussed below) and the transition of the investment advisory role for the Lincoln Variable Insurance Trust product to
another internal advisor within Retirement Solutions (discussed below); and
(cid:120) A reduction in other revenues and fees due primarily to negative returns on seed capital driven by continued significant
unfavorable equity markets.
The decrease in income from operations was partially offset by the elimination of expenses as a result of the transfer of assets
under management in 2007 discussed below, lower asset-based expenses, transitioning the investment accounting function to a
third party, the implementation of several expense management controls and practices that are focused on prudently managing
expenses and lower incentive compensation accruals as a result of lower earnings and production performance relative to planned
goals.
On October 31, 2007, we sold certain institutional taxable fixed income business to an unaffiliated investment management
company. As a result of this transaction, assets under management decreased by $12.3 billion, which resulted in a $16 million
decrease to investment advisory fees – external in 2008.
Effective May 1, 2007, the investment advisory role for the Lincoln Variable Insurance Trust product transitioned to Retirement
Solutions. In the role of investment advisor, Investment Management provided investment performance and compliance oversight
on third-party investment managers in exchange for a fee. Investment Management will continue to manage certain of the assets
as a sub-advisor. As a result of this change, Investment Management’s assets under management decreased by $3.2 billion;
however, there was no impact to our consolidated assets under management or consolidated net income.
98
Future Expectations
We expect lower earnings for this segment in 2009 than we experienced in 2008 due primarily to lower investment advisory fees,
partially offset by lower asset-based expenses, due to the asset under management erosion from unfavorable equity market returns
and negative net flows experienced during 2008.
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.
For factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk Factors” and
“Forward-Looking Statements – Cautionary Language” above.
Comparison of 2007 to 2006
Income from operations increased due primarily to an increase in investment advisory fees – external due to higher third-party
average assets under management as a result of positive equity market returns.
The increase in income from operations was partially offset by a decrease in investment advisory fees – inter-segment, net of
related operating expenses, due to the transfer of assets to an internal advisor within Retirement Solutions, mentioned above,
higher one-time expenses in 2007 associated with a legal expense accrual for existing cases and the launch of Delaware Enhanced
Global Dividend and Income Fund, a new closed-end fund.
We provide information about certain of this segment’s operating revenue and operating expense line items, the period in which
amounts are recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.
Investment Advisory Fees
Details underlying assets under management and net flows (in millions) were as follows:
As of December 31,
2007
2008
Change Over Prior Year
2006
2008
2007
Assets Under Management
Retail – equity
Retail – fixed
Total retail
Institutional – equity
Institutional – fixed
Total institutional
Inter-segment assets – retail and institutional
Inter-segment assets – general account
Total inter-segment assets
Total assets under management
Total Sub-Advised Assets, Included Above
Retail
Institutional
Total sub-advised assets
$
15,222
10,453
25,675
11,203
9,696
20,899
7,968
65,680
73,648
120,222
$
$
31,598
10,801
42,399
21,751
11,536
33,287
9,671
67,417
77,088
152,774
$
$
31,705
8,790
40,495
21,977
21,105
43,082
13,729
67,437
81,166
164,743
$
$
8,047
2,180
10,227
$
$
$
16,219
4,570
20,789
$
$
18,023
4,648
22,671
-52%
-3%
-39%
-48%
-16%
-37%
-18%
-3%
-4%
-21%
-50%
-52%
-51%
0%
23%
5%
-1%
-45%
-23%
-30%
0%
-5%
-7%
-10%
-2%
-8%
99
For the Years Ended December 31,
2006
2007
2008
$
$
$
Net Flows – External (1) (2)
Retail equity sales
Retail equity redemptions and transfers
Retail equity net flows
Retail fixed income sales
Retail fixed income redemptions and transfers
Retail fixed income net flows
Total retail sales
Total retail redemptions and transfers
Total retail net flows
Institutional equity inflows
Institutional equity withdrawals and transfers
Institutional equity net flows
Institutional fixed income inflows
Institutional fixed income withdrawals and transfers
Institutional fixed income net flows
Total institutional inflows
Total institutional redemptions and transfers
Total institutional net flows
Total sales/inflows
Total redemptions and transfers
Total net flows
4,033
(9,470)
(5,437)
4,901
(4,466)
435
8,934
(13,936)
(5,002)
2,972
(5,229)
(2,257)
1,357
(2,879)
(1,522)
4,329
(8,108)
(3,779)
13,263
(22,044)
(8,781)
6,916
(8,942)
(2,026)
4,390
(2,898)
1,492
11,306
(11,840)
(534)
4,369
(6,515)
(2,146)
5,582
(3,500)
2,082
9,951
(10,015)
(64)
21,257
(21,855)
(598)
$
$
$
Change Over Prior Year
2008
-42%
-6%
NM
12%
-54%
-71%
-21%
-18%
NM
-32%
20%
-5%
-76%
18%
NM
-56%
19%
NM
-38%
-1%
NM
2007
-14%
-30%
NM
48%
-21%
159%
3%
-28%
NM
-19%
-42%
NM
-36%
NM
-71%
-30%
-65%
NM
-16%
-42%
NM
8,058
(6,894)
1,164
2,966
(2,389)
577
11,024
(9,283)
1,741
5,409
(4,580)
829
8,760
(1,477)
7,283
14,169
(6,057)
8,112
25,193
(15,340)
9,853
(1) Includes Delaware Variable Insurance Product funds. Our insurance subsidiaries, as well as unaffiliated insurers, participate in
these funds. In addition, sales/inflows includes contributions, dividend reinvestments and transfers in kind, and
redemptions/transfers includes dividends and capital gain distributions.
(2) Excludes $12.3 billion in institutional fixed income business sold to an unaffiliated investment management company in 2007
and $201 million and $190 million of 529 Plan assets transferred to an unaffiliated 529 Plan provider in 2007 and 2006,
respectively, because we do not consider these to be net flows.
Net Flows – Inter-Segment (1)
Total sales/inflows (2)
Total redemptions and transfers (3)
Total net flows
For the Years Ended December 31,
2006
2007
2008
$
2,734
(3,223)
(489)
$
$
2,495
(3,269)
(774)
$
$
2,901
(3,386)
(485)
$
Change Over Prior Year
2008
10%
1%
37%
2007
-14%
3%
-60%
(1)
(2)
(3)
Includes net flows from retail and institutional. Excludes net flows from the general account and the transfer in of $709
million in assets primarily from another internal advisor in Retirement Solutions during 2008 and the transfer of $3.2 billion in
assets to another internal advisor and $780 million in assets to Other Operations during 2007 because we do not consider
these to be net flows.
Includes contributions, dividend reinvestments and transfers in kind.
Includes dividends and capital gains distributions.
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Other Information
Average daily S&P 500
Reinvested dividends and interest and change
1,220.72
1,476.71
1,310.58
in market value
$
(22,281)
$
5,966
$
10,496
-17%
NM
13%
-43%
100
Investment advisory fees are generally a function of the rates priced into the product and our average assets under management,
which are driven by net flows and capital markets. Investment advisory fees – external 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.
Investment advisory fees – inter-segment consists of fees for asset management services this segment provides to Retirement
Solutions and Insurance Solutions for managing general account assets supporting fixed income products, surplus and separate
account assets. These inter-segment amounts are not reported on our Consolidated Statements of Income as they are eliminated
along with the associated expenses incurred by Retirement Solutions and Insurance Solutions. Retirement Solutions and Insurance
Solutions report the cost as a reduction to net investment income, which is the same methodology that would be used if these
services were provided by an external party.
Other Revenues and Fees
Other revenues and fees consists primarily of revenues generated from shareholder and administrative services, 12b-1 fees and the
results from seed capital investments. Seed capital investments are important to establishing a track record for products that will
later be sold to investors. These investments are valued at market value each reporting period and the change in market value
impacts other revenues.
RESULTS OF LINCOLN UK
Lincoln UK is headquartered in Barnwood, Gloucester, England, and is licensed to do business throughout the United Kingdom.
Lincoln UK focuses primarily 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 life and retirement income products. 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 contract holders. 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 in the
value of the U.S. dollar relative to the British pound would have a significant adverse effect on the segment’s operating results.
Income from Operations
Details underlying the results for Lincoln UK (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Operating Revenues
Insurance premiums
Insurance fees
Net investment income
Total operating revenues
Operating Expenses
Benefits
Underwriting, acquisition, insurance and other
expenses
Total operating expenses
Income from operations before taxes
Federal income tax expense
Income from operations
Exchange Rate Ratio - U.S. Dollars to
Pounds Sterling
Average for the period
End-of-period
$
78
171
78
327
$
95
194
81
370
$
79
158
71
308
107
137
108
143
250
77
27
50
$
163
300
70
24
46
$
140
248
60
21
39
$
1.865
1.459
2.007
1.987
1.847
1.958
-18%
-12%
-4%
-12%
-22%
-12%
-17%
10%
13%
9%
-7%
-27%
20%
23%
14%
20%
27%
16%
21%
17%
14%
18%
9%
1%
101
Comparison of 2008 to 2007
Excluding the effect of the exchange rate, income from operations for this segment increased 17% due primarily the recording of a
value added tax refund based on approval of our claim by U.K. tax authorities in 2008.
The increase in income from operations was partially offset by the following:
(cid:120) A decline in insurance fees driven by lower average unit-linked account values resulting primarily from unfavorable markets as
the average value of the Financial Time Stock Exchange (“FTSE”) 100 index was 16% lower;
(cid:120) A reduction in premiums due primarily to declines in the annuitization of vesting pension policies and the face amount of our
insurance in force attributable to the maturity of the block of business; and
(cid:120) A $3 million unfavorable prospective unlocking of DAC, VOBA and DFEL (a $13 million unfavorable unlocking from model
refinements net of a $10 million favorable unlocking from assumption changes related primarily to lower maintenance
expenses and higher persistency than our model projections assumed) in 2008 compared to a $2 million favorable prospective
unlocking (a $4 million favorable unlocking from assumption changes related primarily to higher investment income, lower
maintenance expenses and lower mortality than our model projections assumed, net of a $2 million unfavorable unlocking
from model refinements) in 2007.
Future Expectations
We expect lower earnings for this segment in 2009 than we experienced in 2008, when excluding the impacts of unlocking. The
expected decline is attributable to the following:
(cid:120) Continued deterioration in general economic and business conditions that we believe will result in lower investment fee
income and less favorable foreign exchange rates;
(cid:120) Lower net investment income on the segment’s fixed deposits from the continuation of the low interest rate environment; and
(cid:120) Lower net flows on unit-linked assets due to the current economic challenges, including the current expectation by analysts for
the economic downturn to last through the first half of 2009 and unemployment to continue to increase until early 2010.
For factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk Factors” and
“Forward-Looking Statements – Cautionary Language” above.
Comparison of 2007 to 2006
Excluding the effect of the exchange rate, income from operations for this segment increased 9% due primarily to the following:
(cid:120) Growth in insurance fees driven by higher average unit-linked account values resulting primarily from favorable markets as the
average value of the FTSE 100 index was 8% higher, an increase in linked-taxes deducted from unit-linked funds due to
increasing bond values, partially offset by surrender penalties and declines in older blocks of business; and
(cid:120) A $2 million favorable prospective unlocking of DAC, VOBA and DFEL (discussed above) in 2007 compared to a $6 million
unfavorable prospective unlocking (a $5 million unfavorable unlocking from assumption changes related primarily to lower
retention rates for our pension business than our model projections assumed and a $1 million unfavorable unlocking from
model refinements) in 2006.
The increase in income from operations was partially offset by an increase in our mis-selling reserves.
We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are
recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.
102
Insurance Premiums
Excluding the effect of the exchange rate, insurance premiums are primarily a function of the rates priced into the product and face
amount of our insurance in force.
Our annualized policy lapse rate was 6.3%, 6.4% and 6.7% for 2008, 2007 and 2006, respectively, as measured by the number of
policies in force.
Insurance Fees
Details underlying insurance fees, business in force and unit-linked assets (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Insurance Fees
Mortality assessments
Expense assessments
DFEL:
Deferrals
Amortization, net of interest:
$
34
116
$
37
125
$
34
115
(3)
(3)
(3)
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization, net of interest
Total insurance fees
(1)
-
-
25
171
$
(3)
8
-
30
194
$
(15)
3
(1)
25
158
$
-8%
-7%
0%
67%
-100%
NM
-17%
-12%
9%
9%
0%
80%
167%
100%
20%
23%
Individual life insurance in force
2008
12,284
$
As of December 31,
2007
19,022
$
2006
19,345
$
Change Over Prior Year
2008
-35%
2007
-2%
Excluding the effect of the exchange rate, individual life insurance in force decreased 12% in 2008 and 3% in 2007.
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Unit-Linked Assets
Balance at beginning-of-period
Deposits
Withdrawals and deaths
Net flows
Investment income and change in market value
Foreign currency adjustment
Balance at end-of-period
$
$
$
8,850
299
(767)
(468)
(1,524)
(1,880)
4,978
8,757
323
(969)
(646)
601
138
8,850
7,320
318
(838)
(520)
911
1,046
8,757
$
$
$
1%
-7%
21%
28%
NM
NM
-44%
20%
2%
-16%
-24%
-34%
-87%
1%
Excluding the effect of the exchange rate, unit-linked assets decreased 23% in 2008 and were unchanged in 2007.
The insurance fees reflect mortality and expense assessments on unit-linked account values to cover insurance and administrative
charges. These assessments, excluding the effect of the exchange rate, are primarily a function of the rates priced into the product,
the face amount of insurance in force and the average unit-linked assets, which is driven by net flows on the account values and the
financial markets. The segment’s fee income remains subject to volatility in the equity markets as it affects the level of the
underlying assets that drive the fee income.
103
Net Investment Income
We use our interest income to build the associated policy reserves, which is a function of our insurance premiums and the yields on
our invested assets.
Benefits
Benefits for this segment are recognized when incurred and include claims during the period in excess of the associated account
balance for its unit-linked products.
Underwriting, Acquisition, Insurance and Other Expenses
Details underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Underwriting, Acquisition, Insurance and
Other Expenses
Total expenses incurred
DAC and VOBA deferrals
Total expenses recognized before amortization
DAC and VOBA amortization, net of interest:
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization, net of interest
Total underwriting, acquisition, insurance
$
100
(3)
97
$
114
(4)
110
$
104
(2)
102
(16)
20
(4)
46
(9)
11
(1)
52
(7)
4
(2)
43
and other expenses
$
143
$
163
$
140
-12%
25%
-12%
-78%
82%
NM
-12%
-12%
10%
-100%
8%
-29%
175%
50%
21%
16%
Commissions and other costs, which vary with and are related primarily to the production of new business, are deferred to the
extent recoverable. DAC and VOBA related to unit-linked business are amortized over the lives of the contracts in relation to
EGPs. For our traditional products, DAC and VOBA are amortized on either a straight-line basis or as a level percent of premium
of the related contracts depending on the block of business.
104
RESULTS OF OTHER OPERATIONS
Other Operations includes investments related to the excess capital in our insurance subsidiaries, investments in media properties
and other corporate investments, benefit plan net assets, the unamortized deferred gain on indemnity reinsurance, which was sold
to Swiss Re in 2001, external debt and business sold through reinsurance. We are actively managing our remaining radio station
clusters to maximize performance and future value. Other Operations also includes the Institutional Pension business, which was
previously reported in Employer Markets – Retirement Products prior to our segment realignment discussed in “Introduction –
Executive Summary.” The Institutional Pension business is a closed-block of pension business, the majority of which was sold on
a group annuity basis, and is currently in run-off.
Loss from Operations
Details underlying the results for Other Operations (in millions) were as follows:
Operating Revenues
Insurance premiums
Net investment income
Amortization of deferred gain on business
sold through reinsurance
Media revenues (net)
Other revenues and fees
Inter-segment elimination of investment
advisory fees
Total operating revenues
Operating Expenses
Interest credited
Benefits
Media expenses
Other expenses
Interest and debt expenses
Inter-segment elimination of investment
advisory fees
Total operating expenses
Loss from operations before taxes
Federal income tax benefit
Loss from operations
Comparison of 2008 to 2007
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
4
$
358
$
3
372
9
$
373
74
85
-
(82)
439
171
113
60
165
281
74
107
4
(87)
473
185
146
56
176
284
75
85
(1)
(97)
444
149
141
41
79
223
(82)
708
(269)
(89)
(180)
$
(87)
760
(287)
(114)
(173)
$
(97)
536
(92)
(54)
(38)
$
33%
-4%
0%
-21%
-100%
6%
-7%
-8%
-23%
7%
-6%
-1%
6%
-7%
6%
22%
-4%
-67%
0%
-1%
26%
NM
10%
7%
24%
4%
37%
123%
27%
10%
42%
NM
NM
NM
Loss from operations for this segment increased due primarily to the following:
(cid:120) Lower media earnings related primarily to declines in discretionary business spending, such as advertising, caused by the
general weakening of the U.S. economy in 2008 causing the media market revenues to decline faster than expected;
(cid:120) Lower net investment income from a reduction in invested assets driven by transfers to other segments for other-than-
temporary impairments, share repurchases and dividends paid to stockholders as these items exceeded the distributable
earnings received from our insurance segments, dividends received from our other segments and issuances of debt; and
(cid:120) Less favorable tax items that impacted the effective tax rate related primarily to changes in tax preferred investments.
The increase in loss from operations was partially offset by the following:
(cid:120) Lower other expenses due primarily to higher merger-related expenses as a result of higher system integration work related to
our administrative systems, a separation benefit related to the retirement of a key executive and a net expense related to
changes in our employee benefit plans in 2007, partially offset by restructuring charges associated with expense initiatives,
105
relocation costs associated with the move of our corporate office and increases in litigation expense and incentive
compensation expense in 2008; and
(cid:120) Lower benefits due to unfavorable mortality in our Institutional Pension business in 2007.
Future Expectations
We expect lower earnings for Other Operations in 2009 than was experienced in 2008. The expected decline is attributable
primarily to the following:
(cid:120) Higher expenses attributable to restructuring charges related to recently announced expense reduction initiatives that are
discussed further below;
(cid:120) Lower investment income by approximately $14 million, after-tax, due to lower dividend income from our holdings of Bank of
America common stock as it announced dividend rate cuts during the latter part of 2008 and early 2009;
(cid:120) Lower investment income from a reduction in the distributable earnings that will be received from our insurance segments and
lower dividends received from our other segments due to the current economic challenges, including the current expectation
by analysts for the economic downturn to last through the first half of 2009 and unemployment to continue to increase until
early 2010;
(cid:120) Lower investment income on alternative investment income due to the market conditions in both the equity and credit
markets (see “Consolidated Investments – Alternative Investments” below for additional information on our alternative
investments);
(cid:120) Lower investment income on fixed maturity securities and mortgage loans on real estate from the continuation of the low
interest rate environment;
(cid:120) Lower media earnings as we believe customers will continue to reduce their advertising expenses in response to the credit
markets; and
(cid:120) Higher expenses attributable to our U.S. pension plans (see “Critical Accounting Policies and Estimates – Pension and Other
Postretirement Benefit Plans” above for additional information).
In addition to the above, Other Operations may be affected by the rescission of the reinsurance of disability income business
previously sold to Swiss Re. For additional information on this matter, see “Reinsurance” below.
Sustained market volatility and the economic environment continue to put pressure on many industries and companies, including
our own. After reviewing the impact of this difficult economy on our anticipated sales and business activities, we initiated actions
in the fourth quarter to streamline operations, reduce expenses and ensure that staffing levels were aligned with expected business
activity. We focused on reducing the workforce, reducing capital spending and addressing corporate-wide discretionary spending.
As a result of shrinking revenues due to the impact of unfavorable equity markets on our asset management businesses and a
reduction in sales volumes caused by the unfavorable economic environment, we have launched initiatives to reduce expenses,
including staff layoffs, that we believe will improve our capital position and preserve profits. The restructuring costs associated
with these layoffs will be included within Other Operations’ expenses during 2009. See Note 17 for additional information.
For factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk Factors” and
“Forward-Looking Statements – Cautionary Language” above.
Comparison of 2007 to 2006
Loss from operations for this segment increased due primarily to the following:
(cid:120)
Including the unfavorable results of operations from Jefferson-Pilot for twelve months in 2007 compared to only nine months
in 2006;
(cid:120) Higher interest and debt expenses from increased debt;
(cid:120) Higher other expenses attributable to increases for merger-related expenses due primarily to system integration work, strategic
initiatives and expenses resulting from changes in employee benefit plans, and expenses in 2006 benefited from insurance
recoveries related to U.K. mis-selling losses due to settlements with certain of our liability carriers;
(cid:120) Lower net investment income from a reduction in invested assets driven by share repurchases, dividends paid to stockholders
and decreases in payables for collateral on securities loaned as these items exceeded the distributable earnings received from
our insurance segments, the dividends received from our other segments and issuances of debt, and we recorded $8 million of
default charges in Other Operations during 2006 before the methodology was discontinued; and
(cid:120) Less favorable mortality in our Institutional Pension business.
106
We provide information about this segment’s operating revenue and operating expense line items, the period in which amounts are
recognized, key drivers of changes and historical details underlying the line items and their associated drivers below.
Net Investment Income and Interest Credited
We utilize an internal formula to determine the amount of capital that is allocated to our business segments. Investment income
on capital in excess of the calculated amounts is reported in Other Operations. If regulations require increases in our insurance
segments’ statutory reserves and surplus, the amount of capital allocated to Other Operations would decrease and net investment
income would be negatively impacted. In addition, as discussed below in “Review of Consolidated Financial Condition –
Alternative Sources of Liquidity,” we maintain an inter-segment cash management program where certain subsidiaries can borrow
from or lend money to the holding company to meet short-term borrowing needs. The inter-segment cash management program
affects net investment income for Other Operations, as all inter-segment eliminations are reported within Other Operations.
Write-downs for other-than-temporary impairments decrease the recorded value of our invested assets owned by our business
segments. These write-downs are not included in the income from operations of our operating segments. When impairment
occurs, assets are transferred to the business segments’ portfolios and will reduce the future net investment income for Other
Operations, but should not have an impact on a consolidated basis unless the impairments are related to defaulted securities.
Statutory reserve adjustments for our business segments can also cause allocations of invested assets between the affected
segments and Other Operations.
The majority of our interest credited relates to our reinsurance operations sold to Swiss Re in 2001. A substantial amount of the
business was sold through indemnity reinsurance transactions resulting in some of the business still flowing through our
consolidated financial statements. The interest credited corresponds to investment income earnings on the assets we continue to
hold for this business. There is no impact to income or loss in Other Operations or on a consolidated basis for these amounts.
Benefits
Benefits are recognized when incurred for Institutional Pension products.
Other Expenses
Details underlying other expenses (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Other Expenses
Merger-related expenses
Restructuring charges for expense initiatives
Branding
Strategic initiatives
Taxes, licenses and fees
Net expenses related to changes in benefit plans
UK mis-selling losses settlement
Other
Total other expenses
$
$
$
52
8
33
11
7
-
-
54
165
104
-
36
9
13
4
-
10
176
49
-
34
-
9
-
(26)
13
79
-50%
NM
-8%
22%
-46%
-100%
NM
NM
-6%
112%
NM
6%
NM
44%
NM
100%
-23%
123%
$
$
$
Other in the table above includes expenses that are corporate in nature including charitable contributions, certain litigation
reserves, amortization of media intangible assets with a definite life, other expenses not allocated to our business segments and
inter-segment expense eliminations, excluding those associated with our inter-segment investment advisory fees.
Merger-related expenses were the result of actions undertaken by us to eliminate duplicate operations and functions as a result of
the Jefferson-Pilot merger along with costs related to the implementation of our new unified product portfolio and other initiatives.
These actions will be ongoing and are expected to be substantially complete in the first half of 2009. Our current estimate of the
cumulative integration expenses is approximately $215 million to $225 million, pre-tax, and excludes amounts capitalized or
recorded as goodwill.
107
Interest and Debt Expense
Our current level of interest expense may not be indicative of the future due to, among other things, the timing of the use of cash,
the availability of funds from our cash management program and the future cost of capital. For additional information on our
financing activities, see “Review of Consolidated Financial Condition – Liquidity and Capital Resources – Sources of Liquidity and
Cash Flow – Financing Activities” below.
Details underlying realized gain (loss), after-DAC (1) (in millions) were as follows:
REALIZED GAIN (LOSS)
Pre-Tax
Operating realized gain:
Indexed annuity net derivatives results
GLB
GDB
Total operating realized gain
Realized loss related to certain investments
Gain on certain reinsurance derivative/
trading securities
GLB net derivatives results
GDB derivatives results
Indexed annuity forward-starting option
Gain on sale of subsidiaries/businesses
Total excluded realized gain (loss)
Total realized gain (loss)
After-Tax
Operating realized gain:
Indexed annuity net derivatives results
GLB
GDB
Total operating realized gain
Realized loss related to certain investments
Gain on certain reinsurance derivative/
trading securities
GLB net derivatives results
GDB derivative results
Indexed annuity forward-starting option
Gain (loss) on sale of subsidiaries/businesses
Total excluded realized gain (loss)
Total realized gain (loss)
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
-
$
38
185
223
(1,050)
2
$
6
(2)
6
(126)
2
$
3
(4)
1
(7)
3
398
(127)
7
9
(760)
(537)
$
2
(48)
1
(10)
6
(175)
(169)
$
4
15
2
(2)
-
12
13
$
-100%
NM
NM
NM
NM
50%
NM
NM
170%
50%
NM
NM
0%
100%
50%
NM
NM
-50%
NM
-50%
NM
NM
NM
NM
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
-
$
25
120
145
(682)
1
$
4
(1)
4
(82)
2
259
(83)
5
5
(494)
(349)
$
1
(31)
1
(7)
(2)
(120)
(116)
$
1
$
2
(3)
-
(3)
2
10
1
(1)
-
9
$
9
-100%
NM
NM
NM
NM
100%
NM
NM
171%
NM
NM
NM
0%
100%
67%
NM
NM
-50%
NM
0%
NM
NM
NM
NM
(1) DAC refers to the associated amortization of expense of DAC, VOBA, DSI and DFEL and changes in other contract holder
funds and funds withheld reinsurance liabilities.
For factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk Factors” and
“Forward-Looking Statements – Cautionary Language” above.
For information on our counterparty exposure see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”
108
Comparison of 2008 to 2007
The favorable GLB net derivatives results in 2008 were attributable to the following:
(cid:120) The inclusion in 2008 of an NPR adjustment as required under SFAS 157 due primarily to our widening credit spreads;
(cid:120) Hedge program effectiveness; and
(cid:120) Favorable unlocking.
In 2008, our hedge was generally effective, excluding the effects of unlocking and the NPR adjustment, with changes in reserves
largely offset by the increase in market value of the hedge assets. There were several largely offsetting factors, both favorable and
unfavorable, that led to this result. Significant unfavorable items included: poor underlying fund performance relative to the hedge
instruments used; volatile capital market conditions that resulted in non-linear changes in reserves that our derivatives are not
specifically designed to mitigate; and losses from the strengthening of the dollar as compared to the euro, pound and yen. A large
portion of these unfavorable results in 2008 was attributable to overall market performance during the month of October of 2008
and four specific days in September on which capital markets were extremely volatile, including the first market day after the
Lehman bankruptcy and the day Congress originally failed to pass the original EESA legislation. Significant favorable items
included movements in swap spreads and a change in the characteristics of certain GIB features that resulted in lower liabilities
than had been assumed in establishing our hedge positions. As account values declined, the characteristics of certain GIB features
shifted towards insurance benefits accounted for under SOP 03-1 as opposed to embedded derivatives accounted for under SFAS
133 and SFAS 157. The SOP 03-1 proportion of the associated liabilities increased, reducing the increase in reserves.
The 2008 favorable GLB change in reserves hedged related primarily to assumption changes that reflected updates to implied
volatility assumptions, which, overall, reduced the fair value of the embedded derivatives. The 2007 unfavorable GLB change in
reserves hedged related primarily to assumption changes that reflected improved persistency experience, which increased future
expected claims leading to an increase in liabilities.
The 2008 unfavorable GLB DAC, VOBA, DSI and DFEL prospective unlocking was due primarily to the impact on the DAC,
VOBA, DSI and DFEL models of the aforementioned assumption changes made in calculating the reserves hedged and the
continued significantly unfavorable equity markets.
During 2008, the change in fair value of GDB derivatives, excluding expected cost of hedging instruments, was favorable due to
certain favorable movements in swap spreads and implied volatilities, partially offset by fund underperformance of our hedges,
losses from the strengthening of the dollar as compared to the euro, pound and yen, and volatile capital market conditions that
resulted in non-linear changes in reserves that our hedge program is not designed to fully mitigate.
For a discussion of the increase in realized losses on certain investments see “Consolidated Investments – Realized Loss Related to
Investments” below.
Comparison of 2007 to 2006
The GLB hedge program ineffectiveness, excluding the impact of unlocking, in 2007 was attributable primarily to volatility in the
capital markets along with a modification of the structure of some of our hedges in order to better match the sensitivities of the
embedded derivative liability going forward. In addition, during 2007, there were certain unhedged items, such as those related to
products we sell in New York. Although these items were not a significant component of our account value, movements in the
related embedded derivative liability during 2007 contributed to the negative impact.
We provide information about the pre-tax line items disclosed in the table above and the details underlying them below.
109
Operating Realized Gain
Details underlying operating realized gain (dollars in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Indexed Annuity Net Derivatives Results
Change in fair value of S&P 500 call options
Change in fair value of embedded derivatives
Associated amortization expense of DAC,
VOBA, DSI and DFEL
Total indexed annuity net derivatives results
GLB
Attributed fee in excess of the net valuation
premium
Associated amortization expense of DAC,
VOBA, DSI and DFEL:
Retrospective unlocking (1)
Other amortization
Total GLB
GDB
Pre-DAC (2) amount
Associated amortization expense of DAC,
VOBA, DSI and DFEL:
Retrospective unlocking (1)
Other amortization
Total GDB hedge cost
$
203
(204)
$
(1)
6
$
(59)
62
1
-
69
12
(43)
38
242
67
(124)
185
(3)
2
15
-
(9)
6
(4)
-
2
(2)
(1)
2
9
-
(6)
3
(8)
-
4
(4)
Total Operating Realized Gain
$
223
$
6
$
1
(1) Related primarily to the emergence of gross profits.
(2) DAC refers to the associated amortization of expense of DAC, VOBA, DSI and DFEL.
Operating realized gain includes the following:
Indexed Annuity Net Derivative Results
NM
NM
133%
-100%
98%
-90%
NM
0%
NM
67%
NM
NM
NM
NM
NM
NM
NM
NM
NM
-50%
100%
50%
NM
-50%
50%
NM
Indexed annuity net derivatives results represent the net difference between the change in the fair value of the S&P 500 call options
that we hold and the change in the fair value of the embedded derivative liabilities of our indexed annuity products. The change in
the fair value of the liability for the embedded derivative represents the amount that is credited to the indexed annuity contract.
GLB
Our GWB, GIB and 4LATER® features have elements of both insurance benefits accounted for under SOP 03-1 and embedded
derivatives accounted for under SFAS 133 and SFAS 157. We weight these features and their associated reserves accordingly based
on their hybrid nature. For our GLBs that meet the definition of an embedded derivative under SFAS 133, we record them at fair
value with changes in fair value recorded in realized gain (loss) on our Consolidated Statements of Income. In bifurcating the
embedded derivative, we attribute to the embedded derivative the portion of total fees collected from the contract holder that
relates to the GLB riders (the “attributed fees”). These attributed fees represent the present value of future claims expected to be
paid for the GLB at the inception of the contract (the “net valuation premium”) plus a margin that a theoretical market participant
would include for risk/profit (the “risk/profit margin”).
We include the risk/profit margin portion of the GLB attributed rider fees in operating realized gain and include the net valuation
premium of the GLB attributed rider fees in excluded realized gain (loss). For our Retirement Solutions – Annuities and
Retirement Solutions – Defined Contribution segments, the excess of total fees collected from the contract holders over the GLB
attributed rider fees is reported in insurance fees.
110
GDB
GDB represents the change in the fair value of the derivatives that offsets the benefit ratio unlocking of our SOP 03-1 reserves on
our GDB riders, including our expected cost of the hedging instruments. These changes in reserves attributable to Retirement
Solutions’ benefit ratio unlocking of its SOP 03-1 reserves for GDB riders and associated amortization of DAC, VOBA, DSI and
DFEL is offset in benefits within income from operations. This approach excludes the benefit ratio unlocking from income from
operations according to our definition of income from operations and instead reflects it within GDB derivatives results, a
component of excluded realized gain (loss). On our Consolidated Statements of Income, the benefit ratio unlocking is reported
within benefits.
Realized Loss Related to Certain Investments
See “Consolidated Investments – Realized Loss Related to Investments” below.
Gain (Loss) on Certain Reinsurance Derivative/Trading Securities
Gain (loss) on certain reinsurance derivative/trading securities represents changes in the fair values of total return swaps
(embedded derivatives) theoretically included in our various modified coinsurance and coinsurance with funds withheld reinsurance
arrangements that have contractual returns related to various assets and liabilities associated with these arrangements. Changes in
the fair value of these derivatives are offset by the change in fair value of trading securities in the portfolios that support these
arrangements.
111
GLB Net Derivatives Results and GDB Derivatives Results
Details underlying GLB net derivatives results and GDB derivative results (dollars in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
GLB Net Derivatives Results
Net valuation premium, net of reinsurance
Change in reserves hedged:
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Other
Change in market value of derivative assets
Hedge program effectiveness (ineffectiveness)
Change in reserves not hedged (NPR component)
Associated amortization expense of DAC,
VOBA, DSI and DFEL:
Prospective unlocking - assumption changes
Retrospective unlocking (1)
Other amortization
Loss from the initial impact of adopting
SFAS 157, after-DAC (2)
Total GLB net derivatives results
GDB Derivatives Results
Benefit ratio unlocking of SOP 03-1 reserves
Change in fair value of derivatives, excluding
expected cost of hedging instruments
Associated amortization expense of DAC,
VOBA, DSI and DFEL:
Retrospective unlocking (1)
Other amortization
Total GDB derivatives results
$
80
$
51
$
29
57%
164
-
(3,470)
3,357
51
640
(46)
252
(546)
(6)
8
(305)
167
(136)
-
-
(13)
50
-
-
61
(62)
(1)
-
-
3
(16)
(33)
398
$
-
(48)
$
-
15
$
$
(242)
$
4
$
8
75
(2)
(4)
(58)
98
(127)
$
-
(1)
$
1
-
(2)
$
2
NM
-100%
NM
NM
138%
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
(1) Related primarily to the emergence of gross profits.
(2) DAC refers to the associated amortization of expense of DAC, VOBA, DSI and DFEL
GLB Net Derivatives Results
76%
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
NM
-50%
50%
NM
50%
-50%
Our GLB net derivatives results represents the net valuation premium, the change in the fair value of the embedded derivative
liabilities of our GLB products and the change in the fair value of the derivative instruments we own to hedge. This includes the
cost of purchasing the hedging instruments.
Our GWB, GIB and 4LATER® features have elements of both insurance benefits accounted for under SOP 03-1 and embedded
derivatives accounted for under SFAS 133 and SFAS 157. The SOP 03-1 component is calculated in a manner consistent with our
GDB. We weight these features and their associated reserves accordingly based on their hybrid nature. For the GLB guarantees in
our variable annuity products that are considered embedded derivatives, we record them on our Consolidated Balance Sheets at fair
value under SFAS 133 and SFAS 157. We use derivative instruments to hedge our exposure to the risks and earnings volatility that
result from the embedded derivatives for GLBs. The change in fair value of these derivative instruments is designed to generally
offset the change in fair value of the embedded derivatives. In the table above, we have presented the components of our GLB
results, which can be volatile especially when sudden and significant changes in equity markets and/or interest rates occur. When
we assess the effectiveness of our hedge program, we exclude the impact of the change in the liability related to the NPR required
under SFAS 157. We do not attempt to hedge the change in the NPR component of the liability. The impact of the change in
NPR has had the effect of reducing our GLB liabilities on our balance sheet by $640 million since the adoption of SFAS 157 on
January 1, 2008. For additional information on our guaranteed benefits, see “Critical Accounting Policies and Estimates –
112
Derivatives – Guaranteed Living Benefits” above. For additional information on our hedge program see “Reinsurance” below.
GDB Derivatives Results
Our GDB derivatives results represent the net difference between the benefit ratio unlocking of SOP 03-1 reserves on our GDB
riders and the change in the fair value of the derivative instruments we own to hedge the benefit ratio unlocking, excluding our
expected cost of the hedging instruments. The benefit ratio unlocking of SOP 03-1 reserves for GDB riders is offset in GDB. See
“GDB” above for additional information.
Indexed Annuity Forward-Starting Option
A detail underlying indexed annuity forward-starting option (dollars in millions) was as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Indexed Annuity Forward-Starting Option
Pre-DAC (1) amounts:
Prospective unlocking - assumption changes
Other
-
$
(7)
$
1
(23)
-
$
(4)
Associated amortization expense of DAC,
VOBA, DSI and DFEL
Gain from the initial impact of adopting
SFAS 157, after-DAC (1)
Total
4
12
2
10
$
7
-
(10)
$
-
(2)
$
-100%
70%
-67%
NM
170%
NM
NM
NM
NM
NM
(1) DAC refers to the associated amortization of expense of DAC, VOBA, DSI and DFEL.
The liability for the forward-starting option reflects changes in the fair value of embedded derivative liabilities related to index call
options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed
annuity products as required under SFAS 133 and SFAS 157. These fair values represent an estimate of the cost of the options we
will purchase in the future, discounted back to the date of the balance sheet, using current market indications of volatility and
interest rates, which can vary significantly from period to period due to a number of factors and therefore can provide results that
are not indicative of the underlying trends.
Gain on Sale of Subsidiaries/Businesses
See “Part I – Item 1. Business – Acquisitions and Dispositions” and Note 3 for details.
113
Details underlying our consolidated investment balances (in millions) were as follows:
CONSOLIDATED INVESTMENTS
As of December 31,
2008
2007
Percentage of
Total Investments
2008
2007
Investments
Available-for-sale securities:
Fixed maturity
Equity
Trading securities
Mortgage loans on real estate
Real estate
Policy loans
Derivative instruments
Alternative investments
Other investments
Total investments
Investment Objective
$
$
48,935
288
2,333
7,715
125
2,924
3,397
776
848
67,341
56,276
518
2,730
7,423
258
2,885
807
799
276
71,972
72.6%
0.4%
3.5%
11.5%
0.2%
4.3%
5.0%
1.2%
1.3%
100.0%
78.2%
0.7%
3.8%
10.3%
0.4%
4.0%
1.1%
1.1%
0.4%
100.0%
$
$
Invested assets are an integral part of our operations. We follow a balanced approach to investing for both current income and
prudent risk management, with an emphasis on generating sufficient current income, net of income tax, to meet our obligations to
customers, as well as other general liabilities. This balanced approach requires the evaluation of expected return and risk of each
asset class utilized, while still meeting our income objectives. This approach is important to our asset-liability management because
decisions can be made based upon both the economic and current investment income considerations affecting assets and liabilities.
For a discussion on our risk management process, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”
Investment Portfolio Composition and Diversification
Fundamental to our investment policy is diversification across asset classes. Our investment portfolio, excluding cash and invested
cash, is composed of fixed maturity securities, mortgage loans on real estate, real estate (either wholly-owned or in joint ventures)
and other long-term investments. We purchase investments for our segmented portfolios that have yield, duration and other
characteristics that take into account the liabilities of the products being supported.
We have the ability to maintain our investment holdings throughout credit cycles because of our capital position, the long-term
nature of our liabilities and the matching of our portfolios of investment assets with the liabilities of our various products.
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.
114
Details underlying our fixed maturity and equity securities portfolios by industry classification (in millions) are presented in the
below tables. These tables agree in total with the presentation of available-for-sale securities in Note 5; however, the categories
below represent a more detailed breakout of the available-for-sale portfolio; therefore, the investment classifications listed below
do not agree to the investment categories provided in Note 5.
Fixed Maturity Available-For-Sale Securities
Corporate bonds:
Financial services
Basic industry
Capital goods
Communications
Consumer cyclical
Consumer non-cyclical
Energy
Technology
Transportation
Industrial other
Utilities
Asset-backed securities:
Collateralized debt obligations and credit-linked
notes
Commercial real estate collateralized debt
obligations
Credit card
Home equity
Manufactured housing
Other
Commercial mortgage-backed securities:
Non-agency backed
Collateralized mortgage obligations:
Agency backed
Non-agency backed
Mortgage pass-throughs:
Agency backed
Non-agency backed
Municipals:
Taxable
Tax-exempt
Government and government agencies:
United States
Foreign
Hybrid and redeemable preferred stock
Total fixed maturity available-for-sale securities
Equity Available-For-Sale Securities
Total available-for-sale securities
Trading Securities (1)
Total available-for-sale and trading securities
% Fair
Value
15.1%
3.9%
5.1%
5.0%
5.0%
8.5%
5.7%
1.4%
2.3%
1.4%
15.6%
0.4%
0.1%
0.2%
1.4%
0.2%
0.4%
3.9%
10.7%
2.6%
3.4%
0.2%
0.2%
0.0%
2.6%
2.7%
2.0%
100.0%
Amortized
Cost
$
8,564
2,246
2,668
2,609
2,878
4,296
2,972
766
1,237
718
8,207
796
60
165
1,108
148
196
2,535
5,068
1,996
1,619
141
110
3
1,148
1,377
1,563
55,194
466
55,660
As of December 31, 2008
Unrealized
Losses
Unrealized
Gains
Fair
Value
$
75
15
34
44
33
88
48
9
22
16
104
$
1,264
353
222
222
460
206
246
71
119
38
678
$
7,375
1,908
2,480
2,431
2,451
4,178
2,774
704
1,140
696
7,633
7
-
-
1
2
1
9
180
1
55
-
4
-
167
97
6
1,018
9
1,027
630
23
73
411
28
18
625
29
746
-
47
1
-
25
135
607
7,277
187
7,464
173
37
92
698
122
179
1,919
5,219
1,251
1,674
94
113
3
1,290
1,339
962
48,935
288
49,223
2,307
57,967
$
255
1,282
$
229
7,693
$
2,333
51,556
$
115
Fixed Maturity Available-For-Sale Securities
Corporate bonds:
Financial services
Basic industry
Capital goods
Communications
Consumer cyclical
Consumer non-cyclical
Energy
Technology
Transportation
Industrial other
Utilities
Asset-backed securities:
Collateralized debt obligations and credit-linked
notes
Commercial real estate collateralized debt
obligations
Mortgage-backed securities collateralized debt
obligations
Credit card
Home equity
Manufactured housing
Auto loan
Other
Commercial mortgage-backed securities:
Non-agency backed
Collateralized mortgage obligations:
Agency backed
Non-agency backed
Mortgage pass-throughs:
Agency backed
Non-agency backed
Municipals:
Taxable
Tax-exempt
Amortized
Cost
$
11,234
2,148
2,665
2,903
3,038
3,898
2,688
660
1,409
710
8,051
996
42
1
160
1,209
161
4
235
2,711
4,547
2,347
933
153
133
6
As of December 31, 2007
Unrealized
Losses
Unrealized
Gains
Fair
Value
$
187
52
66
123
56
101
121
15
39
22
195
$
300
35
16
46
94
25
14
5
19
6
77
$
11,121
2,165
2,715
2,980
3,000
3,974
2,795
670
1,429
726
8,169
8
-
-
1
4
7
-
4
48
74
10
18
1
5
-
205
4
-
2
76
5
-
1
70
19
110
2
4
-
-
799
38
1
159
1,137
163
4
238
2,689
4,602
2,247
949
150
138
6
Government and government agencies:
United States
Foreign
Redeemable preferred stock
Total fixed maturity available-for-sale securities
Available-For-Sale - Equity
Total available-for-sale securities
Trading Securities (1)
Total available-for-sale and trading securities
1,261
1,663
103
56,069
548
56,617
2,512
59,129
$
108
92
9
1,366
13
1,379
265
1,644
$
4
19
1
1,159
43
1,202
47
1,249
$
1,365
1,736
111
56,276
518
56,794
2,730
59,524
$
% Fair
Value
19.8%
3.8%
4.8%
5.3%
5.3%
7.1%
5.0%
1.2%
2.5%
1.3%
14.5%
1.4%
0.1%
0.0%
0.3%
2.0%
0.3%
0.0%
0.4%
4.8%
8.2%
4.0%
1.7%
0.3%
0.2%
0.0%
2.4%
3.1%
0.2%
100.0%
(1) Our trading securities support our modified coinsurance arrangements (“Modco”) and the investment results are passed
directly to the reinsurers. Refer below to the “Trading Securities” section for further details.
116
Available-for-Sale Securities
The general intent of the available-for-sale accounting guidance is to reflect stockholders’ equity as if unrealized gains and losses
were actually recognized, it is necessary that we consider all related accounting adjustments that would occur upon such a
hypothetical recognition of unrealized gains and losses. Such related balance sheet effects include adjustments to the balances of
DAC, VOBA, DFEL, other contract holder funds and deferred income taxes. Adjustments to each of these balances are charged
or credited to accumulated other comprehensive income. For instance, DAC is adjusted upon the recognition of unrealized gains
or losses because the amortization of DAC is based upon an assumed emergence of gross profits on certain insurance business.
Deferred income tax balances are also adjusted because unrealized gains or losses do not affect actual taxes currently paid.
The quality of our available-for-sale fixed maturity securities portfolio, as measured at estimated fair value and by the percentage of
fixed maturity securities invested in various ratings categories, relative to the entire fixed maturity available-for-sale security
portfolio (in millions) was as follows:
NAIC
Designation
Rating Agency
Equivalent
Designation
Investment Grade Securities
1
2
Aaa / Aa / A
Baa
Below Investment Grade Securities
3
4
5
6
Ba
B
Caa and lower
In or near default
As of December 31, 2008
Fair
Value
Amortized
Cost
% of
Total
As of December 31, 2007
Fair
Value
Amortized
Cost
% of
Total
$
32,595
19,240
51,835
$
30,386
16,111
46,497
62.0%
32.9%
94.9%
$
34,648
18,168
52,816
$
34,741
18,339
53,080
2,194
772
251
142
3,359
1,698
516
131
93
2,438
3.5%
1.1%
0.3%
0.2%
5.1%
2,184
787
270
12
3,253
2,159
783
238
16
3,196
61.8%
32.6%
94.4%
3.8%
1.4%
0.4%
0.0%
5.6%
Total securities
$
55,194
$
48,935
100.0%
$
56,069
$
56,276
100.0%
Below investment grade as a % of total
fixed maturity available-for-sale securities
6.1%
5.1%
5.8%
5.6%
Comparisons between the National Association of Insurance Commissioners (“NAIC”) ratings and rating agency designations are
published by the NAIC. The NAIC assigns securities quality ratings and uniform valuations, which are used by insurers when
preparing their annual statements. The NAIC ratings are similar to the rating agency designations of the Nationally Recognized
Statistical Rating Organizations for marketable bonds. NAIC ratings 1 and 2 include bonds generally considered investment grade
(rated Baa3 or higher by Moody’s, or rated BBB- or higher by S&P and Fitch), by such ratings organizations. NAIC ratings 3
through 6 include bonds generally considered below investment grade (rated Ba1 or lower by Moody’s, or rated BB+ or lower by
S&P and Fitch).
As of December 31, 2008 and 2007, 92.2% and 90.7%, respectively, of the total publicly traded and private securities in an
unrealized loss status were rated as investment grade. See Note 5 for maturity date information for our fixed maturity investment
portfolio. Our gross unrealized losses on available-for-sale securities increased $6.3 billion in 2008, primarily due to a combination
of reduced liquidity in several market segments and deterioration in credit fundamentals. As more fully described in Note 1, we
regularly review our investment holdings for other-than-temporary impairments. We believe that the securities in an unrealized
loss position as of December 31, 2008, were not other-than-temporarily impaired due to our ability and intent to hold for a period
of time sufficient for recovery. For further information on our available-for-sale securities unrealized losses, see “Additional
Details on our Unrealized Losses on Available-for-Sale Securities” below.
The estimated fair value for all private securities was $7.1 billion as of December 31, 2008, compared to $7.8 billion as of
December 31, 2007, representing approximately 11% of total invested assets as of December 31, 2008 and 2007, respectively.
Trading Securities
Trading securities, which support certain reinsurance funds withheld and our Modco reinsurance agreements, are carried at
estimated fair value and changes in estimated 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
117
liability associated with the underlying reinsurance arrangement. See Notes 1 and 9 for more information regarding our accounting
for Modco.
Mortgage-Backed Securities (Included in Available-for-Sale and Trading 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. Securities that have an amortized cost greater than par and are backed by mortgages that prepay faster than
expected will incur a reduction in yield or a loss. Those securities with an amortized cost lower than par that prepay faster than
expected will generate an increase in yield or a gain. In addition, we may incur reinvestment risks if market yields are lower than
the book yields earned on the securities. Prepayments occurring slower than expected have the opposite impact. We may incur
reinvestment risks if market yields are higher than the book yields earned on the securities and we are forced to sell the securities.
The degree to which a security is susceptible to either gains or losses is influenced by: the difference between its amortized cost
and par; the relative sensitivity of the underlying mortgages backing the assets to prepayment in a changing interest rate
environment; and the repayment priority of the securities in the overall securitization structure.
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. As of December 31, 2008, we did not have a significant
amount of higher-risk trust structures mortgage-backed securities. A significant amount of assets in our mortgage-backed
securities portfolio are either guaranteed by U.S. government-sponsored enterprises or are supported in the securitization structure
by junior securities enabling the assets to achieve high investment grade status.
Our exposure to subprime mortgage lending is limited to investments in banks and other financial institutions that may be
impacted by subprime lending and direct investments in asset-backed securities collateralized debt obligations, asset-backed
securities (“ABS”) and residential mortgage-backed securities (“RMBS”). Mortgage-related ABS are backed by home equity loans
and RMBS are backed by residential mortgages. These securities are backed by loans that are characterized by borrowers of
differing levels of creditworthiness: prime, Alt-A and subprime. Prime lending is the origination of residential mortgage loans to
customers with excellent credit profiles. Alt-A lending is the origination of residential mortgage loans to customers who have
Prime credit profiles but lack documentation to substantiate income. Subprime lending is the origination of loans to customers
with weak or impaired credit profiles.
The slowing U.S. housing market, increased interest rates for non-Prime borrowers and relaxed underwriting standards over the
last several years has led to higher delinquency rates for residential mortgage loans and home equity loans. We expect delinquency
rates and loss rates on residential mortgages and home equity loans to increase in the future; however, we continue to expect to
receive payments in accordance with contractual terms for a significant amount of our securities, largely due to the seniority of the
claims on the collateral of the securities that we own. The tranches of the securities will experience losses according to their
seniority level with the least senior (or most junior), typically the unrated residual tranche, taking the initial loss. The credit ratings
of our securities reflect the seniority of the securities that we own. Our RMBS had a market value of $9.1 billion and an unrealized
loss of $1.0 billion, or 10%, as of December 31, 2008. The unrealized loss was due primarily to deteriorating fundamentals and a
general level of illiquidity in the market resulting in price declines in many structured products.
118
The market value of investments backed by subprime loans was $458 million and represented 1% of our total investment portfolio
as of December 31, 2008. Investments rated A or above represented 84% of the subprime investments and $210 million in market
value of our subprime investments was backed by loans originating in 2005 and forward. Available-for-sale securities represent
$445 million, or 97%, of the subprime exposure and trading securities represent $13 million, or 3%, as of December 31, 2008. The
tables below summarize our investments in available-for-sale securities backed by pools of residential mortgages (in millions):
Fair Value as of December 31, 2008
Prime/
Non -
Agency
Alt-A
Subprime
Prime
Agency
Total
Type
Collateralized mortgage obligations and pass-
throughs
Asset-backed securities home equity
Total (1)
Rating
AAA
AA
A
BBB
BB and below
Total (1)
Origination Year
2004 and prior
2005
2006
2007
2008
Total (1)
$
$
6,819
-
6,819
$
$
$
$
-
$
445
445
$
$
$
8,238
698
8,936
$
$
$
$
$
912
-
912
658
108
59
63
24
912
326
195
140
251
-
912
507
253
760
484
69
38
47
122
760
302
212
210
36
-
760
6,780
20
19
-
-
6,819
3,342
904
372
1,518
683
6,819
300
52
18
64
11
445
238
145
62
-
-
445
8,222
249
134
174
157
8,936
4,208
1,456
784
1,805
683
8,936
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
(1) Does not include the fair value of trading securities totaling $187 million, which support our Modco reinsurance agreements
because investment results for these agreements are passed directly to the reinsurers. The $187 million in trading securities
consisted of $155 million prime, $19 million Alt-A and $13 million subprime. For the table above, credit ratings shown in the
document are based on ratings provided by the major credit rating agencies (Fitch Ratings, Moody’s, S&P) or are based on
internal ratings for those securities where external ratings are not available. For securities where the ratings assigned by the
major rating agencies are not equivalent, the second highest of the three ratings assigned is used.
119
Type
Collateralized mortgage obligations and pass-
throughs
Asset-backed securities home equity
Total (1)
Rating
AAA
AA
A
BBB
BB and below
Total (1)
Origination Year
2004 and prior
2005
2006
2007
2008
Total (1)
Amortized Cost as of December 31, 2008
Prime
Agency
Prime/
Non -
Agency
Alt-A
Subprime
Total
$
$
6,595
-
6,595
$
$
1,477
-
1,477
$
752
363
1,115
$
$
-
745
745
$
$
$
8,824
1,108
9,932
$
$
$
$
$
$
$
6,556
20
18
-
1
6,595
3,246
879
359
1,451
660
6,595
936
184
163
117
77
1,477
423
281
264
509
-
1,477
642
126
69
78
200
1,115
392
326
361
36
-
1,115
424
118
33
130
40
745
335
259
151
-
-
745
8,558
448
283
325
318
9,932
4,396
1,745
1,135
1,996
660
9,932
$
$
$
$
$
$
$
$
$
$
$
$
$
(1) Does not include the amortized cost of trading securities totaling $213 million, which support our Modco reinsurance
agreements because investment results for these agreements are passed directly to the reinsurers. The $213 million in trading
securities consisted of $165 million prime, $29 million Alt-A and $19 million subprime. For the table above, credit ratings
shown in the document are based on ratings provided by the major credit rating agencies (Fitch Ratings, Moody’s, S&P) or are
based on internal ratings for those securities where external ratings are not available. For securities where the ratings assigned
by the major rating agencies are not equivalent, the second highest of the three ratings assigned is used.
None of these investments include any direct investments in subprime lenders or mortgages. We are not aware of material
exposure to subprime loans in our alternative asset portfolio.
The following summarizes our investments in available-for-sale securities backed by pools of consumer loan asset-backed
securities (in millions):
As of December 31, 2008
Fair
Value
Amortized
Cost
Rating
AAA
BBB
Total (1)(2)
$
$
$
$
77
15
92
139
26
165
(1) Additional indirect credit card exposure through structured securities is excluded from this table. See “Credit-Linked Notes”
section below and in Note 5. For the table above, credit ratings shown in the document are based on ratings provided by the
major credit rating agencies (Fitch Ratings, Moody’s, S&P) or are based on internal ratings for those securities where external
ratings are not available. For securities where the ratings assigned by the major rating agencies are not equivalent, the second
highest of the three ratings assigned is used.
(2) Does not include the fair value of trading securities totaling $1 million, which support our Modco reinsurance agreements
because investment results for these agreements are passed directly to the reinsurers. The $1 million in trading securities
consisted of credit card securities.
120
The following summarizes our investments in available-for-sale securities backed by pools of commercial mortgages (in millions):
As of December 31, 2008
Multiple Property
Fair
Value
Amortized
Cost
Single Property
Fair
Value
Amortized
Cost
Commercial Real
Estate Collateralized
Debt Obligations
Fair
Value
Amortized
Cost
Total
Fair
Value
Amortized
Cost
$
1,831
$
2,388
$
88
$
147
$
-
$
-
$
1,919
$
2,535
-
1,831
$
-
2,388
$
-
88
$
-
147
$
37
37
$
60
60
$
37
1,956
$
60
2,595
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
1,386
275
86
67
17
1,831
1,334
243
143
111
-
1,831
1,601
417
172
157
41
2,388
1,580
369
255
184
-
2,388
56
-
29
3
-
88
71
16
1
-
-
88
69
-
67
11
-
147
78
61
8
-
-
147
19
1
17
-
-
37
18
7
12
-
-
37
38
3
19
-
-
60
22
15
23
-
-
60
1,461
276
132
70
17
1,956
1,423
266
156
111
-
1,956
1,708
420
258
168
41
2,595
1,680
445
286
184
-
2,595
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
Type
Commercial mortgage-
backed securities
Commercial real estate
collateralized debt
obligations
Total (1)
Rating
AAA
AA
A
BBB
BB and below
Total (1)
Origination Year
2004 and prior
2005
2006
2007
2008
Total (1)
(1) Does not include the fair value of trading securities totaling $78 million, which support our Modco reinsurance agreements
because investment results for these agreements are passed directly to the reinsurers. The $78 million in trading securities
consisted of $77 million commercial mortgage-backed securities and $1 million commercial real estate collateralized debt
obligations. For the table above, credit ratings shown in the document are based on ratings provided by the major credit rating
agencies (Fitch Ratings, Moody’s, S&P) or are based on internal ratings for those securities where external ratings are not
available. For securities where the ratings assigned by the major rating agencies are not equivalent, the second highest of the
three ratings assigned is used.
121
Monoline insurers provide guarantees on debt for issuers, often in the form of credit wraps, which enhance the credit of the issuer.
Monoline insurers guarantee the timely repayment of bond principal and interest when a bond issuer defaults and generally provide
credit enhancement for bond issues such as municipal bonds and private placements as well as other types and structures of
securities. Our direct exposure represents our bond holdings of the actual Monoline insurers. Our insured bonds represent our
holdings in bonds of other issuers that are insured by Monoline insurers.
The following summarizes our exposure to Monoline insurers (in millions):
Direct
Exposure (1)
Insured
Bonds (2)
As of December 31, 2008
Total
Amortized
Total
Unrealized
Total
Unrealized
Cost
Gain
Loss
Total
Fair
Value
-
$
30
-
-
12
12
27
19
1
72
173
$
$
268
-
97
68
114
7
-
-
$
268
30
97
68
126
19
27
19
-
73
627
$
1
145
800
$
6
$
-
1
1
2
-
-
-
-
2
12
$
$
66
14
38
11
31
4
13
11
$
208
16
60
58
97
15
14
8
1
36
225
$
-
111
587
$
Monoline Name
AMBAC
ASSURED GUARANTY LTD
FGIC
FSA
MBIA
MGIC
PMI GROUP INC
RADIAN GROUP INC
SECURITY CAPITAL
ASSURANCE LTD
XL CAPITAL LTD
Total (3)
(1) Additional direct exposure through Credit Default Swaps with a notional totaling $50 million is excluded from this table.
(2) Additional indirect insured exposure through structured securities is excluded from this table. See “Credit-Linked Notes”
section below and in Note 4.
(3) Does not include the fair value of trading securities totaling $28 million, which support our Modco reinsurance agreements
because investment results for these agreements are passed directly to the reinsurers. The $28 million in trading securities
consisted of $8 million of direct exposure and $20 million of insured exposure. This table also excludes insured exposure
totaling $15 million for a guaranteed investment tax credit partnership.
Credit-Linked Notes
As of December 31, 2008 and 2007, other contract holder funds on our Consolidated Balance Sheets included $600 million and
$1.2 billion outstanding in funding agreements of the Lincoln National Life Insurance Company (“LNL”), respectively. LNL
invested the proceeds of $850 million received for issuing three funding agreements in 2006 and 2007 into three separate credit-
linked notes originated by third party companies. One of the credit-linked notes totaling $250 million was paid off at par in
September 2008, and, as a result, the related structure, including the funding agreement, was terminated. The two remaining credit-
linked notes are asset-backed securities classified as corporate bonds in the tables in Note 5, and are reported as fixed maturity
securities on our Consolidated Balance Sheets. An additional $300 million funding agreement was assumed as a result of the
merger of Jefferson-Pilot, but was not invested into credit-linked notes. This $300 million funding agreement matured on June 2,
2008.
We earn a spread between the coupon received on the credit-linked notes and the interest credited on the funding agreement. Our
credit-linked notes were created using a special purpose trust that combines highly rated assets with credit default swaps to produce
a multi-class structured security. The high quality asset in these transactions is a AAA-rated asset-backed security secured by a pool
of credit card receivables. Our affiliate, Delaware Management Holdings, Inc. (“Delaware Investments”), actively manages the
credit default swaps in the underlying portfolios. As permitted in the credit-linked note agreements, Delaware Investments acts as
the investment manager for the pool of underlying issuers in each of the transactions. Delaware Investments, from time to time,
has directed substitutions of corporate names in the reference portfolio. When substituting corporate names, the issuing special
purpose trust that issued our credit-linked note transacts with a third party to sell credit protection on a new issuer, selected by
Delaware Investments. The cost to substitute the corporate names is based on market conditions and the liquidity of the corporate
names. This new issuer will replace the issuer Delaware Investments has identified to remove from the underlying portfolio. The
substitution of corporate names does not revise the credit-linked note agreement. The subordination and the participation in credit
122
losses may change as a result of the substitution. The amount of the change is dependant upon the relative risk of the issuers
removed and replaced in the pool of issuers. Delaware Investments intends not to select names that would materially increase the
risk of the credit-linked notes.
Consistent with other debt market instruments, we are exposed to credit losses within the structure of the credit-linked notes,
which could result in principal losses to our investments. However, we have attempted to protect our investments from credit
losses through the multi-tiered class structure of the credit-linked note, which requires the subordinated classes of the investment
pool to absorb all of the initial credit losses. LNL owns the mezzanine tranche of these investments. Generally, based upon our
models, the transactions can sustain anywhere from 6-10 defaults, depending on the transaction, in the underlying collateral pools
with no loss to LNL. However, if that number of defaults is realized, any additional defaults will significantly impact our recovery.
Once the subordination is completely exhausted, losses will be incurred on LNL’s investment. In general, the entire investment
can be lost with 4-5 additional defaults. To date, there has been one default in the underlying collateral pool of the $400 million
credit-linked note and two defaults in the underlying collateral pool of the $200 million credit-linked note. There has not been an
event of default on the credit linked notes themselves, and we believe our subordination remains sufficient to absorb future initial
credit losses. Similar to other debt market instruments our maximum principal loss is limited to our original investment of $600
million as of December 31, 2008.
As in the general markets, spreads on these transactions have widened, causing unrealized losses. As of December 31, 2008, we
had unrealized losses of $550 million on the $600 million in credit-linked notes. As described more fully in Note 1, we regularly
review our investment holdings for other-than-temporary impairments. Based upon this review and the information in the
paragraph above, we believe that these securities were not other-than-temporarily impaired as of December 31, 2008 and 2007,
respectively. The following summarizes the fair value to amortized cost ratio (dollars in millions) of the credit-linked notes:
Fair value to amortized cost ratio
As of
January 31,
2009
12%
As of December 31,
2007
2008
8%
78%
The following summarizes the exposure of the credit-linked notes’ underlying collateral by industry and rating as of December 31,
2008:
Industry
AAA
AA
A
BBB
BB
B
Total
Telecommunications
Financial intermediaries
Oil and gas
Insurance
Utilities
Chemicals and plastics
Retailers, except food and drug
Industrial equipment
Sovereigns
Drugs
Forest products
Other industry < 3% (28 industries)
Total
0%
0%
0%
0%
0%
0%
0%
0%
0%
0%
0%
2%
2%
0%
5%
1%
1%
0%
0%
0%
0%
0%
2%
0%
2%
11%
5%
5%
2%
2%
3%
2%
1%
3%
2%
1%
0%
19%
45%
5%
1%
4%
1%
1%
2%
2%
0%
1%
0%
2%
16%
35%
1%
0%
0%
0%
0%
0%
1%
0%
0%
0%
1%
3%
6%
1%
0%
0%
0%
0%
0%
0%
0%
0%
0%
0%
0%
1%
12%
11%
7%
4%
4%
4%
4%
3%
3%
3%
3%
42%
100%
Additional Details on our Unrealized Losses on Available-for-Sale Securities
When considering unrealized gain and loss information, it is important to recognize that the information relates to the status of
securities 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, because 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.
123
We have no concentrations of issuers or guarantors of fixed maturity and equity securities. The composition by industry categories
of securities subject to enhanced analysis and monitoring for potential changes in unrealized loss status (in millions), was as
follows:
As of December 31, 2008
%
Amortized Amortized Unrealized
Cost
Loss
$
Cost
$
%
Unrealized
Loss
32.4%
20.5%
18.8%
13.5%
5.7%
4.0%
1.7%
1.7%
1.1%
0.6%
0.0%
0.0%
0.0%
0.0%
0.0%
100.0%
%
Unrealized
Loss
57.7%
30.8%
11.5%
0.0%
0.0%
0.0%
0.0%
100.0%
31.4%
15.7%
9.7%
11.4%
4.5%
3.7%
13.2%
1.1%
0.9%
5.4%
0.2%
1.3%
1.1%
0.2%
0.2%
100.0%
35.8%
18.7%
3.7%
4.5%
27.6%
6.0%
3.7%
100.0%
57
36
33
24
10
7
3
3
2
1
-
-
-
-
-
176
$
Loss
$
15
8
3
-
-
-
-
26
$
140
70
43
51
20
16
59
5
4
24
1
6
5
1
1
446
$
Cost
$
48
25
5
6
37
8
5
134
$
As of December 31, 2007
%
Amortized Amortized Unrealized
Cost
Non-captive diversified
Automotive
Gaming
Property and casualty
Non-captive consumer
ABS
Entertainment
Refining
Commercial mortgage-backed
securities
Banking
Retailers
Collateralized mortgage obligations
Media - non-cable
Paper
Pharmaceuticals
Total
Property and casualty
Collateralized mortgage obligations
Commercial mortgage-backed
securities
ABS
Non-captive consumer
Banking
Consumer cyclical services
Total
Fair
Value
$
83
34
10
27
10
9
56
2
2
23
1
6
5
1
1
270
$
Fair
Value
$
33
17
2
6
37
8
5
108
$
%
Fair
Value
30.6%
12.6%
3.7%
10.0%
3.7%
3.4%
20.8%
0.7%
0.7%
8.5%
0.4%
2.2%
1.9%
0.4%
0.4%
100.0%
%
Fair
Value
30.5%
15.7%
1.9%
5.6%
34.3%
7.4%
4.6%
100.0%
124
The composition by industry categories of all securities in unrealized loss status (in millions), was as follows:
ABS
Banking
Collateralized mortgage obligations
Commercial mortgage-backed
securities
Electric
Pipelines
Real estate investment trusts
Property and casualty insurers
Metals and mining
Life
Paper
Retailers
Media - non-cable
Food and beverage
Gaming
Diversified manufacturing
Non-captive diversified
Financial - other
Building materials
Owned no guarantee
Home construction
Independent
Distributors
Non-captive consumer
Technology
Automotive
Integrated
Transportation services
Wirelines
Refining
Oil field services
Wireless
Chemicals
Non agency
Healthcare
Entertainment
Sovereigns
As of December 31, 2008
%
Fair
Value
4.0%
12.2%
5.5%
Amortized
Cost
$
2,380
4,714
2,411
%
Amortized
Cost
6.4%
12.5%
6.3%
Unrealized
Loss
$
1,182
1,057
775
%
Unrealized
Loss
15.7%
14.1%
10.4%
Fair
Value
$
1,198
3,657
1,636
2,257
3,242
1,763
918
999
772
716
528
678
867
1,310
303
774
304
479
549
290
308
615
971
253
582
241
490
442
627
340
604
278
522
141
477
531
190
6.0%
8.7%
4.7%
2.5%
2.7%
2.1%
1.9%
1.4%
1.8%
2.3%
3.5%
0.8%
2.1%
0.8%
1.3%
1.5%
0.8%
0.8%
1.6%
2.6%
0.7%
1.6%
0.6%
1.3%
1.2%
1.7%
0.9%
1.6%
0.7%
1.4%
0.4%
1.3%
1.4%
0.5%
625
326
262
256
253
168
131
131
129
117
105
98
88
87
84
82
82
81
82
81
72
71
67
66
66
61
55
54
53
49
47
46
44
44
8.4%
4.4%
3.5%
3.4%
3.4%
2.3%
1.8%
1.8%
1.7%
1.6%
1.4%
1.3%
1.2%
1.2%
1.1%
1.1%
1.1%
1.1%
1.1%
1.1%
1.0%
1.0%
0.9%
0.9%
0.9%
0.8%
0.7%
0.7%
0.7%
0.7%
0.6%
0.6%
0.6%
0.6%
1,632
2,916
1,501
662
746
604
585
397
549
750
1,205
205
686
217
395
467
208
227
533
890
181
511
174
424
376
566
285
550
225
473
94
431
487
146
5.5%
9.7%
5.0%
2.2%
2.5%
2.0%
2.0%
1.3%
1.8%
2.5%
4.0%
0.7%
2.3%
0.7%
1.3%
1.6%
0.7%
0.8%
1.8%
3.0%
0.6%
1.7%
0.6%
1.4%
1.3%
1.9%
1.0%
1.8%
0.8%
1.6%
0.3%
1.4%
1.6%
0.5%
125
(Continued from Above)
Health insurance
Industrial other
Brokerage
Consumer products
Airlines
Lodging
Packaging
Railroads
Local authorities
Construction machinery
Utility - other
Government sponsored
Media - cable
Industries with unrealized losses
less than $10
Total
ABS
Banking
Collateralized mortgage obligations
Commercial mortgage-backed
securities
Electric
Property and casualty insurers
Non-captive diversified
Home construction
Media - non-cable
Retailers
Non-captive consumer
Pipelines
Real estate investment trusts
Paper
Financial - other
Brokerage
Gaming
Distributors
Food and beverage
Metals and mining
Building materials
Automotive
Industries with unrealized losses
less than $10
Total
As of December 31, 2008
Fair
Value
%
Fair
Value
Amortized
Cost
%
Amortized
Cost
Unrealized
Loss
%
Unrealized
Loss
334
368
186
434
72
85
161
232
31
238
87
15
156
1.1%
1.2%
0.6%
1.4%
0.2%
0.3%
0.5%
0.8%
0.2%
0.8%
0.3%
0.0%
0.5%
376
407
223
469
101
112
187
257
45
250
98
26
167
1.0%
1.1%
0.6%
1.3%
0.3%
0.3%
0.5%
0.7%
0.1%
0.7%
0.3%
0.1%
0.4%
42
39
37
35
29
27
26
25
14
12
11
11
11
0.6%
0.5%
0.5%
0.5%
0.4%
0.4%
0.3%
0.3%
0.2%
0.2%
0.1%
0.1%
0.1%
747
29,935
$
2.5%
100.0%
815
37,399
$
2.2%
100.0%
68
7,464
$
0.9%
100.0%
As of December 31, 2007
%
Fair
Value
9.4%
15.0%
13.8%
Amortized
Cost
$
2,239
3,328
3,010
%
Amortized
Cost
10.2%
15.1%
13.7%
Unrealized
Loss
$
293
181
129
%
Unrealized
Loss
24.4%
15.1%
10.8%
Fair
Value
$
1,946
3,147
2,881
1,083
1,406
494
314
287
223
443
258
593
572
273
354
434
126
429
419
328
226
184
5.2%
6.8%
2.4%
1.5%
1.4%
1.1%
2.1%
1.2%
2.9%
2.8%
1.3%
1.7%
2.1%
0.6%
2.1%
2.0%
1.6%
1.1%
0.9%
1,153
1,440
528
347
319
254
469
284
614
593
291
371
449
140
442
431
338
236
194
5.2%
6.5%
2.4%
1.6%
1.5%
1.2%
2.1%
1.3%
2.8%
2.7%
1.3%
1.7%
2.0%
0.6%
2.0%
2.0%
1.5%
1.1%
0.9%
70
34
34
33
32
31
26
26
21
21
18
17
15
14
13
12
10
10
10
5.8%
2.9%
2.8%
2.7%
2.7%
2.6%
2.2%
2.2%
1.7%
1.7%
1.5%
1.4%
1.2%
1.2%
1.1%
1.0%
0.8%
0.8%
0.8%
4,370
20,790
$
21.0%
100.0%
4,522
21,992
$
20.6%
100.0%
152
1,202
$
12.6%
100.0%
126
Unrealized Loss on Below-Investment-Grade Available-for-Sale Fixed Maturity Securities
Gross unrealized losses on available-for-sale below-investment-grade fixed maturity securities represented 12.8% and 12.1% of
total gross unrealized losses on all available-for-sale securities as of December 31, 2008 and 2007, respectively. Generally, below-
investment-grade fixed maturity securities are more likely than investment-grade securities to develop credit concerns. The
remaining 87.2% and 87.9% of the gross unrealized losses as of December 31, 2008 and 2007, respectively, relate to investment
grade available-for-sale securities. The ratios of estimated fair value to amortized cost reflected in the table below were 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 December 31,
2008.
Details underlying fixed maturity securities below investment grade and in an unrealized loss position (in millions) were as follows:
Aging Category
< or = 90 days
Total < or = 90 days
>90 days but < or = 180 days
Total >90 days but < or = 180 days
>180 days but < or = 270 days
Total >180 days but < or = 270 days
>270 days but < or = 1 year
Total >270 days but < or = 1 year
>1 year
Total >1 year
Ratio of
Amortized
Cost to
Fair Value
70% to 100%
40% to 70%
Below 40%
70% to 100%
40% to 70%
Below 40%
70% to 100%
40% to 70%
Below 40%
70% to 100%
40% to 70%
Below 40%
70% to 100%
40% to 70%
Below 40%
As of December 31, 2008
Amortized
Cost
$
Unrealized
Loss
$
Fair
Value
$
253
17
1
271
268
31
5
304
15
14
4
33
291
41
-
332
311
83
10
404
116
35
9
160
501
339
98
938
336
66
-
402
349
140
40
529
143
66
28
237
606
604
376
1,586
45
25
-
70
38
57
30
125
27
31
19
77
105
265
278
648
Total below-investment-grade
$
2,105
$
3,058
$
953
127
Aging Category
< or = 90 days
Total < or = 90 days
>90 days but < or = 180 days
Total >90 days but < or = 180 days
>180 days but < or = 270 days
Total >180 days but < or = 270 days
>270 days but < or = 1 year
Total >270 days but < or = 1 year
>1 year
Total >1 year
Ratio of
Amortized
Cost to
Fair Value
70% to 100%
40% to 70%
Below 40%
70% to 100%
40% to 70%
Below 40%
70% to 100%
40% to 70%
Below 40%
70% to 100%
40% to 70%
Below 40%
70% to 100%
40% to 70%
Below 40%
As of December 31, 2007
Amortized
Cost
$
Unrealized
Loss
$
Fair
Value
$
446
-
-
446
468
1
-
469
22
1
-
23
218
1
-
219
378
-
-
378
121
-
-
121
328
52
-
380
231
1
-
232
408
-
-
408
135
-
-
135
362
84
-
446
13
-
-
13
30
-
-
30
14
-
-
14
34
32
-
66
Total below-investment-grade
$
1,544
$
1,690
$
146
128
Unrealized Loss on Fixed Maturity and Equity Securities Available-for-Sale in Excess of $10 million
As of December 31, 2008, available-for-sale fixed maturity and equity securities with gross unrealized losses greater than $10
million (in millions) for investment grade securities were as follows:
Investment Grade
Credit-linked notes
Credit-linked notes
Domestic bank and finance
U.K. bank and finance
International bank and finance
International bank and finance
International bank and finance
Mortgage related ABS
Domestic finance
Domestic retailer
International forestry
Mortgage related MBS
Domestic bank and finance
Mortgage related ABS
International bank and finance
Mortgage related MBS
Domestic bank and finance
U.K. bank and finance
Mortgage related MBS
Domestic energy
U.K. bank and finance
International energy
U.K. bank and finance
International bank and finance
International investment company
Real estate investment trust
Mortgage related MBS
Domestic bank and finance
International bank and finance
International bank and finance
Property and casualty insurance
Mortgage related ABS
International metals and mining
Domestic bank and finance
Domestic insurance
Mortgage related MBS
International energy
Domestic healthcare
Mortgage related ABS
International communications
International finance
International insurance
Domestic energy
Length of Time
in Loss Position
>1 year
>1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>180 days but <=270 days
>1 year
>270 days but <=1 year
>1 year
>270 days but <=1 year
>180 days but <=270 days
>1 year
>1 year
>1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>1 year
>1 year
>1 year
>180 days but <=270 days
>180 days but <=270 days
>1 year
>180 days but <=270 days
>270 days but <=1 year
>1 year
>180 days but <=270 days
>270 days but <=1 year
>90 days but <=180 days
>270 days but <=1 year
129
As of December 31, 2008
Fair
Value
Amortized Unrealized
Cost
Loss
$
30
20
258
109
70
77
53
18
42
43
63
8
112
15
53
24
171
67
35
95
122
53
44
37
31
34
4
76
6
25
31
2
65
190
48
8
91
108
19
85
82
40
43
$
400
200
404
183
116
123
97
57
80
80
98
42
145
46
84
55
201
97
63
123
149
80
71
64
57
59
29
101
30
48
54
25
88
213
70
29
112
129
40
106
103
61
63
$
(370)
(180)
(146)
(74)
(46)
(46)
(44)
(39)
(38)
(37)
(35)
(34)
(33)
(31)
(31)
(31)
(30)
(30)
(28)
(28)
(27)
(27)
(27)
(27)
(26)
(25)
(25)
(25)
(24)
(23)
(23)
(23)
(23)
(23)
(22)
(21)
(21)
(21)
(21)
(21)
(21)
(21)
(20)
(Continued from Above)
Investment Grade
International shipping
Mortgage related MBS
Mortgage related MBS
Mortgage related ABS
Domestic energy
International metals and mining
International energy
Real estate investment trust
Automotive supplier
International energy
U.K. utilities
Domestic finance
Domestic energy
Global multi-industry
Domestic insurance
Domestic brokerage
International energy
International aircraft leasing
Property and casualty insurance
Mortgage related ABS
Domestic energy
Mortgage related MBS
Automotive rentals
International insurance
Domestic bank and finance
U.K. bank and finance
International communications
Domestic bank and finance
Domestic bank and finance
International bank and finance
Domestic insurance
International energy
Mortgage related MBS
Mortgage related ABS
Mortgage related MBS
Mortgage related MBS
International energy
Mortgage related MBS
International bank and finance
Mortgage related ABS
Domestic bank and finance
Global multi-industry
Domestic energy
Mortgage related ABS
Mortgage related MBS
Length of Time
in Loss Position
>270 days but <=1 year
>1 year
>270 days but <=1 year
>270 days but <=1 year
>270 days but <=1 year
>180 days but <=270 days
>1 year
>1 year
>270 days but <=1 year
>1 year
>1 year
>1 year
>270 days but <=1 year
>90 days but <=180 days
>270 days but <=1 year
>1 year
>180 days but <=270 days
>1 year
>180 days but <=270 days
>1 year
>270 days but <=1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>1 year
>1 year
>180 days but <=270 days
>1 year
>1 year
>180 days but <=270 days
>1 year
>1 year
>180 days but <=270 days
>1 year
<=90 days
>270 days but <=1 year
>1 year
>1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>270 days but <=1 year
>1 year
130
As of December 31, 2008
Fair
Value
Amortized Unrealized
Cost
Loss
63
12
15
43
111
53
21
22
58
70
71
49
112
69
71
181
109
27
54
12
113
9
40
65
68
15
110
43
44
5
37
143
24
23
23
10
80
2
24
10
40
53
77
17
3
83
32
35
63
130
72
40
41
77
89
90
67
130
87
89
198
126
44
71
29
130
26
57
82
85
31
126
58
59
20
52
158
39
38
38
25
95
17
39
25
55
68
92
32
18
(20)
(20)
(20)
(20)
(19)
(19)
(19)
(19)
(19)
(19)
(19)
(18)
(18)
(18)
(18)
(17)
(17)
(17)
(17)
(17)
(17)
(17)
(17)
(17)
(17)
(16)
(16)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(Continued from Above)
Investment Grade
Mortgage related MBS
Domestic insurance
Mortgage related MBS
Monoline insurer
International energy
Mortgage related MBS
International consumer goods
International beverage
International energy
Domestic brokerage
Mortgage related ABS
Real estate investment trust
International metals and mining
Real estate investment trust
Domestic energy
Domestic energy
International energy
Mortgage related MBS
Mortgage related MBS
Domestic bank and finance
Domestic energy
International bank and finance
Mortgage related ABS
Mortgage related MBS
Domestic insurance
Mortgage related MBS
U.K. bank and finance
Domestic healthcare
International bank and finance
Domestic insurance
International energy
International print services
Mortgage related MBS
Mortgage related MBS
Mortgage related MBS
Real estate investment trust
Mortgage related MBS
Domestic metals and mining
Mortgage related MBS
Mortgage related ABS
Domestic energy
Real estate investment trust
International consumer goods
International office products
International bank and finance
Real estate investment trust
Municipal
International insurance
Length of Time
in Loss Position
>270 days but <=1 year
>270 days but <=1 year
>1 year
<=90 days
>1 year
>1 year
>1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>1 year
>1 year
>180 days but <=270 days
>1 year
>270 days but <=1 year
>1 year
>270 days but <=1 year
>1 year
>270 days but <=1 year
>1 year
>90 days but <=180 days
>1 year
>1 year
>1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>180 days but <=270 days
>1 year
>1 year
>1 year
>1 year
>270 days but <=1 year
>180 days but <=270 days
>1 year
>270 days but <=1 year
>1 year
>180 days but <=270 days
131
As of December 31, 2008
Fair
Value
Amortized Unrealized
Cost
Loss
10
74
6
15
105
2
39
100
44
132
6
36
30
42
61
68
42
20
11
143
41
11
11
12
14
11
27
127
18
28
78
42
4
52
10
16
13
35
5
6
92
35
33
45
5
40
20
19
25
89
21
30
120
17
54
115
58
146
20
50
44
56
75
81
55
33
24
156
54
24
24
25
27
24
40
140
31
41
91
55
17
65
23
29
26
48
17
18
104
47
45
57
17
52
32
31
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(14)
(14)
(14)
(14)
(14)
(14)
(14)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(13)
(12)
(12)
(12)
(12)
(12)
(12)
(12)
(12)
(12)
(12)
As of December 31, 2008
Fair
Value
Amortized Unrealized
Cost
Loss
86
47
78
39
25
7
12
34
9
29
34
24
70
4
11
103
28
31
27
48
25
125
56
84
7
13
10
14
23
19
42
13
4
28
21
53
20
93
120
18
20
$
8,298
98
59
90
50
36
18
23
45
20
40
45
35
81
15
22
114
39
42
38
59
36
136
67
95
18
24
21
25
34
30
53
23
14
38
31
63
30
103
130
28
30
$
12,004
(12)
(12)
(12)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(10)
(10)
(10)
(10)
(10)
(10)
(10)
(10)
(10)
(10)
$
(3,706)
(Continued from Above)
Investment Grade
Domestic brokerage
Domestic energy
International energy
Domestic retailer
Real estate investment trust
Mortgage related MBS
Mortgage related ABS
Real estate investment trust
Mortgage related MBS
International steelmaker
International bank and finance
Mortgage related MBS
Domestic energy
Mortgage related MBS
Mortgage related ABS
Domestic energy
Mortgage related ABS
Domestic retailer
Food products
Domestic communications
Real estate investment trust
Domestic energy
International communications
Global multi-industry
Mortgage related ABS
Mortgage related MBS
Domestic finance
Domestic insurance
Mortgage related MBS
International energy
Domestic bank and finance
Mortgage related MBS
Mortgage related MBS
Domestic insurance
Mortgage related ABS
International energy
Domestic insurance
International energy
Domestic bank and finance
International brokerage
Mortgage related ABS
Total investment grade
Length of Time
in Loss Position
>1 year
>270 days but <=1 year
>180 days but <=270 days
>1 year
>270 days but <=1 year
>1 year
>1 year
>1 year
>1 year
>180 days but <=270 days
>1 year
>1 year
>180 days but <=270 days
>1 year
>1 year
>180 days but <=270 days
>270 days but <=1 year
>1 year
>180 days but <=270 days
>270 days but <=1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>270 days but <=1 year
>270 days but <=1 year
>1 year
>270 days but <=1 year
>270 days but <=1 year
>1 year
>1 year
>1 year
>1 year
>180 days but <=270 days
>1 year
>1 year
>180 days but <=270 days
>1 year
>270 days but <=1 year
>1 year
>180 days but <=270 days
132
As of December 31, 2008, available-for-sale fixed maturity and equity securities with gross unrealized losses greater than $10
million (in millions) for non investment grade securities were as follows:
Non Investment Grade
Domestic bank and finance
Entertainment
Mining
International forestry
Domestic homebuilding
Sovereign
Mortgage related MBS
Mortgage related MBS
Automotive supplier
Mortgage related MBS
International communications
Domestic homebuilding
Domestic homebuilding
International bank and finance
International development
Monoline insurer
Mortgage related MBS
Domestic homebuilding
Mortgage related MBS
International construction materials
Entertainment
Mortgage related MBS
Entertainment
Domestic automaker
International energy
Total non investment grade
Length of Time
in Loss Position
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>1 year
>180 days but <=270 days
>1 year
>180 days but <=270 days
>1 year
>1 year
>270 days but <=1 year
>1 year
>1 year
>270 days but <=1 year
>1 year
>270 days but <=1 year
As of December 31, 2008
Fair
Value
Amortized Unrealized
Cost
Loss
$
$
$
18
10
23
43
68
13
8
6
11
1
43
36
49
34
22
8
1
35
8
6
9
4
8
21
23
508
58
43
51
67
91
34
28
25
30
19
59
52
64
47
34
19
12
46
19
17
20
15
18
31
33
932
(40)
(33)
(28)
(24)
(23)
(21)
(20)
(19)
(19)
(18)
(16)
(16)
(15)
(13)
(12)
(11)
(11)
(11)
(11)
(11)
(11)
(11)
(10)
(10)
(10)
(424)
$
$
$
The information above is presented by investment grade and length of time in a loss position on an issuer basis. These
investments are 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 above, this is consistent with the classification of our investment portfolios as available-
for-sale.
133
Mortgage Loans on Real Estate
The following summarizes key information on mortgage loans (in millions):
As of December 31, 2008
Amount
%
As of December 31, 2008
Amount
%
Property Type
Office Building
Industrial
Retail
Apartment
Hotel/Motel
Mixed Use
Other Commercial
Geographic Region
Pacific
South Atlantic
East North Central
Mountain
West South Central
Middle Atlantic
East South Central
West North Central
New England
$
$
$
2,625
2,004
1,834
725
287
135
105
7,715
2,050
1,808
803
743
706
514
457
418
216
7,715
$
34%
26%
24%
9%
4%
2%
1%
100%
27%
23%
10%
10%
9%
7%
6%
5%
3%
100%
State Exposure
CA
TX
MD
FL
TN
NC
AZ
VA
WA
IL
GA
PA
NV
OH
IN
MN
MA
NJ
SC
NY
Other states under 1%
$
1,614
656
439
341
322
321
318
311
297
284
250
237
214
202
192
159
159
146
136
131
986
7,715
$
21%
9%
6%
4%
4%
4%
4%
4%
4%
3%
3%
3%
3%
3%
2%
2%
2%
2%
2%
2%
13%
100%
All mortgage loans that are impaired have an established allowance for credit loss. Changing economic conditions impact our
valuation of mortgage loans. Changing vacancies and rents are incorporated into the discounted cash flow analysis that we
perform for monitored loans and may contribute to the establishment of (or an increase or decrease in) an allowance for credit
losses. In addition, we continue to monitor the entire commercial mortgage loan portfolio to identify risk. Areas of emphasis are
properties that have deteriorating credits or have experienced debt coverage reduction. Where warranted, we have established or
increased loss reserves based upon this analysis. There were no impaired mortgage loans as of December 31, 2008 and 2007. As
of December 31, 2008, there were no commercial mortgage loans that were two or more payments delinquent. As of December
31, 2007, we had one commercial mortgage loan that was two or more payments delinquent. The total principal and interest due
on this loan as of December 31, 2007, was less than $1 million. See Note 5 for additional detail regarding impaired mortgage loans.
See Note 1 for more information regarding our accounting policy relating to the impairment of mortgage loans.
134
Alternative Investments
The carrying value of our consolidated alternative investments by business segment (in millions), which consists primarily of
investments in limited partnerships, was as follows:
Retirement Solutions:
Annuities
Defined Contribution
Insurance Solutions:
Life Insurance
Group Protection
Other Operations
Total alternative investments
As of December 31,
2007
2008
$
89
72
$
108
130
603
8
4
776
$
526
2
33
799
$
Income derived from our consolidated alternative investments by business segment (in millions) was as follows:
Retirement Solutions:
Annuities
Defined Contribution
Insurance Solutions:
Life Insurance
Group Protection
Other Operations
Total alternative investments (1)
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2007
2006
$
(7)
(8)
$
17
17
$
12
18
(16)
(2)
(1)
(34)
$
65
-
3
102
$
12
-
4
46
$
NM
NM
NM
NM
NM
NM
42%
-6%
NM
NM
-25%
122%
(1) Includes net investment income on the alternative investments supporting the required statutory surplus of our insurance
businesses.
The decline in our investment income on alternative investments presented in the table above when comparing 2008 to 2007 was
due to deterioration of the financial markets during 2008, as compared to exceptionally strong returns in the first half of 2007.
This weakness was spread across the various categories of investments within our alternative investment portfolio.
As of December 31, 2008 and 2007, alternative investments included investments in approximately 102 different partnerships,
respectively, that allowed us to gain exposure to a broadly diversified portfolio of asset classes such as venture capital, hedge funds,
oil and gas and real estate. 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 are not material to our liquidity. The capital calls are included on the table of contingent
commitments in “Review of Consolidated Financial Condition – Liquidity and Capital Resources” below. Alternative investments
are accounted for using the equity method of accounting and are included in other investments on our Consolidated Balance
Sheets.
Non-Income Producing Investments
As of December 31, 2008 and 2007, the carrying amount of fixed maturity securities, mortgage loans on real estate and real estate
that were non-income producing was $15 million and $21 million, respectively.
135
Net Investment Income
Details underlying net investment income (loss) (in millions) and our investment yield were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Net Investment Income
Fixed maturity available-for-sale securities
Equity available-for-sale securities
Trading securities
Mortgage loans on real estate
Real estate
Standby real estate equity commitments
Policy loans
Invested cash
Commercial mortgage loan prepayment and bond
makewhole premiums (1)
Alternative investments (2)
Consent fees
Other investments
Investment income
Investment expense
Net investment income
$
3,399
29
166
475
23
3
179
63
29
(34)
5
(4)
4,333
(125)
4,208
$
$
3,367
41
176
494
44
12
175
73
57
102
10
12
4,563
(185)
4,378
$
$
3,012
27
197
417
38
18
159
89
70
46
8
10
4,091
(168)
3,923
$
1%
-29%
-6%
-4%
-48%
-75%
2%
-14%
-49%
NM
-50%
NM
-5%
32%
-4%
12%
52%
-11%
18%
16%
-33%
10%
-18%
-19%
122%
25%
20%
12%
-10%
12%
(1) See “Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums” below for additional information.
(2) See “Alternative Investments” above for additional information.
For the Years Ended December 31,
2008
2006
2007
Basis Point Change
Over Prior Year
2008
2007
Interest Rate Yield
Fixed maturity securities, mortgage loans on
real estate and other, net of investment expenses
5.91%
5.95%
5.97%
Commercial mortgage loan prepayment and
bond makewhole premiums
Alternative investments
Consent fees
Standby real estate equity commitments
Net investment income yield on invested assets
0.04%
-0.05%
0.01%
0.00%
5.91%
0.08%
0.14%
0.01%
0.02%
6.20%
0.11%
0.07%
0.01%
0.03%
6.19%
(4)
(4)
(19)
-
(2)
(29)
(2)
(3)
7
-
(1)
1
Average invested assets at amortized cost
For the Years Ended December 31,
2008
2006
2007
63,338
70,633
71,143
$
$
$
Change Over Prior Year
2008
1%
2007
12%
We earn investment income on our general account assets supporting fixed annuity, term life, whole life, UL and interest-sensitive
whole life insurance products. The profitability of our fixed annuity and life insurance products is affected by our ability to achieve
target spreads, or margins, between the interest income earned on the general account assets and the interest credited to the
contract holder on our average fixed account values, including the fixed portion of variable. Net investment income and the
interest rate yield table each include commercial mortgage loan prepayments and bond makewhole premiums, alternative
investments and contingent interest and standby real estate equity commitments. These items can vary significantly from period to
period due to a number of factors and therefore can provide results that are not indicative of the underlying trends.
136
The decline in net investment income when comparing 2008 to 2007 was attributable to a combination of an of an increase in
lower yielding cash and short term investments held during the period, as well as a decline in investment income on alternative
investments, which had a strong 2007.
The growth in net investment income when comparing 2007 to 2006 was attributable primarily to including the results of
operations of Jefferson-Pilot for twelve months in 2007 compared to only nine months in 2006, positive net flows and continued
growth in our business from sales and favorable persistency.
Standby Real Estate Equity Commitments
Periodically, we enter into standby commitments, which obligate us to purchase real estate at a specified cost if a third-party sale
does not occur within approximately one year after construction is completed. These commitments are used by a developer to
obtain a construction loan from an outside lender on favorable terms. In return for issuing the commitment, we receive an annual
fee and a percentage of the profit when the property is sold. Our long-term expectation is that we will be obligated to fund a small
portion of these commitments. However, due to the current economic environment, we may experience increased funding
obligations.
As of December 31, 2008, we had standby real estate equity commitments totaling $267 million. During 2008, we funded
commitments of $13 million and added the fair value of the associated real estate to our Consolidated Balance Sheets. We did not
fund any commitments in 2007 or 2006.
Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums
Prepayment and makewhole premiums are collected when borrowers elect to call or prepay their debt prior to the stated maturity.
A prepayment or makewhole premium allows investors to attain the same yield as if the borrower made all scheduled interest
payments until maturity. These premiums are designed to make investors indifferent to prepayment.
The decline in prepayment and makewhole premiums when comparing 2008 to 2007 was attributable primarily to the general
tightening of credit conditions in the market resulting in less refinancing activity and less prepayment income.
137
Realized Loss Related to Investments
The detail of the realized loss related to investments (in millions) was as follows:
Fixed maturity available-for-sale securities:
Gross gains
Gross losses
Equity available-for-sale securities:
Gross gains
Gross losses
Gain on other investments
Associated amortization expense (benefit) of DAC,
VOBA, DSI and DFEL and changes in other
contract holder funds and
funds withheld reinsurance liabilities
Total realized loss on investments,
excluding trading securities
Gain (loss) on certain derivative instruments
Associated amortization expense of DAC, VOBA,
DSI and DFEL and changes in other
contract holder funds
Total realized loss on investments and
certain derivative instruments, excluding
trading securities
Write-downs for other-than-temporary impairments
impairments included in realized loss
on available-for-sale securities above
For the Years Ended December 31,
2007
2008
2006
$
74
(1,145)
$
125
(185)
$
132
(103)
5
(164)
32
260
(938)
(112)
8
(111)
18
29
(116)
(11)
-
(1)
4
(41)
(9)
2
Change Over Prior Year
2007
2006
-41%
NM
-38%
-48%
78%
NM
NM
NM
-5%
-80%
NM
NM
NM
171%
NM
NM
-
1
-
-100%
NM
$
(1,050)
$
(126)
$
(7)
NM
NM
$
(1,075)
$
(261)
$
(64)
NM
NM
Amortization expense of DAC, VOBA, DSI, DFEL and changes in other contract holder funds reflects an assumption for an
expected level of credit-related investment losses. When actual credit-related investment losses are realized, we recognize a true up
to our DAC, VOBA, DSI and DFEL amortization and changes in other contract holder funds within realized gain (loss) reflecting
the incremental impact of actual versus expected credit-related investment losses. These actual to expected amortization
adjustments could create volatility in net realized gains (losses). The write-down for impairments includes both credit-related and
interest-rate related impairments.
Realized gains and losses generally originate from asset sales to reposition the portfolio or to respond to product experience.
During 2008, 2007 and 2006, we sold securities for gains and losses. In the process of evaluating whether a security with an
unrealized loss reflects declines that are other-than-temporary, we consider our ability and intent to hold the security until its value
recovers. However, subsequent decisions on securities sales are made within the context of overall risk monitoring, assessing value
relative to other comparable securities and overall portfolio maintenance. Although our portfolio managers may, at a given point
in time, believe that the preferred course of action is to hold securities with unrealized losses that are considered temporary until
such losses are recovered, the dynamic nature of portfolio management may result in a subsequent decision to sell. These
subsequent decisions are consistent with the classification of our investment portfolio as available-for-sale. We expect to continue
to manage all non-trading invested assets within our portfolios in a manner that is consistent with the available-for-sale
classification.
138
We consider economic factors and circumstances within countries and industries where recent write-downs have occurred in our
assessment of the status of securities we own of similarly situated issuers. While it is possible for realized or unrealized losses on a
particular investment to affect other investments, our risk management has been designed to identify correlation risks and other
risks inherent in managing an investment portfolio. Once identified, strategies and procedures are developed to effectively monitor
and manage these risks. The areas of risk correlation that we pay particular attention to are risks that may be correlated within
specific financial and business markets, risks within specific industries and risks associated with related parties.
When the detailed analysis by our credit analysts and investment portfolio managers leads to the conclusion that a security’s decline
in fair value is other-than-temporary, the security is written down to estimated fair value. In instances where declines are
considered temporary, the security will continue to be carefully monitored. See “Item 7. Management’s Discussion and Analysis –
Introduction – Critical Accounting Policies and Estimates” for additional information on our portfolio management strategy.
Details underlying write-downs taken as a result of other-than-temporary impairments (in millions) were as follows:
Other-Than-Temporary Impairments
Fixed maturity securities:
Corporate bonds
Hybrid and redeemable preferred stock
Mortgage-backed securities
Total fixed maturity securities
Equity securities:
Bank of America stock
Preferred stock
Common stock
Total equity securities
Total other-than-temporary impairments
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
$
557
51
304
912
130
24
9
163
1,075
$
$
129
1
20
150
$
61
-
3
64
-
111
-
111
261
$
-
-
-
-
64
$
NM
NM
NM
NM
NM
47%
NM
47%
NM
111%
NM
NM
134%
NM
NM
NM
NM
NM
When comparing 2008 to 2007, the increase in write-downs for other-than-temporary impairments on our available-for-sale
securities were attributable primarily to unfavorable changes in credit quality on certain corporate bond holdings within the
Financial and Media sectors, as well as deteriorating fundamentals within the housing market which affected select RMBS
holdings. Additionally, significant dividend reductions by Bank of America impacted our evaluation of that investment, resulting in
an impairment. When comparing 2007 to 2006, higher write-downs for other-than-temporary impairments on our available-for-
sale securities were attributable primarily to unfavorable changes in credit quality and interest rates.
The $1.1 billion of impairments taken during 2008 are split between $937 million of credit related impairments and $138 million on
non-credit related impairments. The credit related impairments are largely attributable to our financial sector holdings, RMBS, and
mortgage related ABS holdings that have suffered from continued deterioration in housing fundamentals. The non-credit related
impairments were incurred due to declines in values of securities for which we are uncertain of our intent to hold until recovery or
maturity.
REINSURANCE
Our insurance companies cede insurance to other companies. The portion of risks exceeding each of our insurance companies’
retention limits is reinsured with other insurers. We seek reinsurance coverage within the businesses that sell life insurance to limit
our exposure to mortality losses and enhance our capital management.
Portions of our deferred annuity business have been reinsured on a modified coinsurance basis with other companies to limit our
exposure to interest rate risks. As of December 31, 2008, the reserves associated with these reinsurance arrangements totaled $1.1
billion. To cover products other than life insurance, we acquire other insurance coverage with retentions and limits that
management believes are appropriate for the circumstances. The consolidated financial statements included in “Item 8. Financial
Statements and Supplementary Data” reflect premiums, benefits and DAC, net of insurance ceded. Our insurance companies
remain liable if their reinsurers are unable to meet contractual obligations under applicable reinsurance agreements.
Our amounts recoverable from reinsurers represent receivables from and reserves ceded to reinsurers. As of December 31, 2008
and 2007, the amounts recoverable from reinsurers were $8.5 billion and $8.2 billion, respectively. We obtain reinsurance from a
diverse group of reinsurers, and we monitor concentration and financial strength ratings of our principal reinsurers. Swiss Re
represents our largest exposure. In 2001, we sold our reinsurance business to Swiss Re primarily through indemnity reinsurance
139
arrangements. Because we are not relieved of our liability to the ceding companies for this business, the liabilities and obligations
associated with the reinsured policies remain on our Consolidated Balance Sheets with a corresponding reinsurance receivable from
the business sold to Swiss Re, which totaled $4.5 billion and $4.3 billion as of December 31, 2008 and 2007, respectively. Swiss Re
has funded a trust with a balance of $1.9 billion as of December 31, 2008, 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 $2.0 billion and $9 million, respectively, as of December 31, 2008, related to the business sold
to Swiss Re.
Included in the business sold to Swiss Re through indemnity reinsurance in 2001 was disability income business. As of December
31, 2008, there were approximately $1.0 billion of reserves on this business. Under the reinsurance agreement with Swiss Re, there
was a recoverable of approximately $900 million and a corresponding funds withheld liability of approximately $840 million. As
previously disclosed, we had entered into arbitration regarding Swiss Re’s obligation to pay reinsurance recoverables on certain of
this disability income business. As of December 31, 2008, the amount due from Swiss Re was approximately $53 million related to
this disability income business. In late January 2009, we were notified of the arbitration panel’s decision to order a rescission of the
underlying reinsurance agreement. As a result of the ruling, a rescission of the reinsurance agreement previously in place would
result in our writing down this receivable. However, we expect that such a write-down would be partially offset by other items
including the release of our embedded derivative liability related to the funds withheld nature of the reinsurance agreements for this
business. We believe that the rescission will result in the elimination of the recoverable and corresponding funds withheld liability
as well as our being responsible for paying claims on the business and establishing sufficient reserves to support the liabilities.
Because the decision leaves it to the parties to effectuate the rescission, we expect to begin negotiations with Swiss Re regarding
various aspects of the rescission. In addition, we would expect to carry out a review of the adequacy of the reserves supporting the
liabilities. We are also currently evaluating our options in light of the arbitration panel’s ruling; however, based on currently
available information and our views of the manner in which the rescission will be effectuated, we do not currently expect the
rescission to have a material adverse effect on our results of operations, liquidity or capital resources.
In addition, we continue to dispute the contractual terms for interest crediting rates under another funds withheld reinsurance
arrangement with Swiss Re. We are currently seeking approximately $42 million of additional interest and are reviewing our
options with respect to this disputed amount.
From July 2007 until June 2008, we reinsured our Lincoln SmartSecurity® Advantage rider related to our variable annuities. Swiss Re
provided 50% quota share coinsurance of our lifetime GWB, Lincoln SmartSecurity® Advantage, for business written in 2007 and
2008, up to a total of $3.8 billion in deposits.
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 $659 million of fixed annuity business that we reinsure with Scottish Re, approximately 81% 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 $127
million of policy liabilities on the life insurance business that 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 rating downgrades with respect to our
existing exposures to Scottish Re. Based on current information, we do not believe that Scottish Re’s rating downgrades will have
a material adverse effect on our results of operations, liquidity or financial condition.
As of December 31, 2008, we had reinsurance recoverables of $696 million and policy loans of $45 million that were 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.
We have a reinsurance treaty between LNL and another subsidiary of LNC, Lincoln National Reinsurance Company (Barbados)
Limited (“LNBAR”) under which LNL reinsures certain guarantees associated with the GDB and GLB riders on its variable
annuity products. In early January 2008, we entered into a reinsurance treaty between LLANY and LNBAR under which LLANY
reinsures certain guarantees associated with the GLB riders on its variable annuity products. These treaties are traditional
reinsurance programs where LNL and LLANY pay premiums to LNBAR, and LNBAR assumes the associated variable annuity
rider guarantees. The hedge program that is designed to mitigate selected risk and income statement volatility from changes in
equity markets, interest rates and volatility associated with the guaranteed benefit features of these variable annuity products is
conducted in the LNBAR subsidiary. For more information on the results of our hedge program, see “Realized Gain (Loss)”
above.
See Note 9 for further information regarding reinsurance transactions.
140
For factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk Factors” 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 $1.3 billion, $2.0 billion and $3.1 billion in 2008,
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.
During the latter half of 2007 and continuing through August 2008, disruptions in the credit and capital markets, initially driven by
broad market concerns over the impact of sub-prime mortgage holdings of financial institutions, generally resulted in increased
cost of credit for financial institutions in the marketplace, including LNC and its subsidiaries. These disruptions accelerated during
September 2008 following the failure, consolidation of or U.S. federal government intervention on behalf of several significant
financial institutions and continued into 2009. In addition, the disruption resulted in the term credit markets for debt and hybrid
securities generally being closed to all financial institutions, including LNC. Although we currently continue to operate with
adequate cash on the balance sheet and have access to alternate sources of liquidity, as discussed below in “Alternative Sources of
Liquidity,” during this extraordinary market environment, management is continually monitoring and adjusting its liquidity and
capital plans for LNC and its subsidiaries in light of changing needs and opportunities. A continued extended disruption in the
credit and capital markets could adversely affect LNC and its subsidiaries’ ability to access sources of liquidity, and there can be no
assurance that additional financing will be available to us on favorable terms, or at all, in the current market environment.
In late September and early October of 2008, A.M. Best, Fitch, Moody’s and S&P each revised their outlook for the U.S. life
insurance sector to negative from stable. We believe that the rating agencies may heighten the level of scrutiny that they apply to
such institutions, may increase the frequency and scope of their credit reviews, may request additional information from the
companies that they rate and may adjust upward the capital and other requirements employed in the rating agency models for
maintenance of certain ratings levels. In addition, actions we take to access third party financing may in turn cause rating agencies
to reevaluate our ratings. For more information about ratings, see “Part I – Item 1. Business – Ratings.”
141
Details underlying the primary sources of our holding company cash flows (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Change Over Prior Year
2008
2007
Dividends from Subsidiaries
LNL
First Penn-Pacific
Lincoln Financial Media(1)
Delaware Investments
Other non-regulated companies(2)
Lincoln UK
Other
Loan Repayments and Interest from
Subsidiary
LNL interest on intercompany notes (3)
$
400
50
$
769
150
$
569
-
659
51
-
24
54
86
55
395
75
-
39
48
235
85
11
83
1,321
$
82
1,612
$
82
1,069
$
Other Cash Flow and Liquidity Items
Return of seed capital
Net capital received from stock option exercises
$
-
15
15
$
$
-
107
107
$
$
$
21
191
212
-48%
-67%
NM
-7%
-100%
-68%
NM
1%
-18%
NM
-86%
-86%
35%
NM
121%
15%
68%
-12%
-100%
0%
51%
-100%
-44%
-50%
(1) For 2008, amount includes proceeds on the sale of certain discontinued media operations. For more information, see Note 3.
(2) Represents dividend of proceeds from the sale of equity securities used to repay borrowings under the bridge facility in 2006
and a dividend of Bank of America shares to LNC from a subsidiary in September 2007.
(3) Primarily represents interest on the holding company’s $1.3 billion in surplus note investments in LNL. Interest of $20 million
from LNL for the fourth quarter of 2008, 2007 and 2006 was received December 31, 2008, December 31, 2007, and January 2,
2007, respectively.
The table above focuses on significant and recurring cash flow items and excludes the effects of certain financing activities, namely
the periodic issuance and retirement of debt and cash flows related to our inter-company cash management 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. See “Part IV – Item 15(a)(2) Financial Statement Schedules –
Schedule II – LNC Parent Company Only Statement of Cash Flows” for the parent company cash flow statement.
Subsidiaries
Our insurance subsidiaries are subject to certain insurance department regulatory restrictions as to the transfer of funds and
payment of dividends to the holding company. Under Indiana laws and regulations, our Indiana insurance subsidiaries, including
our primary insurance subsidiary, LNL, may pay dividends to LNC without prior approval of the Indiana Insurance Commissioner
(the “Commissioner”) up to a certain threshold, or must receive prior approval of the Commissioner to pay a dividend if such
dividend, along with all other dividends paid within the preceding twelve consecutive months exceed the statutory limitation. The
current statutory limitation is the greater of 10% of the insurer’s contract holders’ surplus, as shown on its last annual statement on
file with the Commissioner or the insurer’s statutory net gain from operations for the prior calendar year. As discussed in “Part I –
Item 1. Business – Regulatory – Insurance Regulation” above, we may not consider the benefit from the permitted practice to the
prescribed statutory accounting principles relating to our insurance subsidiaries’ deferred tax assets in calculating available
dividends. Indiana law gives the Commissioner broad discretion to disapprove requests for dividends in excess of these limits.
New York, the state of domicile of our other major insurance subsidiary, LLANY, has similar restrictions, except that in New York
it is the lesser of 10% of surplus to contract holders as of the immediately preceding calendar year or net gain from operations for
the immediately preceding calendar year, not including realized capital gains.
142
We expect our domestic insurance subsidiaries could pay dividends of approximately $550 million in 2009 without prior approval
from the respective state commissioners. The amount of surplus that our insurance subsidiaries could pay as dividends is
constrained by the amount of surplus we hold to maintain our ratings, to provide an additional layer of margin for risk protection
and for future investment in our businesses. We anticipate that, unless market conditions improve, the dividend capacity of our
insurance subsidiaries will be substantially constrained in 2009.
As discussed in “Part I – Item 1. Business – Regulatory – Insurance Regulation” above, we received approval from the Indiana
Department of Insurance for certain permitted practices to the prescribed NAIC statutory accounting principles for our Indiana-
domiciled insurance subsidiaries as of December 31, 2008. The permitted practices are expected to benefit the statutory capital and
surplus of our Indiana-domiciled insurance subsidiaries by approximately $320 million.
We maintain an investment portfolio of various holdings, types and maturities. These investments are subject to general credit,
liquidity, market and interest rate risks. An extended disruption in the credit and capital markets could adversely affect LNC and
its subsidiaries’ ability to access sources of liquidity, and there can be no assurance that additional financing will be available to us
on favorable terms, or at all, in the current market environment. In addition, further other-than-temporary impairments could
reduce our statutory surplus, leading to lower risk-based capital ratios and potentially reducing future dividend capacity from our
insurance subsidiaries.
Our insurance subsidiaries have statutory surplus and RBC levels above current regulatory required levels. As mentioned earlier,
more than 68% of our life sales consists of products containing secondary guarantees, which require reserving practices under
AG38. Our insurance subsidiaries are employing strategies to lessen the burden of increased AG38 and XXX statutory reserves
associated with certain UL products and other products with secondary guarantees subject to these statutory reserving
requirements. See “Financing Activities” below for additional details. LNC will guarantee that its wholly-owned subsidiary, which
reinsures a portion of the XXX reserves, will maintain a minimum level of capital and surplus as required under the insurance laws
of South Carolina, its state of domicile. The surplus maintenance agreement will remain in effect until such time that we securitize
the reserves, transfer the business to an unrelated party, sell or dissolve the wholly-owned subsidiary or receive notification from
the state insurance department permitting the rescission of the guarantee.
Included in the letters of credit (“LOCs”) issued as of December 31, 2008, reported in the revolving credit facilities table in
“Financing Activities,” was approximately $1.5 billion of LOCs supporting the reinsurance obligations of LNBAR on UL business
with secondary guarantees. Recognizing that LOCs are generally one to five years in duration, it is likely that our insurance
companies will apply a mix of LOCs, reinsurance and capital market strategies in addressing long-term AG38 and XXX needs.
LOCs and related capital market alternatives lower the RBC impact of the UL business with secondary guarantee products. An
inability to obtain the necessary LOC capacity or other capital market alternatives could impact our returns on UL business with
secondary guarantee products. We are continuing to pursue capital management strategies related to our AG38 reserves involving
reinsurance and securitizations. We completed a reinsurance transaction during the fourth quarter of 2008 whereby we ceded a
block of business to LNBAR, which resulted in the release of approximately $240 million of capital previously supporting a portion
of statutory reserves related to our insurance products with secondary guarantees. See “Part I – Item 1A. Risk Factors – Attempts
to mitigate the impact of Regulation XXX and Actuarial Guideline 38 may fail in whole or in part resulting in an adverse effect on
our financial condition and results of operations” for further information on XXX reserves. In addition, a portion of our term life
insurance business is reinsured with a domestic reinsurance captive as part of our overall strategy of managing the statutory capital
of our insurance subsidiaries. There are no outstanding LOCs related to this business.
In September of 2008, the NAIC adopted VACARVM, which will be effective as of December 31, 2009. VACARVM has the
potential to require statutory reserves well in excess of current levels for certain variable annuity riders sold by us. We plan to
utilize existing captive reinsurance structures, as well as pursue additional third-party reinsurance arrangements, 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 are
currently in the process of evaluating the impact of adopting VACARVM. For a discussion of RBC ratios, see “Part I – Item 1.
Business – Regulatory – Risk-Based Capital.”
As a result of the unfavorable impacts from equity markets during 2008, we recognized higher reserves under Commissioners
Annuity Reserve Valuation Method (“CARVM”) for our annuity products and higher reserves for GDB riders, which are only
partially reinsured. CARVM is the current statutory actuarial method used for determining reserves for the base annuity contract.
The impact of these items reduced the statutory surplus of LNL by approximately $225 million in 2008. We estimate that an S&P
level of 700, a substantial drop from the December 31, 2008, level, would require an increase in statutory reserves, and thereby,
further reduce statutory surplus of LNL by $170 million to $200 million at the end of the first quarter of 2009, related primarily to
CARVM. As a result, we estimate that LNL’s estimated RBC ratio at the end of December 31, 2008, would be reduced by
approximately 15 percentage points. The estimated potential increase to statutory reserves is based on the current statutory reserve
formulas and does not take into account the reserve and asset adequacy analysis performed by our actuaries on an annual basis to
determine appropriateness of the reserves at year end. This analysis incorporates the adequacy of assets in LNBAR, our captive
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reinsurance company, supporting the liabilities that it assumes from LNL. The outcome of this analysis may result in an additional
reserve increase and could further reduce the RBC ratio.
The sensitivity of our statutory reserves and surplus established for our variable annuity base contracts and riders to changes in the
equity markets will vary depending on the magnitude of the decline. The sensitivity will be affected by the level of account values
relative to the level of guaranteed amounts, product design and reinsurance. Statutory reserves for variable annuities depend upon
the cumulative equity market impacts on the business in force and therefore result in non-linear relationships with respect to the
level of equity market performance within any reporting period. The RBC ratio is also affected by the product mix of the in-force
book of business (i.e. the amount of business without guarantees is not subject to the same level of reserves as the business with
guarantees). The RBC ratio of LNL is an important factor in the determination of the credit and financial strength ratings of LNC
and its subsidiaries. As a result of declines in the market value of our separate account assets during 2008, our separate account
assets were less than the guaranteed liabilities that they support as of December 31, 2008, resulting in a $109 million reduction in
statutory surplus. The separate accounts include the impact of our variable annuities and also our credit-linked notes. When our
separate account assets are less than the related liabilities, we must allocate additional capital to the separate account for the
difference. Future declines in the market values of our separate account assets could cause future reductions in the surplus of
LNL, which may impact its RBC ratio and dividend capacity.
We have a reinsurance treaty between LNL and LNBAR under which LNL reinsures certain guarantees associated with the GDB
and GLB riders on its variable annuity products and between LLANY and LNBAR under which LLANY reinsures certain
guarantees associated with the GLB riders on its variable annuity products. We also reinsured with Swiss Re on a 50% quota share
coinsurance basis rider sales on certain GLB business written from July 2007 until June 2008. These reinsurance arrangements
serve to reduce LNL’s exposure to changes in the statutory reserves associated with changes in the equity markets; however, the
reinsurance treaty between LNL and LNBAR does not limit our exposure to mortality losses. Both LNBAR and Swiss Re have
established reserves for the business assumed and hold assets to support both the reserves and capital required by the respective
regulatory agencies. For more details on LNBAR, see “Reinsurance” above.
Lincoln UK’s operations consist primarily of unit-linked life and pension products, which are similar to U.S. produced variable life
and annuity products. Lincoln UK’s insurance subsidiaries are regulated by the U.K. Financial Services Authority (“FSA”) and are
subject to capital requirements as defined by the U.K. Capital Resources Requirement. All insurance companies operating in the
U.K. also have to complete an RBC assessment to demonstrate to the FSA that they hold sufficient capital to cover their risks.
RBC requirements in the U.K. are different than the NAIC requirements. In addition, the FSA has imposed certain minimum
capital requirements for the combined U.K. subsidiaries. Lincoln UK typically maintains approximately 1.5 to 2 times the required
capital as prescribed by the regulatory margin. As is the case with regulated insurance companies in the U.S., changes to regulatory
capital requirements can impact the dividend capacity of the U.K. insurance subsidiaries and cash flow to the holding company.
Adverse market conditions resulted in a significant increase in corporate bond spreads, and, combined with the restrictions
imposed by the U.K. statutory valuation basis, surplus capital levels were insufficient to support payment of the planned dividends
to the holding company except for $24 million in the second quarter of 2008, which did not negatively impact our liquidity.
Financing Activities
Although our subsidiaries currently generate adequate cash flow to meet the needs of our normal operations, periodically we may
issue debt or equity securities to maintain ratings and increase liquidity, as well as 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.
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Details underlying debt and financing activities (in millions) were as follows:
For the Year Ended December 31, 2008
Maturities
and
Repayments
Change
in Fair
Value
Hedges
-
$
(300)
(300)
$
-
$
-
$
-
Issuance
-
$
-
$
-
Beginning
Balance
$
$
265
285
550
Other
Changes (1)
Ending
Balance
$
$
$
$
50
515
565
315
500
815
$
2,892
-
$
-
200
-
$
-
$
174
-
$
(511)
-
$
2,555
200
Short-Term Debt
Commercial paper
Current maturities of long-term debt
Total short-term debt
Long-Term Debt
Senior notes
Bank borrowing
Federal Home Loan Bank
of Indianapolis ("FHLBI") advance
-
250
-
-
-
250
Junior subordinated debentures
issued to affiliated trusts
Capital securities
Total long-term debt
155
1,571
4,618
$
-
-
450
$
-
-
$
-
-
-
174
$
-
-
(511)
$
155
1,571
4,731
$
(1)
Includes the net increase (decrease) in commercial paper, non-cash reclassification of long-term debt to current maturities of
long-term debt, accretion of discounts and (amortization) of premiums.
Although current capital market conditions are making it difficult to refinance debt as it matures through the issuance of new debt
securities due to either or both the high cost or availability of such financing, we expect to have access to sufficient internal and
external resources to fund the maturity of the $500 million floating-rate senior note due on April 6, 2009. If the current difficult
conditions continue and external refinancing is not available, we expect to use internal borrowings to meet the April maturity. In
addition, as presented below, we also have available lines of credit that we may access. The specific resources or combination of
resources that we will use will depend upon, among other things, the financial market conditions present at the time of maturity.
Details underlying our credit facilities with a group of domestic and foreign banks (in millions) were as follows:
Expiration
Date
Not Applicable
July 2013
March 2011
February 2011
Revolving Credit Facilities
Credit facility with the FHLBI (1)
Five-year revolving credit facility
Five-year revolving credit facility
Five-year revolving credit facility
Total
Letters of credit issued
As of December 31, 2008
Maximum
Available
Borrowings
Outstanding
$
$
378
200
1,750
1,350
3,678
250
200
-
-
450
$
$
$
2,095
(1) Our borrowing capacity under this credit facility does not have an expiration date and continues while our investment in the
FHLBI common stock remains outstanding. The maturity dates of the borrowings are discussed below.
The LOCs support inter-company reinsurance transactions and specific treaties associated with our business sold through
reinsurance. LOCs are used primarily to satisfy the U.S. regulatory requirements of our domestic insurance companies for which
reserve credit is provided by our affiliated offshore reinsurance company, as discussed above, and our domestic clients of the
business sold through reinsurance.
Under the credit agreements, we must maintain a minimum consolidated net worth level. In addition, the agreements contain
covenants restricting our ability to incur liens, merge or consolidate with another entity where we are not the surviving entity and
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dispose of all or substantially all of our assets. As of December 31, 2008, we were in compliance with all such covenants. All of
our credit agreements are unsecured.
If current debt ratings and claims paying ratings were downgraded in the future, terms in our derivative agreements may be
triggered, which could negatively impact overall liquidity. For the majority of our counterparties, there is a termination event
should long-term debt ratings of LNC drop below BBB-/Baa3. In addition, contractual selling agreements with intermediaries
could be negatively impacted, which could have an adverse impact on overall sales of annuities, life insurance and investment
products. See “Part I – Item 1A. Risk Factors – A decrease in the capital and surplus of our insurance subsidiaries may result in a
downgrade to our insurer financial strength ratings” and “Part I – Item 1A. Risk Factors – A downgrade in our financial strength
or credit ratings could limit our ability to market products, increase the number or value of policies being surrendered and/or hurt
our relationships with creditors” for more information. See “Part I – Item 1. Business – Ratings” for additional information on
our current bond ratings.
In the third quarter of 2008, LNL made an investment of $19 million in the FHLBI, a AAA-rated entity. This relationship
provides us with another source of liquidity as an alternative to commercial paper and repurchase agreements as well as provides
funding at comparatively low borrowing rates. We are allowed to borrow up to 20 times the amount of our common stock
investment in FHLBI. All borrowings from the FHLBI are required to be secured by certain investments owned by LNL. On
December 4, 2008, the LNC and LNL Boards of Directors approved an additional common stock investment of $56 million,
which would increase our total borrowing capacity up to $1.5 billion. As of December 31, 2008, based on our common stock
investment, we had borrowing capacity of up to approximately $378 million from FHLBI. We also had a $250 million floating-rate
term loan outstanding under the facility due June 20, 2017, which may be prepaid beginning June 20, 2010.
Management is monitoring the covenants associated with LNC’s capital securities. If we fail to meet capital adequacy or net
income and shareholders’ equity levels (also referred to as “trigger events”), terms in the agreements may be triggered, which would
require us to make interest payments in accordance with an “alternative coupon satisfaction mechanism.” This would require us to
use commercially reasonable efforts to pay interest in full on the capital securities with the net proceeds from sales of our common
stock and warrants on our common stock with an exercise price greater than the market price. We would have to utilize the
alternative coupon satisfaction mechanism until the trigger events above no longer existed. If we were required to utilize the
alternative coupon satisfaction mechanism and were successful in selling sufficient common shares or warrants to satisfy the
interest payment, we would dilute the current holders of our common stock. Furthermore, while a trigger event is occurring and if
we do not pay accrued interest in full, we may not, among other things, pay dividends on or repurchase our capital stock. For
more information, see “Part I – Item 1A. Risk Factors – We will be required to pay interest on our capital securities with proceeds
from the issuance of qualifying securities if we fail to achieve capital adequacy or net income and shareholders’ equity levels” and
Note 13.
Alternative Sources of Liquidity
In order to manage our capital more efficiently, we have an inter-company cash management program where certain subsidiaries
can lend to or borrow from the holding company to meet short-term borrowing needs. The cash management program is
essentially a series of demand loans, which are permitted under applicable insurance laws, among LNC and its affiliates that reduces
overall borrowing costs by allowing LNC and its subsidiaries to access internal resources instead of incurring third-party
transaction costs. For our Indiana-domiciled insurance subsidiaries, the borrowing and lending limit is currently the lesser of 3%
of the insurance company’s admitted assets and 25% of its surplus, in both cases, as of its most recent year end.
The holding company had an average borrowing balance of $189 million from the cash management program during 2008. The
holding company had a maximum and minimum amount outstanding under the cash management program during 2008 of $512
million and zero, respectively. The balance as of December 31, 2008, was $388 million.
Our insurance subsidiaries, by virtue of their general account fixed income investment holdings, can access liquidity through
securities lending programs and repurchase agreements. As of December 31, 2008, our insurance subsidiaries had securities with a
carrying value of $427 million out on loan under the securities lending program and $470 million carrying value subject to reverse-
repurchase agreements. The cash received in our securities lending program is typically invested in cash equivalents, short-term
investments or fixed maturity securities.
LNC has a $1.0 billion commercial paper program that is rated A-2, P-2 and F1. The commercial paper program is backed by a
bank line of credit. In 2008, LNC had an average of $212 million in commercial paper outstanding with a maximum amount of
$575 million outstanding at any time. LNC had $315 million of commercial paper outstanding as of December 31, 2008.
The Federal Reserve Board authorized the Commercial Paper Funding Facility (“CPFF”) on October 7, 2008, under Section 13(3)
of the Federal Reserve Act to provide a liquidity backstop to U.S. issuers of commercial paper. The CPFF is intended to improve
liquidity in short-term funding markets by increasing the availability of term commercial paper funding to issuers and by providing
146
greater assurance to both issuers and investors that firms will be able to roll over their maturing commercial paper. The
commercial paper must be U.S dollar-denominated and rated A-1/P-1/F1 by at least two rating agencies to be eligible for the
program. On October 29, 2008, we were granted approval to participate in the CPFF, under which we were eligible to issue up to
$575 million of commercial paper. Included in the $315 million of commercial paper outstanding as of December 31, 2008, was
$100 million that was issued under the CPFF program. As of February 26, 2009, we had $475 million of commercial paper
outstanding under the CPFF. As a result of S&P’s recent downgrade of LNC’s short-term credit rating to A-2, we are not
currently eligible to issue new commercial paper under the CPFF. All commercial paper issued under the CPFF prior to the
downgrade will mature as originally scheduled. We believe that the inability to participate in the CPFF will make it more expensive
to sell additional commercial paper, and it may make it more likely that we will have to utilize other sources of liquidity, including
our credit facilities, for liquidity purposes.
On January 8, 2009, the Office of Thrift Supervision approved LNC’s application to become a savings and loan holding company
and its acquisition of Newton County Loan & Savings, FSB, a federally regulated savings bank, located in Indiana. LNC agreed to
contribute $10 million to the capital of Newton County Loan & Savings, FSB, and closed on the purchase on January 15, 2009.
LNC also previously filed an application to participate in the CPP. LNC’s application to participate in the CPP is subject to
approval from the U.S. Treasury. Accordingly, there can be no assurance that we will participate in the CPP.
As a savings and loan holding company, we have applied to participate in the Federal Deposit Insurance Corporation’s (“FDIC”)
Temporary Liquidity Guarantee Program (“TLGP”). At this time, we have not been approved and we do not know if we will
qualify under the provisions of the program, and, therefore, we can give no assurance whether or not this program will be available
to us. If we were to qualify, we believe that we would be eligible to issue up to $793 million of debt under the TLGP. Under this
program, the FDIC guarantees newly issued senior unsecured debt issued on or before June 30, 2009. The debt guarantee expires
June 30, 2012, regardless if the debt matures later. The proceeds of guaranteed debt cannot be used to prepay debt that is not
guaranteed. Entities participating in the program are subject to enhanced supervisory oversight to prevent rapid growth or
excessive risk taking, including additional reporting and on-site reviews to determine compliance with the program.
For factors that could cause actual results to differ materially from those set forth in this section, see “Item 1A. Risk Factors” and
“Forward-Looking Statements – Cautionary Language” above.
Divestitures
For a discussion of our divestitures, see “Part I – Item 1. Business – Acquisitions and Dispositions” and Note 3.
Uses of Capital
Our principal uses of cash are to pay policy claims and benefits, operating expenses, commissions and taxes, to purchase new
investments, to purchase reinsurance, to fund policy surrenders and withdrawals, to pay dividends to our stockholders and to
repurchase our stock and debt securities.
Return of Capital to Stockholders
One of the holding company’s primary goals is to provide a return to our stockholders. Through dividends and stock repurchases,
we have an established record of providing significant cash returns to our stockholders. In determining dividends, the Board takes
into consideration items such as current and expected earnings, capital needs, rating agency considerations and requirements for
financial flexibility. Details underlying this activity (in millions, except per share data) were as follows:
Dividends to stockholders
Repurchase of common stock
Total cash returned to stockholders
Number of shares repurchased
Average price per share
For the Years Ended December 31,
2008
2006
2007
$
$
$
429
476
905
9.091
52.31
$
$
430
986
1,416
15.381
64.13
$
$
429
1,003
1,432
16.887
59.40
$
$
Change Over Prior Year
2008
2007
0%
-52%
-36%
-40%
-19%
0%
-2%
-1%
-12%
8%
Note: Average price per share is calculated using whole dollars instead of dollars rounded to millions.
On October 10, 2008, the Board of Directors approved a decrease in the quarterly dividend on our common stock from $0.415 per
share to $0.21 per share for the dividend payable February 1, 2009. On February 24, 2009, the Board of Directors approved a
further reduction of the dividend on our common stock from $0.21 to $0.01 per share, which, along with the prior reduction, is
expected to add approximately $100 million to capital each quarter. Additionally, we have suspended stock repurchase activity.
147
We expect that both of these changes will favorably impact our capital position prospectively in light of the recent market volatility
and extraordinary events and developments affecting financial markets.
Other Uses of Capital
In addition to the amounts in the table above in “Return of Capital to Stockholders,” uses of holding company cash flow (in
millions) were as follows:
Debt service (interest paid)
Capital contribution to subsidiaries
Total
For the Years Ended December 31,
2008
2006
2007
$
$
$
282
-
282
270
325
595
$
$
$
195
68
263
Change Over Prior Year
2008
2007
4%
-100%
-53%
38%
NM
126%
The above 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 inter-company 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.
Contractual Obligations
Details underlying our future estimated cash payments for our contractual obligations (in millions) as of December 31, 2008, were
as follows:
Future contract benefits and other
contract holder obligations (1)
Short-term debt
Long-term debt (2)
Reverse repurchase agreements
Operating leases
Stadium naming rights (3)
Media obligations (4)
Outsourcing arrangements (5)
Retirement and other plans (6)
Totals
Less
Than
1 Year
1 - 3
Years
3 - 5
Years
More
Than
5 Years
Total
$
12,981
815
$
24,272
-
$
21,522
-
$
76,571
-
$
135,346
815
-
474
53
6
2
35
500
-
76
13
4
55
500
-
52
13
4
37
3,555
-
120
68
8
73
4,555
474
301
100
18
200
85
14,451
$
174
25,094
$
184
22,312
$
465
80,860
$
908
142,717
$
(1)
Includes various investment-type products with contractually scheduled maturities including single premium immediate
annuities, group pension annuities, guaranteed interest contracts, structured settlements, pension closeouts and certain annuity
contracts. Future contract benefits and other contract holder obligations also include benefit and claim liabilities, of which a
significant portion represents policies and contracts that do not have stated contractual maturity dates and may not result in
any future payment obligation. For these policies and contracts, we are not currently making payments and will not make
payments in the future until the occurrence of an insurable event, such as death or disability; or the occurrence of a payment
triggering event, such as a surrender of a policy or contract, which is outside of our control. We have made significant
assumptions to determine the estimated undiscounted cash flows of these policies and contracts, which include mortality,
morbidity, future lapse rates and interest crediting rates. Future contract benefits and other contract holder obligations have
been calculated using a discount rate of 6%. Due to the significance of the assumptions used, the amounts presented could
materially differ from actual results. Amounts for the Lincoln UK business have been translated using a U.S dollar to British
pound sterling exchange rate of 1.459, which was the rate as of December 31, 2008.
(2) Includes the maturities of the principal amounts of long-term debt, but excludes other items such as unamortized premiums
and discounts and fair value hedges, which are included in long-term debt on our Consolidated Balance Sheets.
Includes a maximum annual increase related to the Consumer Price Index.
(3)
(4) Consists primarily of employment contracts and rating service contracts.
(5)
(6)
Includes the Lincoln UK administration agreement, information technology and certain other outsourcing arrangements.
Includes anticipated funding for benefit payments for our retirement and postretirement plans through 2018 and known
payments under deferred compensation arrangements.
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In addition to the contractual commitments outlined in the table above, we periodically fund the employees’ defined benefit plans.
We contributed $14 million, $10 million and $5 million in 2008, 2007 and 2006, respectively, to U.S. pension plans; $1 million, $1
million and $1 million in 2008, 2007 and 2006, respectively, to our U.K. pension plan; and $15 million, $14 million and $14 million
to our U.S. postretirement plan. We do not expect to contribute to our qualified U.S. defined benefit pension plan in 2009. We
expect to fund approximately $10 million to our unfunded non-qualified U.S. defined benefit plan and $10 million to our U.S.
postretirement benefit plans during 2009. These amounts include anticipated benefit payments for non-qualified plans. The
majority of contributions/benefit payments are made at the insurance company subsidiary level with little holding company cash
flow impact. See Note 18 for additional information.
Due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at December
31, 2008, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority.
Therefore, $376 million of unrecognized tax benefits and its associated interest have been excluded from the contractual
obligations table above. See Note 7 for additional information.
Contingencies and Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that are reasonably likely to have a material effect on our financial condition,
results of operations, liquidity or capital resources. Details underlying our contingent commitments and off-balance sheet
arrangements (in millions) as of December 31, 2008, were as follows:
Bank lines of credit
Guarantees (1)
Investment commitments
Standby commitments to purchase real
estate upon completion and leasing (2)
Media commitments (3)
Operating lease guarantees (4)
Total
Amount of Commitment Expiring per Period
Less Than
1 Year
$
-
1
40
148
12
15
216
$
1 - 3
Years
$
3,100
-
157
119
18
-
3,394
$
3 - 5
Years
$
-
-
181
-
9
-
190
$
After
5 Years
$
128
-
60
-
-
-
188
$
Total
Amount
Committed
$
3,228
1
438
267
39
15
3,988
$
(1) Certain of our subsidiaries have sold commercial mortgage loans through grantor trusts, which issued pass-through certificates.
These subsidiaries have agreed to repurchase any mortgage loans that remain delinquent for 90 days at a repurchase price
substantially equal to the outstanding principal balance plus accrued interest thereon to the date of repurchase. In case of
default by the borrowers, we have recourse to the underlying real estate. It is management’s opinion that the value of the
properties underlying these commitments is sufficient that in the event of default, the impact would not be material to us.
These guarantees expire in 2009.
(2) See “Consolidated Investments – Standby Real Estate Equity Commitments” above for additional information.
(3) Consists primarily of employment contracts and rating service contracts.
(4) We guarantee the repayment of operating leases on facilities that we have subleased to third parties, which obligate us to pay in
the event the third parties fail to perform their payment obligations under the subleasing agreements. We have recourse to the
third parties enabling us to recover any amounts paid under our guarantees. The annual rental payments subject to these
guarantees are $15 million and expire in August 2009.
Pension Contributions
On December 23, 2008, a new bill was signed that provides a funding break for companies on their defined benefit plans amid the
market turmoil by providing some relief from the PPA requirements (the “Worker, Retiree, and Employer Recovery Act of 2008”
or “recovery act”). Among other things, the recovery act changes the way companies must move towards the higher funded status
required by the PPA. Under that law, companies had to fund their pensions 92% in 2008 and 94% in 2009. If a company missed a
benchmark, it had to put enough money into the plan the next year to bring funding to 100%. The new bill allows for companies
that did not meet 92% in 2008 to not have to immediately reach full funding, but, instead, it must funnel enough money into the
plan to reach 92% in 2009.
As a result of the unfavorable equity markets in 2008, the value of the plan assets backing our defined benefit plans has
significantly declined. Based on our calculations, we are not currently required to make any 2009 contributions; however, if plan
149
assets continue to decline, we might be required to make contributions in order to meet the requirements under the PPA and the
recovery act.
Significant Trends in Sources and Uses of Cash Flow
As stated above, LNC’s cash flow, as a holding company, is largely dependent upon the dividend capacity of its insurance company
subsidiaries as well as their ability to otherwise forward funds to it through inter-company borrowing arrangements. The insurance
company subsidiaries’ dividend capacity is impacted by factors influencing their risk-based capital and statutory earnings
performance. Although we currently expect to have sufficient liquidity and capital resources to meet our obligations in 2009, a
continuation of or an acceleration of poor capital market conditions, which reduces our statutory surplus and RBC, may require us
to retain more capital in our insurance company subsidiaries and may pressure our subsidiaries’ dividends to the holding company,
which may lead us to take steps to preserve or raise additional capital. For factors that could affect our expectations for liquidity
and capital, see “Item 1A. Risk Factors.”
Other Factors Affecting Our Business
OTHER MATTERS
In general, our businesses are subject to a changing social, economic, legal, legislative and regulatory environment. Some of the
changes include initiatives to require more reserves to be carried by our insurance subsidiaries. Although the eventual effect on us
of the changing environment in which we operate remains uncertain, these factors and others could have a material effect on our
results of operations, liquidity and capital resources. For factors that could cause actual results to differ materially from those set
forth in this section, see “Item 1A. Risk Factors” and “Forward-Looking Statements – Cautionary Language” above.
Recent Accounting Pronouncements
See Note 2 for a discussion of recent accounting pronouncements that have been implemented during the periods presented or
that have been issued and are to be implemented in the future.
ACQUISITIONS AND DIVESTITURES
For information about acquisitions and divestitures, see “Part I – Item 1. Business – Acquisitions and Dispositions” and Note 3.
See Note 17 for the detail of our restructuring activities.
RESTRUCTURING ACTIVITIES
150
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We analyze and manage the risks arising from market exposures of financial instruments, as well as other risks, in an integrated
asset-liability management process that takes diversification into account. By aggregating the potential effect of market and other
risks on the entire enterprise, we estimate, review and in some cases manage the risk to our earnings and shareholder value. We
have exposures to several market risks including interest rate risk, foreign currency exchange risk, equity market risk, default risk,
basis risk and credit risk. The exposures of financial instruments to market risks, and the related risk management processes, are
most important to our Retirement Solutions and Insurance Solutions businesses, where most of the invested assets support
accumulation and investment-oriented insurance products. As an important element of our integrated asset-liability management
process, we use derivatives to minimize the effects of changes in interest levels, the shape of the yield curve, currency movements
and volatility. In this context, derivatives are designated as a hedge and serve to minimize interest rate risk by mitigating the effect
of significant increases in interest rates on our earnings. Additional market exposures exist in our other general account insurance
products and in our debt structure and derivatives positions. Our primary sources of market risk are: substantial, relatively rapid
and sustained increases or decreases in interest rates; fluctuations in currency exchange rates; or a sharp drop in equity market
values. These market risks are discussed in detail in the following pages and should be read in conjunction with, our consolidated
financial statements and the accompanying notes to the consolidated financial statements (“Notes”) presented in “Item 8. Financial
Statements and Supplementary Data,” as well as “Item 7. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (“MD&A”).
Interest Rate Risk
With respect to accumulation and investment-oriented products, we seek to earn a stable and profitable spread, or margin, between
investment income we earn on our invested assets and interest credited to account values of our contract holders. If we have
adverse experience on investments that cannot be passed on to customers, our spreads are reduced. Provided investment yields
and default experience continue to gradually return to levels that are more typical from a long-term perspective, we do not view the
near term risk to spreads over the next twelve months to be material. The combination of a probable range of interest rate changes
over the next twelve months, asset-liability management strategies, flexibility in adjusting policy crediting rate levels and protection
afforded by policy surrender charges and other switching costs all work together to mitigate this risk. The interest rate scenarios of
concern are those in which there is a substantial, relatively rapid increase or decrease in interest rates that is then sustained over a
long period.
151
Significant Interest Rate Exposures
The following provides a general measure of our significant interest rate risk; amounts are shown by year of maturity and include
amortization of premiums and discounts; interest rate cap notional amounts are shown by amount outstanding (dollars in millions)
as of December 31, 2008:
2009
2010
2011
2012
2013
Thereafter
Total
Estimated
Fair Value
Rate Sensitive Assets
Fixed interest rate securities
Average interest rate
Variable interest
rate securities
Average interest rate
Mortgage loans
Average interest rate
Rate Sensitive Liabilities
Investment type
insurance contracts (1)
Average interest rate
Debt
Average interest rate
Rate Sensitive Derivative
Financial Instruments
Interest rate and foreign
currency swaps:
Pay variable/receive fixed
Average pay rate
Average receive rate
Pay fixed/receive variable
Average pay rate
Average receive rate
$
146
2.8%
6.5%
$
-
0.0%
0.0%
$
1,925
6.0%
$
2,273
6.1%
$
3,411
6.2%
$
3,617
6.0%
$
3,997
5.9%
$
38,136
6.2%
$
53,359
6.1%
$
47,761
46
7.9%
266
7.5%
1,032
5.7%
815
1.5%
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
153
5.9%
261
7.0%
1,153
6.1%
250
2.2%
24
3.2%
4.2%
554
4.9%
2.4%
149
3.2%
366
7.7%
1,794
6.3%
250
6.2%
48
5.7%
496
6.8%
1,813
6.0%
300
5.7%
68
2.4%
4.1%
405
3.6%
3.3%
$
-
0.0%
0.0%
510
5.0%
2.7%
$
228
5.8%
455
6.2%
1,942
5.9%
200
1.6%
258
3.4%
4.2%
275
4.0%
2.5%
5,837
5.4%
5,833
6.3%
15,534
6.1%
3,555
5.9%
$
$
6,461
5.4%
7,677
6.5%
$
$
23,268
6.1%
5,370
4.9%
5,112
3.3%
5.2%
1,928
5.1%
3.0%
5,608
3.3%
5.2%
3,672
4.8%
2.9%
$
3,507
$
7,424
$
26,058
$
3,684
$
1,776
$
(568)
$
$
$
$
$
$
$
$
$
$
Interest rate caps:
Outstanding notional
Average strike rate (2)
Forward CMT curve (3)
Interest rate futures:
2-year treasury notes
$
1,000
$
150
$
-
$
-
$
-
$
-
$
-
$
-
7.0%
2.3%
7.0%
2.6%
-
-
-
-
-
-
-
-
-
-
outstanding notional
$
634
$
-
$
-
$
-
$
-
$
-
$
634
$
-
5-year treasury notes
outstanding notional
10-year treasury notes
outstanding notional
Treasury bonds
743
671
outstanding notional
6,522
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
743
671
6,522
-
-
-
(1)
(2)
(3)
The information shown is for our fixed maturity securities and mortgage loans that support these insurance contracts.
The indexes are a mixture of five-year constant maturity treasury (“CMT”) and constant maturity swap.
The CMT curve is the five-year constant maturity treasury forward curve.
152
The following provides the principal amounts and estimated fair values of assets, liabilities and derivatives (in millions) having
significant interest rate risks:
Fixed interest rate securities
Variable interest rate securities
Mortgage loans
Investment type insurance contracts (1)
Debt
Interest rate and foreign currency swaps
Interest rate caps
As of December 31, 2007
Principal
Estimated
Fair Value
Amount
53,113
53,415
$
$
5,891
7,097
7,602
7,370
22,922
5,170
6,835
-
22,667
5,266
41
2
(1) The information shown is for our fixed maturity securities and mortgage loans that support these insurance contracts.
153
Interest Rate Risk on Fixed Insurance Business – Falling Rates
The spreads on our fixed annuity and interest-sensitive whole life, universal life (“UL”) and fixed portion of variable universal life
(“VUL”) insurance policies are at risk if interest rates decline and remain low for a period of time, which has generally been the
case in recent years. Should interest rates remain at current levels that are significantly lower than those existing prior to the
declines of recent years, the average earned rate of return on our annuity and UL investment portfolios will continue to decline.
Declining portfolio yields may cause the spreads between investment portfolio yields and the interest rate credited to contract
holders to deteriorate as our ability to manage spreads can become limited by minimum guaranteed rates on annuity and UL
policies. Minimum guaranteed rates on annuity and UL policies generally range from 1.5% to 5.0%, with an average guaranteed
rate of approximately 4%. The following provides detail on the percentage differences between the December 31, 2008, interest
rates being credited to contract holders and the respective minimum guaranteed policy rate (dollars in millions), broken out by
contract holder account values reported within the Retirement Solutions and Insurance Solutions businesses:
Excess of Crediting Rates over Contract Minimums
CD and on-benefit type annuities
Discretionary rate setting products (1)
No difference
up to .10%
0.11% to .20%
0.21% to .30%
0.31% to .40%
0.41% to .50%
0.51% to .60%
0.61% to .70%
0.71% to .80%
0.81% to .90%
0.91% to 1.0%
1.01% to 1.50%
1.51% to 2.00%
2.01% to 2.50%
2.51% to 3.00%
3.01% and above
Total discretionary rate setting products
Total account values
Account Values
Insurance
Solutions -
Life
Retirement Solutions
Defined
Annuities Contribution Insurance
Total
Percent
of Total
Account
Values
$
10,425
$
1,864
$
-
$
12,289
22.61%
3,298
1,462
790
137
126
74
38
268
7
9
5
48
438
278
176
73
7,227
17,652
$
7,237
74
2
5
1
1,113
125
2
-
-
36
149
205
-
14
194
9,157
11,021
$
12,075
4,147
2,640
859
561
1,196
1,021
440
560
364
632
290
645
232
-
8
25,670
25,670
$
22,610
5,683
3,432
1,001
688
2,383
1,184
710
567
373
673
487
1,288
510
190
275
42,054
54,343
$
41.60%
10.45%
6.31%
1.84%
1.27%
4.39%
2.18%
1.31%
1.04%
0.69%
1.24%
0.90%
2.37%
0.94%
0.35%
0.51%
77.39%
100.00%
(1) Contracts currently within new money rate bands are grouped according to the corresponding portfolio rate band in which they
will fall upon their first anniversary.
The maturity structure and call provisions of the related portfolios are structured to afford protection against erosion of investment
portfolio yields during periods of declining interest rates. We devote extensive effort to evaluating the risks associated with falling
interest rates by simulating asset and liability cash flows for a wide range of interest rate scenarios. We seek to manage these
exposures by maintaining a suitable maturity structure and by limiting our exposure to call risk in each respective investment
portfolio.
Interest Rate Risk on Fixed Insurance Business – Rising Rates
For both annuities and UL, a rapid and sustained rise in interest rates poses risks of deteriorating spreads and high surrenders. The
portfolios supporting these products have fixed-rate assets laddered over maturities generally ranging from one to ten years or
more. Accordingly, the earned rate on each portfolio lags behind changes in market yields. As rates rise, the lag may be increased
by slowing mortgage-backed securities prepayments. The greater and faster the rise in interest rates, the more the earned rate will
154
tend to lag behind market rates. If we set renewal crediting rates to earn the desired spread, the gap between our renewal crediting
rates and competitors’ new money rates may be wide enough to cause increased surrenders that could cause us to liquidate a
portion of our portfolio to fund these surrenders. If we credit more competitive renewal rates to limit surrenders, our spreads will
narrow. We devote extensive effort to evaluating these risks by simulating asset and liability cash flows for a wide range of interest
rate scenarios. Such analysis has led to adjustments in the target maturity structure and to hedging the risk of rising rates by buying
out-of-the-money interest rate cap agreements and swaptions. With these instruments in place, the potential adverse impact of a
rapid and sustained rise in rates is kept within our risk tolerances.
Debt
We manage the timing of maturities and the mixture of fixed-rate and floating-rate debt as part of the process of integrated
management of interest rate risk for the entire enterprise. See Note 13 for additional information on our debt.
Derivatives
We have entered into derivative transactions to hedge our exposure to rapid changes in interest rates. The derivative programs are
used to help us achieve somewhat stable margins while providing competitive crediting rates to contract holders during periods
when interest rates are changing. Such derivatives include interest rate swaps, interest rate futures, interest rate caps and treasury
locks. See Note 6 for additional information on our derivatives used to hedge our exposure to changes in interest rates.
In addition to continuing existing programs, we may use derivative instruments in other strategies to limit risk and enhance returns,
particularly in the management of investment spread businesses. We have established policies, guidelines and internal control
procedures for the use of derivatives as tools to enhance management of the overall portfolio of risks assumed in our operations.
Annually, our Board of Directors reviews our derivatives policy.
Foreign Currency Exchange Risk
Foreign Currency Denominated Investments
We invest in foreign currency securities for incremental return and risk diversification relative to United States Dollar-
Denominated (“USD”) securities. We use foreign currency swaps and foreign currency forwards to hedge some of the foreign
exchange risk related to our investment in securities denominated in foreign currencies. The currency risk is hedged using foreign
currency derivatives of the same currency as the bonds. See Note 6 for additional information on our foreign currency swaps and
foreign currency forwards used to hedge our exposure to foreign currency exchange risk.
The following provides our principal or notional amount in U.S. dollar equivalents (in millions) as of December 31, 2008, by
expected maturity for our foreign currency denominated investments and foreign currency swaps:
Currencies
British pound
Interest rate
Canadian dollar
Interest rate
New Zealand dollar
Interest rate
Euro
Interest rate
Australian dollar
Interest rate
Total currencies
Derivatives
Foreign currency swaps
2009
2010
2011
2012
2013
Thereafter
Total
$
73
5.80%
-
$
0.00%
-
$
0.00%
-
$
0.00%
-
$
0.00%
73
$
$
55
5.20%
-
$
0.00%
-
$
0.00%
-
$
0.00%
-
$
0.00%
55
$
$
58
6.60%
-
$
0.00%
-
$
0.00%
-
$
0.00%
-
$
0.00%
58
$
$
28
7.00%
-
$
0.00%
-
$
0.00%
-
$
0.00%
-
$
0.00%
28
$
$
25
4.00%
-
$
0.00%
-
$
0.00%
-
$
0.00%
-
$
0.00%
25
$
$
$
$
$
$
$
$
$
$
$
626
5.90%
35
5.98%
25
7.50%
195
4.88%
34
7.40%
915
865
5.90%
35
5.98%
25
7.50%
195
4.88%
34
7.40%
1,154
$
$
Estimated
Fair Value
$
851
$
31
$
23
$
172
$
19
$
1,096
-
-
-
-
-
367
367
64
155
The following provides our principal or notional amount in U.S. dollar equivalents of our foreign currency denominated
investments and foreign currency swaps (in millions):
As of December 31, 2007
Principal/
Notional
Amount
Estimated
Fair Value
Currencies
British pound
Canadian dollar
New Zealand dollar
Euro
Australian dollar
Total currencies
Derivatives
Foreign currency swaps
Equity Market Risk
$
$
1,152
53
33
205
43
1,486
1,220
54
31
198
29
1,532
$
$
$
366
$
(17)
Our revenues, assets, liabilities and derivatives are exposed to equity market risk. Due to the use of our reversion to the mean
(“RTM”) process and our hedging strategies, we expect that, in general, short-term fluctuations in the equity markets should not
have a significant impact on our quarterly earnings from unlocking of assumptions for deferred acquisition costs (“DAC”), value of
business acquired (“VOBA”), deferred sales inducements (“DSI”) and deferred front-end sales loads (“DFEL”). However, there is
an impact to earnings from the effects of equity market movements on account values and assets under management and the
related fees we earn on those assets. Refer to our “Item 7. MD&A – Critical Accounting Policies and Estimates – DAC, VOBA,
DSI and DFEL” for further discussion on the impact of equity markets on our RTM.
Fee Revenues
The fee revenues of our Investment Management segment and fees earned from variable annuities and variable life insurance
products are exposed to the risk of a decline in equity market values. These fees are generally a fixed percentage of the market
value of assets under management. In a severe equity market decline, fee income could be reduced by not only reduced market
valuations but also by customer withdrawals and redemptions. Such withdrawals and redemptions from equity funds and accounts
might be partially offset by transfers to our fixed-income accounts and the transfer of funds to us from our competitors’
customers.
Assets
While we invest in equity assets with the expectation of achieving higher returns than would be available in our core fixed-income
investments, the returns on and values of these equity investments are subject to somewhat greater market risk than our fixed-
income investments. These investments, however, add diversification benefits to our fixed-income investments. The following
provides the sensitivity of price changes (in millions) to our equity assets owned and equity derivatives:
As of December 31, 2008
10% Fair
Value
Increase
Estimated
Fair Value
10% Fair
Value
Decrease
Carrying
Value
As of December 31, 2007
Carrying
Value
Estimated
Fair Value
Equity Assets
Domestic equities
Foreign equities
Subtotal
Real estate
Other equity interests
Total
$
$
$
$
$
$
231
88
319
164
1,093
1,576
189
72
261
134
895
1,290
393
131
524
258
960
1,742
393
131
524
285
969
1,778
$
$
$
$
$
$
210
80
290
125
984
1,399
210
80
290
149
994
1,433
156
As of December 31, 2008
10% Fair
Value
Increase
Estimated
Fair Value
10% Fair
Value
Decrease
As of December 31, 2007
Notional
Value
Estimated
Fair Value
Notional
Value
Equity Derivatives (1)
Equity futures
Total return swaps
Put options
S&P 500 options
Total
$
3,769
126
4,700
2,951
11,546
$
-
$
-
1,727
31
1,758
$
$
$
$
(377)
9
1,632
58
1,322
377
(9)
1,881
4
2,253
$
$
$
296
126
4,025
2,858
7,305
-
$
-
529
150
679
$
(1) Assumes a +/- 10% change in underlying indexes. Estimated fair value does not reflect daily settlement of futures or monthly
settlement of total return swaps.
Liabilities
We have exposure to changes in our stock price through stock appreciation rights (“SARs”) issued in 2002 through 2008. See
Note 6 and Note 20 for additional information on our SARs and the related call options used to hedge the expected increase in
liabilities from SARs granted on our stock.
Derivatives Hedging Equity Market Risk
We have entered into derivative transactions to hedge our exposure to equity market fluctuations. Such derivatives include over-
the-counter equity call options, equity collars, variance swaps, total return swaps, put options, equity futures and call options. See
Note 6 for additional information on our derivatives used to hedge our exposure to equity market fluctuations.
Impact of Equity Market Sensitivity
Due to the use of our RTM process and our hedging strategies as described in “MD&A – Critical Accounting Policies and
Estimates,” we expect that, in general, short-term fluctuations in the equity markets should not have a significant impact on our
quarterly earnings from unlocking of assumptions for DAC, VOBA, DSI and DFEL, as we do not unlock our long-term equity
market assumptions based upon short-term fluctuations in the equity markets. However, there is an impact to earnings from the
effects of equity market movements on account values and assets under management and the related asset-based fees we earn on
those assets net of related expenses we incur based upon the level of assets. The following presents our estimate of the annual,
after-tax, after-DAC, impact on income from operations (in millions), from the level of the S&P 500 remaining at 800 and 700 for
the entire year at a 9% growth rate, excluding any impact related to sales, prospective unlocking, persistency, hedge program
performance or customer behavior caused by the equity market change:
Segment
Retirement Solutions - Annuities (1)
Retirement Solutions - Defined Contribution
Investment Management
S&P 500
at 800 (2)
S&P 500
at 700 (2)
$
(68)
(7)
(5)
$
(172)
(12)
(10)
(1) The Annuities amounts reflect a one-time DAC retrospective unlocking of $29 million, after-tax, for S&P 800, and $44
million, after-tax, for S&P 700.
(2) The impact of S&P 500 at 800 and 700, respectively, assumes the index remained at those levels for the entire year.
The impact on earnings summarized above is an expected annual effect. The result of the above factors should be multiplied by
25% to arrive at an estimated quarterly effect. The effect of quarterly equity market changes upon fee revenues and asset-based
expenses will not be fully recognized in the current quarter due to the fact that fee revenues are earned and related expenses are
incurred based upon daily variable account values. The difference between the current period average daily variable account values
compared to the end of period variable account values impacts fee revenues in subsequent periods. Additionally, the impact on
earnings may not necessarily be symmetrical with comparable increases in the equity markets. This discussion concerning the
estimated effects of ongoing equity market volatility on the fees we earn from account values and assets under management is
intended to be illustrative. Actual effects may vary depending on a variety of factors, many of which are outside of our control,
157
such as changing customer behaviors that might result in changes in the mix of our business between variable and fixed annuity
contracts, switching among investment alternatives available within variable products, changes in sales production levels or changes
in policy persistency. For purposes of this guidance, the change in account values is assumed to correlate with the change in the
relevant index.
Default Risk
Our portfolio of invested assets was $67.3 billion and $71.9 billion as of December 31, 2008, and December 31, 2007, respectively.
Of this total, $38.3 billion and $46.1 billion consisted of corporate bonds and $7.7 billion and $7.4 billion consist of commercial
mortgages as of December 31, 2008, and December 31, 2007, respectively. We manage the risk of adverse default experience on
these investments by applying disciplined credit evaluation and underwriting standards, prudently limiting allocations to lower-
quality, higher-yielding investments and diversifying exposures by issuer, industry, region and property type. For each counterparty
or borrowing entity and its affiliates, our exposures from all transactions are aggregated and managed in relation to formal limits set
by rating quality. Additional diversification limits, such as limits per industry, are also applied. We remain exposed to occasional
adverse cyclical economic downturns during which default rates may be significantly higher than the long-term historical average
used in pricing.
We depend on the ability of derivative product dealers and their guarantors to honor their obligations to pay the contract amounts
under various derivatives agreements. In order to minimize the risk of default losses, we diversify our exposures among several
dealers and limit the amount of exposure to each in accordance with the credit rating of each dealer or its guarantor. We generally
limit our selection of counterparties that are obligated under these derivative contracts to those with an A credit rating or above.
Credit-Related Derivatives
We use credit-related derivatives to minimize our exposure to credit-related events and we also sell credit default swaps to offer
credit protection to our contract holders. For additional information see Note 6.
Credit Risk
By using derivative instruments, we are exposed to credit risk (our counterparty fails to make payment) and market risk (the value
of the instrument falls). When the fair value of a derivative contract is positive, this generally indicates that the counterparty owes
us and, therefore, creates a credit risk for us equal to the extent of the fair value gain in the derivative. When the fair value of a
derivative contract is negative, this generally indicates we owe the counterparty and therefore we have no credit risk, but have been
affected by market risk. We minimize the credit risk in derivative instruments by entering into transactions with high quality
counterparties with minimum credit ratings that are reviewed regularly by us, by limiting the amount of credit exposure to any one
counterparty, and by requiring certain counterparties to post collateral if our credit risk exceeds certain limits. We also maintain a
policy of requiring all derivative contracts to be governed by an International Swaps and Derivatives Association (“ISDA”) Master
Agreement. We do not believe that the credit or market risks associated with derivative instruments are material to any insurance
subsidiary or to us.
We have derivative positions with counterparties. Assuming zero recovery value, our exposure is the positive market value of the
derivative positions with a counterparty, less collateral, that would be lost if the counterparty were to default. As of December 31,
2008, and December 31, 2007, our counterparty risk exposure, net of collateral, was $562 million and $781 million, respectively.
Of this exposure, $145 million and $567 million, respectively was related to our program to hedge our variable annuity guaranteed
benefits. We have exposure to 19 counterparties, with a maximum exposure of $153 million, net of collateral, to a single
counterparty. The credit risk associated with such agreements is minimized by purchasing such agreements from financial
institutions with long-standing, superior performance records. For the majority of LNC counterparties, there is a termination
event should long-term debt ratings of LNC rating drop below BBB-/Baa3. Additionally, we maintain a policy of requiring all
derivative contracts to be governed by an ISDA Master Agreement.
As of December 31, 2008 and 2007, our fair value of counterparty exposure (in millions) was as follows:
As of December 31,
2008
2007
Rating
AAA
AA
A
Total
$
3
651
127
781
$
$
$
20
333
209
562
158
Item 8. Financial Statements and Supplementary Data
MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting for LNC to provide
reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those
policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and
expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections
of any evaluation of internal control over financial reporting 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.
Management assessed our internal control over financial reporting as of December 31, 2008, the end of our fiscal year.
Management based its assessment on criteria established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Management’s assessment included evaluation of such elements as the
design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall
control environment.
Based on the assessment, management has concluded that our internal control over financial reporting was effective as of the end
of the fiscal year to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external reporting purposes in accordance with generally accepted accounting principles.
The effectiveness of our internal control over financial reporting as of December 31, 2008, has been audited by Ernst & Young
LLP, an independent registered public accounting firm, as stated in their report which is included immediately below.
159
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Lincoln National Corporation
We have audited Lincoln National Corporation’s (the “Corporation”) internal control over financial reporting as of December 31,
2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). The Corporation’s management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is
to express an opinion on the Corporation’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control
over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in
the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets
of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Lincoln National Corporation maintained, in all material respects, effective internal control over financial reporting
as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Lincoln National Corporation as of December 31, 2008 and 2007, and the related consolidated
statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008 and
our report dated February 25, 2009 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
February 25, 2009
160
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Lincoln National Corporation
We have audited the accompanying consolidated balance sheets of Lincoln National Corporation (the “Corporation”) as of
December 31, 2008 and 2007, and the related consolidated statements of income, shareholders' equity, and cash flows for each of
the three years in the period ended December 31, 2008. Our audits also included the financial statement schedules listed in the
Index at 15(a)(2). These financial statements and schedules are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements and schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position
of Lincoln National Corporation at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows
for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial
statements taken as a whole, present fairly in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 2007 the Corporation changed its method of accounting for
deferred acquisition costs in connection with modifications or exchanges of insurance contracts as well as its method of accounting
for uncertainty in income taxes.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States),
Lincoln National Corporation's internal control over financial reporting as of December 31, 2008, based on criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and
our report dated February 25, 2009 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
February 25, 2009
161
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
As of December 31,
2008
2007
ASSETS
Investments:
Available-for-sale securities, at fair value:
Fixed maturity (amortized cost: 2008 - $55,194; 2007 - $56,069)
Equity (cost: 2008 - $466; 2007 - $548)
Trading securities
Mortgage loans on real estate
Real estate
Policy loans
Derivative investments
Other investments
Total investments
Cash and invested cash
Deferred acquisition costs and value of business acquired
Premiums and fees receivable
Accrued investment income
Reinsurance recoverables
Reinsurance related derivative assets
Goodwill
Other assets
Separate account assets
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Future contract benefits
Other contract holder funds
Short-term debt
Long-term debt
Reinsurance related derivative liabilities
Funds withheld reinsurance liabilities
Deferred gain on business sold through reinsurance
Payables for collateral under securities loaned and derivatives
Other liabilities
Separate account liabilities
Total liabilities
Contingencies and Commitments (See Note 14)
Stockholders' Equity
Series A preferred stock - 10,000,000 shares authorized
Common stock - 800,000,000 shares authorized; 255,869,859 and 264,233,303 shares
issued and outstanding as of December 31, 2008 and 2007, respectively
Retained earnings
Accumulated other comprehensive income (loss)
Total stockholders' equity
Total liabilities and stockholders' equity
See accompanying Notes to Consolidated Financial Statements
162
$
$
48,935
288
2,333
7,715
125
2,924
3,397
1,624
67,341
5,926
11,936
481
832
8,450
31
3,944
3,562
60,633
163,136
56,276
518
2,730
7,423
258
2,885
807
1,075
71,972
1,665
9,580
401
843
8,187
-
4,144
3,530
91,113
191,435
$
$
$
19,260
60,847
815
4,731
-
2,042
619
3,706
2,506
60,633
155,159
$
16,007
59,640
550
4,618
219
2,117
696
1,135
3,622
91,113
179,717
-
-
7,035
3,745
(2,803)
7,977
163,136
$
7,200
4,293
225
11,718
191,435
$
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(in millions, except per share data)
Revenues
Insurance premiums
Insurance fees
Investment advisory fees
Net investment income
Realized gain (loss)
Amortization of deferred gain on business
sold through reinsurance
Other revenues and fees
Total revenues
Benefits and Expenses
Interest credited
Benefits
Underwriting, acquisition, insurance and other expenses
Interest and debt expense
Impairment of intangibles
Total benefits and expenses
Income (loss) from continuing operations before taxes
Federal income tax expense (benefit)
Income from continuing operations
Income (loss) from discontinued operations,
net of federal income tax expense (benefit)
Net income
Earnings Per Common Share - Basic
Income from continuing operations
Income (loss) from discontinued operations
Net income
Earnings Per Common Share - Diluted
Income from continuing operations
Income (loss) from discontinued operations
Net income
For the Years Ended December 31,
2008
2006
2007
$
2,096
3,229
268
4,208
(537)
76
543
9,883
2,501
3,157
3,576
281
393
9,908
(25)
(87)
62
$
$
1,947
3,190
360
4,378
(169)
83
686
10,475
2,435
2,562
3,320
284
-
8,601
1,874
553
1,321
1,406
2,564
328
3,923
13
76
569
8,879
2,191
1,906
2,776
228
-
7,101
1,778
483
1,295
(5)
57
$
(106)
1,215
$
21
1,316
$
$
$
0.24
(0.02)
0.22
$
$
0.24
(0.02)
0.22
$
$
4.89
(0.39)
4.50
$
$
4.82
(0.39)
4.43
$
$
5.13
0.08
5.21
$
$
5.05
0.08
5.13
See accompanying Notes to Consolidated Financial Statements
163
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in millions, except per share data)
Series A Preferred Stock
Balance at beginning-of-year
Conversion into common stock
Balance at end-of-year
Common Stock
Balance at beginning-of-year
Issued for acquisition
Conversion of Series A preferred stock
Stock compensation/issued for benefit plans
Deferred compensation payable in stock
Retirement of common stock/cancellation of shares
Balance at end-of-year
Retained Earnings
Balance at beginning-of-year
Cumulative effect of adoption of SOP 05-1
Cumulative effect of adoption of FIN 48
Cumulative effect of adoption of EITF 06-10
Comprehensive income
Less other comprehensive income (loss), net of tax
Net income
Retirement of common stock
Dividends declared: Common (2008 - $1.455; 2007 - $1.600; 2006 - $1.535)
Balance at end-of-year
Net Unrealized Gain (Loss) on Available-for-Sale Securities
Balance at beginning-of-year
Change during the year
Balance at end-of-year
Net Unrealized Gain on Derivative Instruments
Balance at beginning-of-year
Change during the year
Balance at end-of-year
Foreign Currency Translation Adjustment
Balance at beginning-of-year
Change during the year
Balance at end-of-year
Minimum Pension Liability Adjustment
Balance at beginning-of-year
Change during the year
Balance at end-of-year
Funded Status of Employee Benefit Plans
Balance at beginning-of-year
Change during the year
Balance at end-of-year
Total stockholders' equity at end-of-year
For the Years Ended December 31,
2008
2006
2007
$
-
-
-
$
1
(1)
-
$
1
-
1
7,200
-
-
78
6
(249)
7,035
4,293
-
-
(4)
(2,971)
(3,028)
57
(227)
(374)
3,745
86
(2,740)
(2,654)
53
74
127
175
(169)
6
-
-
-
7,449
20
1
139
6
(415)
7,200
4,138
(41)
(15)
-
827
(388)
1,215
(574)
(430)
4,293
493
(407)
86
39
14
53
165
10
175
-
-
-
1,775
5,632
-
207
7
(172)
7,449
4,081
-
-
-
1,402
86
1,316
(830)
(429)
4,138
497
(4)
493
7
32
39
83
82
165
(60)
60
-
(89)
(193)
(282)
7,977
$
(84)
(5)
(89)
11,718
$
-
(84)
(84)
12,201
$
See accompanying Notes to Consolidated Financial Statements
164
LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred acquisition costs, value of business acquired, deferred sales inducements
and deferred front end loads deferrals and interest, net of amortization
Trading securities purchases, sales and maturities, net
Change in premiums and fees receivable
Change in accrued investment income
Change in future contract benefits
Change in other contract holder funds
Change in funds withheld reinsurance liability and reinsurance recoverables
Change in federal income tax accruals
Realized loss (gain)
Loss (gain) on disposal of discontinued operations
Impairment of intangibles
Amortization of deferred gain on business sold through reinsurance
Stock-based compensation expense
Other
Net cash provided by operating activities
Cash Flows from Investing Activities
Purchases of available-for-sale securities
Sales of available-for-sale securities
Maturities of available-for-sale securities
Purchases of other investments
Sales or maturities of other investments
Increase (decrease) in payables for collateral under securities loaned and derivatives
Purchase of Jefferson-Pilot stock, net of cash acquired of $39
Proceeds from sale of subsidiaries/businesses and disposal of discontinued operations
Other
Net cash provided by (used in) investing activities
Cash Flows from Financing Activities
Payment of long-term debt, including current maturities
Issuance of long-term debt
Issuance (decrease) in commercial paper
Deposits of fixed account values, including the fixed portion of variable
Withdrawals of fixed account values, including the fixed portion of variable
Transfers to and from separate accounts, net
Payment of funding agreements
Common stock issued for benefit plans and excess tax benefits
Repurchase of common stock
Dividends paid to stockholders
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and invested cash
Cash and invested cash at beginning-of-year
Cash and invested cash at end-of-period
For the Years Ended December 31,
2008
2006
2007
$
57
$
1,215
$
1,316
(238)
205
69
11
755
(2)
(305)
(504)
537
12
393
(76)
35
310
1,259
(6,800)
2,285
3,881
(3,510)
3,613
2,571
-
648
(117)
2,571
(300)
450
50
9,840
(5,998)
(2,204)
(550)
49
(476)
(430)
431
(1,276)
352
21
23
677
177
(155)
585
169
(57)
-
(83)
47
260
1,955
(12,299)
6,825
4,202
(2,568)
2,110
(369)
-
64
74
(1,961)
(658)
1,422
265
9,519
(6,733)
(2,448)
-
98
(986)
(430)
49
(902)
259
87
15
426
909
365
175
(13)
-
-
(76)
53
436
3,050
(9,951)
6,466
3,344
(573)
189
58
(1,826)
-
28
(2,265)
(178)
2,045
(564)
7,761
(7,497)
(1,821)
-
166
(1,002)
(385)
(1,475)
4,261
1,665
5,926
$
43
1,622
1,665
$
(690)
2,312
1,622
$
See accompanying Notes to Consolidated Financial Statements
165
LINCOLN NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Operations, Basis of Presentation and Summary of Significant Accounting Policies
Nature of Operations
Lincoln National Corporation and its majority-owned subsidiaries (“LNC” or the “Company,” which also may be referred to as
“we,” “our” or “us”) operate multiple insurance and investment management businesses through six business segments, see Note
23. The collective group of businesses uses “Lincoln Financial Group” as its marketing identity. Through our business segments,
we sell a wide range of wealth protection, accumulation and retirement income products. These products include institutional
and/or retail fixed and indexed annuities, variable annuities, universal life (“UL”) insurance, variable universal life (“VUL”)
insurance, term life insurance, mutual funds and managed accounts.
Basis of Presentation
The accompanying consolidated financial statements are prepared in accordance with United States of America generally accepted
accounting principles (“GAAP”). Certain GAAP policies, which significantly affect the determination of financial position, results
of operations and cash flows, are summarized below.
Certain amounts reported in prior years’ consolidated financial statements have been reclassified to conform to the presentation
adopted in the current year. These reclassifications had no effect on net income or stockholders’ equity of the prior years.
For the two years ended December 31, 2007, we have reclassified the results of certain derivatives and embedded derivatives to
realized gain (loss), which were previously reported within insurance fees, net investment income, interest credited or benefits on
our Consolidated Statements of Income. The associated amortization expense of deferred acquisition costs (“DAC”) and value of
business acquired (“VOBA”) (previously reported within underwriting, acquisition, insurance and other expenses), deferred sales
inducements (“DSI”) (previously reported within interest credited), deferred front-end loads (“DFEL”) (previously reported within
insurance fees) and changes in contract holder funds (previously reported within benefits) have also been reclassified to realized
gain (loss) on our Consolidated Statements of Income. The detail of the reclassifications (in millions) from what was previously
reported in prior period Consolidated Statements of Income (in millions) was as follows:
Realized loss, as previously reported
Effect of reclassifications to:
Insurance fees
Net investment income
Interest credited
Benefits
Underwriting, acquisition, insurance and other expenses
Realized gain (loss), as adjusted
Summary of Significant Accounting Policies
Principles of Consolidation
For the Years Ended
December 31,
2007
$
(118)
2006
$
(3)
64
6
(19)
(138)
36
(169)
$
41
62
(68)
(5)
(14)
13
$
The accompanying consolidated financial statements include the accounts of LNC and all other entities in which we have a
controlling financial interest and any variable interest entities (“VIEs”) in which we are the primary beneficiary. Entities in which
we do not have a controlling financial interest and do not exercise significant management influence over the operating and
financing decisions are reported using the equity method. The carrying value of our investments that we account for using the
equity method on our Consolidated Balance Sheets and equity in earnings on our Consolidated Statements of Income is not
material. All material inter-company accounts and transactions have been eliminated in consolidation. See Note 4 for additional
discussion on our VIEs.
166
Accounting Estimates and Assumptions
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions
affecting the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the
financial statements and the reported amounts of revenues and expenses for the reporting period. Those estimates are inherently
subject to change and actual results could differ from those estimates. Included among the material (or potentially material)
reported amounts and disclosures that require extensive use of estimates are: fair value of certain invested assets and derivatives,
asset valuation allowances, DAC, VOBA, goodwill, future contract benefits, other contract holder funds (including DFEL),
pension plans, income taxes and the potential effects of resolving litigated matters.
Business Combinations
For all business combination transactions initiated after June 30, 2001, the purchase method of accounting has been used, and
accordingly, the assets and liabilities of the acquired company have been recorded at their estimated fair values as of the merger
date. The allocation of fair values may be subject to adjustment after the initial allocation for up to a one-year period as more
information relative to the fair values as of the acquisition date becomes available. The consolidated financial statements include
the results of operations of any acquired company since the acquisition date.
Available-For-Sale Securities
Securities classified as available-for-sale consist of fixed maturity and equity securities and are stated at fair value with unrealized
gains and losses included as a separate component of accumulated other comprehensive income (“OCI”), net of associated DAC,
VOBA, DSI, other contract holder funds and deferred income taxes.
We measure the fair value of our securities classified as available-for-sale based on assumptions used by market participants in
pricing the security. Pursuant to SFAS No. 157, we have categorized these securities into a three-level hierarchy, based on the
priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in
active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3), as described in
“SFAS No. 157 – Fair Value Measurements” in Note 2. The most appropriate valuation methodology is selected based on the
specific characteristics of the fixed maturity or equity security, and we consistently apply the valuation methodology to measure the
security’s fair value. Our fair value measurement is based on a market approach which utilizes prices and other relevant
information generated by market transactions involving identical or comparable securities. Sources of inputs to the market
approach include: third party pricing services, independent broker quotations or pricing matrices. We use observable and
unobservable inputs to our valuation methodologies. Observable inputs include benchmark yields, reported trades, broker-dealer
quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators,
industry and economic events are monitored and further market data is acquired if certain triggers are met. For certain security
types, additional inputs may be used, or some of the inputs described above may not be applicable. For broker-quoted only
securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. In order
to validate the pricing information and broker-dealer quotes, we employ, where possible, procedures that include comparisons with
similar observable positions, comparisons with subsequent sales, and discussions with senior business leaders and brokers as well as
observations of general market movements for those security classes. For those securities trading in less liquid or illiquid markets
with limited or no pricing information, we use unobservable inputs in order to measure the fair value of these securities. In cases
where this information is not available, such as for privately placed securities, fair value is estimated using an internal pricing
matrix. This matrix relies on management’s judgment concerning: the discount rate used in calculating expected future cash flows,
credit quality, industry sector performance and expected maturity.
We do not adjust prices received from third parties; however, we do analyze the third party pricing services’ valuation
methodologies and related inputs and perform additional evaluation to determine the appropriate level within the fair value
hierarchy. See Note 2 “Statement of Financial Accounting Standards (“SFAS”) No. 157 (“SFAS 157”) – Fair Value Measurements” for
more information regarding the fair value hierarchy.
Dividends and interest income, recorded in net investment income, are recognized when earned. Amortization of premiums and
accretion of discounts on investments in debt securities are reflected in net investment income over the contractual terms of the
investments in a manner that produces a constant effective yield. Realized gains and losses on the sale of investments are
determined using the specific identification method.
We regularly review available-for-sale securities for declines in fair value that we determine to be other-than-temporary. The cost
basis of securities that are determined to be other-than-temporarily impaired is written down to current fair value with a
corresponding charge to realized gain (loss) on our Consolidated Statements of Income. A write-down for impairment can be
recognized for both credit-related events and for a decline in fair value due to changes in interest rates. Once a security is written
down to fair value through net income, any subsequent recovery of fair value cannot be recognized in net income until the security
167
is sold. However, in the event that the security is written down due to an interest-rate related impairment, a recovery in value is
accreted through investment income over the life of the security. In evaluating whether a decline in value is other-than-temporary,
we consider several factors including, but not limited to: the severity (generally if greater than 20%) and duration (generally if
greater than six months) of the decline; our ability and intent to hold the security for a sufficient period of time to allow for a
recovery in value; the cause of the decline; and fundamental analysis of the liquidity, business prospects and overall financial
condition of the issuer.
Trading Securities
Trading securities consist of fixed maturity and equity securities in designated portfolios, which support modified coinsurance
(“Modco”) and coinsurance with funds withheld (“CFW”) reinsurance arrangements. Investment results for these portfolios,
including gains and losses from sales, are passed directly to the reinsurers pursuant to contractual terms of the reinsurance
arrangements. Trading securities are carried at fair value and changes in fair value, offset by corresponding changes in the fair
value of embedded derivative liabilities associated with the underlying reinsurance arrangements, are recorded in net investment
income on our Consolidated Statements of Income as they occur. The fair value for our trading securities is determined in the
same manner as our securities classified as available-for-sale discussed in “Available-For-Sale Securities” above. For discussion of how
the fair value of our embedded derivatives is determined see “Derivative Instruments” below.
For asset-backed and mortgage-backed securities, included in the trading and available-for-sale fixed maturity securities portfolios,
we recognize income using a constant effective yield based on anticipated prepayments and the estimated economic life of the
securities. When actual prepayments differ significantly from originally anticipated prepayments, the effective yield is recalculated
prospectively to reflect actual payments to date plus anticipated future payments. Any adjustments resulting from changes in
effective yield are reflected in net investment income on our Consolidated Statements of Income.
Securities Lending
Securities loaned are treated as collateralized financing transactions, and a liability is recorded equal to the cash collateral received,
which is typically greater than the market value of the related securities loaned. This liability is included within payables for
collateral under securities loaned and derivatives on our Consolidated Balance Sheets. Our pledged securities are included in fixed
maturities on our Consolidated Balance Sheets. We generally obtain collateral in an amount equal to 102% and 105% of the fair
value of the domestic and foreign securities, respectively. We value collateral daily and obtain additional collateral when deemed
appropriate. The cash received in our securities lending program is typically invested in cash equivalents, short-term investments
or fixed maturity securities. Income and expense associated with these transactions are recorded as investment income and
investment expense within net investment income on our Consolidated Statements of Income.
Reverse Repurchase Agreements
Reverse repurchase agreements are treated as collateralized financing transactions, and a liability is recorded equal to the cash
collateral received. This liability is included within payables for collateral under securities loaned and derivatives on our
Consolidated Balance Sheets. Our pledged securities are included in fixed maturities on our Consolidated Balance Sheets. We
obtain collateral in an amount equal to 95% of the fair value of the securities, and our agreements with third parties contain
contractual provisions to allow for additional collateral to be obtained when necessary. The cash received in our reverse
repurchase program is typically invested in fixed maturity securities. Income and expense associated with these transactions are
recorded as investment income and investment expense within net investment income on our Consolidated Statements of Income.
Mortgage Loans on Real Estate
Mortgage loans on real estate are carried at unpaid principal balances adjusted for amortization of premiums and accretion of
discounts and are net of valuation allowances. Interest income is accrued on the principal balance of the loan based on the loan’s
contractual interest rate. Premiums and discounts are amortized using the effective yield method over the life of the loan. Interest
income and amortization of premiums and discounts are reported in net investment income on our Consolidated Statements of
Income along with mortgage loan fees, which are recorded as they are incurred. Loans are considered impaired when it is probable
that, based upon current information and events, we will be unable to collect all amounts due under the contractual terms of the
loan agreement. When we determine that a loan is impaired, a valuation allowance is established for the excess carrying value of
the loan over its estimated value. The loan’s estimated value is based on: 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 loan’s collateral.
Valuation allowances are maintained at a level we believe is adequate to absorb estimated probable credit losses. Our periodic
evaluation of the adequacy of the allowance for losses is based on our past loan loss experience, known and inherent risks in the
portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payments), the estimated
value of the underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. We
do not accrue interest on impaired loans and loans 90 days past due, and any interest received on these loans is either applied to the
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principal or recorded in net investment income on our Consolidated Statements of Income when received, depending on the
assessment of the collectibility of the loan. Mortgage loans deemed to be uncollectible are charged against the allowance for losses
and subsequent recoveries, if any, are credited to the allowance for losses. All mortgage loans that are impaired have an established
allowance for credit losses. Changes in valuation allowances are reported in realized gain (loss) on our Consolidated Statements of
Income.
Policy Loans
Policy loans represent loans we issue to contract holders that use the cash surrender value of their life insurance policy as collateral.
Policy loans are carried at unpaid principal balances.
Real Estate
Real estate includes both real estate held for the production of income and real estate held-for-sale. Real estate held for the
production of income is carried at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the
estimated useful life of the asset. We periodically review properties held for the production of income for impairment. Properties
whose carrying values are greater than their projected undiscounted cash flows are written down to estimated fair value, with
impairment losses reported in realized gain (loss) on our Consolidated Statements of Income. The estimated fair value of real
estate is generally computed using the present value of expected future cash flows from the real estate discounted at a rate
commensurate with the underlying risks. Real estate classified as held-for-sale is stated at the lower of depreciated cost or fair value
less expected disposition costs at the time classified as held-for-sale. Real estate is not depreciated while it is classified as held-for-
sale. Also, valuation allowances for losses are established, as appropriate, for real estate held-for-sale and any changes to the
valuation allowances are reported in realized gain (loss) on our Consolidated Statements of Income. Real estate acquired through
foreclosure proceedings is recorded at fair value at the settlement date.
Derivative Instruments
We hedge certain portions of our exposure to interest rate risk, foreign currency exchange risk, equity market risk and credit risk by
entering into derivative transactions. All of our derivative instruments are recognized as either assets or liabilities on our
Consolidated Balance Sheets at estimated fair value. Pursuant to SFAS No. 157, we have categorized derivatives into a three-level
hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest
priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs
(Level 3), as described in “SFAS No. 157 – Fair Value Measurements” in Note 2. The accounting for changes in the estimated fair
value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship, and
further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging
instruments, we must designate the hedging instrument based upon the exposure being hedged: as a cash flow hedge, a fair value
hedge or a hedge of a net investment in a foreign subsidiary.
For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the
derivative instrument is reported as a component of accumulated OCI and reclassified into net income in the same period or
periods during which the hedged transaction affects net income. The remaining gain or loss on the derivative instrument in excess
of the cumulative change in the present value of designated future cash flows of the hedged item (hedge ineffectiveness), if any, is
recognized in net income during the period of change. For derivative instruments that are designated and qualify as a fair value
hedge, the gain or loss on the derivative instrument, as well as the offsetting gain or loss on the hedged item attributable to the
hedged risk are recognized in net income during the period of change in estimated fair values. For derivative instruments that are
designated and qualify as a hedge of a net investment in a foreign subsidiary, the gain or loss on the derivative instrument is
reported as a component of accumulated OCI and reclassified into net income at the time of the sale of the foreign subsidiary. For
derivative instruments not designated as hedging instruments but that are economic hedges, the gain or loss is recognized in net
income within realized gain (loss) during the period of change.
The Company purchases and issues financial instruments and products that contain embedded derivative instruments. When it is
determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic
characteristics of the host contract, and a separate instrument with the same terms would qualify as a derivative instrument, the
embedded derivative is bifurcated from the host for measurement purposes. The embedded derivative, which is reported with the
host instrument in the Consolidated Balance Sheets, is carried at fair value with changes in fair value reported in realized gain (loss)
on our Consolidated Statements of Income. See Note 6 for additional discussion of our derivative instruments.
We employ several different methods for determining the fair value of our derivative instruments. The fair value of our derivative
contracts are measured based on current settlement values, which are based on quoted market prices, industry standard models that
are commercially available and broker quotes. These techniques project cash flows of the derivatives using current and implied
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future market conditions. We calculate the present value of the cash flows to measure the current fair market value of the
derivative.
We do not adjust prices received from third parties. However, we do analyze the third party pricing services’ valuation
methodologies and related inputs and perform additional evaluation to determine the appropriate hierarchy levels described in
Note 2 “SFAS 157 – Fair Value Measurements.”
Cash and Cash Equivalents
Cash and invested cash is carried at cost and includes all highly liquid debt instruments purchased with a maturity of three months
or less.
DAC, VOBA, DSI and DFEL
Commissions and other costs of acquiring UL insurance, VUL insurance, unit-linked products, traditional life insurance, annuities
and other investment contracts, which vary with and are related primarily to the production of new business, have been deferred
(i.e. DAC) to the extent recoverable. VOBA is an intangible asset that reflects the estimated fair value of in-force contracts in a life
insurance company acquisition and represents the portion of the purchase price that is allocated to the value of the right to receive
future cash flows from the business in force at the acquisition date. Bonus credits and excess interest for dollar cost averaging
contracts are considered DSI, and the unamortized balance is reported in other assets on our Consolidated Balance Sheets.
Contract sales charges that are collected in the early years of an insurance contract are deferred (referred to as “DFEL”), and the
unamortized balance is reported in other contract holder funds on our Consolidated Balance Sheets.
The methodology for determining the amortization of DAC, VOBA, DSI and DFEL varies by product type based on two
different accounting pronouncements: 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” (“SFAS 97”); and SFAS No. 60,
“Accounting and Reporting by Insurance Enterprises” (“SFAS 60”). For all SFAS 97 and SFAS 60 contracts, amortization is based
on assumptions consistent with those used in the development of the underlying contract adjusted for emerging experience and
expected trends. Both DAC and VOBA amortization is reported within underwriting, acquisition, insurance and other expenses
on our Consolidated Statements of Income. DSI is expensed in interest credited on our Consolidated Statements of Income. The
amortization of DFEL is reported within insurance fees on our Consolidated Statements of Income.
Under SFAS 97, acquisition costs for UL and VUL insurance and investment-type products, which include unit-linked products
and fixed and variable deferred annuities, are generally amortized over the lives of the policies in relation to the incidence of
estimated gross profits (“EGPs”) from surrender charges, investment, mortality net of reinsurance ceded and expense margins and
actual realized gain (loss) on investments. Contract lives for UL and VUL policies are estimated to be 30 years, based on the
expected lives of the contracts and are variable based on the inception of each contract for unit-linked contracts. Contract lives for
fixed and variable deferred annuities are 14 to 20 years for the traditional, long surrender charge period products and 8 to 10 years
for the more recent short-term or no surrender charge variable products. The front-end load annuity product has an assumed life
of 25 years. Longer lives are assigned to those blocks that have demonstrated favorable lapse experience.
All SFAS 60 contracts, including traditional life insurance, which include individual whole life, group business and term life
insurance contracts, are amortized over periods of 10 to 30 years on either a straight-line basis or as a level percent of premium of
the related policies depending on the block of business. There is currently no DAC, VOBA, DSI or DFEL balance or related
amortization under SFAS 60 for fixed and variable payout annuities.
The carrying amounts of DAC, VOBA, DSI and DFEL are adjusted for the effects of realized and unrealized gains and losses on
debt securities classified as available-for-sale and certain derivatives and embedded derivatives. Amortization expense of DAC,
VOBA, DSI and DFEL reflects an assumption for an expected level of credit-related investment losses. When actual credit-related
investment losses are realized, we recognize a true-up to our DAC, VOBA, DSI and DFEL amortization within realized gain (loss)
on our Consolidated Statements of Income reflecting the incremental impact of actual versus expected credit-related investment
losses. These actual to expected amortization adjustments can create volatility from period to period in realized gain (loss).
On a quarterly basis, we may record an adjustment to the amounts included on our Consolidated Balance Sheets for DAC, VOBA,
DSI and DFEL with an offsetting benefit or charge to revenues or expenses for the impact of the difference between the estimates
of future gross profits used in the prior quarter and the emergence of actual and updated estimates of future gross profits in the
current quarter (“retrospective unlocking”). In addition, in the third quarter of each year, we conduct our annual comprehensive
review of the assumptions and the projection models used for our estimates of future gross profits underlying the amortization of
DAC, VOBA, DSI and DFEL and the calculations of the embedded derivatives and reserves for annuity and life insurance
products with certain guarantees. These assumptions include investment margins, mortality, retention and rider utilization. Based
on our review, the cumulative balances of DAC, VOBA, DSI and DFEL are adjusted with an offsetting benefit or charge to
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revenues or amortization expense to reflect such change (“prospective unlocking”). The distinction between these two types of
unlocking is that retrospective unlocking is driven by the emerging experience period-over-period, while prospective unlocking is
driven by changes in assumptions or projection models related to estimated future gross profits.
DAC, VOBA, DSI and DFEL are reviewed periodically to ensure that the unamortized portion does not exceed the expected
recoverable amounts.
Reinsurance
Our insurance companies enter into reinsurance agreements with other companies in the normal course of business. Assets and
liabilities and premiums and benefits from certain reinsurance contracts that grant statutory surplus relief to other insurance
companies are netted on our Consolidated Balance Sheets and Consolidated Statements of Income, respectively, because there is a
right of offset. All other reinsurance agreements are reported on a gross basis on our Consolidated Balance Sheets as an asset for
amounts recoverable from reinsurers or as a component of other liabilities for amounts, such as premiums, owed to the reinsurers,
with the exception of Modco agreements for which the right of offset also exists. Premiums, benefits and DAC are reported net of
insurance ceded.
Goodwill
We recognize the excess of the purchase price over the fair value of net assets acquired as goodwill. Under SFAS No. 142,
“Goodwill and Other Intangible Assets,” (“SFAS 142”) goodwill is not amortized, but is reviewed at least annually for indications
of value impairment, with consideration given to financial performance and other relevant factors. In addition, certain events,
including a significant adverse change in legal factors or the business climate, an adverse action or assessment by a regulator or
unanticipated competition, would cause us to review the carrying amounts of goodwill for impairment. SFAS 142 requires that we
perform a two-step test in our evaluation of the carrying value of goodwill for impairment. In Step 1 of the evaluation, the fair
value of each reporting unit is determined and compared to the carrying value of the reporting unit. If the fair value is greater than
the carrying value, then the carrying value is deemed to be sufficient and Step 2 is not required. If the fair value estimate is less
than the carrying value, it is an indicator that impairment may exist and Step 2 is required to be performed. In Step 2, the implied
fair value of the reporting unit’s goodwill is determined by allocating the reporting unit’s fair value as determined in Step 1 to all of
its net assets (recognized and unrecognized) as if the reporting unit had been acquired in a business combination at the date of the
impairment test. If the implied fair value of the reporting unit’s goodwill is lower than its carrying amount, goodwill is impaired
and written down to its fair value, and a charge is reported in impairment of intangibles on our Consolidated Statements of
Income.
Specifically Identifiable Intangible Assets
Specifically identifiable intangible assets, net of accumulated amortization, are reported in other assets on our Consolidated Balance
Sheets. The carrying values of specifically identifiable intangible assets are reviewed periodically for indicators of impairment in
value that are other-than-temporary, including unexpected or adverse changes in the following: the economic or competitive
environments in which the company operates; profitability analyses; cash flow analyses; and the fair value of the relevant business
operation. If there was an indication of impairment, then the cash flow method would be used to measure the impairment, and the
carrying value would be adjusted as necessary and reported in impairment of intangibles on our Consolidated Statements of
Income.
Sales force intangibles are attributable to the value of the distribution system acquired in the Insurance Solutions – Life Insurance
segment. These assets are amortized on a straight-line basis over their useful life of 25 years.
Specifically identifiable intangible assets within our Investment Management segment that we acquired include institutional
customer relationships, covenants not to compete and mutual fund customer relationships. These assets are required to be
amortized on a straight-line basis over their useful life for periods ranging from 9 to 15 years depending upon the characteristics of
the particular underlying relationships for the intangible asset. The amortization period for these intangibles ends in 2010.
Specifically identifiable intangible assets also include Federal Communications Commission (“FCC”) licenses and other agreements
reported within Other Operations. The FCC licenses are not amortized.
Other Long-Lived Assets
Property and equipment owned for company use is included in other assets on our Consolidated Balance Sheets and is carried at
cost less allowances for depreciation. Provisions for depreciation of investment real estate and property and equipment owned for
company use are computed principally on the straight-line method over the estimated useful lives of the assets, which include
buildings, computer hardware and software and other property and equipment.
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We periodically review the carrying value of our long-lived assets, including property and equipment, for impairment whenever
events or circumstances indicate that the carrying amount of such assets may not be fully recoverable. For long-lived assets to be
held and used, impairments are recognized when the carrying amount of a long-lived asset is not recoverable and exceeds its fair
value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected
to result from the use and eventual disposition of the asset. An impairment loss is measured as the amount by which the carrying
amount of a long-lived asset exceeds its fair value.
Long-lived assets to be disposed of by abandonment or in an exchange for a similar productive long-lived asset are classified as
held-for-use until they are disposed.
Long-lived assets to be sold are classified as held-for-sale and are no longer depreciated. Certain criteria have to be met in order
for the long-lived asset to be classified as held-for-sale, including that a sale is probable and expected to occur within one year.
Long-lived assets classified as held-for-sale are recorded at the lower of their carrying amount or fair value less cost to sell.
Separate Account Assets and Liabilities
We maintain separate account assets, which are reported at fair value. The related liabilities are reported at an amount equivalent to
the separate account assets. Investment risks associated with market value changes are borne by the contract holders, except to the
extent of minimum guarantees made by the Company with respect to certain accounts. See Note 11 for additional information
regarding arrangements with contractual guarantees.
Future Contract Benefits and Other Contract Holder Funds
The liabilities for future contract benefits and claim reserves for UL and VUL insurance policies consist of contract account
balances that accrue to the benefit of the contract holders, excluding surrender charges. The liabilities for future insurance contract
benefits and claim reserves for traditional life policies are computed using assumptions for investment yields, mortality and
withdrawals based principally on generally accepted actuarial methods and assumptions at the time of contract issue. Investment
yield assumptions for traditional direct individual life reserves for all contracts range from 2.25% to 7.00% depending on the time
of contract issue. The investment yield assumptions for immediate and deferred paid-up annuities range from 1.00% to 13.50%.
These investment yield assumptions are intended to represent an estimation of the interest rate experience for the period that these
contract benefits are payable.
The liabilities for future claim reserves for variable annuity products containing guaranteed death benefit (“GDB”) features are
calculated by estimating the present value of total expected benefit payments over the life of the contract divided by the present
value of total expected assessments over the life of the contract (“benefit ratio”) multiplied by the cumulative assessments recorded
from the contract inception through the balance sheet date less the cumulative GDB payments plus interest. The change in the
reserve for a period is the benefit ratio multiplied by the assessments recorded for the period less GDB claims paid in the period
plus interest. If experience or assumption changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a
manner similar to the unlocking of DAC, VOBA, DFEL and DSI.
With respect to our future contract benefits and other contract holder funds, we continually review: overall reserve position,
reserving techniques and reinsurance arrangements. As experience develops and new information becomes known, liabilities are
adjusted as deemed necessary. The effects of changes in estimates are included in the operating results for the period in which
such changes occur.
The business written or assumed by us includes participating life insurance contracts, under which the contract holder is entitled to
share in the earnings of such contracts via receipt of dividends. The dividend scale for participating policies is reviewed annually
and may be adjusted to reflect recent experience and future expectations.
UL and VUL products with secondary guarantees represented approximately 34% of permanent life insurance in force as of
December 31, 2008, and approximately 68% of sales for these products in 2008. Liabilities for the secondary guarantees on UL-
type products are calculated by multiplying the benefit ratio by the cumulative assessments recorded from contract inception
through the balance sheet date less the cumulative secondary guarantee benefit payments plus interest. If experience or assumption
changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a manner similar to the unlocking of DAC,
VOBA, DFEL and DSI. The accounting for secondary guarantee benefits impacts, and is impacted by, EGPs used to calculate
amortization of DAC, VOBA, DFEL and DSI.
Future contract benefits on our Consolidated Balance Sheets include GLB features and remaining guaranteed interest and similar
contracts that are carried at fair value. The fair values for the GLB contracts are based on their approximate surrender values. Our
Lincoln SmartSecurity® Advantage guaranteed withdrawal benefit (“GWB”) feature, GIB and 4LATER® features have elements of
both insurance benefits accounted for under Statement of Position (“SOP”) 03-1, “Accounting and Reporting by Insurance
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Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (“SOP 03-1”) and embedded
derivatives accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”)
and SFAS 157. We weight these features and their associated reserves accordingly based on their hybrid nature. The fair values for
the remaining guaranteed interest and similar contracts are estimated using discounted cash flow calculations. These calculations
are based on interest rates currently offered on similar contracts with maturities that are consistent with those remaining for the
contracts being valued. We classify these items in level 3 within the hierarchy levels described in “SFAS No. 157 – Fair Value
Measurements” in Note 2.
Borrowed Funds
LNC’s short-term borrowings are defined as borrowings with contractual or expected maturities of one year or less. Long-term
borrowings have contractual or expected maturities greater than one year.
Deferred Gain on Business Sold Through Reinsurance
Our reinsurance operations were acquired by Swiss Re Life & Health America, Inc. (“Swiss Re”) in December 2001 through a
series of indemnity reinsurance transactions. We are recognizing the gain related to these transactions at the rate that earnings on
the reinsured business are expected to emerge, over a period of 15 years, in accordance with the requirements of SFAS No. 113,
“Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts” (“SFAS 113”).
Commitments and Contingencies
Contingencies arising from environmental remediation costs, regulatory judgments, claims, assessments, guarantees, litigation,
recourse reserves, fines, penalties and other sources are recorded when deemed probable and reasonably estimable.
Insurance Fees
Insurance fees for investment and interest-sensitive life insurance contracts consist of asset-based fees, cost of insurance charges,
percent of premium charges, contract administration charges and surrender charges that are assessed against contract holder
account balances. Investment products consist primarily of individual and group variable and fixed deferred annuities. Interest-
sensitive life insurance products include UL insurance, VUL insurance and other interest-sensitive life insurance policies. These
products include life insurance sold to individuals, corporate-owned life insurance and bank-owned life insurance.
In bifurcating the embedded derivative of our GLB features on our variable annuity products, we attribute to the embedded
derivative the portion of total fees collected from the contract holder that relate to the GLB riders (the “attributed fees”), which
are not reported within insurance fees on our Consolidated Statements of Income. These attributed fees represent the present
value of future claims expected to be paid for the GLB at the inception of the contract plus a margin that a theoretical market
participant would include for risk/profit and are reported within realized gain (loss) on our Consolidated Statements of Income.
The timing of revenue recognition as it relates to fees assessed on investment contracts is determined based on the nature of such
fees. Asset-based fees, cost of insurance and contract administration charges are assessed on a daily or monthly basis and
recognized as revenue when assessed and earned. Percent of premium charges are assessed at the time of premium payment and
recognized as revenue when assessed and earned. Certain amounts assessed that represent compensation for services to be
provided in future periods are reported as unearned revenue and recognized in income over the periods benefited. Surrender
charges are recognized upon surrender of a contract by the contract holder in accordance with contractual terms.
For investment and interest-sensitive life insurance contracts, the amounts collected from contract holders are considered deposits
and are not included in revenue.
Insurance Premiums
Our insurance premiums for traditional life insurance and group insurance products are recognized as revenue when due from the
contract holder. Our traditional life insurance products include those products with fixed and guaranteed premiums and benefits
and consist primarily of whole life insurance, limited-payment life insurance, term life insurance and certain annuities with life
contingencies. Our group non-medical insurance products consist primarily of term life, disability and dental.
Investment Advisory Fees
As specified in investment advisory agreements with mutual funds, fees are generally determined and recognized as revenues
monthly, based on the average daily net assets of the mutual funds managed. Investment advisory contracts with non-mutual fund
clients generally provide for the determination and payment of advisory fees based on market values of managed portfolios at the
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end of a calendar month or quarter or the average of the market values at the beginning and ending of the monthly or quarterly
period. Investment management and advisory contracts typically are renewable annually by the fund’s board. Contracts with non-
mutual fund clients normally continue until terminated by either party or at the end of a specified term and often have cancellation
clauses ranging from 30 to 180 days. 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 benefits and expenses.
Realized Gain (Loss)
Realized gain (loss) on our Consolidated Statements of Income includes realized gains and losses from the sale of investments,
write-downs for other-than-temporary impairments of investments, derivative and embedded derivative gains and losses, gains and
losses on the sale of subsidiaries and businesses and net gains and losses on reinsurance embedded derivative and trading securities
on Modco and CFW reinsurance arrangements. Realized gain (loss) is recognized in net income, net of associated amortization of
DAC, VOBA, DSI and DFEL. Realized gain (loss) is also net of allocations of investment gains and losses to certain contract
holders and certain funds withheld on reinsurance arrangements for which we have a contractual obligation.
Other Revenues and Fees
Other revenues and fees consists primarily of fees attributable to broker-dealer services recorded as earned at the time of sale,
changes in the market value of our seed capital investments and communications sales recognized as earned, net of agency and
representative commissions.
Interest Credited
Interest credited includes interest credited to contract holder account balances. Interest crediting rates associated with funds
invested in the general account of LNC’s insurance subsidiaries during 2006 through 2008 ranged from 3.00% to 9.00%.
Benefits
Benefits for UL and other interest-sensitive life insurance products include benefit claims incurred during the period in excess of
contract account balances. Benefits also include the change in reserves for life insurance products with secondary guarantee
benefits and annuity products with guaranteed death benefits. For traditional life, group health and disability income products,
benefits are recognized when incurred in a manner consistent with the related premium recognition policies.
Pension and Other Postretirement Benefit Plans
Pursuant to the accounting rules for our obligations to employees under our various pension and other postretirement benefit
plans, we are required to make a number of assumptions to estimate related liabilities and expenses. We use assumptions for the
weighted-average discount rate and expected return on plan assets to estimate pension expense. The discount rate assumptions are
determined using an analysis of current market information and the projected benefit flows associated with these plans. The
expected long-term rate of return on plan assets is initially established at the beginning of the plan year based on historical and
projected future rates of return and is the average rate of earnings expected on the funds invested or to be invested in the plan.
The calculation of our accumulated postretirement benefit obligation also uses an assumption of weighted-average annual rate of
increase in the per capita cost of covered benefits, which reflects a health care cost trend rate. See Note 18 for additional
information.
Stock-Based Compensation
In general, we expense the fair value of stock awards included in our incentive compensation plans. As of the date our stock
awards are approved, the fair value of stock options is determined using a Black-Scholes options valuation methodology, and the
fair value of other stock awards is based upon the market value of the stock. The fair value of the awards is expensed over the
service period, which generally corresponds to the vesting period, and is recognized as an increase to common stock in
stockholders’ equity. We classify certain stock awards as liabilities. For these awards, the settlement value is classified as a liability
on our consolidated balance sheet and the liability is marked-to-market through net income at the end of each reporting period.
Stock-based compensation expense is reflected in underwriting, acquisition, insurance and other expenses on our Consolidated
Statements of Income. See Note 20 for additional information.
Interest and Debt Expenses
Interest expense on our short-term and long-term debt is recognized as due and any associated premiums, discounts, costs or
hedges are amortized (accreted) over the term of the related borrowing utilizing the effective interest method.
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Income Taxes
We file a U.S. consolidated income tax return that includes all of our eligible subsidiaries. Ineligible subsidiaries file separate
individual corporate tax returns. Subsidiaries operating outside of the U.S. are taxed, and income tax expense is recorded based on
applicable foreign statutes. Deferred income taxes are recognized, based on enacted rates, when assets and liabilities have different
values for financial statement and tax reporting purposes. A valuation allowance is recorded to the extent required to reduce the
deferred tax asset to an amount that we expect, more likely than not, will be realized. See Note 7 for additional information.
Discontinued Operations
The results of operations of a component of the Company that either has been disposed of or is classified as held-for-sale are
reported in income from discontinued operations for all periods presented if the operations and cash flows of the component have
been or will be eliminated from our ongoing operations as a result of the disposal transaction and we will not have any significant
continuing involvement in the operations.
Foreign Currency Translation
Our foreign subsidiaries’ balance sheet accounts and income statement items reported in functional currencies other than the U.S.
dollar are translated at the current and average exchange rates for the year, respectively. Resulting translation adjustments and
other translation adjustments for foreign currency transactions that affect cash flows are reported in accumulated OCI, a
component of stockholders’ equity.
Earnings Per Share
Basic earnings per share (“EPS”) is computed by dividing earnings available to common shareholders by the average common
shares outstanding. Diluted EPS is computed assuming the conversion or exercise of dilutive convertible preferred securities,
nonvested stock, stock options, performance share units and deferred compensation shares outstanding during the year. For any
period where a net loss is experienced, shares used in the diluted EPS calculation represent basic shares because using diluted
shares would be anti-dilutive to the calculation.
2. New Accounting Standards
Adoption of New Accounting Standards
SOP 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 issued SOP 05-1, “Accounting by Insurance
Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts” (“SOP 05-
1”), which provides guidance on accounting for DAC on internal replacements of insurance and investment contracts other than
those specifically described in SFAS 97. 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 are accounted for as a continuation of the replaced contract. Contract modifications that result in a
substantially changed contract are accounted for as an extinguishment of the replaced contract. Unamortized DAC, VOBA,
DFEL and DSI 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 total assets of
$69 million, total liabilities of $28 million and retained earnings of $41 million on our Consolidated Balance Sheets. In addition, the
adoption of SOP 05-1 resulted in an approximately $17 million increase to underwriting, acquisition, insurance and other expenses
on our Consolidated Statements of Income for the year ended December 31, 2007, which was attributable to changes in DAC and
VOBA deferrals and amortization.
FASB Staff Position FAS 115-1 and FAS 124-1 – The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments
In November 2005, the FASB issued FASB Staff Position (“FSP”) Nos. SFAS 115-1 and SFAS 124-1, “The Meaning of Other-
Than-Temporary Impairment and Its Application to Certain Investments” (“FSP 115-1”). The guidance in FSP 115-1 nullified the
accounting and measurement provisions of Emerging Issues Task Force (“EITF”) No. 03-1 – “The Meaning of Other-Than-
Temporary Impairments and Its Application to Certain Investments” and superseded EITF Topic No. D-44 “Recognition of
Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value.” Under the impairment
model in FSP 115-1, any security in an unrealized loss position is considered impaired. An evaluation is made to determine
whether the impairment is other-than-temporary based on existing accounting guidance. If an impairment is considered other-
than-temporary, a realized loss is recognized to write the security’s cost or amortized cost basis down to fair value. The fair value
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of the security on the measurement date of the other-than-temporary impairment becomes the new cost basis for the security,
which may not be adjusted for subsequent recoveries in fair value. Subsequent to the recognition of an interest-related other-than-
temporary impairment for debt securities, the resulting discount, or reduction to the premium, is amortized over the remaining life
of the debt security, prospectively, based on the amount and timing of the estimated future cash flows of the debt security. We
adopted FSP 115-1 effective January 1, 2006. The adoption of FSP 115-1 did not have a material effect on our consolidated
financial condition or results of operations.
SFAS No. 155 – Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140
In February 2006, the FASB issued 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 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.
In December 2006, the FASB issued Derivative Implementation Group (“DIG”) Statement 133 Implementation Issue No. B40,
“Embedded Derivatives: Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets” (“DIG B40”).
Because SFAS 155 eliminated the interim guidance related to securitized financial assets, DIG B40 provided a narrow scope
exception for securitized interests that contain only an embedded derivative related to prepayment risk. 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.
We adopted the provisions of SFAS 155 and DIG B40 on January 1, 2007. Prior period restatement was not permitted. The
adoption of SFAS 155 and DIG B40 did not have a material impact on our consolidated financial condition or results of
operations.
FASB Interpretation No. 48 – Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109
In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of
FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a comprehensive model for how companies should recognize, measure,
present and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. FIN 48
requires companies 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. Such
tax positions shall initially and subsequently be measured as the largest amount of tax benefit that is greater than fifty percent likely
of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. 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 on our Consolidated Balance Sheets, offset by a
reduction to the beginning balance of retained earnings. See Note 7 for more information regarding our adoption of FIN 48.
SFAS 157 – Fair Value Measurements
In September 2006, the FASB issued SFAS 157, “Fair Value Measurements,” which defines fair value, establishes a framework for
measuring fair value under current accounting pronouncements that require or permit fair value measurement and enhances
disclosures about fair value instruments. 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 (exit price) in the principal market, or
the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be
paid to acquire the asset or receive a liability (entry price). 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 non-
performance 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 three-level hierarchy for fair value
measurement is defined as follows:
(cid:120) Level 1 – inputs to the valuation methodology are quoted prices available in active markets for identical investments as of the
reporting date. “Blockage discounts” for large holdings of unrestricted financial instruments where quoted prices are readily
and regularly available for an identical asset or liability in an active market are prohibited;
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(cid:120) Level 2 – inputs to the valuation methodology are other than quoted prices in active markets, which are either directly or
indirectly observable as of the reporting date, and fair value can be determined through the use of models or other valuation
methodologies; and
(cid:120) Level 3 – inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity
for the asset or liability and the reporting entity makes estimates and assumptions related to the pricing of the asset or liability,
including assumptions regarding risk.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an
investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value
measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires
judgment, and considers factors specific to the investment.
We have certain guaranteed benefit features within our annuity products that, prior to January 1, 2008, were recorded using fair
value pricing. These benefits will continue to be measured on a fair value basis with the adoption of SFAS 157, utilizing Level 3
inputs and some Level 2 inputs, which are reflective of the hypothetical market participant perspective for fair value measurement,
including liquidity assumptions and assumptions regarding the Company’s own credit or non-performance risk. 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. See Note 22
for additional information about our fair value disclosures for financial instruments required by SFAS 157.
We adopted SFAS 157 effective January 1, 2008, by recording increases (decreases) to the following categories (in millions) on our
consolidated financial statements:
Assets
DAC
VOBA
Other assets - DSI
Total assets
Liabilities
Future contract benefits:
Remaining guaranteed interest and similar contracts
Embedded derivative instruments - living benefits liabilities
Other contract holder funds - DFEL
Other liabilities - income tax liabilities
Total liabilities
Revenues
Realized loss
Federal income tax benefit
Loss from continuing operations
$
13
(8)
2
$
7
$
(20)
48
3
(8)
23
(24)
(8)
(16)
$
$
$
The impact for the first quarter adoption of SFAS 157 to basic and diluted per share amounts was a decrease of $0.06 per share.
See “Summary of Significant Accounting Policies” in Note 1 for discussion of the methodologies and assumptions used to
determine the fair value of our financial instruments carried at fair value.
FSP No. FAS 157-2 – Effective Date of FASB Statement No. 157
In February 2008, the FASB issued FSP No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”). FSP 157-2
delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November
15, 2008, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least
annually). Accordingly, we did not apply the provisions of SFAS 157 to nonfinancial assets and nonfinancial liabilities within the
scope of FSP 157-2. Examples of items to which the deferral is applicable include, but are not limited to:
(cid:120) Nonfinancial assets and nonfinancial liabilities initially measured at fair value in a business combination or other new basis
event, but not measured at fair value in subsequent periods;
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(cid:120) Reporting units measured at fair value in the goodwill impairment test under SFAS 142, and indefinite-lived intangible assets
measured at fair value for impairment assessment under SFAS 142;
(cid:120) Nonfinancial long-lived assets measured at fair value for an impairment assessment under SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets”;
(cid:120) Asset retirement obligations initially measured at fair value under SFAS No. 143, “Accounting for Asset Retirement
Obligations”; and
(cid:120) Nonfinancial liabilities for exit or disposal activities initially measured at fair value under SFAS No. 146, “Accounting for Costs
Associated with Exit or Disposal Activities.”
As of January 1, 2009, the deferral from FSP 157-2 will no longer be effective. We will apply the provisions of SFAS 157 to
nonfinancial assets and nonfinancial liabilities beginning on January 1, 2009, and we do not expect the application to have a
material impact on our consolidated financial condition or results of operations.
FSP No. FAS 157-3 – Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active
In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That
Asset is Not Active” (“FSP 157-3”). FSP 157-3 clarifies the application of SFAS 157 in a market that is not active and provides an
illustrative example of key considerations to analyze in determining fair value of a financial asset when the market for the asset is
not active. During times when there is little market activity for a financial asset, the objective of fair value measurement remains
the same, that is, to value the asset at the price that would be received by the holder of the financial asset in an orderly transaction
(exit price) that is not a forced liquidation or distressed sale at the measurement date. Determining fair value of a financial asset
during a period of market inactivity may require the use of significant judgment and an evaluation of the facts and circumstances to
determine if transactions for a financial asset represent a forced liquidation or distressed sale. An entity’s own assumptions
regarding future cash flows and risk-adjusted discount rates for financial assets are acceptable when relevant observable inputs are
not available. FSP 157-3 was effective on October 10, 2008, and for all prior periods for which financial statements have not been
issued. Any changes in valuation techniques resulting from the adoption of FSP 157-3 shall be accounted for as a change in
accounting estimated in accordance with SFAS No. 154, “Accounting Changes and Error Corrections.” We adopted the guidance
in FSP 157-3 in our financial statements for the reporting period ending September 30, 2008. The adoption did not have a material
impact on our consolidated financial condition or 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. Effective January 1, 2008, we elected not to adopt the fair value option for any
financial assets or liabilities that existed as of that date.
EITF Issue No. 06-10 – Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements
In March 2007, the FASB Board ratified the consensus reached in EITF Issue No. 06-10, “Accounting for Collateral Assignment
Split-Dollar Life Insurance Arrangements” (“EITF 06-10”). EITF 06-10 requires an employer to recognize a liability related to a
collateral assignment split-dollar life insurance arrangement in accordance with SFAS No. 106, “Employers’ Accounting for
Postretirement Benefits Other Than Pensions,” if the employer has agreed to maintain a life insurance policy during the employee’s
retirement. In addition, based on the split-dollar arrangement, an asset should be recognized by the employer for the estimated
future cash flows to which the employer is entitled. The adoption of EITF 06-10 can be recognized either as a change in
accounting principle through a cumulative-effect adjustment to retained earnings or through retrospective application to all prior
periods. The consensus is effective for fiscal years beginning after December 15, 2007, including interim periods within those
fiscal years.
We maintain collateral assignment split-dollar life insurance arrangements related to frozen policies that are within the scope of
EITF 06-10. Effective January 1, 2008, we adopted EITF 06-10 by recording a $4 million cumulative effect adjustment to the
opening balance of retained earnings, offset by an increase to our liability for postretirement benefits. We also recorded notes
receivable for the amounts due to us from participants under the split-dollar arrangements. The recording of the notes receivable
did not have a material effect on our consolidated financial condition or results of operations.
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Derivative Implementation Group Statement 133 Implementation Issue No. E23 – Issues Involving the Application of the Shortcut Method Under
Paragraph 68
In December 2007, the FASB issued Derivative Implementation Group (“DIG”) Statement 133 Implementation Issue No. E23,
“Issues Involving the Application of the Shortcut Method under Paragraph 68” (“DIG E23”), which gives clarification to the
application of the shortcut method of accounting for qualifying fair value hedging relationships involving an interest-bearing
financial instrument and/or an interest rate swap, originally outlined in paragraph 68 in SFAS 133. We adopted DIG E23 effective
January 1, 2008, for hedging relationships designated on or after that date. The adoption did not have a material impact on our
consolidated financial condition or results of operations.
FSP FAS No. 133-1 and FIN 45-4 – Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133
and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161
In September 2008, the FASB issued FSP FAS No. 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain
Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date
of FASB Statement No. 161” (“FSP 133-1”). FSP 133-1 amends the disclosure requirements of SFAS 133 to require the seller of
credit derivatives, including hybrid financial instruments with embedded credit derivatives, to disclose additional information
regarding, among other things, the nature of the credit derivative, information regarding the facts and circumstances that may
require performance or payment under the credit derivative, and the nature of any recourse provisions the seller can use for
recovery of payments made under the credit derivative. In addition, FSP 133-1 amends the disclosure requirements in FIN 45,
“Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”
(“FIN 45”) to require additional disclosure about the payment/performance risk of a guarantee. Finally, FSP 133-1 clarifies the
intent of the FASB regarding the effective date of SFAS No. 161, “Disclosures about Derivative Instruments and Hedging
Activities – an amendment of FASB Statement No. 133” (“SFAS 161”). The provisions of FSP 133-1 related to SFAS 133 and
FIN 45 are effective for annual and interim reporting periods ending after November 15, 2008, with comparative disclosures
required only for those periods ending subsequent to initial adoption. The clarification of the effective date of SFAS 161 was
effective upon the issuance of FSP 133-1, and will not impact the effective date of SFAS 161 in our financial statements. We have
included these required enhanced disclosures related to credit derivatives, hybrid financial instruments and guarantees in the notes
to the consolidated financial statements beginning in the reporting period ended December 31, 2008.
FSP FAS 140-4 and FIN 46(R)-8 – Enhanced Disclosure Requirements Related to Transfers of Financial Assets and Variable Interest Entities.
In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about
Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP 140-4”). FSP 140-4 amends FASB Statement No.
140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”) to require
additional disclosures regarding a transferor’s continuing involvement with transferred financial assets in a securitization or asset-
backed financing arrangement. FSP 140-4 also amends FIN 46 (revised December 2003) “Consolidation of Variable Interest
Entities,” to expand the disclosure requirements for VIEs to include information regarding the decision to consolidate the VIE,
the nature of and changes in risks related to a VIE, and the impact on the entity’s financial statements due to the involvement with
a VIE. Those variable interests required to comply with the guidance in FSP 140-4 include the primary beneficiary of the VIE, the
holder of a significant variable interest and a sponsor that holds a variable interest. Further, FSP 140-4 requires enhanced
disclosures for certain sponsors and holders of a significant variable interest in a qualifying special purpose entity. The provisions
of FSP 140-4 are effective for the first reporting period ending after December 15, 2008, and comparative disclosures are not
required. We included the enhanced disclosures required by FSP 140-4 in the notes to the consolidated financial statements
beginning in the reporting period ended December 31, 2008.
See Note 4 for more information regarding our involvement with VIEs.
FSP EITF 99-20-1 – Amendments to the Impairment Guidance in EITF Issue No. 99-20
In January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment Guidance in EITF Issue No. 99-20”
(“EITF 99-20-1”), which eliminates the requirement in EITF No. 99-20, “Recognition of Interest Income and Impairment on
Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial
Assets” (“EITF 99-20”) for holders of beneficial interests to estimate cash flow using current information and events that a market
participant would use in determining the current fair value and other-than-temporary impairment of the beneficial interest. FSP
99-20-1 removes the reference to a market participant and requires that an other-than-temporary impairment be recognized in
earnings when it is probable that there has been an adverse change in the holder’s estimated cash flows from the cash flows
previously projected, which is consistent with the impairment model used in SFAS No. 115, “Accounting for Certain Investments
in Debt and Equity Securities.” FSP 99-20-1 is effective for interim and annual reporting periods ending after December 15, 2008,
and must be applied prospectively at the balance sheet date of the reporting period for which the assessment of cash flows is made.
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We adopted the guidance in FSP 99-20-1 as of December 31, 2008. The adoption did not have a material impact on our
consolidated financial condition or results of operations.
Future Adoption of New Accounting Standards
SFAS No. 141(R) – Business Combinations
In December 2007, the FASB issued SFAS No. 141(revised 2007), “Business Combinations” (“SFAS 141(R)”), which is a revision
of SFAS No. 141 “Business Combinations” (“SFAS 141”). SFAS 141(R) retains the fundamental requirements of SFAS 141, but
establishes principles and requirements for the acquirer in a business combination to recognize and measure the identifiable assets
acquired, liabilities assumed and any noncontrolling interests in the acquiree and the goodwill acquired or the gain from a bargain
purchase. The revised statement requires, among other things, that assets acquired, liabilities assumed and any noncontrolling
interest in the acquiree shall be measured at their acquisition-date fair values. For business combinations completed upon adoption
of SFAS 141(R), goodwill will be measured as the excess of the consideration transferred, plus the fair value of any noncontrolling
interest in the acquiree, in excess of the fair values of the identifiable net assets acquired. Any contingent consideration shall be
recognized at the acquisition-date fair value, which improves the accuracy of the goodwill measurement. Under SFAS 141(R),
contractual pre-acquisition contingencies will be recognized at their acquisition-date fair values and non-contractual pre-acquisition
contingencies will be recognized at their acquisition date fair values if it is more likely than not that the contingency gives rise to an
asset or liability. Deferred recognition of pre-acquisition contingencies will no longer be permitted. Acquisition costs will be
expensed in the period the costs are incurred, rather than included in the cost of the acquiree, and disclosure requirements will be
enhanced to provide users with information to evaluate the nature and financial effects of the business combination. SFAS 141(R)
applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual
reporting period on or after December 15, 2008, with earlier adoption prohibited. We will adopt SFAS 141(R) for acquisitions
occurring after January 1, 2009.
SFAS No. 160 – Noncontrolling Interests in Consolidated Financial Statements – an Amendment of Accounting Research Bulletin No. 51
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements - an
amendment of Accounting Research Bulletin (“ARB”) No. 51” (“SFAS 160”), which aims to improve the relevance, comparability
and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing
accounting and reporting standards surrounding noncontrolling interests, or minority interests, which are the portions of equity in
a subsidiary not attributable, directly or indirectly, to a parent. The ownership interests in subsidiaries held by parties other than
the parent shall be clearly identified, labeled and presented in the consolidated statement of financial position within equity, but
separate from the parent’s equity. The amount of consolidated net income attributable to the parent and to the noncontrolling
interest must be clearly identified and presented on the face of the Consolidated Statements of Income. Changes in a parent’s
ownership interest while the parent retains its controlling financial interest in its subsidiary must be accounted for consistently as
equity transactions. A parent’s ownership interest in a subsidiary changes if the parent purchases additional ownership interests in
its subsidiary, sells some of its ownership interests in its subsidiary, the subsidiary reacquires some of its ownership interests or the
subsidiary issues additional ownership interests. When a subsidiary is deconsolidated, any retained noncontrolling equity
investment in the former subsidiary must be initially measured at fair value. The gain or loss on the deconsolidation of the
subsidiary is measured using the fair value of any noncontrolling equity investment rather than the carrying amount of that retained
investment. Entities must provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and
the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. We will adopt SFAS 160 effective January 1, 2009, and do not expect the adoption will
have a material impact on our consolidated financial condition and results of operations.
FSP FAS No. 140-3 – Accounting for Transfers of Financial Assets and Repurchase Financing Transactions
In February 2008, the FASB issued FSP FAS No. 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing
Transactions” (“FSP 140-3”), regarding the criteria for a repurchase financing to be considered a linked transaction under SFAS
140. A repurchase financing is a transaction where the buyer (“transferee”) of a financial asset obtains financing from the seller
(“transferor”) and transfers the financial asset back to the seller as collateral until the financing is repaid. Under FSP 140-3, the
transferor and the transferee shall not separately account for the transfer of a financial asset and a related repurchase financing
unless the two transactions have a valid and distinct business or economic purpose for being entered into separately and the
repurchase financing does not result in the initial transferor regaining control over the financial asset. In addition, an initial transfer
of a financial asset and a repurchase financing entered into contemporaneously with, or in contemplation of, one another, must
meet the criteria identified in FSP 140-3 in order to receive separate accounting treatment. FSP 140-3 is effective for financial
statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. FSP 140-3 will
be applied prospectively to initial transfers and repurchase financings executed on or after the beginning of the fiscal year in which
FSP 140-3 is initially applied. Early application is not permitted. We will adopt FSP 140-3 effective January 1, 2009, and do not
expect the adoption will have a material impact on our consolidated financial condition and results of operations.
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SFAS 161 – Disclosures about Derivative Instruments and Hedging Activities – an Amendment of FASB Statement No. 133
In March 2008, the FASB issued SFAS 161, which amends and expands current qualitative and quantitative disclosure
requirements for derivative instruments and hedging activities. Enhanced disclosures will include: how and why we use derivative
instruments; how derivative instruments and related hedged items are accounted for under SFAS 133; and how derivative
instruments and related hedged items affect our financial position, financial performance and cash flows. Quantitative disclosures
will be enhanced by requiring a tabular format by primary underlying risk and accounting designation for the fair value amount and
location of derivative instruments in the financial statements and the amount and location of gains and losses in the financial
statements for derivative instruments and related hedged items. The tabular disclosures should improve transparency of derivative
positions existing at the end of the reporting period and the effect of using derivatives during the reporting period. SFAS 161 also
requires the disclosure of credit-risk-related contingent features in derivative instruments and cross-referencing within the notes to
the consolidated financial statements to assist users in locating information about derivative instruments. The amended and
expanded disclosure requirements apply to all derivative instruments within the scope of SFAS 133, non-derivative hedging
instruments and all hedged items designated and qualifying as hedges under SFAS 133. SFAS 161 is effective prospectively for
financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We will adopt SFAS 161
effective January 1, 2009, at which time we will include these required enhanced disclosures related to derivative instruments and
hedging activities in our financial statements.
FSP FAS No. 142-3 – Determination of the Useful Life of Intangible Assets
In April 2008, the FASB issued FSP FAS No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”), which
applies to recognized intangible assets accounted for under the guidance in SFAS 142. When developing renewal or extension
assumptions in determining the useful life of recognized intangible assets, FSP 142-3 requires an entity to consider its own
historical experience in renewing or extending similar arrangements. Absent the historical experience, an entity should use the
assumptions a market participant would make when renewing and extending the intangible asset consistent with the highest and
best use of the asset by market participants. In addition, FSP 142-3 requires financial statement disclosure regarding the extent to
which expected future cash flows associated with the asset are affected by an entity’s intent and/or ability to renew or extend an
arrangement. FSP 142-3 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15,
2008, with early adoption prohibited. FSP 142-3 should be applied prospectively to determine the useful life of a recognized
intangible asset acquired after the effective date. In addition, FSP 142-3 requires prospective application of the disclosure
requirements to all intangible assets recognized as of, and subsequent to, the effective date. We will adopt FSP 142-3 on January 1,
2009, and do not expect the adoption will have a material impact on our consolidated financial condition and results of operations.
SFAS No. 163 – Accounting for Financial Guarantee Insurance Contracts – an Interpretation of FASB Statement No. 60
In May 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts – an interpretation of
FASB Statement No. 60” (“SFAS 163”), which applies to financial guarantee insurance and reinsurance contracts not accounted
for as derivative instruments, and issued by entities within the scope of SFAS No. 60, “Accounting and Reporting by Insurance
Enterprises.” SFAS 163 changes current accounting practice related to the recognition and measurement of premium revenue and
claim liabilities such that premium revenue recognition is linked to the amount of insurance protection and the period in which it is
provided, and a claim liability is recognized when it is expected that a claim loss will exceed the unearned premium revenue. In
addition, SFAS 163 expands disclosure requirements to include information related to the premium revenue and claim liabilities, as
well as information related to the risk-management activities used to evaluate credit deterioration in insured financial obligations.
SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods
within those fiscal years; early application is not permitted. However, the disclosure requirements related to risk-management
activities are effective in the first period (including interim periods) beginning after May 2008. Because we do not hold a significant
amount of financial guarantee insurance and reinsurance contracts, no additional disclosures have been made, and we expect the
adoption of SFAS 163 will not be material to our consolidated financial condition or results of operations.
EITF No. 07-5 – Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock
In June 2008, the FASB issued EITF No. 07-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an
Entity’s Own Stock” (“EITF 07-5”). EITF 07-5 provides guidance to determine whether an instrument (or an embedded feature)
is indexed to an entity’s own stock when evaluating the instrument as a derivative under SFAS 133. An instrument that is both
indexed to an entity’s own stock and classified in stockholders’ equity in the entity’s statement of financial position is not
considered a derivative for the purposes of applying the guidance in SFAS 133. EITF 07-5 provides a two-step process to
determine whether an equity-linked instrument (or embedded feature) is indexed to its own stock first by evaluating the
instrument’s contingent exercise provisions, if any, and second, by evaluating the instrument’s settlement provisions. EITF 07-5 is
applicable to outstanding instruments as of the beginning of the fiscal year in which the issue is adopted and is effective for
financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. We
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will adopt EITF 07-5 on January 1, 2009, and do not expect the adoption will be material to our consolidated financial condition
and results of operations.
EITF No. 08-6 – Investment Accounting Considerations
In November 2008, the FASB issued EITF No. 08-6, “Equity Method Investment Accounting Considerations” (“EITF 08-6”),
which addresses the effect of SFAS 141(R) and SFAS 160 on equity-method accounting under Accounting Principles Board
Opinion 18, “The Equity Method of Accounting for Investments in Common Stock” (“APB 18”). EITF 08-6 will continue the
APB 18 requirement that the cost basis of a new equity-method investment will follow a cost accumulation model, which includes
transaction costs in the cost of the equity investment and excludes the value of contingent consideration unless it is required to be
recognized under other literature. Subsequently, issuances of shares by the equity–method investee that reduce the investor’s
ownership percentage should be accounted for as if the investor sold a proportionate share of the investment, with gain or loss
recognized through earnings. The EITF decided that the investor would not have to complete a separate impairment analysis on
the investee’s underlying assets, but rather the entire equity-method investment would continue to be subject to the current other-
than-temporary impairment guidance in APB 18. EITF 08-6 is applicable to all investments accounted for under the equity
method and is effective, prospectively, in fiscal years beginning on or after December 15, 2008, and interim periods within those
fiscal years. We will adopt EITF 08-6 on January 1, 2009, and do not expect the adoption will have a material impact on our
consolidated financial condition and results of operations.
FSP FAS No. 132(R)-1 – Employers’ Disclosures about Postretirement Benefit Plan Assets
In December 2008, the FASB issued FSP FAS No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets”
(“FSP 132(R)-1”), which requires enhanced disclosures of the plan assets of an employer’s defined benefit pension or other
postretirement benefit plans. The disclosures required under FSP 132(R)-1 will include information regarding the investment
allocation decisions made for plan assets, the fair value of each major category of plan assets disclosed separately for pension plans
and other postretirement benefit plans and the inputs and valuation techniques used to measure the fair value of plan assets
including the level within the fair value hierarchy as defined by SFAS 157. FSP 132(R)-1 requires the additional disclosure in SFAS
157 for Level 3 fair value measurements, must also be provided for the fair value measurements of plan assets using Level 3 inputs.
The disclosures in FSP 132(R)-1 are effective for fiscal years ending after December 15, 2009, and are not required for earlier
periods that are presented for comparative purposes. We will include the disclosures required in FSP 132(R)-1 in the notes to our
consolidated financial statements for the year ending December 31, 2009.
3. Acquisitions and Dispositions
Acquisitions
Newton County Loan and Savings, FSB
On January 8, 2009, the Office of Thrift Supervision approved our application to become a savings and loan holding company and
our acquisition of Newton County Loan & Savings, FSB, a federally regulated savings bank, located in Indiana. We agreed to
contribute $10 million to the capital of Newton County Loan & Savings, FSB. We closed on our purchase of Newton County
Loan & Savings, FSB on January 15, 2009.
Jefferson-Pilot
On April 3, 2006, we completed our merger with Jefferson-Pilot Corporation (“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
141. Jefferson-Pilot’s results of operations are included in our results of operations beginning on April 3, 2006.
182
Dispositions
Discontinued Media Operations
During the fourth quarter of 2007, we entered into definitive agreements to sell our television broadcasting, Charlotte radio and
sports programming businesses. These businesses were acquired as part of the Jefferson-Pilot merger on April 3, 2006. The sports
programming sale closed on November 30, 2007, the Charlotte radio broadcasting sale closed on January 31, 2008, and the
television broadcasting sale closed on March 31, 2008. Accordingly, in the periods prior to the closings, the assets and liabilities of
these businesses were reclassified as held-for-sale and were reported within other assets and other liabilities on our Consolidated
Balance Sheets. The major classes of assets and liabilities held-for-sale (in millions) were as follows:
Goodwill
Specifically identifiable intangible assets
Other
Total assets held-for-sale
As of December 31,
2008
2007
-
$
$
-
-
$
-
$
340
266
146
752
Liabilities held-for-sale
$
-
$
354
The results of operations of these businesses have been reclassified into income (loss) from discontinued operations for all
applicable periods presented on our Consolidated Statements of Income. The amounts (in millions) related to operations of these
businesses, included in income (loss) from discontinued operations, were as follows:
Discontinued Operations Before Disposal
Communications revenues, net of agency commissions
Income from discontinued operations before disposal,
before federal income taxes
Federal income tax expense
Income from discontinued operations before disposal
Disposal
Gain (loss) on disposal
Federal income tax expense (benefit)
Loss on disposal
Income (loss) from discontinued operations
For the Years Ended December 31,
2008
2006
2007
$
22
$
144
$
101
8
$
3
5
$
46
16
30
$
33
12
21
(12)
(2)
(10)
(5)
$
57
193
(136)
(106)
$
-
-
-
21
$
Consequently, we have eliminated the Lincoln Financial Media segment and now report our remaining media properties within
Other Operations for all periods presented.
The tax rate associated with the gain on disposal differs significantly from the amount computed by applying our U.S. federal
income tax rate of 35% due primarily to the increase in taxable gain associated with the recognition of $363 million in basis
difference attributable to goodwill.
Fixed Income Investment Management Business
During the fourth quarter of 2007, we sold certain institutional taxable fixed income business to an unaffiliated investment
management company. Investment Management transferred $12.3 billion of assets under management as part of this transaction.
Based upon the assets transferred as of October 31, 2007, the purchase price is expected to be approximately $49 million.
During the fourth quarter of 2007, we received $25 million of the purchase price, with additional scheduled payments over the next
three years. During 2007, we recorded an after-tax loss of $2 million in realized gain (loss) on our Consolidated Statements of
Income as a result of the goodwill we attributed to this business. During 2008, we recorded an after-tax gain of $5 million in
realized gain (loss) on our Consolidated Statements of Income related to this transaction for additional cash received toward the
purchase price.
183
4. Variable Interest Entities
Our involvement with VIEs is primarily to obtain financing and to invest in assets that allow us to gain exposure to a broadly
diversified portfolio of asset classes. We have carefully analyzed each VIE to determine whether we are the primary beneficiary.
Based on our analysis of the expected losses and residual returns of the VIEs in which we have a variable interest, we have
concluded that there are no VIEs for which we are the primary beneficiary, and, as such, we have not consolidated the VIEs in our
consolidated financial statements. However, for those VIEs in which we are not the primary beneficiary, but hold a variable
interest, we recognize the fair value of our variable interest in our consolidated financial statements.
Information (in millions) included in our Consolidated Balance Sheet as of December 31, 2008 for those VIEs where we had
significant variable interest and where we were a sponsor that held a variable interest was as follows:
Affiliated trust
Credit-linked notes
Affiliated Trust
LNC Amounts Related to VIE
Total
Assets
5
$
50
Total
Liabilities
-
$
-
Maximum
Loss
Exposure
-
$
600
We are the sponsor of an affiliated trust, Lincoln National Capital Trust VI, which was formed solely for the purpose of issuing
trust preferred securities and lending the proceeds to us. We own the common securities of this trust, approximately a 3%
ownership, and the only assets of the trust are the junior subordinated debentures issued by us. Our common stock investment in
this trust was financed by the trust and is reported in other investments on our Consolidated Balance Sheets. Distributions are
paid by the trust to the preferred security holders on a quarterly basis and the principal obligations of the trust are irrevocably
guaranteed by us. Upon liquidation of the trust, the holders of the preferred securities are entitled to a fixed amount per share plus
accumulated and unpaid distributions. We reserve the right to redeem the preferred securities at a fixed price plus accumulated and
unpaid distributions and defer the interest payments due on the subordinated debentures for up to 20 consecutive quarters, but not
beyond the maturity date of the subordinated debenture.
Our common stock investment does not represent a significant variable interest in the trust, as we do not receive any distributions
or absorb any losses from the trust. Therefore, we are not the primary beneficiary and do not consolidate the trust. Since our
investment in the common stock of the trust was financed directly by the trust, we do not have any equity investment at risk, and,
therefore, do not have exposure to loss from the trust.
Credit-Linked Notes
We invested in two credit-linked notes where the note holders do not have voting rights or decision-making capabilities. The
entities that issued the credit-linked notes are financed by the note holders, and as such, the note holders participate in the expected
losses and residual returns of the entities. Because the note holders’ investment does not permit them to make decisions about the
entities’ activities that would have a significant effect on the success of the entities, we have determined that these entities are VIEs.
We are not the primary beneficiary of the VIEs as the multi-tiered class structure of the credit-linked notes requires the
subordinated classes of the investment pool to absorb credit losses prior to our class of notes. As a result, we will not absorb the
majority of the expected losses and the coupon we receive on the credit-linked notes limits our participation in the residual returns.
For information regarding our exposure to loss in our credit-linked notes, see “Credit-Linked Notes” in Note 5.
184
5. Investments
Available-for-Sale Securities
Pursuant to SFAS No. 157, we have categorized these securities into a three-level hierarchy, based on the priority of the inputs to
the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for
identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3), as described in “SFAS No. 157 – Fair
Value Measurements” in Note 2. See Note 22 for additional disclosures regarding our fair values required by SFAS 157.
The amortized cost, gross unrealized gains and losses and fair value of available-for-sale securities (in millions) were as follows:
Corporate bonds
U.S. Government bonds
Foreign government bonds
Mortgage-backed securities:
Mortgage pass-through securities
Collateralized mortgage obligations
Commercial mortgage-backed securities
State and municipal bonds
Hybrid and redeemable preferred stocks
Total fixed maturity securities
Equity securities
Total available-for-sale securities
Corporate bonds
U.S. Government bonds
Foreign government bonds
Mortgage-backed securities:
Mortgage pass-through securities
Collateralized mortgage obligations
Commercial mortgage-backed securities
State and municipal bonds
Hybrid and redeemable preferred stocks
Total fixed maturity securities
Equity securities
Total available-for-sale securities
Amortized
Cost
41,219
204
755
$
1,875
6,918
2,535
125
1,563
55,194
466
55,660
$
Amortized
Cost
43,973
205
979
$
1,226
6,721
2,711
151
103
56,069
548
56,617
$
As of December 31, 2008
Gross Unrealized
Gains
$
667
42
56
$
Losses
5,174
-
51
62
174
9
2
6
1,018
9
1,027
$
38
780
625
2
607
7,277
187
7,464
$
As of December 31, 2007
Gross Unrealized
Gains
$
1,120
17
67
$
Losses
945
-
8
24
78
49
2
9
1,366
13
1,379
$
5
130
70
-
1
1,159
43
1,202
$
Fair
Value
$
36,712
246
760
1,899
6,312
1,919
125
962
48,935
288
49,223
$
Fair
Value
$
44,148
222
1,038
1,245
6,669
2,690
153
111
56,276
518
56,794
$
185
The amortized cost and fair value of fixed maturity available-for-sale securities by contractual maturities (in millions) were as
follows:
As of December 31, 2008
Amortized
Cost
Fair
Value
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Subtotal
Mortgage-backed securities
Total fixed maturity available-for-sale securities
$
$
1,739
13,191
14,544
14,392
43,866
11,328
55,194
1,721
12,474
12,483
12,127
38,805
10,130
48,935
$
$
Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.
186
The fair value and gross unrealized losses of available-for-sale securities (in millions), aggregated by investment category and length
of time that individual securities have been in a continuous unrealized loss position, were as follows:
Less Than Or Equal
to Twelve Months
As of December 31, 2008
Greater Than
Twelve Months
Fair
Value
$
19,123
3
159
Gross
Unrealized
Losses
2,398
-
17
$
Fair
Value
$
6,098
-
64
Gross
Unrealized
Losses
2,776
-
34
$
96
853
1,133
29
461
21,857
215
26
299
175
2
267
3,184
184
52
720
499
2
418
7,853
9
12
481
450
-
340
4,093
3
Total
Gross
Unrealized
Losses
5,174
-
51
$
38
780
625
2
607
7,277
187
Fair
Value
25,221
3
223
148
1,573
1,632
31
879
29,710
224
$
22,072
$
3,368
$
7,862
$
4,096
$
29,934
$
7,464
Corporate bonds
U.S. Government bonds
Foreign government bonds
Mortgage-backed securities:
Mortgage pass-through securities
Collateralized mortgage obligations
Commercial mortgage-backed
securities
State and municipal bonds
Hybrid and
redeemable preferred stocks
Total fixed maturity securities
Equity securities
Total available-for-sale
securities
Total number of securities in an unrealized loss position
3,682
Less Than Or Equal
to Twelve Months
As of December 31, 2007
Greater Than
Twelve Months
Total
Fair
Value
$
11,540
-
95
Gross
Unrealized
Losses
679
-
4
$
Fair
Value
$
4,467
3
51
Gross
Unrealized
Losses
266
-
4
$
Fair
Value
$
16,007
3
146
Gross
Unrealized
Losses
945
-
8
$
32
1,742
520
29
13
13,971
402
1
101
47
-
1
833
42
193
1,116
562
17
-
6,409
8
4
29
23
-
-
326
1
225
2,858
1,082
46
13
20,380
410
5
130
70
-
1
1,159
43
$
14,373
$
875
$
6,417
$
327
$
20,790
$
1,202
Corporate bonds
U.S. Government bonds
Foreign government bonds
Mortgage-backed securities:
Mortgage pass-through securities
Collateralized mortgage obligations
Commercial mortgage-backed
securities
State and municipal bonds
Hybrid and
redeemable preferred stocks
Total fixed maturity securities
Equity securities
Total available-for-sale
securities
Total number of securities in an unrealized loss position
2,441
187
The fair value, gross unrealized losses (in millions) and number of available-for-sale securities where the fair value had declined
below amortized cost by greater than 20%, were as follows:
Less than six months
Six months or greater, but less than nine months
Nine months or greater, but less than twelve months
Twelve months or greater
Total available-for-sale securities
Less than six months
Six months or greater, but less than nine months
Nine months or greater, but less than twelve months
Twelve months or greater
Total available-for-sale securities
Fair
Value
$
As of December 31, 2008
Gross
Unrealized
Losses
526
578
818
3,640
5,562
Number
of
Securities
170
219
228
812
1,429
$
$
916
1,222
1,613
4,207
7,958
$
Fair
Value
$
As of December 31, 2007
Gross
Unrealized
Losses
$
49
138
110
81
378
Number
of
Securities
22
32
17
60
131
$
136
427
364
183
1,110
$
As described more fully in Note 1, we regularly review our investment holdings for other-than-temporary impairments. Based
upon this review, the cause of the $6.3 billion increase in our gross unrealized losses for available-for-sale securities for the year
ended December 31, 2008, was attributable primarily to a combination of reduced liquidity in several market segments and
deterioration in credit fundamentals. We believe that the securities in an unrealized loss position as of December 31, 2008 and
2007 were not other-than-temporarily impaired due to our ability and intent to hold for a period of time sufficient for recovery.
Trading Securities
Trading securities at fair value retained in connection with Modco and CFW reinsurance arrangements (in millions) consisted of
the following:
Corporate bonds
U.S. Government bonds
Foreign government bonds
Mortgage-backed securities:
Mortgage pass-through securities
Collateralized mortgage obligations
Commercial mortgage-backed securities
State and municipal bonds
Hybrid and redeemable preferred stocks
Total fixed maturity securities
Equity securities
Total trading securities
As of December 31,
2007
2008
$
1,601
414
39
$
1,999
367
46
32
124
77
14
30
2,331
2
2,333
$
22
160
107
19
8
2,728
2
2,730
$
The portion of the market adjustment for losses that relate to trading securities still held as of December 31, 2008, 2007 and 2006
was $192 million, $10 million and $53 million, respectively.
188
Mortgage Loans on Real Estate
Mortgage loans on real estate principally involve commercial real estate. The commercial loans are geographically diversified
throughout the U.S. with the largest concentrations in California and Texas, which accounted for approximately 30% and 29% of
mortgage loans as of December 31, 2008 and 2007, respectively. As of December 31, 2008, we held no impaired mortgage loans
and, therefore, had no valuation allowance.
Net Investment Income
The major categories of net investment income (in millions) on our Consolidated Statements of Income were as follows:
Net Investment Income
Fixed maturity available-for-sale securities
Equity available-for-sale securities
Trading securities
Mortgage loans on real estate
Real estate
Standby real estate equity commitments
Policy loans
Invested cash
Commercial mortgage loan prepayment and bond
makewhole premiums
Alternative investments
Consent fees
Other investments
Investment income
Investment expense
Net investment income
For the Years Ended December 31,
2008
2006
2007
$
3,399
29
166
475
23
3
179
63
$
3,367
41
176
494
44
12
175
73
$
3,012
27
197
417
38
18
159
89
29
57
70
(34)
5
(4)
4,333
(125)
4,208
$
102
10
12
4,563
(185)
4,378
$
46
8
10
4,091
(168)
3,923
$
189
Realized Loss Related to Investments
The detail of the realized loss related to investments (in millions) was as follows:
Fixed maturity available-for-sale securities:
Gross gains
Gross losses
Equity available-for-sale securities:
Gross gains
Gross losses
Gain on other investments
Associated amortization expense (benefit) of DAC, VOBA, DSI and DFEL and
changes in other contract holder funds and funds withheld reinsurance liabilities
Total realized loss on investments, excluding trading securities
Gain (loss) on certain derivative instruments
Associated amortization expense of DAC, VOBA, DSI and DFEL
and changes in other contract holder funds
Total realized loss on investments and certain
derivative instruments, excluding trading securities
Write-downs for other-than-temporary impairments included
in realized loss on available-for-sale securities above
For the Years Ended December 31,
2008
2006
2007
$
74
(1,145)
$
125
(185)
$
132
(103)
5
(164)
32
260
(938)
(112)
-
8
(111)
18
29
(116)
(11)
1
-
(1)
4
(41)
(9)
2
-
$
(1,050)
$
(126)
$
(7)
$
(1,075)
$
(261)
$
(64)
See Note 16 for a comprehensive listing of realized gain (loss) reported on our Consolidated Statements of Income.
Securities Lending
The carrying values of securities pledged under securities lending agreements were $427 million and $655 million as of December
31, 2008 and 2007, respectively. The fair values of these securities were $410 million and $634 million as of December 31, 2008
and 2007, respectively. The carrying value and fair value of the collateral payable held for derivatives is $2.8 billion as of December
31, 2008. We did not have a collateral payable for derivatives as of December 31, 2007.
Reverse Repurchase Agreements
The carrying values of securities pledged under reverse repurchase agreements were $470 million and $480 million as of December
31, 2008 and 2007, respectively. The fair values of these securities were $496 million and $502 million as of December 31, 2008
and 2007, respectively.
Investment Commitments
As of December 31, 2008, our investment commitments for fixed maturity securities (primarily private placements), limited
partnerships, real estate and mortgage loans on real estate were $705 million, which included $267 million of standby commitments
to purchase real estate upon completion and leasing.
Concentrations of Financial Instruments
As of December 31, 2008, we had investments in the collateralized mortgage obligation industry with a fair value of $6.8 billion or
10% of the invested assets portfolio totaling $67.3 billion. We utilized the industry classifications to obtain the concentration of
financial instruments amount, as such, this amount will not agree to the available-for-sale securities table above. We did not have a
concentration of financial instruments in a single industry as of December 31, 2007. As of December 31, 2008 and 2007, we did
not have a significant concentration of financial instruments in a single investee or geographic region of the U.S.
Credit-Linked Notes
As of December 31, 2008 and 2007, other contract holder funds on our Consolidated Balance Sheets included $600 million and
$1.2 billion outstanding in funding agreements of the Lincoln National Life Insurance Company (“LNL”), respectively. LNL
190
invested the proceeds of $850 million received for issuing three funding agreements in 2006 and 2007 into three separate credit-
linked notes originated by third party companies. One of the credit-linked notes totaling $250 million was paid off at par in
September of 2008, and, as a result, the related structure, including the $250 million funding agreement, was terminated. The two
remaining credit-linked notes are asset-backed securities, classified as corporate bonds in the tables above and are reported as fixed
maturity securities on our Consolidated Balance Sheets. An additional $300 million funding agreement was assumed as a result of
the merger of Jefferson-Pilot, but was not invested into credit-linked notes. This $300 million funding agreement matured on June
2, 2008.
We earn a spread between the coupon received on the credit-linked notes and the interest credited on the funding agreement. Our
credit-linked notes were created using a special purpose trust that combines highly rated assets with credit default swaps to produce
a multi-class structured security. The high quality asset in these transactions is a AAA-rated asset-backed security secured by a pool
of credit card receivables. Our affiliate, Delaware Investments, actively manages the credit default swaps in the underlying
portfolios. As permitted in the credit-linked note agreements, Delaware Investments acts as the investment manager for the pool
of underlying issuers in each of the transactions. Delaware Investments, from time to time, has directed substitutions of corporate
names in the reference portfolio. When substituting corporate names, the issuing special purpose trust transacts with a third party
to sell credit protection on a new issuer, selected by Delaware Investments. The cost to substitute the corporate names is based on
market conditions and the liquidity of the corporate names. This new issuer will replace the issuer Delaware Investments has
identified to remove from the pool of issuers. The substitution of corporate issuers does not revise the credit-linked note
agreement. The subordination and the participation in credit losses may change as a result of the substitution. The amount of the
change is dependant upon the relative risk of the issuers removed and replaced in the pool of issuers.
Consistent with other debt market instruments, we are exposed to credit losses within the structure of the credit-linked notes,
which could result in principal losses to our investments. However, we have attempted to protect our investments from credit
losses through the multi-tiered class structure of the credit-linked note, which requires the subordinated classes of the investment
pool to absorb all of the credit losses. LNL owns the mezzanine tranche of these investments. To date, there has been one default
in the underlying collateral pool of the $400 million credit-linked note and two defaults in the underlying collateral pool of the $200
million credit-linked note. There has been no event of default on the credit-linked notes themselves. We feel the remaining
subordination is sufficient to absorb future credit losses, subject to changing market conditions. We do not anticipate any future
payments under the credit-linked notes, and as such, there are no recourse provisions or assets held as collateral for the recovery of
any future payments. Similar to other debt market instruments, our maximum principal loss is limited to our original investment of
$600 million as of December 31, 2008.
As in the general markets, spreads on these transactions have widened, causing unrealized losses. We had unrealized losses of
$550 million on the $600 million in credit-linked notes as of December 31, 2008 and $190 million on the $850 million in credit-
linked notes as of December 31, 2007. As described more fully in Note 1, we regularly review our investment holdings for other-
than-temporary impairments. Based upon this review, we believe that these securities were not other-than-temporarily impaired as
of December 31, 2008 and 2007.
The following summarizes information regarding our investments in these securities (dollars in millions):
Amortized cost (1)
Fair value (1)
Attachment point (1)
Maturity
Current rating of tranche (1)
Current rating of underlying collateral pool (1)
Number of entities (1)
Number of countries (1)
(1) As of December 31, 2008
Amount and Date of Issuance
$400
December 2006
400
$
30
4.77%
12/20/2016
$200
April 2007
$
200
20
1.48%
3/20/2017
BBB-
Aaa-Caa1
124
20
Baa2
Aaa-Ba3
98
23
191
6. Derivative Instruments
Types of Derivative Instruments and Derivative Strategies
We maintain an overall risk management strategy that incorporates the use of derivative instruments to minimize significant
unplanned fluctuations in earnings that are caused by interest rate risk, foreign currency exchange risk, equity market risk and credit
risk. We assess these risks by continually identifying and monitoring changes in interest rate exposure, foreign currency exposure,
equity market exposure and credit exposure that may adversely impact expected future cash flows and by evaluating hedging
opportunities. Derivative instruments that are currently used as part of our interest rate risk management strategy include interest
rate swaps, interest rate futures, interest rate caps and treasury locks. Derivative instruments that are used as part of our foreign
currency risk management strategy include foreign currency swaps and foreign currency forwards. Call options on our stock, call
options on the Standard & Poor’s (“S&P”) 500 Index® (“S&P 500”), total return swaps, variance swaps, equity collars, put options
and equity futures are used as part of our equity market risk management strategy. We also use credit default swaps as part of our
credit risk management strategy.
As of December 31, 2008 and 2007, we had derivative instruments that were designated and qualified as cash flow hedges, fair
value hedges and the hedge of a net investment in a foreign subsidiary. We also had derivative instruments that were economic
hedges, but were not designated as hedging instruments under SFAS 133. See Note 1 for a detailed discussion of the accounting
treatment for derivative instruments.
Our derivative instruments are monitored by our risk management committee as part of that committee’s oversight of our
derivative activities. Our risk management committee is responsible for implementing various hedging strategies that are
developed through its analysis of financial simulation models and other internal and industry sources. The resulting hedging
strategies are incorporated into our overall risk management strategies.
Our hedging strategy is designed to mitigate the risk and income statement volatility caused by changes in the equity markets,
interest rates and volatility associated with living benefit guarantees offered in our variable annuities including the Lincoln
SmartSecurity® Advantage guaranteed withdrawal benefit (“GWB”) feature, the 4LATER® Advantage GIB feature and the
i4LIFE® Advantage GIB feature that is available in our variable annuity products. Certain features of these guarantees, notably
our GIB and 4LATER® features have elements of both insurance benefits accounted for under SOP 03-1 and embedded
derivatives accounted for under SFAS 133 and SFAS 157. We weight these features and their associated reserves accordingly based
on their hybrid nature. The change in estimated fair value of the portion of guarantee features that are considered to be derivatives
under SFAS 133 is reported in net income. The hedging strategy is designed such that changes in the value of the hedge contracts
generally offset changes in the value of the embedded derivative of the GWB and GIB. As part of our current hedging program,
equity markets, interest rates and volatility in market conditions are monitored on a daily basis. We rebalance our hedge positions
based upon changes in these factors as needed. While we actively manage our hedge positions, our hedge positions may not be
totally effective to offset changes in assets and liabilities caused by movements in these factors due to, among other things,
differences in timing between when a market exposure changes and corresponding changes to the hedge positions, extreme swings
in the equity markets and interest rates, market volatility, contract holder behavior, divergence between the performance of the
underlying funds and the hedging indices, divergence between the actual and expected performance of the hedge instruments, or
our ability to purchase hedging instruments at prices consistent with our desired risk and return trade-off.
We have certain Modco and CFW reinsurance arrangements with embedded derivatives related to the withheld assets of the related
funds. These derivatives are considered total return swaps with contractual returns that are attributable to various assets and
liabilities associated with these reinsurance arrangements. Changes in the estimated fair value of these derivatives are recorded in
net income as they occur. Offsetting these amounts are corresponding changes in the estimated fair value of trading securities in
portfolios that support these arrangements.
We also distribute indexed annuity contracts. These contracts permit the holder to elect an interest rate return or an equity market
component, where interest credited to the contracts is linked to the performance of the S&P 500. This feature represents an
embedded derivative under SFAS 133. Contract holders may elect to rebalance index options at renewal dates, either annually or
biannually. At each renewal date, we have the opportunity to re-price the indexed component by establishing participation rates,
subject to minimum guarantees. We purchase S&P 500 call options that are highly correlated to the portfolio allocation decisions
of our contract holders, such that we are economically hedged with respect to equity returns for the current reset period. The
mark-to-market of the options held generally offsets the change in value of the embedded derivative within the indexed annuity,
both of which are recorded as a component of realized gain (loss) on our Consolidated Statements of Income. In calculating our
future contract benefit liabilities under these contracts, SFAS 133 requires that we calculate fair values of index options we may
purchase in the future to hedge contract holder index allocations in future reset periods. These fair values represent an estimate of
the cost of the options we will purchase in the future, discounted back to the date of the Consolidated Balance Sheets, using
current market indicators of volatility and interest rates. Changes in the fair values of these liabilities are included as a component
of realized gain (loss) on our Consolidated Statements of Income.
192
Pursuant to SFAS 157, we have categorized our derivative instruments into a three-level hierarchy, based on the priority of the
inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets
for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3), as described in “SFAS 157 – Fair
Value Measurements” in Note 2. See Note 22 for additional disclosures regarding our fair values required by SFAS 157. We have
derivative instruments with off-balance-sheet risks whose notional or contract amounts exceed the credit exposure. Outstanding
derivative instruments with off-balance-sheet risks, shown in notional amounts along with their carrying values and estimated fair
values (in millions), were as follows:
Cash flow hedges:
Interest rate swap agreements
Foreign currency swaps
Call options (based on LNC stock)
Total cash flow hedges
Fair value hedges:
Interest rate swap agreements
Equity collar
Total fair value hedges
Net investment in foreign subsidiary:
Foreign currency forwards
All other derivative instruments:
Interest rate cap agreements
Interest rate futures
Equity futures
Interest rate swap agreements
Credit default swaps
Total return swaps
Put options
Call options (based on LNC stock)
Call options (based on S&P 500)
Variance swaps
Total other derivative instruments
As of December 31,
Notional Amounts
2008
2007
Assets (Liabilities)
Carrying or Fair Value
2008
2007
$
780
366
-
1,146
$
1,371
366
-
1,737
$
(50)
64
-
14
$
(5)
(17)
1
(21)
375
49
424
183
2,200
8,570
3,769
7,759
149
126
4,700
18
2,951
31
30,273
375
49
424
-
4,100
259
296
4,722
60
126
4,025
23
2,858
6
16,475
196
138
334
74
-
-
-
998
(51)
-
1,727
-
31
204
2,909
22
47
69
-
2
-
-
41
-
-
529
13
149
(4)
730
Embedded derivatives per SFAS 133/SFAS 157
Total derivative instruments
-
32,026
$
-
18,636
$
(2,858)
473
$
(420)
358
$
The carrying or fair value of total derivative instruments (in millions) reported above is reflected within the Consolidated Balance
Sheets as follows:
Derivative investments
Reinsurance related derivative asset (liability)
Future contract benefits liability
Other liabilities - credit default swaps
Total
As of December 31,
2008
2007
$
$
$
$
807
(219)
(230)
-
358
3,397
31
(2,904)
(51)
473
193
Total
$
780
366
1,146
375
49
424
183
2,200
8,570
3,769
7,759
149
126
4,700
18
2,951
31
30,273
32,026
$
The notional amounts of derivative financial instruments by maturity (in millions) were as follows:
Less Than
1 Year
Remaining Life as of December 31, 2008
5 - 10
Years
After
10 Years
1 - 5
Years
Cash flow hedges:
Interest rate swap agreements
Foreign currency swaps
Total cash flow hedges
Fair value hedges:
Interest rate swap agreements
Equity collar
Total fair value hedges
Net investment in foreign subsidiary:
Foreign currency forwards
All other derivative instruments:
Interest rate cap agreements
Interest rate futures
Equity futures
Interest rate swap agreements
Credit default swaps
Total return swaps
Put options
Call options (based on LNC stock)
Call options (based on S&P 500)
Variance swaps
Total other derivative instruments
Total derivative instruments
$
146
-
146
$
128
-
128
$
240
231
471
$
266
135
401
-
-
-
183
1,200
8,570
3,769
-
-
126
-
-
2,185
-
15,850
16,179
$
-
49
49
-
1,000
-
-
1,966
60
-
1,825
18
766
6
5,641
5,818
$
-
-
-
-
-
-
-
1,706
89
-
2,700
-
-
25
4,520
4,991
$
375
-
375
-
-
-
-
4,087
-
-
175
-
-
-
4,262
5,038
$
194
The settlement payments and mark-to-market adjustments on derivative instruments (in millions) recorded on our Consolidated
Statements of Income were as follows:
Cash flow hedges:
Interest rate swap agreements (1)
Foreign currency swaps (1)
Total cash flow hedges
Fair value hedges:
Interest rate swap agreements (2)
All other derivative instruments:
Equity futures (3)
Interest rate swap agreements (3)
Credit default swaps (1)
Total return swaps (4)
Put options (3)
Call options (based on LNC stock) (4)
Call options (based on S&P 500) (3)
Variance swaps (3)
Total other derivative instruments
Total derivative instruments
For the Years Ended December 31,
2006
2007
2008
$
4
$
5
$
5
(1)
3
6
882
1,167
1
(69)
1,094
(8)
(204)
(1)
4
-
(13)
43
-
-
117
(3)
6
(1)
4
2
(10)
-
-
13
(56)
10
62
267
3,130
3,139
$
(4)
146
150
$
-
19
25
$
(1) Reported in net investment income on our Consolidated Statements of Income.
(2) Reported in interest and debt expense on our Consolidated Statements of Income.
(3) Reported in net realized gain (loss) on our Consolidated Statements of Income.
(4) Reported in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income.
Derivative Instruments Designated as Cash Flow Hedges
Gains (losses) (in millions) on derivative instruments designated as cash flow hedges were as follows:
Ineffective portion recognized in realized gain (loss)
Gains recognized as a component of OCI with the offset to:
Net investment (income)
Benefit expense (recovery)
For the Years Ended December 31,
2008
2006
2007
$
1
$
$
1
(1)
2
$
-
$
2
2
$
1
$
3
3
$
(2)
$
1
As of December 31, 2008, $7 million of the deferred net gains on derivative instruments in accumulated OCI were expected to be
reclassified to earnings during 2009. This reclassification is due primarily to the receipt of interest payments associated with
variable rate securities and forecasted purchases, payment of interest on our senior debt, the receipt of interest payments associated
with foreign currency securities, and the periodic vesting of stock appreciation rights (“SARs”).
For the years ended December 31, 2008, 2007 and 2006, there were no material reclassifications to earnings due to hedged firm
commitments no longer deemed probable or due to hedged forecasted transactions that had not occurred by the end of the
originally specified time period.
195
Interest Rate Swap Agreements
We use a portion of our interest rate swap agreements to hedge our exposure to floating rate bond coupon payments, replicating a
fixed rate bond. An interest rate swap is a contractual agreement to exchange payments at one or more times based on the actual
or expected price level, performance or value of one or more underlying interest rates. We are required to pay the counterparty the
stream of variable interest payments based on the coupon payments from the hedged bonds, and in turn, receive a fixed payment
from the counterparty, at a predetermined interest rate. The net receipts/payments from these interest rate swaps are recorded in
net investment income on our Consolidated Statements of Income. Gains or losses on interest rate swaps hedging our interest rate
exposure on floating rate bond coupon payments are reclassified from accumulated OCI to net income as the related bond interest
is accrued.
In addition, we use interest rate swap agreements to hedge our exposure to fixed rate bond coupon payments and the change in
underlying asset values as interest rates fluctuate. The net receipts/payments from these interest rate swaps are recorded in net
investment income on our Consolidated Statements of Income.
Forward-Starting Interest Rate Swaps
During the year ended December 31, 2006, we entered into a series of forward-starting interest rate swaps to hedge the issuance of
debt to finance the merger with Jefferson-Pilot. We were required to pay the counterparty(s) a predetermined fixed stream of
payments in exchange for a floating rate stream from the counterparty. By doing so, we were able to hedge the exposure to
fluctuations in interest rates prior to issuing the debt. The receipt from the termination of the forward-starting swaps is recorded
in OCI and is reclassified from accumulated OCI to interest expense over the coupon-paying period of the related debt issuance.
As of December 31, 2008 and 2007, we had no open forward-starting swaps hedging debt issuance.
We also use forward-starting interest rate swaps to hedge our exposure to interest rate fluctuations related to the forecasted
purchase of assets for certain investment portfolios. The gains or losses resulting from the swap agreements are recorded in OCI.
The gains or losses are reclassified from accumulated OCI to earnings over the life of the assets once the assets are purchased.
Foreign Currency Swaps
We use foreign currency swaps, which are traded over-the-counter, to hedge some of the foreign exchange risk of investments in
fixed maturity securities denominated in foreign currencies. A foreign currency swap is a contractual agreement to exchange the
currencies of two different countries at a specified rate of exchange in the future. Gains or losses on foreign currency swaps
hedging foreign exchange risk exposure on foreign currency bond coupon payments are reclassified from accumulated OCI to net
income as the related bond interest is accrued.
Call Options (Based on LNC Stock)
We use call options on LNC stock to hedge the expected increase in liabilities arising from SARs granted on our stock. Upon
option expiration, the payment, if any, is the increase in our stock price over the strike price of the option applied to the number of
contracts. Call options hedging vested SARs are not eligible for hedge accounting and are marked-to-market through net income.
Call options hedging nonvested SARs are eligible for hedge accounting and are accounted for as cash flow hedges of the forecasted
vesting of the SARs liabilities. To the extent that the cash flow hedges are effective, changes in the fair value of the call options are
recorded in accumulated OCI. Amounts recorded in OCI are reclassified to net income upon vesting of the related SARs. Our
call option positions will be maintained until such time the related SARs are either exercised or expire and our SARs liabilities are
extinguished.
Treasury Lock Agreements
During the year ended December 31, 2005, we entered into a treasury lock to hedge the issuance of debt to finance the merger with
Jefferson-Pilot. A treasury lock is an agreement that allows the holder to lock in a benchmark interest rate, so that if the
benchmark interest rate increases, the holder is entitled to receive a payment from the counterparty to the agreement equal to the
present value of the difference in the benchmark interest rate at the determination date and the locked-in benchmark interest rate.
If the benchmark interest rate decreases, the holder must pay the counterparty to the agreement an amount equal to the present
value of the difference in the benchmark interest rate at the determination date and the locked-in benchmark interest rate. The
receipt or payment from the termination of a treasury lock is recorded in OCI and is reclassified from accumulated OCI to interest
expense over the coupon-paying period of the related senior debt. The treasury lock agreement related to the merger with
Jefferson-Pilot was unwound in May 2006. As of December 31, 2008 and 2007, we had no outstanding open treasury locks.
196
Derivative Instruments Designated as Fair Value Hedges
We designate and account for interest rate swap agreements and equity collars as fair value hedges, when they have met the
requirements of SFAS 133. Information related to our fair value hedges (in millions) was as follows:
Losses recognized as a component of realized
investment loss
Gains recognized as a component of OCI with the offset to
For the Years Ended December 31,
2008
2006
2007
$
(18)
$
(10)
$
-
interest expense
4
3
3
There were no ineffective portions of fair value hedges for the years ended 2008, 2007 and 2006, respectively.
Interest Rate Swap Agreements
We use a portion of our interest rate swap agreements to hedge the risk of paying a higher fixed rate of interest on junior
subordinated debentures issued to affiliated trusts and on senior debt than would be paid on long-term debt based on current
interest rates in the marketplace. We are required to pay the counterparty a stream of variable interest payments based on the
referenced index, and in turn, we receive a fixed payment from the counterparty at a predetermined interest rate. The net
receipts/payments from these interest rate swaps are recorded as an adjustment to the interest expense for the debt being hedged.
The changes in fair value of the interest rate swap are reported on our Consolidated Statements of Income in the period of change
along with the offsetting changes in fair value of the debt being hedged.
Equity Collars
We used an equity collar on 4 million shares of our Bank of America (“BOA”) stock holdings. The equity collar is structured such
that we purchased a put option on the BOA stock and simultaneously sold a call option with the identical maturity date as the put
option. This effectively protects us from a price decline in the stock while allowing us to participate in some of the upside if the
BOA stock appreciates over the time of the transaction. With the equity collar in place, we are able to pledge the BOA stock as
collateral, which then allows us to advance a substantial portion of the stock’s value, effectively monetizing the stock for liquidity
purposes. The change in fair value of the equity collar is reported on our Consolidated Statements of Income in the period of
change along with the offsetting changes (when applicable) in fair value of the stock being hedged.
Derivative Instruments Designated as a Net Investment in Foreign Subsidiary
We use foreign currency forward contracts to hedge a portion of our net investment in our foreign subsidiary, Lincoln UK. The
foreign currency forward contracts obligate us to deliver a specified amount of currency at a future date at a specified exchange
rate. The foreign currency forward contracts outstanding as of December 31, 2008, were terminated on February 5, 2009. The
gain on the termination of the foreign currency forward contract of $38 million was recorded in OCI.
All Other Derivative Instruments
We use various other derivative instruments for risk management and income generation purposes that either do not qualify for
hedge accounting treatment or have not currently been designated by us for hedge accounting treatment.
Interest Rate Cap Agreements
The interest rate cap agreements entitle us to receive quarterly payments from the counterparties on specified future reset dates,
contingent on future interest rates. For each cap, the amount of such quarterly payments, if any, is determined by the excess of a
market interest rate over a specified cap rate, multiplied by the notional amount divided by four. The purpose of our interest rate
cap agreement program is to provide a level of protection from the effect of rising interest rates for our annuity business, within
our Retirement Solutions – Annuities and Retirement Solutions – Defined Contribution segments. The interest rate cap
agreements provide an economic hedge of the annuity line of business. However, the interest rate cap agreements do not qualify
for hedge accounting under SFAS 133.
197
Interest Rate Futures and Equity Futures
We use interest rate futures and equity futures contracts to hedge the liability exposure on certain options in variable annuity
products. These futures contracts require payment between our counterparty and us on a daily basis for changes in the futures
index price. Cash settlements on the change in market value of financial futures contracts, along with the resulting gains or losses,
are recorded daily as a component of realized gain (loss) on our Consolidated Statements of Income.
Interest Rate Swap Agreements
We use interest rate swap agreements to hedge the liability exposure on certain options in variable annuity products. The change in
market value and periodic cash settlements are recorded as a component of realized gain (loss) on our Consolidated Statements of
Income.
Foreign Currency Forward Contracts
We use foreign currency forward contracts to hedge dividends received from our U.K.-based subsidiary, Lincoln UK. The foreign
currency forward contracts obligate us to deliver a specified amount of currency at a future date and a specified exchange rate. The
contract does not qualify for hedge accounting under SFAS 133. Therefore, all gains or losses on the foreign currency forward
contracts are recorded as a component of realized gain (loss) on our Consolidated Statements of Income.
Total Return Swaps
We use total return swaps to hedge a portion of the liability related to our deferred compensation plans. We receive the total
return on a portfolio of indexes and pay a floating rate of interest. Cash settlements on the change in market value of the total
return swaps along with the resulting gains or losses are recorded in net income as underwriting, acquisition, insurance and other
expenses on our Consolidated Statements of Income.
Put Options
We use put options to hedge the liability exposure on certain options in variable annuity products. Put options are contracts that
require counterparties to pay us at a specified future date the amount, if any, by which a specified equity index is less than the strike
rate stated in the agreement, applied to a notional amount. The change in market value of the put options along with the resulting
gains or losses on terminations and expirations are recorded as a component of realized gain (loss) on our Consolidated Statements
of Income.
Call Options (Based on LNC Stock)
We use call options on our stock to hedge the expected increase in liabilities arising from SARs granted on our stock. Call options
hedging vested SARs are not eligible for hedge accounting treatment under SFAS 133. Mark-to-market changes are recorded in net
income as underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income.
Call Options (Based on S&P 500)
We use indexed annuity contracts to permit the holder to elect an interest rate return or an equity market component, where
interest credited to the contracts is linked to the performance of the S&P 500. Contract holders may elect to rebalance index
options at renewal dates, either annually or biannually. At each renewal date, we have the opportunity to re-price the indexed
component by establishing participation rates, subject to minimum guarantees. We purchase call options that are highly correlated
to the portfolio allocation decisions of our contract holders, such that we are economically hedged with respect to equity returns
for the current reset period. The mark-to-market of the options held generally offsets the change in value of the embedded
derivative within the indexed annuity, both of which are recorded as a component of realized gain (loss) on our Consolidated
Statements of Income.
Variance Swaps
We use variance swaps to hedge the liability exposure on certain options in variable annuity products. Variance swaps are contracts
entered into at no cost and whose payoff is the difference between the realized variance of an underlying index and the fixed
variance rate determined at inception. The change in market value and resulting gains and losses on terminations and expirations
are recorded as a component of realized gain (loss) on our Consolidated Statements of Income.
198
Credit Default Swaps
We buy credit default swaps to hedge against a drop in bond prices due to credit concerns of certain bond issuers. A credit default
swap allows us to put the bond back to the counterparty at par upon a default event by the bond issuer. A default event is defined
as bankruptcy, failure to pay, obligation acceleration or restructuring. Our credit default swaps are not currently qualified for hedge
accounting under SFAS 133, as amounts are insignificant.
We also sell credit default swaps to offer credit protection to investors. The credit default swaps hedge the investor against a drop
in bond prices due to credit concerns of certain bond issuers. A credit default swap allows the investor to put the bond back to us
at par upon a default event by the bond issuer. A default event is defined as bankruptcy, failure to pay, obligation acceleration or
restructuring.
Information related to our open credit default swaps for which we are the seller (in millions) as of December 31, 2008, was as
follows:
Reason
for
Entering
(1)
Nature
of
Recourse
(3)
(1)
(2)
(2)
(2)
(2)
(2)
(2)
(2)
(2)
(2)
(3)
(3)
(3)
(3)
(3)
(3)
(3)
(3)
(3)
(3)
Maturity
3/20/2010
6/20/2010
12/20/2012
12/20/2012
12/20/2012
12/20/2012
3/20/2017
3/20/2017
3/20/2017
3/20/2017
3/20/2017
Aa3/A+
Aa2/A
Aa2/A+
Aa2/A+
A1/A
A1/A
A2/A
A2/A
A2/A
A2/A
A2/A
Credit
Rating of
Counterparty
Fair
Value (4)
Maximum
Potential
Payout
$
$
(1)
-
-
-
-
(1)
(14)
(10)
(8)
(11)
(6)
(51)
10
10
10
10
10
10
22
14
18
18
17
149
(5)
(5)
(5)
(5)
(5)
$
$
(1) Credit default swap was entered into in order to generate income by providing protection on a highly rated basket of securities
in return for a quarterly payment.
(2) Credit default swap was entered into in order to generate income by providing default protection in return for a quarterly
payment.
(3) Seller does not have the right to demand indemnification/compensation from third parties in case of a loss (payment) on the
contract.
(4) Broker quotes are used to determine the market value of credit default swaps.
(5) These credit default swaps were sold to a counter party of the issuing special purpose trust as discussed in the “Credit-Linked
Notes” section in Note 5.
Embedded Derivatives
Deferred Compensation Plans
We have certain deferred compensation plans that have embedded derivative instruments. The liability related to these plans varies
based on the investment options selected by the participants. The liability related to certain investment options selected by the
participants is marked-to-market through net income in underwriting, acquisition, insurance and other expenses on our
Consolidated Statements of Income.
Modco and CFW Arrangements
We are involved in various Modco and CFW reinsurance arrangements that have embedded derivatives. The change in fair value
of the embedded derivatives, as well as the gains or losses on trading securities supporting these arrangements, are recorded
through net income as a component of realized gain (loss) on our Consolidated Statements of Income.
199
Variable Annuity Products
We have certain variable annuity products with GWB and GIB features that are embedded derivatives. Certain features of these
guarantees, notably our GIB and 4LATER® features, have elements of both insurance benefits accounted for under SOP 03-1 and
embedded derivatives accounted for under SFAS 133 and SFAS 157. We weight these features and their associated reserves
accordingly based on their hybrid nature. The change in fair value of the embedded derivatives flows through net income as
realized gain (loss) on our Consolidated Statements of Income. As of December 31, 2008 and 2007, we had approximately $12.7
billion and $18.9 billion, respectively, of account values that were attributable to variable annuities with a GWB feature. As of
December 31, 2008 and 2007, we had approximately $4.7 billion and $4.9 billion, respectively, of account values that were
attributable to variable annuities with a GIB feature. All of the outstanding contracts with a GIB feature are still in the
accumulation phase.
We implemented a hedging strategy designed to mitigate the income statement volatility caused by changes in the equity markets,
interest rates, and volatility associated with GWB and GIB features. The hedging strategy is designed such that changes in the
value of the hedge contracts move in the opposite direction of changes in the value of the embedded derivatives of the GWB and
GIB contracts subject to the hedging strategy. While we actively manage our hedge positions, these hedge positions may not be
totally effective in offsetting changes in the embedded derivative due to, among other things, differences in timing between when a
market exposure changes and corresponding changes to the hedge positions, extreme swings in the equity markets and interest
rates, market volatility, contract holder behavior, divergence between the performance of the underlying funds and the hedging
indices, divergence between the actual and expected performance of the hedge instruments and our ability to purchase hedging
instruments at prices consistent with our desired risk and return trade-off.
Available-For-Sale Securities
We own various debt securities that either contain call options to exchange the debt security for other specified securities of the
borrower, usually common stock, or contain call options to receive the return on equity-like indexes. These embedded derivatives
have not been qualified for hedge accounting treatment under SFAS 133; therefore, the change in fair value of the embedded
derivatives flows through net investment income on our Consolidated Statements of Income.
Credit Risk
We are exposed to credit loss in the event of nonperformance by our counterparties on various derivative contracts and reflect
assumptions regarding the credit or non-performance risk. As of December 31, 2008, the non-performance risk adjustment was
$20 million. The credit risk associated with such agreements is minimized by purchasing such agreements from financial
institutions with long-standing, superior performance records. Additionally, we maintain a policy of requiring all derivative
contracts to be governed by an International Swaps and Derivatives Association (“ISDA”) Master Agreement. We and our
insurance subsidiaries are required to maintain minimum ratings as a matter of routine practice in negotiating ISDA agreements.
Under some ISDA agreements, our insurance subsidiaries have agreed to maintain certain financial strength or claims-paying
ratings. A downgrade below these levels could result in termination of the derivatives contract, at which time any amounts payable
by us would be dependent on the market value of the underlying derivative contract. In certain transactions, we and the
counterparty have entered into a collateral support agreement requiring us to post collateral upon significant downgrade. We do
not believe the inclusion of termination or collateralization events pose any material threat to the liquidity position of any insurance
subsidiary of the Company. The amount of such exposure is essentially the net replacement cost or market value less collateral
held for such agreements with each counterparty if the net market value is in our favor. As of December 31, 2008 and 2007, the
exposure was $562 million and $781 million, respectively.
7. Federal Income Taxes
The federal income tax expense (benefit) on continuing operations (in millions) was as follows:
For the Years Ended December 31,
2006
2008
2007
$
$
$
472
(559)
(87)
499
54
553
$
$
$
270
213
483
Current
Deferred
Total federal income tax expense (benefit)
200
A reconciliation of the effective tax rate differences (in millions) was as follows:
Tax rate times pre-tax income (loss)
Effect of:
Tax-preferred investment income
Tax credits
Goodwill
Prior year tax return adjustment
Other items
Provision for income taxes
Effective tax rate
For the Years Ended December 31,
2008
2006
2007
$
$
$
656
(9)
622
(81)
(25)
58
(35)
5
(87)
N/M
$
(105)
(21)
5
(13)
31
553
30%
$
(98)
(23)
-
(25)
7
483
27%
$
The effective tax rate is a ratio of tax expense over pre-tax income (loss). Because the pre-tax loss of $25 million resulted in a tax
benefit of $87 million in 2008, the effective tax rate was not meaningful. The effective tax rate on pre-tax income (loss) from
continuing operations was lower than the prevailing corporate federal income tax rate. Included in tax-preferred investment
income was a separate account dividend received deduction benefit of $81 million, $88 million and $80 million for the years ended
December 31, 2008, 2007 and 2006, respectively, exclusive of any prior years’ tax return adjustment.
The federal income tax asset (liability) (in millions), which is included in other assets as of December 31, 2008, and other liabilities
as of December 31, 2007, on our Consolidated Balance Sheets, was as follows:
As of December 31,
2008
2007
$
$
(729)
1,755
1,026
$
$
(630)
(308)
(938)
Current
Deferred
Total federal income tax asset (liability)
201
Significant components of our deferred tax assets and liabilities (in millions) were as follows:
Deferred Tax Assets
Future contract benefits and other contract holder funds
Deferrred gain on business sold through reinsurance
Net unrealized loss on available-for-sale securities
Reinsurance related derivative liabilities
Other investments
Postretirement benefits other than pensions
Compensation and benefit plans
Ceding commission asset
Other
Total deferred tax assets
Deferred Tax Liabilities
DAC
VOBA
Net unrealized gain on available-for-sale securities
Net unrealized gain on trading securities
Reinsurance related derivative assets
Other investments
Intangibles
Other
Total deferred tax liabilities
Net deferred tax asset (liability)
As of December 31,
2008
2007
$
2,257
190
2,253
-
241
142
215
5
145
5,448
2,030
1,317
-
9
11
-
56
270
3,693
1,755
$
$
2,041
244
-
77
-
15
266
7
56
2,706
1,492
985
38
76
-
62
130
231
3,014
(308)
$
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. As of December 31, 2008 and 2007, we concluded that it was more likely than not that all gross deferred
tax assets will reduce taxes payable in future years.
We have made the decision not to permanently reinvest earnings in Lincoln National (UK) Plc. Full U.S. deferred taxes applicable
to any un-repatriated earnings have been recorded.
As discussed in Note 2, we adopted FIN 48 on January 1, 2007. As of December 31, 2008 and 2007, $184 million and $174
million of our unrecognized tax benefits presented below, if recognized, would have impacted our income tax expense and our
effective tax rate. We anticipate a change to our unrecognized tax benefits during 2009 in the range of none to $53 million. A
reconciliation of the unrecognized tax benefits (in millions) was as follows:
For the Years Ended
December 31,
Balance at beginning-of-year
Increases for prior year tax positions
Decreases for prior year tax positions
Increases for current year tax positions
Decreases for current year tax positions
Decreases for settlements with taxing authorities
Decreases for lapse of statute of limitations
Balance at end-of-year
202
2008
$
2007
$
329
16
(46)
21
(6)
(8)
(4)
302
309
7
(1)
21
(7)
-
-
329
$
$
We recognize interest and penalties accrued, if any, related to unrecognized tax benefits as a component of tax expense. During
the years ended December 31, 2008, 2007 and 2006, we recognized interest and penalty expense related to uncertain tax positions
of $2 million, $21 million and $14 million, respectively. We had accrued interest and penalty expense related to the unrecognized
tax benefits of $74 million and $72 million as of December 31, 2008 and 2007, respectively.
We are subject to annual tax examinations from the Internal Revenue Service (“IRS”). During the third quarter of 2008, the IRS
completed its examination for tax years 2003 and 2004 resulting in a proposed assessment. We believe a portion of the assessment
is inconsistent with the 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. We are currently under audit by the IRS for years 2005 and 2006. The Jefferson-Pilot subsidiaries acquired in the April
2006 merger are subject to a separate IRS examination cycle. For the former Jefferson-Pilot Corporation and its subsidiaries, the
IRS is examining tax year ended April 2, 2006.
8. DAC, VOBA, DSI and DFEL
During the fourth quarter of 2008, we recorded a decrease to income from continuing operations totaling $263 million or $1.01 per
diluted share, for a reversion to the mean prospective unlocking of DAC, VOBA, DSI and DFEL as a result of significant and
sustained declines in the equity markets during 2008. The pre-tax impact for these items is included within the prospective
unlocking line items in the changes in DAC, VOBA, DSI and DFEL tables below.
Changes in DAC (in millions) were as follows:
Balance at beginning-of-year
Cumulative effect of adoption of SOP 05-1
Deferrals
Amortization, net of interest:
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization, net of interest
Adjustment related to realized gains on
available-for-sale securities and derivatives
Adjustment related to unrealized losses on
available-for-sale securities and derivatives
Foreign currency translation adjustment
Balance at end-of-year
For the Years Ended December 31,
2008
2006
2007
$
6,510
-
1,817
$
5,116
(31)
2,012
$
4,164
-
1,482
(368)
44
(199)
(641)
(203)
35
(55)
67
(824)
79
6
(6)
41
(670)
(53)
1,163
(129)
7,994
$
103
8
6,510
$
86
66
5,116
$
203
Changes in VOBA (in millions) were as follows:
Balance at beginning-of-year
Cumulative effect of adoption of SOP 05-1
Business acquired
Deferrals
Amortization, net of interest:
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization
Accretion of interest
Adjustment related to realized gains (losses) on
available-for-sale securities and derivatives
Adjustment related to unrealized gains (losses) on
available-for-sale securities and derivatives
Foreign currency translation adjustment
Balance at end-of-year
For the Years Ended December 31,
2008
2006
2007
$
$
$
3,070
-
-
40
3,304
(35)
14
46
999
-
2,478
96
9
(15)
(37)
(361)
131
98
14
(7)
11
(449)
143
-
(3)
-
(1)
(372)
128
(8)
1,074
(67)
3,942
$
24
5
3,070
$
(48)
35
3,304
$
Estimated future amortization of VOBA, net of interest (in millions), as of December 31, 2008, was as follows:
2009
2010
2011
2012
2013
Thereafter
Total
$
263
246
215
197
180
1,723
2,824
$
Changes in DSI (in millions) were as follows:
Balance at beginning-of-year
Cumulative effect of adoption of SOP 05-1
Deferrals
Amortization, net of interest:
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization, net of interest
Adjustment related to realized gains (losses) on
available-for-sale securities and derivatives
Balance at end-of-year
For the Years Ended December 31,
2008
2006
2007
$
$
$
279
-
96
194
(3)
116
129
-
86
(37)
-
(13)
(16)
2
(1)
1
(35)
1
-
3
(22)
(46)
263
$
5
279
$
(3)
194
$
204
Changes in DFEL (in millions) were as follows:
Balance at beginning-of-year
Cumulative effect of adoption of SOP 05-1
Deferrals
Amortization, net of interest:
Prospective unlocking - assumption changes
Prospective unlocking - model refinements
Retrospective unlocking
Other amortization, net of interest
Adjustment related to realized gains (losses) on
available-for-sale securities and derivatives
Foreign currency translation adjustment
Balance at end-of-year
9. Reinsurance
For the Years Ended December 31,
2008
2006
2007
$
$
$
1,183
-
432
977
(2)
412
796
-
249
(37)
25
(47)
(161)
4
(34)
9
(191)
21
(4)
9
(142)
(17)
(96)
1,282
$
2
6
1,183
$
(2)
50
977
$
The following summarizes reinsurance amounts (in millions) recorded on our Consolidated Statements of Income, excluding
amounts attributable to the indemnity reinsurance transaction with Swiss Re:
For the Years Ended December 31,
2008
2006
2007
Direct insurance premiums and fees
Reinsurance assumed
Reinsurance ceded
Total insurance premiums and fees, net
Direct insurance benefits
Reinsurance recoveries netted against benefits
Total benefits, net
$
6,331
18
(1,024)
5,325
4,239
(1,082)
3,157
$
$
$
6,077
12
(952)
5,137
$
$
$
3,599
(1,037)
2,562
4,793
8
(831)
3,970
2,833
(927)
1,906
$
$
$
$
$
Our insurance companies cede insurance to other companies. The portion of risks exceeding each company’s retention limit is
reinsured with other insurers. We seek reinsurance coverage within the businesses that sell life insurance in order to limit our
exposure to mortality losses and enhance our capital management.
Under our reinsurance program, we reinsure approximately 50% to 55% of the mortality risk on newly issued non-term life
insurance contracts and approximately 40% to 45% of total mortality risk including term insurance contracts. Our policy for this
program is to retain no more than $10 million on a single insured life issued on fixed and VUL insurance contracts. Additionally,
the retention per single insured life for term life insurance and for corporate owned life insurance is $2 million for each type of
insurance. Portions of our deferred annuity business have been reinsured on a Modco basis with other companies to limit our
exposure to interest rate risks. As of December 31, 2008, the reserves associated with these reinsurance arrangements totaled $1.1
billion. To cover products other than life insurance, we acquire other insurance coverages with retentions and limits.
We obtain reinsurance from a diverse group of reinsurers, and we monitor concentration as well as financial strength ratings of our
principal reinsurers. Our reinsurance operations were acquired by Swiss Re in December 2001, through a series of indemnity
reinsurance transactions. Swiss Re represents our largest reinsurance exposure. Under the indemnity reinsurance agreements,
Swiss Re reinsured certain of our liabilities and obligations. As we are not relieved of our legal liability to the ceding companies, the
liabilities and obligations associated with the reinsured contracts remain on our Consolidated Balance Sheets with a corresponding
reinsurance receivable from Swiss Re, which totaled $4.5 billion as of December 31, 2008. Swiss Re has funded a trust, with a
balance of $1.9 billion as of December 31, 2008, 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 as
of December 31, 2008, included $2.0 billion and $9 million, respectively, related to the business reinsured by Swiss Re.
205
We recorded the gain related to the indemnity reinsurance transactions on the business sold to Swiss Re as a deferred gain in the
liability section of our Consolidated Balance Sheets in accordance with the requirements of SFAS No. 113, “Accounting and
Reporting for Reinsurance of Short-Duration and Long-Duration Contracts” (“SFAS 113”). The deferred gain is being amortized
into income at the rate that earnings on the reinsured business are expected to emerge, over a period of 15 years. During 2008,
2007 and 2006 we amortized $50 million, $55 million and $50 million, after-tax, respectively, of deferred gain on the sale of the
reinsurance operation.
Because of ongoing uncertainty related to personal accident business, the reserves related to these exited business lines carried on
our Consolidated Balance Sheets as of December 31, 2008, may ultimately prove to be either excessive or deficient. For instance,
in the event that future developments indicate that these reserves should be increased, under SFAS 113 LNC would record a
current period non-cash charge to record the increase in reserves. Because Swiss Re is responsible for paying the underlying claims
to the ceding companies, we would record a corresponding increase in reinsurance recoverable from Swiss Re. However, SFAS
113 does not permit us to take the full benefit in earnings for the recording of the increase in the reinsurance recoverable in the
period of the change. Rather, we would increase the deferred gain recognized upon the closing of the indemnity reinsurance
transaction with Swiss Re and would report a cumulative amortization “catch-up” adjustment to the deferred gain balance as
increased earnings recognized in the period of change. Any amount of additional increase to the deferred gain above the
cumulative amortization “catch-up” adjustment must continue to be deferred and will be amortized into income in future periods
over the remaining period of expected run-off of the underlying business. We would not transfer any cash to Swiss Re as a result
of these developments.
In the second quarter of 2007, we recognized increased reserves on the business sold and recognized a deferred gain that is being
amortized into income at the rate that earnings are expected to emerge within a 15 year period. This adjustment resulted in a non-
cash charge of $13 million, after-tax, to increase reserves, which was partially offset by a cumulative “catch-up” adjustment to the
deferred gain amortization of $5 million, after-tax, for a total decrease to net income of $8 million. The impact of the accounting
for reserve adjustments related to this reinsurance treaty is excluded from our definition of income from operations.
Included in the business sold to Swiss Re through indemnity reinsurance in 2001 was disability income business. As of December
31, 2008, there were approximately $1.0 billion of reserves on this business. Under the reinsurance agreement with Swiss Re, there
was a recoverable of approximately $900 million and a corresponding funds withheld liability of approximately $840 million. As
previously disclosed, we had entered into arbitration regarding Swiss Re’s obligation to pay reinsurance recoverables on certain of
this disability income business. As of December 31, 2008, the amount due from Swiss Re was approximately $53 million related to
this disability income business. In late January 2009, we were notified of the arbitration panel’s decision to order a rescission of the
underlying reinsurance agreement. As a result of the ruling, a rescission of the reinsurance agreement previously in place would
result in our writing down this receivable. However, we expect that such a write-down would be partially offset by other items
including the release of our embedded derivative liability related to the funds withheld nature of the reinsurance agreements for this
business. We believe that the rescission will result in the elimination of the recoverable and corresponding funds withheld liability
as well as our being responsible for paying claims on the business and establishing sufficient reserves to support the liabilities.
Because the decision leaves it to the parties to effectuate the rescission, we expect to begin negotiations with Swiss Re regarding
various aspects of the rescission. In addition, we would expect to carry out a review of the adequacy of the reserves supporting the
liabilities. We are also currently evaluating our options in light of the arbitration panel’s ruling; however, based on currently
available information and our views of the manner in which the rescission will be effectuated, we do not currently expect the
rescission to have a material adverse effect on our results of operations, liquidity or capital resources.
206
10. Goodwill and Specifically Identifiable Intangible Assets
The changes in the carrying amount of goodwill (in millions) by reportable segment were as follows:
Retirement Solutions:
Annuities
Defined Contribution
Insurance Solutions:
Life Insurance
Group Protection
Investment Management
Lincoln UK
Other Operations
Total goodwill
Retirement Solutions:
Annuities
Defined Contribution
Insurance Solutions:
Life Insurance
Group Protection
Investment Management
Lincoln UK
Other Operations
Total goodwill
For the Year Ended December 31, 2008
Balance At
Beginning-
of-Year
Purchase
Accounting
Adjustments
Dispositions
and
Other
Balance
At End-
of-Year
Impairment
$
1,046
20
$
(6)
-
-
$
-
-
$
-
$
1,040
20
2,201
274
247
17
339
4,144
$
(13)
-
1
-
(1)
(19)
$
-
-
-
(12)
(164)
(176)
$
-
-
-
(5)
-
(5)
$
2,188
274
248
-
174
3,944
$
For the Year Ended December 31, 2007
Balance At
Beginning-
of-Year
Purchase
Accounting
Adjustments
Impairment
Dispositions
and
Other
Balance
At End-
of-Year
$
1,032
20
$
14
-
-
$
-
-
$
-
$
1,046
20
2,181
281
262
17
344
4,137
$
20
(7)
-
-
(5)
22
$
-
-
-
-
-
$
-
-
-
(15)
-
-
(15)
$
2,201
274
247
17
339
4,144
$
The purchase accounting adjustments above relate to income tax deductions recognized when stock options attributable to
mergers were exercised or the release of unrecognized tax benefits acquired through mergers.
The 2008 goodwill impairment recorded in our Lincoln UK segment was the result of the impact of the deterioration of the
economic and business conditions in the United Kingdom. Our impairment tests showed the implied fair value of this segment
was lower than the carrying amount, therefore we recorded non-cash impairments of goodwill (set forth above), based upon the
guidance of SFAS 142. The implied fair value for our goodwill impairment of Lincoln UK was based upon market observable data
about the industry and previous transactions.
The 2008 impairment recorded in Other Operations for our media business was a result of declines in current and forecasted
advertising revenue for the entire radio market. Our impairment tests showed the implied fair value of our media business were
lower than their carrying amounts; therefore, we recorded non-cash impairments of goodwill (set forth above) and specifically
identifiable intangible assets (set forth below), based upon the guidance of SFAS 142. The implied fair value of our media business
was primarily based upon discounted cash flow calculations.
We performed a Step 1 goodwill impairment analysis on all of our reporting units. The Step 1 analysis for the reporting units
within our Insurance Solutions and Retirement Solutions segments utilized primarily a discounted cash flow valuation technique.
The discounted cash flow analysis required us to make judgments about revenues, earnings projections, growth rates and discount
rates. We also considered other valuation techniques such as an analysis of peer companies and market participants. In the
207
valuation process, we gave consideration to the current economic and market conditions. We also updated our October 1 analysis
of goodwill impairment to reflect fourth quarter results and forecasts as of December 31, 2008, due to sharp declines in the equity
markets and our stock price in the fourth quarter. In determining the estimated fair value of our reporting units, we incorporated
consideration of discounted cash flow calculations, peer company price-to-earnings multiples, the level of our own share price and
assumptions that market participants would make in valuing our reporting units. Our fair value estimations were based primarily
on an in-depth analysis of future cash flows and relevant discount rates, which considered market participant inputs (income
approach). For our other reporting units, we used other available information including market data obtained through strategic
reviews and other analysis to support our Step 1 conclusions.
All of our reporting units passed the Step 1 analysis, except for our Media and Lincoln UK reporting units, which required a Step 2
analysis to be completed. Additionally, while the Step 1 analysis of our Insurance Solutions – Life reporting unit indicated that its
fair value exceeded its carrying value, the margin above carrying value was relatively small. Therefore, we concluded that we should
perform additional analysis for our Insurance Solutions – Life reporting unit under the Step 2 requirements of SFAS 142. In our
Step 2 analysis, we estimated the implied fair value of the reporting unit’s goodwill as determined by allocating the reporting unit’s
fair value determined in Step 1 to all of its net assets (recognized and unrecognized) as if the reporting unit had been acquired in a
business combination at the date of the impairment test. We utilized very detailed forecasts of cash flows and market observable
inputs in determining a fair value of the net assets for each of the reporting units similar to what would be estimated in a business
combination between market participants. The implied fair value of goodwill for Media and the UK was lower than its carrying
amount; therefore, goodwill was impaired and written down to its fair value for those reporting units. The implied fair value of
goodwill for Insurance Solutions – Life was higher than its carrying amount; therefore, the goodwill for this reporting unit was not
impaired.
The gross carrying amounts and accumulated amortization (in millions) for each major specifically identifiable intangible asset class
by reportable segment were as follows:
Insurance Solutions - Life Insurance:
Sales force
Retirement Solutions - Defined Contribution:
Mutual fund contract rights (1)
Investment Management:
Client lists
Other (1)
Other Operations:
FCC licenses (1) (2)
Other
Total
As of December 31,
2008
2007
Gross
Carrying
Amount
Accumulated
Amortiza-
tion
Gross
Carrying
Amount
Accumulated
Amortiza-
tion
$
100
$
11
$
100
$
7
3
92
5
-
92
-
3
92
3
-
90
-
167
4
371
$
-
3
106
$
384
4
586
$
-
3
100
$
(1) No amortization recorded as the intangible asset has indefinite life.
(2) We recorded FCC licenses impairment of $217 million during 2008, as discussed above.
Future estimated amortization of specifically identifiable intangible assets (in millions) as of December 31, 2008 was as follows:
2009
2010
2011
2012
2013
Thereafter
Total
$
4
4
4
4
4
70
90
$
See Note 3 for goodwill and specifically identifiable intangible assets included within discontinued operations.
208
11. Guaranteed Benefit Features
We issue variable annuity contracts through our separate accounts for which investment income and investment gains and losses
accrue directly to, and investment risk is borne by, the contract holder (traditional variable annuities). We also issue variable
annuity and life contracts through separate accounts that include various types of GDB, GWB and GIB features. The GDB
features include those where we contractually guarantee to the contract holder either: return of no less than total deposits made to
the contract less any partial withdrawals (“return of net deposits”); total deposits made to the contract less any partial withdrawals
plus a minimum return (“minimum return”); or the highest contract value on any contract anniversary date through age 80 minus
any payments or withdrawals following the contract anniversary (“anniversary contract value”).
Certain features of these guarantees are considered embedded derivatives and are recorded in future contract benefits on our
Consolidated Balance Sheets at fair value under SFAS 133 and SFAS 157. Other guarantees that are not considered embedded
derivatives meet the criteria as insurance benefits and are accounted for under the valuation techniques included in SOP 03-1. Still
other guarantees contain characteristics of both an embedded derivative and an insurance benefit and are accounted for under an
approach that weights these features and their associated reserves accordingly based on their hybrid nature. Effective January 1,
2008, we adopted SFAS 157, which affected the valuation of our embedded derivatives. See Note 22 for details on the adoption of
SFAS 157. We use derivative instruments to hedge our exposure to the risks and earnings volatility that result from the embedded
derivatives for living benefits in certain of our variable annuity products. The change in fair value of these instruments tends to
move in the opposite direction of the change in fair value of the embedded derivatives. The net impact of these changes is
reported as guaranteed living benefits (“GLB”), which is reported as a component of realized gain (loss) on our Consolidated
Statements of Income and is discussed in Note 16.
Information on the GDB features outstanding (dollars in millions) was as follows (our variable contracts with guarantees may offer
more than one type of guarantee in each contract; therefore, the amounts listed are not mutually exclusive):
Return of Net Deposits
Total account value
Net amount at risk (1)
Average attained age of contract holders
Minimum Return
Total account value
Net amount at risk (1)
Average attained age of contract holders
Guaranteed minimum return
Anniversary Contract Value
Total account value
Net amount at risk (1)
Average attained age of contract holders
As of December 31,
2008
2007
$
33,907
$
44,833
6,337
56 years
93
55 years
$
191
$
355
109
68 years
5%
25
68 years
5%
$
16,950
$
25,537
8,402
65 years
359
64 years
(1) Represents the amount of death benefit in excess of the account balance. The increase in net amount of risk when comparing
December 31, 2008, to December 31, 2007, was attributable primarily to the decline in equity markets and associated reduction
in the account values.
209
The determination of GDB liabilities is based on models that involve a range of scenarios and assumptions, including those
regarding expected market rates of return and volatility, contract surrender rates and mortality experience. The following
summarizes the balances of and changes in the liabilities for GDB (in millions), which were recorded in future contract benefits on
our Consolidated Balance Sheets:
Balance at beginning-of-year
Cumulative effect of adoption of SOP 05-1
Changes in reserves
Benefits paid
Balance at end-of-year
For the Years Ended December 31,
2008
2006
2007
$
$
$
38
-
312
(73)
277
23
(4)
25
(6)
38
15
-
14
(6)
23
$
$
$
The changes to the benefit reserves amounts above are reflected in benefits on our Consolidated Statements of Income.
Account balances of variable annuity contracts with guarantees (in millions) were invested in separate account investment options
as follows:
As of December 31,
2008
2007
Asset Type
Domestic equity
International equity
Bonds
Money market
Total
$
$
24,878
9,204
6,701
5,802
46,585
44,982
8,076
8,034
6,545
67,637
$
$
Percent of total variable annuity separate account values
99%
97%
Future contract benefits also include reserves for our products with secondary guarantees for our products sold through our
Insurance Solutions – Life Insurance segment. These UL and VUL products with secondary guarantees represented approximately
34% of permanent life insurance in force as of December 31, 2008 and approximately 68% of sales for these products in 2008.
12. Other Contract Holder Funds
Details of other contract holder funds (in millions) were as follows:
Account values and other contract holder funds
Deferred front-end loads
Contract holder dividends payable
Premium deposit funds
Undistributed earnings on participating business
Total other contract holder funds
$
$
As of December 31,
2008
2007
57,698
58,931
1,183
1,282
524
498
140
125
95
11
59,640
60,847
$
$
As of December 31, 2008 and 2007, participating policies comprised approximately 1.12% of the face amount of insurance in
force, and dividend expenses were $98 million, $88 million and $88 million for the years ended December 31, 2008, 2007 and 2006,
respectively.
210
13. Short-Term and Long-Term Debt
Details underlying short-term and long-term debt (in millions) were as follows:
As of December 31,
2008
2007
Short-Term Debt
Commercial paper (1)
Current maturities of long-term debt
Total short-term debt
Long-Term Debt, Excluding Current Portion (2)
Senior notes:
LIBOR + 11 bps notes, due 2009
LIBOR + 8 bps notes, due 2010
6.2% notes, due 2011
EXtendible Liquidity Securities®
5.65% notes, due 2012
LIBOR + 110 bps loan, due 2013
4.75% notes, due 2014
4.75% notes, due 2014
LIBOR + 3 bps notes, due 2017
7% notes, due 2018
6.15% notes, due 2036
6.3% notes, due 2037
Total senior notes
Junior subordinated debentures issued to affiliated trusts:
Lincoln Capital VI - 6.75% Series F, due 2052
Total junior subordinated debentures issued to affiliated trusts
Capital securities:
6.75%, due 2066
7%, due 2066
6.05%, due 2067
Total capital securities
Total long-term debt
$
$
$
$
315
500
815
265
285
550
-
$
250
250
-
300
200
290
199
250
200
497
569
3,005
$
500
250
250
15
299
-
288
199
-
200
497
394
2,892
155
155
155
155
275
797
499
1,571
4,731
$
275
797
499
1,571
4,618
$
(1) The weighted-average interest rate of commercial paper was 3.07% and 5.19% as of December 31, 2008 and 2007,
respectively.
(2) Amounts include unamortized premiums and discounts and the fair value of any associated fair value hedges on our long-term
debt.
Future principal payments due on long-term debt (in millions) as of December 31, 2008, were as follows:
2009
2010
2011
2012
2013
Thereafter
Total
$
500
250
250
300
200
3,555
5,055
$
For our long-term debt outstanding, unsecured senior debt, which consists of senior notes, fixed rate notes and other notes with
varying interest rates, ranks highest in priority, followed by junior subordinated debentures and capital securities.
211
Commercial Paper, Revolving Credit Facilities and Letters of Credit
Commercial paper, revolving credit facilities and letters of credit debt programs (in millions) were as follows:
Commercial paper
Revolving credit facilities:
Credit facility with Federal Home Loan
Bank of Indianapolis (1)
Five-year revolving credit facility
Five-year revolving credit facility
Five-year revolving credit facility
U.K. revolving credit facility (2)
Total
Letters of credit issued
Expiration
Date
N/A
Maximum Available as of
December 31,
2008
2007
$
1,000
$
1,000
Debt/Loans
Outstanding as of
December 31,
2008
$
315
2007
$
265
N/A
Jul-13
Mar-11
Feb-11
Nov-08
378
200
1,750
1,350
-
-
1,750
1,350
250
200
-
-
-
-
-
-
-
4,678
$
20
4,120
$
-
765
$
-
265
$
$
2,095
$
1,794
(1) Our borrowing capacity under this credit facility does not have an expiration date and continues while our investment in the
Federal Home Loan Bank of Indianapolis (“FHLBI”) common stock remains outstanding.
(2) The U.K. credit facility that provided for a maximum credit of 10 million pounds sterling was not renewed when it expired in
November 2008.
The revolving credit facilities allow for borrowing or issuances of letters of credit (“LOCs”). Because commitments associated
with LOCs may expire unused, these amounts do not necessarily reflect our future cash funding requirements, however the
issuance of LOCs reduces availability of funds from the credit facilities. These LOCs support our reinsurance needs and specific
treaties associated with our reinsurance business sold to Swiss Re in 2001. LOCs are used primarily to satisfy the U.S. regulatory
requirements of domestic clients who have contracted with the reinsurance subsidiaries not domiciled in the U.S. and for 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. As of December 31, 2008, we were in compliance with all such covenants.
Shelf Registration
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.
Certain Debt Covenants on Capital Securities
Our $1.6 billion in principal amount of capital securities outstanding contain certain covenants that require us to make interest
payments in accordance with an alternative coupon satisfaction mechanism (“ACSM”) if we determine that one of the following
triggers (“trigger events”) exists as of the 30th day prior to an interest payment date (“determination date”):
(cid:120) LNL’s risk-based capital ratio is less than 175% (based on the most recent annual financial statement filed with the State of
Indiana); or
(cid:120) The sum of our consolidated net income for the four trailing fiscal quarters ending on the quarter that is two quarters prior to
the most recently completed quarter prior to the determination date is zero or negative; and
(cid:120) Our consolidated stockholders’ equity (excluding accumulated other comprehensive income and any increase in stockholders’
equity resulting from the issuance of preferred stock during a quarter) (“adjusted stockholders’ equity”) as of the most recently
completed quarter and the end of the quarter that is two quarters before the most recently completed quarter, has declined by
10% or more as compared to the quarter that is ten fiscal quarters prior to the last completed quarter (the “benchmark
quarter”).
212
The ACSM would generally require us to use commercially reasonable efforts to satisfy our obligation to pay interest in full on the
capital securities with the net proceeds from sales of our common stock and warrants to purchase our common stock with an
exercise price greater than the market price. We would have to utilize the ACSM until the trigger events no longer existed. Our
failure to pay interest pursuant to the ACSM will not result in an event of default with respect to the capital securities nor will a
nonpayment of interest unless it lasts for ten consecutive years, although such breaches may result in monetary damages to the
holders of the capital securities.
14. Contingencies and Commitments
Contingencies
Regulatory and Litigation Matters
Federal and state regulators continue to focus on issues relating to fixed and variable insurance products, including, but not limited
to, suitability, replacements and sales to seniors. Like others in the industry, we have received inquiries including requests for
information regarding sales to seniors from the Financial Industry Regulatory Authority, and we have responded to these inquiries.
We continue to cooperate fully with such authority.
In the ordinary course of its business, LNC and its subsidiaries are involved in various pending or threatened legal proceedings,
including purported class actions, arising from the conduct of business. In some instances, these proceedings include claims for
unspecified or substantial punitive damages and similar types of relief in addition to amounts for alleged contractual liability or
requests for equitable relief. After consultation with legal counsel and a review of available facts, it is management’s opinion that
these proceedings, after consideration of any reserves and rights to indemnification, ultimately will be resolved without materially
affecting the consolidated financial position of LNC. However, given the large and indeterminate amounts sought in certain of
these proceedings and the inherent difficulty in predicting the outcome of such legal proceedings, including the proceeding
described below, it is possible that an adverse outcome in certain matters could be material to our operating results for any
particular reporting period.
Transamerica Investment Management, LLC and Transamerica Investments Services, Inc. v. Delaware Management Holdings, Inc. (dba Delaware
Investments), Delaware Investment Advisers and certain individuals, was filed in the San Francisco County Superior Court on April 28, 2005.
The plaintiffs are seeking substantial compensatory and punitive damages. The complaint alleges breach of fiduciary duty, breach
of duty of loyalty, breach of contract, breach of the implied covenant of good faith and fair dealing, unfair competition,
interference with prospective economic advantage, conversion, unjust enrichment and conspiracy, in connection with Delaware
Investment Advisers’ hiring of a portfolio management team from the plaintiffs. We and the individual defendants dispute the
allegations and are vigorously defending these actions.
Lincoln UK Outsourcing Agreement
Lincoln UK agreed to outsource its customer and contract administration functions to the Capita Group Plc (“Capita”) on August
1, 2002. The contract was originally for a term of 10 years. During 2003, this agreement was converted to an evergreen contract.
The annual cost is based on a per-contract charge plus an amount for other services provided. The total costs over the next 10
years of the contract are estimated to be $180 million and annual costs over the next five years are estimated to decline from $24
million to $17 million. The amounts quoted are estimates, as the actual cost will depend on the number of policies in-force and the
applicable inflation rate for the period concerned. Lincoln UK or Capita may terminate the contract, subject to the necessary
conditions being satisfied, by serving six and 12 months notice, respectively.
Commitments
Leases
Certain subsidiaries of ours lease their home office properties through sale-leaseback agreements. The agreements provide for a
25-year lease period with options to renew for six additional terms of five years each. The agreements also provide us with the
right of first refusal to purchase the properties during the terms of the lease, including renewal periods, at a price defined in the
agreements. We also have the option to purchase the leased properties at fair market value as defined in the agreements on the last
day of the initial 25-year lease period ending in 2009 or the last day of any of the renewal periods. In 2006, we exercised the right
and option to extend the Fort Wayne lease for two extended terms such that the lease shall expire in 2019. We retain our right and
option to exercise the remaining four extended terms of 5 years each in accordance with the lease agreement. In 2007, we
exercised the right and option to extend the Hartford lease for one extended term such that the lease shall expire in 2013. During
2007, we moved our corporate headquarters to Radnor, Pennsylvania from Philadelphia and entered into a new 13-year lease for
office space.
213
Total rental expense on operating leases for the years ended December 31, 2008, 2007 and 2006 was $63 million, $65 million and
$68 million, respectively. Future minimum rental commitments (in millions) as of December 31, 2008 were as follows:
2009
2010
2011
2012
2013
Thereafter
Total
$
53
41
35
29
23
120
301
$
Information Technology Commitment
In February 1998, we signed a seven-year contract with IBM Global Services for information technology services for the Fort
Wayne operations. In February 2004, we completed renegotiations and extended the contract through February 2010. Annual
costs are dependent on usage but are expected to be approximately $9 million.
Football Stadium Naming Rights Commitment
In 2002, we entered into an agreement with the Philadelphia Eagles to name the Eagles’ new stadium Lincoln Financial Field. In
exchange for the naming rights, we agreed to pay $140 million over a 20-year period through annual payments to the Eagles, which
average approximately $7 million per year. The total amount includes a maximum annual increase related to the Consumer Price
Index. This future commitment has not been recorded as a liability in our Consolidated Balance Sheets as it is being accounted for
in a manner consistent with the accounting for operating leases under SFAS No. 13, “Accounting for Leases.”
Media Commitments
Lincoln Financial Media has future commitments of approximately $39 million through 2013, related primarily to employment
contracts and rating service contracts.
Vulnerability from Concentrations
As of December 31, 2008, we did not have a concentration of: business transactions with a particular customer or lender; sources
of supply of labor or services used in the business; or a market or geographic area in which business is conducted that makes it
vulnerable to an event that is at least reasonably possible to occur in the near term and which could cause a severe impact to our
financial position.
Although we do not have any significant concentration of customers, our American Legacy Variable Annuity product offered in
our Retirement Solutions – Annuities segment is significant to this segment. The American Legacy Variable Annuity product
accounted for 37%, 46% and 48% of Retirement Solutions – Annuities’ variable annuity product deposits in 2008, 2007 and 2006,
respectively and represented approximately 62%, 66% and 67% of our total Retirement Solutions – Annuities’ variable annuity
product account values as of December 31, 2008, 2007 and 2006. In addition, fund choices for certain of our other variable
annuity products offered in our Retirement Solutions – Annuities segment include American Fund Insurance SeriesSM (“AFIS”)
funds. For the Retirement Solutions – Annuities segment, AFIS funds accounted for 44%, 55% and 58% of variable annuity
product deposits in 2008, 2007 and 2006, respectively, and represented 70%, 75% and 75% of the segment’s total variable annuity
product account values as of December 31, 2008, 2007 and 2006, respectively.
Other Contingency Matters
State guaranty funds assess insurance companies to cover losses to contract holders of insolvent or rehabilitated companies.
Mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. We have accrued
for expected assessments net of estimated future premium tax deductions of $6 million and $4 million as of December 31, 2008
and 2007, respectively.
Guarantees
We have guarantees with off-balance-sheet risks having contractual values of $1 million and $2 million as of December 31, 2008
and 2007, respectively, whose contractual amounts represent credit exposure. Certain of our subsidiaries have sold commercial
mortgage loans through grantor trusts, which issued pass-through certificates. These subsidiaries have agreed to repurchase any
214
mortgage loans which remain delinquent for 90 days at a repurchase price substantially equal to the outstanding principal balance
plus accrued interest thereon to the date of repurchase. In case of default by borrowers, we have recourse to the underlying real
estate. It is management’s opinion that the value of the properties underlying these commitments is sufficient that in the event of
default, the impact would not be material to us. These guarantees expire in 2009. Our assessment of the off-balance-sheet risk was
based upon the borrower’s credit rating of Baa1.
We guarantee the repayment of operating leases on facilities that we have subleased to third parties, which obligate us to pay in the
event the third parties fail to perform their payment obligations under the subleasing agreements. We have recourse to the third
parties enabling us to recover any amounts paid under our guarantees. The annual rental payments subject to these guarantees are
$15 million and expire in 2009. Our assessment of the collection risk of the rent payments was based upon Swiss Re and Safeco
Corporation’s credit rating of Aa3 and bbb+, respectively.
Tax Matters
Changes to the Internal Revenue Code, administrative rulings or court decisions could increase our effective tax rate. In this
regard, on August 16, 2007, the Internal Revenue Service (“IRS”) issued a revenue ruling that purports, among other things, to
modify the calculation of the separate account dividends received deduction received by life insurance companies. Subsequently,
the IRS issued another revenue ruling that suspended the August 16, 2007, ruling and announced a new regulation project on the
issue. See Note 7 for the impact of the separate account dividends received deduction on our effective tax rate.
15. Shares and Stockholders’ Equity
Shares
The changes in our preferred and common stock (number of shares) were as follows:
For the Years Ended December 31,
2007
2008
2006
Series A Preferred Stock
Balance at beginning-of-year
Conversion into common stock
Balance at end-of-year
Common Stock
Balance at beginning-of-year
Issued for acquisition
Conversion of Series A preferred stock
Stock compensation/issued for benefit plans
Retirement of common stock/cancellation of shares
Balance at end-of-year
Common stock at end-of-year:
Assuming conversion of preferred stock
Diluted basis
Our common and Series A preferred stocks are without par value.
11,960
(395)
11,565
12,706
(746)
11,960
15,515
(2,809)
12,706
264,233,303
-
6,320
945,048
(9,314,812)
255,869,859
275,752,668
-
11,936
3,849,497
(15,380,798)
264,233,303
173,768,078
112,301,906
44,944
6,515,230
(16,877,490)
275,752,668
256,054,899
257,690,111
264,424,663
266,186,641
275,955,964
280,188,447
215
A reconciliation of the denominator (number of shares) in the calculations of basic and diluted net income and income from
discontinued operations per share was as follows:
Weighted-average shares, as used in basic calculation
Shares to cover conversion of preferred stock
Shares to cover non-vested stock
Average stock options outstanding during the period
Assumed acquisition of shares with assumed proceeds
and benefits from exercising stock options (at average
market price for the year)
Shares repurchaseable from measured but unrecognized
stock option expense
Average deferred compensation shares
Weighted-average shares, as used in diluted calculation
For the Years Ended December 31,
2007
270,298,843
197,140
566,419
12,826,598
2008
257,498,535
186,578
309,648
6,479,521
2006
252,363,042
229,113
1,291,868
14,557,403
(6,351,278)
(11,101,999)
(13,313,108)
(43,148)
1,310,954
259,390,810
(203,730)
1,322,231
273,905,502
(249,885)
1,290,833
256,169,266
In the event the average market price of LNC common stock exceeds the issue price of stock options, such options would be
dilutive to our EPS and will be shown in the table above. Participants in our deferred compensation plans that select LNC stock
for measuring the investment return attributable to their deferral amounts will be paid out in LNC stock. The obligation to satisfy
these deferred compensation plan liabilities is dilutive and is shown in the table above.
The income used in the calculation of our diluted EPS is our income before cumulative effect of accounting change and net
income, reduced by minority interest adjustments related to outstanding stock options under the Delaware Investments U.S., Inc.
(“DIUS”) stock option incentive plan of less than $1 million for 2008, $2 million for 2007 and less than $1 million for 2006.
216
Accumulated OCI
The following summarizes the components and changes in accumulated OCI (in millions):
Unrealized Gains (Loss) on Available-for-Sale Securities
Balance at beginning-of-year
Other comprehensive income (loss):
Unrealized holding losses arising during the year
Change in DAC, VOBA, DSI and other contract holder funds
Income tax benefit
Change in foreign currency exchange rate adjustment
Less:
Reclassification adjustment for gains (losses) on
available-for-sale securities included in net income
Reclassification adjustment for losses on derivative
instruments included in net income
Associated amortization of DAC, VOBA, DSI, DFEL
and changes in other contract holder funds
Income tax benefit
Balance at end-of-year
Unrealized Gains (Loss) on Derivative Instruments
Balance at beginning-of-year
Other comprehensive income (loss):
Unrealized holding gains (losses) arising during the year
Change in DAC, VOBA, DSI and other contract holder funds
Income tax benefit
Change in foreign currency exchange rate adjustment
Less:
Reclassification adjustment for gains (losses) included in net income
Associated amortization of DAC, VOBA, DSI, DFEL
and changes in other contract holder funds
Income tax (expense) benefit
Balance at end-of-year
Foreign Currency Translation Adjustment
Balance at beginning-of-year
Other comprehensive income (loss):
Foreign currency translation adjustment arising during the year
Income tax (expense) benefit
Balance at end-of-year
Minimum Pension Liability Adjustment
Balance at beginning-of-year
Other comprehensive income: adjustment for adoption of SFAS 158, net of tax
Balance at end-of-year
Funded Status of Employee Benefit Plans
Balance at beginning-of-year
Other comprehensive income (loss):
Adjustment arising during the year
Income tax benefit
Adjustment for adoption of SFAS 158, net of tax
Balance at end-of-year
217
For the Years Ended December 31,
2006
2007
2008
$
86
$
493
$
497
(7,844)
2,606
1,822
(66)
(899)
172
255
(22)
(1,230)
(163)
(112)
-
(126)
24
39
51
28
-
260
340
(2,654)
$
29
47
86
$
(41)
5
493
$
$
53
$
39
$
7
(1)
(36)
37
1
(112)
29
(6)
15
(30)
(11)
26
1
2
4
2
-
39
127
$
1
4
53
$
-
(1)
39
$
$
175
$
165
$
83
(263)
94
$
6
15
(5)
175
$
126
(44)
165
$
-
$
-
$
-
-
$
-
$
-
$
(60)
60
$
-
$
(89)
$
(84)
$
-
(316)
123
-
(282)
$
(8)
3
-
(89)
$
-
-
(84)
(84)
$
16. Realized Gain (Loss)
Details underlying realized gain (loss) (in millions) reported on our Consolidated Statements of Income were as follows:
Total realized loss on investments and certain
derivative instruments, excluding trading securities (1)
Gain on certain reinsurance derivative/
trading securities (2)
Indexed annuity net derivative results (3):
Gross
Associated amortization expense of DAC, VOBA, DSI
and DFEL
Guaranteed living benefits (4):
Gross
Associated amortization expense of DAC, VOBA, DSI
and DFEL
Guaranteed death benefits (5):
Gross
Associated amortization expense of DAC, VOBA, DSI
and DFEL
Gain on sale of subsidiaries/businesses
Total realized gain (loss)
For the Years Ended December 31,
2008
2006
2007
$
(1,050)
$
(126)
$
(7)
3
13
(6)
792
(356)
75
2
(17)
9
(70)
28
(2)
4
(2)
2
37
(19)
(4)
(17)
9
(537)
$
1
6
(169)
$
2
-
13
$
(1) See “Realized Loss Related to Investments” section in Note 5 for detail.
(2) Represents changes in the fair value of total return swaps (embedded derivatives) related to various modified coinsurance and
coinsurance with funds withheld reinsurance arrangements that have contractual returns related to various assets and liabilities
associated with these arrangements. Changes in the fair value of these derivatives are offset by the change in fair value of
trading securities in the portfolios that support these arrangements.
(3) Represents the net difference between the change in the fair value of the S&P 500 call options that we hold and the change in
the fair value of the embedded derivative liabilities of our indexed annuity products along with changes in the fair value of
embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index
allocations applicable to future reset periods for our indexed annuity products as required under SFAS 133 and 157. The year
ended December 31, 2008, includes a $10 million gain from the initial impact of adopting SFAS 157.
(4) Represents the net difference in the change in fair value of the embedded derivative liabilities of our GLB products and the
change in the fair value of the derivative instruments we own to hedge, including the cost of purchasing the hedging
instruments. The year ended December 31, 2008, includes a $34 million loss from the initial impact of adopting SFAS 157.
(5) Represents the change in the fair value of the derivatives used to hedge our GDB riders.
218
17. Underwriting, Acquisition, Insurance, Restructuring and Other Expenses
Details underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows:
For the Years Ended December 31,
2008
2006
2007
Commissions
General and administrative expenses
DAC and VOBA deferrals and interest, net of amortization
Other intangibles amortization
Media expenses
Taxes, licenses and fees
Merger-related expenses
Total
$
$
$
1,946
1,722
(420)
6
60
210
52
3,576
2,169
1,757
(993)
10
56
218
103
3,320
1,625
1,572
(701)
12
41
178
49
2,776
$
$
$
All restructuring charges are included in underwriting, acquisition, insurance and other expenses within primarily Other Operations
on our Consolidated Statements of Income in the year incurred and for the 2006 restructuring plan most such charges are included
within merger-related expenses in the table above.
2008 Restructuring Plan
Starting in December 2008, we implemented a restructuring plan in response to the current economic downturn and sustained
market volatility, which focused on reducing expenses. These actions included the elimination of approximately 500 jobs across
the Company. During the fourth quarter, we recorded a pre-tax charge of $8 million and expect to record additional pre-tax
charges of approximately $7 million in 2009 for severance, benefits and related costs associated with the plan for workforce
reduction and other restructuring actions. We expect to complete the plan by the end of 2009.
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.
Details underlying reserves for restructuring charges (in millions) were as follows:
Restructuring reserve at December 31, 2007
Amounts incurred in 2008
Employee severance and termination benefits
Other
Total 2008 restructuring charges
Amounts expended in 2008
Restructuring reserve at December 31, 2008
Additional amounts expended in 2008 that do not qualify
as restructuring charges
Total expected costs
Expected completion date: 4th Quarter 2009
Total
$
3
2
$
-
2
(4)
$
1
$
49
225
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. Merger integration costs relating to employee severance and termination benefits of
$13 million were included in other liabilities on our Consolidated Balance Sheets in the purchase price allocation. 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.
219
18. Pension, Postretirement Health Care and Life Insurance Benefit Plans
We maintain qualified funded defined benefit pension plans in which many of our U.S. employees, our Delaware Investments
employees and agents are participants. We also maintain non-qualified, unfunded defined benefit pension plans for certain U.S.
employees and agents, certain former employees of Jefferson-Pilot and certain employees from CIGNA Corporation (“CIGNA”).
In addition, for certain former employees we have supplemental retirement plans that provide defined benefit pension benefits in
excess of limits imposed by federal tax law. All of our U.S. defined benefit pension plans were “frozen” as of either December 31,
1994, or December 31, 2007, or earlier. For our frozen plans, there are no new participants and no future accruals of benefits from
the date of the freeze. Our only active defined benefit pension plan covers the employees of our primary foreign subsidiary,
Lincoln National UK.
The eligibility requirements for each plan are described in each plan document and vary for each plan based on completion of a
specified period of continuous service or date of hire, subject to age limitations. The frozen pension plan benefits are calculated
either on a traditional or cash balance formula. Those formulas are based upon years of credited service and eligible earnings as
defined in each plan document. The traditional formula provides benefits stated in terms of a single life annuity payable at age 65.
Under the cash balance formula benefits are stated as a lump sum hypothetical account balance. That account balance equals the
sum of the employee’s accumulated annual benefit credits plus interest credits. Benefit credits, which are based on years of service
and base salary plus bonus, ceased as of the date the plan was frozen. Interest Credits continue until the employee’s benefit is paid.
We also sponsor a voluntary employees’ beneficiary association (“VEBA”) trust that provides postretirement medical, dental and
life insurance benefits to retired full-time U.S. employees and agents who, depending on the plan, have worked for us for 10 years
and attained age 55 (age 60 for agents). VEBAs are a special type of tax-exempt trust used to provide employee benefits and also
are subject to preferential tax treatment under the Internal Revenue Code. Medical and dental benefits are available to spouses and
other eligible dependents of retired employees and agents. Retirees may be required to contribute toward the cost of these
benefits. Eligibility and the amount of required contribution for these benefits varies based upon a variety of factors including
years of service and year of retirement. Effective January 1, 2008, the postretirement plan providing benefits to former employees
of Jefferson-Pilot was amended such that only employees who had attained age 55 with a minimum of 10 years of service by
December 31, 2007, and who later retire on or after age 60 with 15 years of service will be eligible to receive life insurance benefits
when they retire.
220
Obligations, Funded Status and Assumptions
Information (in millions) with respect to our defined benefit plan asset activity and defined benefit plan obligations was as follows:
As of and for the Years Ended December 31,
2008
2007
2008
2007
2008
2007
U.S.
Pension Benefits
Non-U.S.
Pension Benefits
Other
Postretirement Benefits
Change in Plan Assets
Fair value at beginning-of-year
Actual return on plan assets
Company and participant contributions
Benefits paid
Medicare Part D subsidy
Foreign exchange translation
Fair value at end-of-year
$
1,012
(216)
14
(80)
-
-
730
$
1,017
59
10
(74)
-
-
1,012
$
338
(10)
2
(13)
-
(85)
232
353
2
19
-
-
-
-
(35)
(13)
-
-
(88)
238
$
(6)
$
339
6
1
(14)
-
6
338
$
30
2
15
(17)
2
-
32
$
28
2
14
(15)
1
-
30
361
2
18
-
-
-
-
(20)
(14)
-
-
6
353
(15)
$
127
3
8
5
-
-
-
9
(17)
2
-
-
137
(105)
$
152
3
8
5
(8)
-
-
(19)
(15)
1
-
-
127
(97)
$
-
$
(6)
(6)
$
-
$
(15)
(15)
$
-
$
(105)
(105)
$
$
-
(97)
(97)
$
1,030
-
62
-
17
-
-
25
(80)
-
-
-
1,054
(324)
$
5
$
(329)
(324)
$
1,046
33
59
-
-
(2)
(12)
16
(74)
-
(36)
-
1,030
(18)
$
$
82
(100)
(18)
$
$
$
$
$
$
$
256
-
256
52
-
52
35
-
35
54
-
54
$
$
$
$
$
$
(5)
(4)
(9)
(13)
(4)
(17)
N/A
N/A
6.00%
8.00%
6.00%
8.00%
4.00%
4.00%
6.08%
8.00%
6.00%
8.00%
221
0.00%
3.80%
6.30%
6.20%
6.00%
6.40%
0.00%
4.40%
6.00%
6.40%
5.10%
5.90%
N/A
4.00%
6.00%
6.50%
6.00%
6.50%
0.00%
4.00%
6.00%
6.50%
6.00%
6.50%
Change in Benefit Obligation
Balance at beginning-of-year
Service cost
Interest cost
Plan participants' contributions
Amendments
Curtailments
Settlements
Actuarial (gains) losses
Benefits paid
Medicare Part D subsidy
Purchase accounting adjustments
Foreign exchange translation
Balance at end-of-year
Funded status of the plans
Amounts Recognized on the
Consolidated Balance Sheets
Other assets
Other liabilities
Net amount recognized
Amounts Recognized in
Accumulated OCI, Net of Tax
Net (gain) loss
Prior service credit
Net amount recognized
Rate of Increase in Compensation
Salary continuation plan
All other plans
Weighted-Average Assumptions
Benefit obligations:
Weighted-average discount rate
Expected return on plan assets
Net periodic benefit cost:
Weighted-average discount rate
Expected return on plan assets
Consistent with our benefit plans’ year end, we use December 31 as the measurement date.
The expected return on plan assets was determined based on historical and expected future returns of the various asset classes,
using the plan’s target plan allocation. We reevaluate this assumption at an interim date each plan year. For 2009, our expected
return on plan assets for the U.S. pension plan will be 8%.
The calculation of the accumulated postretirement benefit obligation assumes a weighted-average annual rate of increase in the per
capita cost of covered benefits (i.e., health care cost trend rate) was as follows:
Health care cost trend rate
Pre-65 health care cost trend rate
Post-65 health care cost trend rate
Ultimate trend rate
Year that the rate reaches the ultimate trend rate
As of December 31,
2007
2006
2008
N/A
10%
12%
5%
2019
12%
N/A
N/A
5%
2018
12%
N/A
N/A
5%
2017
In order to improve the measurement of the heath care trend rate with industry trends and practice, we separated our trend rate to
assess the pre-65 and post-65 populations separately for the year ended December 31, 2008. We expect the health care cost trend
rate for 2009 to be 10% for pre-65 and 13% for the post-65 population. The health care cost trend rate assumption is a key
percentage that affects the amounts reported. A one-percentage point increase in assumed health care cost trend rates would have
increased the accumulated postretirement benefit obligation by $4 million and total service and interest cost components by $1
million. A one-percentage point decrease in assumed health care cost trend rates would have decreased the accumulated
postretirement benefit obligation by $5 million and total service and interest cost components by $1 million.
Information for our pension plans with an accumulated benefit obligation in excess of plan assets (in millions) was as follows:
U.S. Plan
Accumulated benefit obligation
Projected benefit obligation
Fair value of plan assets
Non-U.S. Plan
Accumulated benefit obligation
Projected benefit obligation
Fair value of plan assets
As of December 31,
2008
2007
$
1,030
1,030
700
$
236
238
232
$
101
101
-
$
349
353
338
222
Components of Net Periodic Benefit Cost
The components of net defined benefit pension plan and postretirement benefit plan expense (in millions) were as follows:
For the Years Ended December 31,
Pension Benefits
2007
2006
2008
Other Postretirement Benefits
2007
2006
2008
U.S. Plans
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized net actuarial (gain) loss
Recognized actuarial (gain) loss due
to curtailments
Recognized actuarial gain due
to settlements
Recognized actuarial loss due to
special termination benefits
Net periodic benefit expense
-
$
62
(77)
-
4
$
33
59
(79)
-
1
$
32
53
(66)
(2)
4
3
$
8
(2)
(1)
(1)
3
$
8
(2)
-
(2)
3
$
8
(1)
-
1
-
-
-
(7)
(13)
-
1
-
2
-
-
-
-
-
-
-
-
-
(recovery)
$
(11)
$
(6)
$
24
$
7
$
7
$
11
Non-U.S. Plans
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized net actuarial loss
Net periodic benefit expense
$
2
19
(19)
-
3
$
5
$
2
18
(20)
-
4
$
4
$
2
16
(17)
-
4
$
5
For 2009, the estimated amount of amortization from accumulated OCI into net periodic benefit expense related to net actuarial
loss is expected to be approximately $29 million for our pension benefit plan and approximately $1 million gain for our
postretirement benefit plan.
Plan Assets
Our pension plan asset allocations by asset category based on estimated fair values were as follows:
U.S. Plans
Domestic large cap equity
International equity
Fixed income securities
Cash and cash equivalents
Total
Non-U.S. Plans
Equity securities
Fixed income securities
Cash and cash equivalents
Total
As of December 31,
2008
2007
Target
Allocation
37%
15%
48%
0%
100%
29%
69%
2%
100%
35%
15%
50%
0%
30%
70%
0%
32%
14%
53%
1%
100%
26%
73%
1%
100%
223
The primary investment objective for the assets related to our U.S. defined benefit pension plan is for capital appreciation with an
emphasis on avoiding undue risk. Investments can be made in various asset classes and styles, including, but not limited to:
domestic and international equity, fixed income securities and other asset classes the investment managers deem prudent. Three-
and five-year time horizons are utilized as there are inevitably short-run fluctuations, which will cause variations in investment
performance.
Our defined benefit plan assets have been combined into a master retirement trust where a variety of qualified managers, with
Northern Trust as the manager of managers, are expected to rank in the upper 50% of similar funds over the three-year periods
and above an appropriate index over five-year periods. Managers are monitored for adherence to approved investment policy
guidelines, changes in material factors and legal or regulatory actions. Managers not meeting these criteria are subject to additional
due diligence review, corrective action or possible termination.
We currently target asset weightings as follows: domestic equity allocations (32%) are split into large cap growth (14%), large cap
value (14%) and small cap (4%); international equity; and fixed income allocations are weighted between core fixed income and
long-term bonds. The performance of the pension trust assets is monitored on a quarterly basis relative to the plan’s objectives.
The performance of the trust is measured against the following indices: Russell 1000 Index; Morgan Stanley Capital International
Europe, Australia and Far East Index; and Lehman Brothers Aggregate Bond Index. We review this investment policy on an
annual basis.
Prior to 2007, our plan assets were principally managed by our Investment Management segment. During the last quarter of 2007,
the management of the equity portion of these plan assets was transferred to third-party managers. Our Investment Management
segment continues to manage the plan's fixed income securities, which comprise approximately 50% of plan assets.
Plan Cash Flows
It is our practice to make contributions to the qualified pension plans to comply with minimum funding requirements of the
Employee Retirement Income Security Act of 1974, as amended. In accordance with such practice, no contributions were made
nor required for the years ended December 31, 2008 or 2007. No contributions are required nor expected to be made in 2009.
We expect the following benefit payments (in millions):
Pension Plans
Qualified Nonqualified Qualified
non-U.S.
U.S.
Defined
Defined
Benefit
Benefit
Pension
Pension
Plans
Plans
$
$
U.S.
Defined
Benefit
Pension
Plans
$
65
65
66
70
70
347
10
10
10
10
10
50
10
11
12
12
12
68
U.S. Postretirement Plans
Reflecting
Medicare
Part D
Subsidy
10
$
10
10
10
10
58
Medicare
Part D
Subsidy
$
(2)
(2)
(2)
(2)
(2)
(12)
Not
Reflecting
Medicare
Part D
Subsidy
12
$
12
12
12
12
70
2009
2010
2011
2012
2013
Following Five Years Thereafter
19. 401(k), Money Purchase, Profit Sharing and Deferred Compensation Plans
401(k), Money Purchase and Profit Sharing Plans
We sponsor a number of contributory defined contribution plans for eligible U.S. employees and agents. These plans include a
401(k) plan for eligible agents, two 401(k) plans for eligible employees (Delaware Investments employees have their own 401(k)
plan) and a defined contribution money purchase plan for eligible employees of Delaware Investments and eligible agents of the
former Jefferson-Pilot. We also sponsor a money purchase plan for LNL agents that was frozen in 2004.
We make contributions and matching contributions to each of the active plans in accordance with the plan document and various
limitations under Section 401(a) of the Internal Revenue Code of 1986, as amended.
224
The expenses (in millions) for the 401(k) and profit sharing plan were as follows:
Total expenses for the 401(k) and profit sharing plans
Deferred Compensation Plans
For the Years Ended December 31,
2008
2006
2007
$
$
$
41
67
45
We sponsor seven separate non-qualified unfunded, deferred compensation plans for various groups: certain U.S. employees; non-
employee directors; and certain agents.
Information (in millions) with respect to these plans was as follows:
Total liabilities
Investment held to fund liabilities
The Deferred Compensation Plan for Certain U.S. Employees
As of December 31,
2008
2007
$
$
336
100
410
134
Certain U.S. employees may participate in the Deferred Compensation & Supplemental/Excess Retirement Plan (the “DC SERP”).
Certain Delaware Investments employees are eligible to participate in the DC SERP, but they receive different benefits than the
non-Delaware Investments participants. All participants may elect to defer payment of a portion of their compensation as defined
by the plan. DC SERP participants may select from a menu of “phantom” investment options (identical to those offered under
our qualified savings plans) used as investment measures for calculating the investment return notionally credited to their deferrals.
Under the terms of the DC SERP, we agree to pay out amounts based upon the aggregate performance of the investment measures
selected by the participant. We make matching contributions to these plans based upon amounts placed into the deferred
compensation plans by individuals after participants have exceeded applicable limits of the Internal Revenue Code. The amount of
our contribution is calculated in accordance with the plan document, which is similar to our 401(k) plans. Expenses (in millions)
for this plan were as follows:
Employer matching contributions
Increase in measurement of liabilites, net
of total return swap
Total DC SERP expenses
For the Years Ended December 31,
2008
2006
2007
$
$
$
7
12
11
4
11
$
16
28
$
10
21
$
The terms of the DC SERP provide that plan participants who select our stock as the measure for their investment return will
receive shares of our stock in settlement of this portion of their accounts at the time of distribution. In addition, participants are
precluded from diversifying any portion of their deferred compensation plan account that has been credited to the stock unit fund.
Consequently, changes in value of our stock do not affect the expenses associated with this portion of the deferred compensation
plan.
Deferred Compensation Plan for Non-Employee Directors
The plan for non-employee directors allows them to defer a portion of their annual retainers into the plan and, in addition, we
credit deferred stock units annually. The menu of “phantom” investment options is identical to those offered to the employees in
the DC SERP. Expenses (in millions) for this plan were as follows:
Total expenses for non-employee directors
For the Years Ended December 31,
2008
2006
2007
$
4
$
1
$
-
225
Deferred Compensation Plan for Certain Agents
We also sponsor a number of deferred compensation plans for certain eligible agents. Plan participants receive contributions based
on their earnings. Plan participants may select from a menu of “phantom” investment options used as investment measures for
calculating the investment return notionally credited to their deferrals. Under the terms of these plans, we agree to pay out
amounts based upon the aggregate performance of the investment measures selected by the participant. LNL agents invest in
phantom investments that mirror those offered to qualified plan participants. Jefferson-Pilot agents invest in a different line up of
“phantom” investments. Expenses (in millions) for this plan were as follows:
Employer matching contributions
Increase in measurement of liabilites, net
of total return swap
Total expenses for certain agents
Deferred Compensation Plan for Certain Delaware Employees
For the Years Ended December 31,
2008
2006
2007
$
-
$
3
$
2
2
$
4
6
$
9
8
$
8
This plan was established in 2005 for certain Delaware Investments employees. Pursuant to the terms of separate employment
agreements, the Company makes payments to a rabbi trust totaling $15 million over a three-year period. Payments to the rabbi
trust are invested in one or more available investments at the direction of the participant. Participants in the plan vest on the third
anniversary of their date of hire. Expenses (in millions) for this plan were as follows:
Total expenses for certain Delaware Investments employees
20. Stock-Based Incentive Compensation Plans
LNC Stock-Based Incentive Plans
For the Years Ended December 31,
2008
2006
2007
$
5
$
6
$
-
We sponsor various incentive plans for our employees and directors, and for the employees and agents of our subsidiaries that
provide for the issuance of stock options, stock incentive awards, SARS, restricted stock awards, performance shares
(performance-vested shares as opposed to time-vested shares) and deferred stock units – also referred to as “restricted stock units.”
LNC’s wholly-owned subsidiary, Delaware Investments U.S., Inc. (“DIUS”), has a separate incentive compensation plan. We have
a policy of issuing new shares to satisfy option exercises.
Total compensation expense (in millions) for all of our stock-based incentive compensation plans was as follows:
Stock options
Shares
Cash awards
DIUS stock options
SARs
Restricted stock
Total
Recognized tax benefit
For the Years Ended December 31,
2008
2006
2007
$
$
$
11
(3)
(1)
11
4
17
39
18
9
1
10
5
11
54
14
25
4
10
(1)
4
56
$
$
$
$
14
$
19
$
20
226
Total unrecognized compensation expense (in millions) for all of our stock-based incentive compensation plans was as follows:
2008
For the Years Ended December 31,
2007
2006
Stock options
Shares
DIUS stock options
DIUS restricted stock
SARs
Restricted stock
Weighted
Average
Period
1.7
1.9
0.0
3.3
3.9
1.4
Expense
$
7
3
-
25
1
16
Total unrecognized stock-based
incentive compensation expense
$
52
Weighted
Average
Period
1.7
1.7
2.3
4.0
3.3
1.6
Expense
$
12
11
35
-
6
12
$
76
Expense
$
11
6
15
24
4
24
$
84
Weighted
Average
Period
1.9
1.5
3.1
-
3.4
2.0
In the first quarter of 2008, a performance period from 2008-2010 was approved for our executive officers by the Compensation
Committee. Executive officers participating in the 2008-2010 performance period received one-half of their award in LNC stock
options with ten year terms or DIUS restricted stock units with ten-year terms, with the remainder of the award in a combination
of performance shares and cash. LNC stock options granted for this performance period vest ratably over the three-year period;
DIUS restricted stock units vest ratably over a four-year period and were granted only to employees of Delaware Investments and
its subsidiaries. All LNC and DIUS awards granted during this period vest solely based on meeting service conditions. Depending
on performance results for this period, the ultimate payout of performance shares and cash could range from zero to 200% of the
target award. Under the 2008 long-term incentive compensation program, a total of 1,564,800 LNC stock options were granted,
zero DIUS stock options, and 2,726 DIUS restricted stock units were granted and 218,308 LNC performance shares were awarded.
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 the 2007-2009 performance period received one-half of their award in LNC or
DIUS stock options with ten year terms, with the remainder of the award in a combination of performance shares and cash. LNC
stock options granted for this performance period vest ratably over the three-year period; DIUS stock options vest ratably over a
four-year period and were granted only to employees of Delaware Management Holdings, Inc. and its subsidiaries. All LNC and
DIUS options granted during this period vest solely based on meeting service conditions. Depending on performance results for
this period, the ultimate payout of performance shares and cash could range from zero to 200% of the target award. Under the
2007 long-term incentive compensation program, a total of 942,932 LNC stock options were granted, 12,237 DIUS stock options
were granted and 126,879 LNC performance shares were awarded.
In the second quarter of 2006, a performance period from 2006-2008 was approved by the Compensation Committee. Participants
in the 2006-2008 performance period (which was slightly less than three full calendar years) received one-half of their target award
in LNC stock options with ten year terms, with the remainder of the target 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 a
three-year period. Vesting is “time-vesting,” based solely on meeting service conditions. Depending on actual performance during
this period, the ultimate payout of performance shares and cash could range from zero to 200% of the target award.
For the three-year performance period 2006-2008, the performance measures and goals used to determine the ultimate number of
performance shares granted (and cash paid) were established at the beginning of the performance period. Depending on the
performance results, the actual number of shares granted and cash paid could have ranged from zero to 200% of the target award.
Options were granted at target at the beginning of the cycle, but vested based on performance. Performance over target resulted in
the grant of shares of LNC common stock – not more options. Actual performance under target resulted in the forfeiture (not
vesting) of target options. Certain Jefferson-Pilot executives were brought into the 2005-2007 performance cycle on a pro-rata
basis.
227
The option price assumptions used for our stock option incentive plans were as follows:
Dividend yield
Expected volatility
Risk-free interest rate
Expected life (in years)
Weighted-average fair value per option granted (1)
For the Years Ended December 31,
2008
2006
2007
3.2%
19.0%
2.0%-3.2%
5.8
2.2%
17.6%
3.9%-5.1%
5.1
2.7%
23.1%
4.3%-5.0%
4.2
$
7.54
$
12.28
$
11.02
(1) Determined using a Black-Scholes options valuation methodology.
Expected volatility is measured based on the historical volatility of the LNC stock price for the previous period. The expected
term of the options granted represents the weighted-average period of time from the grant date to the exercise date, weighted for
the number of shares exercised for an option grant relative to the number of options exercised over the previous three-year period.
Information with respect to our incentive plans involving stock options with performance conditions (aggregate intrinsic value
shown in millions) was as follows:
Outstanding as of December 31, 2007
Granted-original
Exercised (includes shares tendered)
Forfeited or expired
Outstanding as of December 31, 2008
Vested or expected to vest as of December 31, 2008 (1)
Exercisable as of December 31, 2008
(1)
Includes estimated forfeitures.
Shares
1,185,283
1,511,878
(45,919)
(188,262)
2,462,980
2,341,225
933,672
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term
Aggregate
Intrinsic
Value
$
49.42
52.43
51.35
48.31
51.30
$
$
$
51.44
49.00
6.68
6.61
4.07
$
-
$
-
$
-
The total fair value of options vested during the years ended December 31, 2008, 2007 and 2006 was $6 million, $1 million and $5
million, respectively. The total intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006 was
$1 million, $13 million and $6 million, respectively.
228
Information with respect to our incentive plans involving stock options with service conditions (aggregate intrinsic value shown in
millions) was as follows:
Outstanding as of December 31, 2007
Granted-original
Granted-reloads
Exercised (includes shares tendered)
Forfeited or expired
Outstanding as of December 31, 2008
Vested or expected to vest as of December 31, 2008 (1)
Exercisable as of December 31, 2008
(1) Includes estimated forfeitures.
Shares
11,447,459
1,625,824
14,326
(525,182)
(809,485)
11,752,942
11,657,465
9,496,444
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term
Aggregate
Intrinsic
Value
$
48.35
52.75
54.55
41.87
55.72
48.79
$
$
$
48.72
46.90
4.95
4.92
4.11
$
-
$
-
$
-
The total fair value of options vested during the years ended December 31, 2008, 2007 and 2006 was $6 million, $17 million and $9
million, respectively. The total intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006 was
$41 million, $78 million and $104 million, respectively.
Information with respect to our performance shares was as follows:
Nonvested as of December 31, 2007
Granted
Vested (1)
Forfeited
Nonvested as of December 31, 2008
Weighted-
Average
Grant-Date
Fair Value
$
51.69
47.59
43.15
58.09
56.21
Shares
511,424
245,847
(349,411)
(69,333)
338,527
(1) Shares vested as of December 31, 2007, but were not issued until the second quarter of 2008.
DIUS Incentive Compensation Plan
The option price assumptions used for the DIUS Incentive Compensation Plan were as follows:
Dividend yield
Expected volatility
Risk-free interest rate
Expected life (in years)
Weighted-average fair value per option granted
(1) We did not grant DIUS incentive plan stock options in 2008.
1.1%
For the Years Ended December 31,
2008
2006
2007
N/A (1)
N/A (1)
N/A (1)
N/A (1)
N/A (1)
32.0%
4.5%
61.03
$
$
4.1
1.1%
32.3%
4.5%
60.55
4.1
Expected volatility is measured based on several factors including the historical volatility of the DIUS valuation since the inception
of the plan in 2001 and comparisons to public investment management companies with similar operating structures. The expected
229
term of the options granted represents the weighted-average period of time from the grant date to the exercise date, based on the
historical expected life of DIUS options.
In December 2008, there was a modification to the Delaware Incentive Compensation Plan in which all outstanding DIUS stock
options were cancelled and settled with a combination of cash consideration and new DIUS restricted stock units. Associated with
the accelerated vesting of certain cancelled DIUS stock options, we recognized $2 million of compensation expense in the fourth
quarter of 2008 and replaced the cancelled options with cash consideration of $6 million and DIUS restricted stock units which will
primarily vest into shares in the first quarter of 2009. The cash consideration, payable in the second quarter of 2009, was
recognized in other liabilities on our Consolidated Balance Sheets as of December 31, 2008. Other cancelled options were replaced
with new DIUS restricted stock units that will vest ratably over a four-year period and are classified as equity on our Consolidated
Balance Sheets. The unrecognized compensation expense associated with these cancelled options is being recognized over the
four-year vesting period of the new DIUS restricted stock units. There was no incremental expense associated with this
modification as the fair value of the replacement award was not in excess of the fair value of the cancelled awards.
Information with respect to the DIUS Incentive Compensation Plan involving stock options was as follows (aggregate intrinsic
value shown in millions):
Outstanding as of December 31, 2007
Exercised (includes shares tendered)
Forfeited or expired
Cancellation of all options upon modification
Outstanding as of December 31, 2008
Vested or expected to vest as of December 31, 2008
Exercisable as of December 31, 2008
Weighted-
Average
Exercise
Price
$
158.90
139.92
183.05
164.90
-
$
$
-
$
-
Shares
1,042,544
(273,183)
(31,000)
(738,361)
-
-
-
Weighted-
Average
Remaining
Contractual
Term
Aggregate
Intrinsic
Value
-
-
-
-
$
$
-
$
-
The total intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006 was $15 million, $5 million
and $6 million, respectively. The amount of cash received and the tax benefit realized from stock option exercises under this plan
during the year ended December 31, 2008, was $3 million and $5 million, respectively, compared to $9 million and $2 million for
the year ended December 31, 2007 and $15 million and $2 million for the year ended December 31, 2006.
In addition to the DIUS stock options discussed above, we awarded DIUS restricted stock units under the DIUS Incentive
Compensation Plan, subject to a four-year ratable vesting period. DIUS restricted stock units granted prior to the modification are
categorized as liabilities on our Consolidated Balance Sheets as of December 31, 2008. Information with respect to DIUS
restricted stock units classified as liabilities were as follows:
Nonvested as of December 31, 2007
Granted - original
Vested
Forfeited
Nonvested as of December 31, 2008
Units
142,217
2,726
(34,570)
(3,826)
106,547
Weighted-
Average
Grant Date
Fair Market
Value
$
195.98
194.38
195.98
195.98
195.94
$
The value of DIUS shares and DIUS restricted stock units granted prior to the modification is determined using a market
transaction approach based on profit margin, assets under management and revenues. Prior to 2008, the valuation was performed
by a third-party appraiser semi-annually. Beginning in 2008, the valuation is performed at least quarterly. The last valuation was
performed as of December 31, 2008, with a value of $154.27 per share.
230
Information with respect to DIUS restricted stock units classified as equity was as follows:
Nonvested as of December 31, 2007
Granted - original
Vested
Forfeited
Granted due to modification - cancellation and replacement of all options
Nonvested as of December 31, 2008
Weighted-
Average
Grant Date
Fair Market
Value
-
$
-
-
-
63.23
63.23
$
Units
-
-
-
-
129,877
129,877
The value of the DIUS restricted stock units classified as equity on our Consolidated Balance Sheets is determined based on an
independent appraisal valuation of DIUS performed by a third-party appraiser, in general, quarterly. The first quarterly
independent appraisal was performed as of December 31, 2008, with a value per share of $63.23.
The value of outstanding shares under this plan and the intrinsic value of vested and partially vested restricted stock units was $10
million and $40 million as of December 31, 2008 and 2007, respectively, and was included in other liabilities on our Consolidated
Balance Sheets.
Stock Appreciation Rights
Under our Incentive Compensation Plan, we issue SARs to certain planners and advisors who have full-time contracts with us.
The SARs under this program are rights on our stock that are cash settled and become exercisable in increments of 25% over the
four-year period following the SARs grant date. SARs are granted with an exercise price equal to the fair market value of our stock
at the date of grant and, unless cancelled earlier due to certain terminations of employment, expire five years from the date of
grant. Generally, such SARs are transferable only upon death.
We recognize compensation expense for SARs based on the fair value method using the Black-Scholes option-pricing model.
Compensation expense and the related liability are recognized on a straight-line basis over the vesting period of the SARs. The
SARs liability is marked-to-market through net income, which causes volatility in net income as a result of changes in the market
value of our stock. We have hedged a portion of this volatility by purchasing call options on LNC stock. Call options hedging
vested SARs are also marked-to-market through net income. The mark-to-market gains (losses) recognized through net income on
the call options on LNC stock for the years ended December 31, 2008, 2007 and 2006 were $(8) million, $(3) million and $10
million, respectively. The SARs liability as of December 31, 2008 and 2007 was $0 and $6 million, respectively.
The option price assumptions used for our SARs plan were as follows:
Dividend yield
Expected volatility
Risk-free interest rate
Expected life (in years)
Weighted-average fair value per SAR granted
For the Years Ended December 31,
2008
2006
2007
1.2%
37.0%
3.3%
5.0
15.26
$
2.3%
23.2%
5.0%
5.0
16.59
$
2.8%
23.0%
5.1%-5.4%
5.0
11.06
$
Expected volatility is measured based on the historical volatility of the LNC stock price. The expected term of the options granted
represents time from the grant date to the exercise date.
231
Information with respect to our SARs plan (aggregate intrinsic value shown in millions) was as follows:
Outstanding as of December 31, 2007
Granted-original
Exercised (includes shares tendered)
Forfeited or expired
Outstanding as of December 31, 2008
Vested or expected to vest at December 31, 2008 (1)
Exercisable as of December 31, 2008
(1)
Includes estimated forfeitures.
Shares
620,447
234,800
(68,989)
(40,458)
745,800
732,257
269,845
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term
Aggregate
Intrinsic
Value
$
53.28
50.60
33.17
53.99
54.26
$
$
$
54.25
52.24
2.68
2.68
1.52
$
-
$
-
$
-
The payment for SARs exercised during the years ended December 31, 2008, 2007 and 2006 was $1 million, $7 million and $6
million, respectively.
Nonvested Stock
In addition to the stock-based incentives discussed above, we have awarded restricted shares of our stock (nonvested stock) under
the incentive compensation plan, generally subject to a three-year vesting period. Information with respect to our restricted stock
was as follows:
Nonvested as of December 31, 2007
Granted
Vested
Nonvested as of December 31, 2008
21. Statutory Information and Restrictions
Shares
652,840
-
(223,968)
428,872
Weighted-
Average
Grant-Date
Fair Market
Value
$
61.50
-
56.97
63.94
$
The Company’s domestic life insurance subsidiaries prepare financial statements in accordance with statutory accounting principles
(“SAP”) prescribed or permitted by the insurance departments of their states of domicile, which may vary materially from GAAP.
Prescribed SAP includes the Accounting Practices and Procedures Manual of the National Association of Insurance
Commissioners (“NAIC”) as well as state laws, regulations and administrative rules. Permitted SAP encompasses all accounting
practices not so prescribed. The principal differences between statutory financial statements and financial statements prepared in
accordance with GAAP are that statutory financial statements do not reflect DAC, some bond portfolios may be carried at
amortized cost, assets and liabilities are presented net of reinsurance, contract holder liabilities are generally valued using more
conservative assumptions and certain assets are non-admitted.
232
Specified statutory information (in millions) was as follows:
U.S. capital and surplus
U.S. net income (loss)
U.S. dividends to LNC Parent Company
As of December 31,
2008
2007
$
4,925
$
5,284
For the Years Ended December 31,
2008
2006
2007
$
$
$
(234)
450
1,030
1,211
382
569
The decline in statutory net income in 2008 from that of 2007 was primarily due to a significant increase in realized losses on
investments combined with reserve strain due to deteriorating market conditions throughout 2008.
The states of domicile of the Company’s insurance subsidiaries have adopted certain prescribed accounting practices that differ
from those found in NAIC SAP. These prescribed practices are the use of continuous Commissioners Annuity Reserve Valuation
Method (“CARVM”) in the calculation of reserves as prescribed by the state of New York and the calculation of reserves on
universal life policies based on the Indiana universal life method as prescribed by the state of Indiana. The insurance subsidiaries
also have several accounting practices permitted by the states of domicile that differ from those found in NAIC SAP. Specifically,
these are the use of a more conservative valuation interest rate on certain annuities as of December 31, 2008 and 2007, the use of
less conservative mortality tables on certain life insurance products as of December 31, 2008, and a less conservative standard in
determining the admitted amount of deferred tax assets as of December 31, 2008. The effects on statutory surplus compared to
NAIC statutory surplus from the use of these prescribed and permitted practices (in millions) were as follows:
Calculation of reserves using the Indiana universal life method
Calculation of reserves using continuous CARVM
Conservative valuation rate on certain variable annuities
Less conservative mortality tables on certain life insurance products
Less conservative standard in determining the amount of deferred tax assets
As of December 31,
2008
2007
$
$
289
(10)
(12)
16
312
246
(10)
(14)
-
-
A new statutory reserving standard (commonly called “VACARVM”) has been developed by the NAIC replacing current statutory
reserve practices for variable annuities with guaranteed benefits, such as GWBs. The effective date for VACARVM is December
31, 2009. Based upon the level of variable annuity account values as of December 31, 2008, we estimate that VACARVM would
have decreased our statutory capital by $125 to $175 million. The actual impact of the adoption will be dependent upon account
values and conditions that exist as of December 31, 2009. We plan to utilize existing captive reinsurance structures, as well as
pursue additional third-party reinsurance arrangements, 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 (“RBC”) ratios and
potentially reduce future dividend capacity from our insurance subsidiaries.
Our domestic insurance subsidiaries are subject to certain insurance department regulatory restrictions as to the transfer of funds
and the payment of dividends to the holding company. Under Indiana laws and regulations, our Indiana insurance subsidiaries,
LNL and First Penn-Pacific Life Insurance Company, may pay dividends to LNC within the statutory limitations without prior
approval of the Indiana Insurance Commissioner (the “Commissioner”). The current statutory limitation is the greater of 10% of
the insurer’s policyholders’ surplus, as shown on its last annual statement on file with the Commissioner or the insurer’s statutory
net gain from operations for the previous twelve months. If a proposed dividend, along with all other dividends paid within the
preceding twelve consecutive months exceeds the statutory limitation, the insurance subsidiary must receive prior approval of the
Commissioner to pay such dividend. Indiana law gives the Commissioner broad discretion to disapprove requests for dividends in
excess of these limits. LNC is also the holder of surplus notes issued by LNL. The payment of principal and interest on the
surplus notes to LNC must be approved by the Commissioner as well. Generally, these restrictions pose no short-term liquidity
concerns for the holding company. The Lincoln Life & Annuity Company of New York, a wholly-owned subsidiary of LNL, is
subject to similar, but not identical, regulatory restrictions as our Indiana domiciled subsidiaries with regard to the transfer of funds
and the payment of dividends. We expect our life insurance subsidiaries could pay dividends of approximately $550 million in
2009 without prior approval from the respective insurance commissioners. However, if current conditions do not improve, we
believe this dividend capacity will decline.
233
We received approval from the Indiana Department of Insurance for a permitted practice to the prescribed NAIC statutory
accounting principles for our Indiana-domiciled insurance subsidiaries as of December 31, 2008. The permitted practice modifies
the statutory accounting for deferred income taxes prescribed by the NAIC by increasing the realization period for deferred tax
assets from one to three years and increasing the asset recognition limit from 10% to 15% of statutory capital and surplus. This
permitted practice is expected to benefit the statutory capital and surplus of our Indiana-domiciled insurance subsidiaries by
approximately $300 million, but may not be considered when calculating the dividends available from the insurance subsidiaries.
We also received approval from the Department for two more permitted practices for LNL relating to the application of specified
mortality tables for life insurance. These are expected to benefit the statutory capital and surplus of LNL by approximately $16
million.
The Company also has insurance subsidiaries in the U.K., which are regulated by the U.K. Financial Services Authority (“FSA”)
and are subject to capital requirements as defined by the U.K. Capital Resources Requirement. All insurance companies operating
in the U.K. also have to complete a risk-based capital (“RBC”) assessment to demonstrate to the FSA that they hold sufficient
capital to cover their risks. RBC requirements in the U.K. are different than the NAIC requirements. In addition, the FSA has
imposed certain minimum capital requirements for the combined U.K. subsidiaries. Lincoln UK typically maintains approximately
1.5 to 2 times the required capital as prescribed by the regulatory margin. Lincoln UK paid dividends of $24 million and $75
million to LNC during 2008 and 2007, respectively.
22. Fair Value of Financial Instruments
The carrying values and estimated fair values of our financial instruments (in millions) were as follows:
Assets
Available-for-sale securities:
Fixed maturities
Equity
Trading securities
Mortgage loans on real estate
Derivative instruments
Other investments
Cash and invested cash
Liabilities
Future contract benefits:
Remaining guaranteed interest and similar contracts
Embedded derivative instruments - living benefits
(liabilities) contra liabilities
Other contract holder funds:
Account value of certain investment contracts
Reinsurance related derivative assets (liabilities)
Short-term debt (1)
Long-term debt
Off-Balance-Sheet
Guarantees
As of December 31,
2008
2007
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
$
48,935
288
2,333
7,715
3,397
1,624
5,926
$
48,935
288
2,333
7,424
3,397
1,624
5,926
$
56,276
518
2,730
7,423
807
1,075
1,665
$
56,276
518
2,730
7,602
807
1,075
1,665
(782)
(782)
(2,904)
(2,904)
(21,974)
31
(815)
(4,731)
(22,372)
31
(775)
(2,909)
(619)
(229)
(22,503)
(220)
(550)
(4,618)
(619)
(229)
(21,819)
(220)
(550)
(4,511)
-
(1)
-
(2)
(1) Difference between the carrying value and fair value of short-term debt as of December 31, 2008, relates to current maturities
of long-term debt.
See Note 1 for discussion of the methodologies and assumptions used to determine the fair value of financial instruments carried
at fair value. The following discussion outlines the methodologies and assumptions used to determine the fair value of our
financial instruments not carried at fair value. Considerable judgment is required to develop these assumptions used to measure
fair value. Accordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time,
current market exchange of all of our financial instruments.
234
Mortgage Loans on Real Estate
The fair value of mortgage loans on real estate is established using a discounted cash flow method based on credit rating, maturity
and future income. The ratings for mortgages in good standing are based on property type, location, market conditions,
occupancy, debt service coverage, loan to value, quality of tenancy, borrower and payment record. The fair value for impaired
mortgage loans is based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s
market price, or the fair value of the collateral if the loan is collateral dependent.
Other Investments and Cash and Invested Cash
The carrying value of our assets classified as other investments and cash and invested cash on our Consolidated Balance Sheets
approximates their fair value. Other investments include limited partnership and other privately held investments that are
accounted for using the equity method of accounting.
Future Contract Benefits and Other Contract Holder Funds
Future contract benefits and other contract holder funds on our Consolidated Balance Sheets include account values of investment
contracts and certain guaranteed interest contracts. The fair value of the investment contracts is based on their approximate
surrender value at the balance sheet date. The fair value for the remaining guaranteed interest and similar contracts are estimated
using discounted cash flow calculations at the balance sheet date. These calculations are based on interest rates currently offered
on similar contracts with maturities that are consistent with those remaining for the contracts being valued.
Short-term and Long-term Debt
The fair value of long-term debt is based on quoted market prices or estimated using discounted cash flow analysis determined in
conjunction with our incremental borrowing rate at the balance sheet date for similar types of borrowing arrangements where
quoted prices are not available. For short-term debt, excluding current maturities of long-term debt, the carrying value
approximates fair value.
Guarantees
Our guarantees relate to mortgage loan pass-through certificates. Based on historical performance where repurchases have been
negligible and the current status of the debt, none of the loans are delinquent and the fair value liability for the guarantees related to
mortgage loan pass-through certificates is insignificant.
235
Financial Instruments Carried at Fair Value
See “Summary of Significant Accounting Policies” in Note 1 and “SFAS 157 – Fair Value Measurements” in Note 2 for discussions
of the methodologies and assumptions used to determine the fair value of our financial instruments carried at fair value.
The following summarizes our financial instruments carried at fair value (in millions) on a recurring basis by the SFAS 157 fair
value hierarchy levels described in Note 2:
As of December 31, 2008
Quoted
Prices
in Active
Markets for
Identical
Assets
(Level 1)
Significant
Observable Unobservable
Significant
Inputs
(Level 2)
Inputs
(Level 3)
Total
Fair
Value
Assets
Investments:
Available-for-sale securities:
Fixed maturities
Equity
Trading securities
Derivative instruments
Cash and invested cash
Separate account assets
Reinsurance related derivative assets
Total assets
Liabilities
Future contract benefits:
Remaining guaranteed interest and similar
$
$
$
$
274
41
2
-
-
-
-
317
45,395
153
2,250
1,249
5,926
60,633
31
115,637
3,266
94
81
2,148
-
-
-
5,589
48,935
288
2,333
3,397
5,926
60,633
31
121,543
$
$
$
$
contracts
$
-
$
-
$
(252)
$
(252)
Embedded derivative instruments - living
benefits liabilities
Total liabilities
-
$
-
-
$
-
(2,904)
(3,156)
$
(2,904)
(3,156)
$
We did not have any assets or liabilities measured at fair value on a non-recurring basis as of December 31, 2008.
The following table summarizes changes to our financial instruments carried at fair value (in millions) and classified within Level 3
of the fair value hierarchy. This information excludes any impact of amortization on DAC, VOBA, DSI and DFEL. When a
determination is made to classify an asset or liability within Level 3 of the fair value hierarchy, the determination is based upon the
significance of the unobservable inputs to the overall fair value measurement. Certain securities trade in less liquid or illiquid
markets with limited or no pricing information, and the determination of fair value for these securities is inherently more difficult.
However, Level 3 fair value investments may include, in addition to the unobservable or Level 3 inputs, observable components
(that is, components that are actively quoted or can be validated to market-based sources). The gains and losses in the table below
may include changes in fair value due in part to observable inputs that are a component of the valuation methodology.
236
For the Year Ended December 31, 2008
Items
Included
in
Net
Income
Gains
(Losses)
in
OCI
Beginning
Fair
Value
Sales,
Issuances,
Maturities,
Settlements,
Calls,
Net
Transfers
In or
Out
of
Level 3,
Net (1)
Ending
Fair
Value
$
4,420
54
112
767
$
(171)
(30)
(29)
1,204
$
(1,217)
(17)
-
30
$
48
87
(14)
147
$
186
-
12
-
$
3,266
94
81
2,148
(389)
37
-
100
-
(252)
Investments:
Available-for-sale securities:
Fixed maturities
Equity
Trading securities
Derivative instruments
Future contract benefits:
Remaining guaranteed interest
and similar contracts
Embedded derivative
instruments - living benefits
liabilities
Total, net
(279)
4,685
$
(2,476)
(1,465)
$
-
(1,204)
$
(149)
219
$
-
198
$
(2,904)
2,433
$
(1) Transfers in or out of Level 3 for available-for-sale and trading securities are displayed at amortized cost at the beginning of
the period. For available-for-sale and trading securities, the difference between beginning of period amortized cost and
beginning of period fair value was included in OCI and earnings, respectively, in prior periods.
237
The following table provides the components of the items included in net income, excluding any impact of amortization on DAC,
VOBA, DSI and DFEL and changes in future contract benefits, (in millions) as reported in the table above:
For the Year Ended December 31, 2008
Gains
(Losses)
from
Sales,
Maturities,
Settlements,
Other-
Than-
Temporary
Unrealized
Holding
Gains
(Losses)(3)
(Amortization)
Accretion,
Net
Impairment
Calls
Total
Investments:
Available-for-sale securities:
Fixed maturities (1)
Equity
Trading securities (1)
Derivative instruments (2)
Future contract benefits:
Remaining guaranteed interest and similar
contracts (2)
Embedded derivative instruments - living
benefits liabilities (2)
Total, net
2
$
-
$
(170)
(31)
$
(3)
1
-
$
-
$
(171)
(30)
2
-
-
(7)
-
-
-
90
14
(24)
1,114
(29)
1,204
23
37
-
$
4
-
(208)
$
8
110
$
(2,484)
(1,371)
$
(2,476)
(1,465)
$
(1) Amortization and accretion, net and unrealized holding losses are included in net investment income on our Consolidated
Statements of Income. All other amounts are included in realized gain (loss) on our Consolidated Statements of Income.
(2) All amounts are included in realized gain (loss) on our Consolidated Statements of Income.
(3) This change in unrealized gains or losses relates to assets and liabilities that we still held as of December 31, 2008.
The fair value of available-for-sale fixed maturity securities (in millions) classified within Level 3 of the fair value hierarchy was as
follows:
$
Fair
Value
As of December 31, 2008
% of Total
Fair Value
64.8%
8.1%
7.5%
4.8%
0.5%
3.5%
7.8%
3.0%
100.0%
2,116
264
244
158
20
113
254
97
3,266
$
Corporate bonds
Asset-backed securities
Commercial mortgage-backed securities
Collateralized mortgage obligations
Mortgage pass-through securities
Municipals
Government and government agencies
Redeemable preferred stock
Total available-for-sale fixed maturity securities
238
Corporate bonds
Asset-backed securities
Commercial mortgage-backed securities
Collateralized mortgage obligations
Mortgage pass-through securities
Municipals
Government and government agencies
Redeemable preferred stock
Total available-for-sale fixed maturity securities
23. Segment Information
$
Fair
Value
As of December 31, 2007
% of Total
Fair Value
48.5%
25.2%
8.9%
6.7%
0.7%
3.1%
6.2%
0.7%
100.0%
2,143
1,113
395
296
31
139
272
31
4,420
$
On July 21, 2008, we announced the realignment of our segments under our former Employer Markets and Individual Markets
operating businesses into two new operating businesses – Retirement Solutions and Insurance Solutions. We believe the new
structure more closely aligns with consumer needs and should lead to more coordinated product development and greater
effectiveness across the enterprise. The segment changes are in accordance with the provisions of SFAS No. 131, “Disclosures
about Segments of an Enterprise and Related Information,” and reflect the manner in which we are organized for purposes of
making operating decisions and assessing performance. Accordingly, we have restated results from prior periods in a consistent
manner with our realigned segments.
Under our newly realigned segments, we report the results of the Executive Benefits business, which as of June 30, 2008, was part
of the Retirement Products segment, in the Life Insurance segment. We do not view these changes to our segment reporting as
material to our consolidated financial statements.
We provide products and services in four operating businesses: Retirement Solutions; Insurance Solutions; Investment
Management; and Lincoln UK, and report results through six business segments. We also have Other Operations, which includes
the financial data for operations that are not directly related to the business segments. Our reporting segments reflect the manner
by which our chief operating decision makers view and manage the business. The following is a brief description of these
segments and Other Operations.
Retirement Solutions
The Retirement Solutions business provides its products through two segments: Annuities and Defined Contribution. The
Retirement Solutions – Annuities segment provides tax-deferred investment growth and lifetime income opportunities for its
clients by offering individual fixed annuities, including indexed annuities and variable annuities. The Retirement Solutions –
Defined Contribution segment provides employer-sponsored variable and fixed annuities and mutual-fund based programs in the
401(k), 403(b) and 457 marketplaces.
Insurance Solutions
The Insurance Solutions business provides its products through two segments: Life Insurance and Group Protection. The
Insurance Solutions – Life Insurance segment offers wealth protection and transfer opportunities through term insurance, a linked-
benefit product (which is a UL policy linked with riders that provide for long-term care costs) and both single and survivorship
versions of UL and VUL, including corporate-owned UL and VUL insurance and bank-owned UL and VUL insurance products.
The Insurance Solutions – Group Protection segment offers group life, disability and dental insurance to employers, and its
products are marketed primarily through a national distribution system of regional group offices. These offices develop business
through employee benefit brokers, third-party administrators and other employee benefit firms.
Investment Management
The Investment Management segment, through Delaware Investments, provides a broad range of managed account portfolios,
mutual funds, sub-advised 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 affiliates.
239
Lincoln UK
Lincoln UK is headquartered in Barnwood, Gloucester, England, and is licensed to do business throughout the United Kingdom.
Lincoln UK focuses primarily 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 life and retirement income products. 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 contract holders. The segment is sensitive to
changes in the foreign currency exchange rate between the U.S. dollar and the British pound sterling.
Other Operations
Other Operations includes investments related to the excess capital in our insurance subsidiaries, investments in media properties
and other corporate investments, benefit plan net assets, the unamortized deferred gain on indemnity reinsurance, which was sold
to Swiss Re in 2001, external debt and business sold through reinsurance. We are actively managing our remaining radio station
clusters to maximize performance and future value. Other Operations also includes the Institutional Pension business, which was
previously reported in Employer Markets – Retirement Products prior to our segment realignment. The Institutional Pension
business is a closed-block of pension business, the majority of which was sold on a group annuity basis, and is currently in run-off.
Beginning with the quarter ended June 30, 2008, we changed our definitions of segment operating revenues and income from
operations to better reflect: the underlying economics of our variable and indexed annuities that employ derivative instruments to
hedge policy benefits; and the manner in which management evaluates that business. Our change in the definition of income from
operations is primarily the result of our adoption of SFAS 157 during the first quarter of 2008 (see Note 2). Under the fair value
measurement provisions of SFAS 157, we are required to measure the fair value of these annuities from an “exit price” perspective,
(i.e., the exchange price between market participants to transfer the liability). We, therefore, must include margins that a market
participant buyer would require as well as a factor for non-performance risk related to our credit quality. We do not believe that
these factors relate to the economics of the underlying business and do not reflect the manner in which management evaluates the
business. The items that are now excluded from our operating results that were previously included are as follows: GLB net
derivatives results; indexed annuity forward-starting option; and GDB derivatives results. For more information regarding this
change, see our current report on Form 8-K dated July 16, 2008.
We continue to exclude the effects of any realized gain (loss) on investments from segment operating revenues and income from
operations as we believe that such items are 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.
We believe that our new definitions of operating revenues and income (loss) from operations will provide investors with a more
valuable measure of our performance because it better reveals trends in our business.
Segment operating revenues and income (loss) from operations are internal measures used by our management and Board of
Directors to evaluate and assess the results of our segments. Income (loss) from operations is GAAP net income excluding the
after-tax effects of the following items, as applicable:
(cid:120) Realized gains and losses associated with the following (“excluded realized gain (loss)”):
Sale or disposal of securities;
Impairments of securities;
(cid:131)
(cid:131)
(cid:131) Change in the fair value of embedded derivatives within certain reinsurance arrangements and the change in the fair value
of related trading securities;
(cid:131) Change in the fair value of the embedded derivatives of our GLBs within our variable annuities net of the change in the
fair value of the derivatives we own to hedge the changes in the embedded derivative;
(cid:131) Net difference between the benefit ratio unlocking of SOP 03-1 reserves on our GDB riders within our variable annuities
and the change in the fair value of the derivatives excluding our expected cost of purchasing the hedging instruments; and
(cid:131) Changes in the fair value of the embedded derivative liabilities related to index call options we may purchase in the future
to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products as required
under SFAS 133 and 157.
Income (loss) from the initial adoption of changes in accounting principles;
Income (loss) from reserve changes (net of related amortization) on business sold through reinsurance;
(cid:120)
(cid:120)
(cid:120) Losses on early retirement of debt, including subordinated debt;
(cid:120) Losses from the impairment of intangible assets; and
(cid:120)
Income (loss) from discontinued operations.
240
Operating revenues represent GAAP revenues excluding the pre-tax effects of the following items, as applicable:
(cid:120) Excluded realized gain (loss);
(cid:120) Amortization of deferred gains arising from the reserve changes on business sold through reinsurance; and
(cid:120) Revenue adjustments from the initial impact of the adoption of changes in accounting principles.
Operating revenues and income (loss) from operations do not replace revenues and net income as the GAAP measures of our
consolidated results of operations.
Segment information (in millions) was as follows:
Revenues
Operating revenues:
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management (1)
Lincoln UK (2)
Other Operations
Excluded realized gain (loss), pre-tax
Amortization of deferred gain arising from
reserve changes on business sold through
reinsurance, pre-tax
Total revenues
For the Years Ended December 31,
2008
2006
2007
$
2,610
936
3,546
$
2,533
986
3,519
$
2,060
988
3,048
4,250
1,640
5,890
438
327
439
(760)
4,189
1,500
5,689
590
370
473
(175)
3,470
1,032
4,502
564
308
444
12
3
9,883
$
9
10,475
$
1
8,879
$
(1) Revenues for the Investment Management segment included inter-segment revenues for asset management services provided
to our other segments. These inter-segment revenues totaled $82 million, $87 million and $97 million for the years ended
December 31, 2008, 2007 and 2006, respectively.
(2) Revenues from our Lincoln UK segment are from a foreign country.
241
Net Income
Income (loss) from operations:
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Excluded realized gain (loss), after-tax
Early extinguishment of debt
Income (loss) from reserve changes (net of related
amortization) on business sold through
reinsurance, after-tax
Impairment of intangibles, after-tax
Income from continuing operations, after-tax
Income (loss) from discontinued
For the Years Ended December 31,
2008
2006
2007
$
193
123
316
$
485
181
666
$
399
204
603
541
104
645
28
50
(180)
(494)
-
2
(305)
62
719
114
833
76
46
(173)
(120)
-
(7)
-
1,321
531
99
630
55
39
(38)
9
(4)
1
-
1,295
operations, after-tax
Net income
(5)
57
$
(106)
1,215
$
21
1,316
$
Net Investment Income
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Lincoln UK
Other Operations
Total net investment income
For the Years Ended December 31,
2008
2006
2007
$
972
695
1,667
$
1,032
709
1,741
$
976
738
1,714
1,988
117
2,105
78
358
4,208
$
2,069
115
2,184
81
372
4,378
$
1,685
80
1,765
71
373
3,923
$
242
Amortization of DAC and VOBA, Net of Interest
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Lincoln UK
For the Years Ended December 31,
2008
2006
2007
$
675
129
804
$
373
94
467
$
302
74
376
551
36
587
46
514
31
545
53
447
16
463
38
Total amortization of DAC and VOBA,
net of interest
$
1,437
$
1,065
$
877
Federal Income Tax Expense (Benefit)
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Excluded realized gain (loss)
Loss on early retirement of debt
Amortization of deferred gain on reinsurance
related to reserve changes
Impairment of intangibles
Total federal income tax expense (benefit)
For the Years Ended December 31,
2008
2006
2007
$
(55)
29
(26)
$
159
72
231
$
90
76
166
267
56
323
17
27
(89)
(266)
-
366
61
427
43
24
(114)
(54)
-
266
53
319
29
21
(54)
4
(2)
1
(74)
(87)
$
(4)
-
553
$
-
-
483
$
Assets
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Total
As of December 31,
2008
2007
$
81,424
30,180
111,604
50,476
2,430
52,906
629
11,167
15,129
191,435
$
$
69,280
22,906
92,186
48,778
2,482
51,260
531
6,555
12,604
163,136
$
243
For the Years Ended December 31,
2008
2006
2007
$
$
$
282
418
195
320
39,197
(5,632)
(1,865)
31,700
-
$
-
-
-
-
$
-
-
$
-
$
-
$
-
-
-
$
-
$
$
$
$
$
$
(732)
127
647
42
(54)
(12)
$
$
$
10
(1)
$
9
$
25
(19)
$
6
268
177
86
(20)
(1)
65
(45)
6
42
3
54
57
24. Supplemental Disclosures of Cash Flow Information
The following summarizes our supplemental cash flow data (in millions):
Interest paid
Income taxes paid
Significant non-cash investing and financing transactions:
Business combinations:
Fair value of assets acquired (includes cash and invested cash)
Fair value of common stock issued and stock options recognized
Cash paid for common shares
Liabilities assumed
Business Dispositions:
Assets(cid:172)disposed(cid:172)(includes cash and invested cash)
Liabilities(cid:172)disposed
Cash received
Realized gain on disposal
Estimated gain on net assets held-for-sale in 2007
Gain (loss) on dispositions
Sale of subsidiaries/businesses:
Proceeds from sale of subsidiaries/businesses
Assets(cid:172)disposed(cid:172)(includes cash and invested cash)
Gain on sale of subsidiaries/businesses
244
25. Quarterly Results of Operations (Unaudited)
The unaudited quarterly results of operations (in millions, except per share data) were as follows:
2008
Total revenues (1)
Total benefits and expenses (1)
Income (loss) from continuing operations
Loss from discontinued operations,
net of federal income tax expense (benefit)
Net income (loss)
Earnings (loss) per common share - basic:
Income (loss) from continuing operations
Loss from discontinued operations
Net income (loss)
Earnings (loss) per common share - diluted: (2)
Income (loss) from continuing operations
Loss from discontinued operations
Net income (loss)
2007
Total revenues (1)
Total benefits and expenses (1)
Income from continuing operations
Income (loss) from discontinued operations,
net of federal income tax expense (benefit)
Net income
Earnings (loss) per common share - basic:
Income from continuing operations
Income (loss) from discontinued operations
Net income
Earnings (loss) per common share - diluted:
Income from continuing operations
Income (loss) from discontinued operations
Net income
For the Three Months Ended
March 31,
June 30,
September 30, December 31,
$
2,592
2,174
293
$
2,582
2,382
125
$
2,436
2,284
149
$
2,273
3,068
(505)
(4)
289
1.13
(0.02)
1.11
1.12
(0.02)
1.10
-
125
0.48
-
0.48
0.48
-
0.48
(1)
148
0.58
-
0.58
0.58
-
0.58
-
(505)
(1.98)
-
(1.98)
(1.98)
-
(1.98)
$
2,621
2,063
388
$
2,671
2,145
370
$
2,600
2,153
323
$
2,583
2,240
240
8
396
1.41
0.03
1.44
1.39
0.03
1.42
6
376
1.37
0.02
1.39
1.35
0.02
1.37
7
330
1.20
0.02
1.22
1.18
0.03
1.21
(127)
113
0.91
(0.46)
0.45
0.90
(0.47)
0.43
(1) See Note 1 for a description of the reclassification of certain derivatives and embedded derivatives, which resulted in increases
(decreases) to total revenues and total benefits and expenses of $68 million, $(24) million, $(47) million, $(41) million and $(7)
million, for the three months ended March 31, 2008, December 31, 2007, September 30, 2007, June 30, 2007 and March 31,
2007, respectively.
(2) As a result of the net loss in the fourth quarter of 2008, shares used in the earnings (loss) per share calculation represent basic
shares because using diluted shares would have been anti-dilutive to the calculation.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None.
Item 9A. 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
245
such information is accumulated and communicated to the Company’s 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 required
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) Management’s Report on Internal Control Over Financial Reporting
Management’s Report on Internal Control Over Financial Reporting is included on page 159 of “Item 8. Financial Statements and
Supplementary Data” and is incorporated herein by reference.
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.
(c) 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 December 31, 2008, that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.
Item 9B. Other Information
None.
246
Item 10. Directors, Executive Officers and Corporate Governance
PART III
Information for this item relating to officers of LNC is incorporated by reference to “Part I – Executive Officers of the
Registrant.” Information for this item relating to directors of LNC is incorporated by reference to the sections captioned
“GOVERNANCE OF THE COMPANY – Qualifications and Director Nomination Process,” “THE BOARD OF DIRECTORS
AND COMMITTEES – Current Committee Membership and Meetings Held During 2009,” “THE BOARD OF DIRECTORS
AND COMMITTEES – Audit Committee,” “ITEM 1 – Election of Directors,” “SECTION 16(a) BENEFICIAL OWNERSHIP
REPORTING COMPLIANCE” and “GENERAL – Shareholder Proposals” of LNC’s Proxy Statement for the Annual Meeting
scheduled for May 14, 2009.
We have adopted a code of ethics, which we refer to as our “Code of Conduct,” that applies, among others, to our principal
executive officer, principal financial officer, principal accounting officer or controller and other persons performing similar
functions. The Code of Conduct is posted on our Internet website (www.lincolnfinancial.com). LNC will provide to any person
without charge, upon request, a copy of such code. Requests for the Code of Conduct should be directed to: Corporate Secretary,
Lincoln National Corporation, 150 N. Radnor Chester Road, Suite A305, Radnor, PA 19087. We intend to disclose any
amendment to or waiver from the provisions of our Code of Conduct that applies to our directors and executive officers on our
website, www.lincolnfinancial.com.
Item 11. Executive Compensation
Information for this item is incorporated by reference to the sections captioned “EXECUTIVE COMPENSATION,”
“COMPENSATION OF DIRECTORS” and “COMPENSATION COMMITTEE INTERLOCKS AND INSIDER
PARTICIPATION” of LNC’s Proxy Statement for the Annual Meeting scheduled for May 14, 2009.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information for this item is incorporated by reference to the sections captioned “SECURITY OWNERSHIP” and “EQUITY
COMPENSATION PLAN INFORMATION” of LNC’s Proxy Statement for the Annual Meeting scheduled for May 14, 2009.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information for this item is incorporated by reference to the sections captioned “RELATED PARTY TRANSACTIONS” and
“GOVERNANCE OF THE COMPANY – Director Independence” of LNC’s Proxy Statement for the Annual Meeting
scheduled for May 14, 2009.
Item 14. Principal Accountant Fees and Services
Information for this item is incorporated by reference to the sections captioned “ITEM 2 – RATIFICATION OF THE
APPOINTMENT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM – Independent Registered
Public Accounting Firm Fees and Services” and “ITEM 2 – RATIFICATION OF THE APPOINTMENT OF THE
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM – Audit Committee Pre-Approval Policy” of LNC’s Proxy
Statement for the Annual Meeting scheduled for May 14, 2009.
247
Item 15. Exhibits and Financial Statement Schedules
(a) (1) Financial Statements
PART IV
The following Consolidated Financial Statements of Lincoln National Corporation are included in Part II Item 8:
Management Report on Internal Control Over Financial Reporting
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets – December 31, 2008 and 2007
Consolidated Statements of Income – Years ended December 31, 2008, 2007 and 2006
Consolidated Statements of Stockholders’ Equity – Years ended December 31, 2008, 2007 and 2006
Consolidated Statements of Cash Flows – Years ended December 31, 2008, 2007 and 2006
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedules
The Financial Statement Schedules are listed in the Index to Financial Statement Schedules on page FS-1, which is incorporated
herein by reference.
(a) (3) Listing of Exhibits
The Exhibits are listed in the Index to Exhibits beginning on page E-1, which is incorporated herein by reference.
(c) The Financial Statement Schedules for Lincoln National Corporation begin on page FS-2, which are incorporated herein by
reference.
248
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, LNC has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date: February 27, 2009
LINCOLN NATIONAL CORPORATION
By:
/s/ Frederick J. Crawford
Frederick J. Crawford
Executive Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities indicated on February 27, 2009.
Title
President, Chief Executive Officer and Director
(Principal Executive Officer)
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Vice President and Chief Accounting Officer
(Principal Accounting Officer)
Director
Director
Director
Director
Director
Director
Director
Director
Director
Signature
/s/ Dennis R. Glass
Dennis R. Glass
/s/ Frederick J. Crawford
Frederick J. Crawford
/s/ Douglas N. Miller
Douglas N. Miller
/s/ William J. Avery
William J. Avery
/s/ J. Patrick Barrett
J. Patrick Barrett
/s/ William H. Cunningham
William H. Cunningham
/s/ George W. Henderson, III
George W. Henderson, III
/s/ Eric G. Johnson
Eric G. Johnson
/s/ M. Leanne Lachman
M. Leanne Lachman
/s/ Michael F. Mee
Michael F. Mee
/s/ William Porter Payne
William Porter Payne
/s/ Patrick S. Pittard
Patrick S. Pittard
249
Signature
/s/ David A. Stonecipher
David A. Stonecipher
/s/ Isaiah Tidwell
Isaiah Tidwell
Title
Director
Director
250
Index to Financial Statement Schedules
I – Summary of Investments – Other than Investments in Related Parties
II – Condensed Financial Information of Registrant
III – Supplementary Insurance Information
IV – Reinsurance
V – Valuation and Qualifying Accounts
FS-2
FS-3
FS-6
FS-8
FS-9
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange
Commission are not required under the related instructions, are inapplicable, or the required information is included in the
consolidated financial statements, and therefore omitted. See “Critical Accounting Policies and Estimates” on page 53 for more
detail on items contained within these schedules.
FS-1
LINCOLN NATIONAL CORPORATION
SCHEDULE I – CONSOLIDATED SUMMARY OF INVESTMENTS – OTHER THAN INVESTMENTS IN
RELATED PARTIES (in millions)
Column A
Type of Investment
Available-For-Sale Fixed Maturity Securities (1)
Bonds:
U.S. government and government agencies and authorities
States, municipalities and political subdivisions
Asset and mortgage-backed securities
Foreign governments
Public utilities
Convertibles and bonds with warrants attached
All other corporate bonds
Hybrid and redeemable preferred stocks
Total available-for-sale fixed maturity securities
Available-For-Sale Equity Securities (1)
Common stocks:
Banks, trusts and insurance companies
Industrial, miscellaneous and all other
Nonredeemable preferred stocks
Total available-for-sale equity securities
Trading securities
Derivative instruments
Mortgage loans on real estate
Real estate
Policy loans
Other investments
Total investments
Column B
Column D
Column C
As of December 31, 2008
Fair
Value
Carrying
Value
Cost
$
204
125
11,328
755
5,809
8
35,402
1,563
55,194
298
85
83
466
2,307
931
7,715
125
2,924
1,624
71,286
$
$
246
125
10,130
760
5,457
8
31,247
962
48,935
164
70
54
288
2,333
3,397
7,424
N/A
N/A
1,624
$
246
125
10,130
760
5,457
8
31,247
962
48,935
164
70
54
288
2,333
3,397
7,715
125
2,924
1,624
67,341
$
(1) Investments deemed to have declines in value that are other-than-temporary are written down or reserved for to reduce the
carrying value to their estimated realizable value.
FS-2
LINCOLN NATIONAL CORPORATION
SCHEDULE II – CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS
(Parent Company Only) (in millions, except share data)
ASSETS
Investments in subsidiaries (1)
Derivative instruments
Other investments
Cash and invested cash
Loans to subsidiaries (1)
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Dividends payable
Short-term debt
Long-term debt
Loans from subsidiaries (1)
Other liabilities
Total liabilities
Contingencies and Commitments
Stockholders' Equity
Series A preferred stock - 10,000,000 shares authorized
Common stock - 800,000,000 shares authorized
Retained earnings
Total accumulated other comprehensive income (loss)
Total stockholders' equity
Total liabilities and stockholders' equity
(1) Eliminated in consolidation.
As of December 31,
2008
2007
$
11,652
407
187
117
1,785
147
14,295
$
$
15,231
68
442
271
1,640
281
17,933
$
$
54
815
4,481
$
109
550
4,772
388
580
6,318
327
457
6,215
-
7,035
3,745
(2,803)
7,977
14,295
$
-
7,200
4,293
225
11,718
17,933
$
FS-3
LINCOLN NATIONAL CORPORATION
SCHEDULE II – CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
STATEMENTS OF INCOME
(Parent Company Only) (in millions)
Revenues
Dividends from subsidiaries (1)
Interest from subsidiaries (1)
Net investment income
Realized gain (loss) on investments
Other
Total revenues
Expenses
Operating and administrative
Interest - subsidiaries (1)
Interest - other
Total expenses
For the Years Ended December 31,
2008
2006
2007
$
1,239
$
1,613
$
907
99
17
(156)
22
1,221
52
25
280
357
102
21
(49)
14
1,701
64
93
281
438
87
19
1
(1)
1,013
67
22
190
279
Income before federal income tax benefit, equity in income of subsidiaries,
less dividends
Federal income tax benefit
Income before equity in income of subsidiaries, less dividends
Equity in income of subsidiaries, less dividends
Net income
864
(136)
1,000
(943)
57
$
1,263
(126)
1,389
(174)
1,215
$
734
(91)
825
491
1,316
$
(1) Eliminated in consolidation.
FS-4
LINCOLN NATIONAL CORPORATION
SCHEDULE II – CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
STATEMENTS OF CASH FLOWS
(Parent Company Only) (in millions)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in income of subsidiaries greater than distributions (1)
Realized (gain) loss on investments
Change in fair value of equity collar
Change in federal income tax accruals
Other
Net cash provided by operating activities
Cash Flows from Investing Activities
Net sales (purchases) of investments
Purchases of derivatives
Proceeds received on stock monetization
Purchase of Jefferson-Pilot stock
Increase in investment in subsidiaries (1)
Cash acquired through affiliated mergers
Net cash used in investing activities
Cash Flows from Financing Activities
Payment of long-term debt, including current maturities
Issuance of long-term debt
Issuance (decrease) in commercial paper
Net increase (decrease) in loans from subsidiaries (1)
Net increase in loans to subsidiaries (1)
Common stock issued for benefit plans
Retirement of common stock
Dividends paid to stockholders
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and invested cash
Cash and invested cash at beginning-of-year
Cash and invested cash at end-of-year
(1) Eliminated in consolidation.
For the Years Ended December 31,
2008
2006
2007
$
57
$
1,215
$
1,316
943
156
109
(240)
(34)
991
-
-
-
-
-
-
-
(300)
200
50
61
(299)
49
(476)
(430)
(1,145)
(318)
49
-
(12)
26
960
(1)
(26)
170
-
(325)
16
(166)
(350)
1,443
265
(378)
(308)
91
(989)
(429)
(655)
(491)
(1)
-
67
7
898
25
-
-
(1,865)
(68)
-
(1,908)
(178)
2,045
(120)
433
(47)
167
(1,002)
(385)
913
(154)
271
117
$
139
132
271
$
(97)
229
132
$
FS-5
LINCOLN NATIONAL CORPORATION
SCHEDULE III – CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION
(in millions)
Column A
Segment
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Total
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Total
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solution
Investment Management
Lincoln UK
Other Operations
Total
Column B
DAC and
VOBA
Column C
Future
Contract
Benefits
Column D
Unearned
Premiums (1)
Column E
Other Contract
Holder
Funds
Column F
Insurance
Premiums
As of or for the Year Ended December 31, 2008
$
2,977
883
3,860
$
3,958
25
3,983
7,383
146
7,529
-
534
13
11,936
$
6,380
1,378
7,758
-
828
6,691
19,260
$
$
-
-
-
-
-
-
-
-
-
$
-
$
17,220
11,628
28,848
$
136
-
136
29,998
149
30,147
-
277
1,575
60,847
$
360
1,518
1,878
-
78
4
2,096
$
As of or for the Year Ended December 31, 2007
$
2,477
514
2,991
$
817
-
817
5,692
123
5,815
-
772
2
9,580
$
6,255
1,273
7,528
-
1,147
6,515
16,007
$
$
-
-
-
-
-
-
-
-
-
$
-
$
17,750
10,892
28,642
$
118
-
118
28,427
17
28,444
-
403
2,151
59,640
$
351
1,380
1,731
-
95
3
1,947
$
As of or for the Year Ended December 31, 2006
$
2,050
498
2,548
$
438
-
438
4,924
138
5,062
-
809
1
8,420
$
5,657
1,183
6,840
-
1,119
6,374
14,771
$
-
$
-
-
-
-
-
-
-
-
$
-
$
18,230
10,983
29,213
$
47
-
47
27,231
17
27,248
-
436
2,248
59,145
$
322
949
1,271
-
79
9
1,406
$
(1) Unearned premiums are included in Column E, other contract holder funds.
FS-6
LINCOLN NATIONAL CORPORATION
SCHEDULE III – CONSOLIDATED SUPPLEMENTARY INSURANCE INFORMATION (Continued)
(in millions)
Column A
Segment
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Total
Retirement Solutions:
Annuities
Defined Contribution
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Total
Retirement Solutions:
Annuities
Defined Contributions
Total Retirement Solutions
Insurance Solutions:
Life Insurance
Group Protection
Total Insurance Solutions
Investment Management
Lincoln UK
Other Operations
Total
Column G
Net
Investment
Column H
Benefits
and
Interest
Column I
Amortization
of DAC
and
Income
Credited
VOBA
Column J
Column K
Other
Operating
Expenses (2)
Premiums
Written
For the Year Ended December 31, 2008
$
972
695
1,667
$
1,150
443
1,593
$
675
129
804
$
647
212
859
1,988
117
2,105
-
78
358
4,208
$
2,565
1,108
3,673
-
107
285
5,658
$
551
36
587
-
46
-
1,437
$
326
335
661
393
97
410
2,420
$
For the Year Ended December 31, 2007
$
1,032
709
1,741
$
830
418
1,248
$
373
94
467
$
686
221
907
2,069
115
2,184
-
81
372
4,378
$
2,262
999
3,261
-
138
350
4,997
$
514
31
545
-
53
-
1,065
$
328
295
623
471
109
429
2,539
$
For the Year Ended December 31, 2006
$
976
738
1,714
$
717
411
1,128
$
302
74
376
$
552
223
775
1,685
80
1,765
-
71
373
3,923
$
1,908
663
2,571
-
108
290
4,097
$
447
16
463
-
38
-
877
$
318
200
518
479
102
253
2,127
$
-
$
-
-
-
-
-
-
-
-
$
-
$
-
-
-
-
-
-
-
-
-
$
-
-
$
-
-
-
-
-
-
-
-
$
-
(2) Excludes impairment of intangibles of $393 million for the year ended December 31, 2008. The allocation of expenses
between investments and other operations is based on a number of assumptions and estimates. Results would change if
different methods were applied.
FS-7
LINCOLN NATIONAL CORPORATION
SCHEDULE IV – CONSOLIDATED REINSURANCE
(in millions)
Column A
Column B
Column C
Description
Individual life insurance in force
Premiums:
Life insurance and annuities (1)
Health insurance
Total
Individual life insurance in force
Premiums:
Life insurance and annuities (1)
Health insurance
Total
Individual life insurance in force
Premiums:
Life insurance and annuities (1)
Health insurance
Total
Gross
Amount
Ceded
to Other
Companies
Column D
Assumed
from
Other
Companies
Column E
Net
Amount
Column F
Percentage
of Amount
Assumed
to Net
As of or for the Year Ended December 31, 2008
$
777,700
$
346,900
$
3,700
$
434,500
5,255
1,076
6,331
$
1,002
22
1,024
$
18
-
18
$
4,271
1,054
5,325
$
As of or for the Year Ended December 31, 2007
$
744,500
$
350,500
$
3,700
$
397,700
5,109
968
6,077
$
925
27
952
$
12
-
12
$
4,196
941
5,137
$
As of or for the Year Ended December 31, 2006
$
697,900
$
333,800
$
4,700
$
368,800
4,116
677
4,793
$
810
21
831
$
8
-
$
8
3,314
656
3,970
$
0.9%
0.4%
-
0.9%
0.3%
-
1.3%
0.2%
-
(1) Includes insurance fees on universal life and other interest-sensitive products.
FS-8
LINCOLN NATIONAL CORPORATION
SCHEDULE V – CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
(in millions)
Column A
Column B
Column C
Additions
Column D
Column E
Description
Deducted from asset accounts:
Balance at
Beginning-
of-Year
Charged to
Costs
Expenses (1)
Charged
to Other
Accounts - Deductions -
Describe (2)
Describe
Balance
at End
of-Year
As of December 31, 2008
Reserve for mortgage loans on real estate
$
-
$
-
$
-
$
-
$
-
Included in other liabilities:
Investment guarantees
Deducted from asset accounts:
-
-
-
-
-
As of December 31, 2007
Reserve for mortgage loans on real estate
$
2
$
-
$
-
$
(2)
$
-
Included in other liabilities:
Investment guarantees
Deducted from asset accounts:
-
-
-
-
-
As of December 31, 2006
Reserve for mortgage loans on real estate
$
9
$
2
$
-
$
(9)
$
2
Included in other liabilities:
Investment guarantees
-
-
-
-
-
(1) Excludes charges for the direct write-off assets.
(2) Deductions reflect sales, foreclosures of the underlying holdings or change in reserves.
FS-9
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INDEX TO EXHIBITS
2.1 Agreement and Plan of Merger dated as of October 9, 2005, among LNC, Quartz Corporation and Jefferson-Pilot
Corporation is incorporated by reference to Exhibit 2.1 to LNC’s Current Report on Form 8-K (File No. 1-6028) filed with
the SEC on October 11, 2005.
2.2 Amendment No. 1 to the Agreement and Plan of Merger dated as of January 26, 2006 among LNC, Lincoln JP Holdings,
L.P., Quartz Corporation and Jefferson-Pilot Corporation is incorporated by reference to Exhibit 2.1 to LNC’s Current
Report on Form 8-K (File No. 1-6028) filed with the SEC on January 31, 2006.
2.3
3.1
Stock Purchase Agreement between Lincoln Financial Media Company and Raycom Holdings, LLC is incorporated by
reference to Exhibit 2.3 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2007.***
LNC Restated Articles of Incorporation are incorporated by reference to Exhibit 3.1 to LNC’s Form 8-K (File No. 1-6028)
filed with the SEC on May 10, 2007.
3.2 Amended and Restated Bylaws of LNC (effective November 6, 2008) are incorporated by reference to Exhibit 3.1 to LNC’s
Form 10-Q (File No. 1-6028) for the quarter ended September 30, 2008.
4.1
4.2
4.3
4.4
4.5
4.6
4.7
Indenture of LNC, dated as of January 15, 1987, between LNC and Morgan Guaranty Trust Company of New York is
incorporated by reference to Exhibit 4(a) to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 1994.
First Supplemental Indenture, dated as of July 1, 1992, to Indenture dated as of January 15, 1987 is incorporated by reference
to Exhibit 4(b) to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2001.
Indenture of LNC, dated as of September 15, 1994, between LNC and The Bank of New York, as trustee, is incorporated by
reference to Exhibit 4(c) to LNC’s Registration Statement on Form S-3/A (File No. 33-55379) filed with the SEC on
September 15, 1994.
First Supplemental Indenture, dated as of November 1, 2006, to Indenture dated as of September 15, 1994 is incorporated by
reference to Exhibit 4.4 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2006.
Junior Subordinated Indenture, dated as of May 1, 1996, between LNC and The Bank of New York Trust Company, N.A.
(successor in interest to J.P. Morgan Trust Company and The First National Bank of Chicago) is incorporated by reference to
Exhibit 4(j) to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2001.
First Supplemental Indenture, dated as of August 14, 1998, to Junior Subordinated Indenture dated as of May 1, 1996 is
incorporated by reference to Exhibit 4.3 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on August 27, 1998.
Second Supplemental Junior Subordinated Indenture, dated April 20, 2006, to Junior Subordinated Indenture, dated as of
May 1, 1996, is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on April
20, 2006.
4.8 Third Supplemental Junior Subordinated Indenture dated May 17, 2006, to Junior Subordinated Indenture, dated as of May 1,
1996, is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on May 17, 2006.
4.9
Fourth Supplemental Junior Subordinated Indenture, dated as of November 1, 2006, to Junior Subordinated Indenture, dated
May 1, 1996, is incorporated by reference to Exhibit 4.9 to LNC’s Form 10-K (File No. 1-6028) for the year ended December
31, 2006.
4.10 Fifth Supplemental Junior Subordinated Indenture, dated as of March 13, 2007, to Junior Subordinated Indenture, dated May
1, 1996, is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on March 13,
2007.
4.11
Indenture, dated as of November 21, 1995, between Jefferson-Pilot Corporation and U.S. National Bank Association (as
successor in interest to Wachovia Bank, National Association), is incorporated by reference to Exhibit 4.7 to LNC’s Form 10-
Q (File No. 1-6028) for the quarter ended June 30, 2006.
4.12 Third Supplemental Indenture, dated as of January 27, 2004, to Indenture dated as of November 21, 1995, is incorporated by
reference to Exhibit 4.8 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended June 30, 2006.
E-1
4.13 Fourth Supplemental Indenture, dated as of January 27, 2004, to Indenture dated as of November 21, 1995, is incorporated
by reference to Exhibit 4.9 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended June 30, 2006.
4.14 Fifth Supplemental Indenture, dated as of April 3, 2006, to Indenture, dated as of November 21, 1995, incorporated by
reference to Exhibit 10.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on April 3, 2006.
4.15
Sixth Supplemental Indenture, dated as of March 1, 2007, to Indenture dated as of November 21, 1995, is incorporated by
reference to Exhibit 4.4 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2007.
4.16 Form of 7% Notes due March 15, 2018 incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No. 1-6028) filed
with the SEC on March 24, 1998.
4.17 Form of 6.20% Note dated December 7, 2001 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-
6028) filed with the SEC on December 11, 2001.
4.18 Form of 6.75% Trust Preferred Security Certificate is incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No.
1-6028) filed with the SEC on September 16, 2003.
4.19 Form of 6.75% Junior Subordinated Deferrable Interest Debentures, Series F is incorporated by reference to Exhibit 4.3 to
LNC’s Form 8-K (File No. 1-6028) filed with the SEC on September 16, 2003.
4.20 Form of 4.75% Note due February 15, 2014 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028)
filed with the SEC on February 4, 2004.
4.21 Form of 7% Capital Securities due 2066 of LNC is incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File NO. 1-
6028) filed with the SEC on May 17, 2006.
4.22 Form of 6.75% Capital Securities due 2066 of Lincoln Financial Corporation is incorporated by reference to Exhibit 4.2 to
LNC’s Form 8-K (File No. 1-6028) filed with the SEC on April 20, 2006.
4.23 Form of Floating Rate Senior Note due April 6, 2009 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File
No. 1-6028) filed with the SEC on April 7, 2006.
4.24 Form of 6.15% Senior Note due April 6, 2036 is incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No. 1-
6028) filed with the SEC on April 7, 2006.
4.25 Amended and Restated Trust Agreement dated September 11, 2003, among LNC, as Depositor, Bank One Trust Company,
National Association, as Property Trustee, Bank One Delaware, Inc., as Delaware Trustee, and the Administrative Trustees
named therein is incorporated by reference to Exhibit 4.1 of Form 8-K (File No. 1-6028) filed with the SEC on September
16, 2003.
4.26 Guarantee Agreement, dated September 11, 2003, between LNC, as Guarantor, and Bank One Trust Company, National
Association, as Guarantee Trustee is incorporated by reference to Exhibit 4.4 to LNC’s Form 8-K (File No. 1-6028) filed
with the SEC on September 16, 2003.
4.27 Form of 6.05% Capital Securities due 2067 is incorporated by reference to Exhibit 4.2 to LNC’s Form 8-K (File No. 1-6028)
filed with the SEC on March 13, 2007.
4.28 Form of Floating Rate Senior Notes due 2010 is incorporated by reference to Exhibit 4.3 to LNC’s Form 8-K (File No. 1-
6028) filed with the SEC on March 13, 2007.
4.29 Form of 5.65% Senior Notes due 2012 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed
with the SEC on August 27, 2007.
4.30 Form of 6.30% Senior Notes due 2037 is incorporated by reference to Exhibit 4.1 to LNC’s Form 8-K (File No. 1-6028) filed
with the SEC on October 9, 2007.
4.31 First Supplemental Indenture, dated as of April 3, 2006, among Lincoln JP Holdings, L.P. and JPMorgan Chase Bank, N.A.,
as trustee, to the Indenture, dated as of January 15, 1997, among Jefferson-Pilot and JPMorgan Chase Bank, N.A., as trustee,
is incorporated by reference to Exhibit 10.2 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on April 3, 2006.
E-2
10.1 LNC Amended and Restated Incentive Compensation Plan (as amended and restated on May 10, 2007) is incorporated by
reference to Exhibit 4 to LNC’s Proxy Statement (File No. 1-6028) filed with the SEC on April 4, 2007.*
10.2 Amendment Nos. 1 and 2 to the LNC Amended and Restated Incentive Compensation Plan are incorporated by reference to
Exhibit 10.3 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2007.*
10.3 Form of Restricted Stock Unit Award Agreement under the LNC Amended and Restated Incentive Compensation Plan,
adopted February 7, 2008 is incorporated by reference to Exhibit 10.6 to LNC’s Form 10-Q (File No. 1-6028) for the quarter
ended March 31, 2008.*
10.4 Form of Restricted Stock Award Agreement is incorporated by reference to Exhibit 10.7 to LNC’s Form 10-Q (File No. 1-
6028) for the quarter ended March 31, 2008.*
10.5 Form of Restricted Stock Unit Award Agreement under the LNC Amended and Restated Incentive Compensation Plan,
adopted May 2008, is incorporated by reference to Exhibit 10.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on
May 6, 2008.*
10.6 LNC Stock Option Plan for Non-Employee Directors is incorporated by reference to Exhibit 5 to LNC’s Proxy Statement
(File No. 1-6028) filed with the SEC on April 4, 2007.*
10.7 Non-Qualified Stock Option Agreement for the LNC Stock Option Plan for Non-Employee Directors is incorporated by
reference to Exhibit 10.3 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on May 10, 2007.*
10.8 Retirement and Release Agreement, dated July 6, 2007, between Jon A. Boscia and LNC is incorporated by reference to
Exhibit 10.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on July 11, 2007.*
10.9 Description of Change in Compensation Arrangement in connection with promotion of Dennis R. Glass to CEO is
incorporated by reference to Exhibit 10.2 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended September 30, 2007.*
10.10 2007 Non-Employee Director Fees (revised to include fee for non-Executive Chairman) (unchanged for 2008) is
incorporated by reference to Exhibit 10.3 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended September 30, 2007.*
10.11 Form of Restricted Stock Award Agreement (2007) is incorporated by reference to Exhibit 10.1 to LNC’s Form 10-Q (File
No. 1-6028) for the quarter ended September 30, 2007.*
10.12 Amended and Restated LNC Supplemental Retirement Plan is incorporated by reference to Exhibit 10.10 to LNC’s Form 10-
K (File No. 1-6028) for the year ended December 31, 2007.*
10.13 The Salary Continuation Plan for Executives of LNC and Affiliates as amended and restated through August 1, 2000 is
incorporated by reference to Exhibit 10(b) to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2001.*
10.14 Amended and Restated Salary Continuation Plan for Executives of LNC and Affiliates is incorporated by reference to Exhibit
10.13 to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2007.*
10.15 The LNC Outside Directors’ Value Sharing Plan, last amended March 8, 2001, is incorporated by reference to Exhibit 10(e)
to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2001.*
10.16 LNC Deferred Compensation and Supplemental/Excess Retirement Plan is incorporated by reference to LNC’s
Registration Statement for the plan on Form S-8 (File No. 333-155385) filed November 14, 2008.*
10.17 LNC 1993 Stock Plan for Non-Employee Directors, as last amended May 10, 2001, is incorporated by reference to Exhibit
10(g), to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2001.*
10.18 Amendment No. 2 to the LNC 1993 Stock Plan for Non-Employee Directors (effective February 1, 2006) is incorporated by
reference to Exhibit 10.1 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on January 13, 2006.*
10.19 Non-Qualified Stock Option Agreement (For Non-Employee Directors) under the LNC 1993 Stock Plan for Non-Employee
Directors is incorporated by reference to Exhibit 10(z) to LNC’s Form 10-K (File No. 1-6028) for the year ended December
31, 2004.*
E-3
10.20 Amendment of outstanding Non-Qualified Option Agreements (for Non-Employee Directors) under the LNC 1993 Stock
Plan for Non-Employee Directors is incorporated by reference to Exhibit 10.2 to LNC’s Form 8-K (File No. 1-6028) filed
with the SEC on January 12, 2006.*
10.21 Amended and Restated LNC Executives’ Severance Benefit Plan (effective August 7, 2008) is incorporated by reference to
Exhibit 10.3 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended June 30, 2008.*
10.22 Amended and Restated LNC Excess Retirement Plan is incorporated by reference to Exhibit 10.26 to LNC’s Form 10-K
(File No. 1-6028) for the year ended December 31, 2007.*
10.23 LNC Deferred Compensation Plan for Non-Employee Directors, as amended and restated November 5, 2008 is filed
herewith.*
10.24 Revised Framework for Long-Term performance awards under the Amended and Restated Incentive Compensation Plan is
incorporated by reference to Exhibit 10(a) to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on May 12, 2005.*
10.25 Form of LNC Restricted Stock Agreement is incorporated by reference to Exhibit 10(b) to LNC’s Form 8-K (File No. 1-
6028) filed with the SEC on January 20, 2005.*
10.26 Form of LNC Stock Option Agreement is incorporated by reference to Exhibit 10(c) to LNC’s Form 8-K (File No. 1-6028)
filed with the SEC on January 20, 2005.*
10.27 Overview of 2006 long-term incentives for senior management committee members under the Amended and Restated
Incentive Compensation Plan is incorporated by reference to Exhibit 10.1 to LNC’s Form 8-K (File No. 1-6028) filed with
the SEC on April 18, 2006.*
10.28 2006-2008 Long-Term Incentive Award Measures under the LNC Amended and Restated Annual Incentive Compensation
Plan and certain compensation information, is incorporated by reference to Exhibit 10.3 to LNC’s Form 10-Q (File No. 1-
6028) for the quarter ended June 30, 2006.*
10.29 Form of Long-Term Incentive Award Agreement for senior management committee members (2006-2008 cycle) is
incorporated by reference to Exhibit 10.2 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on April 18, 2006.*
10.30 Form of 2008-2010 Performance Cycle Agreement under the LNC Amended and Restated Incentive Compensation Plan, is
incorporated by reference to Exhibit 10.1 of LNC’s Form 8-K (File No. 1-6028) filed with the SEC on February 13, 2008.*
10.31 Description of Special 2008 Annual Incentive Payout Arrangement with Terrance J. Mullen, Former President of Lincoln
Financial Distributors, is incorporated by reference to Exhibit 10.4 to LNC’s Form 10-Q (File No. 1-6028) for the quarter
ended March 31, 2008.*
10.32 Agreement, Waiver and General Release between Elizabeth L. Reeves and LNC is incorporated by reference to Exhibit 10.2
to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended June 30, 2008.*
10.33 Form of 2008 Non-Qualified Stock Option Agreement under the LNC Amended and Restated Incentive Compensation Plan
is incorporated by reference to Exhibit 10.2 of LNC’s Form 8-K (File No. 1-6028) filed with the SEC on February 13, 2008.*
10.34 LNC Employees’ Supplemental Pension Benefit Plan is incorporated by reference to Exhibit 10(e) to LNC’s Form 8-K (File
No. 1-6028) filed with the SEC on January 20, 2005.*
10.35 Description of resolution dated January 13, 2005 amending the LNC Employees’ Supplemental Pension benefit Plan
incorporated by reference to Exhibit 10(d) to LNC’s Form 10-Q (File No 1-6028) for the quarter ended March 31, 2005.*
10.36 Amended and Restated Delaware Investments U.S., Inc. Incentive Compensation Plan is filed herewith.*
10.37 Non-qualified Stock Option Agreement Under the Delaware Investments U.S., Inc. Stock Option Plan is incorporated by
reference to Exhibit 10(bb) to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 2005.*
10.38 Form of Restricted Stock Unit Agreement under the Delaware Investments U.S., Inc. Incentive Compensation Plan is
incorporated by reference to Exhibit 10.3 to LNC’s Form 8-K (File No. 1-6028) filed with the SEC on February 13, 2008.*
E-4
10.39 LNC Non-Employee Director Compensation is incorporated by reference from Exhibit 10.1 to LNC’s Form 8-K (File No.
1-6028) filed with the SEC on September 15, 2006.*
10.40 Form of Stock Option Agreement is incorporated by reference to Exhibit 10.3 to LNC’s Form 8-K (File No. 1-6028) filed
with the SEC on April 18, 2006.*
10.41 Form of nonqualified LNC restricted stock award agreement is incorporated by reference to Exhibit 10.15 to LNC’s Form 8-
K (File No. 1-6028) filed with the SEC on April 7, 2006.*
10.42 Employment Agreement of Dennis R. Glass, dated December 6, 2003, is incorporated by reference to Exhibit 10(ii) of
Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 2003.*
10.43 Amendment No. 1 to Employment Agreement of Dennis R. Glass, dated March 23, 2005, is incorporated by reference to
Exhibit 10.1 of Jefferson-Pilot’s Form 10-Q (File No. 1-5955) for the quarter ended September 30, 2005.*
10.44 Amendment No. 2 to Employment Agreement of Dennis R. Glass, dated April 2, 2007, is incorporated by reference to
Exhibit 10.4 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended June 30, 2007.*
10.45 Amendment No. 3 to Employment Agreement of Dennis R. Glass, effective as of August 6, 2008, is incorporated by
reference to Exhibit 10.2 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended September 30, 2008.*
10.46
Jefferson Pilot Corporation Long Term Stock Incentive Plan, as amended in February 2005, is incorporated by reference to
Exhibit 10(iii) of Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 2004.*
10.47
Jefferson Pilot Corporation Non-Employee Directors’ Stock Option Plan, as amended in February 2005, is incorporated by
reference to Exhibit 10(iv) of Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 2004.*
10.48
Jefferson Pilot Corporation Non-Employee Directors’ Stock Option Plan, as last amended in 1999, is incorporated by
reference to Exhibit 10(vii) of Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 1998.*
10.49
Jefferson Pilot Corporation Executive Change in Control Severance Plan, is incorporated by reference to Exhibit 10(xi) of
Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 1998.*
10.50 1999 Amendment to the Jefferson Pilot Corporation Executive Change in Control Severance Plan, is incorporated by
reference to Exhibit 10(ix) of Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 1999.*
10.51 2005 Amendment to the Jefferson Pilot Corporation Executive Change in Control Severance Plan, is incorporated by
reference to Exhibit 10(vii) of Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 2005.*
10.52
Jefferson Pilot Corporation Separation Pay Plan, adopted February 12, 2006, is incorporated by reference to Exhibit 10(viii)
of Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 2005.*
10.53
Jefferson Pilot Corporation forms of stock option terms for non-employee directors are incorporated by reference to Exhibit
10(xi) of Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 2004 and to Exhibit 10.2 of
Jefferson-Pilot’s Form 8-K filed with the SEC on February 17, 2006.*
10.54
Jefferson Pilot Corporation forms of stock option terms for officers are incorporated by reference to Exhibit 10(xi) of
Jefferson-Pilot’s Form 10-K (File No. 1-5955) for the year ended December 31, 2004 and to Exhibit 10.1 of Jefferson-Pilot’s
Form 8-K filed with the SEC on February 17, 2006.*
10.55
Jefferson-Pilot Deferred Fee Plan for Non-Employee Directors, as amended and restated November 5, 2008 is filed
herewith.*
10.56 Lease and Agreement dated August 1, 1984, with respect to LNL’s offices located at Clinton Street and Harrison Street, Fort
Wayne, Indiana is incorporated by reference to Exhibit 10(n) to LNC’s Form 10-K (File No. 1-6028) for the year ended
December 31, 1995.
10.57 First Amendment of Lease, dated as of June 16, 2006, between Trona Cogeneration Corporation and The Lincoln National
Life Insurance Company, is incorporated by reference to Exhibit 10.22 to LNC’s Form 10-Q (File No. 1-6028) for the
quarter ended June 30, 2006.
E-5
10.58 Agreement of Lease dated February 17, 1998, with respect to LNL’s offices located at 350 Church Street, Hartford,
Connecticut is incorporated by reference to Exhibit 10(q) to LNC’s Form 10-K (File No. 1-6028) for the year ended
December 31, 1997.
10.59 Lease and Agreement dated December 10, 1999 with respect to Delaware Management Holdings, Inc., offices located at One
Commerce Square, Philadelphia, Pennsylvania is incorporated by reference to Exhibit 10(r) to LNC’s Form 10-K (File No. 1-
6028) for the year ended December 31, 1999.
10.60 First Amendment to Lease dated December 10, 1999 with respect to Delaware Management Holdings, Inc. for property
located at Commerce Square, Philadelphia, Pennsylvania is incorporated by reference to Exhibit 10(e) to LNC’s Form 10-Q
(File No. 1-6028) for the quarter ended June 30, 2005.
10.61 Sublease and Agreement dated December 10, 1999 between Delaware Management Holdings, Inc. and New York Central
Lines LLC for property located at Two Commerce Square, Philadelphia, Pennsylvania is incorporated by reference to Exhibit
10(s) to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 1999.
10.62 Consent to Sublease dated December 10, 1999 with respect to Delaware Management Holdings, Inc. for property located at
Two Commerce Square and Philadelphia Plaza Phase II, Philadelphia, Pennsylvania is incorporated by reference to Exhibit
10(t) to LNC’s Form 10-K (File No. 1-6028) for the year ended December 31, 1999.
10.63 Stock and Asset Purchase Agreement by and among LNC, The Lincoln National Life Insurance Company, Lincoln National
Reinsurance Company (Barbados) Limited and Swiss Re Life & Health America Inc. dated July 27, 2001 is incorporated by
reference to Exhibit 99.1 to LNC’s Form 8-K (File No. 1-6028) filed with the Commission on August 1, 2001.***
10.64 Fifth Amended and Restated Credit Agreement, dated as of March 10, 2006, among LNC, as an Account Party and
Guarantor, the Subsidiary Account Parties, as additional Account Parties, JPMorgan Chase Bank, N.A. as administrative
agent, J.P. Morgan Securities Inc. and Wachovia Capital Markets LLC, as joint lead arrangers and joint bookrunners,
Wachovia Bank, National Association, as syndication agent, Citibank, N.A., HSBC Bank USA, N.A. and The Bank of New
York, as documentation agents, and the other lenders named therein is incorporated by reference to Exhibit 10.1 to LNC’s
Form 8-K (File No. 1-6028) filed with the SEC on March 15, 2006.
10.65 Credit Agreement, dated as of February 8, 2006, among LNC, JPMorgan Chase Bank, N.A. as administrative agent, J.P.
Morgan Securities Inc. and Banc of America Securities LLC, as joint lead arrangers and joint bookrunners, Bank of America
N.A., as syndication agent, and the other lenders named therein is incorporated by reference to Exhibit 10.1 to LNC’s Form
8-K (File No. 1-6028) filed with the SEC on February 13, 2006.
10.66 Master Confirmation Agreement and related Supplemental Confirmation, dated March 14, 2007, and Trade Notification,
dated March 16, 2007, relating to LNC’s Accelerated Stock Repurchase with Citibank, N.A. is incorporated by reference to
Exhibit 10.2 to LNC’s Form 10-Q (File No. 1-6028) for the quarter ended March 31, 2007.**
10.67
Indemnity Reinsurance Agreement, dated as of January 1, 1998, between Connecticut General Life Insurance Company and
Lincoln Life & Annuity Company of New York is filed herewith.***
10.68 Coinsurance Agreement, dated as of October 1, 1998, AETNA Life Insurance and Annuity Company and Lincoln Life &
Annuity Company of New York is filed herewith.***
12 Historical Ratio of Earnings to Fixed Charges.
21
Subsidiaries List.
23
Consent of Independent Registered Public Accounting Firm.
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
E-6
* This exhibit is a management contract or compensatory plan or arrangement.
** 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.
*** Schedules to the agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. LNC will furnish supplementally a
copy of the schedule to the SEC, upon request.
We will furnish to the SEC, upon request, a copy of any of our long-term debt agreements not otherwise filed with the
SEC.
NOTE: This is an abbreviated version of the Lincoln National Corporation 10-K. Copies of these exhibits are available
electronically at www.sec.gov or www.lincolnfinancial.com, or by writing to the Corporate Secretary at Lincoln National
Corporation, 150 N. Radnor Chester Road, Suite A305, Radnor, PA 19087.
E-7
LINCOLN NATIONAL CORPORATION AND SUBSIDIARIES
HISTORICAL RATIO OF EARNINGS TO FIXED CHARGES
(dollars in millions)
2008
For the Years Ended December 31,
2007
2005
2006
2004
Exhibit 12
Income (loss) from continuing operations
before taxes
Sub-total of fixed charges
Sub-total of adjusted income
Interest on annuities and financial products
Adjusted income base
Fixed Charges
Interest and debt expense (1)
Interest expense related to uncertain tax positions
Portion of rent expense representing interest
Sub-total of fixed charges excluding interest
on annuities and financial products
Interest on annuities and financial products
Total fixed charges
Ratio of sub-total of adjusted income to
sub-total of fixed charges excluding interest on
annuities and financial products
Ratio of adjusted income base to
total fixed charges
$
$
$
$
$
(25)
303
278
2,532
2,810
1,874
325
2,199
2,519
4,718
1,778
242
2,020
2,260
4,280
1,075
110
1,185
1,570
2,755
1,036
116
1,152
1,571
2,723
$
$
$
$
$
$
281
2
20
303
2,532
2,835
$
$
284
21
20
325
2,519
2,844
$
$
223
-
19
242
2,260
2,502
$
$
89
-
21
110
1,570
1,680
$
$
94
-
22
116
1,571
1,687
$
0.92
0.99
6.77
1.66
8.35
1.71
10.77
1.64
9.93
1.61
(1) Interest and debt expense excludes $5 million related to the early retirement of debt in 2006.
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the following registration statements of Lincoln National Corporation and in the
related prospectuses listed below:
Exhibit 23
1. Forms S-3
a. Nos. 333-132416, 333-132416-01, 333-132416-02, and 333-132416-03 pertaining to the Lincoln National
Corporation automatic shelf registration for certain securities,
b. No. 333-133086 pertaining to the Jefferson-Pilot Corporation Long Term Stock Incentive Plan,
c. No. 333-131943 pertaining to The Lincoln National Life Insurance Company Agents’ Savings and Profit-Sharing
Plan,
d. Nos. 333-142871 and 333-124976 pertaining to the Lincoln National Corporation Amended and Restated
Incentive Compensation Plan,
e. Nos. 333-84728, 333-84728-01, 333-84728-02, 333-84728-03 and 333-84728-04 pertaining to the Lincoln
National Corporation shelf registration for certain securities,
f. No. 333-32667 pertaining to the Lincoln National Corporation 1997 Incentive Compensation Plan, and
g. Nos. 333-146213 and 33-51415 pertaining to the Lincoln National Corporation Executive Deferred
Compensation Plan for Agents;
2. Form S-4 (No. 333-130226) pertaining to the proposed business combination with Jefferson-Pilot Corporation;
3. Forms S-8
a. No. 333-155385 pertaining to the Lincoln National Corporation Deferred Compensation and
Supplemental/Excess Retirement Plan,
b. No. 333-148289 pertaining to the Delaware Management Holdings, Inc. Employees’ Savings and 401(k) Plan,
c. No. 333-142872 pertaining to the Lincoln National Corporation Stock Option Plan for Non-Employee
Directors,
d. No. 333-133039 pertaining to various Jefferson-Pilot Corporation benefit plans,
e. Nos. 333-143796 and 333-126452 pertaining to the Lincoln National Corporation Executive Deferred
Compensation Plan for Employees,
f. No. 333-126020 pertaining to the Lincoln National Corporation Employees’ Savings and Profit-Sharing Plan,
g. Nos. 333-143795 and 333-121069 pertaining to the Lincoln National Corporation Deferred Compensation Plan
for Non-Employee Directors,
h. No. 033-58113 pertaining to the Lincoln National Corporation 1993 Stock Plan for Non-Employee Directors,
i. No. 333-105344 pertaining to the Lincoln National Corporation 1993 Stock Plan for Non-Employee Directors;
of our reports dated February 25, 2009, with respect to the consolidated financial statements and financial statement schedules of
Lincoln National Corporation and the effectiveness of internal control over financial reporting of Lincoln National Corporation,
included in this Annual Report (Form 10-K) for the year ended December 31, 2008.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
February 25, 2009
Exhibit 31.1
Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
I, Dennis R. Glass, President and Chief Executive Officer, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Lincoln National Corporation;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is
being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by
this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;
and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons
performing the equivalent functions):
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report
financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Dated: February 27, 2009
/s/ Dennis R. Glass
Dennis R. Glass
President and Chief Executive Officer
Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 31.2
I, Frederick J. Crawford, Executive Vice President and Chief Financial Officer, certify that:
1.
2.
3.
4.
I have reviewed this annual report on Form 10-K of Lincoln National Corporation;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods
presented in this report;
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is
being prepared;
b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by
this report based on such evaluation; and
d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting;
and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons
performing the equivalent functions):
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report
financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Dated: February 27, 2009
/s/ Frederick J. Crawford
Frederick J. Crawford
Executive Vice President and Chief Financial Officer
Certification Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant to Section 906
Of the Sarbanes-Oxley Act of 2002
Exhibit 32.1
Pursuant to 18 U.S.C. § 1350, the undersigned officer of Lincoln National Corporation (the “Company”), hereby certifies that the
Company’s Annual Report on Form 10-K for the year ended December 31, 2008 (the “Report”) fully complies with the
requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in
the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: February 27, 2009
/s/ Dennis R. Glass_____________ __
Name: Dennis R. Glass
Title: President and Chief Executive Officer
The foregoing certification is being furnished solely pursuant to 18 U.S.C. § 1350 and is not being filed as part of the Report or as a
separate disclosure document.
A signed original of this written statement required under Section 906 has been provided to the Company and will be retained by
the Company and furnished to the Securities and Exchange Commission or its staff upon request.
Certification Pursuant to 18 U.S.C. Section 1350,
As Adopted Pursuant to Section 906
Of the Sarbanes-Oxley Act of 2002
Exhibit 32.2
Pursuant to 18 U.S.C. § 1350, the undersigned officer of Lincoln National Corporation (the “Company”), hereby certifies that the
Company’s Annual Report on Form 10-K for the year ended December 31, 2008 (the “Report”) fully complies with the
requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and that the information contained in
the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: February 27, 2009
/s/ Frederick J. Crawford
Name: Frederick J. Crawford
Title: Executive Vice President and Chief Financial Officer
The foregoing certification is being furnished solely pursuant to 18 U.S.C. § 1350 and is not being filed as part of the Report or as a
separate disclosure document.
A signed original of this written statement required under Section 906 has been provided to the Company and will be retained by
the Company and furnished to the Securities and Exchange Commission or its staff upon request.
Comparison of Five-Year Cumulative Total Return
The following represents a five-year comparison of the annual performance of our cumulative total shareholder return (change in
the year-end stock price plus reinvested dividends), based on a hypothetical investment of $100 (invested on December 31, 2003,
with dividends reinvested through December 31, 2008), with the Standard & Poor’s (“S&P”) 500 Index and the S&P Life/Health
Index. Returns of the S&P Life/Health Index have been weighted according to their respective aggregate market capitalization at
the beginning of each period shown on the graph.
Comparison of Five-Year Cumulative Total Return
250.00
200.00
150.00
100.00
50.00
-
2003
2004
2005
2006
2007
2008
Lincoln National Corporation
S&P Life/Health Index
S&P 500 Index
$
2003
100.00
100.00
100.00
$
2004
119.21
122.14
110.88
Lincoln National Corporation
S&P Life/Health Index
S&P 500 Index
$
As of December 31,
2005
2006
179.68
139.80
174.28
149.59
134.66
116.31
$
$
2007
161.41
193.42
142.05
2008
$
54.79
99.84
89.51
There can be no assurance that our stock performance will continue in the future with the same or similar trends depicted in the
preceding graph. We will not make or endorse any predictions as to future stock performance. Pursuant to Securities and
Exchange Commission (“SEC”) rules, the Comparison of Five-Year Cumulative Total Return graph shall not be considered
“soliciting material” or to be “filed” with the SEC, except to the extent we specifically request that such information be treated as
soliciting material or specifically incorporates such information by reference into a document filed with the SEC under the
Securities Exchange Act of 1934, as amended, or under the Securities Act of 1933, as amended.
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Board of Directors
William J. Avery
Retired Chairman and CEO
Crown Cork & Seal
J. Patrick Barrett
Chairman and CEO
CARPAT Investments
William H. Cunningham
Professor of Marketing
The University of Texas at Austin
Dennis R. Glass
President & CEO
Lincoln National Corporation
George W. Henderson, III
Retired Chairman and CEO
Burlington Industries, Inc.
Eric G. Johnson
President and CEO
Baldwin Richardson Foods Company
M. Leanne Lachman
President
Lachman Associates LLC
Michael F. Mee
Retired EVP and CFO
Bristol-Myers Squibb Company
William Porter Payne
Partner
Gleacher Partners LLC
Patrick S. Pittard
Distinguished Executive in Residence
Terry Business School, University of Georgia
David A. Stonecipher
Retired Chairman and CEO
Jefferson-Pilot Corporation
Isaiah Tidwell
Retired EVP and Georgia Wealth Management Director
Wachovia Corporation
Corporate Headquarters
Lincoln National Corporation
150 N. Radnor Chester Road
Radnor, PA 19087-5238
Internet Information
Information on LNC’s financial results and its products and services as well as SEC filings are available on the Internet at
www.lincolnfinancial.com.
Stock Listings
LNC’s common stock is traded on the New York and Chicago stock exchanges under the symbol LNC.
Inquiries
Analysts and institutional investors should contact:
James P. Sjoreen
Vice President – Investor Relations
Lincoln National Corporation
150 N. Radnor Chester Road, Suite A305
Radnor, PA 19087
E-mail: investorrelations@LFG.com
Annual Meeting of Shareholders
The annual meeting of shareholders will be held at The Ritz-Carlton Hotel., 10 Avenue of the Arts, Philadelphia, PA 19102 at
9 a.m. (local time) on Thursday, May 14, 2009.
Shareholder Services
General inquiries or concerns about LNC shareholder services may be directed to shareholder services at 1-800-237-2920 or by
email at shareholderservices@LFG.com. Questions that are specific in nature, such as transfer of stock, change of address or
general inquiries regarding stock or dividend matters, should be directed to the transfer agent and registrar.
Transfer Agent and Registrar
For regular mailings use:
BNY Mellon Shareholder Services
P.O. Box 358015
Pittsburgh, PA 15252-8015
1-866-541-9693
website: www.bnymellon.com
For registered or overnight mailings use:
BNY Mellon Shareholder Services
480 Washington Blvd.
Jersey City, NJ 07310-1900
Dividend Reinvestment Program/Direct Stock Purchase Plan
LNC has a Dividend Reinvestment and Cash Investment Plan. For further information, write to BNY Mellon Shareholder
Services at the addresses noted above.
Direct Deposit of Dividends
Quarterly dividends can be electronically deposited to shareholders’ checking or savings accounts on the dividend payment date.
Telephone inquiries may be directed to BNY Mellon Shareholder Services at 1-866-541-9693.
Dividend Payment Schedule
Dividends on LNC common stock are paid February 1, May 1, August 1 and November 1.
New York Stock Exchange (“NYSE”) Certification
The 2008 NYSE Annual CEO certification, regarding our compliance with the NYSE’s Corporate Governance listing standards,
was filed with the NYSE in May 2008. The most recent certifications by our Chief Executive Officer and Chief Financial Officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 are filed as exhibits to our 10-K.
Lincoln Financial Group is a registered service mark of LNC.
Lincoln National Corporation
2008 Annual Report to Shareholders
Lincoln National Corporation
150 N. Radnor Chester Road
Radnor, PA 19 80 7-5238
www.lincolnfi nancial.com
Lincoln Financial Group is the marketing name for
Lincoln National Corporation and its affi liates.
AR-LNC08